CORPORATE LAW NOTES I Introduction

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1 CORPORATE LAW NOTES I Introduction 4 Types of companies Note the different types of shares available: ordinary preference bonus partly-paid Forms of business structure: Sole Trader: individual conducting a business alone without the benefit of any legal structure or entity status distinct from that of the individual who conducts it. Trader personally liable for debts and other liabilities without any limitation. Income received from the business is taxable on an individual basis. Features: simple operation; total control over business direction. Drawbacks: unlimited liability. Partnership: relationship between persons carrying on business in common, with a view to achieving a profit. Features: shared capital contribution; different areas of expertise. Drawbacks: liable for actions of fellow partners; no separate legal existence; creditors can enforce judgment personally. Co-operative: an incorporated body corporate subject to the principles that govern formation, distribution of profits and operations. Features: limited liability for members (liable only for unpaid portion of shares). Drawbacks: restrictions on transfer of assets; Registrar s discretion as to whether or not you may become registered. Incorporated Association: (non-profit) In NSW an association of five or more persons may be formed for a lawful object to incorporate and if the association is not geared towards trading or securing a pecuniary gain for members. The incorporated association is subject to a number of continuing obligations. Features: inexpensive to set up; limited liability; committee members are not exposed to personal liability for the contracts and torts of the association. Drawbacks: association must maintain public liability insurance for $2m; obligations are similar to those applying to companies (AGM and accounting statements) Company: Features: limited liability; perpetual succession; separation of ownership and control; financing; taxation. Drawbacks: Banks can request personal guarantees from directors; High costs and formalities involved. Types of companies: Section 112(1) provides for registration of six types of company: o Proprietary companies Limited by shares Unlimited with share capital o Public companies Limited by shares Limited by guarantee Unlimited with share capital No liability company 1

2 Sections 9 and 12 define the following types of company: A company is either a proprietary or a public company. A proprietary company must have less than 51 non-employee shareholders. If a company is not registered as a proprietary company, it is a public company and can raise funds from the public (but is subject to more rigorous reporting and regulatory requirements). Limited by shares: liability limited to any amount unpaid on the shares. If shares are issued as fully paid, their holder has no further obligation to contribute to debts and liabilities. This is the most prevalent type of company. Features: ltd liability; can raise more funds by issuing more shares. Drawbacks: creditors cannot recover full debt; costs involved with issuing shares and restrictions on how you pay out profits. Limited by guarantee: liability of members limited to the respective amounts that members have undertaken to contribute if company is wound up. Features: no formalities involved with raising/dealing with share capital good for nonprofit organizations. Drawbacks: not a convenient way of running business if more capital is required. Unlimited: past and present members have no limit placed on their liability. Debts can only be called in when company is wound up. Features: easy to attract creditors; no restrictions on reducing share capital. Drawback: no limit to liability. No liability: a company that has share capital. Sole objective must be mining. Company has no right to call on shareholders who haven t fully paid their shares. Features: shareholders more likely to invest. Drawbacks: negative connotations associated with this type of company. Listed company: shares can be bought/sold on ASX. Access to wider market liquidity for shareholders. But subject to additional regulations. B 5 Corporate constitution and organs 6 Corporate groups Section 9 defines a holding company as a body corporate of which the first body corporate is a subsidiary. Section 46 defines a subsidiary as being one provided that the other body controls the composition of its board; or the other body controls a majority of the votes at a general meeting; or the other body holds more than half of its share capital. Section 50AA contains an accounting definition of a subsidiary. CASAC argues that this is the def that should be used. Walker v Winborne defines a corporate group as a group of companies associated by common or interlocking shareholding or where companies control other companies. Administration of Australian companies ASIC monitors compliance with the CA, Corporations Regulations, ASIC Act etc. ASX is the other main regulator, which monitors compliance with the ASX Listing Rules. 2

3 D How do you form a company? Incorporation is effected by written application by a single person, natural or corporate. Proposed company need have only one member and no constitution: s114. Must lodge an application with a statement of the matters set out in s 117. ASIC will register the company and issue an ACN and a certificate with the company s details: s118. A company comes into existence as a body corporate once it is registered by ASIC: s 119. From registration, the company has the legal capacity and powers of an individual together with the distinctive powers of a body corporate: s

