LAW504 Business and Corporations Law

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LAW504
Business and Corporations Law
FACULTY OF BUSINESS
MODULES
*LAW504*
Business and Corporations Law
LAW504 Modules
Faculty of Business
Written and compiled by
Bede Harris
ii
Educational designer
Ben Bohmfalk
Produced by Division of Learning and Teaching Services, Charles Sturt University, Albury –
Bathurst – Wagga Wagga, New South Wales, Australia.
First published June 2013
Last updated January 2018
Printed at Charles Sturt University
© Charles Sturt University
Previously published material in this book is copied on behalf of Charles Sturt University pursuant
to Part VB of the Commonwealth Copyright Act 1968.
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Contents
Page
Topic 1 The Australian legal system 1
Topic 2 Sources of law and interpretation of statutes 14
Topic 3 Torts – Elements of liability 24
Topic 4 Torts – Damages and defences 35
Topic 5 Contract – Formation 40
Topic 6 Contract – Legal validity and validity of consent 52
Topic 7 Contract – Contents of contracts 60
Topic 8 Contract – Discharge of contracts 68
Topic 9 Consumer Law 76
Topic 10 Property law 83
Topic 11 Introduction to business organisations 87
Topic 12 The law of agency 90
Topic 13 Partnership 97
Topic 14 The concept of incorporation 105
Topic 15 Company liability in crime, tort and contract 118
Topic 16 Corporate governance – the constitution 128
Topic 17 Members’ meetings 133
Topic 18 Members’ remedies 138
Topic 19 Directors 147
Topic 20 Directors’ duties 152
Topic 21 Corporate finance: shares and debentures 173
Topic 22 Fundraising by public companies 181
Topic 23 Liquidation 188
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Topic 1 The Australian legal system
Learning Objectives
At the completion of this topic you should be able to:
1. explain the nature of law and the functions of law in society;
2. outline how different world legal systems are classified;
3. describe each of the components of the Australian federal
system;
4. outline the functions of the three branches of government:
legislative, executive and judicial;
5. describe the structure and the functions of the
Commonwealth parliament and the distribution of power
between the Commonwealth and the States;
6. outline the jurisdiction of Commonwealth and State courts;
and
7. outline the ways in which disputes can be resolved other
than by litigation, using Alternative Dispute Resolution
(ADR) mechanisms.
Video
A. The nature of law
Introduction
Law is the body of rules for human conduct that are enforceable by the coercive
power of the state. Thus law consists of the rules that are generally regarded as
being obligatory in any given society. They differ from other rules, such as social
rules or the rules of etiquette, in that they will be enforced by the courts – in other
words, the courts will give an order that will be enforced by the police if
necessary, to give effect to the rules of law.
Where a person is found guilty of a criminal offence, the court might order that
they pay a fine or sentence them to prison.
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If there is a civil case (that is, one person sues another) the court may give what
is called a remedy to the person who wins the case – for example, may order the
other person to pay money in compensation, restore property or perform as they
agreed to under a contract.
The function of law in society
Most people think very little about the law until something goes wrong. But the
law is continuously regulating our behaviour. Goods are sold. People work.
Couples get married or live in de facto relationships. Cars are driven. Individuals
die. We pay taxes. Property is leased or purchased. Companies are formed. The
law lays down rules in respect of these and other matters that affect us all. So
there is a multitude of functions performed by law, including:
 Controlling social relations and behaviour;
 Providing the machinery and procedures for the settlement of disputes;
 Protecting individuals by maintaining order;
 Preserving the existing legal system;
 Protecting ownership and enjoyment of the use of property;
 Reinforcing and protecting the family;
 Facilitating social change.
The law is obviously of immense importance in our society.
Classification of law
Laws may be classified in different ways. Some of the major classifications or
divisions are as follows:
1. A very broad classification is between international law and national,
domestic or municipal laws.
International law is the body of rules of law that regulate the conduct of
countries between themselves, known as ‘public international law’, or the
citizens of different countries in an international context, known as ‘private
international law’. The national, domestic or municipal laws govern
relations between people in or within a country.
2. Within the international community, domestic legal systems can be divided
into a number of families. Common law jurisdictions are those like
England, the United States, Write my essay for me – CA Essay writer Canada, Australia, New Zealand, Hong Kong
and Singapore, whose legal systems are all based on the principles of
English common law, the principles of which are found in case law,
supplemented by statute law. In Civil law jurisdictions, which include
European countries, Japan, 论文帮助/论文写作服务/负担得起我及时提交我最好的质量 – China and countries in Latin America, the
primary source of law is a Code based on 18th and 19th century models
originating in Europe. The courts themselves do not create legal rules in the
form of case law – their role is restricted to the interpretation of the Code.
In Sharia systems, law is based on religious rules found in the Qu’ran – in
other words, there is no separation between religious law governing the
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lives of believers and the general law applicable to society. The law is
interpreted by religious scholars.
3. Another classification is between public law and private law.
Public law is the body of law more concerned with the government of a
country, for example, constitutional law, administrative law, criminal law
and revenue law.
Private law is concerned with regulating the lives of individual citizens in
their relations with one another, for example tort law (covered in next
topic), contract law, property law and family law.
4. A third classification is between criminal law and civil law.
Criminal law is directed towards the enforcement of rules on behalf of
society as a whole. A criminal case is brought by a prosecutor acting on
behalf of the government, pursuing the interest society has in ensuring that
order is maintained. The objective of criminal law is punishment. The level
(or ‘onus’) of proof required is high – the court must be convinced of the
defendant’s guilt beyond reasonable doubt, which is a very high level of
probability.
Civil law (note the completely different meaning of the term ‘civil law’ to
that used in point 2 above) involves a dispute between two private parties
which could be people or companies). In a civil case the person bringing
the case (the plaintiff) asks the court to adjudicate a private dispute that they
have with the defendant. The objective of a civil case is compensation of
the plaintiff for the damage they allege they have suffered because of the
acts or omissions of the defendant. The standard of proof in civil cases is
lower than in criminal cases – the court needs only to be persuaded that the
case of one party or the other is true on a balance of probabilities – that is,
that that party’s case is more likely to be true than not.
Note that, although criminal law and civil law are different in important
respects, both a criminal and a civil case could result from the same event.
For example, if a speeding driver hits a pedestrian on a crosswalk, the driver
may be charged with the criminal offence of dangerous driving causing
grievous bodily harm, and could then face a separate civil action where the
pedestrian sues him or her for damages under the law of torts.
5. A fourth classification is between substantive law and procedural law.
The divisions within substantive law include criminal law, property, torts,
contracts and constitutional law. Substantive law consists of those laws
which identify the rights and liabilities under the law.
Procedural law provides the means of enforcement and operation of the
substantive law, for example, the laws relating to civil procedure, criminal
procedure and evidence. They specify the courts in which actions are to be
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commenced, how trials are to be conducted, the orders the judges make, and
the grounds and avenues of appeal.
Sources of law
There are two main sources of law:
 Statute law (also referred to as legislation) which is enacted by a law
making body, such as the Commonwealth or State Parliaments or a local
authority.
 Case law (or common law) which consists rules of law developed over the
centuries and applied by the courts if there is no statute law on a topic.
We will explore this distinction in much more detail in the next Topic.
Web Content
The most comprehensive source of Australian statute and
case law is AUSTLII (the Australian Legal Information
Institute) at https://monkessays.com/write-my-essay/austlii.edu.au/ . Follow this link to the
site, where you will be able to search for Commonwealth,
State and Territory law.
B. Australian constitutional law
The institutions, or branches of government, that collectively constitute the legal
system are:
1. The Legislature – the Commonwealth Parliament, State Parliaments,
Territory Assemblies and local authorities that make statute law;
2. The Executive – the government departments – Federal, State and Territory –
that apply, administer and implement the laws; and
3. The Judiciary – the Commonwealth, State and Territory courts and tribunals
that apply and interpret statute law, develop rules of common law and
resolve disputes.
Other components of the legal system include the law enforcement agencies such
as the customs, prisons, health inspectors and the police which enforce the laws
and play an important part in the judicial process.
Though strictly not part of the legal system, the legal profession also plays an
important part in the administration of law and the operation of the legal system.
Australia has a federal parliamentary system. This means that Australia has a
central government located in Canberra empowered to make laws for the whole
country, while each State and Territory has its own government that can make
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laws that have application within their respective States and Territories. The effect
is that there are two legal systems, that is the Commonwealth, and that of each
State or Territory. Australia, the United States of America, and Write my essay for me – CA Essay writer Canada have
federal systems of government in contrast to the United Kingdom and New
Zealand that have a single or unitary system.
Any federal system of government has three key features. They are:
1. A division of legislative authority by the national Constitution, with some
powers being given to the central / federal / Commonwealth legislature that
makes laws for the whole country, and the rest to State / Provincial
legislatures which make laws for their particular jurisdictions;
2. The inability of either the federal or the State governments to change the
Constitution on their own and
3. A court with jurisdiction to enforce the Constitution and determine disputes
between the central and state governments.
These features are found in the Commonwealth of Australia Constitution Act
1900, which came into operation on 1 January 1901.
Under the Australian model of federalism, the Commonwealth Parliament can
legislate only on those matters which are stated in the Commonwealth
Constitution as falling within its legislative power. If a topic is not mentioned in
the Constitution, then by implication it is left to the States to legislate on.
Although this arrangement appears to give only a limited role to the
Commonwealth, broad judicial interpretation of the Commonwealth’s legislative
powers over the past 90 years has led to an increase in Commonwealth legislative
powers at the expense of the States. Furthermore, the Commonwealth often
exploits the fact that the States are reliant on the Commonwealth for grants (as
they do not raise enough revenue to run their governments) by making the grants
conditional on the States enacting laws that serve the policy ends of the
Commonwealth.
Most of the powers of the Commonwealth Parliament are listed in s 51 of the
Commonwealth of Australia Constitution Act – you can follow this link to look
up sections in the Constitution. Others are found in ss 52, 90, 114 , 115 and 122.
Some of the Commonwealth’s powers – found in ss 52, 90, 114 and 115 are
exclusive. This means that the States may never legislate on these topics.
However of the legislative powers of the Commonwealth are not exclusive – in
other words the States may legislate on the topics they relate to. However, this is
subject to the qualification that if the Commonwealth legislates on a topic and
there is existing or future legislation passed by a State that is inconsistent with the
Commonwealth legislation, s 109 of the Constitution provides that the State
legislation will be invalid to the extent of the inconsistency.
It should also be noted that the Territories are in a special position: Although the
ACT, Northern Territory and Norfolk Island have Legislative Assemblies that can
enact laws, s 122 of the Constitution gives the Commonwealth complete power
over the Territories – in other words, the Commonwealth is not restricted to the
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powers listed in s 5 of the Constitution when passing laws applying to the
Territories. The Territories do have Assemblies, created by the Commonwealth
using the power contained in s 122, but the Commonwealth can and does limit
what the Territories can legislate on, and can invalidate any law passed by a
Territory Assembly.
An important legal doctrine is that of separation of powers. The classic
statement of this, by the 18th century French political philosopher Montesquieu
was that each of the three branches of government – legislature, executive and
judiciary – should be separate from each other in that none should perform the
functions of any other and no individual should hold office in more than one
branch. The doctrine does not fully apply to countries, such as Australia, which
have a Westminster system, also referred to as the system of ‘responsible
government’, because under that system, Ministers (who are members of the
executive) must be members of Parliament (the legislature) and hold office only
so long as they have a majority in the legislature. So separation of power does
not apply between the executive and the legislature. However, under the
Commonwealth Constitution separation of power does apply between the
judiciary one the one hand and the executive and the legislative branches on the
other, as only the courts can exercise judicial power.
Exercise
Answer the following questions, by following this link to the
Commonwealth of Australia Constitution Act:
1. If the federal Parliament was concerned that private people in
Queensland were selling to each other cars which did not
have working brakes, is there any power in s 51 of the
Constitution which would enable the Commonwealth
Parliament to legislate on this intra-State trade (i.e. trade
between residents of Queensland)? Would your answer to be
different if the cars were being sold by corporations ?
2. Could Victoria enact a law for the formation of a State Navy
to protect its coastline ?
3. Under what three sub-sections of s 51 the Constitution might
the Commonwealth Parliament have the power to pass laws
governing the selling of goods on flights by a corporation
running an airline which flies to overseas destinations?
4. What is an excise duty? Could the State of New South Wales
impose a customs duty on imported cars?
5. If the federal Parliament passed an Act stipulating that the
metric system was to be abandoned and Australia was to
revert to the Imperial system of weights and measures, and
South Australia then passed legislation retaining the metric
system, what would the legal position be in that State?
Write my Essay Online Writing Service with Professional Essay Writers – Explain your answer step by step, first identifying whether
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such legislation lies within the competence of the
Commonwealth Parliament.
C. The legislative branch
The federal parliament is a bi-cameral (that is, two-chamber) law-making body.
The two chambers are the House of Representatives or the Lower House, and the
Senate or the Upper House. The third component of the Parliament is the Queen
(or the Crown) who is represented by the Governor-General.
The House of Representatives
The House of Representatives is elected directly by the people divided into
electorates based on population size, varying from State to State by a preferential
voting system. General elections take place about every three years. The elected
representatives are known as Members of Parliament (MPs). They may be the
members of the government, opposition members, and independent members.
The political party or coalition of political parties with the majority of members in
the House of Representatives forms the government. The head of the government
is the Prime Minister. The Governor-General appoints as Prime Minister a person
who can form a government enjoying the confidence of the House of
Representatives. Ministers are the parliamentary heads in charge of administering
particular public service departments. The senior ministers constitute the Cabinet.
The political party or parties in coalition which has the second largest membership
in the Lower House, and is therefore not the governing party constitutes the
opposition. The opposition has its own leader, known as the leader of the
opposition. In addition the opposition allots ‘portfolios’ to its shadow ministry and
cabinet. The opposition expresses its dissent to government policy by its
continued criticism and makes itself attractive to the electorate as an alternative to
the government.
The Senate
The Senate or Upper House is also elected directly by the people by a system of
preferential voting, but on a State-wide basis. Each State elects twelve senators,
while the Australian Capital Territory and the Northern Territory elect two
Senators each. A Senator’s term is six years, but because of the rotation system
there are six senators from each of the six States retiring every three years.
The Senate was intended to represent the interests of the people of the States, as a
federal device, to protect the rights of the smaller states against the more populous
states. Thus, the reason for an equal number of representatives from each State,
irrespective of their population and size. The Senate was also established as a
house of review, to consider legislation initiated by the Lower House. However,
in reality the Senate does not operate as a house of review or as a symbol of the
union and equality of the States because in practice the Senate operates on
political and party lines.
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The Senate has the same legislative power as the House of Representatives but for
one important difference that money bills, a bill that appropriates money or
imposes taxation must not originate in the Senate. Neither can the Senate amend
such bills, but the Senate can send a money bill back to the Lower House with a
‘request’ for amendment. Apart from money bills, the Senate can introduce or
amend ordinary bills, just as much of the House of Representatives can. The
limitation on money bills is one of the chief distinctions between the Senate and
the House of Representatives.
The Queen
The Queen (or the Crown) who is represented by the Governor General is the
third element in the Australian Legislature. All bills passed by the House of
Representatives and the Senate have to be assented by the Government General
for their legal validity. Royal Assent is required for a Bill to become an Act of
Parliament. However, according to long-established ‘conventions’ (which are
essentially customs that everyone follows), the Governor-General must always
grant her assent to Bills that have passed both houses. The role of the Governor
General is in fact now of reduced significance because, with only a few
exceptions (notably the power to dismiss a Prime Minister who has lost her
majority in the House or cannot get parliamentary approval for taxation and
expenditure legislation), under the constitutional conventions, the GovernorGeneral
exercises her powers on the advice of the Ministers.
Delegated legislation
The process of passing an Act of Parliament can be slow. Quite often, the time
involved and expense of having Parliament sit and debate laws means that it is not
efficient for Parliament to spend time on minute details in legislation. Parliament
can therefore delegate some of the detail needed for laws to some responsible
person. An immense volume of law appears in regulations. Thus, most Acts of
Parliament (be it Commonwealth or State) will confer power on a Minister to
make regulations to give effect to the Act – for example, making regulations to
add to the list of substances prohibited by anti-narcotics legislation, or making
regulations specifying the maximum weight of vehicles on the roads. Such
regulations are termed ‘delegated’ or ‘subordinate’ legislation, because the power
to make them derives from a higher body (that is, Parliament). If regulations
conflict with an Act of Parliament they will be invalid.
D. The executive branch
Under the Constitution the executive power of the Commonwealth is vested in the
Queen, and is exercised by the Governor General as the Queen’s Representative.
The Governor General is advised by a Federal Executive Council comprising the
Prime Minister and other ministers. All ministers are members of the formal
Executive Council, but most important decisions are taken by the informal body
known as the cabinet, which consists of the Prime Minister and her inner circle of
ministers, usually about 20 in number. The Prime Minister is appointed by the
Governor General and is the leader of the political party or the coalition of
political parties with a majority of seats in the House of Representatives.
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The concept of responsible government means that Ministers are responsible to
Parliament, for their policies and the administration of government departments
under their control. Ministers are made responsible to Parliament by the
requirement in s 6 of the Constitution that all ministers must be members of the
Senate or the House of Representatives and. Furthermore, the doctrine of
responsible government means that a government must retain the support of (ie a
majority in) the House of Representatives, and a Prime Minister who loses her
majority in Parliament must either resign or call an election. The concept of
collective responsibility means that decisions of Ministers are treated as collective
decisions of the Cabinet and all Ministers are expected to support cabinet
decisions.
It is a constitutional convention that the Governor General generally acts only on
the advice of the Prime Minister. However, there are certain situations when the
Governor General may act independently of the advice of the Prime Minister. The
Governor General has reserve, discretionary or prerogative powers. The dismissal
of the Whitlam Government in 1975 is be an example of the exercise of such
independent powers.
Underneath the Ministers are the various Commonwealth government
departments, staffed by public servants. The Minister in charge of a particular
department under his control is the parliamentary head, while the public servant
who heads the department is the permanent head. Public servants continue in
office despite change in government, and are expected to be impartial.
E. The judicial branch
Section 71 of the Commonwealth Constitution vests the judicial power of the
Commonwealth in the High Court of Australia, and such other federal courts as
Parliament creates, and such other courts as it invests with federal jurisdiction.
The High Court of Australia was established in 1903. The principal functions of
the High Court are to interpret the Constitution, to act as an appellate court from
other courts exercising federal jurisdiction, hear appeals from Supreme Courts of
the States, and in certain cases act as a court of original jurisdiction. The High
Court is the highest court in Australia and its judgements are binding precedents
on all other Australian courts.
The provisions of the Constitution have been interpreted by the High Court in a
manner that effects a separation of the Commonwealth’s judicial power from both
its legislative and executive power. Judicial powers of the Commonwealth cannot
be vested in non-judicial bodies, nor can Commonwealth Courts be vested with
non-judicial functions. The independence of the judges of the High Court are also
established by provisions in the Constitution relating to their appointment, tenure
and remuneration.
The Federal Court of Australia was created in 1976 to cover areas of
Commonwealth jurisdiction such as bankruptcy, federal tax, industrial law,
intellectual property law and trade practices. The Family Court of Australia was
established in 1976 to administer the Family Law Act 1975 (Cth).
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The function of the courts is to decide disputes between people. The courts
interpret statute law when its meaning is doubtful and, in areas of the law where
there is no statute law, to create rules of common law through the decisions they
make. These decisions are also referred to as ‘case law’.
Courts exist at two levels, Commonwealth and State. The Commonwealth courts
have jurisdiction to hear matters arising under Commonwealth law, while the
State courts hear matters arising under State law. Remember that, under the
division of powers between the Commonwealth and the States, the
Commonwealth Parliament legislates only in relation to matters allocated to it by
the Constitution. Thus it is only cases arising under Commonwealth legislation
that would start in the Commonwealth courts – for example, litigation involving
issues arising under the Corprations Act 2001 (Cth), the Competition and
Consumer Act 2010 (Cth) (which replaced the Trade Practices Act), as well as
litigation arising in relation to marriage, bankruptcy, intellectual property, banking
and insurance, and offences against Commonwealth legislation, prosecuted under
the Crimes Act 1904 (Cth). All other matters, such as those involving contracts,
torts and motor vehicle accidents will be heard in the State courts. It can of
course sometimes happen that a case involves both Commonwealth and State law.
In that event, the case will be heard in the State courts, because the Jurisdiction of
Courts (Cross-Vesting) Act 1987 (Cth) gives State courts the jurisdiction to hear
such matters.
The two hierarchies of courts (State and Commonwealth) are linked, in that the
High Court of Australia is the ultimate court of appeal for Commonwealth matters
and for State law matters appealed from the Courts of Appeal of the six States and
from the Territories.
The hierarchy of Commonwealth courts, from top to bottom, is as follows:
High Court of Australia (single judge and full court)
Federal Court of Australia (single judge and full court)
Federal Circuit Court.
Note that two of these courts (the Federal Court and the High Court) have two
divisions – a single judge, and a full court (3 or more judges). So, for example, if
a case is heard in the Federal Court, it will be heard by a single judge, but if one
of the parties appeals against that judge’s decision, the case will go to the Full
Court of the Federal Court.
Although the names of the courts differ slightly from State to State, most have a
hierarchy as follows:
Court of Appeal
Supreme Court
District Court
Magistrates Court
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Jurisdiction of the courts
The ‘jurisdiction’ of a court is the authority it has – in other words, what types of
case it is able to hear. When bringing a legal action, it is important to initiate it in
the correct court. The jurisdiction of a court depends on a number of factors:
The first issue to determine is whether the case involves Commonwealth or State
law, as that will determine whether you bring the case in the Commonwealth or
State courts. If the case involves State law, one then has to determine in which
State the events occurred, as it is that State’s courts that will have jurisdiction. If
it involves a matter arising under a Commonwealth statute, then you would
commence it in either the Federal Magistrates Court or the Federal Court,
depending on the amount involved. Once one has worked out which hierarchy
has jurisdiction, the next issue to consider is whether the case is being heard for
the first time (in which case, you must find a court which has original jurisdiction
over the matter), or whether it is being brought on appeal (in which case you must
find a court which has appellate jurisdiction to hear cases on appeal from the
court that originally heard it). Thus ‘original jurisdiction’ is the power to hear a
case for the first time, while ‘appellate jurisdiction’ is the power to hear a case on
appeal from a lower court.
