Welcome to Contemporary Australian Corporate Law. Our primary purpose in writing this book is to explain the rules, principles, doctrines and policies that constitute corporate law in Australia. We do this by locating those rules in their legal, social, economic and political context: our purpose is to provide students of corporate law with the capacity to develop a contextual understanding of this important area of law.

The book is written for undergraduate and postgraduate law students who are approaching the study of corporate law for the first time, and for those returning to investigate specific aspects of the law. We have made no assumptions about the background which individual students may bring to the reading of this book. We know that corporate law is studied by students with a range of disciplinary interests, from economics and commerce to political science and international relations, and more.

We take the view that corporate law is not just a branch of business or commercial law. It is the law that governs and facilitates one of the most significant legal, social and economic structures in contemporary society: the corporation. The corporation, in its many different forms and settings, is an integral part of the contemporary social fabric. Corporations are found in every part of our lives; this book is published by a corporation, and its authors are employed by statutory corporations. We have written this book using computers and software that have been developed, built and supplied by multinational chains of corporations.

It is easy to be critical of corporations and their activities. There are many – too many – examples of corporate misfeasance and misbehaviour that involve environmental damage, financial collapse, personal injury and death, or neglect of human rights. We examine some of this behaviour in this book. However, as US corporate law academic Professor Lynn Stout emphasises, ‘We created corporations; now we share the planet with them’. This underlines the need to understand the parameters of corporate behaviour, and that means understanding the law which governs that behaviour.

Of course, not everyone is sceptical about the role of corporations. Historically, the significance of the corporate form has sometimes been praised in glowing terms. In 1911, for example, one commentator described the limited liability company as ‘the greatest single discovery of modern times’, adding that ‘even steam and electricity are far less important’!

Introduction

Directors’ duties can be classified into two themes: duties in relation to care and skill, and duties in relation to loyalty and good faith. Chapter 10 provided an overview of the duties as a whole, and Chapter 11 provided the history and current law for those duties which are related to care and skill. Chapter 12 was the first of two chapters addressing the duties of loyalty and good faith and discussed the duty to act bona fide in the interests of the company and for proper purposes, and the duty not to fetter discretions. This chapter deals with the standard of conduct expected from directors by the fiduciary obligation, the duties in the Corporations Act ss 182–183, and the duties on disclosure of material personal interest of directors in ss 191–195 and ch 2E of the Corporations Act. All of these duties relate to the issue of conflict of interests.

First, the chapter canvasses the history of the fiduciary obligation as it applies to the director– company relationship. The fiduciary obligation includes two duties: a duty of loyalty and a duty to account for benefits gained – more informally termed the ‘no conflict’ and ‘no profit’ rules. The chapter then discusses examples of the ‘no conflict’ and ‘no profit’ rules from case law, and the modern exceptions to this general principle on the basis of commercial realities, such as the business opportunity rule. It then considers ss 182–183 of the Corporations Act which deal with a director's misuse of information or position to gain an advantage for themselves or others, or to cause detriment to the company. These sections have a clear analogy to the ‘no profit’ rule, but have developed differently since enactment as legislative provisions. The chapter considers the requirements for directors to disclosure their material personal interests under ss 191–195, and the inconsistent treatment of the disclosure requirements with the ability of a fiduciary to seek the fully informed consent of the company in general meeting for what would otherwise be a breach of their fiduciary obligation. Finally, the chapter considers the protection afforded to members of a public company under ch 2E of the Corporations Act in relation to related party transactions.

Introduction

A company is a legal entity, distinct from its creators, members, directors and managers. The separate legal status of the company is discussed in Chapter 3 of this book. For the purposes of this chapter, we emphasise that for a company to come into existence there must be a conferral of that status by the state. Unlike some other forms of association, such as a partnership, it is not legally effective for a group of people to simply declare themselves to be a company. A company is a type of corporation. The corporate status of a company is brought into existence through a process of registration under the Corporations Act. Other types of corporate entities are created by different legislative mechanisms, and we briefly describe some of these later in this chapter.

Defining ‘corporation’

A company is a type of corporation. While the focus of this book is on companies, some sections in the Corporations Act refer to ‘corporation’, while others refer to ‘company’. Accordingly, it is useful to focus for a moment on the scope of the term ‘corporation’.

