Question 5 (11 marks)(Note this question is from the Week 8 Tutorial) Required:Explain the nature of the fiduciary duties owed by a director. Discuss specifically the four (4) areas relating to the directors’ duty of loyalty to the company.(Word Limit: Maximum 600 words)
Question 6 (7 marks) (Note this question is from the Week 11 Tutorial)Discuss the role of a receiver. How does the role of a receiver differ from that of the administrator or liquidator?(Word Limit: Maximum 300 words)
HA3021 Week 8 interactive tutorial questions – Duties of Directors and Other Officers 1. Outline the duties and obligations of directors and officers. The obligation of a director or officer of the company comes under contract law (see s 140(1)(b)), the law of agency (common law), fiduciary law (equity) and the statutory provisions of the Corporations Act. Ensuring that the directors and officers of a company comply with their duties is a responsibility of the company (including fellow directors and the shareholders and other officers who ultimately control and manage the company, such as liquidators) and the regulator (ASIC). The regulator (as a representative of society) is concerned about the appropriateness of the person to be a director (remember under the separation of powers that the operators manage the affairs of the company). Its role is to protect shareholders, punish, set an example to others of the standard expected and deter others. The company can seek civil remedies against directors for their breaches (contract, fiduciary or statutory) and ASIC can institute legal proceedings seeking civil penalties (such as civil penalty orders and disqualification orders) and ultimately instruct prosecutors to seek criminal sanctions such as fines or jail terms. 2. Oriel, Lars and Reese are directors of Sweetie Pty Ltd. Sweetie owns and operates a very profitable confectionary retailing business. Reese owns 50 shares in Sweetie and Oriel and Lars each own 25 shares. Oriel and Lars have a bitter disagreement with Reese. Lars calls a board meeting and the following resolution is proposed. Cheri is Oriel’s wife. Oriel and Lars vote in favour of the resolution and to vote Reese off the board. At the meeting Cheri, Oriel and Lars vote Reese off the board. The next week, Oriel and Lars hold a directors’ meeting and appoint Cheri as a director. Did the directors breach any of their duties in passing the resolution to issue the shares to Cheri? Answer: The board of directors has the power to issue new shares in the company, but the power must be exercised for a proper purpose: Mills v Mills (1938). This is mirrored in section 181(1)(b) of the Corporations Act. A proper purpose for issuing shares is: • raising capital, • employee incentive schemes, or • for acquisitions. An improper purpose for issuing shares would be for the purpose of: • retaining control, or • depriving shareholders of rights. It is legitimate for the board to issue new shares, if it is to raise capital (as per the resolution). If the purpose of the share issue is to deprive another shareholder of their rights is not a proper purpose. Where officers may be motivated by a number of purposes — some of which are proper and some of which are improper —the court will ask whether the act would have been performed if it were not for the reasons behind the improper purpose: Whitehouse v Carlton Hotels Pty Ltd (1987). 3. Luis is a director of Papadapolis Ltd. Papadapolis Ltd sells toy dolls called ‘Cute Kids’. The dolls are not selling well and the company is running low on working capital. To remedy the situation, Luis obtains an unsecured loan of $1 million. Luis thinks that the company will be able to pay the loan back because it is nearing the end of the year and his projections suggest he will sell lots of dolls around Christmas. Unfortunately, things don’t go as expected and Luis doesn’t sell as many dolls as he anticipated. It is now January — a slow period for selling dolls. Luis is aware of s 588G of the Corporations Act and doesn’t want to breach it. He hires Shoddey&Dadgy Accountants to prepare a solvency report. The report shows that Papadapolis Ltd has net assets and, based on projections, can pay its debts when they fall due. Based on the report, Luis has the company enter into a contract to purchase $10 million worth of material for doll manufacturing. (a) It transpires that Shoddey&Dadgy’s report was incorrect, and Papadapolis Ltd is placed into liquidation. Does Luis have any liability under s 588G of the Corporations Act? (b) How would your answer be different if Luis was ill when the contract was entered into, and instead his fellow directors made the decision to move forward with the contract? (c) How would your answer be different if Luis did not seek a solvency report, but entered into the contract because he thought that the company was performing well? (d) What if his fellow directors were eager to enter into the contract but Luis was against it, even after reading the solvency report? How would you have advised Luis? Answer: a) The main issue is to determine the principles of liability for insolvent trading, including access to any defences available for Luis under Corporations Act section 588G. Liability will be established if: 1. Luis was a director when the debt was incurred 2. At the time the debt was incurred the company was insolvent or would become insolvent