Case Study of Corporate Law

This assignment related to the company Gemsales Pty Ltd, which is engaged in the business of importing and supplying jewellery as wholesalers to the local market. Andrew, Brian, Elizabeth, Diana and Colin were the directors of the company. The company decided that the market becoming more competitive so they need to expand its business. To achieve their target they obtained 4 million dollar loan from Friendly Bank Ltd. They spent all the money to increase their business.

All the directors of the company not attended the meetings of the company. Brian and Andrew only participate in the meetings actively. At this time Brian contact with another retailer of jewellery company, victor who looking for reliable suppliers. But he would not deal Gemsales Pty Ltd because he didn’t like the managing director Andrew. Brian could not miss this great opportunity so he setup his own business and entered into a contract with victor without telling other directors of the company. All other members were unaware about this deal. After six months Brian resigned from director post because company become insolvent and could not pay the interest on its loan

Issues * The main issue in this case was that the company became insolvent due to the expansion and was unable to pay the interest on its loans. * Another issue is Brian s breach of duties which he owned to Gemsales Pty Ltd. * There are many other issues in this case like; the other directors were unaware that Brian was a major shareholder in Trades Pty Ltd.at the time of purchase of the warehouse and showrooms. * Brian entered into a contract with victor to set up his new business.

* Brian approaches established customers of Gemsales Pty Ltd.to secure orders for his own business.

There are different arguments which is used by each of director in his or her favour under the common law as well as the corporation law and the counter arguments given by ASIC which is discussed below

Arguments of the directors for their defence 1) Colin can be argued that when the above decision taken he was absent from the meeting because he was suffered from illness due to serious accident. Section 588H Corporation act states that: if a person was a director of the company at the time when the debt was incurred, it is a defence if it is proved that, because of illness or for some good reason, he or she did not take part at that time in the management of the company.

Colin would use the defence under S588h (4) and argued he was not responsible for the decision taken in his absence due to accident and has no liability for the debt was incurred. Although not relevant here there are cases used for a defence under this section: Metropolitan Fire Systems v Miller (1997) 23 ACSR 699

Tour print International Pty Ltd v Bott (1999) 17 ACLC 1543

2) Dina had abstained from voting, she may be able to use the defence under s588H where a director may not be liable if they took reasonable steps to prevent the debt being incurred. If Diana had tried to talk the other directors out of proceeding with the loan and had voiced her concerns and had backed them up with positive action such resigning her position as director then she may escape liability. However simply abstaining from voting would not be enough to prevent liability. Diana can argued that she was not breach of duty under section 181

3) If directors had reasonable grounds to expect solvency S588H (2) they may also be able to use this as a defence Elizabeth could not use this defence as she had not attended any meetings and seemed to make no attempt to acquaint herself with the affairs of the company. But she might argue in her favour that she is not in breach of duty under section 181 of the corporation act, which states that: a director or other officer of a corporation must exercise their powers and discharge their duties: - In good faith in the best interests of the corporation

- For a proper purpose

4) Brian could not use the defence that he was no longer a director of the company as he was involved at the time the debt was incurred. S588G applies, when a person is a director of the company at that time company incurs a debt. This section applies to Brian because he was the directors of the company and participates actively in the meetings.

5) Andrew, being the managing director, can argue that he took the decision of expansion of the business seeing the competitiveness of the market Andrew appears not to fit into any categories outlined above and therefore would probably also be held liable under s588g to friendly bank ltd 6. Also consider consequences where director is liable for insolvent trading and some of the orders that can be made under Sections 588J-588Q and Section1317E.

Arguments put by ASIC and the company

1) The first issue to deal with is the liability of directors for payment of the interest on the loans to friendly Bank Ltd. The courts will first decide whether or not the directors of the company have engaged in insolvent trading and breached s588G. ASIC can argued against all the directors under section 588G, which implies upon a person if

(a) A person is a director of a company at that time when the company incurs a debt, (b) The company is insolvent at that time or becomes insolvent by incurring that debt, (c) At that time, there are reasonable grounds for suspecting that the company is insolvent, or would so become insolvent, as the case may be; (d) The director is aware at the time the debt is incurred that there are reasonable grounds for suspecting the company is insolvent or a reasonable person in a similar position in the company s circumstances would be aware.”(Hanrahan, et.al. 2013)

Company insolvency means according to section 95 A (1) defines solvency as being able to pay debts as and when they fall due. Section 95 A (2) defines insolvency as not being solvent. In this situation it is highly likely that the company will be declared insolvent. When a company is declared insolvent the courts are prepared to lift the corporate veil and go behind the company to attach liability to the directors under s588G where the directors had a duty to prevent insolvent trading – an exception to the separate Legal Entity Doctrine was established in Salomon v Salomon & co Ltd. At the time when the company became insolvent,

