Corporate Legal Framework - Case Study Example

Introduction This paper examines important elements of Australian Company Law. This is done by critically evaluating a case that involves an issue relating to ethics amongst the management of an Australian company. This report will provide important insights into the issue in a critical manner. It will evaluate the issues in the context of the relevant Common Law principles, conventions and statutes that are relevant to the case. ISSUE ANALYSIS From the case at hand, Red & White Limited has been involved in a hastily organised meeting that led to the quick and non-through evaluation of documents prior to the acquisition of Phillips Glass Property for $75 million. This provides a set of issues and matters that must be examined and critiqued on the basis of Australian law and other Common Law provisions. The issues involve: 1. Whether or not Vernon, the non-executive director was involved in insider trading and/or breached conflict of interest principles; 2. Whether or not Rocco, the company non-executive director and chairman of the board of directors acted with due diligence or not; 3. Whether or not Nicole (managing director) and Jacques (financial officer) bear responsibility for negligence in preparing the financial analysis or not. CORPORATE LEGAL FRAMEWORK In order to provide answers to the various issues raised above, there is the need to draw into important statues and Common Law provisions that regulate actions related to the persons involved in the case. This will involve the identification of important elements and features that form the fundamental obligations and requirements of directors in the position of persons involved in the case illustrated above. Companies are formed by various shareholders who come together to pool their resources to raise capital. There is a complete separation of ownership and control in corporate law. Hence, companies are run by people who are nominated and by the shareholders, which is the board of directors. The board of directors are given power by the owners of the business (shareholders) to run a company and they do this by taking decisions and supervising activities in the organisation. The right to use the firms resources gives rise to the agency problem which involves the directors seeking to satisfy their own personal interest ahead of the interest of the company1. This is an issue that can be traced back to the early propositions of Adam Smith that sought to provide major regulatory systems for the control of affairs in corporate entities. This has reflected in the national legal systems which have evolved over the years to include various corporate laws and principles. The fundamental legal requirements and expectations of company directors include amongst others: 1. Act honestly in the companys best interest; 2. Not to fetter discretion; 3. Avoid conflict of interest and 4. Exercise power for their proper purpose2 Conflict of Interest Conflict of interest has been an issue that was prohibited and restricted by Common Law. In Cook V Deeks3 it was held that directors of a company will have to act in the best interest of the company. And where they subjugated the companys interest in favour of a personal interest of some of the directors, a fraud is committed on the shareholders who stand to lose from the gains of the directors. In another landmark case, Green V Bestobell4, a director of an business that had completed the first phase of a given contract and was expecting to gain more profit from the second stage tendered for the contract for the second stage whilst still a director. The director however got the contract but it was declared that a fiduciary duty existed with the defendant and hence, the breach of that duty made it ineligible for the director to abuse privileged information for his personal benefit. Due to the significance of the conflict of interest principle, the Corporations Act of 2001 integrated statutory rules that made it obligatory for directors to avoid conflicts of interest in carrying out their duties. Section 182 of the Corporations Act make it improper for a person in a directorship position to abuse privileged information. Section 183 also forbids directors to abuse insider information to gain wealth. These statutes were put to the test in the case of ASIC V Vizard5 where Vizard gained some privileged information that led to the formation of a company owned solely by his accountant. Although criminal actions failed, a civil action by the Australian Securities and Investments Commission led to the fining and banning of Vizard for insider trading. Section 191 places additional limitations on directors and requires them to disclose their personal interests in other companies a firm transacts with. If a director discloses his interest in a firm it is trading with, that director can vote if the company is private, but if it is a public company, the director in question cannot vote on the matter6. Moreover, Section 210 of the Corporations Act require transactions led by directors to be done based on proper negotiations. In other words, commercial agreements must be based on an arms length transaction. Duty of Care and Due Diligence The principle of observing a duty of care is a Common Law duty that has been preserved for generations. Where a person holds himself out as a professional and another person relies on that claim, that individual