Elements For Determining The Existence Of A Partnership Under Law And Directors’ Duties Under The Corporations Act 2001

Partnership under Law

Samuel, Thomas and Peta set up an internet business for reselling products from companies that had gone into liquidation at a profit. They did not discuss or decide on the structure of their newly formed venture, however, the three worked together and made the venture profitable. During the first year, Peta was not paid anything, however, a $6000 per month payment was agreed on as gratuity thereafter. On the other hand, Samuel and Thomas received payments in consultancy arrangements. Samuel and Thomas deny the existence of a partnership, as such, the following discussion aims to determine whether a partnership exists by evaluating the elements used to determine the existence of a partnership under law.

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The Partnership Act describes a partnership as “the relationship between people carrying on a business in common with a view of profit” (Latimer, 2012). This definition highlights the three core elements for establishing a partnership. The Act also provides statutory rules for establishing the existence of a partnership. Essentially, as provided for under the Act, a partnership is not created under the circumstances of tenancy in common, joint tenancy, part ownership or joint property even where the co-owners share profits from the use of the property or things owned. Additionally, regardless of the existence of a common interest in the property, the sharing of gross returns derived therefrom does not create a partnership. Finally, the receipt of a share of profits serves as prima facie evidence of partnerships, however, receiving the said “share or a payment contingent on or varying with the profits of a business does not in itself make one a partner”. This was illustrated in Cox v Hickman (1880) 8 HL Cas 268, where the court was of the opinion that Cox and Wheatcroft, creditors who had been appointed to serve as trustees, could not be found liable for the debts owed to Hickman as they were not partners, this is regardless of the fact that they were entitled to a portion of the profits as creditors. 

The element of ‘carrying on business’ was illustrated in Smith v Anderson (1880) 15 ChD 247 where some investors subscribed to buy shares in a number of submarine cable companies through a trust. They bought the shares and certificates were issued, Smith was among the people who received a certificate after purchase. Smith later applied for the winding up of the trust citing that it was illegal based on the provisions of s 4 of the Companies Act 1862. The court had to establish whether the trust was a partnership and in doing so it evaluated the nature of the trust and the relationship of the parties in question. It was held that there was no partnership as the trust was not established with the objective of “carrying on business”.

Carrying on Business

Additionally, the business has to be carrying on “in common”, that is, by the partners or on their behalf; it is not compulsory that every partner take up an active role (Re Ruddock, (1879)). In Lang v James Morrison & Co Ltd (1912) 13 CLR 1, the court explored this element whereby an English company brought an action against three parties; McFarland, Keates and Lang. The company made claims that the three had worked together in Melbourne under a company called “T McFarland & Co.” and in some occasions as “McFarland, Lang and Keates”. Before the suit commenced, two of the defendants become bankrupt as such the action proceeded against Lang and their assignees where the court of first instance gave judgement against the defendants. On appeal, the High Court was of the opinion that there had been no partnership; the agreement between the plaintiffs and the Thomas McFarland was a joint venture as separate bank accounts were maintained. Additionally, neither Lang nor Keates acted as an agent of ‘T McFarland & Co.’. The lack of existence of this agency relationship was evidence that no partnership exists.

The third element is that partnerships should operate with a view to profit. Essentially, the Partnership Act does not provide any definition for profit; however, courts have adopted various methods to cure this lacuna. In Wise v Perpetual Trustee Co Ltd [1903] AC 139, the pecuniary gain made between accounting periods was used to differentiate clubs from partnerships. Comparing the change in value of assets between two different points in time is the common test adopted by courts to evaluate profit with respect to partnerships (Bond Corporation Holdings Ltd & Anor v Grace Bros Holdings Ltd & Ors , (1983)).

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In the case study provided, Samuel, Thomas and Peta agreed to start up the internet business with the aim of reselling goods for a substantial gain. This illustrates the existence of two of the three elements, that is, the association formed with the objective of carrying on business to gain profit. The agreement between the three also outlines how they will receive payments from the profits of the venture. Additionally, it is stated that the three worked together, in the venture illustrating that they worked in common. The identification of these elements in the case study illustrates the existence of a partnership. 

