Separation of management and ownership

Introduction

This article mainly relates law issues like the separation of management and ownership, directors' duties to run a company and the discussion of objects clause. Generally, in a company shareholders should not override the management. Also, when directors run the company, there are several duties to owe. Last, the application of objects clause is meaningful to directors and shareholders.

The rights and obligations of James & Jenny Lee as majorities in relation to management of the company

This question aims to discuss whether shareholders should interfere with the management of the company. To make it clear, it is helpful to understand the separation of ownership and management of a company, the powers of directors, and the removing of directors by shareholders.

As shareholders give powers of management to directors, there is a separation of ownership and management. The scope of management power is very broad under s 198A. It includes changing the direction of company and sells the only business of company. Another very important point is that shareholders cannot override the directors and make themselves involve in the management of their company, like Automatic Self-Cleansing Filter Syndicate Co v Cunninghame[1906] 2 Ch 34. John Shaw & Sons (Salford) Ltd v Shaw [1935] 2 KB 113 states that the court held that the board of directors was properly exercising the powers of management vested in it by the constitution and the general meeting could not usurp this power. S 203D states that a public company may by resolution remove a director from office despite anything in the company's constitution or an agreement between the company and the director or an agreement between any or all members of the company and the director. In addition, under s 181, directors must act in the best interest of the shareholders, as a collective group. S 125(2) states a company's constitution may contain an objects clause that identifies and restricts the businesses and activities in which the company may engage.

In this instance, Harry, Wang and Frank are the directors of Space Technology Ltd. Shareholders of SPL appointed Harry, Wang and Frank as directors. So there is a separation of ownership and management. Harry, Wang and Frank have the powers to control the direction of the company. James and Jenny have no powers to override the directors. What James and Jenny did is a behavior of overriding the management like the case of John Shaw & Sons (Salford) Ltd v Shaw [1935] 2 KB 113 talked above. Besides, they even threaten to sack the directors if they do not comply with their wishes. If James and Jenny want to remove a director, it should comply with SPL's constitution and the agreement between Harry, Wang and Frank and the company. Or there should be a resolution for removal of director, under 203D. Under s 181, the directors should act in the interest of the company, as a collective group, not individuals. So directors cannot just listen to the two major shareholders. The company's constitution restricts the activities and direction of company. But James and Jenny want to change company's strategy. So they go against the constitution. This was the situation in Hickman v kent or Rommney Marsh Sheep Breeders' Assoc [1915] 1Ch 881.

This means that James and Jenny acted beyond the scope of their powers. James and Jenny cannot force directors to change the business strategy. What's more, they cannot take over the management of the company.

Mary Li's authority as minority shareholder

This question is about whether the director should call a general meeting and the issue of dividends. It is very necessary to make sure the rights of minority shareholders, possible remedy to call a general meeting of shareholders and payment of dividens.

On the one hand, s 249D and s 249Q. S 249D states that the directors of a company must call and arrange to hold a general meeting on the request of: (a) members with at least 5% of the votes that may be cast at the general meeting or (b) at least 100 members who are entitled to vote at the general meeting. On the other hand, s 249Q requires that a meeting of shareholders must be held for a proper purpose. If the request of holding a general meeting is to think about a resolution, it is a proper purpose. But it is not a proper purpose, if the request is to enforce self-interest, like NRMA v Scandrett [2002] NSWSC 1123. So the directors can refuse to hold a general meeting, if the purpose of calling is to trouble the company.

In this case, if Mary Li wants an extraordinary meeting, there should be a request of members with at least 5% of the votes and at least 100 members' votes, under s 249D. In addition, according to s 249Q, the board has the right to refuse to call a meeting, because the purpose of Mary Li is not proper. She just worried about directors would run down the company and drain her assets.

Secondly, another issue about this question is that the declaration of dividends.