Section 57A defines the term ‘corporation’ for the purposes of the Corporations Act (the Act). It does this by specifying, in a non-exhaustive way, four types of entity that fall within the definition, and by excluding others. Once the specific exclusions are noted, the definition of ‘corporation’ in the Act is open-ended.

Section 57A(1) and (3) provide that the term ‘corporation’, wherever it is used in the Act, includes (but is not limited to) four types of entity:

Introduction

This chapter addresses the rights of company members to protect their own interests or those of the company. The chapter focuses on the rights of shareholders in a company limited by share capital, but the principles and rules discussed here apply equally to members of companies limited by guarantee. The legal protections and remedies discussed here can arise in a number of situations.

A typical situation is a contest of interests between shareholders and those who control the management of the company. The matters which can give rise to a dispute include: disregard by management of a shareholder's rights (including rights to participate in meetings); dilution of a shareholder's voting power by the issue of new voting shares; ongoing mismanagement of the company; few or no dividends being paid to shareholders; involuntary expropriation of shares; alterations to the constitution that disadvantage minority shareholders; and inadequate provision of information about the company's affairs.

These contests can be subdivided, depending upon who is purporting to speak for the company. On the one hand, there may be a contest between shareholders and directors, where the directors are exercising their powers of company management in ways that adversely affect the shareholders’ interests. On the other hand, there may be a contest between shareholders themselves where, for example, a minority group of shareholders disagree with a decision made at a general meeting by a majority vote. Here the question is whether the law should give recognition to the position of minority shareholders. This highlights the tension between two competing views of the corporation.

On one view, we might respond to these situations from a contractual perspective, as outlined in Chapter 2. We could argue that shareholders have come together through a process of voluntary agreement embodied in the constitution and the Corporations Act. Those documents spell out the rights of members and indicate that individual members may find themselves out-voted in meetings. These contractual arrangements are reinforced by the law relating to directors’ duties (discussed in Chapters 10 to 13) which is intended to protect members from self-serving managerial conduct.

The other view could draw on concession theory, also examined in Chapter 2.

Introduction

In this Chapters 8 and 9 we examine the law relating to corporate finance. This chapter discusses corporate finance, including share and debt finance. We examine the nature of share finance (including different types of shares), the different forms of debt finance (including debentures), and the nature of security interests. We consider share capital transactions including dividends, alterations and reduction of capital, share buy-backs and financial assistance transactions. In Chapter 9 we look at the rules concerning the raising of capital including the disclosure requirements in ch 6D of the Corporations Act 2001 (Cth).

The concept of capital

In this chapter, and Chapter 9, frequent reference is made to the concept of a company's capital. The meaning of ‘capital’ varies depending upon the context:

However, the primary aspect of capital that must be understood here is the distinction between share capital (also known as ‘equity’) and debt capital.

Share or equity capital is raised by the company issuing shares. The legal relationship between the company and its shareholders is complex. In the commonly understood but legally incorrect sense the shareholders ‘own’ the company and so the legal relationship is often described in terms of the proprietary rights held by the shareholder. However, due to the concept of corporate legal personality, shareholders do not own the property of the company – the company does. The legal nature of a share is discussed below at 8.15.15.

By comparison, debt capital refers to borrowings by the company. The legal relationship between the company and a lender is that of debtor and creditor and is predominantly regulated by contract law. Importantly, lenders do not become members of the company that they provide finance to and usually do not have voting rights in the company. Their claims are against, not in, the company. As stated by Redmond ‘they stand outside the collectivity whose interests define those of the company’.

Introduction

So far, we have established what a company is (Chapter 3), how a company is created (Chapter 4), and what rules govern a company's internal operations (Chapter 5). This chapter discusses the legal capacity of a company to enter contracts. We discuss how companies enter contracts through agents and the statutory assumptions that protect third parties when dealing with companies. We also discuss pre-registration contracts.

There are a number of competing policy issues in this area of law. It is important that companies can enter contracts easily and be bound by their obligations. It is also important that third parties are not prejudiced if the internal requirements of a company in terms of capacity or authority to act as the company are not complied with. Both the law of contract and the Corporations Act seek to balance these issues – sometimes in interesting ways. It is useful to keep these policy perspectives in mind when studying this area of law.