The second issue is what the amount of money involved is, because different
courts have different monetary jurisdiction.
There is a diagram illustrating the jurisdiction of the courts in the Resources
folder on Interact.
Original civil jurisdiction
Although the jurisdictional amounts differ slightly from State to State, the
following example of the jurisdictional limits of the courts in New South Wales
gives a good idea of how jurisdiction is structured:
Magistrates court matters up to $100,0001
District court matters from $100,000 – $750,000
all motor vehicle matters, irrespective of
amount
Supreme Court matters > $750,000
In the case of the Commonwealth courts, the original jurisdiction is as follows:
Federal Circuit Court matters up to $750,000
Federal Court (single judge) matters over $750,000
High Court (single judge) constitutional matters

1 Note that the jurisdiction used to be $ 60 000 but has been increased to $ 100 000.
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Appellate jurisdiction
When it comes to appellate jurisdiction, New South Wales courts have jurisdiction
as follows:
District Court from Magistrates Court
Court of Appeal from Supreme Court and from District Court
The appellate jurisdiction of the Commonwealth courts is as follows:
Federal Court (full court) from Federal Circuit Court and from
Federal Court
High Court (full court) from Federal Court (full court) and from
State Courts of Appeal
Exercise
Imagine that you are advising your employer on which court to
bring a case before. Consider the following situations, and state
which court would be the correct one to approach. Assume all
events have occurred in NSW:
1. A truck belonging to your company has been involved in a
motor accident caused by a drunk driver. The damage to the
truck is $120,000.
2. Judgment has been given in a matter heard by the District
Court and you wish to appeal it.
3. You believe that the directors of your company have
breached the Corporations Act 2001 (Cth) and you want to
bring legal action against them to recover $1million that they
have defrauded from the company.
4. You have lost an appeal heard by the New South Wales Court
of Appeal and want to take that decision on appeal.
F. Alternative dispute resolution
Crime, by its nature must generally be resolved in a court system. Civil claims
need not be. Using court process to resolve disputes does not always achieve a
good and prompt resolution, and it has the effect of clogging the court system
with claims, some of which are lodged only designed to intimidate the other side.
The court system itself now provides a number of means to reduce the number of
claims that go to trial through case management systems where parties appear
before a Registrar (a quasi-judicial officer) in order to narrow down the issues
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between the parties. Empirical research has shown that almost 90% of court
claims are settled before trial, and even more are settled during the course of trial
before a judgment is delivered. As costs of litigation rise and waiting times in
court lists grow longer, individuals and businesses no longer wish to waste time
and money on litigation, and therefore often have recourse to alternative dispute
resolution (ADR). Many commercial contracts contain clauses in which the
parties undertake to resolve disputes by ADR before having recourse to the courts.
There are three types of ADR:
Mediation is a process whereby a 3rd party assists he parties in dispute to achieve
an agreed settlement. The mediator acts as a go-between, facilitating negotiations
between the parties. However it is the parties themselves who must ultimately
come to an agreement – if they fail to do so, the mediator cannot impose a
settlement.
Conciliation is similar to mediation, in that a 3rd party provides a channel of
communication between the parties, however a conciliator takes a more active
role than a mediator, and may suggest solutions to the parties – but successful
conciliation still depends on the parties voluntarily coming to an agreement.
Arbitration is a process whereby a person settles a dispute between parties – in
other words, the arbitrator acts in a manner similar to a judge, and their decision
binds the parties. The process by which arbitration takes place is regulated by
legislation – in New South Wales by the Commercial Arbitration Act 1984
(NSW). Contract clauses prohibiting parties from going to court unless they have
submitted their case to arbitration are invalid (s 55). However, once parties have
gone to arbitration, they cannot appeal to the courts except on narrow grounds of
misconduct by the arbitrator (s 42) or where all the parties agree to an appeal to
the courts on a matter of law (s 38(2)).
G. The states
The same system of parliamentary government that exists at Commonwealth level
operates at State level. All State parliaments (except Queensland), like the
Commonwealth Parliament, have a bi-cameral system, with parliament consisting
of a Upper House and a Lower House. In NSW the Upper House is known as the
Legislative Council and the Lower House is known as the Legislative Assembly.
In State Parliaments, the Governor appoints as Premier whoever leads the party or
coalition which has a majority in the lower house. The Premier and the State
Ministers form the State cabinet which runs the executive branch of government.
In all the States, the Parliaments have delegated some of their law-making powers
to local authorities which, within the scope of the Acts creating them, have the
power to enact local ordinances which, like Acts, are a form of statute law.
However, because the local authorities are only the delegates of the State
Parliaments, their laws are known as ‘delegated’ or ‘subordinate’ legislation, and
can be over-ridden by State Parliaments.
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Topic 2 Sources of law and interpretation of
statutes
Learning Objectives
At the completion of this topic you should be able to:
1. describe the nature of statute law and common law;
2. outline how the doctrine of precedent operates;
3. explain how cases are cited in law reports;
4. engage in legal research and find statute and case law;
5. explain the role of the courts in statutory interpretation; and
6. apply the common law rules and presumptions of statutory
interpretation to statutory texts.
A. Sources of law
Statute law
As stated in Topic 1, statute law, or legislation, is enacted by a law-making body.
In Australia, these legislative bodies (or ‘legislatures’) exist at three levels:
 The Commonwealth Parliament which, on the topics allocated to it by the
Constitution, makes laws for the whole
country
 State and Territory Parliaments and Legislative Assemblies
which make laws for their particular
jurisdictions
 Local authorities which are given authority by State and
Territory legislatures to make laws for
particular municipal areas.
Legislation passed by the Commonwealth, State and Territory legislatures are
called Acts. But, as noted in Topic 1, it is simply not possible for legislatures to
update the details of the law, and so it is common for Acts of Commonwealth or
State Parliament to delegate the power to make legislation to government
ministers. Such pieces of delegated, or subordinate, legislation are called
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Regulations. In addition, State Parliaments delegate law-making power to local
authorities, which produce delegated legislation called Ordinances or Local Laws.
Although regulations, ordinances and local laws have the same legal effect as
Acts, their subordinate status means that if they conflict with an Act of their
jurisdiction, they will be invalid.
The key feature of statute law is that it is a superior source of law to common
law and over-rides it if there is an inconsistency. Thus, if faced with a statute that
is different to a rule of the common law, a court must apply the statute, no matter
how long-standing the rule of common law. To take an example, whereas in the
19th century it was an accepted rule of common law, brought to Australia at
settlement, that a man could lawfully chastise (that is, beat) his wife, legislation
was enacted by the various State Parliaments in Australia declaring the practice to
be illegal and indeed a crime. That is an example of legislation reforming the
common law.
Another important feature of statute law is that it (i) affects everyone and (ii) is
presumed to be prospective – in other words, only affects events arising after the
legislation comes into effect. It is however possible for Parliament to legislate
retrospectively – for example, to state in an Act that comes into effect on 1 July
2010 that tax rates are reduced with effect from 1 January 2010, with the result
that people get an unexpected rebate. However, retrospective legislation is
unusual, and would obviously have unjust consequences in the case of criminal
law if Parliament were to make conduct criminal even though it had not been a
crime when it was engaged in.
Common law, or case law
The second source of law is called ‘common law’ or ‘case law’. So far as the
term ‘common law’ is concerned, students may find it confusing, because it tends
to be used in three different ways.
In one sense it is used to refer to the type of legal system which exists in England.
The English system was passed on to many countries including Australia, through
the British Empire. Today the Australian legal system differs from the English
system in many respects, but is still based on the English model as is the system in
New Zealand, United States of America, Write my essay for me – CA Essay writer Canada and other former colonies of
Britain. It is referred to as the Common Law system as opposed to Islamic law or
Hindu law, or the Civil Law system which exists in many countries of Europe.
In the second sense the ‘common law’ is used to refer to a source of law, that is,
the body of law produced by the judges as distinct from Parliament. This is the
sense in which it is used in these notes.
In the third sense, the ‘common law’ is used in a narrower context to refer to a
type of judge-made law. When used in this sense, the common law is often
distinguished from the law of equity. The distinction between common law and
equity is of little importance nowadays. The law of equity refers to a collection of
rules and principles established and developed by judges in the Courts of
Chancery which were distinct and separate from the Common Law Courts.
However, this system of dual law between equity and common law was
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inconvenient, and the branches of law were fused so that Supreme Courts of the
States and Territories are now vested with jurisdiction to apply both bodies of law
in cases coming before them. We therefore do not need to concern ourselves with
the distinction between common law and equity – nowadays when people refer to
‘common law’ or ‘case law’ they mean all judge-made law, irrespective of the
historical origins of those principles.
The key thing to remember about the common law is that it developed over
hundreds of years when judges were called upon to decide legal disputes in the
absence of statute law. The facts of the cases, along with the decisions they made,
were recorded and then applied in later cases with the same facts in accordance
with the doctrine of precedent (discussed below). So, to take a simple,
hypothetical example, one could imagine a judge in 16th century England hearing
a dispute between two farmers, one of whom had sold a pig to the other, the pig
having died a few days after the sale. If the buyer sued the seller to recover the
price of the pig, and assuming there was no statute governing such cases, the court
would have to make a decision. Assuming there was no previous reported case on
the issue, the court would be free to make its own decision. Let us assume that
the court held that the seller could not recover his money. By making that
decision, the court would be doing two things: deciding the case between those
particular litigants and laying down a rule for lower courts to follow in any other
case involving sales of animals. Thus many of the principles of torts and
contracts were developed by judges in this way.
However, if there is statute law which is applicable to a case, the courts must
apply the statute, even if there was a rule of common law to the contrary. Thus, to
take the example discussed above, if Parliament enacted a consumer law which
gave a seller the right to bring an action to recover their money if livestock fell ill
within a certain period of having been bought, the pre-existing common law rule
would be overridden.
An important feature of judge-made law is that, unlike statute law, it is
retrospective – in other words, it a common law decision in a contractual dispute
between parties A and B changes the common law rule governing al other people
in the same relationship – even if they entered into that relationship before the
court decided the case of A v B – so parties C and D whose case had the same
facts as that of A and B would, if they went to court, have that same rule applied
to them, even though they could not have known of that rule at the time they
entered into the contract.
B. The doctrine of precedent
How does one know whether a case decided by an earlier court should be
followed? The answer to this is provided by the doctrine of precedent (sometimes
referred to as stare decisis – ‘let the decision stand) which is that a court is bound
by an earlier decision if that decision was on the same material facts and by a
higher court in the same hierarchy.
As was explained in Topic 1, each State has its own hierarchy of courts, as does
the Commonwealth. Under the doctrine of precedent, a court in a State is bound
by earlier decisions delivered by courts higher than it in that State, so a District
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Court judge in NSW would be bound by a NSW Court of Appeal decision, but
would not be bound by a decision of the Victorian Supreme Court, for example.
All courts in Australia are bound by decisions of the High Court, because it is the
ultimate court to which one can appeal from all the state Courts of appeal (as well,
of course, as from the Commonwealth courts).
The fact that a court in one State is not bound by decisions handed down by the
courts of another means that the common law can differ from State to State, at
least until someone appeals a case on that point of law to the High Court.
Although the courts of one State are not bound by decisions in another, such
decisions are very commonly referred to in judgments, because they have
persuasive value, and might be drawn upon by judges in other States in their
reasoning. Similarly, decisions by courts in New Zealand, England and other
Commonwealth countries are often referred to by courts in Australia.
Ratio decidendi and obiter dictum
What part of a court’s decision is binding? Judgments are often very long, and it
takes skill in reading cases to determine what principle of law a case stands for.
The binding rule in a decision is called the ratio decidendi – or ‘reason for the
decision. It consists of the material facts + the rules of law used by the judge +
his or her decision. Any lower court presented with a case with the same facts
will have to reach the same decision. So, in our example about the pig discussed
above, the ratio would be that if one person buys an animal from another which
dies after three days [material facts], the law of sale does not permit the seller to
recover the cost of the animal [rule of law] and so the buyer is not liable to the
seller [decision].
Anything else in the judgment is referred to as obiter dictum – ‘statements by the
way’. These are things written by the judge which were not necessary for
deciding the case. They may have been general comments on the area of law or
statements by the judge as to how the case would have been decided if the facts
were different. This can be useful persuasive authority for later courts to draw on
(even though they are not bound by obiter dicta ) if they do have to decide a case
with those different facts.
C. Legal research
Statute law is found in the official sets of statutes published by the
Commonwealth, State and Territory legislatures. Acts are referred to by their
name, year of enactment and jurisdiction – for example the Corporations Act
2001 (Cth).
Case law is reported in law reports. There are many different series and publishers
of law reports. Reports of the High Court are published in the Commonwealth
Law Reports (CLR). High Court and Federal Court cases are reported in the
Australian Law Reports (ALR). Each State and Territory has its own set of law
reports in which are reported the decisions of their Supreme Courts and Courts of
Appeal (for example the New South Wales Law Reports (NSWR).
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There is a system for finding case reports, and it is fairly simple once you ‘break
the code’. You will have noticed already from your reading that cases have names
and a ‘code’ after the name. The ‘code’ is the citation or the place where the case
report is located.
Take for example:
Donoghue v Stevenson [1932] AC 562
This is a civil case, in which Donoghue and Stevenson were the parties to the
dispute. The use of the lower case letter ‘v’ between the names is short for versus,
however, when we say the name of the case we never say ‘versus’, we merely say
‘Donoghue and Stevenson’.
The citation is a relatively simple system.
Donoghue Stevenson v [1932] AC 566
The year in which the case was decided.
If it appears in square brackets, then the Report
is bound in volumes for each year.
Name of the Report – Appeal Cases. These
are English cases. See the Style Guide in your
Subject Outline booklet.
Page number
Note firstly that the names of the parties must always appear in italics when you
are giving a case citation. The name which appears first is the name of the party
who is commencing the dispute. When a case is first heard the first party is called
the plaintiff and the second party is called the defendant. Thus if Donoghue v
Stevenson was the name of the case, Donoghue (the plaintiff) is suing Stevenson
(the defendant).
It is rare for the initial hearing of a case to be reported. Donoghue v Stevenson is
in fact an appeal. The first party, Donoghue is the appellant, the person bringing
the appeal against the earlier decision. The second party, Stevenson, is the
respondent.
In a criminal case the Crown or the State usually prosecutes and the crown’s
participation is indicated by the letter ‘R’ or ‘Regina’.
For example, R v Clark (1927) 40 CLR 227 is a criminal case and when reciting
the name verbally we say ‘The Crown against Clark’.
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R Clark v (1927) 40 CLR 227
Year of decision, but these reports
are not bound in volumes each year.
Volume number
of Reports
Page
number
Name of the Reports. The
Commonwealth Law Reports
(CLR) are the official reports of
the High Court of Australia.
Law libraries have copies of statutes and law reports. However, the most
convenient way to look up the law is by referring to the AUSTLII (Australian
Legal Information Institute) website, at https://monkessays.com/write-my-essay/austlii.edu.au . It provides a
searchable database of Commonwealth, State and Territory law.
The site lists each jurisdiction, and within each jurisdiction databases of statute
law and case law. It is possible to browse statute and case law alphabetically or
by year. Austlii also contains an Advanced Search feature, which enables one to
search across the entire database, or within specific jurisdictions, for particular
words or terms. The Boolean search function allows one to search for particular
phrases.
Exercise
Use Austlii to answer the following questions:
1. What is the Commonwealth Law Report citation of the case
of Lange v Australian Broadcasting Corporation?
2. How is the term ‘action’ defined in the Limitations Act 1969
(NSW)?
3. Name a decision handed down by the Supreme Court of
South Australia this month.
4. What is the citation of the decision by the New South Wales
Court of Appeal in Higgins v Brennan?
5. What is the most recent Tasmanian case to deal with the
concept of vicarious liability?
6. Who were the three justices who delivered the joint judgment
at paragraph 26 of the decision in Griffith University v Tang?
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D. Statutory interpretation
It is often incorrectly assumed that when courts apply a statute they are engaging
in a mechanical act that involves no discretion. The reality is far different –
language is inherently ambiguous. Take as a simple example, a statute dealing
with weapons which said:
It is an offence to possess arms.
Taking the word ‘arms’ literally, it could have two meanings: limbs attached to a
person or weapons of war. Clearly the former interpretation would be absurd, but
there must be some rule which indicates to a court that it is the second meaning
that should be adopted. To take another example, if a statute said
A motorist must stop their vehicle if they are involved in an accident.
Would a court convict a person who, after crashing into another vehicle, stopped
their car and then drove off? Does ‘stop’ here literally mean ‘stop’ or does it
mean ‘stop and wait’? Arguably one can say that such ambiguities reflect poor
draughtsmanship, but that does not solve the problem of what the courts should do
when faced by such ambiguities.
Three major sources are used to interpret legal words and statutes in cases of
ambiguity (that is, uncertainty as to the meaning of the statute):
Legislation
Sometimes the Act one is interpreting will contain a definition section in which
words used in the statute are defined.
Failing a definition in the Act, one should refer to the Acts Interpretation Act of
the jurisdiction from which the Act comes. Interpretation Acts contain rules that
apply to all Acts passed by the relevant Parliament – for example how ‘days’ are
calculated. The content of these Acts lies outside the scope of this subject, except
for very important provision, relating to the ‘purpose rule’ (see below).
Common law rules of Statutory Interpretation
Over the centuries, the courts have developed common law rules of statutory
interpretation to assist them in interpreting statutes. Note the very important point
that, apart from the purpose rule, all the common law rules and presumptions have
equal weight, and it is up to the courts to decide which of them to apply. In other
words, judges can affect the outcome of the cases they decide by the choice of
rules of statutory interpretation they apply – so this is an area in which judges
have real power. There are four major rules:
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 The literal rule
This is the starting point for interpreting statutes, and means that the
meaning of a statute is determined by referring to the natural or ordinary
meaning of the words (i.e., from an Australian dictionary – e.g., Macquarie
dictionary).
 The golden rule
This is a proviso to the literal rule to the effect that if a word has more than
one literal meaning, one which is irrational or absurd, and the other sensible,
then the latter should be chosen. This approach would obviously be of
assistance in interpreting the words ‘arms’ and ‘stop’ in the examples given
above.
 The mischief rule
If the statute was enacted to overcome a specific ‘mischief’ or problem, then
the statute should be interpreted in such a way as to ensure that it is effective
in overcoming the problem.
 The purpose rule
Although originally a common law rule of interpretation, the purpose rule,
which requires the courts to interpret statutes in a manner which furthers to
purpose for which they were enacted, now appears in s 15AA of the Acts
Interpretation Act 1901 (Cth) and in identical provisions in all the other
jurisdictions’ Acts Interpretation Acts. In the case of New South Wales this
is contained in s 33 of the Interpretation Act 1987 (NSW).
The Commonwealth Act states
…a construction that would promote the purpose or object underlying the Act
(whether that purpose or object is expressly stated in the Act or not) shall be
preferred to a construction that would not promote that purpose or object.
Note however that although this principle is important, it becomes relevant
only if the Act one is interpreting is ambiguous – if there is only one
possible meaning, then s 15AA cannot be used to give the Act a different
meaning that its text cannot support.
In applying the purpose rule and the mischief rule where legislation is ambiguous,
the courts may refer to ‘extrinsic’ material – that is, material lying outside the text
of the Act itself. Such material includes Parliamentary reports and the
explanatory memorandum that accompanied the legislation when it was
introduced to Parliament as a Bill, along with the relevant Minister’s speech to
Parliament when the Bill was introduced.
The eiusdem generis rule
Eiusdem generis means ‘same kind’ in Latin and is to the effect that if specific
words belonging to a single class or type are followed by a general word, then the
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general word is presumed to be qualified and refers only to items of the same
class as the specific words. For example, if an Act provides that a person may
keep only ‘horses, cows, sheep, and other animals’ on a farm, could they keep a
tiger? Because horses, cows and sheep are domestic animals, the words ‘other
animals’ are interpreted to mean only domestic animals.
Presumptions of statutory interpretation
A presumption is something that the law assumes to be true unless someone
proves that it is not true. In cases where a statute is ambiguous, the common law
provides that certain presumptions of statutory interpretation apply. Note that
presumptions apply only if there is ambiguity – they will not apply if the meaning
of the legislation is such that it is clear that the legislative body did not intend
them to apply. Examples of presumptions include:
 the presumption that legislation is not retrospective; and
 the presumption that the legislature did not intend to take away fundamental
rights.
Exercise
Amidst growing concern at the level of violent crime in society, the
New South Wales Police Minister makes a speech to Parliament in
which he says:
‘This government is determined to crack down on violent street
crime, particularly crimes involving young people going out armed
with knives.’
Assume that, as a result, the New South Wales Parliament enacts
the Crimes (Dangerous Weapons Amendment ) Act 2011 (NSW), s
1 of which provides as follows:
Dangerous weapons
It is an offence to carry any knife, club, gun or other
dangerous weapon in a public place. Penalty: Fine of
$2,000.
Tom Butcher, who is an apprentice chef, is walking to work one
day. He is carrying a 10 cm long carving knife in a sheath attached
to his belt. His jacket swings open just as he is walking past
Constable Plod, who is on foot patrol in the CBD. Constable Plod
arrests Tom for a breach of s 1 of the Act.
Advise Tom of the likely outcome of the case. In the course of your
answer discuss the various rules of statutory interpretation that may
be considered to resolve this problem, what the outcome would be
if each was applied, and reach a conclusion on the question of
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which approach you think would be best for a court to adopt and
why.
NOTE: The statute in this problem is fictional – so you will not
find it, or cases interpreting it, on Austlii. You must interpret the
law solely with reference to the rules of statutory interpretation.
You must use the Issues, Law, Application, Conclusion format
when writing your answer.
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Topic 3 Torts – elements of liability
Learning Objectives
At the completion of this topic you should be able to:
1. discuss the nature of tort law;
2. explain the various interests protected by tort law;
3. describe the three essentials of the tort of negligence;
4. apply the test of reasonable foreseeability in relation to the
duty of care;
5. explain the circumstances in which a duty of care arises
when giving advice;
6. explain the factors used to determine the breach of the
standard of care;
7. describe the ‘but for’ test of causation; and
8. apply these principles of liability to factual situations.
