A Case Study Illustrating Legal Limits on Remuneration of a Managing Director and Actions of the Board of Directors, and Providing Judicial Remedies Therefore

Question:

Henry Dunn is the major shareholder and managing director of HD Industrial Castings Ltd, a publicly listed company on the stock exchange.  He proposes that the company should pay off the debts owed on his house and his boat.  The board agrees and he is advanced a sum of $400 000.  Sarah Buchanan, a minor shareholder, hears about the deal and approaches you for advice.  She wonders if there have been any breaches of duty by Henry.  Comment.

Relevant Areas of the Law

What are the applicable legal provisions pertaining to remuneration and other financial benefits of a managing director of a publicly listed company? What are the limits set by law concerning the fixing of remuneration and the pertinent procedural requirements in doing so? What are the legal remedies afforded to aggrieved minority shareholders pertaining to illegal actions committed by the top management of a publicly listed company? Applicable Legal Principles in the Instant Case

Basic nature of a private company

Corporations experienced a long history of evolution, initially beginning as chartered entities by the Royal Crown.  The continued expansion of economic activities and increasing complexity in business transactions led to the development of private corporations as distinct entities apart from the governing body.  Various laws were passed to govern the activities and liability of a private enterprise, including the very nature of its legal personality.

Corporations eventually evolved having separate legal personality distinct and apart from its founders, owners, shareholders and other persons directly involved in its operations.  The landmark case of Salomon v Salomon & Co (1987) AC 22 remains the binding legal principle pertaining to the issue.  In the said case, the House of Lords ruled that the subsequent company founded and its founder who exercised sole power and responsibility in running the affairs of the company are two distinct and separate personalities.

The case eventually resulted to the evolution of the concept of “corporate veil”, describing the nature of a company as separate legal persons from natural persons who found it.  From the said principle stems the delineation of the extent of liability of the company and its officers.

Earlier, various state and territory governments enacted their respective laws governing private corporations.  Desirous of legislating uniform laws governing all corporations in Australia and reforming further corporate laws, the federal legislature passed into law the Corporation Act 2001, currently the omnibus law governing the existence and activities of all private companies in Australia (Adams 2005, 5).

Lifting the corporate veil

All members of the corporation’s board of directors, including the corporate secretary, hold their respective position because of presumed consent that the company shall be managed according to what is best to its interest.  The principle is apart from the fact that members of the top management may own majority shareholdings in the company.  Under the Corporation Act 2001 and common law principles, there are specific instances providing for the piercing of the corporate veil to extract liability among concerned officers, as follows:

Attempt to hide illegal actions of the officers of the company; Frauds committed by officers, citing the case of Re Darby (1991) 1 KB; or Attempt by company officers in evading legal obligations and responsibilities, in accordance with the principles enunciated in Gilford Motor Company Ltd v Home (1933), 1 Ch 935 (Maltas 2009, 167). Legal provisions on functions of managing director and directors’ remuneration

 Under Corporation Act 2001 (s201J), the managing director may be appointed by the board of directors to execute full executive powers and discharge the same on behalf of the entire board.  However, the same provision provides that the powers and authority of the managing directors are concurrent and not exclusive of the said board.  In the Shirlaw v Southern Foundries (1936) Ltd (1939) All ER 113, the board is given so much breadth in determining the extent of powers of the managing director, including the fixing of remuneration, compensation packages and other benefits with monetary value.  A fiduciary relationship exists between the managing director and the company as a whole and the specific terms of appointment are usually stipulated in a contract, commonly called as service agreement (Tomasic, Bottomley and McQueen 2002, 271).

Under CA s201J, the board alone fixes the compensation of the executive directors, including its managing director.  As employees of the company, they have the natural right to remuneration normally afforded to the typical employees.  CA s202C also provides that the board may allow that the travelling and other expenses of the managing director may be paid out of company funds (Cassidy 2006, 207).

Legal limits on remuneration and other financial benefits

 As indicated earlier, the relationship existing between the directors and the company as a whole is intrinsically fiduciary in character.  Although granted its own separate legal personality, the company could not act on its own, rather through its various officers and directors.  The board of directors, therefore, is a repository of the common will of the entire company. In Boardman v Phipps (1966) 3 All ER 721, the House of Lords opined that the fiduciary character binding the directors to the company should be upheld strictly.

The law frowns upon directors exploiting their positions of trust to gain benefits for themselves at the expense of the interests of the company.  This ruling extends to the establishment of financial benefits extended to directors, including the managing director, that do not necessarily accrue to the best interests of the company or whose functions are not directly related to the discharge of their official functions.

