Corporations Law in Australia - Case Study Example

Retailer limited Name: University: Course: Tutor: Date: RETAILOR LIMITED Introduction The directors of a company have several duties to the company. First, they must ensure that they make decisions in the best interest of the company. They should also be diligent and always act in good faith. This requires the directors to avoid conflicts of interest with the company and disclose circumstances that may lead to such conflicts. Honesty and integrity is also important since shareholders trusts the directors with the day-to-day running of the organization and dishonesty would breach such trust. The directors have a duty to inform the shareholders on related party transactions to aid them while making financial decisions. Disclosures especially where transactions are not at arm’s length should be disclosed (Vickery, 2012). Such disclosures are an example of avoiding conflict of interest and acting in the best interest of the company shareholders. This is because these disclosures assist the shareholders to make informed decisions when considering a change in their level of investment. It also promotes a transparent free and fair market. The Corporation Act of 2001 addresses the issue of related party transactions and the directors of Retailer Ltd should ensure they conform to it. It is important therefore for directors to make sure they follow these regulations. There are legal consequences of breaching these provisions and a director may be found guilty in a court of law on various grounds. A director for instance may be fined or imprisoned for up to five years if found to be guilty of a criminal offence. Damages can also be sought from a director if he is found to have infringed a provision of the civil law. A director may also be banned if found acting as such. In some cases, courts may rule that directors compensate the company any losses it has incurred. These legal provisions act as a deterrent so that directors do not negate the need to act in the best interests of the company. ii CASE SCENARIO DISCUSSION A Executive Director-Smith Retailer Ltd awarded a three year supply contract to Myco Ltd, a company in which Smith has material personal interest. Myco Ltd is a related party because Smith holds a substantial shareholding and has family members in the company’s board. This puts Smith’s interest in conflict with the interest of the company. Smith would be keen to ensure that a transaction entered into between Retailer Ltd and Myco Ltd benefits the later. This is clear because his family members and he stands to benefit. His shareholding is material and it is apparent that this may impair his independence. He therefore should not have voted or attended meetings discussing the transactions with Myco Ltd. However, Smith did not participate in the final vote and this was a good decision considering the impairment of his independence. It would have been in the best interest of the company that Smith discloses his shareholding to the directors for review. It is however not enough to just disclose an interest and withdraw from voting. In the case Fitzsimmons v R. a director was held to have breached his duty to act in good faith for failing to disclose what he knew about the true financial position of another company by reason of being the director of the other company (Cassidy, 2006). Smith must have been aware of the financial condition of Myco and should have disclosed this to retailer limited to avoid detrimental effects. Distancing himself or arguing that he’s protecting the confidentiality of Myco is unacceptable. Failure to disclose may lead to a criminal proceeding being started against him. It seems that by being present in the discussions and not formally declaring his interest in Myco Ltd, Smith wanted Myco limited to gain undue advantage. Smith has a duty to act fairly and in the best interest of the company and should therefore have considered formal disclosure. Under common law Smith, a director, has a fiducially duty not to benefit from a position of trust or put himself in a position that gives rise to conflict of interest. It is possible that other non-interested directors can vote to allow a director in such situation to attend or even vote on the matter subject to compliance with company law 2001. Smith should have sought this approval before attending the meeting discussing the tenders. It is manifest that Smith has breached his duties under the company Act and has put himself in a position giving rise to conflict of interest. According to Chan v Zacharia (1984) 154 CLR 178, 199: ‘a person who is under fiduciary obligation must account to the person whom the obligation is owned for any benefit or gain,(1) which has been obtained or received in circumstances where a conflict or a significant possibility of a conflict existed between his fiduciary duty and his personal interest in the pursuit or possible receipt of such a benefit or gain or (2) which was obtained by use or reason of his fiduciary position or knowledge resulting from it’ (Warne, 2007). So, by Myco limited winning the tender it can be argued that Smith benefited from his fiduciary position. The directors decided to award the tender on the grounds that they know Smith well. The fact that Smith gained financially primarily as a result of his position as a company officer should have been disclosed to shareholders. B Jones Jones is a director of Retailor Ltd, this position of trust creates a fiducially duty to the company. It should be noted that the close and long term relationship between him and Smith may impair his independence when making decisions. Jones should act in the best interest of Retailer Company; however he may be motivated to make