Nuances of Corporation Law - Case Study Example

Question 1 i) Susie, confronted with the fact that Dave has withdrawn all the money from their joint bank account, prevented her from viewing the accounting books of their news-agency business, and told her she was “fired” from her “job” at the news-agency, wishes to establish that she was in fact Dave’s partner rather than his employee; and that as such, she has the right to continue to receive her share of the earnings of the partnership or to receive half the net proceeds of the dissolution of the partnership. The fact that Susie was co-owner of a joint bank account funded by the profits from the news-agency, rather than being paid a set salary, provides a good indication that she was in fact a partner in the business and not merely an employee. According to the Partnership Act 1891 (Qld) s6(1)(c), “[T]he receipt by a person of a share of the profits of a business is prima facie evidence that the person is a partner in the business,” subject to a number of exceptions which do not apply in this case. The case for the existence of a partnership is further supported by the (implied) fact that Susie had access to the firm’s accounts until her falling-out with Dave. If there is a partnership and Susie is a partner, s27(1)(a) gives her the right to an equal share of the partnership’s profits (lacking a partnership agreement specifying a different distribution); and s27(1)(i) gives her the right to access and copy the firm’s books. According to s28, lacking a partnership agreement containing language to the contrary, Dave does not have the right to expel Susie from the partnership. Under s35(1)(c), however, he does have the right to dissolve the partnership; but if he does so, Susie is entitled to an equal share (since there is no partnership agreement to the contrary) of any winding-up proceeds. Should the partnership be wound up, the proceeds must first be used first to pay any outstanding debts of the partnership; then any advances the partners have made to the firm must be repaid or offset; and finally, any remaining partnership assets must be evenly divided between Dave and Susie. iia) If a partnership between Dave and Susie exists, and if the loan from WhichBank is to be treated as a loan to the partnership (and, of course, assuming that Dave fails to make payments on the loan), Susie can be held jointly liable for payment. However, the Partnership Act 1891 (Qld) s8(1)(b) states that if “the person with whom the partner is dealing… does not know or believe the partner to be a partner”, the acts of the partner in question do not bind the firm or the other partners. This case would appear to fit in with this exception. S9 (1), which otherwise would obligate Susie as Dave’s partner with regard to the loan, does not apply, since the loan was not taken out “in the firm-name, or in any other manner showing an intention to bind the firm”—at least if “the firm” is properly construed to mean the partnership between Dave and Susie, and not merely the news-agency. Also, since Dave made no representation to WhichBank regarding the partnership, s17 (“holding out”) does not apply. According to Lynch v Stiff (1943) 68 CLR 428 (which dealt with misappropriation of funds under s14 rather than with a bank loan, but is otherwise applicable), partners may be held liable “(1) where a person has by words or by conduct represented himself or knowingly suffered himself to be represented as a partner in a firm; (2) where another person has given credit to the firm; and (3) where that person has so given credit on the faith of the representation.” Clearly no such representation has been made: WhichBank extended credit to Dave as an individual without reference to, or knowledge of, his partnership with Susie. WhichBank may counter-argue that Susie ”ratified” the status of the loan as a partnership obligation by profiting from the business financed by the loan, participating in making payments against the loan, and so on. If loan payments were made from their joint bank account and/or the loan from WhichBank was shown as a liability on the business’s books, her case in this regard is weakened; but if Dave paid the loan out of his own bank account and did not enter the WhichBank loan on the news-agency’s books, Susie’s case is considerably strengthened. Iib) Since the WhichBank loan was a business loan taken out in order to finance the creation of the news-agency, it would seem as a matter of equity that if the firm were dissolved the loan should be paid off in full before any remaining assets were distributed to the partners. According to this interpretation, the loan would be treated as a “first charge” against the partnership’s profits—see Canny Gabriel Castle Jackson Advertising Pty Ltd v. Volume Sales (Finance) Pty Ltd 131 CLR 321. Susie, having access to the business’s books and knowing the business’s history, can be assumed to have been aware of the loan from its inception, and continued to function as a partner in the business for several years thereafter; thus she