will have to exercise the level of care expected of a professional at such a level. This principle is known as the Hedley-Byrne7 principle and it assets that where a person holds himself as a professional, that individual also assumes responsibility for diligence and care commensurate with the level of professionals in that rank. Thus, in the broad sense, where a person is appointed as a director, that individual holds himself or herself out as a competent person. Hence, the individual must act with due care, skill and diligence and exercise reasonable judgement. This is integrated in the Corporations Act 2001. Section 180(1) of the Act requires that directors need to carry out their activities with a degree of care and diligence of a reasonable person. A director has a duty to monitor the management of a company and ensure that they do the right things. In doing this, a director must exercise care, skill and due diligence8. In the case of Vines V ASIC9 it was established that the director has a primary responsibility of inquiring and crosschecking facts. And in the process, a director needs to use all necessary skills and seek external help where necessary. The directors must make judgements in good faith and take decisions that they rationally believe to be true (Section 180(2) of Corporation Act, 2001). And where there is the need for a director to seek external advice, he must take advice from a reliable and reasonable source (Section 189, Corporations Act, 2001). Delegation of Due Diligence As a general rule, a director cannot delegate responsibility for actions. In other words, a director is responsible for whatever happens. However, there are case where delegation can pass as a valid defence for a director. Section 190 allows a director to delegate technical duties like preparing accounts, however, the board of directors will need to monitor these technical duties. Section 198 of the Corporations Act allow directors to delegate power to the managing director and financial officer. However, Section 251 requires it to be documented appropriately. Responsibility for Major Losses Ultimate responsibility for delegation falls upon the directors. This is because the Corporations Act 2001 states that directors must not trade during insolvency or stop trading where there is a risk of insolvency. Where insolvency occurs, directors are held responsible and this could lead to sanctions. However, the defence for insolvency is that the directors took all reasonable steps to prevent the insolvency10 APPLICATION OF RULES TO CASE FACTS Red & White Ltd operates a wine‐producing business and owns vineyards around Australia. The five directors on the board of Red & White Ltd are: 1. Rocco, the company’s non‐executive director chairman; 2. Nicole, the company’s managing director; 3. Jacques, the company’s financial officer; 4. Chinnelle, the company’s non‐executive director; and 5. Vernon, the company’s non‐executive director who previously was the managing director of the company and had a detailed knowledge of the company’s business operations and the wine industry generally. At Vernon’s suggestion, a proposal for Red & White Ltd to acquire the bottling manufacturing businesses owned by Phillip’s Glass Bottles Pty Ltd for $75 million was an agenda item at Red & White Ltd’s board meeting a few months ago. At the meeting, because it was late in the day and all the directors were anxious to leave, Rocco allowed only 10 minutes for Nicole to present a business plan for the proposed acquisition. Jacques’s financial report on the impact of the acquisition was tabled at the board meeting but he was not allowed to speak or answer questions. After a few minutes’ discussion the directors approved the acquisition and Nicole subsequently signed a contract to buy the business on behalf of Red & White Ltd. Subsequently, the board discovered that Jacques’s financial analysis had obvious mistakes and therefore the $75 million purchase price was grossly excessive. Unfortunately, this discovery was made only after Nicole signed the purchase of business contract on behalf of Red & White Ltd. The board was also unaware that Vernon’s family company owned most of the shares in Phillip’s Glass Bottles Pty Ltd. Assume that:  Red & White Ltd completed the $75 million purchase of business from Phillip’s Glass Bottles Pty Ltd; and  The purchase of the business proved to be a financial disaster for Red & White Ltd with the result that the shareholders replaced the whole board with new directors. Advise the new directors of Red & White Ltd whether its former directors breached any of their duties in relation to the decision to purchase the business from Phillip’s Glass Bottles Pty Ltd. Your answer should also consider whether the former directors are able to rely on the business judgment rule or any other defences to avoid liability. Bibliography Burton-Jones Alan and Spencer John. Oxford Handbook of Human Capital Oxford: Oxford University Press. 2012. Du Pleiss, John, McConvill, James and Bagaric Mirko. Principles of Contemporary Corporate Governance. Cambridge: Cambridge University Press. 2010 Statute Corporations Act 2001 Cases ASIC V Vizard [2005] FCA 1037 Cook V Deeks [1916] 1 AC 554 Daniels v Anderson [1995] 37 NSWLR 438 Green & Clara Pty Ltd v Bestobell Industries Pty Ltd [1982] WAR 1 Hedley Byrne & Co Ltd v Heller & Partners Ltd [1964] AC 465 Vines V ASIC [2007] 73 NSWLR 451 Read More