A. Law of Torts
A ‘tort’ is a civil wrong which the law redresses by an award of damages. A
‘wrong’ is an infringement or violation of a person’s legal right by another. There
are many torts, each relating to a different type of harm:
Negligence: careless causation of injury to person, damage to property or
economic loss
Defamation: damage to reputation
Nuisance: conduct that interferes with a neighbour’s enjoyment of their
property
Trespass: to person (physical assault), to goods (unlawful entry onto
property) to goods (interference in a person’s use of their
goods)
In this Topic we will focus on the tort of negligence, which is a failure to take
reasonable care towards another person which results in that person suffering
harm. There is no need for the plaintiff to prove that harm was intended by the
defendant – the essence of the action is that insufficient care was taken, and that
that resulted in harm. Negligence can also be defined as the doing of something
that a reasonable person would not do, or, not doing something that a reasonable
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person would do, which causes harm. In other words, both acts and omissions can
amount to a tort.
In recent years all Australian jurisdictions have enacted statutes (such as the Civil
Liability Act 2002 (NSW)) which effect reforms in the area of torts law, such as
capping the amount of damages that can be awarded for certain claims. Each
jurisdiction enacted a similar Act in 2002-03, but for the sake of convenience,
section numbers in this subject refer to the NSW Act.
However, it is important to note that, apart from these specific reforms, the Civil
Liability Act largely re-states the common law, is not inconsistent with the
common law and so does not replace the common law. Indeed, where the Act
refers to terms such as ‘duty of care’, it assumes that such terms will continue to
be interpreted in light of the existing case law. Therefore, when you are
answering questions to do with the law of torts and you are stating what the law
is, you should refer to sections in the Act (where there is a relevant section – many
parts of the common law are left unmentioned by the Act, and so carry on being
governed by the common law on its own) and to cases which give meaning to
concepts mentioned in the Act, in order to give a complete statement of the law.
B. Three essentials of negligence
There are three essentials that a plaintiff needs to prove on a balance of
probabilities in order to establish a claim in negligence:
 that the defendant owed the plaintiff a duty of care
 that the defendant breached the standard of care of a reasonable person
 that the defendant’s conduct caused harm to the plaintiff
Video
C. Duty of care – 1
st essential
The plaintiff must establish that the defendant owed him or her a duty of care.
The test for establishing duty of care re negligent acts was formulated in the
famous case of Donoghue v. Stevenson [1932] All ER 1. In this case two women
went to a cafe. One of them bought the other, Mrs Donoghue, a bottle of ginger
beer. Mrs Donoghue drank the ginger beer, and found a decomposed snail at the
bottom of the bottle. She became severely ill with gastro-enteritis. Because Mrs
Donoghue had not been the person to buy the ginger beer, she could not sue for
breach of contract. Her only course of action was in negligence. The issue was
whether the defendant (Stevenson, who owned the factory that made the ginger
beer) owed the plaintiff a duty of care. The court formulated a test for
determining whether a duty of care is owed (sometimes called the ‘neighbour’
test), stating as follows:
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There must be, and is, some general conception of relations giving rise
to a duty of care…The rule that you are to love your neighbour
becomes in law you must not injure your neighbour; and the lawyer’s
question: Who is my neighbour? receives a restricted reply. You must
take reasonable care to avoid acts or omissions which you can
reasonably foresee would be likely to injure your neighbour. Who,
then, in law, is my neighbour? The answer seems to be – persons who
are so closely and directly affected by my act that I ought reasonably
to have them in contemplation as being so affected when I am
directing my mind to the acts or omissions that are called in question .
. . a manufacturer of products, which he sells in such a form as to
show that he intends them to reach the ultimate consumer in the form
in which they left him with no reasonable possibility of intermediate
examination, and with knowledge that the absence of reasonable care
in the preparation or putting up of products will result in an injury to
the consumer’s life or property, owes a duty to the consumer to take
that reasonable care.
The key test that emerges from Donoghue v Stevenson is that of reasonable
foreseeability. The test is also adopted in s 5B(1) of the Civil Liability Act 2002
(NSW), but it is the case law which continues to dominate this issue, because the
cases contain the tests for determining whether a duty of care exists and which
contain the factors that the courts will refer to in making that determination.
The test of whether a duty of care exists, as enunciated in Donoghue v Stevenson
depends on whether a reasonable person in the position of the defendant would
have foreseen that their conduct could cause harm to someone in the position of
the plaintiff. This must be established by the plaintiff in order to satisfy the first
element of the tort of negligence. Note that ‘reasonable foreseeability’ is an
objective test – ‘what would a reasonable person have foreseen?’ not, ‘What did
this particular defendant actually foresee?’ Note also that the plaintiff does not
have to prove that the defendant owed a duty of care to him or her as a specific
person (after all, as for example in a motor accident, the plaintiff may be
completely unknown to the defendant). The issue is whether the defendant owed
a duty of care to a person in the position of the plaintiff – i.e., that they belong to
the class of person who the defendant should have been aware of when doing the
culpable act.
A problem that the courts have had to grapple with is how far liability should
extend. There may be many persons to whom harm could be foreseen because of
an act or omission by the defendant, however whether the defendant should be
liable to all of them is a different question. For example, in the famous case of
Ultramares Corp v Touche, Niven & Co 174 NE 441 (1931), in which accountants
had been negligent in auditing a company, and that company had then shown the
audited reports to another company which lent it money in the belief that the
accounts were accurate, the court had to decide whether the accountants would be
liable to the lender. The court said that they would not, because to hold that they
owed a duty of care to anyone who happened to read the reports would create
liability ‘in an indeterminate amount for an indeterminate time to an indeterminate
class’. In other words, it would be unfair to impose liability even if, theoretically,
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it was foreseeable that if the accounts were shown to 3rd parties, they might suffer
loss, because the liability could be limitless.
In addressing the problem of how to determine whether harm is reasonably
foreseeable, the courts have used a variety of tests. The current law in Australia
was stated in Perre v Apand (1999) 198 CLR 180, in which the High Court said it
will pay attention to a number of factors (none of which is decisive) in deciding
whether a duty of care is owed, including:
 whether harm was reasonably foreseeable because of the proximity, or
closeness in relationship, between the plaintiff and the defendant,
 other cases in which a duty of care has been found to exist,
 the salient features of the relationship between the plaintiff and the
defendant (for example, whether the plaintiff relied on the defendant,
whether the plaintiff was vulnerable to the defendant’s conduct, whether the
defendant could control whatever caused the harm)
 whether there are any policy reasons not to impose liability (for example,
because the potential number of claims or the size of the liability would be
impossible to meet, as in Ultramares)
The key focus is on how close the connection or relationship was between the
defendant and the plaintiff, and the courts refer to this broad question when
deciding whether the defendant should have anticipated that someone in the
position of the plaintiff would suffer harm. In Perre v Apand the defendant was a
chemical company which had carelessly sprayed a farm with a harmful product.
The crops on that and adjacent farms were destroyed by the chemical. The State
government imposed a prohibition on crops grown within a certain radius of these
farms from being sold (even if those farms had not showed any sign of being
affected), as it was unknown how far the chemical had drifted. The High Court
held that the defendant owed a duty of care to the plaintiff, who owned one of
these quarantined farms and who suffered economic loss because they could not
sell their crop, because it was reasonable to foresee that a careless spraying of
chemicals could lead to such consequences – in other words, quarantining of
surrounding farms was a reasonably foreseeable consequence of careless spraying
of a poison.
A duty of care can arise from a number of circumstances:
 Physical – where there is closeness in time and space between the defendant
and the plaintiff, as when one motorist crashes into another.
 Circumstantial – where the particular relationship between the defendant
and the plaintiff gives rise to a duty of care, as between a doctor and patient
or investment adviser and client.
 Causal – where harm is foreseeable to the plaintiff as an expected cause of
the defendant’s conduct, even if the plaintiff is physically removed from the
defendant and is not known by them, as in Jaensch v Coffey (1984) 155
CLR 549, where a defendant who crashed into a motor cycle rider was held
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liable not only to the rider but also to his wife, who suffered emotional
shock and psychological illness as a result of hearing of her husband’s
injuries. Note that under s 31 of the Civil Liability Act 2002 (NSW), where
A negligently injures B, a plaintiff C can recover for emotional shock only
if the shock resulted in psychiatric illness that goes beyond ordinary levels
of grief and, under s 30(2) if they (i) either witnessed the injury or (ii) did
not witness the injury but were an immediate family member of B.
Exercise
Albert is driving his car and is talking on his mobile phone.
Because he is distracted, he crashes into the back of Bob, who is
stopped at traffic lights, damaging Bob’s car. The impact pushes
Bob’s car forward, and Bob knocks over Cathy, who is injured.
Cathy is a surgeon on her way to operate on Doug. Cathy cannot
do the operation. Because there is no other surgeon available,
Doug dies. To whom does Albert owe a duty of care and why do
you reach those conclusions?
Over the decades, case law has established many of categories in which there is a
recognised duty of care of which these are some of the more prominent:
 employer to employee;
 legal adviser to client;
 doctor to patient;
 road users to other road users and to pedestrians; and
 school to student.
The courts have also recognised certain categories of duty of care which are ‘nondelegable’.
This means that the defendant cannot escape liability simply by
giving to a 3rd party the job of ensuring that due care is taken. A good example of
such a category is the non-delegable duty of care owed by a landlord to a tenant to
ensure that rented premises are maintained in a safe condition. If a tenant suffers
injury from electric shock because an electrician employed by the landlord did not
do his job properly, the landlord cannot plead that, as the electrician was properly
qualified, he (the landlord) had discharged his duty of care by hiring the
electrician to do maintenance. The tenant could still sue the landlord (although
the landlord could in turn recover from the electrician, but that would be a
separate case).
Specific rules on duty of care in cases of negligent advice
Specific issues arise in determining whether a duty of care exists in cases of
negligent advice. People give advice in numerous contexts, including to friends
and casual acquaintances. On the other hand, the law should impose liability for
negligent advice given in professional contexts (for example, by doctor to patient,
lawyer to client, engineer to builder).
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In Shaddock & Associates Pty Ltd v Parramatta City Council (1981) 36 ALR 285,
the High Court held a local government liable for negligently failing to check
what roads were going to be widened before advising a property developer that a
road would not be widened adjacent to the land he was buying. That advice was
not correct and, after the sale, 1/3 of the property was compulsorily bought by the
government, making redevelopment of the remainder impossible, resulting in loss
of profit by the developer. The court held that a duty of care in relation to advice
is foreseeable if:
 the advice is given in a professional context;
 the speaker ought to have realised, that his or her advice would be acted on;
and
 it was reasonable for the recipient to act on the advice.
Whether a duty of care exists between the giver of advice and someone who acts
on it is of particular importance to accountants, as is shown by Esanda Finance
Corporation v Peat Marwick Hungerfords (1997) 188 CLR 241. This is currently
the leading case on negligent mis-statement. In this case, Peat Marwick
Hungerfords, a firm of accountants, conducted an audit of a company called EX
Ltd. The audit was conducted negligently in that Peat Marwick failed to detect
fraud by an employee in EX Ltd, and overstated EX Ltd’s financial position.
Clearly the accountants would have been liable if they had been sued by their
clients, EX Ltd, as they clearly owed them a duty of care.
But that is not what happened: Some months later, EX Ltd wanted to borrow
money from Esanda, who asked for information of EX Ltd’s financial position.
EX Ltd gave Esanda a copy of the audit report, and on the basis of the information
in it, Esanda lent EX Ltd money. EX Ltd was unable to pay the money. Esanda
sued Peat Marwick, alleging that they had conducted the audit negligently, that it
was because Esanda relied on the audit that it had lent EX Ltd the money, which it
(Esanda) would not have done had it known EX Ltd’s true financial position. The
courtheld Peat Marwick were not liable to Esanda, as they did not owe Esanda a
duty of care. They had written the report for EX Ltd, not for Esanda. They did
not foresee that the report would be used by a 3rd party for loan risk purposes – it
had been written solely for EX Ltd’s audit purposes. Esanda was not someone the
defendants had in mind As in the US case of Ultramares Corp v Touche, Niven &
Co 174 NE 441 (1931) the court was influenced by the fact that if liability was
imposed on a defendant in respect of any and all 3rd parties who might act on the
advice, liability would be potentially limitless.
D. Breach of standard of care – 2nd essential
How much care must be exercised, assuming a duty of care is owed? The answer
is that one must take reasonable care – i.e., must act as a reasonable person would
in the circumstances. What are the attributes of the ‘reasonable person’? The
‘reasonable person’ is: a person who behaves with due care in all circumstances
and is presumed to be of average intelligence. If they engage in an activity
requiring any particular qualifications, they are presumed to have the level of
knowledge and skill that it would be reasonable to expect such a qualified person
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to have – so in performing an operation, a surgeon’s conduct is compared to that
of the reasonable surgeon, not the reasonable ordinary person. Minors are judged
against normal children of the same age. Persons with disabilities are judged
against similarly disabled persons.
Factors determining breach of standard
Section 5B(2) of the Civil Liability Act (2002) NSW refers to four factors in
determining whether the standard of reasonable care has been breached. These
factors must be balanced against each other in order to determine whether the
plaintiff’s conduct was negligent (i.e., breached the required standard of care).
The courts balance
 the likelihood that the defendant’s acts would cause harm;
 the seriousness that harm would occur and
 the social utility (ie importance to society) of the defendant’s conduct
against
 the cost and effort that would have been required to avoid the harm.
This means that the outcome of each case is different, because it depends on the
facts of the case. What the court is doing is comparing what the reasonable
person would have done with what the plaintiff did by asking itself: ‘In light of
the likelihood of the harm occurring, the its seriousness if it did and the
importance of the activity, what steps would a reasonable person have taken to
avoid the harm, and did the plaintiff in this case take those steps?’
(i) Likelihood (or probability) of harm
In Bolton v. Stone [1951] AC 850, the plaintiff was struck by a cricket ball, which
had been hit from a cricket pitch in the town gardens opposite her house. Such
event (i.e., a cricket ball being hit out of this ground) had occurred only six times
in the previous 30 years and no one had been injured. It was decided that the risk
of a ball actually striking someone on the road was so small that a reasonable
person would have been justified in disregarding it, and thus so too was the
defendant.
(ii) Seriousness of harm if it does occur
In Paris v. Stepney Borough Council [1951] AC 367 a garage mechanic with sight
in only one eye was removing a rusted bolt with a hammer when a metal chip flew
into his good eye blinding him totally. His employer (the Council) had not
provided goggles for him to wear. The court held that, in view of the fact that this
employee would suffer particularly serious harm if his eye was injured (i.e., he
would become totally blind) a reasonable person in the position of his employer
would have taken care to provide him with goggles.
(iii) Steps needed to avoid the risk of harm
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After evaluating the likelihood of harm and its seriousness, the court looks at what
steps a reasonable person, in the position of the plaintiff, would have done to
avoid the harm. This will depend on the effort and cost that would be required to
avoid the harm. For example, if the likelihood of harm is small, and the cost (or
difficulty) of avoiding the risk is great, then a court is likely to find that a
reasonable person would not have bothered to take those steps, and so if the
plaintiff did not take those steps, he or she was not negligent. But if the likelihood
of harm and / or its seriousness were so great that the reasonable person would
have taken steps (even if they required great effort or expense) so as to avoid the
harm, and the plaintiff did not take those steps, then the plaintiff will be held to
have been negligent. Complex cases arise where, for example, the likelihood of
harm occurring is small, but if it does occur it will be significant (or vice versa).
In those cases, determining what steps the reasonable person would have taken
can be difficult.
An example of the application of this factor is Latimer v. AEC Ltd [1953] AC 643,
in which a factory had been flooded with oil. The owner put sawdust on the floor
in order to prevent workers from slipping. However, one worker did slip and
injure himself. The factory was found not liable. The court held that it had done
everything a reasonable employer would do, given the moderate degree of risk
involved, to avoid harm. Risk could have been completely avoided only by
shutting down the factory completely, and this was beyond what was reasonably
required. Denning L. J. said ‘In every case of foreseeable risk it is a matter of
balancing the risk against the measures necessary to eliminate it.’
In other words, you need to consider the facts of each case carefully in order to
determine whether the plaintiff fell below the standard of the reasonable man.
The important thing to remember is that in most cases it will not be possible to
eliminate risk entirely – the question then becomes what the reasonable person
would have done to reduce the risk to an acceptable level, and whether the
defendant did the same.
(iv) Social utility of the defendant’s activity
This factor, added by the Civil Liability Act 2002 (NSW) is one that was not taken
into account by the common law. Its operation in concrete circumstances is
therefore yet to be fully fleshed out. Some have argued that an activity that is of
higher benefit to society may warrant the taking of greater risks, but no court has
concluded that as yet.
Relevance of professional standards
Note that, if the negligence is alleged to have occurred in the course of providing
services as part of a profession or occupation, then whether the defendant
conformed to what was required under current standards of practice in that
profession will be taken into account in determining whether reasonable care was
exercised. This is also provided by s 5O(1) of the Civil Liability Act 2002 (NSW).
So, whether a surgeon was negligent will depend in part on what a reasonable
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surgeon would have done in the same situation. Thus in Pacific Acceptance
Corporation v Forsyth (1970) 92 WN (NSW) 29 where the defendant auditors
failed to detect fraud by an employee of the plaintiff, the auditors were held liable
because they way they conducted the audit did not meet the standard of a
reasonable auditor.
E. Causation of harm – 3
rd essential
The plaintiff must show that they suffered harm and then that the defendant’s act
or omission was the cause of the harm. This is a common law requirement, reiterated
by s 5D(1) of the Civil Liability Act 2002 (NSW).
Harm can take a variety of forms, for example:
 personal physical injury,
 psychological injury (‘nervous shock’)
 damage to property
 financial loss.
Causation
In addressing causation, the question is whether the defendant’s culpable act
caused the plaintiff’s loss? The plaintiff must show that, if the defendant had not
acted as he did, the plaintiff would not have suffered harm. The test to determine
causation is called the ‘but for’ test, which was formulated by Lord Denning in
Cork v Kirby Maclean [1952] 2 ALL ER 402 where it was stated:
If you can say that the damage would not have happened but for(or in
the absence of) a particular fault, then that fault is in fact a cause of
the damage; but if you can say that the damage would have happened
just the same, fault or no fault, then the fault is not a cause of the
damage.
So if the harm would not have happened ‘but for’ the defendant’s negligent act,
then that act is a cause of the harm (note that it doesn’t have to be the sole or even
major cause) but if the harm would have happened even if the defendant had not
been negligent, then the defendant’s act is not a cause of the harm, and so the
defendant will not be liable for the harm. What the ‘but for’ test requires us to do
is take away the defendant’s negligent act from the story, and see if the harm
would still have happened. If removing the defendant’s conduct means that the
harm would not have happened, we can say that the defendant caused the harm.
But if taking away the defendant’s conduct doesn’t change the outcome, then the
defendant’s conduct did not cause the harm.
In Cork v Kirby MacLean Ltd a painter who was working on a platform next to a
building had a fit and fell to the ground. The employer had not fitted the platform
with guardrails. If the plaintiff would not have fallen but for the lack of
guardrails, then defendant’s failure to provide guardrails was a cause (albeit not
necessarily the sole, or even, major cause) of the harm. If plaintiff would have
fallen with/without guardrails present, then their absence was not a cause. The
court held that the plaintiff would not have fallen ‘but for’ the absence of
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guardrails. Thus, defendant’s failure to provide guardrails was a cause (i.e.,
causation established); and defendant was liable.
An example of the application of the ‘but for’ test is provided by Barnett v.
Chelsea & Kensington Hospital [1969] 1 QB 428. The facts were that after
drinking tea and vomiting, the plaintiff went to the hospital’s casualty section. He
was examined cursorily by a doctor, who told him to go home and see his own
doctor in the morning. Five hours later plaintiff died. An autopsy revealed that
this was due to arsenic poisoning. It was held that although the defendant hospital
obviously owed the patient a duty of care and had breached the required standard
of care (because the doctor had not examined him properly), the hospital was not
liable because the patient would have died even if the correct diagnosis had been
made. In other words, because at the stage that he came in there was nothing that
medicine could have done for him, it could not be said that plaintiff would not
have died ‘but for’ the failure to treat him – but, it could be said that he would
have died with treatment. Even if one removed the hospital’s negligence from the
story, the man would still have died, so there was no causation and thus no
liability for negligence.
Remoteness
An important factor that must be considered whether a defendant caused damage
suffered by the plaintiff is the issue of remoteness. Because the consequences of
an act can be infinite, the law distinguishes between factual causation and legal
causation. Once it has been established (using the ‘but for’ test) that, as a matter
of fact, the defendant caused the harm to the plaintiff, the next question is whether
that causation was reasonably foreseeable, because defendants are liable only for
kinds of damage that is reasonably foreseeable (that is, damage that is not too
remote or unpredictable). A defendant can only be expected to guard against
eventualities that they could predict, so if harm is caused in a way that could not
be reasonably predicted, the defendant will not be liable.
This doctrine was laid down in Overseas Tankship (UK) Ltd v Morts Dock &
Engineering Co Ltd [1961] AC 388, often referred to as The Wagon Mound (No
1) case, after a ship involved in the case). In this case, the defendant company had
disposed of waste oil by pouring it into the harbour. Several hundred metres cross
the harbour, welders were working on a ship called The Wagon Mound, owned by
the plaintiffs, and sparks were falling into the sea. Unknown to the defendants,
there was cotton lint floating on the water in the harbour, and it absorbed the oil,
and the oil-soaked lint was carried it across the harbour by currents. The sparks
fell onto the cotton which ignited the oil, resulting in the adjacent wharf being
burnt down. The court held that although the defendants owed a duty of care to
other people in the harbour, had been negligent in pouring the oil into the water
and had, in a factual sense, caused the fire, it was not reasonably foreseeable that
the oil would ignite. For this reason legal causation was not satisfied, and so they
were not liable. Because it was not reasonably foreseeable that oil floating on
water would burn down a wharf, the defendant was not liable.
Note that this is the second issue in the law of negligence where you encounter a
foreseeability test – the other being in relation to whether a duty of care exists –
but the tests are used differently. In the case of the duty of care foreseeability is
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used to identify the class of people who might suffer harm because of the
defendant’s acts. In the case of causation, foreseeability is used to determine
whether the way in which the actual type of harm caused to the plaintiff was
foreseeable or not. If the way in which the harm was caused is not reasonably
foreseeable, the defendant will not be liable.