4 II Corporate Personality and Limited Liability A The Doctrine of Corporate Personality A company needs to have at least one member: s 114 A company registered under the Act is invested with the legal capacity and powers of an individual: s124(1). A company s legal capacity to do something is not affected by the fact that the company s interests are not served by doing it: s 124(2). The exercise of a power or an act of the company that is contrary to the company s objects or constitution is not invalid: s 125 A proprietary company must have at least one director who resides in Australia. A public company must have at least 3 directors, 2 of which reside in Australia: s201a. B Concepts of separate corporate personality and limited liability Saloman v Saloman & Co FACTS: Saloman had been sole trader for many years. In 1892 he incorporated into a company, with seven shares (the minimum) which were held by his family members. Hard times followed the company had to borrow from Broderip, which did not save the company. Broderip appointed receiver and manager to recoup his funds. There were unsecured trade creditors with no recourse to the assets of the company, who were owed 8,000pounds. Mr Saloman claimed he was owed 5,000pounds from the company as a secured debt. At this stage the business only worth 1,000pounds. QUESTION: Was the company actually a company at all? Was Mr Saloman personally liable for the debts (could the corporate veil be lifted?)? Could he claim that the company owed him money? 1 st INSTANCE: rejected notion that the company was formed to defraud liquidators. Judge argued on the basis of agency company was the agent of Mr Saloman and he should indemnify the company for its debts. This was seen as a question of agency law not piercing the corporate veil technically. APPEAL: when Mr S appealed, CofA didn t accept the agency argument. They found that the incorporation was a mere scheme to allow Mr S to carry on business with limited liability, and this was contrary to the ideals behind incorporation and limited liability. Court found that the company was a sham and were prepared to pierce the veil. HofL: The Lords said that both previous findings should be dismissed. Company was acting on its own behalf. There was no fraud because all legal obligations had been met. Found that there was nothing fraudulent or against public policy in incorporating a oneman company to get limited liability. Held that the liability of the members was limited to the amount unpaid on the shares creditors could not make Mr S liable for the debts. Court noted that the creditors should have been more aware of the way the company had been set up, and they should have requested personal security from Mr Saloman. 4

5 Corporations are separate from their members. Small traders can impose a separate entity between themselves and their creditors. Lee v Lee s Air Farming Ltd FACTS: Business formed by Lee for purpose of crop spraying. Mr Lee was governing director and had full control. His solicitor held one share. Mr Lee was also employed by the company as a pilot. He died while working and his wife claimed workers comp. QUESTION: was Mr Lee employed for the purposes of NZ Workers Comp legislation? NZ Court: because Mr Lee was the governing director and had full control, he could not also be the company s servant. HELD by Privy Council: Mr Lee entered into a contract with the company, which was a separate legal entity. The contract of service was negotiated by the company on behalf of Mr Lee. Lord Morris focused on the fact that Lee was paid wages from the company and these were recorded in the wage book. PC found that Mr Lee had two different capacities with respect to the business that of director, and that of employee. They followed Saloman s case and said that one person may function in dual capacities. (N.B There was no fraud in this case) C Piercing the Veil of Incorporation 1. At Common Law (a) Fraud or improper conduct Gilford Motor Co Ltd v Horne FACTS: Horne was the former MD of the company. He had promised that during and after his employment he would not entice customers away from the company, and entered into a restrictive covenant to that effect. After he was fired, he set up his own company so that he could get around the provisions in the covenant. Plaintiff sought injunction to restrain defendant s business from enticing his customers. Horne claimed that his company was not bound by his personal covenant with the plaintiff. HELD: court decided to pierce the veil of incorporation because Horne had formed the company as a device to allow a breach of contract, and is the company is a device or sham, then the court can look behind the corporate veil. (N.B There is fraud in this case) Jones v Lipman Lipman had entered into contract to sell land to the Joneses. But before completion of the contract, he sold and transferred the land to a company which he had newly acquired. The sale price was less than he had agreed to receive from Jones. Jones sought specific performance against Lipman and his company. HELD: Lipman should be bound by the contract and specific performance should be the remedy. The formation of the company was solely to defeat the contract, and the defendant had full control of the company. The company was seen as a sham and a mask which the Lipman used to avoid recognition by the eye of equity. An order was made on both defendant and the company for specific performance. Note the fine distinction as to when you can look behind the corporate veil: if the purpose of incorporation is to provide limited liability (Saloman) then this is OK. 5