To solve this problem, it is essential to concern about the s 254T, s 254 U, and s 254S. S 254T states that a dividend may only be paid out of profits of the company. Moreover, according to s 254U, the directors may determine that a dividend is payable and fix: the amount, and the time for payment, and the method of payment. Also, s 254S states that a company may capitalize profits. The capitalization need not be accompanied by the issue of shares. The replaceable rule in s 254U (1) gives directors the power to pay a dividend without the need for a prior dividend declaration by shareholders. As a general rule, shareholders cannot force a company to pay dividends even though it has available profits: Burland v Earle

In this case, Harry, Wang and Frank can determine the amount, the time and method of dividend payment, under s 254U. And shareholders cannot enforce directors to pay a dividend, like Burland v Earle [1902] AC 83.

Therefore, the board has the right to refuse to call a general meeting and shareholders cannot force directors to pay high level dividends.

Implications of directors' proposal to change business focus of company

This question aims to explore whether the directors breached the duties.

To make sure this, it is very useful to make sure the effect of original purpose of the doctrine of ultra vires and directors' duties to exercise powers for proper purposes. In addition, this question relates to changing constitution.

A company's constitution includes an objects clause that justify the businesses and activities in which the company may engage. The original purpose of the doctrine of ultra vires was to protect a company's shareholders and creditors. Under the object clause, the shareholders would believe that their capital only be used for the objects placed in the company's constitution. The doctrine could be only having application to a company whose constitution included an objects clause.

As s 181 stated, directors and other officers should act in the best interest of shareholders and with a proper purpose. If there is a breach of this duty to exercise powers for a proper purpose, the directors will have civil penalty provisions and possibly criminal liability.

On the other hand, this company's constitution restricts the company to plasma televisions and DVD players.

In this case, Harry, Wang and Frank changed the business focus without consulting with shareholders. That is not a proper purpose. Under s 125(2), there is a contravention of a company's constitution. The fiduciary duty of directors needs them to use their powers for a proper purpose. Harry, Wang and Frank breached the duty even if they honestly thought their action were in the best interest of shareholders, under s 181. A failure to comply with the constitution may be against the interest of the company. At the same time, their act is beyond the restrictions of object clause and changes the constitution of the company.

So, the three directors breach directors' duties to act for a proper purpose, and will receive penalties.

Implications of directors' behavior regarding management of company.

To identify if directors breach their duties, it is necessary to make sure directors' duties. Common law requires that directors should have the duties to act in good faith in the best interests of the company, to exercise powers for proper purposes, to avoid conflicts of interest and the ones of care, sill and diligence.

Firstly, when directors make decisions, they should have a fiduciary duty to consider the company's best interest. Section 181 requires that directors have a fiduciary duty to act in good faith and in the best interests of the company. It will be a breach if the act of directors does not comply with the best interest of the company, like ASIC v Adler [2002] NSWSC 171. At the same time, if the company is solvent, the interests of the company belong to the one of shareholders. But once the company is in a financial crisis, the company's creditors' interests become very important. In Darvall v North Sydney Brick & Tile Co Ltd, Hodgson J stated: "I think it is proper to have regard to the interests of present and future members of the company, on the footing that it should be continued as a going concern."?

Secondly, directors owe a fiduciary duty to exercise their powers for proper purposes. When it is alleged that the directors' act for an improper purpose, generally the courts will consider two reasons: the power was granted for that purpose and the purpose which in fact motivated the use of the power. Moreover, statutory duty to act in good faith and for a proper purpose that s 181 states that a director or other officer of a corporation must exercise their powers and discharge their duties in the best interest of company and with a proper purpose. This is particularly in a situation where directors' personal interests conflict with the interests of the company. If directors breach this duty, they will have civil penalty provisions.

Thirdly, the directors should owe the duty of conflicts of interests. There is usually a situation where a conflict between directors and the company. The directors should consider the interest of shareholders first and avoid the interest conflict. They cannot improperly use their position and information to gain benefits for themselves and ignore company's interests. As s 182 states that directors, other officers and employees of a corporation must not improperly use their position to gain an advantage for themselves or someone else and cause detriment to the corporation. In addition, s 183 requires that a person who obtains information because they are, or have been, a director or other officer or employee of a corporation must not improperly use the information to gain an advantage for themselves or someone else or cause detriment to the corporation.

Lastly, directors should have the duty of care, skill and diligence to run a company. As s 180 needs that a director or other officer of a corporation must exercise their powers and discharge their duties with the degree of care and diligence that a reasonable person would exercise if they were a director or officer of a corporation in the corporation's circumstances and occupied the office held by, and had the same responsibilities within the corporation as, the director or office.