Finally in relation to causation, it is necessary to mention the ‘egg shell skull’
rule, which qualifies the issue of remoteness / reasonable foreseeability, but only
in cases personal injury. The rule is to the effect that if the plaintiff has some
physical weakness or illness which leads to them suffering greater harm that
would usually be foreseeable, then, provided that some injury was reasonably
foreseeable, the defendant will be liable for all the injuries suffered by the
plaintiff – including those not reasonably foreseeable. The rule is sometimes
referred to by the dictum ‘You must take your victim as you find him’.
Exercise
Bob works on a building site. He is told to keep his tools in a box,
but does not do this, as he finds it too bothersome to put each tool
into the box after he has finished using it. Instead he simply leaves
the tools around him as he works. He knocks a hammer off the
building. The hammer hits Frank on the foot, cutting it open. An
ambulance is called to take Frank to hospital. The building site is
in a very busy part of town. The police stop the traffic in order to
allow the ambulance a clear run to the hospital. Because of the
resultant delays Tom, an electrician, is stuck in traffic for an hour.
Because Tom cannot get to his next repair job of fixing the
refrigerators in Sam’s restaurant, Sam has to destroy $5,000 worth
of meat which goes bad. When Frank arrives at the hospital, it is
discovered that the cut in his foot is small, and would usually not
be serious, but that because Frank suffers from a rare circulatory
disease, his foot has to be amputated. Advise on all the legal
liabilities that arise out of this situation. Cite case authority where
relevant.
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Topic 4 Torts – Damages and defences
Learning Objectives
At the completion of this topic you should be able to:
1. outline the various heads of damage and explain how they
are calculated;
2. explain the principles of proportionate liability and
vicarious liability;
3. explain what defences are available to a claim in
negligence; and
4. apply the common law principles of tortious liability to
factual situations.
A. Calculation of damages
‘Damages’ is the sum of money that is awarded for loss or damage suffered. The
purpose is fair compensation, not punishment or retribution – that is, to put the
plaintiff back in the same financial position they would have been in if the harm
had not occurred. The law of torts recognises various types of loss or harm that
are compensable:
 physical injury;
 damage to property; and
 pure economic loss.
When a plaintiff goes to court they must make sure that they have calculated all
the amounts they are suing for. Once judgment is entered, they cannot go back to
court to sue for more – this is known as the ‘once and for all’ rule.
Losses – for which damages in Negligence may be awarded are categorised as
either:
 pecuniary = a loss that can be readily determined in monetary terms.
 non-pecuniary = a loss that is difficult to determine precisely in monetary
terms, and so has to be estimated by the courts.
The type of damages that will be claimable depend on the type of harm caused.
Thus, for physical injury, one could claim:
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 pecuniary damages to compensate the plaintiff for the calculable financial
losses flowing from the injury such as
– medical expenses (e.g., hospital, dental, optical, physiotherapy,
psychiatric or psychological counselling expenses – past and future);
– loss of earning capacity (e.g., loss of profits, bonuses, wages, salary,
other remuneration etc);
– rehabilitation expenses (e.g., cost of providing wheelchairs, modifying
cars, home-carers, conveyances or dwellings, prosthetic devices etc);
and
 non-pecuniary damages, to compensate the plaintiff for other (non-financial)
consequences of the injury, such as
– pain and suffering arising from physical or mental injury;
– shortening of life expectancy;
– loss of amenities (i.e., inability to enjoy normal activities because of,
for example, the loss of a limb, teeth, etc.); and
– loss of faculties (e.g., loss of smell, taste, hearing, sight, touch, etc.).
In the case of harm to property, only pecuniary losses would be recoverable, for
example, repair of damage caused to plaintiff’s motor vehicle by defendant’s
negligent driving.
Damages for pure economic loss similarly results in pecuniary damages being
awarded – for example, recovery of lost investment due to negligent financial
planning advice.
Note that the Civil Liability Act 2002 (NSW) places caps on damages for pain and
suffering and for loss of earnings consequent on personal injury. Different caps
apply in different jurisdictions.
Exercise
Bill is driving down the road after drinking. He runs over Tom,
who is riding along in the cycle lane. Tom’s bicycle is destroyed,
and he suffers a broken collar bone. Tom owns his own business as
an I.T. consultant. He was also a keen tennis player, but now can
no longer play tennis at the level he used to. Assume that you are
Tom’s lawyer, Jennifer, and that Tom has asked you to launch a
claim in negligence against Tom. Under what heads of damage
will you claim?
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B. Proportionate liability
It may sometimes occur that more than one person contributes to a plaintiff’s loss
– for example where A is driving in his car, B swerves carelessly in front of him,
damaging the side of his car, and C, who is following too closely, crashes into
him, damaging the rear of his car. In such circumstances, A can sue B and C, and
B and C are said to share proportionate liability. The court will apportion the
amount of damages each of them has to pay A (for example 70% – 30%) in
accordance with the court’s estimate of how much loss each of them caused. This
common law doctrine is recognised in s 34(1) of the Civil Liability act 2002
(NSW).
C. Vicarious liability
The doctrine of vicarious liability applies where the law makes someone jointly
liable for a tort committed by someone-else because of the relationship between
them. The most important example of this is the liability that attaches to
employers because of the negligent acts of their employees. If the employee’s
negligent act was performed during the ‘course and scope’ of their employer’s
business, the plaintiff can sue both the employee and (which will be more useful)
the employer. So if, for example, a bricklayer working on a building-site drops a
brick onto a passer-by, the passer-by will be able to sue the worker directly, and
the company that employs him vicariously, for damages. The court will award
damages against the bricklayer and the company jointly, and the plaintiff can
enforce the judgment against either or both. In practical terms, successful
plaintiffs who have won a case against employee and employer usually enforce
the judgment against the latter, as they will be likely to be able to meet the entire
judgment.
D. Defences to negligence
In response to a plaintiff’s claim the defendant can raise various defences (apart,
of course, from the obvious defence of arguing that they did not owe a duty of
care / were not negligent / did not cause the harm). The following are the
defences that can be raised:
Contributory negligence
Here the defendant seeks to prove that the plaintiff failed to take reasonable care
for his/her own interests (e.g. not wearing a seat belt in car), and thus was partially
responsible for the loss he or she suffered. The common law and s 5R of the Civil
Liability Act 2002 (NSW) provide that the plaintiff must take reasonable care to
avoid harm to themselves. Contributory negligence is a partial defence – the
defendant is still liable to the plaintiff, but the amount of damages he or she has to
pay are reduced according to the court’s decision as to the relative percentages of
responsibility to be borne by the defendant and by the plaintiff – for example, if
the plaintiff claims $ 100 000 in damages, but is found to be 20% responsible for
the event which caused the loss, the defendant will have to pay only $ 80 000.
In Mak Woon King v Wong Chiu [2000] 2 HKLRD 295, a factory-owner had
failed to adjust safety-guards on an industrial saw, and a worker was killed. The
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worker had himself failed to comply with safety instructions relating to the use of
the saw. The court held that the factory and the worker were liable for the
worker’s injury in the proportions of 85% – 15%, and so the worker’s estate was
awarded only 80% of the damages he claimed.
In Imbree v McNeilly [2008] HCA 40 the plaintiff had allowed the defendant, who
had no licence, to drive his (the plaintiff’s) 4WD on a gravel road while under the
plaintiff’s supervision. The defendant swerved to avoid rubbish on the road and
crashed, injuring the plaintiff. The plaintiff’s claim was reduced by 30% on the
basis that, as the supervising driver, he was partially responsible for his own
injury in allowing the defendant to drive the vehicle.
Exercise
Answer the following question, taking into account all the legal
principles you have learned in this Topic:
Frances owns a florist’s shop, Fancy Flowers Pty Ltd. She
employs Brad to drive a delivery vehicle. One night, contrary to
Frances’ instructions, Brad exceeds the speed limit while delivering
flowers because he wants to have a longer dinner break. He
crashes into Edward’s car. Edward’s car did not have functioning
rear lights. Advise Edward on his legal rights.
Voluntary assumption of risk (‘volenti non fit injuria’)
The phrase volenti non fit injuria means ‘no harm can be done to one who
consents’ – in other words, a plaintiff who, with full knowledge of a risk, accepts
the risk freely and voluntarily will not be able to recover damages. Section 5G of
the Civil Liability Act 2002 (NSW) creates a presumption that someone who
engages in activities that are inherently and obviously risky – such as parachuting
or hang-gliding – is aware of the risks thereof. By engaging in such activities,
which are commonly known to be risky, the plaintiff is deemed to have accepted
that risk, and can therefore not sue the person who organised the activity. In other
circumstances, there is a duty to warn of risks. Voluntary assumption of risk is a
complete defence – in other words, the plaintiff cannot recover anything from the
defendant.
Express exclusion of liability
It is possible for a person to expressly advise potential plaintiffs that they (the
defendants) engage in conduct towards the plaintiffs, or provide advice to
plaintiffs, on the basis that liability for negligence is excluded. Thus, an entrance
to a building site may have a notice in which the public is warned that liability on
the part of the builder is excluded when people enter the site, and an investment
adviser may expressly disclaim liability for advice they provide. Note, however,
that exclusion notices are ‘read down’, or strictly interpreted by the courts – i.e.,
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against defendants’ relying on them, as they run counter to the general common
law principle that a defendant should be liable for his or her conduct.
It is also important to note that under s 64 of the Australian Consumer Law
(discussed in Topic 9), it is not possible to exclude liability under provisions of
that Act – including liability arising from a breach of the implied guarantee in s
54(2)(d) that goods are safe.
Expiration of time (prescription)
Statutes require legal proceedings to be commenced within a certain time. If the
plaintiff does not bring his case before the courts within the required time, he
loses his right to sue the defendant because of expiration of time, and the claim is
said to be prescribed. The standard period for prescription of claims in Australian
jurisdictions is six years. Thus s 14 of the Limitation Act 1969 (NSW) provides a
general rule that a claim expires within six years of the right of action arising.
(However, note that the act provides different periods for some specific types of
claim). Expiration of time is a complete defence.
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Topic 5 Contract – formation
Learning Objectives
At the completion of this topic you should be able to:
1. explain the three elements of a valid contract: agreement,
intention to be legally bound and consideration;
2. describe the process of contract formation through offer an
acceptance;
3. outline the impact of estoppel on the law;
4. distinguish contracts, which are intended to be legally
binding, from other types of non-contractual agreements;
5. explain the role performed by consideration in contract law;
6. explain how problems created by consideration can be
circumvented; and
7. explain how international contracts differ from domestic
contracts, and what treaties govern their terms.
Video
A. Introduction to contract law
The law of contract is concerned with the rights, duties and obligations of parties
who have entered into a legally binding agreement. This should be clearly
distinguished from the law of torts which imposes obligations automatically on
everyone.
The law of contract has it origins in laissez-faire philosophy. This philosophy is
based on the idea that individuals should be free to contract with each other on
whatever terms they wish, with minimal governmental intervention and subject
only to limited restraint on the grounds of public policy (i.e. parties should not be
able to enter into a contract for illegal purposes).
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Fundamental to this philosophy is the notion that the parties to a contract are
essentially equal and therefore can negotiate the terms of a contract so that it is
acceptable to both. Accordingly, if a party to a contract enters into a bad bargain
then that is considered to be their own fault as they failed to make proper inquiries
or foolishly agreed to a term which was particularly harsh.
Parties entering into contracts thus have the responsibility of making whatever
inquiries are appropriate to satisfy themselves in respect to the terms and subject
matter of the transaction. This concept is found in law in the maxim caveat
emptor, which means ‘buyer beware’.
Since the late 1960’s the laissez-faire philosophy has been weakened by
increasing judicial and legislative recognition that parties to a contract are often
not in equal bargaining positions and this may result in unfair or unconscionable
contracts being entered into, often by individuals who are unable to negotiate with
large corporations. Anyone who has tried to negotiate the standard terms of a
mortgage with a large bank will appreciate the difficulties which a consumer will
have in trying to reach an agreement which is acceptable to them, as well as to the
bank.
In an attempt to remedy some of the more serious excesses of the laissez-faire
system the courts and Parliaments have developed a range of doctrines and have
introduced legislation intended to protect consumers when entering into certain
contracts. The equitable doctrine of unconscionability, the Competition and
Consumer Act 2010 (Cth) (formerly the Trade Practices Act 1974 (Cth)) and the
Fair Trading Acts of the various jurisdictions are good examples of this.
B. Elements of a valid contract
A contract can be defined as a legally binding agreement. This serves to
distinguish contracts from other types of social agreement, which are not legally
binding – for example where one person agrees to go to the other’s house for
dinner. Contracts are fundamental to an individual’s daily life. Every time we
purchase something in a shop, ride in a taxi or book a room in an hotel, we enter
into a contract. The knowledge that contracts are binding and that they will be
enforced by the courts is the foundation of the certainty that underpins the
business sector.
There are three essentials of a valid contract:
 agreement
 intention to be legally bound and
 consideration
C. Agreement (offer and acceptance) – 1
st essential
Offer
The existence of an agreement obviously depends on communication between the
parties. However it is important to note at the outset that communication can be
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by any means – by writing, by spoken words or even by actions. So, if I go into a
shop and put goods down at the till, and the till-operator enters the price, takes my
money and then I take the goods, we have entered into a contract even if no words
have passed between us. Our agreement is implicit from, and has been
communicated by, our actions.
The process by which an agreement to enter into a contract occurs is that of offer
and acceptance. In this process the person who makes the offer is the offeror, the
person who receives the offer is the offeree.
A contractual agreement occurs when
the offeror has communicated an offer to the offeree; and
the offeree has communicated acceptance to the offeror.
It is important to note that the offer may not be as clear as one party saying to the
other ‘I offer to sell you my car’ and the other party saying ‘I accept’. Where there
has been a series of negotiations involved in reaching an agreement it is
sometimes necessary to consider all of the representations made to determine
precisely what was offered by one party and what was accepted by the other.
Although ideally contractual liability should arise only when each party actually
agrees to enter into a contract (that is, has subjective intention to offer or accept),
the law has to address the question of what happens if a person appears (from an
objective perspective) to agree to something even if they don’t actually intend to
agree or communicate agreement in error. In other words, the law has to deal with
the problem posed by the fact that it is impossible to tell what is in another
person’s mind. For this reason, the courts adopt an objective approach in
determining whether there has been offer and acceptance – ie, they ask whether a
reasonable person observing the conduct of the offeror or the offeree would
believe that they were making an offer or giving acceptance. As was held in
Smith v Hughes (1871) LR 6 QB 597 at 607
If, whatever a man’s real intention may be, he so conducts himself that a
reasonable man would believe that he was assenting to the terms proposed
by the other party, and that other party upon that belief enters into the
contract with him, the man thus conducting himself would be equally
bound as if he intended to agree to the other party’s terms.
See also Empirnall Holdings Pty Ltd v Machon Paull Partners Pty Ltd (1988) 14
NSWLR 523, and Brambles Holdings Ltd v Bathurst City Council (2001) 53
NSWLR 153 where it was held that agreement could be inferred from conduct.
The effect of this doctrine in the law of contract is that if a person appears to have
made an offer or communicated acceptance (that appearance being tested
according to how it would be interpreted by a reasonable person in the position of
the other party), and the other party has relied on that appearance, then the first
party will be taken to have made the offer or communicated the acceptance.
Offers can be expressed in writing or in words or can be implied from conduct –
for example, taking groceries to the cashier at a store implies an offer to buy them.
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Usually (in the vast majority of cases), and offer is a bilateral offer – that is, it is
made to a specific person, and the contract comes into being when the offeror
receives that person’s communication of acceptance.
However, in a few circumstances, the offer is a unilateral offer. This means that
the offeror communicates it to a large group of people – sometimes this is said to
be an offer ‘to the world at large’. In that circumstance anyone who hears or reads
the offer can form a contract just by doing what the offeror asks, without needing
to communicate acceptance to the offeror. This is shown by Carlill v. Carbolic
Smoke Ball Co [1893] 1 QB 256 in which a company offered a £100 reward to
any person who caught influenza after using one of its smoke balls. After buying
and using a smoke ball, Mrs. Carlill caught influenza and sued for the reward.
The court held that an offer did not have to be made to a particular person – it
could be made to the ‘world at large’ resulting in a contract with anyone who
came forward and accepted it. The court also held that in such event, the usual
rule that acceptance must be notified to the offeror did not apply – the offeror was
taken to have agreed that anyone who did what the offer invited them to do had
accepted the offer.
A publication, such as an advert, which uses words that indicate that an offer is
being made to a specific person (or to the public) – for example by using the
words ‘for sale’ – would be an offer capable of being accepted by the offeree (or
by the public at large if widely published).
However, an offer must be distinguished from ‘invitation to treat’ (that is, an
invitation to make an offer). Under the common law, the mere listing of a price
in an advert or putting price labels on goods without the use of words such as ‘for
sale’ do not amount to the making of an offer – they are an invitation to treat –
that is, an invitation to the customer to make an offer. The reason for this rule is
to protect shop owners who mis-label price-tags – if the price-tag was an offer that
the customer could accept simply by picking up the item, then the contract would
be binding at that moment and the shop keeper would have to accept the amount
indicated. But since it is the customer who is making the offer, the shop-keeper
can decline to accept if the price-tag is wrong. The operation of this rule is shown
by Pharmaceutical Society of Great Britain v. Boots Cash Chemists [1953] 1 QB
401 in which an Act required drugs to be sold under supervision of a pharmacist.
A pharmacy put goods on display on open shelves with price tags attached.
Customers would then select the goods and take them to the check-out counter,
where the pharmacist was on duty. The pharmacy was prosecuted on the basis
that by putting the goods on the shelf it had been making an offer, which
customers then accepted by picking up the goods. The court held that a display of
goods is an ‘invitation to treat’, not an offer, and thus the contract had not been
entered into when the customer selected the goods. The Act had not been
breached because it is the customer who offers to buy the goods, not the shop
which offers to sell. The contract was formed when the customer took the goods
to the till (where the pharmacist was on duty) and the pharmacist accepted the
offer. If the pharmacist declined the offer, there would be no contract.
An offer will terminate (and thus no longer be open for acceptance) in the
following circumstances:
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 Where the offeror has revoked the offer, which he can do at any time before
acceptance by the offeree has reached the offeror (see Byrne & Co v
Tienhoven (1880) LR 5 CPD 344). The offeror may revoke the offer even if
he has stated that the offer will remain open until a particular date or time
(The only exception to this is if the offeror and offeree have entered into a
separate contract called an option contract, whereby the offeror has paid the
offeree something, and the offeror has agreed to leave the offer open for a
particular period).
 Where it has not been accepted by the offeree within the time or in
accordance with the place or method of communication (if any) stipulated
by the offeror. So if an offer is stipulated to be open until 11 am on 20
October, it will lapse automatically if no acceptance has been received by
that time.
 Where the offer has not been accepted within a reasonable time (assuming
that the offeror did not stipulate a time for acceptance). A reasonable time is
considered in view of all the circumstances of the offer – e.g. a reasonable
time to accept an offer of perishables will be less than that for nonperishables.
 Where the offeree has made a counter-offer: A counter offer is an offer by
the party to whom the original offer was made to deal with the first party on
different terms. This destroys the original offer, which is thus no longer
open for acceptance by the offeree. For example, in Hyde v Wrench [1840]
49 ER 132, H made an offer to sell W a plot of land for £1,000. W
responded by stating that he would pay £950. W thereby made a counteroffer
which vitiated the first offer by H. H rejected W’s counter-offer.
Because a counter-offer destroys the preceding offer, when W then
contacted H saying that he would pay £1,000 after all, and H said that he no
longer wanted to sell the land, the court rejected W’s argument that there
was a contract. There was no offer in existence for W to accept. The rule
about counter-offers applies to every detail of an offeree’s response. Thus,
if A offers to sell B a green car, for $3,000, with delivery at 10 am on 3
October, and B responds ‘I agree to buy your green car for $3,000 with
delivery at 10.30 am on 3 October’, that is not acceptance. It is a counteroffer.

 Where the death of either party has occurred before acceptance.
Acceptance
In order for there to be a valid contract the party to whom the offer has been made
must accept the offer and that acceptance must be communicated to (that is, reach
the mind of) the offeror (subject to the exception relating to ‘offers to the world’
discussed above). Generally, acceptance can be communicated by any means,
irrespective of how the offer was communicated. However, if a certain manner of
acceptance is required then it must be complied with and failure to comply will
render the purported acceptance invalid.
An exception to the rule relating to communication being effective when it
reaches the mind of the offeror is the postal acceptance rule, established in the
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case of Adams v Lindsell (1818) 106 ER 250. This rule is to the effect that,
where the offeror impliedly nominates the post as a method of communication by
sending the offer in the mail, then the acceptance is effective when the offeree
puts the acceptance letter in the post, not at some later date when the offeror
receives the acceptance. Thus, assume that A sends B a letter offering to sell a
car. B gets the letter on 1 October and posts their acceptance on 4 October. On 6
October, before receiving the acceptance, A contacts B to revoke the offer. A
receives the letter on 10 October. In that scenario, there is a contract, as
acceptance occurred on 4 October, so it was no longer open to A to revoke the
offer on 6 October. Obviously in such circumstances it would be prudent for B to
have registered their letter so as to have proof of having posted it.
Faced acceptances are effective when read by the offeror – in other words, the
normal rules, not the postal acceptance rule, applies to faxes.
Emails are governed by s 14(1) if the Electronic Transactions Act 1999 (Cth),
which provides that communications sent by email are effective when they reach
the recipient’s server (irrespective of whether the recipient has actually checked
his or her email). So, an acceptance would be effective when it reached the
offeror’s server, even if the offeror had not opened the email.
Exercise
1. Samuel received a printed advertisement in the post stating
that a screwdriver set was ‘on sale’ at a local hardware store
for $25.00. Samuel went to the store, found the item and took
it to the counter. When he tried to pay for the item the cashier
said that he could not sell it to him as it was the last
screwdriver set left and it was required for display purposes.
Advise Samuel.
2. Gina telephoned Victor on November 12 and offered to sell
him 1000 super-deluxe lawn-mowers at the wholesale price
of $230 a piece. On November 20 Victor purported to accept
this offer by sending Gina a facsimile. However,
unbeknownst to him or Gina, Gina’s facsimile machine was
out of order at the time. Hearing nothing from Victor Gina
thought that Victor did not want to take up the offer and sold
the lawn-mowers to Michelle. Victor claims that he validly
accepted the offer. Advise Victor.
