2Key Corporate Collapses/Scandals and Legal Issues

Corporations Law

Exam notes

Contents

1Key cases – generally

2KEY CORPORATE COLLAPSES/SCANDALS AND LEGAL ISSUES

(i)Australian Wheat Board

(ii)Enron Corp

(iii)HIH Insurance

(iv)James Hardie Industries

(v)Sanlu Dairy Group

(vi)Storm Financial

3Key legal doctrines and issues

(vii)Corporate form v non-corporate forms

(viii)Separate legal entity doctrine

(ix)Subsidiary companies

(x)Statutory contract

(xi)Constitution

(xii)Pre-registration dealings

(xiii)Dealing with outsiders

(xiv)Membership

(xv)Members remedies

(xvi)Meetings

(xvii)Corporate governance

(xviii)Directors & officers

(xix)Share capital

(xx)Share capital maintenance doctrine

(xxi)Loan capital

(xxii)Dividends – L9

(xxiii)Fundraising

(xxiv)Insolvency

4Oppression remedy

5Derivative action

6Challenge variation of class rights

7External administration

8Winding up application

9General law remedies

9.1Fraud on minority

10Inspection of books

11Injunction

12Director’s duties

13Irregularities

14Summaries completed

1Key cases – generally

Saloman v Saloman & Co Ltd

The company is a separate legal entity from its members

Gambotto v WCP Ltd

Proper purpose requirement

Since a share is property,[1] expropriation of minority interests is permitted (i) pursuant to the principles decided in Gambotto v WCP Ltd,[2] provided it is necessary to avoid serious detriment to the company[3] (ii) for regulatory compliance (iii) because the shareholder is competing with the company[4] or (iv) by the Corporations Act.[5] The primary basis for the proposal is for reasons of financial performance and this was not considered to be a proper purpose in Gambotto v WCP Ltd.[6]

’Fair in the circumstances’ requirement

The amendment must also be considered to be ‘fair in the circumstances’.[7] The oppression remedy was discussed above. If the amendment was procedurally and substantively fair, especially with respect to the purchase price, then the amendment would not be oppressive, however that would not cure the improper purpose. Accordingly, the majority of shareholders are constrained from expropriating Adam’s shares.

ASIC v Adler

Financial assistance

Breach directors duties

See notes on HIH collapse

Wayde v NSW Rugby League

The appellants, representing a club which the respondent's board excluded from a football competition on the grounds that only 12 clubs might compete, sought relief.

Oppression meaning is a composite whole

Although action might be discriminatory, it can still be in good faith for the benefit of the company as a whole. The court will consider whether the decisions of the directors were such that no board acting reasonably could have made them.

Foss v Harbottle

2 key issues for members remedies:

proper plaintiff is the company not the member
the alleged wrong can be ratified by a simple majority of members by way of resolution as provided by the company’s constitution (the internal management rule)

See statutory derivative action

Walker v Wimbourne

Single economic unit principle

The argument that transactions were undertaken for the benefit of a group of companies or another company in the group provides no justification for a misapplication of funds. Here the companies were not members of a "group" in the sense in which the word is generally applied, that is to a number of companies associated by common or interlocking shareholdings, allied to unified control or capacity to control. It was the duty of the directors of the company making payments to consult its interests alone. In discharging their duty to the company they must take account of the interest of its shareholders and creditors. Any failure to take into account the interests of creditors would have adverse consequences also for the company.

Tesco supermarkets

Store assistant restocked shelves with product at normal price, not discounted price.

For a company to be liable, the person acting must have been the “directing mind or will” of the company

there was no delegation of any part of the functions or responsibilities

2KEY CORPORATE COLLAPSES/SCANDALS AND LEGAL ISSUES

(i)Australian Wheat Board

AWB’s involvement in paying bribes to the Iraqi regime
Possible contraventions by the officers of AWB of; sections 180, 181, 182, 184, 1307(1) and 1309 of the Corporations Act,[8] sections 135.1(7), 135.4 (7) and 136.1 of the Criminal Code,[9]sections 29A, 29B and 29D of the Crimes Act[10]and sections 81, 82 and 321 of the Crimes Act.[11]
The Federal Court of Australia Act[12] permits the commencement of class actions.
A derivative class action[13] brought against AWB alleged misleading and deceptive conduct[14] and breaches of the Corporations Act[15] by AWB arising from the failure to maintain their continuous disclosure obligations to the ASX.[16]

(ii)Enron Corp

The Enron failure demonstrated a failure of corporate governance, in which internal control mechanisms were short-circuited by conflicts of interest that enriched certain managers at the expense of the shareholders.