On the other hand, directors should disclosure their interests. S 191(1) states that 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 unless subsection (2) says otherwise. Also, s 191(3) needs that the notice required by subsection(1) must give details of the nature and extent of the interest and the relation of the interest to the affairs of the company and be given at a directors 'meeting as soon as practicable after the director becomes aware of their interest in the matter.

So a director may need to give notice to the other directors if the director has material personal interest in a matter relating to the affairs of the company, like the case Regal (Hastings) Ltd v Gulliver[1967] 2 AC 134n.

In this case, the 3 directors set up a new company and bought the television from SPL. Because they are the directors of SPL, they will sell the television at a very cheap price to their new company STV. They may increase the revenue of the company in this way. However, that is not the best interest of the company, because the Korean company offered a generous price to buy the television in SPL. So the 3 directors breached s 181 which states that directors should act in the best interest of the company. They only care their own short term interests and ignore company's future interests. At the same time, they did not act for a proper purpose. The purpose of setting up another company and sell the television of SPL to STV is avoiding the pressures from shareholders. Shareholders are not satisfied with their way of running the company and the low level of dividends.

They may increase the degree of satisfaction of shareholders by selling more television, but this purpose motivated their exercise of the power which increased their own interests a lot and does not comply with the best interest of the company. So it is not a proper purpose. They breached s 181 and will receive civil penalty provisions. Furthermore, the directors sell television to STV for their personal interests. The directors should disclose their interests in transactions with their company, under s 191, 193 and 194. So the directors breached the duty disclose self-interested transactions with the company, like Regal (Hastings) Ltd v Gulliver [1967] 2 AC 134n. Meantime, their seeking to avoid their pressures from shareholders breached the duty of care, skill and diligence. The directors should take over those pressures and strength the company.

When directors breached any of their fiduciary duties, there is a variety of remedies available for the company. And the company will choose the remedy that achieves the best result from their own benefit, like Tavistock Holdings Pty v Saulsman (1991) 9 ACLC 450. Similarly, the court would award equitable compensation to relieve the company against loss arising from the breach of fiduciary duty. The directors were liable to compensate the company to the extent it was unable to recover its losses from the company. Sometimes, the directors who get benefit from a breach of duty may not knowingly be concerned in the breach. So the company needs to prove that the directors had knowledge of the essential facts constituting the breach before property may be recovered, like Abeles v P A( Holdings) Pty Ltd [2000] NSWSC 1008. If the 3 directors make a loss for SPL by selling television to STV, similarly to the common law remedy of damages, SPL Company may apply for the equitable remedy of compensation. So all directors who participate in the breach of duty are liable. SPL Company can sue any one of the 3 directors in breach of duty for full compensation. That director then has a right to seek contribution from the others who participated in the breach of duty. In addition, there are civil penalties for the directors. There are three types of penalties: a pecuniary penalty of up to $ 200,000 (s 1317G), disqualification from management ( s 206C) and compensation for damage suffered s 1317H.

All in all, the directors breached the duty to act in good faith in the best interest of company, to exercise their power for a proper purpose and duty of care, skill and diligence. Also, they breached the requirement of disclosing directors' interests. Then they will compensate for the damages and receive penalties.

Conclusion

Final overall conclusion, firstly James and Jenny acted beyond the scope of their powers, because there is a separation of ownership and management, and the directors' powers. Secondly, the board has the right to refuse to call a general meeting and shareholders cannot force directors to pay high level dividends. Thirdly, the three directors breach directors' duties to act for a proper purpose, and will receive penalties. Lastly, the directors breached the duty to act in good faith in the best interest of company, to exercise their power for a proper purpose and duty of care, skill and diligence. Also, they breached the requirement of disclosing directors' interests. Then they will compensate for the damages and receive penalties.

Bibliography

Understanding Company Law Lipton and Herzberg, 14th ed.

Australian Corporations Legislation, 2008

Information Services, Pyrmont NSW.

How to study business law crosling Murphy

Law, 8th ed, Butterworths, Australia