The Scenario

Discuss About The Constitutional Rethink Corporate Governance.

Urbanlodge Limited (‘Urbanlodge’) is planning a takeover of its competitor Uninest Limited (‘Uninest’). The prevailing share prices are $10 and Urbanlodge has offered $12 per share. The directors of Uninest through a resolution sanction loans in favour of one of the directors, namely, Gilligan. This loan would be approved from the company’s reserves. Using this loan Gillian was tasked with the responsibility of purchasing shares of Uninest in bulk. This would inflate the share prices and hence Urbanlodge would be unable to make payments for such an inflated price and thus would be unable to execute the takeover. This step was suggested by a consultant Christine Neales. This was undertaken because the takeover would result in a complete change of the management including the Board of Directors. However, as the management was not performing satisfactorily the change would be beneficial for the company. The issue here is to analyze if the directors breached any statutory or common law duties in doing so and if the consultant is liable for such an action as well.

The law governing companies in Australia is the Corporations Act, 2001 but Australia also embodies common law principles[1]. Under common law which is also referred to as general law directors have various fiduciary duties which must be observed by the directors. These include the duty to act in utmost good faith in line with the interests of the company, duty to not improperly use the powers vested in them, duty to use their discretion in line with the interests of the company and a duty to avoid any kind of conflict of interest to the best of their abilities[2]. This meant that the director’s first and foremost duty lies towards the interests of the company.

In Chan v Zacharia[3]  it was held that an action that creates a conflict of interest between the management and the interests of the company is in breach of their statutory obligations. This means that using an authoritative position for personal gain where the use of power leads to a harmful effect on the corporation it would be considered a conflict of interest[4]. This has also been reiterated in ASIC v Citigroup Global Markets Australia Pty Ltd (No 4)[5].

As per Section 181 of the Corporations Act, 2001 the common law duty to act in good faith and in the best interests of the company has been enacted statutorily[6]. This states that the directors have an obligation to act in the best interests of the company with bona fide intentions.

Fiduciary Duties of Directors

Section 184 of the Corporations Act, 2001 set out criminal liabilities for a breach of the director’s statutory obligation and sets out that such is applicable in cases where the directors have worked against the interests of the company or have not observed utmost good faith (as per Section 184 (1) (c) of the Act)[7]. Section 184 (2) (a) and (b) of the Act set out that where the directors have used their position to gain an advantage for themselves or have acted recklessly and this has detrimental effects on the company it would also attract criminal liabilities under this section[8].

Howard Smith Ltd v Ampol Petroleum Ltd[9] laid down a two-step test to determine if the powers exercised by the board of directors are for proper purposes. This would aid in interpreting if the board of directors are indeed in breach of their statutory and general law duties. It was further stated here that the directors’ use of their powers to determine the final selling price of the shares of the company is unlawful. The motivation to retain their positions through improper use of their powers would also be deemed a breach of their statutory duties as held in this case.

The Corporations Act, 2001 does not provide for any liability on consultants and independent contractors for the actions of the company[10]. This was also reiterated in the HIH report published in 2003 following the HIH Insurance fraud[11]. 

In the given set of circumstances the directors of the corporation conspired to sanction a loan from the company’s resources to a director to enable him to inflate share prices through bulk purchase. This was done to prevent the change of management through takeover by a competitor. This takeover would however aid the underperforming company’s ultimate interests.  

Following the judgment in Howard Smith Ltd v Ampol Petroleum Ltd the two-step test may be applied to this situation. The first is to determine the purpose of the power that is being exercised by the board of directors. Here the power in question is their power to grant loans through passing resolutions. The purpose of the power to pass resolutions through voting comes by virtue of section 248G and the purpose of it is to allow the decision making process of the company to be scrutinized through voting and that the opinions of all directors are taken into account. By virtue of Section 181 of the act the decisions taken by the board must be in good faith and in the best interests of the company and so it may be inferred that the powers conferred in terms of passing these decisions must also be aligned with the obligations of this section.

Breach of Fiduciary Duties

The second step is to identify the purpose that their power was exercised for. In this situation it is evident that the resolution was passed so that directors could retain their position is the company by inflating share prices. This would also be detrimental to the company as the takeover would ideally usher in better management. Thus, the purpose the power was used for is improper.

