I.Chapter 6– The use of corporate property in the context of ratification
TEMPORARY TABLE OF CONTENTS
Contents
I.Chapter 6 – Should corporate property be used for proper corporate purposes?
II.Introduction
I.The intersection of shareholder ratification and use of corporate property
III.Should corporate property be used for proper corporate purposes?
A.What are proper corporate purposes?
1Related party transactions
2Corporate insolvency or companies near insolvency
3Breach of a director’s fiduciary or statutory duties
4Statutory oppression
5Summary of the current law in Australia
B.What are the limits of the statutory duty in the context of proper purpose pursuant to section 181?
C.Proper corporate purpose
6The meaning of proper corporate purpose
7Can a gift of corporate property be the use of corporate property for a proper corporate purpose?
8The benefits of the amendment to section 232
IV.Conclusion
II.Introduction[MR1]
In this Chapter, it is necessary first to discuss the intersection of shareholder ratification and the use of corporate property under the Corporations Actto explain the contemporary role of the doctrine of ratification in respect of solvent and insolvent companies, discuss the continuing importance of the doctrine of ratification to companies and to provide a different perspective for this reassessment of the doctrine. These matters have evaded close scrutiny by academics and the judiciary.
In light of the significant intersection between the doctrine of ratification and the use of corporate property, this Chapter then considers whether corporate property should be used for proper corporate purposes. Such an approach which is argued in this thesis would be a narrower approach than the current law enunciated in Hutton v West Cork Railway Co[1]andANZ Executors & Trustee Company Limited v Qintex Australia Limited (Receivers and Managers appointed).[2] The focus of the discussion in the context of ratification is whether a gift of corporate property, such as the extinguishment of a cause of action against a director arising from the approval of a ratification resolution, should be considered to be the use of corporate property for a proper corporate purpose. An important aspect of this discussion is whether the best interests of the corporation are a relevant consideration and whether there is prejudice to the company’s stakeholders because the law does not recognise the relevance of the corporation’s best interests. If the corporation’s best interests are relevant, then this criterion, together with a consideration of the principles of good corporate governance discussed in Chapter 7, may indicate that there should be law reform in Australia.
I.The intersection of shareholder ratification and use of corporate property[M2]
Under the Corporations Act and the general law there is a legal nexus between the use of corporate property and the doctrine of ratification. As referred to above, the use of corporate property and the doctrine of ratification intersect in 7 different ways under the Corporations Act. The legal relationship between ratification and the use of corporate property has not been considered by the academic literature [NW3]and is a novel aspect of this thesis.
This thesis concerns, in part, the prejudice to stakeholders which arises from the operation of the doctrine of ratification.As a part of the doctrinal review presented in this thesis, it is necessary to place ratification and authorisation of breaches of directors’ duties in the context of companies incorporated under the Corporations Act because this analysis assists to explain the nature of the corporation, the limits of shareholders’ powers and the extent to which shareholder primacy theory is implemented by the Corporations Act.
It is useful at this point to reflect on the position of minority shareholders in the context of companies. The relationship between each shareholder and the company is contractual[NW4][3] and no shareholder has any right to absolute protection if their interests are affected.[4] Further, unless the company is listed on a securities exchange, there may be no liquid market for their shares and in ordinary circumstances [NW5]there is no mechanism for a shareholder to compel a buyout of their shares. A shareholder may choose to seek to protect their interests by the enforcement of their rights under the Corporations Act [NW6]or under the company’s constitution and this choice will turn on considerations of the legal and factual matrix and economic considerations because of the costs involved in commercial litigation in Australia. This highlights the prejudicial [NW7]position which shareholders are in where the directors of a company are using their powers in their own interests or for their own benefit. A minority shareholder may seek to reduce or eliminate any prejudice under section 232 or section 461 of the Corporations Act and seek orders (for example) for the buyout of their shares by a majority shareholder or damages arising from a breach of duty to the company.