3. Bob telephones Mary and says ‘Would you like to buy 1,000
litres of fuel at $2.00 per litre to be delivered on 4 October?’
Mary says ‘I’ll think about it’. Later that day she phones Bob
and says ‘I accept your offer, but with delivery on 5 October’.
Bob says ‘No’. Then Mary says ‘OK, I accept your original
offer’. Advise Bob.
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D. Intention to enter legal relations – 2
nd essential
Although often taken for granted, the law requires evidence (express or implied)
that the parties intended to make their agreement legally binding. Without
evidence, the law presumes that the parties intended to be legally bound by
commercial or business agreements, but did not intend to be legally bound by
family, domestic or social agreements. However, these presumptions can be
rebutted (i.e., shown to be incorrect) by evidence to the contrary.
In Cohen v. Cohen (1929) 42 CLR 91, a husband’s agreement to pay his wife a
dress allowance was held to be not binding because it was of a ‘domestic’ nature
and the presumption was not rebutted in court.
By contrast, in Parker v. Clark (1960) 1 All ER 93, an agreement between friends
was found to be a contract. An elderly couple (the Clarks) lived in a large house
in the south of England and were on good terms with a middle-aged couple from
Sussex (the Parkers). The Clarks wrote to the Parkers and invited them to come
and live with them and share their large house. Mr. Clark’s letter outlined how
they would share expenses/running of the house. It also said that, if they agreed
to come and live with them, the house would be left to Mr. Parker. The Clarks
understood that, to do this, the Parkers would have to sell their house in Sussex.
The Parkers agreed to the offer and sold their house. Disagreements between the
couples eventually led to the Parkers being forced out of the Clarks’ house, so
they sued for breach of contract. The Court had to decide whether there was an
intention to create a legal relationship? The court held that although the agreement
was prima facie of a ‘domestic’ nature (i.e., thus, legal relations were presumably
not intended) there was sufficient evidence available to rebut the presumption.
Thus, the Parkers were successful. Evidence, which led the court to believe the
parties intended to become legally bound, included the fact that Mr. Clarks’ letter
was precise and detailed; the sale of the Parkers’ house was a major financial
transaction entered into in reliance on the agreement, and the alteration of Mr
Clark’s will also indicated that he regarded the agreement as binding.
The normal position is that business agreements are presumed to be contracts.
However, ‘honour’ clauses in commercial agreements can rebut the presumption
that legal relationships were intended. In Rose & Frank Co v. J. R. Crompton &
Bros Ltd [1925] AC 445 an agreement for the supply of tissue paper stated: ‘This
arrangement is not entered into …as a formal or legal agreement…but is only a
record of the purpose and intention of the …parties…to which they each
honourably pledge themselves…that it will be carried through…with mutual
loyalty and friendly cooperation.’ The agreement was terminated without the
required period of notice; and the plaintiff (tissue manufacturer) sued for breach
of contract. The court held that no contract existed – only an arrangement binding
in an honourable pledge from which all legal consequences were excluded. It
should however be noted that statutory provisions regulating contracts, such in
State Sale of Goods Acts and the Competition and Consumer Act 2010 (Cth)
cannot be evaded simply by the parties stating that their agreement is not a
contract. If the agreement is clearly a contract as meant in such legislation, the
legislation will apply.
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F. Consideration – 3rd essential
The third element of a valid contract is consideration.
This means that each party must promise to give the other something of value to
for the agreement to be a contract. The promise can be to give something, to do
something or even not to do something (sometimes called a ‘forebearance’). So
for example, these would be contracts:
A promises B promises
To give B her car To pay A $5,000
To pay B $500 To paint A’s house
Not to sell her car to anyone-else for 4 days To pay A $50
To cut B’s lawn To wash A’s dog
As long as each party is getting some advantage or is better off as a result of the
agreement, there is consideration. The law will not, as a general rule, enforce a
mere promise by one party (A) to do something or give something to the other (B)
without getting anything in return. Thus if A were to promise to give B her car,
but later reneged on the promise and refused to hand it over, B could not enforce
the promise at law. In contrast, if B had agreed to pay $5,000 in exchange for A’s
promise to deliver the car then, subject to all other requirements being satisfied,
the agreement would be legally enforceable.
Whilst the law requires that consideration is an element of a contract it is not
concerned with the adequacy (the financial value) of the consideration. For
example, a contract for the sale of a prestige car for $50 will be valid irrespective
of the fact that the consideration given was less than the market value. This is
shown by Chappell & Co Ltd v. Nestle & Co [1960] AC 87 in which Nestle & Co
offered purchasers of its chocolates that they would sell them a music record in
exchange for 1 shilling and sixpence and three chocolate bar wrappers, as part of
an advertising campaign. Under copyright law, the holder of the copyright in the
record (Chappell & Co Ltd) were entitled to a royalty of 6.25% of the ‘selling
price of the record’. Were royalties owed on 1 shilling & sixpence or 1 shilling &
sixpence plus the value of 3 wrappers (which were generally thrown away as
having no value, but which Nestle had obviously profited from, because
customers had to buy a chocolate to get a wrapper). The court held that royalties
were payable on the value of 1 shilling and 6 pence + 3 wrappers. The court said
that the wrappers had some value, even if that was very small, and this had to be
included in the calculation of the royalties because they were part of the
consideration that Nestle had received from its customers.
It is also not relevant when the consideration is to be given: In some contracts the
consideration is exchanged at the same time the contract is made (for example,
when you buy something in a shop), and this is called ‘executed consideration’.
However, in other contracts, it may be agreed that consideration will pass between
the parties (i.e. the contract is actually performed) some time after it is made (for
example, when a builder agrees to build a house, and the customer receives the
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keys and the builder receives the money a year after the contract was entered into)
– this is called ‘executory consideration’.
Note that because the doctrine of consideration requires that each party promise to
give something in exchange for something the other person will give them, past
event cannot be counted as consideration. So if A washes B’s car on Monday,
and then on Tuesday A and B agree that, because A washed B’s car, A will pay B
$25, that is not a contract, because A is not getting any advantage now or in the
future in exchange for promising to pay B $25.
There is an important exception to the requirement that there be consideration in
order to create a valid contract. This is where the contract is made ‘under seal’.
Contracts which are made under seal are called deeds. It is no longer necessary
that an actual wax seal be affixed to a deed. However, it is still necessary that they
are:
1. signed by the person making the deed;
2. witnessed by a person who is not a party to the deed;
3. either a seal is affixed or the document is expressed to be a deed.
All contracts which are not under seal are called simple contracts and require
consideration to be legally enforceable.
Where a party to a contract promises to do something that they are already
obliged to do either at law or under another contract with the promisor, then they
will not have given anything in addition under the contract which will constitute
consideration. A promise to do something one is already legally bound to do has
no value because it is not giving anything extra – for example, the fire brigade has
a duty to protect people’s houses from fire, so if a person who owned a house
agreed to pay the fire brigade $500 in exchange for the fire brigade coming to put
out a fire, that would not be a contract, because the owner of the house is not
getting any consideration – they already had a right to ask the fire brigade to put
out the fire. This principle was applied in Stilk v Myrick (1809) 2 Camp 317; 170
ER 1168, in which the crew of a ship had agreed to work for a specified sum.
After some of the crew deserted, the captain agreed to pay the remaining crew
members more than the agreed wage. However, when they tried to enforce this
agreement, the court said that there was no contract, because the captain was not
getting any consideration in exchange for the increased wage, as the work the
ship’s crew did was what they were originally obliged to do.
However, if someone who already has a duty to do something for you does do
something extra, there will be a contract. This is shown by Glasbrook Bros. v
Glamorgan County Council [1925] AC 270. During a miner’s strike in South
Wales, in 1921, a colliery manager applied for police protection and insisted they
provide a live-in garrison. This was agreed, providing the colliery paid the
associated costs of £2,200. When order was restored, the manager refused to pay,
claiming there was no consideration – i.e., police were only doing what they were
legally bound to do. Judgment was given for the police because, although police
are bound to give protection, here they had done something extra, above and
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beyond their normal duties, for the benefit of the coal company by setting up a
camp at the mine.
The doctrine of consideration creates a problem in cases where someone wants to
release someone from all or part of a debt. Such an agreement obviously gives no
advantage to the releasor, and thus if the other party seeks to enforce the promise
by the releasor, they will be unable to, as they themselves gave nothing in return.
This is shown by Foakes v Beer (1884) 9 App Cas 605. Dr Foakes owed Mrs
Beer a debt of £2090 plus £360 in interest. Mrs. Beer agreed to let Dr Foakes off
the £360 interest if he paid the £2090, which he did. However, Mrs Beer then
sued Dr Foakes for the £360. Was there a contract, enforceable by Dr Foakes?
The court held that Dr. Foakes had paid only the amount he was legally obliged to
pay Mrs. Beer; so her promise in relation to the additional sum was not binding
because there was no consideration from him (i.e., he did not give her anything in
exchange for not being obliged to pay interest). Thus, her promise was not a
contract and he was liable to pay the additional 360 pounds.
There are however exceptions to the rule that an agreement to accept a lesser sum
of money than is owing is not a binding contract. The parties can ensure that they
have a binding agreement if:
 they put the agreement in a deed;
 the agreement requires the debtor to give the creditor something (no matter
how trifling its value) in exchange for the creditor agreeing to let the debtor
off part of the debt; and
 the creditor agrees to take part payment on an earlier day than the full
payment was due (the theory here is that the creditor has received an
advantage in the form of interest that he can earn on the lesser amount paid
early).
Problems raised by the issue of consideration have also been significantly
eliminated by the doctrine of estoppel, which has been used by the courts to
require a person to comply with a unilateral promise unsupported by consideration
from the other party in certain limited circumstances. The doctrine originated in
Central London Property Trust Ltd v High Trees House Ltd [1947] KB 130, in
which the owner of an apartment block in London was anxious to keep tenants
during World War II. In order to do this they told their tenants that he would
reduce the rent for the duration of the war. After the war was over he raised the
rent to what it had been, but also sued the tenants for the rent that had not been
paid. The tenants argued that the owner was bound by its promise to reduce the
rent. The owner said that he had received no consideration for the promise and so
no binding contract concerning a reduction of rent existed. The court held that it
was reasonable for the tenants to rely on the owner’s representation, and they had
done so (by arranging their financial affairs on the assumption that the rent would
not be reclaimed). The owner was therefore estopped from raising the argument
relating to consideration, and the promise he had made to reduce the rent was
enforceable against him. Arguably cases such as Stilk v Myrick and Foakes v Beer
would be differently decided today in light of the doctrine of estoppel.
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The doctrine of estoppel was accepted into Australian law in Walton’s Stores Ltd
v Maher (1988) 164 CLR 387 – although unlike in the Central London case, this
case did not involve absence of consideration but rather the issue of whether one
party had acted in such a way as to lead another to believe there was a contract. In
this case, W Ltd had negotiated a contract with Maher in terms of which Maher
would demolish a building on a plot of land, build a new one and then lease it to
W Ltd. The contract was in writing but had yet to be signed. W Ltd’s lawyers
told M that W Ltd’s director would sign the contract, and W Ltd’s director knew
that his lawyer had said this to M. Based on this representation, M began the
demolition job. W Ltd’s directors knew that the demolition had begun. A few
months later he was contacted by W Ltd’s lawyers to say that W Ltd had decided
not to enter into the contract, and so would not be paying M anything. The court
held that it was reasonable for M to have believed, because of the statement by W
Ltd’s agent (the lawyers), that W Ltd had agreed to the contract. W Ltd were
therefore estopped from arguing that they had not agreed to the contract and were
liable to pay damages to M. They knew that M had relied on the belief that there
was a contract and has suffered detriment by incurring expense, yet W Ltd had
allowed that situation to carry on. Brennan J listed what he considered to be the
essential elements of an action for promissory estoppel. These were:
1. that the plaintiff assumed that a particular legal relationship existed between
the parties or that a particular legal relationship would exist between them,
and in the latter case;
2. that the defendant would not be free to withdraw from that expected
relationship; that the defendant induced that assumption or expectation;
3. that the plaintiff acted or abstained from acting in reliance on the
assumption or expectation;
4. that the defendant knew or intended that the plaintiff act or abstain from
acting in that manner;
5. that the plaintiff’s action or inaction will cause it detriment if the
assumption or expectation is not fulfilled; and
6. the defendant failed to avoid that detriment.
G. International contracts
Specific issues need to be considered when a contract is entered into across
national boundaries.
Choice of law
The first, and perhaps most important, issue to be considered is whose law will
govern the contract ? Imagine the CEO of a company registered in France signs a
contract with the CEO of a contract registered in the UK while both are attending
a conference in Hong Kong, for the construction of a sugar refinery in Brazil. If
litigation ensues, which jurisdiction’s law will apply in determining the dispute?
The parties are to some extent free to specify in the contract whose law will
apply, but if they do not the issue will be determined by applying the principles of
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private international law (also known as ‘conflict of laws’). Most countries adopt
the principle that, it is the place where a contract is entered into whose law applies
– so in the example given, any dispute would be determined applying the laws of
Hong Kong. That would mean that a French court hearing the case would have to
ascertain what the law of Hong Kong is on the point at issue.
International sale of goods
There are a number of questions which parties to an international contract for the
sale of goods need to consider when entering a contract, including when risk
passes (that is, whether the loss occasioned by damage or destruction of the goods
is borne by the buyer or the seller); who is responsible for arranging customs
clearance; who must bear the costs of freight et cetera. In order to promote
uniformity in international sales, a treaty known as the Vienna Sales Convention
came into force in 1988. Signatories (including Australia) undertook to enact its
provisions into domestic law, and each jurisdiction within Australia has done so
(see, for example, the Sale of Goods (Vienna Convention Ac ) 1986 (NSW)). The
provisions of the Convention now provide a set of default rules governing
international sale contracts in the absence of the contracting parties agreeing
otherwise.
International transportation of goods
Because all international sales of goods involve transportation of goods,
conventions have been drafted governing the rules that apply to carriage of goods
by sea (the Hague-Visby Rules of 1968 and the Hamburg Rules of 1978),parts of
which were enacted into Australian law by the Carriage of Goods by Sea Act
1991 (Cth). Similarly, the Warsaw Convention of 1929, governing airtransportation,
have been adopted into Australian law by the Civil Aviation
(Carriers Liability) Act 1959 (Cth).
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Topic 6 Contract – Legal validity and validity of consent
Learning Objectives
At the completion of this topic you should be able to:
1. explain why a contract may be void from the start or may be
declared voidable by a court on application by a party in
certain instances;
2. describe the remedy of rescission and explain when the right
to claim it may be lost;
3. explain the concept of contractual capacity, and how it may
be limited by minority, intoxication or mental illness;
4. distinguish which contracts have to be entered into in a
particular way;
5. explain the effect of illegality on contracts;
6. explain why a contract may be voidable if a party’s consent
was unfairly obtained;
7. explain how misrepresentation, duress, undue influence and
unconscionability may vitiate consent; and
8. explain how mistake by the parties in relation to what they
were agreeing to may invalidate a contract.
A. Factors affecting legal validity
Sometimes, although there is an agreement between the parties which satisfies the
three essentials for a contract, the law may make the contract invalid. In this
Topic we will examine rules relating to capacity, legality and form and the effect
they can have on a contract.
The following terms are relevant to this area of the law:
 void – a contract which is a nullity, does not exist, has no legal effect; and
 voidable – a contract which can be ‘rescinded’ by a party.
The concept if rescission is an important one, relevant to this Topic. When a
party wants to rescind a contract, they are asking the court to end the contract and
to put the parties back in the same position they were in before the contract was
entered into – so each party must give back to the other anything they received.
The effect of this remedy is to put everything back to where it was, as if the
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contract never existed. The person seeking rescission is referred to as the
‘innocent’ party, in the sense that they are alleging that there are grounds why it
would be unfair to hold them to the contract.
The right to obtain rescission can be lost if:
 it is not exercised within a reasonable time;
 the parties cannot be replaced reasonably close to their original positions
(for example, the contract was for the purchase of a car, but the car has been
destroyed by lightening);
 the innocent party has affirmed the contract in the interim (in other words
has indicated that they wish to stand by the contract); or
 another party has in the interim, acquired rights in the subject matter of the
contract in good faith and for valuable consideration (for example, A sold B
a car, B then sold the car to C – so B cannot give the car back to A as this
would adversely affect C).
B. Legal capacity
Legal capacity is the ability of certain people to make legally binding agreements.
If a party lacks legal capacity, an otherwise valid contract may be voidable. We
will consider the position of minors, mentally ill persons and intoxicated persons.
Minors
Minors are people under 18 years of age. They have limited contracting capacity,
as only contracts for ‘necessaries’ or ‘beneficial services’ are legally enforceable.
‘Necessaries’ includes obvious things such as food, clothes and shelter, but is not
restricted to the bare necessities of life. In determining whether goods/services
were ‘necessaries’, the courts consider whether they were suitable for the minor
given his or her station in life. So contracts for taxi rides, movie tickets or CDs
would be considered ‘necessaries’ in this sense, whereas a motor vehicle or a
diamond ring would not.
‘Beneficial services’ refers to contracts for education and /or employment training
which are of benefit to the minor.
Contracts which are not for necessaries or beneficial services are not enforceable
by the other party against the minor. The minor can choose to remain with the
contract or rescind the contract.
Mentally ill persons
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Mentally ill persons have limited contracting capacity. Their contracts are
voidable if the mentally ill person (or, more usually, someone acting on their
behalf) can establish that, when the contract was made:
 they were unable to understand their contractual obligations, and
 the other party knew, or should have known this.
Intoxicated persons
The same rules apply to contracts entered into by intoxicated persons as apply to
contracts entered into by persons who are mentally ill – i.e. the person wishing to
rescind the contract must show:
 they were so intoxicated by alcohol or drugs when they entered the contract
that they did not understand what they were doing; and
 the other party was, or should have been, aware of their drunken or drugged
condition.
Affirmation
A party loses the right to rescind a contract if they say or do something which
indicates that they affirm (i.e. wish to stand by) the contract. In Matthews v
Baxter (1873) LR 8 Exch 132, the plaintiff contracted to buy a property at auction
when he was drunk. Later, when he sobered up and realised what he had done, he
sought information about the contract, which he decided to affirm (i.e., confirm).
He later had a change of heart and, wanting to avoid the obligation, sought
rescission on grounds of intoxication. The court held that although he had
established the elements of his plea (i.e., he was so drunk he did not understand
what he was doing and the other party knew or should have been aware, that he
was drunk), Baxter’s subsequent confirmation of the contract meant that his right
of rescission was lost. Thus, Baxter was bound by the contract, because he had
adopted it while sober.
C. Legality
The law does not permit enforcement of contracts that are illegal. Contracts can
be made illegal by a statute or by common law. Contracts which are illegal (eg a
contract to commit a crime), are completely void, regardless of the parties’
knowledge of the illegality).
D. Form
The ‘form’ of a contract refers to the way in which it was entered into. In general,
the common law does not require contracts to be entered into in any particular
way – any form of communication – by writing, words or actions is deemed
sufficient to reach agreement. However, in some circumstances, legislation does
require a specific method of communication to be used.
You may come across the terms ‘simple contracts’ and ‘formal contracts’. Simple
contracts are those entered into by words, by writing or by action. Most contracts
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entered into are simple contracts. Formal contracts are contracts entered into
using a deed.
The following are some significant statutory requirements which must be
complied with for certain types of contract to be valid:
 Contracts for the sale of land must not only be in writing but must be by
deed;
 A variety of contracts must be in writing, for example
insurance contracts
assignments of rights in copyright, patents and trade marks
credit agreements.
E. Factors affecting consent
In order to create a valid contract the parties to the agreement must have given
their genuine consent to the agreement. Accordingly, the existence of the
following may affect the validity or enforceability of the contract:
 misrepresentation;
 duress;
 undue influence;
 unconscionable conduct; and
 mistake.
Lack of genuine consent provides a right of rescission to the innocent party.
Misrepresentation
A misrepresentation is a false statement of fact, which induces a person to enter a
contract. Note: representations must be distinguished from self-evident
exaggerations which are referred to as advertising ‘puffs’ – e.g., ‘This is the best
car in town!’
There are three elements of misrepresentation. The statement must be:
 false;
 of fact; and
 relied upon when the contract is made.
A misrepresentation has no effect if the other party was not aware of its existence
or untruth, or does not allow it to affect their judgement – it must, in fact, persuade
the other party to enter the contract. Silence is not a misrepresentation – for
example, if you don’t tell someone about a defect in a product, that does not
amount to misrepresentation. However, remember that anything you do say has to
be the full truth – so if the seller of a car says it has been tested, but then does not
go on to tell the buyer of what the test revealed, that would be a
misrepresentation. Also note that if a representation becomes false (to the maker’s
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knowledge) between when it was made and the contract being entered, then the
maker has to inform the party of the true position.
There are three types of misrepresentation:
 fraudulent;
 negligent; and
 innocent.
Fraudulent Misrepresentation is made ‘knowingly or without believing in its truth
or recklessly (careless whether it be true of false) with deliberate intention to
deceive’, as stated in Derry v. Peek (1889) 14 App Cas 33. It must be shown that
the person making the statement knew it was false or had no belief in its truth
Negligent misrepresentation occurs where the person making the representation
did not know that what they were saying was untrue, but failed to take reasonable
steps to find out whether it was true.
Innocent Misrepresentation is a statement which was made by a person who
believed it was true and did not make it negligently.
The remedies that the innocent party (that is, the party who entered the contract in
reliance on the misrepresentation) can obtain are as follows:
 Fraudulent Misrepresentation: rescission + recovery of any consequential
damages flowing from the misrepresentation.
 Negligent Misrepresentation: rescission + consequential damages.
 Innocent Misrepresentation: rescission only.
Duress
Duress occurs where the innocent party or their immediate family (i.e., parent,
spouse or child) is threatened with actual or perceived violence or imprisonment;
or where a threat is made to damage the innocent party’s property, and the
innocent party enters the contract in order to avoid the harm.
If proven, duress renders the contract voidable at the injured party’s option.
Undue Influence
Undue influence is the improper use by an ascendant person in a relationship of
trust and confidence, of their power or influence over another, for personal
benefit, so that the act of the influenced party to enter a contract is not free and/or
voluntary. If proven the innocent party (that is, the party who was subject to
undue influence) can obtain rescission.
