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Suggested Answer Guide TO EXAM Revision - Practice

Questions (1)
Company Law for Business (Curtin University of Technology)

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COMPANY LAW 266

SUGGESTED ANSWER GUIDE TO EXAM REVISION – PRACTICE QUESTIONS
2014 SEMESTER 1

QUESTION 1

MANAGING COMPANIES – TOPIC 4

“Directors do not have to follow decisions made by members in general meeting.” Discuss.

Suggested Answer

Discussion: Division of power between members and directors. If the company does not have
a constitution, RRs apply. With RRs198A directors of the company have power to manage.
For members to call a meeting and pass a resolution that is an interference in a management
matter is unconstitutional (breaches contract of s140(1)). See Automatic Self Cleansing Filter
Syndicate; John Shaw; NRMA v Parker. Members could amend constitution of the company
(if can pass a special resolution) and transfer the power to decide the matter over to the
members who would then be acting properly. Another alternative is for members to use its
voting power to replace the directors RR s203C or 203D.

QUESTION 2

DIRECTORS DUTIES – TOPICS 6 and 7

Noodles Ltd operates a wholemeal noodle outlet. The company has three directors, Hong, Li
and Luwa. Hong is the managing director. Li left school when he was 15 and has no further
qualifications other than being an expert on wholemeal noodle manufacturing. He is in charge
of the manufacturing process. Luwa is a non-executive director and was only appointed to the
Board because she comes from a wealthy family and has connections with financial
institutions.

Noodles Ltd has been trading profitably until six months ago when a competitor selling
seaweed noodles emerged and is rapidly gaining market share. Hong thinks that Noodle Ltd
should open up outlets in major shopping centres.

Hong calls a board meeting and tells Li and Luwa that by opening an outlet in the most
expensive and prestigious city shopping centre will solve all the company’s problems. He
says that they will have to act quickly as the seaweed noodle competitor is also interested in
that outlet. Hong does not tell Li and Luwa that he has not carried out a feasibility study into
the financial implications of this proposal. Hong also proposes that they should issue shares
to Luwa’s brother to fund the proposal and advises Li and Luwa that this will also prevent the
seaweed noodle manufacturer from taking over their company.

Luwa is doubtful about the whole proposal and feels that they are being rushed into making a
decision without being given time to consider alternatives. Li however agrees to Hong’s
proposal without really understanding the financial implications.

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Within 6 months of opening the new outlet, it becomes apparent that the company was not in
a financial position to have taken such a step and a proper feasibility study would have shown
this. The company is unable to pay its debts and a liquidator has been appointed.

REQUIRED

(a) Advise Hong, Li and Luwa whether they have breached any duties under the
Corporations Act and case law in making the decision to open the outlet. Also discuss
any defences they may have.

(b) Advise the directors whether they have breached any duties under the Corporations
Act and case law in making the decision to issue shares to Luwa’s brother.

(c) Advise the directors of the procedures that should have followed under the
Corporations Act in making the decision to issue shares to Luwa’s brother.

Suggested Answer
Part (a)

Main Issue: Directors duty of care, skill and diligence and duty to prevent insolvent trading.

Discussion: Care and Diligence, SS180(1), 180(2), Daniels v AWA, ASIC v Hellicar; ASIC v
Adler; ASIC v Rich. Also a discussion of SS588G and 588H is required and case of
Metropolitan Fire System v Miller.

Apply and conclude: All the directors are likely to have breached their duty to exercise care,
skill and diligence as they did not carry out a proper feasibility study of opening an outlet in
the most prestigious city shopping centre. Although LI is uneducated, he owes the same duty
as other directors. Although Luwa is a non-executive director, she owes the same duty as an
executive director. The defences under S180(2) will not apply as the decision was not made
on an informed basis.

A discussion of whether section 588G is breached should be based on whether the directors
would have suspected that the company would become insolvent by entering into the
transaction of opening up the new expensive outlet. Although the company has been trading
profitably, feasibility study would have shown that the company was not in a financial
position to have opened up an outlet in the most prestigious shopping centre. Directors are
likely to have breached s588G. The directors could argue a defence under S588H(2) that they
expected the company to be solvent as it had been trading profitably until 6 months ago.