Duty of Care and Diligence

As the image of leadership in a company or organisation, directors are tasked with the mandate of managing and controlling the organisation’s activities (Longman, 2003). A director is defined under s 9 of the Corporations Act 2001 (Cth) as one who is “appointed to fill this position or one who is appointed to the position of an alternate director and acts in that capacity” (Gibson & Fraser, 2013). Originally available under common law, directors’ duties have developed significantly over the years and are now incorporated in statute under the Corporations Act 2001 (Cth). They include; “the duty not to misuse their position of power, the duty of care and diligence, the duty to act in loyalty and good faith and the duty not to use company information for personal gain”. In Australia the Australian Securities and Investments Commission is tasked with the mandate of monitoring and ensuring the enforcement of the aforementioned duties (CCH Australia Ltd, 2011).

Operating in Common

Directors are tasked with the responsibility of employing a reasonable degree of care and diligence in the fulfilment of their powers and obligations (Langford, 2014). This duty, which is originally a creature of common law, is incorporated into statute under s 180 of the Act 2001 (Cth). In executing this mandate, a director is tasked with demonstrating that any actions or inactions taken with respect to company activities were reasonable and not based on personal interest (ASIC, 2016). It is paramount for a reasonable director, in the interest of ensuring care and diligence, to refrain from engaging in any action or inaction that would amount to an illegality against the company.

The traditional approach to the duty of care and diligence is illustrated in Re City Equitable Fire Insurance Co Ltd [1925] Ch 407. This case expressed a more lenient view of the obligation bestowed upon company directors by stating that “a director is not bound to give continuous attention to the affairs of the company.  His duties are of an intermittent nature to be performed at periodical board meetings”. This case set precedent by setting an objective test by which director’s actions are evaluated to identify compliance with this duty. Essentially, the degree of care, skill and diligence required, as illustrated in this case, is that which would be expected of a person with a similar degree of knowledge and experience. However, this position is no longer good law. 

In Australia, the modern application of the duty of care and diligence has adopted a higher standard. As illustrated in Daniels v Anderson [1995] 37 NSWLR 438, the duty of care, skill and diligence is restricted to the knowledge and experience of a director in a particular circumstance or any inaction on their part. Certain special qualifications may also inform the scope of a director’s duty in this regard. In Daniels v Anderson [1995], an employee incurred and hid forex trading losses from the company by undertaking foreign currency borrowings which were unauthorised. Senior executives had failed to put in place internal control measures to adequately monitor the activities of the employee. The plaintiff, who was the auditor, failed to detect the unauthorised borrowings but warned the company’s senior executives of the inefficient control measures. He, however, failed to warn directors or alert them as to the inadequacies. The company sued the auditor who then alleged the board was liable for contributory negligence. In the determination of the case, it was held that directors have an ongoing duty to stay informed as to the corporation’s activities, “they may not shut their eyes to corporate misconduct”. The failure to inquire cannot form a defence against liability for negligence. Executive and non-executive directors have to employ the same standard of care, skill and diligence as illustrated in ASIC V Plymin, Elliot and Harrison [2003] VSC 123.

Operating with view to Profit

Under the Corporations Act 2001, s 1371E, breach of this duty attracts civil sanctions, whereby when a court is satisfied that a director has contravened the duties bestowed on the under s 180(1), they make a declaration of contravention. ASIC acts on this declaration by seeking a pecuniary penalty order under s 1317G or a disqualification order under s 206C against the contravening party. General damages in law can also be awarded to parties aggrieved by the actions of the contravening officer.

Duty of loyalty and good faith

As aforementioned, directors’ also have a responsibility to ensure loyalty and good faith in the execution of their obligations (Latimer, 2012).  Essentially, directors are expected to; “act bona fide in the interests of the company”, “use their powers for a proper purpose”, “avoid conflict of interest” and “retain their discretionary power” (ASIC, 2016). Section 181(1) (a) provides that “a director should exercise their powers and discharge their duties in good faith, in the company’s best interests and for a proper purpose”. Contravention of this provision attracts a civil penalty under s 1371E of the Act 2001 (Cth).