This is also a conflict of interest and thus the judgment delivered in Chan v Zacharia would also apply. And thus they were in breach of their general law duty to act in good faith and in the best interests of the company.

This would also amount to a breach of their statutory duties as per Section 181 of the act. This would attract criminal liability as per section 184 of the act.

The consultant Christine Neales would not be liable for any of the acts of the company as the Corporations Act, 2001 does not provide for any liability in relation to consultants and independent contractors. There is no liability under common law either.

The directors of the company were in breach of their fiduciary duty to act in good faith and in the best interests of the company.

The directors were in breach of their statutory duties under Section 181 of the act. This also relates to their duty to act in good faith and in the best interests of the company.

The consultant Christine Neales would not fact any liability for the advice given by her.

Shane is a director and shareholder of Primo Construction Limited (“Primo”) and has incorporated a company called Iconstruct Limited (“Iconstruct”). This company was formed in order to obtain a tender from another organization known as Landstock Limited (“Land stock”). Both Primo and Iconstruct are bidding for the tender and it is awarded to Iconstrcut due to the low price offered by it. But Shane was aware of the price offered by both companies and it may be inferred that he used this information to his advantage in getting the tender in favour of the company incorporated by him. The issue here is if this amounted to a conflict of interest and the remedies.

In Streeter v Western Areas Exploration Pty Ltd[12] it was held that merely holding the position of a director in two competing entities does not constitute a breach off the no-conflict of interest rule. However, the director must ensure that no confidential information is divulged from both sides[13].

Liability of Consultants

It was held in Green v Bestobell Industries Pty Ltd[14] that diversion of business opportunities would amount to conflict of interest. Diversion of business opportunities would denote the misdirection of business opportunities to different entities or depriving a corporation of opportunities that would otherwise come to them. This is a common law fiduciary duty that must be observed by the directors of all corporations[15].  A breach of such a duty would attract damages.

The directors of a corporation have a civil obligation under Section 183 prohibiting them from using information they have obtained by virtue of their position as a director to gain an advantage for themselves or a third party [As per Section 183 (1) (a)] or to cause any detriment to the corporation [As per Section 183 (1) (b)][16].

Section 184 (3) of the act provides for criminal liability in case of an improper use of information obtained by person by virtue of his position as a director as per defined in Section 184 of the act[17].

In the given set of circumstances, Shane is a director and shareholder of both Primo and Iconstruct. He had information about the tender bid made by both companies. Iconstruct making a lower bid can be attributed to him having access to information regarding Primo’s bid. Following Streeter v Western Areas Exploration Pty Ltd Shane’s position as a director in both companies would not amount to a conflict of interest. However, the information he obtained as a director of Primo was used to gain an unfair advantage which could be construed as divulging of confidential information thus as laid down in the case Shane would be in breach of his common law fiduciary duties relating to conflict of interest.

The information divulged would give an advantage to Shane’s newly formed company formed company and thus is a conflict of interest in light of his position as a director of Primo. The information further lead to Primo losing the tender which could only be attributed to the lower price quoted by Iconstruct (as stated by the facts). Thus, resultantly Primo lost out on a business opportunity which it would have obtained under ordinary circumstances. This would be construed as a diversion of business opportunities resulting from the acts of a director. This is a conflict of interest as laid down by the judgment in Green v Bestobell Industries Pty Ltd and thus is also a breach of the director’s fiduciary duties as per common law.

Analysis of Scenario

he information divulged by Shane gave Iconstruct and him (as a director and shareholder) an advantage over Primo’s tender bid. Consequently the loss of the tender can be construed as a detrimental effect caused to the company. Thus all requisites of Section 183 of the act is in the present in the current scenario. Shane is thus in breach of his statutory duties as a director of the corporation

Shane is also in breach of his statutory duties as a director as he is in contravention of Section 183 of the act. The breach of his statutory duties as a director would attract penalties in the form of criminal liabilities as per the provisions of Section 184 of the act.