6 But if you incorporate in order to avoid an existing legal obligation, then the court can pierce the corporate veil. (b) Agency The separate legal body is acting for another person. Smith Stone and Knight Ltd v Birmingham Corporation FACTS: SSK was a paper manufacturer who acquired a waste business and premises in Birmingham, then they incorporated the Waste Co as a separate entity. All but 5 shares were held by the Waste Co directors, who were also directors of SSK. Waste Co had one manager but no other staff. It had no books all accounts kept by SSK. All of its profits were recorded as SSK s and no dividends declared. Local council wanted to acquire the premises and offered compensation to SSK to that effect. Legislation only allowed a company to get compensation for resumption if they carried on business on the premises. Council argued that SSK was merely a shareholder and thus this test was not satisfied. SSK argued agency. QUESTION: was subsidiary carrying on the business as SSK s business or as its own? HELD: Agency argument followed. Atkinson J raised 6 points which must all be satisfied before agency relationship can be established: 1. were the subsidiary s profits treated as though there were those of parent? 2. were the persons conducting the business appointed by the parent? 3. was the parent the head and brains of the business? 4. did the parent govern the business? 5. were the profits made by the skill and direction of the parent? 6. was the parent in effective and constant control of the subsidiary? In this case all of the factors were satisfied and therefore Waste Co was considered an agent of SSK. The issue of control was important. (c) Groups DHN Food Distributors Ltd v Tower Hamlets LBC FACTS: Local council was trying to compulsorily acquire the land. Could the company claim compensation for this? The land was owned by a group of three companies: DHN (holding company), Bronze Investments Ltd (a subsidiary who owned the land) and DHN Food Transport (a subsidiary which controlled the vehicles). Directors of all companies were the same. Premises were assessed at 360k. Also, the parent company claimed compensation for disturbance to business, but DHN was only described as the bare licensee of the land. Council took the view that Bronze was entitled to compensation money for the land, but the other two companies only got negligible amounts for disruption to business. QUESTION: what is the effect of the firm being three separate companies? HELD: Lord Denning was influenced by the fact that the subsidiaries were wholly owned, and parent could control their actions. He treated their relationship as a partnership and found that the subsidiaries were bound hand and foot to the parent company. Therefore, the companies as a group were entitled to compensation for the value of the land and for disruption. Goff LJ said that the facts of the situation should be looked at, because the courts are not entitled to pierce the veil in every case where there is a group. He took into account 3 factors when piercing the veil: 1. wholly owned 2. no separate business operations 3. nature of the issue in this case was highly relevant. 6

