Month: November 2012

Director’s Duties Become More Onerous

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Carefully consider your responsibilities.

Many of us are company directors and often sit on boards to assist in the efficient management of the business operations.

Below are a couple of cases worth noting as they have wide implications for those bold enough to put themselves up as an ‘officer’ of a Corporation.

Shafron v. Australian Securities and Investments Commission [2012] HCA 18 considered the extent of the duty owed under s.180(1) of the Corporations Act 2001 (Cth). In particular, it considered the extent of the phrase ‘in their position and with their responsibilities’ and the definition of ‘officer’ under the Corporations Act. The applicant was the company secretary and general counsel of James Hardy Industries Ltd (JHIL) and it was alleged that he had failed to display an appropriate degree of care and diligence in that he failed to give appropriate advice to the board of JHIL on two separate occasions, and on one occasion also failed to give appropriate advice to the chief executive officer.

The principle question before the trial judge, Court of Appeal and High Court was whether the applicant’s responsibilities under s.180(1) extended to his duties as general counsel or were limited to his responsibilities as company secretary. There was no argument that, as company secretary, the applicant was an officer of JHIL, but the applicant argued that his ‘responsibilities’ as an officer should be limited to the role that made him an officer, i.e. his position as company secretary. Notwithstanding that the Court ultimately found him to be an officer in either capacity, the High Court held that the duties of an officer under s.180(1) extends to all roles undertaken by the officer within the corporation unless there is a clear distinction between actions undertaken in one capacity and actions undertaken in another. The applicant was not able to demonstrate any such distinction.

It was further argued by the applicant that his duties as company secretary did not extend to the provision of legal advice and that it was not, therefore, a breach of s.180(1) for him to fail to give that advice. The trial judge, Court of Appeal and the High Court all rejected this assertion, concluding that a company secretary with a legal background would be expected to raise legal issues to the board. Even if the applicant was not the general counsel of JHIL, he would still owe this responsibility.

The applicant claimed that he was not, as general counsel, an officer of the company (admitting to being an officer as company secretary) because the general counsel did not make, or participate in making, decisions that affected the whole or a substantial part of the company, as required by s.9(b)(i) of the Corporations Act 2001 (Cth). He submitted that a person participates in making a decision only if they had a part in actually making the decision.

The High Court rejected this argument. The Court held that participating in making a decision required more than simply offering advice and information, but found that the applicant, as a senior executive of JIHL had gone beyond the mere offering of advice. He had played an active part in formulating the proposals that went before the board so, though it was the board that ultimately made the decision, he participated in making it. This was deemed sufficient to make him an officer in his role as general counsel of JIHL.

Omnilab Media Pty Ltd v. Digital Cameras Network Pty Ltd [2011] FCAFC 166 considered both the duty of directors to not disclose business opportunities to a rival company and the accessorial liability of that rival company for the loss occasioned by the first company.

In regards to the duty owed by the director, the Federal Court found that the means by which the business opportunity had been acquired was irrelevant, as was any reluctance by the person giving the business opportunity to grant it to Digital Cinema Network Pty Ltd (DCN). What was important is that it was a maturing business opportunity that DCN was actually pursuing. By diverting the business opportunity to another company with which he was associated, the director breached his duty. There was significant evidence that Omnilab Media Pty Ltd (Omnilab) knew that the director was breaching his duty by diverting the business opportunity to them and they therefore had accessorial liability for his breach.

Australian Securities and Investments Commission v. Healey and Others [2011] FCA 717 considered the duty of directors in relation to annual financial reports.

The directors in that case had relied on management and external advice when adopting and approving the 2007 financial statements. The 2007 statements contained misclassifications and failed to make full disclosure. As a result, the company suffered loss. The Federal Court found that the directors were required to exercise due care and diligence under s.180(1) of the Corporations Act 2001 (Cth) when considering the financial statements and, further, under s.344 then had to take all reasonable steps to ensure the financial statements complied with financial reporting provisions. The Court held that the directors were not entitled to delegate their responsibilities under these sections and, by failing to read, understand and consider the financial statements they had each breached their duties to the company.

This certainly raises the bar for the level of compliance for company officers and all directors or secretaries should take notice!

ATC Digest Edition #87

Business Succession and Property

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Each business will have its unique requirements.

I assisted some clients in relation to a business succession agreement for four partners in a successful business.

At the time of formation of the original business entity, there was a simple husband and wife team. Over the years, the business grew. They were joined by their management executive and they sold shares in the company as a result.

The business expanded again and they sold a further tranche of shares to another key management person.

During the expansion phase they also had the opportunity to purchase the business real property from which the business was conducted.

As it was around the time of the last manager’s buy in, he could not afford to purchase an interest in the property as well.

So the end reality was four business owners and three property owners.

They acquired the property in a separate family discretionary trust as tenants in common in one-third shares each. A commercial lease was established between the business trading entity and the three trusts as owners of the property.

All simple so far…

The question arose as to how to deal with the property interests upon death of a principal in the business.

It is a simple matter for the one that did not buy in, as it is simply the value of his interest in the shares of the trading entity. However, when it comes to the buy/sell agreement for the three that have an interest in the property, this was a completely different matter.