Had Enron complied with existing market practices, not to mention existing accounting and disclosure requirements, it could not have built the house of cards that eventually led to its downfall

Sarbanes–Oxley Act – enhanced disclosure requirements, officer liability for financial statements, auditor independence

(iii)HIH Insurance

In the Judgment, HIH and HIHC (who were not parties to the proceedings) were held in the circumstances found to have contravened

s208 (related party financial benefits without shareholder approval) of the Corporations Law by the payment of $10 million to AEUT in the circumstances;
s260A (financial assistance for the purchase of shares) of the Corporations Law by such payment of $10 million followed by the purchase of shares by AEUT from part of the $10 million; paras [182], [183] and[355].
Mr Adler and Adler Corporation, as well as the Second Defendant ("Mr Williams") and Third Defendant ("Mr Fodera"), were also found to have been relevantly "involved" in those contraventions, so as to place themselves in breach of (respectively) ss209(2) and 260D(2) of the Corporations Law; [199], [217] & [369].
Mr Adler was held to have contravened his directorial duties, or duties as an officer, that were owed to HIH and HIHC and (save in relation to s183) PEE, under ss180, 181, 182 and 183 of the Corporations Law, by reason of the transactions, described above: [387], [577], [694], [706] & [730]. Adler Corporation was found to have been "involved" in these contraventions, so as to be liable itself under ss181(2), 182(2) and 183(2) of the Corporations Law: [578]. Mr Adler was also relevantly involved in Williams' contravention of his duty under s182 so as to be liable himself under s182(2): [731].
Mr Williams was held to have contravened his directorial duties, or duties as an officer, owed to HIH and HIHC, under ss180 and 182 of the Corporations Law, through his involvement with the payment of $10 million by HIHC to PEE: [453], [461].

Corporate governance

There was a culture where senior management failed to bring important facts to the Board's attention
The Board failed to monitor systematically the performance of management and generally failed to hold executives to account in the interests of the company

(iv)James Hardie Industries

With respect to corporate governance, the directors considered that the short-term profitability of the company was paramount.[17] The objectives of the company were to be dogmatically pursued, including running the risk to the health of employees and consumers of the products. This may have been exacerbated by the failure of the first asbestos diseases law suit against JHI.[18]
Two key aspects of JHI’s conduct permitted the continuous illegality; (i) silence and (ii) a ‘corporate culture of deceit’.[19]
JHI’s directors breached their duties[20] to hide illegality with respect to breaching trade sanction imposed upon South Africa,[21] the actuarial compensation studies[22] and the cancellation of the partly paid shares[23] which had the effect of denying $1.96 billion[24] to the foundation.[25]
In Australian Securities & Investments Commission v McDonald (No 11),[26] it was held that JHIL[27] and JHI[28] had breached their obligations and that three of its officers and seven non-executive[29] directors had breached their duties.[30]
Those breaches included; (i) failures to advise the directors of key matters, that there were limitations in analysis and whether disclosure was required, (ii) a failure to seek advice about disclosure requirements, (iii) the release of misleading or deceptive information and (iv) a failure to ensure their continuous disclosure obligations.
Corporate social responsibility in the form of full compensation funding was resisted by the directors until the very end. It was the combined effect of global union boycotts, media scrutiny, public opinion and political maneuvering[31] that finally saw JHI agree to fully fund the Asbestos Injuries Compensation Trust.[32]

(v)Sanlu Dairy Group

Executives at Sanlu Dairy Group in 2008 were involved in the deadly tainting of milk by the addition of melamine

(vi)Storm Financial

Personal advice & s 945A

the majority of Storm clients were given the same, or substantially similar, financial advice.
Storm advisers strongly downplayed the risk of losing the family home
Some investors report being reassured by the fact that Storm held a professional indemnity insurance policy
s 953B – civil action for loss for contraventions of section 945A, 945B, 949A or 949B.

3Key legal doctrines and issues

(vii)Corporate form v non-corporate forms

(sole trader, partnership, unincorporated association, trust, joint venture)

(viii)Separate legal entity doctrine

119 – comes into existence on registration
112 – limited by shares
113 – no of shareholders
124 – legal capacity and powers
125 – company can restrict its powers. Abolishes doctrine of ultra vires.
516 - Limited liability

The corporate veil

Saloman v Saloman & Co Ltd - The company is a separate legal entity from its members.

