Question

QUESTION 1 10 MARKS Mick, Mark and Mike are directors and shareholders of MMM Hotels Pty. Ltd. Mick, the founder of the company, owns 80% of the shares while Mark and Mike each own 10% of the shares in the company. Mick is also a single director and shareholder of CAT Construction Pty Ltd. Mick convinced the board of MMM Hotels that the company could improve its position by refurbishing and expanding one of its hotels. The expansion required Council approval and a loan of $2.5 million. Mick sought quotes from other construction companies (which exceeded the quote from CAT Construction) and ensured the quote from CAT Construction is well below these other quotes. At the Board meeting, Mick showed Mark and Mike various financial figures, prepared by Ned, the newly hired graduate accountant at MMM Hotels and said “Ned is confident the company would benefit financially if we go ahead with this”. None of the directors understood the financial figures and had not realised the company’s cash flow was low and that the loan could lead the company into insolvency. Mark and .Mike were unaware that Mick was also a director and shareholder at CAT Construction. At the Board meeting, Mick further represented that “Council approval for this expansion is not a problem – our competitors have done similar expansions and have managed to get Council approval in a month or so.” Mark and Mike relied on Mick’s representations to the Board meeting, as they were excited about the refurbishment and the potential for profits to increase and hence their remuneration to rise accordingly. Mick had assumed that Council approval would be easily granted and did not attempt to seek approval until after Mark and Mike had signed the contract with CAT Construction. In the meantime, CAT Construction has commenced work and collected an advance payment of $400,000 from MMM Hotels. Two months after the refurbishment commenced, the Council informed him that the approval was not granted. MMM Hotels was struggling to meet its loan repayments and has become insolvent. Mark and Mike have now realised the true state of affairs and demand that Mick repay the $400,000 to MMM Hotels at the general meeting. Mick being a majority shareholder in the general meeting passes a resolution ratifying the contract with CAT Construction Answer the following questions: 1. Advise Mick, Mark and Mike whether they have breached any of the directors’ duties under the Corporations Act 2001 (Cth). 2 marks 2. Advise what if any defences are available to Mick, Mark and Mike 2 marks 3. Advise Mark and Mike what member’s remedies are suitable for them in the circumstances where Mick being a majority shareholder in the general meeting passes a resolution ratifying the contract with CAT Construction 2 marks As things transpired, the directors had no alternative but to place MMM Hotels into voluntary administration and it was subsequently placed into liquidation. 4. The liquidator now desires to commence an action against the directors alleging the directors for insolvent trading. Advise 2 marks 5. The liquidator also desires to recover the $400,000 payment to CAT Construction, a related entity to Mick, under Part 5.7B Div 2 of the Corporations Act. Advise

Answer 1

Answer:

The directors of MMM Hotels Pty are in breach of the following director duties under Corporations Act 2001(Cth)

a)Duty to avoid improper use of information and position. Section 183 of the Act provides an obligation that prohibits a director from making improper use of their position to gain advantage to the detriment of the company. Mick is under obligation to use his position properly and must not use his position for personal gain.He uses his position to get a contract for his company CAT constructions by under quoting competitors using information gained from his position in the company.

b)Duty to act in good faith and proper purpose. The directors must promote the future success of the company in decision making. In Re Smith & Fawcett Ltd the directors are bound to exercise their power in a way that they consider in the best interest of the company. Mick does not promote the success of the company by ratifying the contract with CAT Construction even though he knows the company does not get council approval.Additionally Mark and Mike rely on Mick's representation and do not conduct thorough investigations on the proposal since they are were excited about the refurbishment and the potential for profits to increase and hence their remuneration to rise instead of company success

c)Duty to disclose interest in proposed transaction. Directors of a company must disclose personal interest in proposed transactions or arrangement. The director must disclose to the other directors any material interests in any proposed transactions to avoid conflicts.Director must not enter into any arrangement in where company's interest is clashed with their own interests. The directors must not make any secret profit using the position in the company. In Aberdeen Rly Ltd v Blaike Brothers it was held that a director is not allowed to enter into any arrangement that may raise conflict of interest. Mick does not disclose interest in CAT construction and the contract and thus is in conflict of interest

d)Duty to act with care and diligence.The directors must act with care in exercising their powers as director.They must act as a person with similar knowledge and skills in similar position is expected to act.Failure to conduct further investigation to the financials of the company means the directors missed a chance to discover the project was not viable and thus save the company from insolvency.Thus all directors are in breach of this duty

Detailed Explanation:

2) Business Judgement Rule

The defense for directors for decisions that may be seen to breach their director duties is the Business Judgement Rule under the Australian Corporations Act 2001 section 180.Section 180(2) makes 4 conditions for this rule;

Makes the judgement in good faith for a proper purpose

Do not have a material personal interest in the subject matter of the judgement

Inform themselves about the subject matter of the judgement to the extend they reasonably believe to be appropriate

Rationally believe that the judgement is in best interest of the corporation

3)Mark and Mike can institute a derivative action against Mick on behalf of the company. The allowance for derivative actions is codified in the Corporations Act 2001 (Cth) in part 2F.1A. It dictates that the court should allow a derivative action where it is satisfied by those bringing the action that the relevant grounds required for an application have been established. These are,

that shareholders are acting in good faith,

that the action is in best interest of the company

it is unlikely the company would bring the action itself or take responsibility over the matter.

In John Shaw & Sons(Salford) Ltd v Shaw the court determines that if the power to sue is solely vested on the directors,then there will be difficulties if the wrong doers are the same board members and are in a position to prevent an action,then the court allows individual shareholder to bring action on behalf of the company

Thus Mark and Mike can succeed in bringing a derivative action to void the contract ratified by Mick.

4)Under Part 5.7B Div 2 of the Corporations Act , Insolvency trading refers to a company that is insolvent but continues to trade even after the directors discover of the fact.A company is insolvent if it is unable to meet its financial obligations when they fall due. The directors of a company must take reasonably sufficient measures to mitigate from insolvency in order to protect its creditors interests. Failure to take these measures and continuing to trade makes the directors personally liable for the debts incurred while the company was insolvent.

The directors of MMM Hotels Pty engage in insolvent trading when Mick unilaterally ratifies the CAT Construction contract knowing the company does not have the cashflows to avoid insolvency. the directors must not continue trading if they have knowledge of insolvency.Any contracts made afetr this means the directors are personally liable.Thus Mick can be sued by the liquidator for the $400,000 paid to CAT.

References

Reisberg, A. (2009). Derivative actions and corporate governance. Oxford University Press.Thai, L. (2002). How Popular are Statutory Derivative Actions in Australia? Comparisons with United States, Canada and New Zealand. Australian Business Law Review, 30, 118-137.

Is the threat of voluntary administration credible in restructurings? (n.d.). Legal Services | Australia | Clayton Utz - Clayton Utz. https://www.claytonutz.com/from-red-to-black-2019/is-the-threat-of-voluntary-administration-credible-in-restructurings

Routledge, J., & Morrison, D. S. (2009). Voluntary administration: Patterns of corporate decline. C&S Law Journal, 27, 95.

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