Companies entering contracts directly

Under s 124 of the Corporations Act, a company has the legal capacity and powers of an individual. This means that, from registration, a company can enter contracts in its own right. There are two ways in which a company can enter a contract: directly or through an agent.

To enter a contract directly, the common seal of a company must be used and the contract must be signed in accordance with the requirements of s 127(2). A common seal is a rubber stamp with the company's name and Australian Company Number (ACN) on it. Prior to 1998, companies were required to have a common seal. Now, under s 123, a company may choose whether to have a seal or not. If a common seal is used on a document, s 127(2) requires that it must be witnessed by two directors or by one director and the company secretary. In a proprietary company with a single director, where that person is also the company secretary, that director can witness the use of the common seal.

The advantage of a document being entered into using the common seal is that this is a direct act of the company, as the common seal works like the company's signature.

Introduction

In this chapter, we explore in detail two key corporate law concepts; namely, the separate legal status of the corporation and limited liability. We discuss limitations and inroads into these concepts, as well as how the corporation – separate from the people who invest in or run it – can be liable in tort and criminal law.

This chapter builds on the themes raised in Chapter 2; namely, the relevance of different theoretical and ideological perspectives on the corporation and its role and purpose in contemporary society. To reiterate why these questions are important:

The separate legal entity doctrine

One of the most fundamental principles of corporate law is that a corporation is regarded as a separate legal entity from the people who set it up, invest in it, or run it (the founders, members and directors). Once the requirements for incorporation have been met, and the company is registered, it is taken to exist as its own legal person. This means, for example, that a company can sue and be sued, enter contracts in its own name, employ staff, borrow money, own property, and engage in most other legal acts that a natural person can do. Whilst companies must clearly act through people (most often directors, managers, and sometimes shareholders), the legal obligations that arise from such actions are usually those of the company and do not attach to the individuals.

The separate legal entity doctrine was confirmed and applied by the House of Lords in Salomon v Salomon & Co Ltd (‘Salomon's case’), referred to in Chapter 1. This case was an important turning point in corporate law. Prior to the decision in 1897, it was generally assumed that the benefits of incorporation were primarily for use by large joint stock enterprises, rather than small ‘one-person’ companies.

Introduction

Directors’ duties can be classified into two themes: duties in relation to care and skill, and duties in relation to loyalty and good faith. Chapter 10 provided an overview of the duties as a whole, and Chapter 11 provided the history and current law in relation to the duties of care and skill. This chapter is the first of two chapters addressing the duties of loyalty and good faith. These duties fall into two categories: those concerned with the way in which directors exercise the powers and discretions vested in them, and those concerned with the standard of conduct expected from directors. This chapter will focus on the first category, which includes the duty to act bona fide in the best interests of the company and for proper purposes, its counterpart in s 181 of the Corporations Act, and the limitations on directors not to fetter the future exercise of their discretions. Chapter 13 will deal with the duties of loyalty and good faith that are concerned with the standard of conduct expected from directors, such as the fiduciary obligation of directors, officers and senior employees, the corresponding duties in ss 182–183, and the other Corporations Act duties around disclosure and management of conflicts.

This chapter starts with a discussion of the general law in relation to the duty to act bona fide in the best interests of the company and for proper purposes. The discussion examines how the law developed historically and how it exists today. It then considers s 181 of the Corporations Act, before moving to consider alternative approaches to this area of law, which demonstrate a development of the stakeholder approach to corporate theory.

The duty to act bona fide in the best interests of the company and for proper purposes under the general law

Introduction

Within equity there are relationships in which fiduciary obligations are owed, including the director–company relationship. Fiduciary obligations impose higher standards of behaviour upon the parties than those imposed in arms-length relationships. The precise content of the fiduciary obligations will be considered in Chapter 13, but for now, they can be summarised as the ‘no conflict’ and ‘no profit’ rules. The duty to act bona fide in the best interests of the company has a source in equity as a ‘duty of good faith’.