The common law courts recognise special (i.e., dominant and/or subservient)
relationships, where undue influence is presumed to have occurred – in other
words, where, if the subservient party alleges duress, the dominant party will need
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to rebut the presumption of duress. These relationships include: parent / child;
doctor / patient; religious adviser / believer.
A good example of duress vitiating a contract is provided by Johnson v. Buttress
(1936) 56 CLR 113: An illiterate widower with a low IQ in his 60’s, was wholly
dependant relatives for guidance and support, including Mrs. Johnson (a relative
of his late wife). He decided to bequeath his small cottage to Mrs. Johnson. Then
he executed a deed transfer the property to her right away. Mrs. Johnson’s
solicitor prepared both documents. His family only became aware of what had
occurred after the man died a few years later; and his only son (Mr. Buttress)
sought to have the transaction set aside on the ground of undue influence. The
court held that Mrs. Johnson was in a position of trust and confidence and, thus,
could exercise dominance over the man. The gift of the property was set aside.
Unconscionability
‘Unconscionable’ means unprincipled or unscrupulous. Although the courts will
not intervene simply because one party to a contract has made a bad bargain, they
will do so if a party is at a special disadvantage, which affects their ability to
safeguard their own interests (e.g., through illness, ignorance, inexperience,
impaired faculties, financial need etc) and the other party, being aware of this,
unconscionably takes advantage of the opportunity presented when contracting
with them. Intervention by a Court for this reason can result in:
 the contract being rescinded; or
 damages being awarded; or
 a new contract being substituted for the old contract; or
 the old contract being amended to remove its harshness.
Unconscionability is illustrated by Commercial Bank of Australia Ltd v. Amadio
(1982-1983) 151 CLR 447. An elderly Italian couple with limited English were
persuaded by their son (a builder) and the son’s bank manager to sign a mortgage
over their property as security for a loan the son’s company had with the bank.
Neither son nor bank manager disclosed the company’s true financial position and
the couple mistakenly believed their liability was limited to $50,000 for six
months; when, in fact, it was $240,000. The couple successfully had the
mortgage and security set aside on the ground that they would not have signed had
they had known the true state of the company’s account and insolvency. The
court held that because of their age and limited competence with the English
language, the parties were not in an equal bargaining position. The bank should
have disclosed the true position of the son’s company. The mortgage and security
were set aside because of the bank’s unconscionable conduct.
F. Mistake
Generally, a ‘mistake’ is considered to be a belief that something exists when, in
fact, it does not (i.e., a state of affairs, matter or object); or, where there is
ignorance of the true state of affairs. The legal view of ‘mistake’ is much
narrower – thus the mistake must be about an underlying, or fundamental, fact in
the contract’s subject matter. Mistake renders a contract void – in other words,
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since the parties were not agreeing about the same thing, there never was a
contract. There are three types of mistake:
 common mistake;
 mutual mistake; and
 unilateral mistake.
Common mistake occurs where both parties make the same mistake about the
subject matter of the contract – e.g. Jessica agrees to buy Sam’s pet bird which,
unbeknown to both, now lies dead in its cage.
Mutual mistake occurs where the parties misunderstand each other – that is, they
were thinking and/or talking about different things when the contract was made.
For example: Jessica accepts Sam’s offer to buy his owl, thinking that he (Sam)
was offering his pet white owl whereas in fact Sam was thinking of his grey owl.
Unilateral mistake occurs where only one party is mistaken, and the other party
knows (or should be aware) of the first person’s mistake – e.g., Sam offers to sell
Jessica a car from his car lot. She says ‘Yes, I will buy that car, because it has a
CD player in it’. If the car does not have a CD player in it, Jessica is making a
mistake which Sam knows about. He must correct the mistake by telling her what
the true position is.
Non est factum
Special rules apply when a person tries to raise the argument that they were
mistaken as to the contents of a written document, so the argument is very
difficult to make successfully. This is known as the ‘non est factum’ (‘it is not my
act’) defence to contractual liability. This is a very difficult defence to prove, as
the law presumes that a signature indicates that the signatory has read and
understood the document, and accepted its terms, thus, ‘mistaken’ signatories
must show:
 the signed document was radically different from what they thought they
were signing; and
 when signing they were under a disability (e.g., blindness, illiteracy,
reliance on another);
 which made them unable to understand the meaning of the document
through no fault of their own (i.e., it was not just a case of them failing to
read a document they could have understood).
Rectification
Parties who have actually agreed on certain matters but due to a mistake at the
time of putting the agreement in writing one or more terms have been erroneously
cited can apply to a court to have the written document rectified. This is called the
remedy of rectification. The parties must prove that at the time of signing they
both agreed on the terms of the contract and that the contract as written does not
reflect those terms.
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Exercise
1. David had run away from home at the age of 14 and at the
age of 15 joined a religious sect known as ‘Wakki Koresh
Freedom Fighters’. David was financially and emotionally
dependent on the sect and he relied on the sect leader, Wakki,
for advice and guidance on a number of matters. David has a
job as a checkout operator at Truworths Ltd, where he was
paid $250 per week. Each week David had gives $50 to the
sect to cover food and board expenses, and at the request of
Wakki, had pus $100 each week into Wakki’s ‘Freedom
(Fighters) Account’ with St. George Bank. David has
become disenchanted with the sect and now wants to enrol in
the Bachelor of Business degree at Charles Sturt University.
He has no savings and asks your advice as to whether he can
reclaim any of the money which he paid to the sect. Advise
David.
2. You need a ute for your business.. You go to Ubeaut Utes and
inspect a number of vehicles in their caryard. The salesperson,
Donna, comes to your assistance. You tell Donna that you
want a low mileage utility that has a good service record. She
shows you a 2004 Ford utility and says that the other
salesperson has an identical model with only 40,000 km on the
odometer, and has a full service history. When you ask about
the condition of the engine she says ‘It was fully tested by the
NRMA’. She further says that the utility is not currently at the
caryard because the other salesperson has taken it to show
another interested customer. She says she can sell it to you that
day and shows you a photo of a 2004 Ford utility with
numberplates UDIL,000 and some registration papers for the
vehicle. You sign a contract to purchase the utility for
$20,000. You return the next day and pay $20,000 to Ubeaut
Utes and Donna hands you the keys to your new vehicle.
Unfortunately, when you look at the odometer and find that it
has 140,000 km recorded on it. As you drive off, it produces a
pall of blue smoke from the exhaust and the engine dies.
Donna refuses to take the vehicle back or refund your money.
You find out from the NRMA that only 3 of the vehicle’s 4
cylinders worked when it was tested. You are losing $400 per
day in income from your business because you do not have the
ute. What remedies do you have?
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Topic 7 Contract – Contents of contracts
Learning Objectives
At the completion of this topic you should be able to:
1. explain the difference between express and implied terms;
2. explain the difference between conditions and warranties
and how the remedies available for breach of each differ;
3. describe the nature of exclusion clauses and explain the
conditions under which they are valid;
4. outline the doctrine of privity of contract.
A. Contents of contracts
Given the different methods by which parties may communicate, the content or
terms of the contract may be expressed (in writing or orally) or be wholly implied
(from conduct), or may be a combination of two or three of these. In other words,
in determining what obligations parties have undertaken, it may be necessary to
pay attention to what the parties wrote, what they said and what they did.
B. Express and implied terms
Express terms are those explicitly agreed between the parties (i.e., which are
spoken or written. Implied terms are those not actually expressed but are
presumed (or ‘read into’ the contract). Some contracts may be wholly expressed,
others may be partly expressed and partly implied, while others may be wholly
implied (as when you go into a shop and purchase goods from the shopkeeper and
neither of you says anything during the transaction.
Terms can be implied into a contract in the following circumstances:
 where it is necessary to give efficacy to the contract (i.e., the contract will
not work unless the term is read into it – see The Moorcock case below);
 where there were previous dealings between the same parties on certain
terms, and those terms are presumed, in the absence of anything to the
contrary being said, to carry over into a new contract;
 where there is a trade custom that everyone engaging in that type of contract
should be aware of; and
 where the term is mandatorily implied by statute law.
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For a term to be implied it must be:
 fair and reasonable;
 obvious (i.e., it must ‘go without saying’ that both parties intended the
term);
 not be inconsistent with any express term; and
 capable of clear expression.
A good example of the implication of a term on grounds of efficacy is provided
by The Moorcock (1889) 14 PD 64, in which the owner of a ship rented space at a
wharf with the intention of tying up the ship at the wharf for the purpose of taking
on cargo. The owner of the wharf knew what size ship would be moored there.
When the owner moored the ship, it became damaged through hitting the bottom
of the harbour as the tide went out. The ship-owner said that the wharf owner had
breached the contract by not providing a wharf where the sea was deep enough to
accommodate the ship at low tide. The Court implied a term into a contract that
the owner of the wharf would provide a place for the ship to berth safely
(i) because the contract would be useless (i.e. would not be efficacious) unless the
ship could be tied up at the wharf and (ii) the owner of the wharf knew the size of
the ship.
Implied terms often come to the rescue of parties if they have been careless in
specifying terms and have left out something vital – for example, if a person
agrees to do work for another but no mention of a payment rate is made, the law
would say that an implied term of their agreement would be that a ‘a reasonable
price’ would be paid for ‘the work done’.
An example of terms being implied by trade custom might be where an oil
company hires a tanker for 6 months and returns it to the owner without cleaning
it. Assuming that the contract did not contain a terms relating to who was
responsible for cleaning the ship and the parties entered into a dispute on this
issue, either of them might seek to prove that, within the shipping industry it was
accepted practice that the obligation to clean the vessel lay on the hirer or the
owner.
Note that, where the contract is in writing then the ‘parol evidence rule’ applies.
This rule provides that in such contracts the contract is presumed to contain the
entirety of the agreement between the party, and the courts may not look at
extrinsic evidence in construing the meaning of the terms of the document. In
other words, the party who seeks to rely on other, implied, terms, bears the onus
of proving that the written contract did not contain the entirety of what the parties
intended.
Finally note that terms must not be vague – they must be sufficiently clear and
certain so that an understanding of the contents agreement between the parties can
be readily established. If terms of a contract are incomprehensible to the extent
that the contract is meaningless, the courts may declare the contract void for
uncertainty. However, if the essentials of the agreement are clear and it is only a
particular term that cannot be understood, the courts may delete the uncertain term
and leave the rest of the contract in existence.
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Exercise
Joe has been involved in the pig-farming industry for 20 years. He
enters into an oral contract over the phone with Mike, Managing
Director of Tip-Top Meats Ltd, to supply 40 pigs @ $200 each in
January. He has vaccinated the animals prior to sending them to
the market. In February and March Joe phones up Mike to offer
40 pigs @ $200 each, Mike accepts the offer and Joe delivers the
pigs as before. In April Mike phones Joe and says ‘Please send
more pigs’. Joe puts the pigs on a truck. He receives a phone call
from Mike after the pigs arrive at the meat works. Mike says ‘I am
not accepting these pigs – they have not been vaccinated, and you
know that farmers always vaccinate animals before sending them to
market. Take them back and vaccinate them. By the way, I’m only
willing to pay $180 per pig for this order’. Joe tells you that no
mention was made of vaccination in any of his conversations with
Mike, and that he also wants $200 per pig. Advise Joe.
C. Conditions and warranties
When considering the terms of a contract a fundamental distinction has to be
made between a condition and a warranty. This is important because of the
consequences of which may flow from a breach of a condition as compared to a
breach of a warranty.
A condition can be defined as an important or essential term of the contract one
that was so fundamental to the agreement that the parties would not have entered
into the contract without it. Breach of a condition entitles the innocent party to
either terminate the contract and sue for damages, or to elect to affirm the contract
and sue for damages.
A warranty is a term which, whilst important, is not essential to the contract such
that the contract would not have been entered into without it. A breach of a
warranty entitles the innocent party to sue for damages only. There is no right to
terminate the contract.
The following three cases illustrate the difference between a condition and a
warranty:
 In Bettini v. Gye (1876) 1 QBD 183 a singer, contracted to sing in a show
for 3½ months and attend rehearsals at least 6 days prior to the season
commencing, arrived four days late because of illness. The promoter
terminated the contract alleging a breach of a condition. The court held that
the term relating to attendance at rehearsals was a warranty, not a condition.
The core of the contract could still be performed, so the theatre owner was
not entitled to terminate it.
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 Poussard v. Spiers (1876) 1 QBD 410 was another contract relating to a
performing artist. An actress, engaged to play the leading part in an operetta
for the whole season, missed the first week of the season. The promoter
(Spiers) terminated the contract alleging a breach of a condition. The court
held that the promise to perform from the first night went to the ‘root’ of the
contract and was a condition. Unlike in Bettini v Guy, where the performer
had only missed rehearsals, here the performer had missed the actual
performance.
 In Associated Newspapers v. Banks (1951) 83 CLR 322 a comic strip artist
contracted with a newspaper to provide a full-page comic for 10 years, to be
placed on the front page of its comic section. A newsprint shortage caused
it to printed on page 3 instead of page 1, which the artist regarded as a
breach of a condition and held himself no longer bound by the contract. The
newspaper sued for breach of contract. The court held that the page 1
requirement went to the ‘root’ of the contract and was a condition – the
newspaper had breached the contract, so the cartoonist had been entitled to
terminate it and was not himself in breach.
An intermediate or innominate term is a term which does not easily fit within
the category of either a condition or a warranty until the circumstances of the
breach have been determined. This is because some terms may be breached in a
serious way in a trivial or less serious way. For example, a term that a motor
vehicle is ‘roadworthy’ may be breached in a serious way if the engine has
completely seized up. However, the same term may be breached in a less serious,
or minor way, as a result of the windscreen wipers being defective. In such cases
it is necessary to consider the seriousness of the breach in order to determine
whether the innocent party may treat it as a breach of a warranty or a condition.
Generally, if there is a serious breach of an innominate term then the innocent
party will have the same rights as if the term had been a condition (as in Poussard
v. Spiers (1876) 1 QBD 410). If the breach is less serious then the innocent party
will only have the right to sue for damages as if it had been a warranty (as in
Bettini v. Gye (1876) 1 QBD 183). Note that it is up to the court, taking an
objective view of all the circumstances of the contract, to determine whether a
breach of an innominate term should be treated as a breach of a condition or of a
warranty – whether the parties themselves have called the term a condition or a
warranty is not decisive. The key case which applies where a court needs to work
out whether a breach is of a condition or a warranty is Hong Kong Fir Shipping
Co Ltd v Kawasaki Kisen Kaisha Ltd [1962] 2 QB 26, in which one company had
chartered (ie hired) a ship from another for a year. The contract stipulated that
the ship owners were obliged to supply it in a seaworthy state, however it was not
clear whether thos term was a condition or a warranty. The ship was not
seaworthy in several respects, and the hirers were unable to use it for several
weeks during its voyage while as it needed repairs. The court held that although
the owners of the ship were undoubtedly in breach of contract, the length of time
for which the ship had not been able to be used was not so long as to have
deprived the hirers of the substantial benefit of the contract, and so they were
entitled only to damages, and could not terminate the contract.
The distinction between conditions and warranties is of great importance when it
comes to determining what remedy is available for breach of a contract. We will
deal with this later, but for the present it is important to remember the following:
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Breach of condition Plaintiff can choose termination + damages
OR
Plaintiff can choose specific performance (an
order that the defendant perform as required)
+ damages.
Breach of warranty Plaintiff can choose specific performance (an
order that the defendant perform as required)
+ damages. Termination is not available.
D. Exclusion clauses
Exclusion clauses are terms that exclude or limit the liability of a party to a
contract – for example a sign at the entrance to a car park says ‘No responsibility
is accepted for the loss or theft of patrons’ valuables’, or a clause in a building
contract says ‘The liability of the builder for damages in the event of a breach of
contact is limited to $1,000’. Exclusion clauses can operate to exclude liability
either in tort or in contract, or both.
In contract, exclusion clauses will be effective in excluding or limiting the
liability of the party relying on them, if they are:
 incorporated into the contract, and
 expressed widely enough to cover the particular situation.
Incorporation into the contract
Like any term in a contract, an exclusion clause must obviously be part of the
contract to be effective.
If the contract is a written one, and the exclusion clause is contained in the
contract, the clause will be effective, as is shown by L’Estrange v Graucob [1934]
2 KB 394. In this case, a person rented a cigarette-vending machine. The contract
was a written one. It contained a clause excluding the supplier of the machine of
any liability to repair the machine if it broke down. The machine broke down and
was therefore useless to the person hiring it. She claimed that the contract had
been breached because the machine did not work, and that the supplier should
either repair the machine or provide her with a new one. She said that she had not
read the exclusion clause when she signed the contract. The court held that a
person is presumed to have read a contract they sign. The person hiring the
machine was bound by all the terms of the contract, including the exclusion
clause. The supplier of the machine was therefore not liable to repair it.
Irrespective of whether the contract is written or oral, the exclusion clause must be
in the contract at the time it is entered into. A person cannot unilaterally add
clauses to a contract. Giving notice of a term after a contract has been formed is
ineffective. This is shown by Olley v. Marlborough Court Ltd [1949] 1KB 532.
Mrs Olley booked into a hotel with her husband. They signed a form at the
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reception desk. This form contained the contract they had with the hotel. On
reaching their room a notice was found on the back of the door excluding liability
regarding the safety of articles left in hotel rooms. Their room was burgled and
the hotel claimed exemption from liability because of the clause. The court held
that the hotel could not rely on the exclusion clause because it had not been
brought to the guests’ attention when the contract was made (i.e., at reception
desk).
If the contract is oral (that is, not written) whether the exclusion term is part of the
contract will depend on whether reasonable steps have been taken to bring the
clause to attention before, or at the time, the contract was made. The requirement
that the term must be brought to the person’s notice in a reasonable manner has
been interpreted in a number of cases where people entered into oral contracts and
were then given a receipt or ticket on which an exclusion clause was printed. This
has been held not to amount to reasonable notice. In Causer v. Browne [1952]
VLR 1 a person sued for damage to her dress caused by staining during drycleaning,
The dry-cleaner argued that he was not liable because he had handed the
plaintiff a receipt for her dress when she left it and on the back of the receipt was
a notice that the dry-cleaner was not liable for damage to clothes. The court held
that people were reasonably entitled to assume that the receipt was given to the
owner after the contract was entered into merely to enable an owner to reclaim the
article (dress). The receipt was not a contractual document with terms. Thus, the
plaintiff was not bound by the exclusion clause and the dry-cleaner was liable for
the damage caused to the dress. In such cases, if a person wants an exclusion
clause to be effective, they should either actually tell the person that they exclude
liability before the oral contract is entered into, or have a notice to that effect
prominently displayed so that all customers can see it before deciding whether or
not to enter into a contract.
Similarly, in Thornton v. Shoe Lane Parking Ltd [1971] 2 QB 163 the plaintiff
entered and parked his car in parking garage. After he had paid his money into
the machine at the automatic entry gate he received a ticket which said: ‘This
ticket is issued subject to the conditions of issue as displayed on the premises.’
The conditions were in a notice inside the garage, which exempted the proprietors
(defendant) from liability for personal injury (amongst other things). The plaintiff
was injured when he returned to collect his car and sued for damages. The court
held that the contract was made before the ticket was dispensed from the machine.
Thus, the terms (and exclusion clause in particular) were not incorporated into the
contract and the ticket was a mere receipt. Nowadays, garages display their terms
(including any exclusion clause) at a place that drivers can see them before they
buy a ticket – that is, the terms of the contract are made known before the contract
is entered into.
Sufficient width
To be effective, exclusion clauses must be expressed widely enough to cover the
liability that has arisen. Courts have traditionally been hostile to exclusion
clauses because they deprive a party of remedies they would usually have, so any
uncertainty or ambiguity concerning the meaning or circumstances of application
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of a clause will be resolved in the plaintiff’s favour, where possible. This principle
is known as the ‘contra proferentem’ rule, which is to the effect that exclusion
clauses will be strictly construed against those who seek to rely on them.
The application of this principle is demonstrated by Sydney City Council v. West
(1965) 114 CLR 481, in which the plaintiff left his car in a car park and was given
a ticket, which excluded liability for ‘damage to the car and its contents or injury
to any person’. Later, someone claiming to be the plaintiff and had lost his ticket,
was allowed to drive the car from the car park, notwithstanding citing a
registration number that was different from that recorded for plaintiff’s car. The
plaintiff sued for damages. The court held that the defendant could not rely on the
clause and was liable for the loss of plaintiff’s car because what happened was
outside its terms – i.e., the clause, as written, did not cover theft of the car; and,
the defendant’s releasing the car without the correct ticket being presented was an
unauthorised act. The court held that clear words must be used to negate liability
(in this case, liability for negligence).
Exercise
Jack and Jill had attended a formal Ball following which both
Jack’s dinner jacket and Jill’s evening dress required dry cleaning.
Jack took both garments to D & C Dry Cleaners which he had used
on numerous occasions. As in the past Ms Gordon, the attendant,
took the garments and handed jack a docket which Jack placed in
his wallet without reading it. When he returned to collect the items
he found his dinner suit had shrunk due to being treated at too high
a temperature. When he asked for Jill’s dress he was told that a
woman who looked like Jill had arrived to pick it up but said that
she had lost the docket. Ms Gordon had allowed the woman to sort
through the garment rack and take the dress which she identified as
belonging to her. When shown a photograph of Jill, Ms Gordon
admitted that the woman who collected the dress did not look
anything like Jill. When Jack demanded compensation for both his
damaged suit and Jill’s dress Ms Gordon directed him to a clause
on the back of his docket which said:
D C Dry Cleaners will not be liable for any damage to clothing left
for cleaning howsoever such damage may be caused.
Ms Gordon also pointed to a large sign above the counter which
was in the same terms as the clause on the docket. Jack
remembered seeing the sign but said that he had never read either
the sign or the clause on the back of the docket. Advise Jack.
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E. Privity of contract
A fundamental rule of Law of Contract is known as privity of contract, which
means that only the parties to a contract acquire contractual rights and/or
obligations (because they alone have given consideration).
For example, if A enters into a contract to sell B a TV set for $100. If A does not
deliver the TV set to B, another person, C, cannot sue A for breach of contract, as
only A and B are parties to the contract.
