We like to challenge our lawyers with hypothetical situations to see if they can develop a solution. Our most recent example and a sample response is below.
Question 2:
Marlin Fishing Pty Ltd carries on the business of commercial fishing. The company is run by Michael, who is the founder and governing director and Michael’s three (3) sons Dan, Terence and Pat who are also directors and shareholders. The company has a constitution that requires that all contracts to be entered into on behalf of the company must in the first instance be approved by a meeting of the directors and that the company seal should be affixed. The constitution expressed that when the company seal was affixed it needed to be accompanied by the signatures of two (2) directors.
Michael discovers a new boat for sale which would considerably improve the ability of the fishermen to stay at sea longer and better keep the catch of fish. He decides to purchase the boat on behalf of the company believing that his sons would agree with the decision. He simply signed the contract: ‘Michael for and on behalf of Marlin Fishing Pty Ltd’.
When Dan, Terence and Pat learned of the purchase of the new boat they refuse to ratify the contract and do not wish to spend the company funds on such a vessel at this time. Advise the sons whether the company will be bound by the contract and also identify the possible personal liability of Michael (if any).
Marlin Fishing Pty Ltd:
Michael acting in his position as director of Marlin Fishing Pty Ltd has purchased a new boat for the company. He signed the contract for the purchase as ‘Michael for and on behalf of Marlin Fishing Pty Ltd’, however the company constitution requires that all contracts entered into by the company must be approved by a meeting and have the company seal affixed with the signature of two directors.
His three sons Dan, Terence and Pat, who are also directors and shareholders of the company have refused to ratify the contract, not willing to spend company funds at this time and are seeking a remedy.
The company has adopted a constitution under s 136 of the Corporations Act 2001 (Cth), which sets out the rules the company is to operate by, as well as its structure and operation. Under section 140 of the Act a company’s constitution will have effect as a contract between the company and each director, which binds each person to observe and perform the constitution and its rules.
Under s 124 of the Act a company has the power to act in the same way as any individual, which includes entering into contracts for purchase, meaning that the company could legally enter into a contract for the boat’s purchase. The company constitution however outlines how all contracts to be handled and in purchasing the boat Michael has clearly breached this rule, through improperly signing the contract.
The enforceability of the contract with the third party for the boat may remain enforceable unless the third party knew or suspected the company to be acting in breach of its powers under its constitution. The third party does not have to prove they actually made the assumption in order to rely upon it. Under s 128 of the Act the third party is entitled to make the assumption that Michael rightly had the authority to purchase the boat.
However it can be argued that the third party was wrong to make this assumption as under s 128 the assumption must be one listed in s 129. Michael signed the contract as ‘Michael for and on behalf of Marlin Fishing Pty Ltd’. Under s 129(5) a document signed without a company seal can only be assumed to have been duly exercised if it appears to have been signed in the way laid out in s 127(1).
Under s 127(1) a document without a common seal must be signed by two directors. In this case the document was only signed by Michael, meaning only the signature of one director was present on the contract. As it was evident that the signing of the contract was not carried out correctly the third party was wrong to assume that he had complied with the company constitution. The assumptions under the Act do not serve to validate a transaction. Therefore the third party was wrong to make the assumption that Michael had the authority to purchase the boat and Dan, Terence and Pat will not be bound by the contract for its purchase.
Michael acted improperly in entering into the contract as the company has in place a constitution that deals with how a contract is to be handled. Firstly the directors must approve the contract at a meeting of directors, and secondly the company seal must be attached and accompanied by two director’s signatures.
Michael and his sons are shareholders in the private company and thus as shareholders are entitled to sue in contract for a breach by another shareholder, in this case Michael.
Section 180(1) of the Act covers the care and diligence a director must take in carrying out their role. It states that a director must exercise their powers with “the degree of care and diligence that a reasonable person would exercise.” The risk of harm is balanced by the court against the potential benefits of the director’s actions. This is a civil obligation that Dan Terence and Pat could argue Michael breached due to him not exercising proper diligence when entering into the contract. A reasonable person in his position as director should be aware of the company requirements for the entering into of contracts.
Directors have a common law duty to act in the best interests of the company. The test for this duty is a subjective test of whether the director acted ‘honestly or in good faith.’ A director breaches this duty where they don’t give proper consideration for the company’s interests. It is evident that Michael was in fact acting in good faith and for the company’s interests.
Michael could use s 180(2) as a defence to any action against him, which allows for a director to meet the requirements of subsection 1 if they; “(a) make the judgment in good faith for a proper purpose; and (b) do not have a material personal interest in the subject matter of the judgment; and(c) inform themselves about the subject matter of the judgment to the extent they reasonably believe to be appropriate; and (d) rationally believe that the judgment is in the best interests of the corporation.” If the director can satisfy these elements then they will not have breached their duty to the company.
Michael could argue that he fulfilled these criteria in that he made the purchase for a proper purpose; that being it would considerably improve the ability to the company’s fisherman to stay at sea longer and also better keep the fish. He also had no personal interest in the boat, purchasing it on behalf of the company wholly for the company’s use. He believed it would benefit the company, and his sons would agree with his decision. If Michael can successfully make this argument then he will face no personal liability.
It is probably not in the best interests of the company to pursue action against Michael, due to his defence under s 180(2), and also that imposing personal liability against a director can make directors overly cautious. Michael was attempting to improve the company’s position and imposing personal liability could reduce the future economic performance of the company.
Although Michael breached the company constitution in purchasing the new boat the company will not be bound by the contract if they don’t ratify it as the third party was wrong to assume a contract not signed by two directors was valid. Michael is unlikely to be personally liable though, having acted in good faith in the company’s best interests.
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