A ratification resolution approved by a majority of shareholders may be contrary to section 232[NW8][5] and/or section 461 of the Corporations Act and accordingly there is an important connection between the use of corporate property, [NW9]ratification and the limitation of the shareholders’ powers.[6] The doctrine of ratification therefore does not operate free from some constraints under the Corporations Act and the general law which impose some limitations on the proprietary rights of shareholders [NW10]to vote in their own interests.
Transactions which involve a director’s material personal interest are required to be approved by the shareholders in general meeting[NW11].[7] Unless the company is a public company, a director whom has the personal interest in a related party transaction[NW12][8] is permitted to vote on the approval of the transaction and this aligns with the right of a director/shareholder to approve a ratification resolution in respect of their own breach of statutory and fiduciary duty. The principles discussed in this thesis underlying the recognition of the shareholder’s proprietary right to vote highlights the intersection between the use of corporate property [NW13]and the doctrine ratification. Save for the statutory prohibition against certain shareholders voting on related party transactions,[9] the right of a director and their associates to vote on a transaction where a director will obtain a financial benefit from the approval of the resolution highlights the prejudice which arises from the largely unconstrained right of a shareholder to vote in their own interests and contrary to the interests of the company. The company, minority shareholders, employees and creditors are prejudiced because the doctrines of equity are not imposed [NW14]to ameliorate the unfairness which arises in these circumstances.
The doctrine of ratification and the use of corporate property are interrelated in the context of abuses of power by one or more of the directors. A typical example of this problem arises in relation to the sale of a company’s assets[NW15].[10] An abuse by the directors of their powers which created rights in a third party is voidable [NW16]and the ratification of the breach of duty by the shareholders in general meeting cures the breach [NW17]to regularise the directors’ conduct. There is evident prejudice to minority shareholders and other company stakeholders in these circumstances since they will be unable to limit the majority’s power to approve a ratification resolution which concerns the use of the company’s property.
The enforcement of third party securities such as guarantees and security interests registered over land or pursuant to the Personal Property Securities Act 2009 (Cth) may involve considerations of (i) the assumptions the third party is entitled to make under section 129 of the Corporations Act[11] (ii) the protection of irregularities which arise in shareholders’ meetings under section 1322 (iii) whether the shareholders approved (and were legally entitled to approve) the creation of the rights in the third party[12] and (iv) whether because of an abuse of power by the directors, the shareholders in general meeting are required [NW18]to ratify the directors' conduct.[13]
In the absence of a ratification resolution which remedies a breach of duty by a director, provided that the third party does not have actual or constructive knowledge of different facts, [NW19]a third party may be limited to reliance on the assumptions in section 129 of the Corporations Act.[14] Ratification therefore has a role in resolving questions of the enforceability of third party securities as it relates to corporate property since a third party is entitled to rely upon the ratification resolution for the purposes of section 129 [NW20]and as evidence generally of the company’s powers being regularly exercised, however, whether there has been a ratification of a director’s conduct is not a complete answer to the legal controversy surrounding the enforcement of third party securities.[15][NW21]
The introduction of the statutory derivative action into the Corporations Act changed the common law position with respect to the operation of the doctrine of ratification and this therefore is an important intersection with the use of corporate property[NW22]. Whilst section 236 of the Corporations Act permitted shareholders to bring derivative actions even where a director’s conduct was ratified[NW23], the approval of a ratification resolution remains relevant to the ultimate orders [NW24]which may be made by a court in relation to derivative proceedings[16] and in respect of applications for relief from liability made under sections 1317S and 1318 of the Corporations Act. A court may order that a shareholder’s costs of bringing a derivative action be paid by the relevant company and this would have the effect of reducing the prejudice to the shareholders which commenced the legal proceedings.[NW25]
In respect of proposed or actual conduct which is a contravention of the Corporations Act, a shareholder and creditors have rights pursuant to section 1324 of the Corporations Act to seek an injunction.[17] [NW26]It is notable that under section 1324, a court may make an order against a director of a company for damages for a breach of their duties[18][NW27]and that declaratory relief may [NW28]be sought in respect of the invalidity of a corporate act. Whilst minority shareholders and creditors are protected against a purported ratification of a breach of statutory duty,[19] there remains the legal possibility of the attenuation of statutory duties which is discussed in detail in Chapter 4. The doctrine of ratification has a limited role in resolving questions of invalidity in this context and overall section 1324 may have an effect of reducing prejudice to minority shareholders and creditors entirely separate from the operation of the doctrine of ratification.