behaved as if she considered the loan as a liability of the partnership, and not just of Dave as an individual. Alternatively, S27(b) of the Partnership Act would tend to support a contention that since Dave took out the loan in order to establish the partnership’s business, the partnership should indemnify him even though the loan is technically his personal liability. Under this interpretation, the bank loan remains a matter between Dave and WhichBank (which cannot come after Susie should Dave fail to repay the loan); but Dave has forwarded the proceeds of this loan as an advance to the partnership. Upon dissolution of the partnership, any such advances (including the proceeds of the WhichBank loan, the proceeds of Dave’s redundancy package, any similar contributions from Susie, and so on) should be repaid or mutually offset before any remaining proceeds are distributed. Question 2 The Smith Family Trust was created to facilitate the conduct of a family business. Woodcraft Pty Ltd, owned by Michael and Claire Smith, is the trustee, authorized to engage in all aspects of the furniture business on the trust’s behalf. Unless the trust deed has been amended, any other business venture undertaken by Woodcraft in its capacity as trustee is a violation of the terms of the trust. If the trust deed gives Woodcraft a right of indemnity against trust assets to settle its debts as trustee, this right would apply only to liabilities incurred in the course of business activities consonant with the trust deed—not including horse breeding or real-estate investing. At the same time, since Woodcraft is a “$2 corporation” with no other assets of its own, and since Michael and Claire Smith’s personal assets would normally be protected from Woodcraft’s creditors, these creditors would normally be faced with a serious likelihood of unrecoverable loss should Woodcraft become insolvent. The three creditors in this case represent three very different situations: one is owed money for goods purchased consonant with the terms of the trust; one has lent money to the trustee for a venture not consonant with the terms of the trust; and one has lent Woodcraft Pty Ltd money with no reference made to the company’s role as a trustee. These three circumstances lead to quite different possibilities for recovery of the respective debts. a) Forest Products Pty Ltd is owed $20,000 for the purchase of timber. Because this obligation was incurred in the course of carrying out the legitimate trust business of manufacturing furniture, Forest Products has a right of subrogation to pursue the trust’s assets upon liquidation of Woodcraft if—and only if—the trust deed grants Woodcraft the right of indemnity for such obligations. (Vacuum Oil Co. Pty. Ltd. v. Wiltshire [1945] HCA 37; (1945) 72 CLR 319) If Woodcraft does not have the right of indemnity under the trust deed, the trust’s assets are protected and Forest Products must settle for a portion of any proceeds of the liquidation of Woodcraft Pty Ltd. Michael and Claire’s personal assets are protected in this transaction, since they acted properly within the bounds of their obligations as directors of the trustee, and since there was no indication at the time the timber was purchased that Woodcraft’s new ventures would fail and the firm would become insolvent. (See [c] below.) b) Eastpac Bank Ltd lent Woodcraft $500,000 to finance the purchase of a stud horse (who, evidently, was not as much of a stud as had been thought). In this transaction, Woodcraft represented itself to Eastpac as the trustee of the Smith Family Trust—and thus this transaction was a clear violation of the terms of the trust, since it did not involve any aspect of the furniture business. Accordingly, the trust’s assets are unavailable to Eastpac even if Michael and Claire have a right of indemnity against trust assets, since such indemnity is applicable only to debts incurred in the course of legitimate trust business. On the other hand, under s197 of the Corporations Act 2001 (Cth), Eastpac can pursue Michael and Claire’s personal assets because, as directors of a trustee, they have violated the terms of the trust. c) National Finance Ltd is owed $2,500,000 lent to Woodcraft to purchase a commercial property. Assuming that Woodcraft did not represent itself as a trustee in taking out this loan, s197 does not apply. Accordingly, the only way in which the “corporate shield” may be breached would be if Michael and Claire Smith had violated the provisions of s588(G), which holds directors of a corporation personally liable if they incur corporate debts at a time when they know that the firm is insolvent or is likely to become insolvent. If the conditions of s588(G) apply, s588(M) allows National Finance or a liquidator to recover losses from Michael and Claire Smith personally as directors of Woodcraft. In order for this to be the case, National Finance must show that Woodcraft was already insolvent at the time the loan was taken out, or that Woodcraft would become insolvent as a result of the various debts incurred at