Are there grounds for Butterfly to sue some or all of John, Paula, George, Robyn or Brian in relation to entering into the lease and the marketing plan?

1.

John, Paula, George and Robyn are experts in the mining business and have been engaging in various business activities. Due to their concern regarding the liability involved in an unincorporated business and decided to form a company called Butterfly Pty Ltd. Robyn entered into a lease on behalf of the company which was immensely expensive and George gave a marketing contract to his brother Tom which was also expensive. In the first meeting of the shareholder/directors the incorporation of the company was declared and these contracts were agreed upon. The issue here is if there is any breach by any of these shareholders/directors and if Butterfly can successfully sue them for the same.

In the case of- North side Development v Register-General as an example the principles of separate legal entity of a company was discussed. The court stated that the identity of the company is different from the identity of the owners. Section 198A provides that a person who has been appointed as the director of the company has the power of carrying out all obligations which are required for the operations of the company. According to the principles of the Agency Law the Director is the agent of the company. Companies functioning within the jurisdiction of the Australian Commonwealth are administrated and governed under the provisions of the Corporations Act, 2001 (Cth)[1]. This act defines all necessary scenarios that may arise when incorporating, carrying on business as or winding up a company. A promoter under company law is a person who undertakes various steps in order to facilitate the formation of a company. This position was reiterated in the landmark judgment Twycross v Grant[2]. Pre-registration contracts are contracts entered into on behalf of the company before incorporation. Under general law, promoters of a company have a fiduciary duty to act in the best interests of the company and avoid conflicts of interest as prescribed by the judgment in Gluckstein v. Barnes[3]. As envisaged by the provisions of Section 131 (1) of the Corporations Act, 2001 (Cth), pre-registration contracts entered into by promoters would have to be ratified by the company at the time of incorporation or within a reasonable time thereafter[4]. Section 131 (2) of the Corporations Act, 2001 (Cth) states that in case the company does not ratify these pre-registration contracts the persons entering into the same would be held liable for any liabilities arising from these contracts[5].

Must Butterfly pay for the financial advice provided by Sally after the acquisition of all shares in Butterfly by Xco Ltd?

As per Section 132 (1) of the Corporations Act, 2001 (Cth) the third party in the pre-registration may release the individual from liability. In such a case the debt or liability would be extinguished and neither the party entering into the contract nor the company itself would be liable for the debts or liabilities arising from such a pre-registration contract. The general law relating to pre-registration contracts in repealed within the Australian Commonwealth and the provisions of the corporation act would apply in its place and stead. This is prescribed under Section 133 of the Corporations Act, 2001 (Cth)

The Actual Authority allows a third party to act on behalf of the organization and engages itself in the decision making process for the organization or a particular agency. Therefore the acts, decisions or authorization taken by the third party acting with the actual authority of the organization is believed to be legally binding and enforceable before the law. The express actual authority generally occurs when the third party is told that he has the permission to act on behalf of the company or the agency. The example of an actual authority is the case of Eva Weaver vs. Priscilla Deverell.

Under the given set of facts and circumstances it can be assessed that John, Paula, George and Robyn were sharing an office space that they rented together however due to the unincorporated nature of their business activities the same would amount to unlimited liability hence would be risky business venture. Due to this, John, Paula, George and Robyn decide to incorporate a company and enter into pre-registration contracts. Therefore as per the provisions of the Corporations Act, 2001 (Cth) and judgment laid down in Twycross v Grant it can be inferred that John, Paula, George and Robyn were acting as promoters of the company.

Under general law also known as common law or jus commune the promoters of a company have a fiduciary duty to act in the best interests of the company and avoid conflicts of interest[6]. This has also been stated in the case Gluckstein v. Barnes. This means that the promoters must ensure that their action during the time of the formation of the company do not have detrimental effects on the company. Moreover, acting in self-interest as opposed to the interests of the company would also not be endorsed under general law.

In this case Robyn entered into a lease which would be extremely expensive for the company and the company faced financial difficulties due to the same however,  Robyn and a few of the other directors thought it would be extremely profitable  and resultantly Robyn was acting in good faith. Hence this duty was not breached. George on the other hand gave the marketing campaign to his brother who was not getting a lot of work and resultantly was acting in self-interests. He additionally did not disclose the same hence he was in breach of fiduciary duty under general law. Moreover, the problem with this transaction was that it additionally caused detriment to the company. However, these breaches would not be considered for the reasons discussed below.