Frank and Diane are executive directors of a company. The company also has two non-executive directors Ron and Kelly. Frank and Diane are risk-takers and want to enter into an agreement with “CorpGrain” whereas Ron and Kelly oppose it. There is a report stating that it would not be feasible for the company to undertake a contract as it was likely to fail. Under such circumstances Frank and Diane went forward with the contract and Ron and Kelly are persuaded to vote in favour of it. The issue is if in doing so all the directors named above have committed a breach of their fiduciary duties under common law and/or their statutory duties under the Corporations Act, 2001.

Under Section 180 of the directors are expected to act with due dare and diligence when acting on behalf of the company under the provisions of Section 180 (1) of the act. As per Section 180 (2) they are expected to meet their equivalent common law obligations which embody the same responsibilities[18]. Thus when undertaking contracts directors are expected to meet these standards of due diligence and care.

Under the given set of circumstances Frank and Diane would be expected to meet due standards of care when undertaking ventures on behalf of the company as per their duties under Section 180 (2) of the act. The report from Ron and Kelly on their apprehensions about the venture and the report of the expert would have to be perused by both Frank and Diane. Such perusal would make it evident that this venture would be detrimental for the company. Thus the Business Judgment Rule would apply. This contravention would also be a breach of the common law duties to act responsibly.

Ron and Kelly would also have the same responsibility and having read the experts report would be obligated to vote against such a venture since they are fully aware of the risk the same entails. Thus they would also be in breach of their duties under Section 180 (2) of the act if convinced to vote in favour of it and hence their common law duties.

All the directors of the company, namely, Frank, Diane, Ron and Kelly are in breach of their common law and statutory duties.

nder the same premise as Scenario A there is now an expert report in favour of the venture and an agreement is entered with “CorpGrain”. The provided robotic assistance however does not meet the expected standards of the contract and “CorpGrain” is suing for damages. The issue here is if any statutory defenses would be available to the directors.

Section 189 of the act deals with reliance placed on expert advice and the reliance being brought it into question with regard to a directors performance of a duty under the statute or a duty under common law [As per Section 189 (c)][19]. It is stated here that unless proven to the contrary the reliance is taken to be reasonable.

Under Section 189 (b) (ii) the reliance would have to be put after a diligent assessment of the advice given with regard to the corporation and its operations[20]. This is a binding statutory duty on the directors.

The directors of the company would have to fully assess the implications of such a contract before entering into one as per their duties under Section 189 (b) (ii) of the act. However careful assessment of the same would have forewarned the directors of the effects it could have on the company. Thus executing the contract without complete assessment of the situation would be a breach of their duties under the section.

Conclusion

Frank, Diane, Ron and Kelly were in breach of their statutory duties under Section 189 of the act and hence would not have any statutory defenses available to them.

References

Chan v Zacharia [1984] HCA 36.

ASIC v Citigroup Global Markets Australia Pty Ltd (No 4) [2007] HCA 963.

Howard Smith Ltd v Ampol Petroleum Ltd [1974] AC 821.

Streeter v Western Areas Exploration Pty Ltd [2011] 82 ACSR 1.

Green v Bestobell Industries Pty Ltd [1982] 1 ACLC 1.

Brudner, Alan. The unity of the common law. OUP Oxford, 2013.

Miller, Paul. “Justifying Fiduciary Duties.” McGill Law Journal/Revue de droit de McGill 58.4 (2013): 969-1023.

Llewellyn, Karl N. The common law tradition: Deciding appeals. Vol. 16. Quid Pro Books, 2016.

Bottomley, Stephen. The constitutional corporation: Rethinking corporate governance. Routledge, 2016.

Schultz, Emma, Gloria Y. Tian, and Garry Twite. “Corporate governance and the CEO pay–performance link: Australian evidence.” International Review of Finance 13.4 (2013): 447-472.

Leung, Philomena, et al. Modern Auditing and Assurance Services 6e. Wiley, 2014.

Carey, Peter John, Gary S. Monroe, and Greg Shailer. “Review of Post?CLERP 9 Australian Auditor Independence Research.” Australian Accounting Review 24.4 (2014): 370-380.

Tarr, Julie-Anne, and Janet Mack. “Auditor obligations in an evolving legal landscape.” Accounting, Auditing & Accountability Journal 26.6 (2013): 1009-1026.