Part (b)

Main Issue: Proper purpose S181.

Discussion:

 2 Questions, purpose and motive

 Use only for purpose conferred

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 Proper purpose for share issue to raise capital and any other purpose (eg to block
takeover) improper. Howard Smith v Ampol and Western Ventures Pty Ltd v Resource
Equities Ltd
 Tests: Where multiple motives, the substantial purpose test and But For test in
Whitehouse v Carlton

Apply and conclude: The shares were issued to Luwa’s brother to fund the opening of new
outlet and to prevent the seaweed noodle manufacturer from taking over their company. The
directors may fail the “but for” test if the emerging of the competitor brought about the
issuing of shares to Luwa’s brother. However, it could be argued that the shares issue was
only considered to fund the opening of store, and this is a proper purpose.

Part (c)

Main Issue: Disclosure.

Discussion: Disclosure under s191; absence from room under s195 (unless other directors
resolve otherwise); not to vote under s195; case law operates in addition to statute s193 and
thus equitable duty not to profit (see Regal Hastings case) can be discussed. Chapter 2E
should be discussed. Expect an analysis of a director’s brother being a related party (s228)
especially if the director is acting in concert with the brother; financial benefit (s229);
members to approve (s208) with, Luwa’s brother not voting (s224); or, directors approving if
terms arms length (s210).

Apply and conclude: A detailed discussion of how Luwa should have properly conducted
herself under the Corporations Act under sections 191 and 195 at the meetings of the
directors of Noodles Ltd when decision was made about the share issue to her brother. There
is enough quorum if Luwa left the room under S195. Applying chapter 2E, the directors will
be unlikely to be able to make the decision as the arms length exception is unlikely to apply.
At the members meeting, Luwa’s brother will not be able to vote.

QUESTION 3

MEMBERS REMEDIES –TOPIC 8

Sonia, Chris and Debbie are the only directors and shareholders of King Pty Ltd, which owns
and operates the King’s tavern. Sonia is the only non-executive director of the company. The
company has 9000 ordinary shares that are fully paid up. Each shareholder holds 3000 shares.
Chris and Debbie are married to each other and are also part owners of Duke Financial
Brokers.

King Pty Ltd has been very successful but has not paid a dividend for the last 5 years. Profits
have instead been invested in financial products. Sonia is 60 years old and her husband is ill.
She requests Chris and Debbie for the company to commence paying a dividend, but instead
Chris and Debbie successfully pass a resolution at a members’ meeting to remove Sonia as a
director. Sonia wishes to sell her shares, but, Chris and Debbie refuses to buy them. On
further investigation Sonia discovers that King Pty Ltd has been inappropriately paying large
“management fees” to Duke Financial brokers without any justification of work done.

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REQUIRED

(a) Explain to Sonia the proper plaintiff rule and the internal management rule.

(b) Sonia seeks your advice on whether there are any remedies available to her under the
Corporations Act, including the procedures she may need to follow to obtain those
remedies.

Suggested Answer

Part (a)

Discussion: Brief discussion of the principles from Foss v Harbottle, the internal
management rule (majority should rule) and the proper plaintiff rule (companies have the
legal capacity to sue s124).

Part (b)

Main Issue: Minority shareholder remedies.

Discussion: Statutory derivative action has replaced the exemptions of Foss v Harbottle
except for personal right of action. Analysis and explanation of statutory derivative action
under s236 and 237 (including the 5 conditions of s237); S232 (discuss the meaning of
oppression with cases such as Wayde v New South Wales Rugby League Ltd; Thomas v HW
Thomas Ltd; Kokotovich Construction Pty Ltd v Wallington); S233 Remedies; s1324
(injunction) and S461 (winding up).