Legal principles of separate legal entity of a company, fiduciary duties of promoters and directors, pre-registration contracts, and actual authority of third parties

As stated by Section 131 (1) of the Corporations Act, 2001 (Cth) a company may ratify pre-registration contracts at the time of incorporation or within a reasonable time[7]. In case the company does ratify the contracts they would form a part of the pre-registration obligations it would observe then the company would be liable for the debts arising from such contracts. In this case, the first meeting after the incorporation of the company recorded (through signatures) that all the pre-registration contracts were ratified. Hence, as per the provisions of the Corporations Act, 2001 (Cth) these contracts would be borne by the company and furthermore the company would not be able to sue the individuals entering into the contracts since these are now contracts of the company.

The ratification is believed to be the process where the company adopts the actions of a particular person who tends to purport any kind of contract on the behalf of that company without informing the company itself. Ratification generally operates as a retrospective grant of actual authority to the agent of the company.

Conclusion

To conclude, the company will not be able to sue some or all of the Shareholders/directors, namely, John, Paula, George and Robyn. This is because the pre-registration contracts are entered into by the company due to the ratification.

2.

Following the scenario given above, John, Paula, George and Robyn have incorporated a company and are carrying on business activities under the same name. The company has been deemed to be under financial difficulties and would need to be wound up or acquired by another company. A company Xco Ltd was interested in making the purchase and the same was allowed by people. Under these circumstances, John who a director in the company had met Sally two weeks before the acquisition by Xco and had asked for advice relating to investments. These investment advices were clubbed in a single invoice and sent to Butterfly a week after the acquisition had taken place. Thus, the issue here is to determine if this invoice would have to be paid for by Butterfly since its ownership and management have changed over the last few weeks.

The Corporations Act, 2001 (Cth) defines provisions that deal with the debts and liabilities of companies formed in or carrying on business activities inside the jurisdiction of the Australian Commonwealth[8]. These would ideally define the mode of discharge of liabilities in case of change of ownership and also would regulate provisions relating to the authority and capacity of individuals acting within the same place.

Impact of a change in company ownership on debts and liabilities

A company is a separate legal entity and resultantly can exercise the rights of a juristic person. This means that the company can enter into transactions and contracts in its own name and additionally can be legally pursued as a distinct legal person. The company can additionally sue other entities in its own name. However, in practicality it may be stated that the company cannot act on its own as all its decisions are taken by members of the administration of the company. In doing so it may be inferred that when dealing with third parties a member of the administration who holds the authority and capacity to do the same would enter into the transactions on behalf of the company. Authority can be of various kinds mainly actual, implied and ostensible. According to the provisions of Section 126(1) of the Corporations Act, 2001 (Cth), a company has the authority to alter or discharge a contract that can be exercised by an individual who can perform the activities on behalf of the company. Common Seal does not play a major role in it. Section 129 of the Corporations Act, 2001 (Cth) states when dealing with a company the person so dealing with it can assume that the company constitution has been complied with, a person dealing in the capacity of a director has express authority [Section 129 (2)] and a person dealing in the capacity of an employee or agent would have implied authority [Section 129 (3)].

In terms of ostensible authority it is assumed authority when the same can be inferred from the conduct of the person dealing with the third party[9]. This position has been clarified in the judgement in Freeman and Lockyer v Buckhurst Park Properties (Mangal) Ltd[10]. Therefore in case the authority exercised by a person falls within one of the categories, it may be assumed that these parties can enter into transactions and contracts on behalf of the company[11]. In the event such authority is exercised the contract or transaction would be part of the company’s debt and liabilities and resultantly would have to be borne by the company.

From the given set of facts and circumstances it may be assumed that in case a person holding authority as prescribed under the provisions of the Corporations Act, 2001 (Cth) exercises the same in order to enter into transactions on behalf of the company, by virtue of this authority the company would be liable for all debts arising from such a transaction. In this case it maybe stated that Butterfly was under financial troubles and would have to be acquired by another entity. The company Xco Ltd would be the acquiring entity. Two weeks before the acquisition a person who was the director of Butterfly at the time (John) consulted an advisor (Sally) on investments the company can enter into. Under Section 129 of the Corporations Act, 2001 (Cth) it maybe stated that as a director the third party dealing with the same would have assumed that the company constitution has been complied and would also assume that this person has the authority to act in the said manner[12].

