XY Bank (XY) and Buck Insurance (BI) Largely Want to Prevent the Issue of Shares. If This

LAWS 2203

SEMESTER 1 2000

QUESTION 2

MARK: 80

XY Bank (XY) and Buck Insurance (BI) largely want to prevent the issue of shares. If this fails, they can attempt to force someone to buy their shares for the higher price.

(1) Preventing the issue

XY and BI can attempt to prevent the issue by arguing the directors of Gunawan (G) have acted in breach of their director's duties. Both under the statute and at common law, there is a fiduciary duty requiring directors to act in the interests of the company as a whole (Hospital Products, s181). This duty has been held to extend to the directors acting with proper purpose (Howard Smith). If XY and BI can establish a breach of this duty, the company can void any contract resulting from it. Essentially, the share issue, whether or not shares have yet been sold, can be cancelled.

Proper Purpose

Howard Smith is the principal case on proper purpose. It concerned some directors who were about to be toppled, so issued shares to a friendly Howard Smith, who it knew would support them. This case is similar in that it also concerns an attempt by a majority of shareholders to oust the directors, and an issuing of shares to dilute the shareholding. AS such, proper purpose must be considered.

Howard Smith set out a two link test for improper purpose:

(i) What was the purpose for which the power was granted?

As in Howard Smith, the power is issuing shares. The proper purpose of this was held to include raising capital in Howard Smith, and this is the purpose claimed by the directors.

(ii) What was the actual purpose of the directors in exercising the power?

XY and BI will argue the directors issued shares to dilute the shareholding and protect their own positions, as was found in Howard Smith.

Howard Smith considered a number of factors:

(i) Timing

In this case, the share issue was timed when threats to the directors' positions on the board were made, as in Howard Smith.

(ii) Planning for the spending

Unlike Howard Smith, there is evidence that G has been planning to spend the money, at least in the long term. There exists a long-term corporate strategy to show this.

(iii) Financial situation

More evidence is needed as to whether G needed the funds, or already had sufficient money to carry out the plan.

(iv) Unlike Howard Smith, the shares were not issued to a supporter, but to the public at large. The fact XY and BI could have bought these shares goes strongly in the directors' favour. XY and BI will attempt to argue G knew it would buy such shares due to their investment policies and that Private (P), given its takeover bids, would buy anything it could. This issue hinges on factors such as whether the shares were overpriced and how much interest could reasonable have been expected from parties other than P. As such, more evidence is needed.

(v) Was there an independent expert's report?

Given this was already part of the company's strategy, this is likely. More evidence is needed to properly weigh up these factors.

In this case, it could be argued the directors had a mixed purpose - they were both raising funds and protecting their positions. The High Court in Whitehouse V Charleton, held that in such cases, for a breach of duty, the improper purpose must be causative in the sense that but for its existence, the power would not have been exercised. It is certainly arguable G would have issued shares for their plan whatever the position of XY and BI. However, this issue in the issuing of shares at the time they were issued - the long-term plan was changed to bring the issue forwards. This comes down to a competition between the directors' claims of the development of the market, and XY and BI's claim of improper purpose. This relies firstly upon the extra evidence discussed above in the Howard Smith factors, and evidence form G as to the changing nature of the market. In my opinion, there is probably not enough on the present evidence for XY and BI to establish a case. However, given the extra evidence discussed earlier, they would have a very strong case. My advice would be to seek the extra evidence, the case may still be strong enough to warrant bringing a case if G cannot prove their arguments as to the pace of the market.

Remedy

This action is best brought as a statutory derivative action under Pt 2F.1A. A s1324 injunction may also be possible despite not fitting into the non-exclusive factors under s1324(1A) a member can use to bring an action.

(2) Selling Shares

XY and BI could attempt to force G to buy their shares for the higher price by arguing oppression. In the event the share issue constitutes oppressive conduct, the court would be unlikely to make such an order as XY and BI can still sell their shares on the open market.

Conclusion

XY and BI should mount a statutory derivative action on behalf of the company alleging the directors acted with improper purpose, and thus attempted to void the share sale.