The duty of loyalty and good faith is derived from the fiduciary relationship between directors and shareholders; this was illuminated in Regal (Hastings) Ltd v Gulliver [1967] 2 AC 134 whereby directors act as trustees to ensure shareholder interests are met. In this case, the directors bought some property in the company’s name without shareholder knowledge or consent. The court was of the opinion that the directors had breached their fiduciary duty by placing their interests above those of the company and its shareholders (Cassidy, 2006).  Under the s 181 of the Act 2001(Cth), directors, while acting in good faith, should ensure that they avoid any situation that would compromise the company and disclose any issues that would amount to a conflict of interest in the execution of their responsibilities. 

Further, legal purposes and actual purposes are considered in establishing the component of ‘proper purpose’ under this duty. In Whitehouse v Carlton Hotel Pty Ltd (1968) 162 CLR 285, the court adopted the ‘but for’ test to determine the director’s liability. Whitehouse was a director at Carlton. He held shares in all classes in the company and decided to share them out among his family members. He issued class B shares to his wife and class C shares to his children and remained with class A shares. He decided to issue shares to his children so as to swamp everyone. In the determination of the case, it was held that ‘but for’ Whitehouse’s intent to transfer control, the shares would not have been issued as such the purpose, in this case, was improper as it was based on personal interest.

In Pine Vale Investments Ltd v McDonnell and East Ltd [1983] 1 ACLC 1294, Pine Vale Investments made an announcement to show intent of making a takeover bid for McDonnell. McDonnell then entered an agreement to acquire the business of another company and issued new shares to existing shareholders. The court held that the issue of shares was proper purpose as there was need for the company to raise capital as well as defeat a takeover bid.

In addition to the civil consequences for breach under s 181, s 184 of the Act 2001 (Cth) provides that failure of a director to execute the obligations bestowed on them under the Act in good faith and for a proper purpose constitutes a criminal offence. 

References

ASIC v Plymin, Elliott and Harrison ( [2003]) VSC 123.

ASIC, 2016. Directors-What are My Duties as A Director?. [Online] Available at: https://asic.gov.au/regulatory-resources/insolvency/insolvency-for-directors/directors-what-are-my-duties-as-a-director/ [Accessed 19 May 2018].

Australin Institute of Company Directors, 2016. General duties of directors. [Online] Available at: https://aicd.companydirectors.com.au/~/media/cd2/resources/director-resources/director-tools/pdf/05446-6-2-duties-directors_general-duties-directors_a4-web.ashx
[Accessed 19 May 2018].

Bond Corporation Holdings Ltd & Anor v Grace Bros Holdings Ltd & Ors ((1983)) 1 ACLC 1009.

Cassidy, J., 2006. Concise Corporations Law. Sydney: Federation Press.

CCH Australia Ltd, 2011. Australian Corporations & Securities Legislation: Corporations Act 2001, ASIC Act 2001, related regulations. s.l.:Wolter Kluwer Group.

Cox v Hickman ((1880)) 8 HL Cas 268; 11 ER 431.

Daniels v Anderson ([1995]) 37 NSWLR 438.

Gibson, A. & Fraser, D., 2013. Business Law 2014. NSW: Pearson Higher Education AU.

Lang v James Morrison & Co Ltd ((1912)) 13 CLR 1.

Langford, R. T., 2014. Director’s Duties: Principles and Application. s.l.:Federation Press.

Latimer, P., 2012. Australian Business Law. Sydney: CCH Australia Ltd.

Longman, 2003. Dictionary of Contemporary English. Essex: Pearson Education Limited.

Pine Vale Investments Ltd v McDonnell and East Ltd ( [1983]) 1 ACLC 1294.

PWC Australia, 2011. A Guide to Directors’ Duties and Responsibilities for non-listed public companies in Australia. [Online] Available at: https://etraining.communitydoor.org.au/pluginfile.php/608/course/section/95/GuideDirectors_Apr08.pdf [Accessed 19 May 2018].

Re City Equitable Fire Insurance Co Ltd ( [1925]) Ch 407.

Re Ruddock ((1879)) 5 VLR (IP & M) 51.

Regal (Hastings) Ltd v Gulliver ( [1967]) 2 AC 134.

Smith v Anderson ((1880)) 15 ChD 247 .

Whitehouse v Carlton Hotel Pty Ltd ((1968)) 162 CLR 285.

Wise v Perpetual Trustee Co Ltd ( [1903]) AC 139