Introduction

As discussed in earlier chapters, a company has the legal powers and capacity of a individual, in addition to any specific powers conferred by law (s 124). The two key decision-making organs that can act as the company in exercising these powers are the board of directors and the members in general meeting. The general law and Corporations Act divide the company's powers and responsibilities between these two groups. This chapter discusses this division of powers. Also discussed is how meetings of members and directors are held, and the requirements on companies to prepare and disclose key information, including financial reports.

Decision-making

There are many decisions that need to be made within companies: day-to-day decisions on how the business operates, who will be its directors, how it will raise money, how it will distribute profits, and ultimately whether the company will come to an end. Except where a company is in financial difficulty, and has to appoint a receiver or liquidator, the responsibility for making these decisions is divided between the board of directors and the members in general meeting. Provided the decision is properly made, both groups act as the company and can delegate their responsibility to make decisions to another body or person.

The division of power between the board and the members in general meeting is determined by looking at the company's constitution. As discussed in Chapter 4, the constitution contains the rules on the internal workings of a company. Under the replaceable rule contained in s 198A of the Corporations Act, or a similar provision contained in the company's constitution, the power to manage the business of a company is vested in the board of directors or their delegate. This power is broad and includes all areas of decision-making not reserved specifically for members in general meeting. This principle is expressed in the replaceable rule in s 198A(2) which provides that ‘the directors may exercise all of the powers of the company except any powers that [the Corporations Act] or the company's constitution (if any) requires the company to exercise in general meeting.’ It is possible for companies to alter this balance of power by including different provisions in the corporate constitution; however, most companies adopt similar provisions to s 198A.

Introduction

Companies are brought into existence by registration. As discussed in Chapter 4, for a company to be registered it must have a constitution and/or have adopted all or some of the replaceable rules set out in the Corporations Act. The constitution and/or replaceable rules establish the internal rules that govern how the company operates. This chapter discusses the importance of these rules, who they bind, and how they can be amended. It also discusses the rules that apply when there is a variation of the rights attaching to shares.

An overview of the internal management of a company

Companies have to act through their directors, officers or members and there need to be rules to govern how the internal processes of the company operate. These rules govern a wide range of issues including how shares will be allocated, the rights attaching to shares, the rights and responsibility of members and directors, and how meetings will be held. Historically, it was necessary for the persons setting up a company to adopt a Memorandum of Association and Articles of Association to deal with such issues. The Memorandum of Association contained basic information about the company such as its name; the amount of its share capital; the number of shares issued; that the liability of members was limited; and the names, addresses, occupation and number of shares taken by each member. Sometimes it also contained an objects clause, which stated the purpose of the company.

The Articles of Association contained the company's internal rules. These rules governed how members’ and directors’ meetings were held; how directors were appointed and removed; and how the company would be wound up. The companies legislation at the time included a set of model Articles of Association in Table A annexed to the statute.

In 1998, the requirement for a Memorandum and Articles of Association was removed, and companies can now choose to have a corporate constitution and/or to adopt some or all of the replaceable rules in the Corporations Act. Companies formed before 1998 that still have Memorandum and Articles are treated as if those documents comprise the company's constitution. In the following discussion, all references to the corporate constitution include a reference to the Memorandum and Articles of Association.

Introduction: the importance of context

Corporate law, like all law, has a context; indeed, it has many contexts. To understand corporate law today, we need to appreciate the forces – social, political, economic, global and local – which shape that law. Modern corporations and contemporary Australian corporate law should be understood as a product of, and a compromise between, various social, economic and legal ideas and philosophies. This is the focus of the first two chapters of this book.

We begin the book by looking at two contextual settings of contemporary Australian corporate law: its history and its regulatory structure. This chapter will explain the history of the modern corporation and the various approaches to regulating corporate conduct. History is important; it assists in understanding how and why modern corporations and the law that regulates them have developed into their current form. A deeper appreciation of modern corporations and their regulatory framework can be gained by understanding why things have developed as they have.