a decision that suits Myco at the expense of Retailor. Being aware that Myco had been experiencing financial difficulties, Jones should have brought this topic up at the directors meeting. This would have been in the interest of the company so that it does not enter into a contract with a supplier who is unreliable both in the short term and in the long term. By withholding information on Myco’s financial distress Jones led the directors to make an uninformed decision. This means that lack of the financial information had led the directors of Retailer to enter into a contract that is not ideal for the company. Jones may be seen as acting as an advocate of his fellow director Smith whom he has known for many years. The fact that he actually recommended Myco to be awarded the tender knowing its financial condition and knowing that Smith is a shareholder may exemplify this point. It would have been in the best interest of the company for Jones to disclose all information he had about Myco and ensure that the provisions of company law are followed. Jones seems to have flouted his duties to act in good faith, honestly and in the best interest of the company. C The Other Directors The other directors have fiducially duties as well as they are held in a position of trust by the shareholders. They should have ensured that the tender is awarded to a supplier who benefits the company most. It may be argued that the other directors were not aware of the extent of Smith’s shareholding or the financial condition of Myco ltd. However the directors have a duty under company law 2001 to exercise care and diligence. This would have ensured that the directors did a thorough job in carrying out a background research on Myco to help in unearthing its financial condition and key shareholders. The other directors were aware that Smith had a shareholding in Myco but did not look into this matter before going on with their search for a supplier. This shows that the directors breached their duty to act with care and diligence. Had the directors known the extent of the conflict of interest existing, they should have taken steps to ensure compliance with the Company Act. The Act states that a director with material personal interests in a matter may not vote on the matter or attend meetings where the matter is being considered, unless approved by non-interested directors (Tomasic et al., 2002). The non-interested directors could have considered whether to allow Smith to attend meetings in which the issue of the tender was being discussed. The directors did not formally decide on this and let smith to attend the meetings despite them knowing his conflicts of interest. The directors should have decided on the issue of the tender objectively and in the best interest of the company without favoring Myco Pty Ltd because of its relationship with Smith. The directors should have ensured that Smith does not attend their meetings where they discussed the tender so that he does not influence their decisions. This is consistent with the duties of a director as laid out in 2D of the Corporations Act of 2001 Section 128(1). iii RELEVANT LEGAL GUIDANCE Corporations Act 2001 (Cth), Section 180(1) states: ‘a director has a duty of care and diligence. The directors should exercise their powers with care and diligence that a reasonable person would exercise if they (a) were a director of the company in the circumstances and (b) occupied the office held by, and had the same responsibilities within the corporation as the director or officer’ (Comlaw.gov, 2012). Company officers have to inform themselves about the subject matter of judgment to the extent they believe to be appropriate. Complying with the provisions of this section would have required the directors to have been more diligent and inquisitive when discussing Myco pty ltd. The directors would therefore have reviewed the nature and risk of the related party transaction and also obtain financial information on Myco Pty Ltd. Smith attendance in meetings where matters he is an interested party are discussed, contravenes Corporations Act 2001 (Cth), section 195 (Tomasic et al., 2002). This section state that if a director of a public company has material personal interest in the maters being discussed in a directors meetings they should not (1) be present when the matter is being discussed (2) vote on that matter (Tomasic et al., 2002). It should be noted that the term meeting should be extended to cover other ways through which directors may pass resolutions. The director’s retailer should have acted diligently to enable them to establish that Smith is a materially interested party. With such information they would have complied with this section and ensure that Smith does not attend meetings where matters relating to the tender were discussed. The Corporations Act 2001 (Cth), section 208, provides protection to members of a public company by requiring approval of members for giving financial benefits that could endanger the members’ interests (Tomasic et al., 2002). However, there may be some exemptions to this rule where the transactions are at an arm’s length in line with section 210. Arm’s length transactions are not defined by the corporation act but may suggest terms that each party is acting on its own behalf and none owe a special duty to the other. It also suggests that the terms are not affected by relationships and are not influenced by the other party (Vickery and Flood, 2012). The directors of retailor should determine whether the terms offered by Myco are at arm’s length. This would aid in deciding on whether to seek approval of the company members before entering into a contract with Myco. If the directors determine that the transaction is at