Legal Issues In Two Business Scenarios
Scenario 1: Contract Validity
Jana Jones and Adrian Allport planned to establish a company that produces customized artwork for scooters, for which, they discussed with Bob Golding. He had an experience of mass-producing scooters for various Australian companies. In July, three of them decided to do business together and on 10th of August, they got their company registered under ASIC with Sunshine Scooter Art (SSA) Pty Ltd. and all of them became the directors of the company. However, eager to get things done with pace, Bob signed a contract on behalf of SSA on 4th August with Computer Supplies Pty Ltd. for 10 new computers to be delivered on 1st September.
Had Bob any legal right to sign the contract on behalf of the company which has not been registered yet?
Under the Corporations Act 2001, a company is considered as a separate legal entity and possesses its own property, rights and obligations. The company holds the controls of an individual, which include authority to own or discard property or possessions, power to enter into contract and to litigate and be litigated. All these rights and obligations and a separate legal status can only be enjoyed by the company, after the company gets registered under ASIC and until ASIC deregisters the company.
Bob signed the contract with Computer Supplies Pty Ltd. on 4th August, but the company got registered by its name i.e. SSA on 10th August. As Bob signed the contract on behalf of the company, the contract itself is invalid as the company was not registered until then. Furthermore, he did not inform the other partners about the contract he entered into on behalf of the company. Jana and Adrian were unaware about the contract. So, he had no legal right to sign the contract on behalf of the company which has not been registered yet.
When Jana and Adrian were busy in preparing business plan and were excited about the potential art designs being developed by them, in enthusiasm of mass-production of scooters, Bob held a meeting on 15th August, with Talia Clint, who was the sales manager in Plastica Pty Ltd. Bob provided his business card in which he was named as the Director of SSA. A large supply contract of $50000 was negotiated between the two to be paid in installments, of which, first payment was due on 1st September. He signed the contract as ‘sole director’ of the company.
Had Bob acted in good faith of the company by acting as a sole director when there were two directors who had no information about the contract?
Scenario 2: Breach of Directors’ Duties
Bob entered into a contract with Plastica Pty Ltd. of which, the other two directors had no information. Above it, Bob did not inform the contracting party about the other two directors of the company. Under the Corporations Act 2001, all the decisions related to the company must be taken with consent of all or at least a specific number of directors. Furthermore, signing the contract by only one director, in case of existence of three directors of the company, is not considered as a valid contract as the other two directors must have provided the consent regarding the contract.
Bob hid the information about the other two directors intentionally and acted as a sole director of the company, which is considered as fraud under Common Law as well. He fraudulently entered into the contract with Plastica Pty Ltd. and provided them his business card in which, he was mentioned as the director of SSA and there was not any mention about the other two directors. Firstly, he entered into contract without the consent of other two directors and secondly, he did several acts that proved him as a sole director of the company before Plastica Pty Ltd. such as he provided the business card with his position as director of the company and signed the contract as the sole director of the company. It proves that Bob had not acted in good faith of the company by acting as a sole director, when there were two directors who had no information about the contract. Furthermore, it was deceitful and fraudulent on his part that he deceived the contracting party as well as Jana and Adrian as directors.
His eagerness or enthusiasm cannot be justified for the actions he did, and how he fraudulently entered into contract with two companies. Even though, he acted for the business initiation of the company, but he entered into contract on behalf of the company and solely took all the decisions despite presence of two other directors for the company. It is considered as the mutual decision of all the directors with their mutual decisions and out of three, at least two directors should sign the contract, if all three are not present.
Under the Corporations Act 2001, it is essential for the directors to keep a written record of the resolutions and meetings. The resolution can be passed either at meeting or by having all the directors recording and signing the decision.
Additionally, there was a provision in the constitution of SSA that any contract of amount greater than $10000, could only be binding on SSA, if it is approved by board resolution and executed by at least two of the directors. When there is such a provision in the constitution of the company, there is no validity of contract signed by one director of the company. Additionally, both the contracts which Bob entered into were of amount greater than $10000 so, it required to be approved by board resolution.
So when on 1st September, Jana and Adrian had received the delivery of new computers along with invoice of payment and request from Plastica for payment of first installment, they should inform both the companies about the fraudulent act of Bob and how he entered into contract without their consent and signatures.
Conclusion
Jana and Adrian are shocked because Bob took decisions on behalf of the company and entered into contract without the mutual consent of all the directors and without their signature. So, neither Jana and Adrian nor the SSA is bound to the contracts entered into with Computer Supplies Pty Ltd. and Plastica Pty Ltd. by Bob in a fraudulent manner, because it was not even in their knowledge that one of the directors acted fraudulently and entered into contract. In both the cases, the contracts are invalid because when Bob entered into contract with Computer Supplies Pty Ltd., the company was not even in existence and when it was in existence, its constitution did not allow any resolution without the signature of two of the directors of amount greater than $10000. So, both the companies and Jana and Adrian should sue Bob for illegal and fraudulent act on behalf of the company.
Superdry Holdings Ltd. (Holdings) is the parent company of a group of several companies which include Superdry Manufacturing Ltd. (Manufacturing) and Superdry Retail Stores Ltd. (Stores) manufacturing, distributing and selling variety of wet-weather gear. The directors of Holdings are Francis Nice, Jack Roach and Alice Wendall and they are the board members of Manufacturing and Stores. However, each of these subsidiaries has three independent non-executive directors as well.
