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Please note that the word limit of 1 000 words is a total for the questions

Question

John, Paul and Ringo and George are musicians who operate out of a garage in Melbourne. They initially form a partnership, but then decide to incorporate, and register a company called New Beatles Pty Ltd of which John, Paul and Ringo own 30% each and George owns 10%. The business of the company is to play music, hold concerts and record CDs. All four brothers are also directors. Things go well for a year, but then disputes occur. Ringo comes to you and asks you advice in relation to the following:

Ringo has found out that a meeting of shareholders was held without giving notice to him and that at the meeting an ordinary resolution to change the company logo from a silver guitar to a red trumpet was agreed to by all his brothers. Ringo tells you that he objects to this step.

By another resolution – also agreed to by the other three brothers - the actual constitution of New Beatles Pty Ltd was changed so as to insert a provision which limits the company’s activities to Australia. Ringo tells you that he objects to this, as he believed the company should start touring overseas.

Ringo also discovered that over the past couple of years Paul has been giving his (Paul’s) girlfriend Sarah $ 500 per week from company funds, and that in total the company has suffered a loss of $ 50 000 because of these payments. When Ringo raised this at a board meeting and proposed that the company’s lawyers be asked to initiate action against Paul and Sarah to recover the money, the other three directors voted against the proposal.

Finally, Ringo tells you that since he confronted his brothers about Paul’s conduct, they have begun holding board meetings without telling him (Ringo).

Advise Ringo as to what remedies he can obtain in relation to the above, citing legal authority. [You should assume, and therefore do not need to prove, that the payments by Paul to Sarah are a breach of the duty to act in the best interests of the company under s 181 of the Corporations Act 2001 (Cth).]

Explanation / Answer

Under provisions of section 181 of the Corporations Act 2001directors indeed are subject to compliance of strict duties because power conferred upon directors with regard to controlling of company management eventually can be tempted towards misuse of their position for their own benefit. Furthermore shareholders who are passive investors and do not follow the company’s management on a daily basis may be vulnerable.

Directors owe duties under the general law and statute wherein the relationship between director and company is indeed regarded as fiduciary wherein necessitates setting up of high standard of loyalty which eventually is reflected through positive duties aimed towards effective functioning of the organization. For instance it includes duties to act in good faith and best interests of the company aimed towards appropriate corporate purposes, give adequate consideration to matters for decision and maintain strict regulated discretions.

These duties are reinforced by section 181 of the Corporations Act 2001. Furthermore necessitates directors to avoid various conflicts of interest which eventually is reinforced by sections 182 and 183 of Corporations Act 2001. Under the common law directors owe a duty of care towards their organization which is enumerated by section 180(1) of the Corporations Act 2001.

In deciding whether a director has breached any of their duties courts are unwilling to substitute their own judgment for the business judgments made by directors. Furthermore there indeed is a statutory business judgment rule that applies in respect of the statutory duty of care and diligence. The statutory business judgment rule only applies to the duty of care and diligence as enumerated under section 180(1) and not to the duties imposed by sections 181 or 182 of general law.

The statutory business judgment rule provides that a director of an organization who makes a business judgment is regarded to have met the requirements of section 180(1) and their corresponding duties mentioned under common law and equity in respect of the judgment. Furthermore they indeed need to make the judgment in good faith for a common appropriate business purpose; do not have a material personal interest in the subject matter of the judgment; inform other directors about the subject matter of the judgment to the extent they reasonably believe to be appropriate and rationally believe that the judgment is in the best interests of the business.

If director breaches any of their enumerated duties they may be absolved provided they had acted honestly as provided under section sections 1317S and 1318 of the Corporations Act 2001. However director would need to prove that they acted without deceit or conscious impropriety, without intent to gain an improper benefit and without carelessness or imprudence.

Directors are subject to strict duties at law which eventually are aimed towards protecting shareholders from inherent risks that are present when a person entrusts their property or affairs to other individuals. However if directors make business judgments in good faith and for proper purposes and act honestly court eventually are reluctant to intervene.

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