Walker v Wimbourne

Industrial Equity v Blackburn

Lifting the corporate veil

Statute

588G – insolvent trading
588FB-FG – uncommercial transactions
588FDA – unreasonable director related transactions
267 – Company officer charges
260A – financial assistance
233 - Trustees

Common law

Re Darby - fraudulent purpose

Gilford Motor Co v Home – avoid legal obligation

Green v Bestobell – involvement in director ‘s fiduciary breach

Tesco Supermaket Ltd v Nattrass – attributing mind and will of company

(ix)Subsidiary companies

46(a) – definition
47 – control
50 – related body corporate
260A – financial assistance
588V-X – insolvent trading
202B – remuneration disclosure
Briggs v James Hardie & Co; CSR Ltd v Young – parent liability for subsidiary
Patrick Stevedores Operations No 2 P/L v MUA
187 – director duties of subsidiaries modified

(x)Statutory contract

140(1)
Hickman v Kent – contract between company and members
Caratti Holdings Co P/L – contract between members
Forbes v NSW Trotting Club – non-members cannot enforce member’s rights even if granted
Hickman v Kent; Eley v Positive GSLA Co – only enforce member’s rights in their capacity as members
Bailey v New South Wales Medical Defence – can enforce special contract
1322(2) – court invalidate irregularity
Carrier Australasia Ltd v Hunt – ‘director for life’ clause was a separate contract
Breach of 140 not contravention
Remedies limited to injunction not damages

(xi)Constitution

135 – companies after 1 July 1998
135(2) – can displace/modify RR
134 – RR or constitution or both
141 – RR list
136(2) – power to alter
Allen v Gold Reefs of West Africa Ltd; Malleson v National Insurance and Guarantee Corporation – cannot deprive itself of power
75% majority to amend constitution
Allen v Gold Reefs of West Africa Ltd Peters’ American Delicacy Ltd v Heath– The power to alter articles must be exercised bona fidefor the benefit of the company as a whole
Sidebottom v Kershaw, Leese & Co Ltd; Peters’ American Delicacy Ltd v Heath- The fact that an alteration prejudices or diminishes some of the rights of the shareholders is not in itself a ground for attacking the validity of an alteration
Shuttleworth v. Cox Brothers & Co. (Maidenhead) Ltd; Peters’ American Delicacy Ltd v Heath- the decision is not such as no reasonable man could have reached

Modification limits

140(2)
Ding v Sylvania Waterways Ltd – members protected by 140(2)
variation of rights
cannot be oppressive
Gambotto v WCP Ltd – fairness test in expropriation
Allen v Gold Reef of West Africa – bona fide for benefit of the Co as a whole
Breach: Part 2D.1; Part 2F.1; Winding up (461(1)(k)

(xii)Pre-registration dealings

Pre registration dealings refer to transactions/contracts entered into by promoters

Twycross v Grant
May be active (Aequitas v AEFC)or passive promoter (Tracy v Mandalay Pty Ltd)

Duties of promoters

fiduciary duties (Erlanger v New Sombrero Phosphate Co; Gluckstein v Barnes)
711(2)-(3) - Fundraising disclosure – nature and extent of interest in formation, property acquired, offer of securities
Promoters are within “related entities” in s9 and may be liable to a liquidator under the voidable antecedent transaction provisions

Contracts

131(1) - Aztech Science Pty ltd v Atlanta Aerospace (woy woy) Pty Ltd
131(2) – personal liability for non-performance
131(4) – Failure to perform after ratification
131(3) – Court orders

(xiii)Dealing with outsiders

128-130 – outsider entitled to make assumptions when dealing with the company
129 – each assumption is separate and discrete
129(8) – cumulative operation to assumptions
129(1) – Turquand’s case (indoor management rule); Oris Fund Management v NAB, unless outsider has actual knowledge or irregularity or is put on inquiry
129(2)-(3) – “customary authority”. Compare director/MD/Chairperson/Co Sec
129(3) - Freeman and Lockyer v Bathurst Park Properties; ANZ v Australian Glass and Mirrors
129(3) – Story v Advance Bank Australia Ltd - covers fraud/forgery
129(4)–knew or suspected assumption incorrect
129(5) – Brick & Pipe Ind Ltd v Occidental Life Nominees
NAB v Sparrow Green P/L – actual authority of Co. agents
Freeman and Lockyer v Bathurst Park Properties –Apparent/ostensible authority of Co. Agents (eg. not properly appointed)

Contractual liability

Freeman and Lockyer v Bathurst Park Properties – 4 preconditions to enforce contract if agent had no authority; (i) representation of authority (ii) by a person who had actual authority (iii) induced (iv) Co. had power to enter the contract.