Ratification and the use of corporate property do not intersect in the context of pre-insolvency and insolvency situations.It is notable that in an insolvency context where the company has acted to the prejudice of creditors, even the shareholders’ reserve powers are curtailed in favour of creditors' rights.A line of authority following Kinsella v Russell Kinsella Pty Ltd (in liq)[20] explains that creditors in these circumstances have rights in respect of a company’s property and not the shareholders.[21]
In a similar context, the Corporations Act establishes a code under Part 5.7B Division 2 for determining whether any corporate transactions are voidable transactions[22] and what orders should be made if a transaction is voidable[23] and Part 5.6 Division 6 Subdivision D establishes the priorities for the payment of moneys to creditors and employees of a company.[24] The voidable transactions regime principally seeks to protect employees and creditors since a declaration that a transaction is voidable may result in moneys being paid back or property returned to a company. In this context, the doctrine of ratification does not affect a court’s jurisdiction under section 588FF of the Corporations Act to make orders in relation to voidable transactions.
Notwithstanding the series of conclusions reached by this thesis which argues in favour of statutory reform to the operation of the doctrine of ratification because of the doctrinal analysis, the application of good corporate governance principles and by reason of the criticisms and uncertainty in the operation of ratification, the proposed statutory reforms cannot provide an answer to legal issues which arise in the context of insolvency and voidable transactions.[NW29]
The foregoing discussion places ratification in connection with the use of corporate property with respect to the theory of the corporation applied by the doctrine, the shareholder primacy doctrine and the limits imposed upon the powers of shareholders in general meeting to ratify or authorise a breach of a director’s duty. [NW30]Each of those matters were addressed earlier in this thesis.
III.Should corporate property be used for proper corporate purposes?
The problems affecting company stakeholders which concern the use of corporate property arise in a variety of contexts including; related party transactions, corporate insolvency, breaches of both fiduciary and statutory duties of directors, statutory oppression within the meaning of section 232 of the Corporations Act and the limits of the powers of the shareholders in general meeting.
It is an old principle of corporate law that the powers or funds of a company must be used only for company purposes.[25] In the context of ratification, a resolution approved by the shareholders in general meeting for the ratification of a director’s conduct for nil consideration is a gift of corporate assets to the director and by reason of the ratification of the director’s conduct, the company will lose its legal right to seek an order for damages against the director.
In this section of this Chapter, as a means to consider the prejudice to stakeholders of a company, consideration is given to:
(i)what are ‘corporate purposes’ to properly define the subject matter of the question whether corporate property be used for proper corporate purposes;
(ii)the current state of the law in Australia with respect to the limits of the use of corporate property;
(iii)whether there is an argument in support of a new doctrine of waste of corporate assets; and
(iv)the prejudice to stakeholders which arises from corporate property not being used for proper corporate purposes.
A.What are proper corporate purposes?
The meaning of what are ‘proper corporate purposes’ will arise in the following different contexts:
(i)a related party transaction;
(ii)corporate insolvency or a company near insolvency;[26]
(iii)a breach of director’s fiduciary or statutory duties;[27]
(iv)statutory oppression;[28] or
(v)the limits of powers of the shareholders in general meeting.[29]
Each of the first four matters are considered below. The issues which concern the limits of powers of the shareholders was considered in Chapter 2 Section VII.