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Topic 8 Contract – Discharge of contracts
Learning Objectives
After completing this topic you should be able to:
1. outline the various ways that a contract may come to an end
(be ‘discharged’);
2. outline the rules relating to discharge by performance;
3. recognise the circumstances in which the law automatically
discharges a contract;
4. outline what happens when a contract is discharged as a
result of a breach by one of the parties, and what remedies
are available;
5. outline determine what damages are recoverable for breach
of contract and how such amounts are limited by the
concepts of remoteness and mitigation;
6. outline the consequences of termination of a contract as a
remedy for breach;
7. describe the equitable remedies and the circumstances when
they are available; and
8. discuss when a contractual claim becomes prescribed
through elapse of time.
A. Discharge of contract
When a contract comes to an end it is said to be ‘discharged’. This can be by:
 performance;
 agreement;
 operation of law; or
 breach.
Discharge by performance
The most common method for a contract to come to an end is when both parties
fulfil their promises. The common law requires that performance be precise
(i.e.- exactly what was promised), otherwise, the defaulting party is in breach of
the contract and not entitled to its benefits. The rule of precise performance thus
means that you are entitled to receive performance only if you are ready to give
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performance – part performance by one party does not oblige the other party to
give any performance.
For example, if Sam orders 5,000 bricks from Mary but only 4,000 are
delivered. Sam can (i) refuse to accept the bricks or (ii) keep them without
being liable to pay Mary the purchase price until the rest are delivered.
Because of its harshness to defaulting parties, the courts have developed
exceptions to that rule. The first of these is where the contract is ‘divisible’ (i.e.,
can be separated into parts).
For example, if Jessica contracts with Sam for him to build five tennis
courts @ $7,000 per court, can part-payment (i.e., $28,000) be sought by
Sam if he completes only four? The courts would say that, because the
contract specified $7000 per court, the contract was ‘divisible’ and
payment is entitled for the four completed courts because the contract was
to do five separate things. Note however that contracts are presumed to be
entire unless the contrary can be shown – thus divisibility has to be
proved.
The other exception is where there has been ‘substantial’ performance (i.e., only a
slight difference between the actual and required performance).
For example: Sam contracts to build five tennis courts for Jessica. On the
designated day for completion, all five courts have been built, but the net
of the fifth court has not been installed. The contract could be said to have
been ‘substantially’ performed, and Sam would be entitled to payment for
five courts, less damages in the amount of what it would cost Jessica to get
someone to install a net.
Discharge by agreement
What is formed by agreement can be ended at any time by agreement. Agreement
can take several forms:
Mutual agreement (called a bi-lateral discharge) is available where both parties
still have something to do under the contract.
For example: Sam contracts to build Jessica’s house for $150,000 to be
paid progressively during building, and after $100,000 is paid, they both
agree to discharge their agreement, then Sam does not have to complete
the house and Jessica does not have to pay the outstanding $50,000.
Unilateral discharge happens where one party has fully performed, and the other
party has not.
For example: Sam has completely finished building Jessica’s house.
Jessica has paid $100,000 of the $150,000 price. Sam wants to release
Jessica from paying the remaining $50,000. For such an agreement by
Sam to be binding, Jessica must do something extra – i.e., she must
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provide some consideration. (See the earlier discussion of Foakes v Beer
(1884) 9 App Cas 605).
The other option is for both parties to execute a deed of release (because a deed is
binding without consideration).
Finally, remember that the doctrine of estoppel may operate to enable a person to
enforce a promise, even where they themselves are not paying consideration
(Look back to the discussion of Central London Property Trust Ltd v High Trees
House Ltd [1947] KB 130).
B. Discharge by operation of law
The law provides automatically discharges contracts in certain circumstances,
including:
 death,
 bankruptcy, and
 frustration.
Death
The law presumes that, in the event of the death of either party personal service
contracts terminate automatically, but other contracts (such as for the sale of
goods) do not terminate, as they can be performed by deceased person’s executor
or administrator.
Bankruptcy
Bankruptcy is a process by which individuals who are unable to pay their debts as
and when they fall due can be cleared of their debts under the law. The bankrupt
person is no longer personally liable for contracts entered pre- bankruptcy, and
claims by creditors are lodged with the ‘Official Receiver in Bankruptcy’, who
determines what percentage of the claims can be satisfied out of the bankrupt
person’s assets. The contractual capacity of the bankrupt person is limited until
the order of bankruptcy is discharged by a court.
Frustration
If it becomes impossible for a contract to be completed because of events beyond
the control of the parties, the contract is said to be ‘frustrated’ – for example, if a
natural disaster or a war makes the contract impossible to fulfil, or the law is
changed to make the contract illegal. Parties are free to specify in their contract
what sort of events will be considered to frustrate a contract, as under the common
law, only an event that made the contract impossible (as distinct from more
difficult) counted as frustration. For example, the wash-out of a bridge used by a
coal company to send trucks of coal purchased by a power station would not make
the contract impossible to perform if there was another bridge further downstream,
even if that required a long diversion and made the contract unprofitable
for the trucking company.
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The parties are also free to specify who will bear the financial loss resulting from
frustration, but if they do not, legislation governs this issue. In NSW provisions
contained in Part 3 of the Frustrated Contracts Act 1978 (NSW) provide that each
party bears equally in the losses flowing from the frustration – in other words,
each party must pay half the expense the other has incurred in preparing to
perform under the contract.
C. Discharge by breach
Breach of contract can arise in two ways:
 anticipatory breach – a party says or does something, before the due date of
performance, which indicates that they do not intend to perform; or
 actual breach – a party fails to do something at the actual time stipulated for
performance;
 in either circumstance the aggrieved party (that is, the person who is entitled
to the performance) is entitled to the remedies for breach of contract.
Video
The effect of the breach depends upon what type of term of the contract was
breached. As you will recall, a term of a contract can be classified as
 a condition – a term which is of such importance to the contract that a party
would not have entered into the contract at all had they known that the term
would not be complied with
OR
 as a warranty – term which is of lesser importance (in other words, all the
other terms of the contract which are not conditions)
For breach of a condition the aggrieved part can obtain
 specific performance (an order that the contract be performed by the other
party) + damages
OR
 termination (a declaration that the contract is at an end and that the innocent
party no longer has to perform) + damages.
For breach of a warranty, the aggrieved party cannot obtain termination, and can
only obtain
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 Specific performance + damages
Exercise
Frank needs a new house. He meets with Gordon, who is a builder.
He looks at several house plans. He chooses one that he likes and
on 1 July they sign a 50-page contract in which the fact that the
house will have a steel roof is listed as one of the specifications.
The overall cost of the house is stated in the contract as being
$250,000. On 5 July , Gordon sends to Frank a bulky set of
documents containing site plans, house plans, agreed colour
schemes and landscaping plans, all consistent with the contract that
was signed. Unnoticed by Frank was a single sheet of paper
included in the pile, headed ‘Standard Terms of Our Construction
Contracts’, which contained a statement (which did not appear in
the July 1 contract) as follows:
The building contractor excludes all liability for consequential
damages taking the form of financial loss in the event of a breach
of this contract.
The day the house is finished Frank notices that although all the
other terms of the contract have been complied with, the house has
a tile roof, not a steel one. It would take 3 months to take off the
tile roof and put on a steel one, and it would cost Frank $6,000 to
rent another house to live in while the work is done. Advise Frank
fully as to all the legal issues arising out of this scenario and his
legal rights against Gordon.
D. Damages
Damages are intended to provide compensation and are based on the principle of
restitution – that is, their purpose is to replace plaintiff in the same financial
position as if the breach had not occurred – in other words, to put them in the
financial position they would have been in had the contract been performed
properly.
The first thing that a plaintiff seeking an award of damages must do is prove
causation – that is, that the damages were caused by the defendant’s breach of
contract.
The amount of damages that will be awarded is limited by the concept of
remoteness: The party who has breached the contract is not necessarily liable for
all damage caused by the breach. They are liable only for damages that flow
naturally from the breach – i.e., in the usual course of things, and/or were
anticipated by the parties when the contract was made. Damages that were not
foreseeable, because they were too remote, are not recoverable – see Hadley v.
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Baxendale (1854) 9 Exch 341, in which the court held that a defendant is only
liable for:
 damages that ‘flow naturally from the breach’ – i.e., in the usual course of
things (and it was unusual in this case that the mill had only one crankshaft);
and/or
 such damages ‘as may reasonable be supposed to have been in the
contemplation of both parties’ when the contract was made.
Compare this case with Victoria Laundry Ltd v Newman Industries Ltd [1949]
2 KB 528, in which a commercial laundry entered into a contract to have one of
its boilers repaired. It was agreed that the repairs would be done by a certain date.
The repair company knew that the laundry relied upon the boiler to operate at its
normal level of business. However, the repair company did not know that the
laundry was due to receive a special order to do the laundry for a hotel, from
which it would have earned profits above what it normally earned. The court held
that the repair company was liable to pay damages to the laundry company equal
to the average profit per day that the laundry company would usually make, as
these were losses that were reasonably predictable. However the repair company
did not have to pay damages to compensate the laundry for the loss of the extra
profit it would have made from the special contract, as the repair company had not
been informed of this potential (and not reasonably foreseeable) loss by the
laundry.
Exercise
Qantas Ltd signs a contract with Airbus Industries SA under which
Airbus will build a new-generation A380 for Qantas at a price of
$200 million. The contract contains 500 clauses of specifications.
Clause 34 states that the aircraft must have 400 economy, 50
business and 25 first class seats. On the day the aircraft is due to be
handed over, Qantas finds that all clauses of the contract have been
complied with, except clause 34, in that the aircraft has 400
economy, 45 business and 25 first class seats. The board of Qantas
has asked you if they can terminate the contract. You are also told
that it would take Airbus two weeks to add 5 business class seats,
that Qantas makes a profit of $250,000 per day an aircraft is
operational, and that over the next two weeks it stands to make
$100,000 extra because of a special contract it has with the
Australian Netball Federation to take players to the World Netball
Championships in Germany. Advise Qantas on its legal position.
Pecuniary loss
Under the common laws, compensation can be paid only for actual financial (or
pecuniary) loss. It is not available for injury to a plaintiff’s feelings due to
inconvenience, discomfort or mental stress However, ‘sentimental’ damages can
be recovered where the object of the contract was to provide pleasure and/or
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relaxation (i.e., in holiday travel / accommodation type contract), as in Jarvis v
Swan Tours [1973] 1QB 233, where the court held that the plaintiff was entitled to
damages for disappointment when a Swiss skiing holiday didn’t match the
description in the defendant’s advertising brochure.
Mitigation of loss
The innocent party has a duty to mitigate their loss – i.e., do everything
reasonable to keep their loss to a minimum. For example, assume that a tenant
breaches a 12 month lease agreement after two months by leaving the property
and ceasing to pay rent. The lessor is entitled to sue the tenant for the loss
flowing from the breach, i.e. lost rental payments, but is also obliged to take
reasonable steps to mitigate their loss by trying to find another tenant. If the
lessor finds another tenant after say, three months, then the damage recoverable
against the first tenant will be the lost rental over the three month period, plus
incidental expenses. If the lessor fails to take any steps to find another tenant and
the first tenant can show that there was a reasonable supply of suitable tenants
available, then the lessor will not be able to claim as damages against the first
tenant the whole ten months lost rental – a court would award only what it
calculated the lessor would have lost had he taken reasonable steps in mitigation.
The defendant must establish that the plaintiff has not mitigated his/her loss (not
vice versa).
Liquidated damages clauses and penalty clauses
Damages are classified as either liquidated or unliquidated. Liquidated damages
are those that are determined (and included as a clause) when the contract is made.
For example, in their contract, Sam and Jessica agree that, if her house is not
completed by a specified date, Sam will pay damages of $250 per week to Jessica
until it is finished so that she can rent a house while she is waiting. Unliquidated
damages are those that have to be proved by a party in the usual if they sue for
breach of contract.
A penalty provision is a sum specified in a contract to deter the other party from
possible breach – for example, a clause in a contract which says ‘If you fail to
maintain our IT system, we can recover $2,000 per day in lost profits, plus ,1,000
per day in penalties’. Penalties are not enforceable at law. The law does not allow
one party to punish another – parties are entitled to recover only their actual loss
or (in the case of liquidated damages clauses) a reasonable estimate thereof. If a
court concludes that a sum in a contract is not a genuine estimate of potential loss,
it cannot be relied upon – and the plaintiff will have to prove actual damage.
Parties often erroneously refer to liquidated damages clauses as penalty clauses,
but this should be avoided for obvious reasons.
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E. Termination
If a condition of a contract is breached, the plaintiff may elect to terminate the
contract. Performance of the contract ceases at that time. Although the parties do
not have to return any property that they may have given each other during the life
of the contract, anything they have each lost and gained financially up until
termination will be taken into account in determining what damages will be
payable to the aggrieved party.
For example: Assume Adam contracts to build a warehouse for Bob for
$100,000, anticipating a profit of $25,000 (i.e. that it would cost $75,000
to build the warehouse). Assume also that Adam and has already spent
$30,000 on the project and has received a deposit of $10,000 from Bob. If
Bob breaches the contract by saying that they no longer want the
warehouse, how much will the court award Adam?
F. Equitable remedies
The remedies of damages and termination came from the common law. The
remedies of specific performance and injunction come from the law of equity.
This distinction in origins is now of historical interest only, as the same courts
apply common law and equity rules. Equitable remedies are discretionary (i.e., at
a court’s discretion) and will not be awarded where damages are considered to be
an adequate remedy. This means that, given a choice between ordering a party to
perform under a contract or to pay damages to the aggrieved party, the courts will
do the latter. An exception to this rule is provided by contracts of sale for land or
anything that is unique and cannot readily be obtained elsewhere. In such cases,
the courts will order a defaulting seller to perform.
Specific performance is a court order requiring a party to complete his or her
contractual obligation. Specific performance is not granted in contracts of
employment, because the very fact that litigation has occurred indicates that the
employer-employee relationship has been damaged and that it would be futile to
require the employee to work for the employer.
An injunction is a court order that restrains someone from doing a wrongful act.
In the case of contract law an example would be where A and B enter a contract
that A will sell his car to B, and two days before delivery, B finds out that A is
about to give the car to C. B can get an injunction prohibiting A from doing this.
G. Prescription
We have already seen in the discussion of the law of torts that there are statutory
time limits on the right to sue. In New South Wales the right to sue on a contract
is lost if legal proceedings are not commenced within six years from the cause of
action arising in the case of simple contracts (s 14(1)) of the Limitation Act 1969
(NSW), and 12 years from the cause of action in the case of deeds (s 16).
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Topic 9 Consumer law
Learning Objectives
After completing this topic you should be able to:
1. explain why consumer protection requires that the common
law of contract be modified by statute law;
2. explain how to identify who is a consumer under the
Australian Consumer Law;
3. describe the operation of the implied guarantees contained
in the Australian Consumer Law;
4. describe the protection given by the Competition and
Consumer Act 2010 (Cth) to consumers against misleading
and deceptive conduct;
5. explain how the Competition and Consumer Act 2010 (Cth)
protects consumers against duress, unconscionable conduct
and unfair terms.
A. Statute law, common law and consumer protection
In previous topics you have studied have contract law and have begun to apply it
to factual situations. A defect in the common law of contract is that it offers little
protection to contracting parties who find that the goods or services they have
purchased do not match their expectations. True the common law does provide
remedies in cases of misrepresentation, but in the absence of misrepresentation, a
person who finds that what they have bought is defective has no remedy – the
general rule is caveat emptor (let the buyer beware). In addition, many of the
common law rules governing certain types of contract, such as sale and lease,
were found to be unsuitable to modern commerce. For these reasons the law of
contract has been considerably modified by statute, and in this topic we are going
to examine some of these modifications.
B. The Australian Consumer Law (ACL)
A major reform of consumer law took place with the enactment of the
Competition and Consumer Act 2010 (Cth), which replaced the Trade Practices
Act 1974 (Cth). The Australian Consumer Law (ACL) is a Schedule to the 2010
Act. Although the Commonwealth Parliament cannot legislate generally on
business law, it can legislate on corporations, and so the Act applies to any
contract which a consumer enters into with a corporation. In addition, and in
order to make the ACL applicable to contracts entered into by consumers other
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than with corporations (for example, with a sole trader), all the States undertook
to enact the ACL into law in their jurisdictions. The result is that there is now a
uniform law national governing consumer contracts. Any contracts which do not
fall under the definition of consumer contracts continue to be governed by the
various State Sale of Goods Acts.
Who is a consumer?
Key to the operation of the ACL is the definition of a ‘consumer’ contained in
s 3(1), which states that a consumer is a person who acquires goods or services
either if
 the price of the goods is less than $40,000 or
 the price exceeds $40,000 but the goods are those commonly acquired for
personal, domestic or household use or consumption.
Section 3(2) excludes from the category of goods acquired as a consumer those
goods which are acquired for purposes of re-supply or for the purpose of being
used up or transformed in trade or commerce in the course of a process of
production or manufacture, or of the treatment or repair of other goods or fixtures
to land.
The ACL implies a number of guarantees into all consumer contracts. These
guarantees cannot be excluded by agreement – s 64 provides that such an
exclusion clause will be invalid. The purpose of this non-exclusion provision is to
protect consumers who are usually in a weaker bargaining power than suppliers.
The guarantees implied by the ACL are as follows:
s 51 that the supplier has clear title in the goods, and can thus transfer
ownership to the consumer.
s 52 that the consumer obtains the right to undisturbed possession – that is,
will not be legally challenged in their right to possess the property
s 53 that there are no undisclosed securities over the property – that is, that
there is no 3rd party who has rights over the property because it had been
used a security for a loan, for example
s 54 that goods are of acceptable quality – we will examine this in more detail
below
s 55 that goods are fit for any specific purpose that the consumer made known
to the supplier
s 56 that goods will correspond to any description of them by the supplier
s 57 that goods supplied with reference to a sample shown to the consumer
will correspond to the sample
In the case of contracts for the supply of services, the ACL implies the following
guarantees:
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s 60 that services will be performed with due care and skill (which will be
tested according to a standard of reasonableness)
s 61 that services are suitable for any purpose which the consumer made
known to the supplier
s 62 that services will be rendered within a reasonable time.
Acceptable quality – s 54
Perhaps the most common consumer complaint is that goods were not of
acceptable quality. It is very important to realise at this juncture that a
consumer’s rights are not limited by the terms and duration of any warranty they
may have received when they purchased goods – such warranties cannot limit the
operation of any provision of the ACL – so just because a warranty has expired
does not prevent a consumer from pursuing remedies under the ACL.
The key provision of the ACL is s 54, which imports into consumer contracts a
guarantee that goods are of acceptable quality. ‘Acceptable quality’ is defined as
follows:
(2) Goods are of acceptable quality if they are as:
a. fit for all the purposes for which goods of that kind are commonly
supplied;
b. acceptable in appearance and finish;
c. free from defects;
d. safe; and
e. durable.
as a reasonable consumer fully acquainted with the state and condition
of the goods (including any hidden defects of the goods), would
regard as acceptable having regard to the matters in subsection (3).
The factors listed in subsection (3) are the nature of the goods, their price (if
relevant), any statement made on the packaging of the goods and any
representation by the manufacturer or the supplier, and any other relevant
circumstance. The guarantee does not apply if the reason the goods were not of
acceptable quality was drawn to the consumer’s attention (ss (4)), if the
consumer’s own conduct causes them to become of unacceptable quality (ss (6))
or the goods were examined by the consumer and the examination ought
reasonably to have revealed that the goods were not of acceptable quality (ss (7)).
Remedies for breach of statutory guarantees are found in sections 259-264 of the
ACL. Key to the operation of these provisions is the concept of ‘major failure’ of
goods, defined in s 260 as meaning, inter alia, failure which would have caused
the consumer not to acquire the goods if aware of the failure (s 260(a)), or failure
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which renders the goods ‘substantially unfit’ for the purpose for which such goods
are commonly supplied, and which cannot be remedied within a reasonable time
(s 260(c)).
If a failure to comply with a guarantee – such as the guarantee of acceptable
quality in s 54 – constitutes a major failure, the consumer may, subject to s 262
(discussed below), reject the goods (s 259(3)(a)) or recover compensation for the
reduction in value of the goods resulting from the failure to comply with the
guarantee (s 259(3)(b)). In addition, the consumer may recover any
consequential damages caused by the failure to comply with the guarantee (s
259(4)).
In cases where the failure was not a major failure, s 259(2) states that the
consumer must give the supplier an opportunity to remedy the failure within a
reasonable time, but that if the supplier fails to comply, the consumer may either
have the defect remedied and recover the costs from the supplier, or may reject the
goods. Section 261 provides that where a supplier is required under s 259(2) to
remedy a failure to comply with the guarantee, the supplier may do so by
repairing the goods, replacing the goods with identical goods, or refunding the
consumer what they paid for the goods.
Under s 262(1), the consumer’s right to reject the goods is lost if the rejection
period for the goods has ended, the goods have been lost, destroyed or disposed of
by the consumer, if the goods were damaged after delivery to the consumer for
reasons unrelated to their condition at the time of supply or if the goods have been
attached to other property and cannot be detached without damage to the goods.
The key provision which will limit consumers’ rights to return goods and obtain a
refund is that relating to expiry of the rejection period, contained in s 262(1)(a).
The ‘rejection period’ is defined in s 262(2) as follows:
The rejection period for goods is the period from the time of the supply of
the goods to the consumer within which it would be reasonable to expect the
relevant failure to comply with a guarantee referred to in section 259(1)(b)
to become apparent, having regard to:
a. the type of goods; and
b. the use to which a consumer is likely to put them; and
c. the length of time for which it is reasonable for them to be used; and
d. the amount of use for which it is reasonable for them to be put before
such failure becomes apparent.
The operation of s 262 is problematic, as it will be difficult for a court to
determine how long any given item – a fridge, a TV, a pair of shoes – should
reasonably be expected to last.
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Exercise
Tom buys a DVD player from the local branch of Darley Gorman
Appliances Ltd. It is a top range model, costing $250. The DVD
player comes with a 12 month warranty. The order form that Tom
signed at the time of purchase contained the following clause:
Darley Gorman Ltd makes no representation as to the quality
of the goods purchased. The liabilities of Darley Gorman Ltd
are confined to the terms of our 12 month warranty, which
requires that we may choose to repair or replace goods at our
discretion, where the purchaser can prove that goods were
defective at the time of sale. The purchaser acknowledges
that this contract contains the entirety of the terms of the
contract with Darley Gorman Ltd, and that all other remedies,
statutory or common law, are excluded.