Not binding:

ANZ Executors & Trustee Co v Quintex Australia – not for the benefit of the company
Walker v Wimbourne – made when near or in insolvency

Criminal liability

Criminal Code Act 1995 (Cth)

12.1(2)
12.2
12.3(6)
12.5(1)
Tesco Supermaket case

Tort liability

128(3) – common law vicarious liability
Co vicariously liable for torts committed by employees in the course of their employment
Daniels v Anderson

(xiv)Membership

231 – upon registration or after of Co.
1070C(2) – Re Independent Quarries Pty Ltd - share certificate is evidence of title
129 – reliance on share certificate strengthened by assumptions in s 129
168 – register of members
169 – names must be entered
176 – Re Clifton Springs Hotel Ltd - is proof of matters shown in it
172 – place of register
173(1) – inspection of register
177(1) prohibited use of registers
177(1A) – exceptions to prohibitions in 177(1); IMF (Aust) Ltd v Sons of Gwalia Ltd
Axa Asia Pacific Holdings Limited v Direct Share Purchasing Corporation Pty Ltd - $250 to access register
applying for shares
1070A - transfer of shares as per constitution
Greenhalgh v Mallard - any restriction on transfer contained the co’s constitution must be clear and unambiguous
1071E – must give notice of refusal
1072G – P/L may refuse transfer
1072F(3) – Co. may refuse transfer of partly paid shares
1071F – remedy refused transfer

Re Smith and Fawcett Ltd – directors acted in bad faith or improper purpose
1071F – refusal was without just cause
232 - Re Winmardun Pty ltd - oppression remedy

1072A – transmission by operation of law on death
1072B - transmission by operation of law on bankruptcy
exercise option

Rights

Right to vote at General Meeting
Right to receive dividends
right in certain circumstances to force dividend payment
140 – right to enforce statutory contract
485 – right to surplus assets
247A – right to inspect books
175 – right to correct register
Right to be informed and participate in certain decisions (i) affecting the constitution, (ii) affecting share capital (iii) rights as a member and (iv) rights attached to shares
member’s remedies (see below)

Certain rights depend upon the class of shares issued

Entitlement to dividend;
Rights to priority in payment of dividend;
Voting rights;
Rights to repayment of capital on winding up;
Rights to participate in surplus assets on winding up; and
Rights of enjoyment of certain assets such as co’s property.

Liabilities

254M(2) - Pay calls on partly paid shares
516 – on winding up liability limited to unpaid amount on shares
Chase Corp (Aust) Pty Ltd v North Sydney Brick and Tile Co ltd – lien may secure debts of shareholder
cannot pass liability to a man of straw

(xv)Members remedies

232 - Oppression remedy (Part 2F.1)
236 - Statutory derivative action (Part 2F.1A)
Breach member’s personal rights (3rd exception to Foss v Harbottle) – personal action
Enforce statutory contract
Enforce express contract
461 – Wind up application
1324 – Injunction to prevent contravention
Part 2F.2 – Variation or cancellation of class rights
247A - Part 2F.3 – Right to inspect books
1322 - Seek to invalidate irregularities

Available when:

breach of director’s duties and Co. not likely to institute recovery proceedings
action taken by directors or majority which is unfairly detrimental to minority interests

(xvi)Meetings

249C – director may call a meeting
249D – shareholders holding at least 5% or 100 members
249F - shareholders holding at least 5%
249G – Court may call a meeting
249E – members can call meeting if directors do not comply with 249D
249Q – NRMA v parker - meeting must be held for a proper purpose
249H – notice of meeting
249L – content of notice
1309 – Fraser v NRMA Holdings Ltd - offence if notice misleading, not full and fair disclosure
249T - Quorum

Duomatic principle

If shareholders are in agreement, business may be transacted without the formalities of calling a meeting and passing a resolution
Herrman v Simon

(xvii)Corporate governance

Cadbury Reportdefinition - “..the system by which companies are directed and controlled …board of directors are responsible for the governance of their companies”

HIH, Royal Commissioner, Justice Owen - “Corporate governance – describes the framework of rules, relationships, systems and processes within and by which, authority is exercised and controlled in corporations. …it embraces not only the models and systems themselves but also the practices by which that exercise and control of authority is in fact effected”

ASX Corporate Governance Council - “…corporate governance influences how the objectives of the company are set and achieved, how risk is monitored and assessed, and how performance is optimised”

Regulation of Corporate Governance

180-184; 588G - Director’s duties
232, 236, 237 - Member’s remedies
Member’s rights
Internal corporate organs
140 - Internal Management rules
191, 674 - Market disclosure rules
Ch 2M - Integrity of financial information

Non-legal regulation