The issues are

  1. Does the deceased business owner need a continuing interest in the real property
  2. Is there a greater inherent value to the property in light of the commercial lease linked to the business
  3. Should the principals be able to leave the property interest to their family in their estate as a separate matter from the business
  4. Does the buy/sell agreement take account of the goodwill attached to the business premises?

These questions were more difficult to answer than I first thought. It was always a regret of the last owner to buy in that he did not acquire an interest in the property as well. It may be that this is dealt with separately and there is no requirement to sell down the interest in the property.

In the interim, a solution was reached so that the value placed upon the business had a recognition of the business premises, pursuant to the long-term lease in place with the current owners.  A simple buy/sell agreement was prepared to allow for self insurance of the principals in the business.

Further, self-owned policies were put in place for the property ownership via the family trusts. It was an issue as to how the mortgage facility was structured and the parties are considering a variation to the agreement that governs the holding of the property. I have recommended that this be included in the buy/sell agreement, to allow the continuing owner that presently does not have a share in the property, a right of first refusal to buy that interest of the departing principal.

All sorted, for now…

ATC Digest Edition #86

Do You Know Your Shareholders?

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You probably can’t stop disputes, but you can diffuse them more easily.

It is a critical step for a business owner to understand the implications of an agreement with the people they own the business with and the rules, should they have a dispute.

Commonly, parties confirm how a company should be managed by the terms of a Shareholder’s Agreement.  However, often I find that people do not bother with such an agreement. They feel when times are good there is less chance of an argument, or they have a perception the costs of preparing this document are too high.

The reality is that, if the parties have a dispute, the costs will be enormous.

Here are a few tips and pointers in preparing a document and understanding its importance.

Directors

  • Directors should be carefully chosen to ensure that control and daily management of the company occurs in a way that reflects the understanding of all concerned.
  • There are very serious obligations on directors, including Workplace Health and Safety liability, tax liability and Corporate Act penalties for non-compliance. This includes keeping proper accounts, acting in the interest of the company as a whole and not obtaining a benefit where there is a conflict of interest.
  • The specific roles of each director should be set out clearly, whether it is finance, accounting, marketing, legal or management of staff.
  • The degree of delegation and authority to a director, including signatures required on cheque accounts or transfer of funds from a bank, should be clearly stated. Often small companies have at least two directors that must sign for the capital account and just one director or a secretary for a smaller operational account.

Limitations

  • A Shareholder’s Agreement should describe the limitations placed on directors in acting on behalf of the company. That might be the credit limits that apply for which they can commit the company and should state the maximum debt a single director can write off or compromise. It should also state how many directors must sign cheques and other negotiable instruments or contracts.
  • The quorum or number of directors required to form a valid meeting should be clearly outlined. The ability to appoint a proxy or alternate director in writing should be described. If there is a managing director with a casting vote, then that should be very clearly enunciated within the document.
  • The role of managing director should be described sufficiently including the process and frequency of appointment.

Voting

  • The equality of votes, or otherwise, by the directors appointed to the board should be clearly stated.
  •  If there is to be a casting vote on certain issues by a managing director, or if there is a deadlock, that should be included.
  • Whether a shareholder has the right to one vote at a shareholder’s meeting or whether votes are attributable to the number of shares held, then that should be clearly stated.
  • Whether the shareholders votes are affected by restricted issues should be included and it should identify the input of a non-shareholding director in the management of the company.
  • Any Shareholder’s Agreement should be resolved in general meeting to override the constitution, when appropriate, on specific issues.
  • Points such as a full sale of the business might need a unanimous decision of shareholders, as well as the admission of new shareholders or transfer of shares.
  • The events of default of a director or shareholder, including breach of agreement, insolvency, disability or perhaps death should be dealt with.
  • The process of meetings including how regular, where and agenda decisions should be included.
  • On exit of a shareholder there should be a reference to an independent valuation and perhaps a conditional grant of options subject to the event. A notice of retirement of director and whether that triggers a compulsory sale of their shares should be considered.
  •  The methods of dispute resolution should be canvassed including compulsory mediation and whether that appointment is by way of a professional expert.

Other issues

  • In reality, this Shareholder’s Agreement will be the document that is used if the parties cannot agree. It should have a positive emphasis, including the specific vision for the company and perhaps growth targets anticipated by the shareholders within an agreed time frame if they aim to grow the business or sell within a specific period.
  • If there are specific business planning issues, targets such as achievement of quality control or accreditation, then they should be included.
  • Specific qualities of a director or financial position of a shareholder should be specified as well.
  • Requirements regarding retirement of a director or exit of a shareholder by voluntary notice should be clearly stated in writing. This should take account of the position of the company and the financial framework.
  • If the shareholders are contributing capital then they should record any loans on the balance sheet.

If the directors require further loans from working capital or stock or plant and equipment, then each director and perhaps each shareholder should guarantee the loan equally in accordance with their shareholding to make sure there is fairness between them. If there are different levels of contribution of capital loans by shareholders or directors to the company then that should be recorded in formal loan documents and interest paid.

By having a clear checklist of these issues completed by the parties at the outset, it is less likely that a surprise or a point of dispute will occur in the future.

Independent accounting and legal advice should be obtained by each shareholder on a proposed Shareholder’s Agreement to ensure that all parties understand their obligations and requirements.

At the end of the day, people get together to create company value. It is, therefore, important to ensure that the rules are understood so that that value is preserved wherever possible.

ATC Digest Edtion #85