Law in Business Associations: Duty of Care and Negligence - Case Study Example

Business Associations Law Xxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxx Name Xxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxx Course Xxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxx Instructor Xxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxx Date Issue Smith is the Chief executive of Retailer Ltd and still owns 10% of the issued shares of Myco Pty Ltd which is a private company run by his wife and brother in law. The Board of Retailer is considering tenders by Australian companies for lucrative contract to supply Retailer with the clothing. They had shortlisted three competitive companies and Myco was in this threshold. Smith who is the CEO in Retailer and also owns some shares from Myco remains present when board discusses different tenders but does not vote for he leaves before they vote. He does not state to the board the details of his shareholding in Myco Pty Ltd; however, some directors from Retailer are aware of the fact that, Smith is a shareholder in the other company. Jones, advocates for the selection of Myco, stating that, it is the company they know and therefore best suits for the contract and he was well aware that the company had been struggling financially in recent times and therefore this contract will be a good platform for their revival. They all agreed fro they knew Smith as a respected business man and therefore Myco would supply the clothing without disruptions and at reasonable price, and they therefore assign the contract to Myco, a three year contract to supply Retailer. The issue is whether Smith, Jones and other directors acted at per their legal threshold, as those entrusted to running the affairs of Retailers and what could have been done to ensure that every legal aspect governing the company is followed in this case. Facts According to the Company Act, the directors must act in good faith and for the best interest of the company and for proper purposes. This being the case, all the directors were supposed to make their judgement basing the whole issue from what is of good benefit of Retailer as a company, not from articulating certain aspects of Smith who runs Retailer and also owns some shares from the other company. The duty of directorship requires them to be honest and therefore they are obliged to exercise independent judgement in light of relevant facts, materials and other views when working towards the best interest of the company1. This did not happen in the scenario. Smith could only be present in the companies’ discussions but did not at any time vote in the board. Additionally, Jones knew the situation that was faced by Myco, this company was struggling financially. However, he went ahead and advocated for their assignment of the contract. This means that in accordance to his duty which dictates that, a director should never breach duty that involves fraud, dishonesty and even recklessness was despaired. In the same case, a director must never make improper use of his position to gain advantage for themselves or any other person or to cause detriment to the company. This was not the case, Jones, acted in the favour of Smith and Smith also refused to vote. This was an improper use of their position because all this actions were directed towards the benefit of self and not that of the company. It was a breach of duty2. All directors are supposed to disclose all material or personal interests that they may have in relation to the affairs of the company, according to Section 191(1)3. Smith never disclosed that one of the shortlisted companies was linked to him. And even after quite a number of directors being aware of such an interest, they never notified the board of such an existence of a conflict. This is the reason why Smith kept on absconding voting session for there were conflicts of interest. Further more, even those directors or rather board member who were present in the whole discussion and were fully aware of what was happening did not disclose it4. They all acted against the law that governs their position as directors. As directors, they are owe the duties to third parties, and therefore they have a duty to prevent the company from trading while insolvent and also prevent the same company from trading in a way that will make it insolvent5. Trading with a company that was financially struggling was a risk which the director had to bare, in case the contract was not honoured. This is attributed to the fact that, Jones was aware of the situation but only acted in the favour of Smith, who was also aware, and in so doing they were liable of any occurrence. When assigning contracts, the good of the company should be given first priority. Fair play should be given to all companies which are competitive enough to tender. The board should never act in favour of any shortlisted company but should always follow the merits and fairly assign the tender. This did not happen in this case, all the competitive companies were not given a chance just because there was another company, linked to one of the board members. This was totally unfair. Discussion As expressed by Aberdeen railway Company v Blaikie Bros (1985) 1 Macq 461 at 471-1 by Lord Cranworth LC6. Smith, Jones and other directors did not fully discharge their legal duties to Retailer. This is attributed to the fact that, the contracted a company not because of any merits but because it was connected to their CEO, Smith. It is clear from the above mention case that, no one, having fiduciary duty to discharge, shall be allowed to enter into engagements in which he has, or can even have, a personal interest conflicting, or can conflict, with the interest of those whom he is bound to protect. Regardless of the powers given to them, they must use them for proper purposes. This can be traced from a case of Mills v Mills (1938) 60 CLR 1507, which clearly indicate that, fiduciary agents of any company must exercise their powers only for the benefits of the company8. In this case, the directors acted against the powers assigned to them to secure some private advantages for Smith and this is an improper purpose because it is outside of the purpose of benefiting the company. Above all there were other companies who much could have been considered in the assignment of this contract. Favouring Smith, because he has some interest in Myco was a breach of duty and a use of power in an improper manner. In sections 182 and 183, an officer must not improperly use their position (s 182)9 or information (s 183)10 obtained because of their position in order to gain benefits for themselves or someone else. This did not happen, or was not obeyed in this case, Jones and other directors acted on the favour of Smith. This contract was assigned just because Smith has some interest in Myco where he owns 10% of the issued shares. They therefore did not do it in the favour of those they are obliged to protecting, but they did so to the advantage of someone else, who is their CEO, Smith, and not Retailer who is their employer. The corporation act extends duties to cover directors, officers and even employees. This therefore means that, their actions can result to liability under s 184 (2). According to section 195 (1), since smith had some interest on the matter being discusses, it was his legal duty not to vote. This therefore means that, for him not to vote, it was the best option. Additionally, under the same section, it is clear that, a director who has material or personal