7 Shaw LJ looked at 3 different factors in determining the complete identity of the companies as a group: 1. common directors 2. common shareholding 3. common interest in maintaining the property Woolfson v Strathclyde Regional Council Referred to the above decision: courts should only pierce the corporate veil when there is a façade merely concealing the facts. The above decision was distinguished because there was no unity of ownership in the Woolfson case, and there was no control over the owners of the land as there was in DHN. Industrial Equity Ltd v Blackburn CA s 254T: a dividend may only be paid out of the profits of a company. FACTS: IE (holding company) declared a dividend but their profits were insufficient to cover that dividend. A shareholder challenged this and the holding company replied that their subsidiaries had profits to cover the dividend payout. They argued they could pay the div from the profits of the subsidiaries because they had the capacity to control the general meetings of the subsidiaries. They pointed to the groups accounting procedures, which were consolidated. HELD: the fact that the HC couldn t pay dividends out of the profits of the subsidiaries was a natural consequence of the separate legal personalities. He referred to Saloman s case and found that the HC couldn t draw on the profits of its subsidiaries. Other judges agreed. This case illustrates that Australian courts are less likely to pierce the veil. Qintex Australia Finance Ltd v Schroders Australia Ltd FACTS: Qintex Group comprised the holding company and four subsidiaries, one of which was called Qintex Australia Finance Ltd. Def (Schroders) was purchasing forex contracts on behalf of Qintex group. One contract lost $1.4m, and defendant was attempting to get this money back. Qintex Aust Finance had $1.150m in accounts with Schroders (a bank), who took all of this money even though it was another subsidiary of the Qintex group that had sustained the loss. Both Qintex group and all of its subsidiaries had one trading code with Schroders Bank. QUESTION: was Qintex Aust Finance a party to the loss-making transaction? HELD: Rogers CJ questions whether the law is operating correctly, before concluding that the subsidiaries should be considered individually, and Schroders should not have set off the losses of one of the subsidiaries against Qintex Aust Finance. Qintex Aust Finance was not a party to the contract. Walker v Winborne The directors of subsidiaries owe their duty to the separate legal entities in the group to those with which they are associated. (d) Other categories NOTE OVERLAP ON THIS SECTION! Briggs v James Hardie FACTS: Briggs worked for Asbestos Mines Pty Ltd for 6 yrs over a 20yr period. 5 yrs later, suffered asbestosis. He brought an action against Asbestos Mines (AM) and the two companies that owned it (They had a 50% shareholding each). Briggs limitation period had expired so he sought an extension. District Court judge awarded it for AM 7

8 but no the two holding companies. Briggs argued that he should be able to bring his action against the holding companies for two reasons: 1. agency 2. piercing the corporate veil HELD: in the Court of Appeal: Rogers AJA: considered Briggs arguments: 1. agency: due to the agreements in place between the companies, AM was not an independently functioning company. Briggs claimed that this situation was no different to a holding co exercising complete control over a subsidiary. Rogers didn t like this; he said that if this argument were to hold, then every holding company relationship could be classified as acting as an agency-type relationship. He struck out the agency argument. 2. piercing the veil: Rogers notes what isn t sufficient to pierce the veil: a. the potential only to exercise control over the subs is insufficient. b. The exercise of some control over the subs is insufficient. Rogers allowed Briggs to bring his action against the HCs because you couldn t say what evidence was required; and that it was possible a different test applied when deciding a matter in relation to a tort victim. This is because tort victims are involuntary creditors. Rogers criticised the tests laid down by Atkinson J in Smith Stone. He decided that it should not have been held that the plaintiff had failed to prove the availability of evidence which may make out a cause of action against the holding companies. Therefore the extensions should be granted. CSR Ltd v Wren FACTS: CSR was a holding company with a wholly owned subsidiary. Wren was employed by the subsidiary. He contracted a disease and brought a negligence claim against CSR Ltd. The subsidiary s board and mgmt staff were CSR Ltd employees. The mgmt and the directors were the same for both. CSR board meeting regularly made decisions about the operations of the subs. Working conditions often determined by the policies of the parent. Wren argued that CSR owed a duty of care to him. HELD: this argument was accepted: CSR owed a duty of care to employees of the subs directly and not an a secondary basis corporate veil was lifted. CSR had a duty directly to Wren he was treated as if employed by CSR. Court focused on the fact that the whole of the mgmt staff who had responsibility for the operational aspects of the subs were CSR staff. (d) Other Categories Briggs v James Hardie Facts: Briggs contracted asbestosis while working in an asbestos mine. He worked in the mine for 6 years between 1946 and He contracted the disease in the 1970s and didn t commence the claim until He sued James Hardie, Marlew Mining and Seltsan [or Wunderlich]. The commencement for the action was well outside the limitation period. The plaintiff made an application for an extension of time. The application was granted against Marlew but not the other two. Evidence shows that at the time the mine was owned and operated by Marlew [then called Asbestos Mines]. Between 1946 and 1953 Asbestos Mines was half owned 8