 John was acting in the capacity of a director and under the provisions of Section 129 (2) of the Corporations Act, 2001 (Cth) it may be inferred that as a director John had actual authority to do the same[13]. Therefore, when Sally entered into transactions with a director of the company the same would be inferred to be a transaction with the company itself. Hence, ideally the transaction with John would be a contract which the company had entered into. All of Butterfly’s shares were acquired by Xco Ltd and as a result the same would mean that the ownership of the company has completely changed. However, being a company Butterfly Pty Ltd is a separate legal entity and is therefore distinct from its ownership and management[14]. Even after such an acquisition the company would be considered to have entered into the transaction with Sally and would be liable to pay any debts that arise from the transaction. This would also mean that the company would have to pay for the invoice which encompasses various transactions relating to advice delivered by Sally on several investment opportunities which could be used by the company.

Conclusion

To conclude, even after the acquisition by Xco Ltd, Butterfly would be liable to pay for the advice given by Sally as a transaction it had entered into on its own.

Corporations Act, 2001 (Cth).

Twycross v Grant [1877] 2 CPD 469

Gluckstein v. Barnes [1900] A.C. 240

Freeman and Lockyer v Buckhurst Park Properties (Mangal) Ltd [1964] 2 QB 480

Baxt, Robert, Paul Augustine Usman Ali, and Robert Thomas, eds. Company and Securities Law Journal. Thomson Reuters (Professional) Australia Limited, 2015.

Ferran, Eilís, and Look Chan Ho. Principles of corporate finance law. Oxford University Press, 2014.

Finch, Vanessa, and David Milman. Corporate insolvency law: perspectives and principles. Cambridge University Press, 2017.

Gullifer, Louise, and Jennifer Payne. Corporate finance law: principles and policy. Bloomsbury Publishing, 2015.

Hannigan, Brenda. Company law. Oxford University Press, USA, 2015.

Hanrahan, Pamela F., Ian Ramsay, and Geofrey P. Stapledon. “Commercial applications of company law.” (2013).

Hayne, K. M. “Directors’ duties and a company’s creditors.” Melb. UL Rev. 38 (2014): 795.

Klettner, Alice, Thomas Clarke, and Martijn Boersma. “The governance of corporate sustainability: Empirical insights into the development, leadership and implementation of responsible business strategy.” Journal of Business Ethics122.1 (2014): 145-165.

McLaughlin, Susan. Unlocking company law. Routledge, 2018.

Sealy, Len, and Sarah Worthington. Sealy & Worthington’s Cases and Materials in Company Law. Oxford University Press, 2013.

[1] Hanrahan, Pamela F., Ian Ramsay, and Geofrey P. Stapledon. “Commercial applications of company law.” (2013).

[2] [1877] 2 CPD 469

[3] [1900] A.C. 240

[4] Sealy, Len, and Sarah Worthington. Sealy & Worthington’s Cases and Materials in Company Law. Oxford University Press, 2013.

[5] Gullifer, Louise, and Jennifer Payne. Corporate finance law: principles and policy. Bloomsbury Publishing, 2015.

[6] Hannigan, Brenda. Company law. Oxford University Press, USA, 2015.

[7] McLaughlin, Susan. Unlocking company law. Routledge, 2018.

[8] Ferran, Eilís, and Look Chan Ho. Principles of corporate finance law. Oxford University Press, 2014.

[9] Baxt, Robert, Paul Augustine Usman Ali, and Robert Thomas, eds. Company and Securities Law Journal. Thomson Reuters (Professional) Australia Limited, 2015.

[10] [1964] 2 QB 480

[11] Hayne, K. M. “Directors’ duties and a company’s creditors.” Melb. UL Rev. 38 (2014): 795.

[12] Corporations Act, 2001 (Cth).

[13] Finch, Vanessa, and David Milman. Corporate insolvency law: perspectives and principles. Cambridge University Press, 2017.

[14] Klettner, Alice, Thomas Clarke, and Martijn Boersma. “The governance of corporate sustainability: Empirical insights into the development, leadership and implementation of responsible business strategy.” Journal of Business Ethics122.1 (2014): 145-165.