the time this loan was taken out; and also that Michael and Claire had “reasonable grounds for suspecting that the company [was] insolvent, or would so become insolvent” (s588G (1)). Section 588(H)(2) provides a defense if “at the time when the debt was incurred, the person had reasonable grounds to expect, and did expect, that the company was solvent at that time and would remain solvent even if it incurred that debt and any other debts that it incurred at that time.” Since there is no indication that the various borrowings and investments that Michael and Claire made at this time were obviously commercially unsound, and since Woodcraft’s insolvency occurred only after these debts were incurred and the firm later suffered unexpected business reverses, s588(G) does not in fact apply; in this case, then, the corporate shield should hold. National Finance has no recourse to assets beyond whatever it can recover as a result of Woodcraft’s liquidation. Question 3 The Downs Turf Club, as an unincorporated association, is not a separate legal entity, and thus it cannot form contracts or incur any liability on its own behalf (Leahy v Attorney-General [NSW] [1959] 101 CLR 611). Accordingly, those affected by food poisoning at a club social function cannot sue the club itself, since the club is not a “person” that can be sued. The maximum exposure of the Downs Turf Club to liability in this matter is that under Bradley Egg Farm v Clifford [1943] 2 All ER 378, management committee members may be indemnified from the club’s “common funds” for liabilities they incur in the course of carrying out club business; so if the victims of food poisoning sue the management committee members and win, the latter may have the right to use any available common funds of the club to pay damages before using their own personal assets. Normally, unincorporated association rules do not have contractual force; Cameron v Hogan [1934] 51 CLR 358 established the principle that such rules have contractual force only if they clearly express an intention to establish legally binding obligations. Unless the Downs Turf Club’s rules satisfy the Cameron criteria and include a right of indemnity for management committee members against ordinary members, no such right of indemnity exists—and thus ordinary members cannot be held liable for any debts or other obligations of the club or the management committee, except to the extent that money they have already contributed to the club’s funds may be used to indemnify members of the club’s management committee (Wise v Perpetual Trustee Company Ltd [1903] A. C. 139). Under Bradley Egg Farm v Clifford [1943] 2 All ER 378 and Smith v Yarnold [1969] 2 NSWR 410, members of an unincorporated association’s management committee are held personally liable for torts of the association, even if they were not directly involved in making the decision that gave rise to the tort (Ward v Etherington [1982] Qd R 561). Accordingly, the members of the Downs Turf Club’s management committee, including the club’s treasurer, can be sued and may be held liable for the food poisoning that occurred at a club function. If those who suffered food poisoning sue the members of the management committee and win, the members of the committee may have the right of indemnity to pay damages out of the club’s common funds, to the extent that such funds exist. While Michael, the club member who insisted that the management committee choose one of his business associates as the food supplier for the event in question, is “influential”, he is not a member of the management committee; and thus for legal purposes he is merely an ordinary member of the club and cannot be held liable for any tort the club or its management committee may have committed (Wise v Perpetual Trustee Company Ltd [1903] A. C. 139). Further, he has no special expertise in food hygiene, and thus has no professional duty of care in providing advice to the committee in this matter. Accordingly, Michael faces no personal liability for damages due to the food-poisoning incident, unless he was aware in advance that the food supplier he recommended was likely to provide tainted food. Question 4 ia) Under the Corporations Act 2001 (Cth) s148, Provincial Millers Ltd satisfies the naming rules for a public company limited by shares; further, the fact that its shares are publicly traded is consistent with its being a public company limited by shares. Ib) According to s162, Provincial Millers Ltd can change from being a public company limited by shares to any of three categories: an unlimited public company, an unlimited private company, or a proprietary company limited by shares. Considering that Provincial Millers is in a weak financial position, transforming it into any form of unlimited company would be a very bad idea, leaving its new owners personally vulnerable to Provincial’s creditors. However, Sharp and Smart might well benefit from converting Provincial to a proprietary company limited by shares; this would preserve its “corporate shield” while releasing them