The corporation and corporate law were not invented in a single session by the work of enlightened lawyers or politicians. They have evolved in a piecemeal and sometimes inconsistent fashion. They were not developed in harmony. Key steps in the evolution of the corporation as a legal structure often occurred despite the intentions of law-makers. This book will refer to and compare the historical antecedents of the various concepts and ideas which comprise modern corporate law in Australia. Chapter 1 presents an historical overview and framework to assist the reader with subsequent material. This chapter is a truncated version of corporate history. When reading the chapter, it is important to bear in mind that ‘history means interpretation’. Historians take different views and provide different accounts of historical events. This is true of corporate law history, and it is not our intention to canvass the full range of historical argument. The reader is encouraged to pursue a more detailed study, using the materials referred to in the footnotes.

This chapter asks the reader to temporarily postpone the quest for a more detailed explanation of the legal concepts which are introduced. We will come back to examine these concepts in detail elsewhere in the book.

Some perennial questions

Corporate lawyers may assume that the corporation is a legal structure over which they have a unique claim to expertise.

Introduction

This is the first of three chapters dealing with directors’ duties. The duties are divided into two themes: duties of care, skill and diligence, and duties of loyalty and good faith. The focus in this chapter is on the duties of care, skill and diligence. These duties are imposed by the common law, equity and ss 180(1) and 588G of the Corporations Act. This chapter commences with the common law and equitable foundations of the duty of care, skill and diligence, and considers their adoption into statute and the current law within s 180. It examines the safe harbour provided by the business judgment rule in s 180(2), and recent discussion on the scope and application of that rule. This chapter examines the ability of directors to delegate their duties and to reasonably rely on the information or advice provided by certain types of persons. Finally, the chapter considers the requirements imposed on directors by s 588G as a company approaches insolvency, and the defences available under s 588H to a claim of breach of that duty. The chapters which follow then consider the duties of loyalty and good faith: Chapter 12 discusses the various duties of good faith, and Chapter 13 canvasses the loyalty element through the duties relating to conflicts of interest.

Although these three chapters refer to ‘directors’, the duties may be owed by others including de facto directors (10.20.05), shadow directors (10.20.10), officers, shadow officers and senior management employees (10.20.15).

Common law and equitable foundations

The early case law

Before directors’ duties were enacted in legislation, they arose through the common law and equity. These duties still arise in negligence, in equity, and can also be established under the terms of service between an executive director and company. The scope and content of the duties has developed significantly over the past century.

The duty of care, skill and diligence was established in cases from the nineteenth century initially as a subjective standard of care, dependent on the characteristics of the director in question. This mirrored the role and expectations of directors, when companies appointed large boards and where directorships were an office of status, with little regard to the appointed person's interest or skill in the position.

Introduction

This chapter is the first of two chapters that examine what can happen when a company cannot pay all or some of its debts. This chapter discusses the types of action that can be taken other than winding a company up, focusing upon receivership, schemes of arrangement and voluntary administration. This chapter commences with a consideration of the state of insolvency, and how it may be determined. This is a complex question, relying on an array of information specific to each company, beyond that company's demonstrated assets and liabilities according to a balance sheet. Each of the actions which the chapter considers are also demonstrative of different aspects of insolvency law, with different motivations and consequently vastly different outcomes. Receiverships, in particular, differ from other types of arrangements discussed in this chapter because they usually involve a receiver being appointed to look after the interests of one secured creditor. As a consequence, the receiver's main responsibility is to protect and enforce a security interest that has been granted by the company to that creditor over particular company property. The duties and powers of receivers vary accordingly from those of administrators and liquidators. In contrast, schemes of arrangement and voluntary administrations usually involve an impartial evaluation of the company's financial position, followed by a binding agreement between the company and its creditors, or a group of creditors. The policy behind Australia's voluntary administration process is corporate rescue, which impacts on the way in which it proceeds in contrast to receivership and liquidation. The administrator has responsibilities to report to the creditors as a whole, and to seek an outcome for the unsecured creditors which leaves them with no less than they would have received on a winding up. These arrangements may therefore be useful in cases where the whole or part of the business of the company can be saved or the return to creditors will be greater if the company continues to trade.

Insolvency

External administration refers to the administration of the company by an external party. The processes that form part of external administration are receivership, schemes of arrangement, voluntary administration, and liquidation. Liquidation or winding up is the final step in external administration. This is discussed in Chapter 16.