arm’s length, then they may decide that members’ approval is not required. The directors should note that members’ approval of a related party transaction does not absolve them of their fiduciary duty relating to the transaction. Before a claim can be made against the company the shareholder must prove that he holds some interests in the company. There are several ways through which one can prove to be a member in accordance with corporation act 2001 (chapter 231) which states that; a person is a member of a company if they are: ‘(a) are a member of a company during on its registration; or (b) agree to become a member of the company after its registration and the na me is entered on the register of members; or (c) become a member of the company under section 167 (membership arising from the conversion of a company from one limited by guarantee to one limited by shares) (Tomasic et al., 2002).’ However, it should be noted that no duty is owed to the particular shareholder in isolation. The directors owe a fiduciary duty to the company as a whole which is duty to act with fidelity, trust, honestly and in good faith in the interest of the company. Therefore, the member can only claim remedies as part of the company as a whole and not individually. The shareholder should therefore seek to bring the claims against the directors as part of the company but not against individuals. It is possible that the shareholders may apply to a court to bring action against directors who have benefited or assisted a director to benefit from their position of trust knowingly. In this case, Smith was an interested director who benefited from his position of trust by breaching the provisions of the Corporation Act. The company may prove that Smith gained financially or caused the company to incur losses by not informing the company about the financial situation of Myco Ltd. Similarly the other directors and Jones actions can be seen as aiding Smith to breach his duty to the company. This is because Jones was aware of the information about the financial conditions but did not inform the company as required by the corporation act 2001. He therefore also breached a duty to act in the best interest of the company. The directors as discussed earlier also did little due diligence research on Myco Ltd and thereby failed on their duty to the shareholders to act diligently. This provides basis on which the company can bring actions against the shareholders. iv REMEDIES There are several remedies that the shareholders of retailer as a whole may seek from the courts. The court may decide to award the following remedies against Smith and/or the other directors; (a) a constructive trust; (b) an account of profits; and(c) equitable compensation (Vickery and Flood, 2012). An account of profit may require Smith to give back to the company the funds that he has inappropriately obtained. This would involve giving back the gains that he obtained in Myco as a result of being awarded the tender. However, since Smith only has 10% of the share capital in Myco Ltd means the company may only be able to recover only a small percentage of the $10 million that they have lost. The company may consider that suing Smith personally is unwise because he might be unable to cover damages awarded by the court. In this case the company may choose to bring action to recover the funds given to Myco consistent with ruling made in the case of Latec Investments Ltd v Hotel Terrigal Pty Ltd (1965) 113 CLR 265 (Tomasic et al., 2002). This would involve a process called tracing. This is where the funds would be traced to Myco ltd or successive recipients of the funds and then claiming priority for repayment over other parties in accordance to general regulations. However, for tracing to work the company must prove that a fraud has occurred, the funds can be identified and a clear line of succession exists. It is also possible that the courts may award constructive trust. In this case the company may get entitled to a share of returns from the investments funds that were fraudulently obtained by Myco limited. In this case the shareholders of retailer may seek to obtain returns from any investments that Myco with funds acquired as a result of winning the tender. However, it is the court that would decide whether retailer would be compensated as an equitable investor or equitable creditor. v Conclusion It is possible that the directors could sue all directors rather than sue only Smith alone. This would have been a better option since they can recover more money if the directors were told to bear personal responsibility and indemnify the company. In some circumstances the company may apply for the nullification of the contracts already entered into. It is rare that the courts may declare contracts null and void where the other party (Myco) was unaware of the breach. It should be noted that the shareholder can only bring action as part of the company. From the options discussed above it seems that suing all the directors would be the best course of action. References Cassidy, J. 2006. Concise corporations law. Annandale: Federation Press. Comlaw.gov. 2012. Corporations Act 2001.Online] (Updated 2012) Available at: http://www.comlaw.gov.au/Details/C2012C00634/Html/Volume_1#_Toc333925387 [Accessed On 20 September 2012] Tomasic, R., Bottomley, S., &Mcqueen, R. 2002. Corporations law in Australia. Sydney: Federation Press. Vickery, R. & Flood, M. 2012. Australian business law: compliance and practice. Frenchs Forest, N.S.W: Pearson Australia. Warne, S. 2007 The latest on fiduciary relationships. [Online] (Updated 2010) Available at: http://lawyerslawyer.net/2007/07/16/the-latest-on-fiduciary-relationships/ [Accessed On 20 September 2012] Read More