Apply and conclude: Sonia is a minority shareholder and non-executive director. The
executive directors, Chris and Debbie are the majority shareholders, and they have been
inappropriately been paying large management fees to Duke, a company they partly own.
Sonia has been oppressed, by being removed as a director and being unable to sell her shares.
Sonia should be able to prove the 5 conditions in s237 to obtain leave of court to commence
statutory derivative action. She may also apply for upfront costs under S242. Alternatively if
Sonia has the funds to commence action, she should seek an order under S233.

QUESTION 4
REPORTING AND DISCLOSURE

A small proprietary company has many advantages compared with a large proprietary
company and a disclosing entity. Discuss.

Discussion of S45A as to what is a small proprietary company. Sections 292 and 301 state
that a financial report, a director’s report and auditor’s report must be prepared by disclosing
entities, public companies and large proprietary companies. A small proprietary company
only needs to prepare financial reports and director’s report if: directed by shareholders
holding 5% of the votes – S293; directed by ASIC – S294; or it is controlled by foreign
company – S292 (2)(b).

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The reporting deadlines are also different as stated in SS315, 319 and 320. For a disclosing
entity, the reports must be sent to ASIC the earlier of 21 days before AGM or 4 months after
the year end and reports must be sent to the members 3 months after the year end. Disclosing
entities all need to prepare half yearly reports and send them to ASIC or ASX 75 days after
the half-year end. Large proprietary companies need to send their reports to the shareholders
and ASIC 4 months after the year end, whereas small proprietary company only needs to send
their reports to members if the members have requested, the later of 2 months after the date of
request and 4 months after the year end.

QUESTION 5
SHARES AND SHAREHOLDING – TOPIC 9

The directors of Gains Ltd need to raise finance and are considering 2 options:

1. A public issue of redeemable preference shares; and

2. A loan from State Bank.

What are the advantages and disadvantages of the 2 options?

Suggested Answer

Discussion: Preference shares are equity and loan is debt. Equity v debt; equity belongs to
company, debt is repayable (potential insolvency); dividend v interest (potential insolvency);
risk issues (higher for equity; less for debt particularly if secured); priority in a winding up;
etc. See page 9-3 in Guide Book.

QUESTION 6
TOPIC 10 – CAPITAL MAINTENANCE

Craft Ltd wishes to reduce the number of shares it has issued to its members. Advice the
directors of Craft Ltd of how this can be achieved under the Corporations Act and whether
any creditors may have cause to be concerned about the reduction of shares.

Suggested Answer

Discussion: Detail description of equal access, on-market and selective buy-backs under
S257. The share buy-backs must not materially prejudice the interests of creditors. Also, sign
post section 257J applies insolvent trading provision s588G.

QUESTION 7
FUNDRAISING - TOPIC 10

Ginko Ltd needs to raise $10million to purchase machinery. The directors propose to issue
debenture stock to the public. To do this, the company will be required to prepare and provide
a prospectus.

With reference to the Corporations Act discuss:

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(a) Whether the directors have to insert information in the prospectus that the company is
being sued by the Taxation office for non-payment of taxation?

(b) Who is liable to investors if the prospectus has a mistake in it or omits material
information? Are there any defences available?

(c) Are there any alternatives available if the directors do not want to issue a prospectus?

Suggested Answer
Some sections are not in the text book in which case students need to quote the law without
the section numbers.

Part (a)

Main Issue: Contents of prospectus in s710

Discussion: Section 710 requires that a prospectus must contain all information that investors
may require in make an informed assessment pertaining to the financial position of the
company.

Apply and conclude: The disclosure will depend upon whether the company’s financial
position is likely to be affected by non-payment of taxation.

Part (b)

Discussion: Sections 728, 729 and due diligence defence under S731. S728 imposes liability
for misleading and deceptive conduct. S729 lists those persons who may be liable. S731
provides a due diligence defence for prospectus.

Part (c)

Discussion: S708 exclusions and Offer Information Statement. OIS fundraising restricted to
$10million in S709. A discussion of S708 exclusions include: Small scale offerings;
sophisticated investor exception; executive officers exception; issues to existing debenture
holders or professional investors.

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