9 by both Hardies and Wunderlich. In 1953 Wunderlich transferred its 50 per cent holding to Hardies. For unknown reasons, the plaintiff was unsatisfied with the order that he had leave to proceed against Asbestos. He wanted to pursue his claim that until 1953 his employers were Hardies and Wunderlich and thereafter Hardies. This meant he was claiming that, in employing him Asbestos acted as agent for the other defendants ie he wants to pierce the corporate veil of the limited liability of Asbestos and sue the shareholders and controllers of Asbestos. Evidence: The plaintiff provided plenty of material that shows initially, the mining operation was conducted by a partnership of Wunderlich and Hardies which determined the direction of the company. In everything but name, the two are as one. Hardies and Wunderlich submitted that if it were to be held that for their period of joint holding they were the principal and Asbestos were the agent, then this would apply to virtually every holding company and fully-owned subsidiary. This would mean that the principle of limited liability in relation to the activities of the subsidiaries would be in tatters. No settled principle for piercing the corporate veil: There is no unified principle that explains the court s occasional piercing of the veil. The rule in Salomon was laid down at a time where the laissez faire ruled supreme. Now things are vastly different. Unity of enterprise theory: This is the proposition that the company has a separate legal personality from its corporators. The consequence of such a theory is the court s acertain the actual enterprise-fact to which is attached the consequences of the component individuals or corporations to that enterprise entity, to the extent that the economic outlines of the situation require. That the corporate veil can be pierced where one company exercises complete dominion over another is too simplistic. The law cares not to the reality that every holding company has the potential, and in fact often does, exercise complete control over the subsidiary. It remains to be seen whether a more principled approach is developed. The incorrect test applied: In the case the judge hold there are several reasons why the plaintiff has failed to make out a cause of action against Hardies and Wunderlich: o Such is the state of the present law it is not possible to say what evidence would make out a sufficient case to get around the test of agency. It is only the High Court who can rectify the decision in Salomon and adapt it to today s economy. o The doctrine of lifting the corporate veil has never been invoked in negligence cases. Different consideration should be taken into account in deciding whether the corporate veil should be pierced in tort cases. The key according to my teacher: 9

10 The general rule: The proposition that a co has a separate legal personality from its corporators survived the coming into existence of the large numbers of fully-owned subsidiaries of companies and their complete domination by their holding company There was a continued adherence to the principle recognised by Salomon, notwithstanding that for a number of purposes, legislation recognised the existence of a group of companies as a single entity. [That s verbatim from Rogers] With regards to the agency argument: It is clear that the relationship between Asbestos, Hardies and Wunderlich was no different from the everyday situation of a holding company and its fully-owned subsidiary. In everything but name the two are as one. The holding company customarily exercises complete dominion and control over the subsidiary [Hardies and Wunderlich there fore argued that if the court held] that they were the principal, and Asbestos the agent, then that conclusion could apply in relation to just about every holding company and fullyowned subsidiary and the principal of limited liablity in relation to the activities of subsidiaries would be in tatters. CSR v Wren Our teachers main point was that given the fact that the whole of the management staff, who had responsibility for the operational aspects of AP s enterprise and therefore the condition in which Mr Wren worked, were CSR staff, CSR had a duty directly to Mr Wren and that duty was co-extensive with that owed by an employer to an employee [verbatim from Beazely and Stein] Wren was awarded damages in the Dust Tribunal for the illness he suffered after inhaling asbestos while employed by the wholly owned subsidiary of CSR. The subsidiary s board of managers were all employed by CSR. The parent regularly made decisions that effected the subsidiary The court s held that CSR owed a duty of care to employees of the subsidiary directly and not on a secondary basis by lifting the corporate veil. Given that the whole of the management staff had responsibility for the operational aspects of the subsidiary and the conditions in which Wren worked, CSR owed a duty directly to Wren that was co-extensive with that owed by an employer to an employee. In the EU companies have a minimum requirement for assets. Kahn Freund put this argument forward. (e) General principle? Quote from Briggs v James Hardie, Rogers AJA: There is no common, unified or settled principle which underlies the occasional decision of the courts to pierce the corporate veil. It is a matter of extreme difficulty to say whether the evidence adduced meets even the less than exacting requirements of the section. 10