interest in a matter that is being discussed at a meeting must not vote on any resolution in respect to the matter and must not be present whilst the matter is being considered by the meeting. Thus Smith did the right thing to be out of the meeting when the decision was being made and not voting at all in any resolution. The directors should have complied with sections 182 and 183 which govern their duties to the company whereby they would have assigned the contract on other merits other than that it was linked to Smith. There were supposed to reinforce their duty in order to avoid conflicts of interest, and therefore. The good of the company should have been the driving force not otherwise. The Corporation Act clarifies and codifies the existing judge made legal duties that are supposed to be made by directors. This means that, all directors owe the company equitable duties of loyal and good faith. As it is well clarified by Donoghue v Stevenson [1932] AC 56211, directors must exercise due care, skills and diligence in the performance of their duties. They must therefore avoid negligence resulting in reasonably foreseeable harm. This was not followed in this matter as Jones and other directors went ahead with assigning the contract to a company whose performance was wanting. This is exonerated in section 181, whereby they are supposed to act in good faith for proper purpose. All fiduciaries who in this case happen to be the directors are obliged to be honest for they owe their duties to the company as a whole, starting from the shareholders and the employees. This in other words means that, fiduciary duty to act in the company’s best interest is an obligation to act in good faith for the benefit of all shareholders generally12. They would have followed all the companies’ legislation in assigning the contract. Additionally, the situation of the company should have been considered for it is the one that will determine whether the company will benefit from any transaction or not. Under section 191 of the Act13, Smith was supposed to disclose any personal interest that is related to the affairs of the company. He was supposed to state that, he was a shareholder in the company that was under discussion to be given the contract14. A director should disclose any personal interest that he has to the board at the first board meeting. Which he violated and waited until the company was shortlisted. Any decision made by the directors or rather any judgement rule applies to the duty of care and diligence under section 180 (1) of the Act15. This therefore means that, the decision to assign the contract to Myco should have been diligent which not the case was. They would have followed all the required procedures and just in case the Myco was found wanting, like the case of their financial performance, then they were supposed to rule it out and go for another more stable competitor. Additionally, they would have given all companies which have tendered all equal opportunities. They failed the test of diligence and giving a tender to a company that performance is wanting, just because they know it or because they are familiar with one of the share holders was unethical and wanting. The Australian law recognizes the rights of shareholders to undertake derivative action on behalf of the company where appropriate16. As for this case, the contract between Retailer and Myco has cost Retailer $10 million over the term of the three years contract. This would have been cheaper if they contracted another company. The shareholder has a right to question the directors of the criteria used to assign this tender. In this case, the directors acted in abuse of their powers by knowingly or recklessly acting contrary to the general rule and this caused the loss17. This act by directors’ fiduciary duty could result to a derivative action. This being the case, the individual shareholder is supposed to seek to bring the action the company has vested in it against the directors for the damage they have caused in the company for breach of the fiduciary duty18. In this case, Retailer is the proper party, and therefore the judgement should be in the favour of the company as well stated in the Australian Agricultural Co v Oatmont Pty Ltd (1992) 8 ACSR 255 at 26619 , case. Jenkins v Enterprise Gold Mines NL (1992) 6 ACSR 539, the shareholder need to point the actual irregularity or even the lack of probity or want good faith towards him on the part of those given the mandate to control the company who in this case happens to be the directors20. Section 260 gives the shareholder a right to seek relief where the affairs of the company are being conducted in a manner this is contrary to the interest of the members as a whole. Is s 260 (2)(g)21, a company, can prosecute, defend or discontinue specified proceedings, or even authorise a member or members of the company to prosecute, defend or discontinue the specified proceeding in the name and on behalf of the company.Additionally, under section 1324, the shareholders through the company law may seek an injunction or damages because their interests have been affected by action of those in control of the company. Conclusion The duty of care and negligence is used in many instances when director’s conduct is scrutinized, as it is the case of Retailer Pty Ltd. Directors are held to high standards by the law and are therefore expected to display a lever of acre and diligence in their positions which is in this case Retailer. This being the case, they cannot be forgiven even if they lacked knowledge or facts about the financial state or even particular course of action for they are expected to have a high level of skills and knowledge peculiar to the company they are running and the position they hold in the company. Directors owe a civil duty to their company to make decisions that are for the best interest of the company and do no harm to the business. This was violated in this case and therefore, these directors are liable of their actions which cost the company $10 million. In this case, they went against the power invested in them by giving a contract to a company which was not performing well in its finances as well as because they knew of its shareholders. However, Smith went in accordance to the law when he did not vote or even sit in the meeting when the decision was being made. Conclusively, all directors acted against the law and therefore they are liable of ever consequence which befell the company. If the shareholders decide to prosecute them, then they are liable of the losses incurred by the company for they made the decision to give Myco the contract and not other companies who in this case, they seem to have quoted much less than Myco by $10 million. Works Cited Austin, R.P., Ford, H.A.J. and Ramsay, I.M. 2005 Company Directors: Principles of Law and Corporate Governance, LexisNexis Butterworths, Chatswood, NSW. Baxt, Fletcher and Fridman,. 2009. Corporations & Associations: Cases & Materials (10th ed),. LexisNexis : Butterworths,. Elizabeth Boros and John Duns. 2007. Corporate Law, . Oxford: Oxford University Press, . Standen, M. 2003. The ASX Corporate Governance Council’s Principles of Good Corporate Governance and Best Practice Recommendations. Keeping Good Companies, 55(4) , 222-225. Uhrig, J. 2003. Review of the Corporate Governance of Statutory Authorities and Office Holders. Canberra.: Australian Government. W, H. 2007. ‘The Director’s “fiduciary duty” of Care and Skill:A misnomer’ . 25 Company and Securities Law Journal . , 370. Read More