by incurring the debt or the were reasonable grounds to suspect the company was insolvent or would become insolvent by incurring the debt. 3. Luis was aware there were grounds for suspecting or a reasonable person in Luis’s position would be aware. The court will look at whether a director has a basic understanding of the company’s financial status and ask whether the director was aware at the time the debt was incurred that there were reasonable grounds to suspect the company was insolvent. This assessment will be based on whether a reasonable person in the same position as the director would have suspected insolvency. This is one of the standards of care and diligence to understand financial information. in Queensland Bacon Pty Ltd v Rees (1996) 115 CLR 266, this would involve ‘ a positive feeling of actual apprehension and not mere speculation’. It appears that there were reasonable grounds for suspicion and that Luis was aware of those grounds as he commissioned the report. However, commissioning the report is also a proactive action: Corporations Act section 588G (5) may provide Luis with a defence as a result him engaging Shoddy and Dodgy for their report, ‘directors took all reasonable steps to prevent the company from incurring the debt’. The next issue is to determine the ambit of the defences in section 588H. In summary, to successfully defend a breach, a director must: • have reasonable grounds to expect the company to be solvent based on their own knowledge (e.g. their understanding of financial statements), or • have reasonable grounds to expect the company to be solvent based on a reasonable reliance on information supplied by another person (e.g. the financial controller), or • have been absent from management due to illness or some other good reason, or • have taken all reasonable steps to prevent the company incurring debt — a major incentive for a board of directors to call in external expertise and place the company under voluntary administration is to show reasonable steps to avoid insolvent trading. The extent of any proactive actions enlivens the safe harbour protection. Section 588GA provides for ‘a safe harbour’ under which directors are shielded from liability under s 588G. The safe harbour is available when the following conditions are met (s 588GA(1) of the Corporations Act): • at a particular time after the person starts to suspect the company may become or be insolvent, the person starts developing one or more courses of action that are reasonably likely to lead to a better outcome for the company; and • the debt is incurred directly or indirectly in connection with any such course of action, etc. In Luis’ case, there is not a strong connection that the new borrowing is part of a course of action for restructuring or getting the company out of debt but it is a useful discussion point. (b) Luis may have a defence under Corporations Act section 588H if he did not take part in the decision as a result of illness. (c) Luis’s own belief is not sufficient to avoid breach of the section, Luis would need to show what a reasonable person in a company in the circumstances of Papadapolis Ltd would have thought. (d) Luis would need to show that he took all reasonable steps to prevent the company from incurring the debt. Luis should document the steps he took under Corporations Act section 588G (4). Tutorial questions – Week … HA3021 Week 11 interactive tutorial questions – Insolvency; External Administration 1. Explain what happens when a company is placed into receivership. When a receiver is appointed, it is entitled to take control of the secured asset and manage or sell it to use the proceeds to repay the money owing to the creditor. The receiver owes duties both to the creditor that appoints them and to the company, as a receiver is an officer under the definition in s9. If the secured assets comprising both circulating and non-circulating assets are managed or sold by the receiver, it should be considered whether the receiver can trade the company out, or whether the company’s business is no longer viable. Another issue to consider is how the creditor would recover any shortfall and how the creditor would overcome any shortfall (personal guarantees, other assets as security). At the time of sale of the assets, the receiver has a duty to take reasonable care to sell at market value. However, the sale may not represent the true market value that would exist under normal circumstances and not under fire sale conditions. 2. Explain the process of voluntary administration. If the company directors feel the company can survive, then under s435A, this is the aim of the voluntary administration regime. Appointing an administrator is a proactive step directors can take to avoid insolvent trading liability. If there is no prospect of survival, then consider liquidation. The role of the administrator in terms of s435A is to maximise survival, or maximise return to creditors in a winding up. The voluntary administrator reports back to creditors after making investigations — at the first meeting within 5 days (s436E) and the second meeting within 20–25 days under s439A. At the second meeting, there are only three recommendations the administration can make: end voluntary administration; enter into a deed of company arrangement; or wind up. The decision is made by the creditors by a voting system referred to ‘majority