1Related party transactions
Chapter 2E of the Corporations Act establishes a code for matters which concern related party transactions. The restriction on related party transaction only relates to public companies and accordingly does not prohibit directors of proprietary companies from entering into transactions which would be prohibited by Chapter 2E.
The principal restrictions on a director of a company obtaining a financial or other benefit arise from; a director’s duty of disclosure of a material personal interest,[30] the operation of the Duomatic principle (addressed in Chapter 2), corporate governance regulation established by the Corporations Act (addressed in Chapter 5), whether the director has modified statutory duties pursuant to sections 18 and 187 of the Corporations Act because the person is a director of a wholly owned subsidiary, the exemption limitations pursuant to section 199A of the Corporations Act (Indemnification and exemption of officer or auditor), the prohibition against fraud on the minority and the prohibition against oppressive conduct under Part 2F.1 of the Corporations Act (Oppressive conduct of affairs).[31]
Each of the above restrictions explains an aspect of the public policy which supports the use of corporate assets for corporate purposes. What is notable about the above restrictions is that a ratification resolution may be contrary to one or more of the restrictions. This thesis argues that there should not be circumstances which give rise to prejudice to stakeholders arising from a ratification or approval of a director’s conduct.
2Corporate insolvency or companies near insolvency
The interaction of corporate insolvency laws with other law always raises a question about fairness to stakeholders since corporate insolvency laws establishes a statutory formula which is the mechanism by which the net assets (if any) of the insolvent company are to be distributed. Which stakeholders obtain any benefit and the quantum of that benefit will depend on the circumstances of each case[32] and will be primarily affected by the rights of secured creditors by reason of registered mortgages and caveatable interests over real property or registered security interests over personal property.[33]
The principle protection for stakeholders when a company is trading insolvent is the director’s duty to prevent insolvent trading[34] and the duties established by sections 180 and 181 of the Corporations Act. Corporate insolvency laws however also seeks to protect stakeholders of companies when a company is verging on insolvency.[35]
In ANZ Executors & Trustee Company Limited v Qintex Australia Limited (Receivers and Managers appointed),[36] it was held that a commercial or trading company confronting insolvency would infringe the principle of using corporate property only for company purposes by making a gift of its assets in derogation of the interests of its creditors.[37] The principle was explained in Hutton v West Cork Railway Co[38] as follows:
The money which is going to be spent is not the money of the majority. That is clear. It is the money of the company, and the majority want to spend it. What would be the natural limit of their power to do so? They can only spend money which is not theirs but the company's, if they are spending it for the purposes which are reasonably incidental to the carrying on of the business of the company. That is the general doctrine. Bona fides cannot be the sole test, otherwise you might have a lunatic conducting the affairs of the company, and paying away its money with both hands in a manner perfectly bona fide yet perfectly irrational. The test must be what is reasonably incidental to, and within the reasonable scope of carrying on, the business of the company.[39]
The principle in Hutton[40] has been applied numerous times, including in Australia.[41] It was not considered in Qintex[42] that the principle in Hutton[43] which was applied was dependent upon the doctrine of ultra vires.[44] However, the principle in Hutton[45] may be broader since the High Court has held subsequently (without considering the decision of Hutton[46]) that the directors may exercise their powers for ‘any purpose or advantage of the company’.[47] Subsequently to the decisions of Hutton[48] and Richard Brady Frank Ltd,[49] doubt was expressed in Westpac Banking Corporation v The Bell Group Ltd (in liq) [No 3][50]as to the correctness of the principle in Hutton.[51]
The decision in Qintex[52] has not been followed internationally although it has been cited in the Court of Appeal of New Zealand.[53] This may be explainable on the basis that the decision was a Full Court of a State Supreme Court and not an appellant court and that the case followed Hutton[54] and existing authorities of the High Court[55] and thus no new principle of law may be suggested to arise.