It is evident that the shares of the directors are as follows. Francis holds 50%, Jack holds 30% and Alice hold 20% in the Holdings. In Manufacturing, 70% shares are held by Holdings and 30% shares are widely dispersed while in Stores, 30% shares are of Holdings and 70% shares are widely dispersed. It means maximum shares are held by Holdings i.e. 70% in Manufacturing and 30% in Stores. The financial growth of Stores is because of purchase of wet weather gear by the Manufacturing at considerable reduced rates. In addition, Stores have started selling other brands as well which are sold better than Superdry products. As Holdings and Manufacturers are in financial trouble and pressurized by Finance Bank Ltd. for business overdraft facilities provided by the bank to these companies and it has now exceeded the agreed limits. However, the bank has not taken legal actions against Holdings and Manufacturers until further security for debts could be provided by the three directors.
Whether Jack, Alice and Francis have breached their equitable and statutory duties towards Superdry Stores Ltd.
Under the Corporation Act 2001, the directors of a company might be required to take into consideration the interests of the creditors, particularly wherein, the company is insolvent or going to be insolvent. The Act requires the interests of the creditors to be taken into consideration specifically. Furthermore, in case of wholly-owned subsidiaries, a director of a company owes duties towards that company and not towards related companies or towards shareholders. It is considered as breach of duty on behalf of director, if they enter into transaction or take decisions for the interests of the related company and the shareholders until it is not in the welfare of their company. In addition, the director of a company which is entirely owned subsidiary of a holding company can act for the welfare of the subsidiary, if the constitution of the subsidiary provides the authority to the director to act for the welfare of the holding company and the subsidiary is not bankrupt during that time and would get prevented from being insolvent by the actions of the director. However, all the directors are required to act collectively as a board, each of the directors is individually liable to statutory and common law duties, which include acting in welfare of the company with due care and diligence.
Firstly, the parent company holds 70% shares in Manufacturing and 30% shares in Stores out of total shares of the subsidiaries. Secondly, the Stores is dependent on the purchase from Manufacturing for its financial progress because it provides products on reduced rates through which, Stores could attain benefit from. As Francis, Jack and Alice are the directors in the parent company and are also the board members in the Manufacturing and Stores, they hold all the rights and duties to act in welfare of the subsidiaries. Furthermore, each of these subsidiaries include three independent non-executive directors, if they are also the board members in the Manufacturing and Stores, their opinion also matters. So, their consent should also be taken into consideration in taking any decisions regarding the benefit of the subsidiaries.
Currently, Stores are doing well financially while Holdings and Manufacturers are in the situation of financial trouble. Being the directors of the parent company and the board members to one of the companies who are facing the situation of financial trouble i.e. Manufacturing it becomes the responsibility of the directors to get the companies out of the troubled situation when it is under their control. It is the statutory duties of independent non-executive directors as well to support the decision of the directors of the parent company.
The board of directors conducted a meeting and decided the guarantee to be provided by the Stores regarding the debts of Holdings and Manufacturers to Finance Bank. As per the minutes, the reason behind this decision was is in the welfare of Stores to guarantee for Manufacturers because it supplies products to them at reduced costs. Furthermore, the reputation of Stores could be adversely affected due to failure of any of the companies within the corporate group. So, it would be beneficial for the Stores and in the welfare of it as well, to take the guarantee of the debts of Holdings and Manufacturers to Finance Bank. All these subsidiaries are getting benefitted by each other so directors can take the guarantee for both the companies, as it would be beneficial for the parent company as well and for Stores and Manufacturing also.
However, it should be essential on part of directors that they would act in the welfare of the two subsidiaries as well. Even if they are taking decisions for the welfare of their company, it should benefit Stores and Manufacturing as well. Above all, the consent of independent non-executive directors should also be considered as it would be their concern that Parent Company holds only 30% share in Stores, then also, it has been decided in the meeting to hold Stores liable for the debts of Manufacturing and Holdings. The consent of Stores should also be taken into consideration and the decision should be taken on mutual basis and not on the basis of power or authority of the directors over the company.
Conclusion
Karen is one of the non-executive directors of Stores and she disagreed with the decision and she believes that the directors of the parent company are concerned about their potential liability on personal guarantees to be provided to the bank as well as about their reputations as directors, if group of companies get indebted. Her concern is genuine but the decision is for the benefit of group of companies to which, sufficient votes have been counted. However, the directors are concerned about their company and position, but they have taken decision for the benefit of group of companies being the directors of the parent company. So, they have not breached their equitable and statutory duties towards Stores.
References
Australian Institute of Company Directors, What are the Duties of Directors? (2018) Awlnsw.com.au <https://www.awlnsw.com.au/assets/Latest%20news/Duties%20of%20Directors.pdf>
Australian Institute of Company Directors, Duties of Directors (2018) Companydirectors.com.au https://www.companydirectors.com.au/dutiesofdirectors
Australian Government, Federal Register of Legislation- Corporations Act 2001 (2018) legislation.gov.au <https://www.legislation.gov.au/Details/C2017C00129/Html/Volume_2>
ASIC, Directors’ Key Responsibilities | ASIC – Australian Securities and Investments Commission (2016) Asic.gov.au <https://asic.gov.au/for-business/your-business/tools-and-resources-for-business-names-and-companies/asic-guide-for-small-business-directors/directors-key-responsibilities/>
ASIC, ASIC Guide for Small Business Directors | ASIC – Australian Securities and Investments Commission (2018) Asic.gov.au <https://asic.gov.au/for-business/your-business/tools-and-resources-for-business-names-and-companies/asic-guide-for-small-business-directors/>
ASIC, Steps To Register A Company | ASIC – Australian Securities and Investments Commission (2018) Asic.gov.au <https://asic.gov.au/for-business/registering-a-company/steps-to-register-a-company/>
Baker Mckenzie, “Duties And Liabilities Of Directors Of Australian Companies” (2017) <https://www.bakermckenzie.com/-/media/files/locations/australia/bk_australia_dutiesliabilitiesofdirectors_dec17.pdf?la=en>