 Citing Re Smith and Fawcett Ltd (1942) 1 All ER 542 and Re Lee Behrens & Co Ltd (1932) 2 Ch 46, company officers are expected to execute their functions in good faith and for good purpose, respectively.  Aberdeen Railway Co Ltd v Blaikie Bros (1854) 1 Macq 461 even went to the extent of requiring directors of making full and transparent disclosures of any financial interest in any contract involving the company.  This has been construed to extend to future contracts where the liability eventually rests with the company.  Furs Ltd v Tomkies (1936) 54 CLR 583 even states that the said disclosure should be made even to the shareholders of the company in a general meeting, and not just to the board.

Legal remedies available to a minority shareholder against illegal actions of the directors

There are basically two sets of remedies accorded by law even to a minority shareholder against what he perceives as an illegal action of the board of directors or members therefore.  This is notwithstanding the abolition of the ultra vires doctrine.  Corporation Act 2001 (s202B1) provides that the members of the company may compel the board of directors to make full disclosure of the remuneration of its members in a general meeting.  At least 5% votes or 100 members with voting powers may do so in a resolution petitioning the board to make the said disclosure.

CA s 182 also provides the various mechanisms to counterbalance actions of the board of directors detrimental to the best interest of the company.  Civil obligations may arise from actions by officers of the company using their position to gain advantage and benefits for themselves, as in the case of increasing remuneration or expanding the same what do not serve for the best purpose.        CA s184 further provides criminal liability for reckless and dishonest actions of the directors and officers by defining those actions as criminal offenses.

Directors owe their fiduciary duties to the company as a whole.  Under the “proper plaintiff rule”, any aggrieved member of the company, even those with minor shares may apply for a court injunction or interim injunction, as provided in CA s1324 (1).  CA ss1324 (1) and (2) even extends the applicability of the remedial rule to past, present and proposed violations of the fiduciary relationships.

Application of the Relevant Legal Principles in the Instant Case

Notwithstanding that Sarah Buchanan owns only a minor share in the company, she is, by common law principles and statutes, entitled to seek judicial remedy against the actions of the board she perceives as illegal and detrimental to the best interest of the company.

Approval of the board of the proposal of Henry Dunn, the major shareholder and managing director of HD Industrial Castings Ltd, providing for specific financial provision, constitutes an expansion of the remuneration of the directors that require disclosure to the members in a general meeting.  Moreover, the approved $400,000 item payable to the already existing liability of Mr Dunn (debts owed on his house and boat) partakes of an illegal act where the company’s funds are made answerable to a purely personal liability of its managing director.  It does not even appear that the said debts were accrued with the prior approval of the board nor the same were incurred purposely for good purpose and benefit of the company.

The company cannot be made to pay for loans contracted for items or properties with purely personal character, such as house and boat.  By asking the board for approving his request and being present during the board deliberation, Mr Dunn can be held civilly liable, in addition to specific violations of procedural rules stipulated in Corporation Act 2001.

By benefiting the same for entirely personal benefit without any substantial benefit to the company, Mr Dunn is committing both civil and criminal offence.  By approving the said request, the board violates the “best interest” and “good purpose” rules.  They could not even seek shelter under the “best management decision” rule, allowing them autonomous powers to decide on matters they perceive as for the best interest of the company.

The Corporation Act 2001 is clear and precise as to the lifting of the corporate veil.  For centuries, the concept was used to shield company officers and directors from any suits instituted by any member of the company, regardless of the extent of its ownership, or even by a third party.  The law constitutes part of economic reform packages providing for enhanced check and balances, defining clearly the limits of prerogatives earlier enjoyed by company officers and managing directors, as in the instant case.

Conclusion

At the onset, Mr Dunn is liable civilly and criminally by proposing and enjoying the approved benefit.  By ratifying the proposal, the board commits violation of its fiduciary relationship with the shareholders and the company as a whole.  Said action could be invalidated.

References

Texts

Adams, M. 2005. Australian Essential Corporate Law. Coogee, NSW: Cavendish Publishing Pty Ltd.

Cassidy, J. 2006. Concise Corporations Law (5th edition revised). Annandale, NSW: Federation Press.

Corporation Act 2001.

Maltas, J.D. 2009. Student Notes on Business Organisations Law. School of Business Law: Curtin University of Technology.

Tomasic, R., S. Bottomley, and R. McQueen. 2002. Corporations Law in Australia. Annandale, NSW: Federation Press.

Legal Authorities

Aberdeen Railway Co Ltd v Blaikie Bros (1854) 1 Macq 461

Boardman v Phipps (1966) 3 All ER 721

Furs Ltd v Tomkies (1936) 54 CLR 583

Re Darby (1991) 1 KB

Re Lee Behrens & Co Ltd (1932) 2 Ch 46

Re Smith and Fawcett Ltd (1942) 1 All ER 542

Salomon v Salomon & Co (1987) AC 22

Shirlaw v Southern Foundries (1936) Ltd (1939) All ER 113