Andrew, Colin, Elizabeth, Brian, Diana were the directors of the company. Also another reason for insolvency was the debt occurred due to the expansion of the company so therefore under section 588G all the directors are liable for insolvency

2) The second issue is that Brian’s breach of director’s duties which he owned to Gem sales Pty Ltd. Common law duties to Gemsales Pty Ltd include: Duty to act in good faith, Duty to act with care, skill and diligence Statutory duties under s180 -183 include:

S180 (1) duty of care, skill and diligence S181 duty to act in good faith S182 & 183 duty not to misuse the position or make improper use of information gained whilst in the position of director. In the case of Brian, ASIC can argue that he was in breach of section 180 as he had not acted in the best interests of the company. Being a director of Gemsales Pty Ltd, because his own interest he had opened up his own company which was a rival company which he approached established customers of Gemsales Pty Ltd.

Also he was a shareholder in Traders Pty ltd, from which the company brought the warehouse and the showrooms and he had not disclosed this information to the rest of the director’s .according to section 191: “A director of a company who has a material personal interest in a matter that relates to the affairs of the company must give the other directors notice of the interest in a matter of the interest unless the section provides an exemption.”(Hanrahan, et.al, 2013) But the other directors were unaware of his interests in the other company; therefore Brian was in breach of section 191.

3) Other directors like Diana and Colin can give the argument against that of ASIC that they are not liable under section 588H because Colin was ill and Diana had abstained from voting.

4) Andrew can argued against ASIC that he was took the decision only the expansion of the company due to the competitiveness in the market 5) Elizabeth can argue in her favour that she was not breach in duty section 181 of the corporation act, which states that: a director or other officer of a corporation must exercise their powers and discharge their duties: In good faith in the best interests of the corporation, for a proper purpose.

Breaches of these duties are discussed below:

1) Brian has a statutory duty to disclose material interests to the company (S191.) This includes when he has an interest in a contract being entered into with the co-Traders Pty Ltd. As well as breaching this provision he has breached S181 by failing to act in good faith and has also breached his common law fiduciary duty to avoid conflicts of interest.

2) Brian has also breached duties by using his position as director for personal gain to disadvantage of the company and misusing information gained whilst in the position of director of Gemsales s182 and 183

3) Brian has also taken an opportunity by dealing with victor to supply him jewellery. Victor said that he didn’t like Andrew and therefore did not want to deal with Gemsales. However, if Brian had been acting in the best interest of the company he would have brought the matter to the attention of the other directors who would have been in a position to take action to remedy the situation. Again Brian failed to act in good faith and breached s(181).

Conclusion At the end if court is satisfied that Brian has contravened under section 180(1), 181(1), (2) and 182(1),(2) and 183(1)and (2) than breach of these obligations or duties may lead to court making a “declaration of contravention” according to section 1317E. ASIC may than ask the court to impose a fine on the director if the breach materially prejudices the interest of the company or its shareholders, materially prejudices the company’s ability to pay its creditors or is serious pursuant to section 1317G The court may also order the Brian to compensate the company for any damage suffered by the company as a result of breach according to Section1317H

Remedies available to Gemsales P/L could include: a. Brian may have to pay Gemsales profits made from his personal contracts – (Furs Ltd v Tomkies). b. Section1317HA (1) also allows for recovery of profits by Gemsales and compensation for loss or damage caused by Brian’s breaches of his duties under S180-183. References

* Lynn A Stout, In Praise of Procedure: An Economic and Behavioural Defence of Smith v. Van Gorkom and the Business Judgement Rule, 96Nw.U.L.Rev 675 (2002)

* Daniel Fischel, the Business Judgement Rule and the Trans Union Case, 40 Bus.Law.1437, 1455 (1985).

* Pamela Hanrahan, Lan Ramsay, Geoff Stapledon,(2013), Commercial Application Of Company Law,14th Edition, Publisher McPherson’s Printing Group.

* Farrer J, “Corporate Governance, Business Judgement And The Professionalism Of Directors”(1993) 6 Corporate And Business Law Journal 1 At 21-22.

* Allen’s Arthur Robinson.2007, Directors Duties during Insolvency, 2nd Edition, and Thomson Law book Co., ISBN 9780455223490.

* Keavy A, 2006, Company Directors Responsibility to Creditors, Rutledge-Cavendish, ISBN 9781845680084.

* Baxt R, “Forgiving Directors For Insolvent Trading- Some Promising Signs”(February 2008) Company Director 48.

* Wong S, Forgiving A Director’s Breach Of Duty: A Review Of Recent Decisions (Centre For Corporate And Securities Regulation – Research Reports And Research Papers, 2009).