from the burdensome reporting requirements associated with public companies. Of course, should Sharp and Smart succeed in turning the company around, they may decide in future to return Provincial to its public-company status and once again float its shares on the stock exchange. ii) Given that Provincial Millers Ltd appears to be a healthy concern except for several contracts that obligate it to supply flour at uneconomic prices, it would be tempting to transfer its assets, employees, good-will, and so on to a new company, leaving Provincial Millers Ltd as an empty shell with contractual obligations but no means of fulfilling them. This “ghost company” could then be painlessly (for its owners, at least) wound up, leaving its contracts unfulfilled; the new owners of its ongoing business would be left with a “reborn” version of Provincial Millers, with all its strengths but divested of its uneconomic obligations. Quite apart from the legal aspects of such a strategy, the supposed commercial benefits of this “cut and run” approach might well prove to be illusory. Were Sharp and Smart, as the new owners of Provincial Millers, to engage in this kind of asset-stripping as a means of evading the company’s contractual obligations, their future ability to interest other businesspeople in contracting with them would be vastly reduced. Who, after all, wants to commit to a contract knowing that the other side is likely to evade its obligations in this manner as soon as the contract’s terms become commercially disadvantageous? Accordingly, on purely commercial grounds Sharp’s proposal is not smart. In any case, Sharp’s proposed strategy is unlikely to be effective in shielding Sharp and Smart and their new incarnation of Provincial Millers from the existing company’s contractual obligations. The transfer of assets and business to the new company would be considered an “uncommercial transaction” under s588FB of the Corporations Act, since “a reasonable person in the company's circumstances would not have entered into the transaction”; nobody “reasonable”, after all, would want to transfer all his/her assets to someone else without receiving something of at least equal value in return. This transfer would also qualify under s588FDA as an “unreasonable director-related transaction”. Most importantly, the transfer of assets would be classed as an “insolvent transaction” under s588FC, since the transaction would materially contribute to Provincial Millers Ltd’s insolvency. Under s588FE subsection (5), the transfer of assets and business to the new company is voidable because it constitutes an insolvent transaction entered into “for the purpose, or for purposes including the purpose, of defeating, delaying, or interfering with, the rights of any or all of its creditors on a winding up of the company”. As subsection (5) applies to transactions entered into as much as ten years in the past, there is no way of avoiding its strictures by waiting a short period of time before allowing Provincial Millers Ltd to become insolvent. (Subsection 6A, permitting an “unreasonable director-related transaction” to be voided, would also apply, with a four-year applicability.) Section 588FF of the Corporations Act gives courts sweeping powers to act in cases where a voidable transaction has taken place before a company becomes insolvent. These powers could be used to force the new company, or perhaps Sharp and Smart as individuals, to pay Provincial Millers Ltd an amount equal to the fair value of the assets that were transferred to the new company (subsection 1c); to force the new company to return the assets that were transferred to it back to Provincial Millers Ltd (subsection 1b); or, possibly, to alter the transfer agreement under subsection 1i such that Provincial Millers Ltd’s contractual obligations to its customers are now part of the package of assets that have been transferred to the new company. Further, under s 588G of the Corporations Act, the directors of Provincial Millers Ltd—presumably Sharp and Smart—can be held criminally liable for knowingly causing the company to carry out a transaction that would render it insolvent; and under s 588M, the liquidator of Provincial Millers can pursue their personal assets if necessary to compensate the company’s customers for any loss relating to the liquidation of the company. Case law also gives a clear indication that the kind of transaction envisioned by Sharp will not work. For example, in Pioneer Concrete Services Ltd. v. Yelnah Pty. Ltd. & Ors (1987) 5 ACLC 467, Young J. stated that the “corporate veil” could be pierced if a company had been created or was being used in order to avoid a legal obligation or carry out a fraud. Accordingly, the proposed strategy, even if it were commercially advisable, would not work: Provincial Millers Ltd’s contracts would be enforced one way or another, and by attempting to evade these contracts by dishonest means, Sharp and Smart would render themselves vulnerable to seizure of their personal assets and to criminal prosecution. Read More