13 months after purchase, the DVD player stops working. He takes
it back to Darley Gorman Ltd. They say that because the warranty
period has expired they have no obligations towards Tom. Advise
Tom as to the likelihood of success if he was to take this matter to
court.
C. Misleading and deceptive conduct
One of the most frequently used provisions under the Trade Practices Act 1974
was s 52 which prohibited a corporation when engaging in trade or commerce
from engaging in ‘conduct that is misleading or deceptive or is likely to mislead
or deceive’. This section has now been replaced by s 18 of the ACL, contained in
the Competition and Consumer Act 2010 (Cth). One would expect the courts to
draw upon case-law generated under the old s 52 as they interpret the new s 18.
The section has deliberately been framed in broad terms and encompasses a wide
range of business activities. It is not confined to cases involving consumer
contracts and would, for example, apply to actions performed by one corporation
vis-a-vis to another.
Section 18 says that ‘a person must not, in trade or commerce, engage in
misleading or deceptive conduct, or conduct that is likely to mislead or deceive’.
Section 18 applies only to a person engaging in trade or commerce – that is, in the
course of a business. So a person selling their car would not be subject to s 18 in
relation to any statements they made (although they would be subject to the
common law of misrepresentation).
Note that an intention to mislead or deceive is not required for liability. It is not
the intention or negligence of the person engaging in the conduct that has to be
proved – it is the effect of that conduct on the plaintiff. Once a plaintiff proves
that they were misled, the question becomes whether the defendant’s conduct was,
objectively, misleading or deceptive. The objective nature of the test means that
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the court determines what an average consumer in the position of the plaintiff
would have believed, and if such a person would have been misled, then s 18 has
been breached – see Taco Company of Australia Inc v Taco Bell Pty Ltd [1982]
ATPR 40-303.
The Act provides a wide range of remedies for breach of s 18, including:
s 232 injunction ordering a party not to engage in conduct in breach
of the ACL
s 236 damages to compensate parties who suffered financial loss as a
result of being misled
ss 237-238 ancillary orders (such as rescission of the contract, variation of
the contract, a declaration that all or part of the contract is
void, or an order that money be refunded or property be
returned).
Exercise
Mary reads an advert in the local newspaper which reads as
follows:
Special offer: Get a full set of tyres from Exhaust `n Tyre
this week and we will throw in a free one-year membership
of the NRMA. You can have confidence in our tyres and in
the road services offered to motorists by the NRMA.
Mary goes to her local Exhaust ‘n Tyre branch. She buys four tyres
at $150 each, and receives an NRMA membership. She is very
pleased about this until she speaks to her friend Tom, who tells her
that he bought the same set of tyres from Exhaust `n Tyre the
previous week for $100 per tyre, and that he is an NRMA member,
the annual fees for which are $80. When Mary contacts Exhaust ‘n
Tyre about this, they say that the advertising campaign put into the
newspaper in error by a misguided marketing manager, and that the
company had not intended it to run. Advise Mary as to what
remedies she might have.
D. Unconscionable conduct
We have already seen how the common law allows a contract to be rescinded
where the consent of a party was obtained by unconscionable means – see
Commercial Bank of Australia v Amadio (1983) 151 CLR 447. The Competition
and Consumer Act 2010 (Cth) contains a statutory version of unconscionability,
which can be remedied by a wider range of orders than were available under the
common law. The key provisions are as follows:
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s 20 provides that a person may not, in trade and commerce, engage in
conduct which is unconscionable under the unwritten (i.e. common) law
s 21 specifically prohibits unconscionability in consumer contracts (for goods
ordinarily acquired for personal or domestic use), with factors listed in s
21(2) to guide the courts in determining whether unconscionability exists
(such as the relative bargaining strength of the parties; whether the terms
of the contract were not reasonably necessary to protect the supplier; the
consumer’s ability to understand documentation and the use of pressure
tactics by the supplier)
s 22 provides specific protection from unconscionability to small business, in
that unconscionability is prohibited in the supply of goods and services
under commercial contracts to unlisted companies.
Thus one would expect that consumers will use s 21, small businesses s 22 and all
other contracting parties s 20 when alleging unconscionability.
The remedies available for unconscionable conduct are the same as for misleading
and deceptive conduct.
E. Unfair contract terms
A similar area to unconscionability is unfair contract terms. Section 23(1) of the
ACL provides that a term of a consumer contract (that is, a contract goods,
services or land acquired predominantly for person al or domestic purposes) will
be void if
 it is unfair and
 the consumer contract is a standard form contract
Section 25 lists the criteria that will determine if a term is unfair – essentially if
the term leads to an imbalance of contractual rights and obligations; it is not
reasonably necessary to protect the legitimate interests of the party who would be
advantaged by the term and it would cause the consumer detriment.
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Topic 10 Property law
Learning Objectives
After studying this topic you should be able to:
1. outline the legal definition of property;
2. explain the distinction between real and personal property;
3. explain how that ownership consists of a bundle of rights in
relation to property;
4. explain the distinction between ownership and possession;
5. explain the statutory regimes protecting copyright.
A. The nature of property
Property is anything that a person can have rights of ownership over.
Property can be classified as:
Real property immovable property, such as land and buildings
Personal property everything other than real property, including
tangible movable property, called ‘chattels’ (such as
a car or a TV set) and also intangible property, such
as shares and rights of action
Property can also be classified as:
Tangible property things that can be touched, such as houses or cars)
Intangible property incorporeal property, such as shares or rights of
action and intellectual property
B. Ownership and possession
If you are the owner of property, a list of things you can do with it might look like
this: I can
 possess it
 use it
 sell it
 give it away
 lend it to someone
 use it as security for a loan
 destroy it
 stop others from using it or taking it.
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You will have fairly described most of the rights of ownership attached to
personal property. Property law protects each of these rights, although you may
find that the law will give these rights a special name. So ownership is best
considered to be a bundle of rights.
The right to use or keep property is referred to as the right to possession. Note that
possession is a lesser right than ownership – if I lend my car to someone for a
month, I have temporarily transferred one of the rights that is an incident of
ownership to them, because they have possession – but I am still the owner. The
fact that ownership is a bundle of rights in respect of a particular item means that
(as in the example of lending someone your car) it is possible to split or divide
these rights amongst two or more persons. This can be done in at least 3 ways.
C. Intellectual property
There are two types of personal property or ‘choses’ (chose is the French word for
‘thing’) – tangible personal property or ‘choses in possession’, called chattels (like
cars, books, cats) and intangible personal property or ‘choses in action’. Even
though they have no physical existence, choses in action are rights that are legally
protected, and it is in this area that intellectual property belongs. The law that
regulates this area is mostly statute law but there are some areas where common
law remedies apply. The most important types of intellectual property: patents,
designs, copyright, trade marks, and circuit layouts. This Study Guide focuses on
copyright.
The purpose of granting intellectual property rights are threefold:
 to stimulate the creation of new technology and inventions by research and
development;
 to reward creators of inventions with assurances of gain from the potential
benefit from their endeavours by granting a monopoly for a limited period
so that it may be commercially exploited but not be a bar to the
dissemination of information; and
 to protect customers and traders by preventing confusion between genuine
products and cheap imitations.
D. Copyright
In Australia copyright is regulated by the Copyright Act 1968 (Cth). Copyright
grants protection to two categories of the intellectual property – original literary,
dramatic, musical and artistic works, and subject matter other than works,
including sound recordings, films, television, sound broadcasts and published
editions of works. Protection is also given to the way in which a particular edition
of the work is set out, as distinct from the copyright material that it contains.
In general, while copyright is granted only to original works, the degree of
originality required is not high. Thus, maps, lectures, bingo cards, and a model
contract for the sale of land have been held to be capable of copyright protection.
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Unlike in the case of patents, designs and trade marks, copyright is not required to
be registered for protection. Once a work is created, it is automatically protected
by copyright, although authors often put the copyright symbol: © on their work to
remind others that the work is protected. Copyright only applies to something that
has been given a physical form. Copyright does not protect ideas. Therefore, if
someone gives an author an idea for a book or a song writer an idea for a song, the
person who gave the idea has no copyright in the book or the song when it is
completed. This is shown by Donoghue v Allied Newspapers Ltd [1938] Ch 106,
where a jockey told his life story to a newspaper, and the newspaper printed an
article based on that story. The newspaper owned the copyright in the article, as
one of its journalists was the author – only the idea came from the jockey, and he
could not own copyright in that.
Ownership of copyright
The author of the work is the usual owner of the copyright. However, if a work is
produced by an employee pursuant to a contract of employment, the copyright
belongs to the employer (s 35(5)).
The copyright holder may license the copyright to others. A licence of copyright
permits the licensee to do what would otherwise be an infringement of the
copyright owner’s rights. An exclusive licensee may protect his or her exclusive
rights in the same way as an owner, and institute infringement proceedings against
any person who, without permission, infringes his or her exclusive rights. Thus
an author of a novel may sell the copyright to a publisher in exchange for a
royalty (calculated as a flat fee or as a % of what the publisher sells books for).
Thereafter it is the publisher, not the author, who owns the copyright and who
would therefore take legal action if the book was illegally copied.
Duration of copyright
The duration of copyright protection is seventy years after publication or first
performance or, if the work is not published in the author’s lifetime, seventy years
after the death of the author. Copyright protection in the case of sound
recordings, films, television and sound broadcasts is seventy years after the expiry
of the calendar year in which they were published.
Infringement and remedies
The Act provides statutory remedies for infringement (s 115). An injunction may
be brought to restrain continued infringement. In addition, an action may be
brought for an account of the infringer’s profits. In the case of flagrant
infringements, such additional damages may be awarded by a court, as it
considers appropriate in the circumstances. A copyright owner may also bring an
action for conversion or detention to recover any infringing copies of the
copyright material or devices used for making them, which are usually then
destroyed.
In addition to the statutory remedies, a copyright owner may also be able to obtain
an Anton Piller Order, which is an order given under the law of civil procedure,
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named after the case of Anton Piller KG v Manufacturing Processes Limited
[1976] Ch 55. This order permits the copyright owner or his or her representative
to enter the infringer’s premises to search for and take into custody offending
copies of works as well as other documentary evidence relating to them to prevent
destruction or disposal of the offending materials before copyright action can be
taken.
Penal sanctions
In addition, to the civil remedies, the Copyright Act also provides for a number of
penal sanctions, punishable normally by a fine and in some cases by
imprisonment (s 132). Examples of illegal infringing activity that attracts
criminal sanctions include making articles for sale or hire or creating a literary,
dramatic or musical work or a sound recording to be performed or heard in public.
International copyright protection
International copyright protection is covered by the Berne Convention for the
Protection of Literary and Artistic Works 1866. In order to be covered by the
Berne Convention, material must be published or made available in a member
country. A similar agreement that also provides copyright protection is the
Universal Copyright Convention of 1952, administered by the United Nations
Educational, Scientific, and Cultural Organisation. Citizens of member countries
of the UCC holding copyrights are entitled to the same protection against
copyright infringement as nationals. Several other international conventions and
agreements have also an impact on copyright protection. For example, the
International Covenant on Economic, Social and Cultural Rights 1966, and the
Universal Declaration on Human Rights. The latter convention protects the moral
and material interests in any copyright. Finally, the General Agreement on Tariffs
and Trade (GATT) Treaty requires signatories not to apply intellectual property in
a discriminatory manner.
Exercise
Bartholomew is a musician. He has written a song which he is
trying to get a recording contract for. To develop some publicity for
his song, he often plays it on the street corner. Matthew has often
stopped to listen. Bartholomew discovers that Matthew has released
a CD containing a song which uses exactly the same words as the
first two verses from Bartholomew’s own song. He also finds that
a local CD shop is selling Matthew’s CD. Bartholomew used to
work for a hotel as a pianist in its restaurant. Part of his job
involved composing and playing music for the restaurant. He no
longer works for the hotel and is angry when one day, as he walks
past the hotel, he hears a recording of his music being played over
speakers in the hotel lobby. Advise Bartholomew as to his legal
position in relation to Matthew and the hotel owners, citing relevant
sections from legislation.
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Topic 11 Introduction to business organisations
Learning Objectives
After completing this topic, you should be able to:
1. Distinguish between incorporated and unincorporated
organisations;
2. Distinguish between the different types of business
organisations;
3. Determine which factors should be taken into account when
choosing an appropriate business structure.
A. Introduction
There are a variety of factors that must be taken into account when advising
someone on what business structure to adopt. A critical factor in determining
which to adopt is the extent to which the person who has established the business
will be liable for its debts. This Topic gives a brief overview of four principal
business structures, focusing on the rules of liability for each. Subsequent
sections of this Study Guide give an overview of partnerships and trusts, but most
of the subject is devoted to corporations, which are by far the most important
vehicle for business, generating in excess of 97% of business turnover in
Australia.
B. Business structures
(i) Sole proprietorship
Sole proprietorship carries numerous disadvantages. First and most importantly,
is the risk of personal unlimited liability – as the business is not a separate entity,
the personal assets of the owner of the business can be attached by creditors
enforcing a judgment debt.
The scale of business is restricted by the individual’s personal capital resources.
The scope of the business is restricted to proprietor’s areas of knowledge and skill
(i.e., ownership and management vest in same person)
3rd parties entering into contracts with the business have no way of determining
through any public records what assets the individual has and thus how creditworthy
he or she is.
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(ii) Partnership
The risks associated with partnership are even worse than sole proprietorship:
Not only is the partner personally liable for their own business debts, because the
partnership is not a legal entity, they have personal unlimited liability for the debts
incurred by other partners in the course of the partnership business. Great caution
is thus needed in choosing partners!
The scale of the business restricted by personal expertise of partners, however the
capital of several individuals can be pooled
A 3rd party dealing with a partnership bears the risk of no public knowledge of
the assets of partners, however some security provided by their joint liability.
(iii) Company
A person wanting to create a business can incorporate a company and become its
shareholder.
The crucial point here is that the shareholder’s liability limited to paying up shares
– the company is separate legal entity and it, not the shareholder(s) are liable for
its debts.
A company provides a mechanism for raising large amounts of capital.
As there will usually be a large number of members, ownership is generally
separated from control – directors control the company – usually (but not
necessarily) elected by shareholders in proportion to shareholding. Shareholders
are usually not given any day to day decision- making power. Experts can be
elected as directors and/or employed as managers. Investment security for
shareholders is provided by internal rules and accounting requirements.
So far as 3rd parties are concerned, the assets of individual company members are
unavailable to satisfy the company’s debts – only the company’s assets can be
looked to for that purpose, but there are public records available which give an
insight into the company’s financial position, particularly if it is listed on the
ASX.
(iv) Trust
A trust not a separate legal entity. Rather it is a relationship where a person who
owns property (the settler) transfers that property to a trustee to be managed on
behalf of others (the beneficiaries). The settler and the trustee may be the same
person, as where a parent creates a trust in relation to property for the benefit of
their children and also administers the trust. A beneficiary can also be the trustee
(except in cases where he or she is the sole beneficiary). Although ownership of
the property vests in the trustee (or trustees), the benefits derived from the
property (such as income) belong to the beneficiaries who are said to have the
‘equitable interest’ in the property, and the trustee must always act in the best
interests of the beneficiaries, to whom he or she owes a fiduciary duty.
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The scale of business for which a trust can be used is limited by the assets of the
trust, and the areas in which it will involve itself is determined by the knowledge
and skill of the trustees.
The trustee can be sued by the beneficiaries if he or she does not fulfil her
fiduciary duties.
3
rd parties dealing with a trustee have no knowledge of the trustee’s or the trust’s
assets. However, trusts that are managed investment schemes which raise funds
from the public (eg unit trust funds) are regulated under Ch 5C of the
Corporations Act 2001 (Cth).
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Topic 12 The law of agency
Learning Objectives
After completing this topic, you should be able to:
1. Understand the nature of the agency relationship;
2. Distinguish between the different types of authority an
agent may have;
3. Appreciate the fiduciary nature of the agent’s relationship
with the principal;
4. Understand what happens when an agent represents a
principal without disclosing the existence of the principal to
the 3rd party;
5. Apply the law of agency and determine the liabilities of
principal, agent and third party in different circumstances.
A. Introduction
Agency is a special type of contract.
It is particularly important because:
(i) In a partnership, each partner is an agent of all the others.
(ii) Only someone who is an agent of a company can bind it.
We therefore need to examine the law of agency before looking at business
structures in detail.
B. Definition
Agency is simply an agreement by one person (the principal) in terms of which he
or she confers authority on another (the agent) to make contracts with third parties
on his or her (i.e. the principal’s) behalf.
Agency can be gratuitous (i.e. no consideration given by principal to agent) and
can arise by operation of law (i.e. without an agreement between agent and
principal).
Thus three parties are involved in agency:
the Principal (P)
the Agent (A)
the Third party (T)
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Note that (subject to a few exceptions) no obligations arise between agent and
third party – the contractual link created by the agent is between principal and
third party.
C. Types of authority
Whether the principal is bound depends on whether he or she conferred authority
on the agent.
The following are the types of authority recognised by the common law:
Actual authority express
implied (sometimes called ‘customary’ authority)
Ostensible authority
Authority of necessity
Video
D. Actual authority
Express: stated by the principal (orally or in writing)
Implied: such authority as is necessary to execute express authority or, where no
express authority is given and someone is appointed to a position, such authority
as normally falls within the scope of activities of that position. Thus titles given
to employees matter, because by giving them a title or a role, you are
automatically vesting them with the authority necessary to discharge that role.
Note the important point that a private agreement between principal and agent
limiting the latter’s authority to something less than what usually attaches to the
position will not disable 3rd party from relying on the normal scope of that
Authority
Principal Agent
Contract Conduct
Third Party
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authority: In Watteau v Fenwick [1893] 1 QB 346, the owner of a pub appointed
a manager to run it for him, thereby giving him all the authority that usually went
with the title of ‘pub manager’. The fact that the owner had expressly told the
manager not to buy cigars did not prevent the principal being bound by a contract
for the purchase of cigars by the manager, because the purchase of cigars was
something that fell within the usual range of authority of a pub manager in 19th
century England. Only if the 3rd party has been made aware of the limitation on
the agent’s authority will it be effective against him.
E. Ostensible / apparent authority
In this case, the principal does not intend to give authority, but because he
represents that the agent has authority, the principal is bound by that
representation – i.e. is estopped from denying the agent’s authority.
The representation must be by the principal – the agent’s own representation that
he has authority is not, in itself, sufficient to create apparent authority.
However, it should be noted that the ‘representation’ by the principal can take the
form of inaction, as where the principal knows that the agent is acting as if he had
authority, and the principal either does not intervene to correct the impression that
arises in the mind of 3rd parties, or actually condones what the agent is doing:
Freeman & Lockyer v Buckhurst Park Properties [1964] 1 All ER 630 – the
board of a company knowingly allowed one of its directors (Kapoor) to act
as M.D on several occasions, even though he had not been appointed to that
role. The Co was held bound by contract Kapoor had entered into with
architects – because in light of what the board had knowingly allowed
Kapoor to do, it was reasonable for the 3rd party to believe that he had been
given the actual authority of an MD. Thus the key test is whether, because
of something the principal has done or has knowingly allowed the agent to
do, it was reasonable for the 3rd party to believe that the principal gave the
agent authority.
Of course if 3rd party knew, or ought reasonably to have suspected, that the agent
had no authority, the principal is not bound – this is a vital issue of evidence.
Apparent authority can carry on in existence even after an agent is dismissed by
the principal but 3rd parties with whom the agent used to deal do not know of that
fact.
F. Authority of necessity
This arises where a person is in control of with the property of another person, an
immediate expense is required to preserve the property, the owner of the property
is virtually impossible to contact, the person entrusted with the property (agent)
must act in the best interests of the principal and go no further than is necessary to
preserve the property.
An example of agency of necessity is Great Northern Railway Co. v Swaffield
(1874) LR 9 Ex 132, in which the owner of a horse was not on hand to collect it
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when it arrived by train at a country station. As it was raining, the station-master,
who could not contact the owner, entered into a contract with a stable-owner to
accommodate and feed the horse. The owner of the horse was held liable on the
contract with the owner of the stables, on the basis that the station-master had
been vested with agency of necessity.
G. Ratification
A principal may agree to be bound even in the absence of authority (express,
implied or ostensible) if he or she decides to ratify (adopt) the unauthorised
contract entered into by the agent. Of course the principal will ratify only if he or
she wants to be bound by the contract.
Special rules apply in respect of ratification, among them are:
(a) ratification effective retrospectively to when the agent acted.
(b) the principal must have existed (ie, if a company, must have been
registered), and the 3rd party must have known that the agent was purporting
to act on behalf of a principal at the time
(c) to bind the 3rd party the principal must manifest ratification and within a
reasonable time.
H. Where the agent acts without authority
If there is no express, implied or ostensible authority then in the absence of
ratification by the principal or the principal being bound by the doctrine of
necessity, no contract is formed between the principal and the 3rd party, however
the agent is liable to 3rd party either
in tort, for deceit or negligent misstatement or
in contract, for breach of common law implied warranty of authority which
the agent is held to have given to the third party – ie, anyone who says they
have authority when they do not becomes liable to compensate the 3rd party
for any financial loss the 3rd party suffers (eg, loss of profit) because they
(the 3rd party) discovers that they have no contract with the principal the
‘agent’ purported to represent (Yonge v Toynbee [1910] 1 KB 215).
I. Duties of the parties
(1) The agent’s duties to principal:
to adhere to the principal’s instructions
to act within the principal’s authority – note that the agent will be liable to
the principal if the agent breaches the principal’s authority (as, for example
in a situation such as that in Watteau v Fenwick, where the principal found
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himself liable to the third party under a contract where the agent had
exceeded restrictions on his authority)
to use due skill and care, measured according to the standards of the
business involved
to act in good faith (fiduciary duty).
Fiduciary duty involves:
(a) avoidance of conflict of interest – the agent must inform principal
where such a conflict arises – Christie v Harcourt [1973] 2 NZLR 139
the principal successfully sued the agent for damages and for the
commission on the sale of the principal’s home because the agent sold
the house at less than market value to his daughter and her fiancé.
(b) the agent may not make secret profit at principal’s expense – Bentley v
Craven (1853) 52 ER 29 – agent retained by a sugar refinery to obtain
sugar for it (obviously at the lowest market price) bought up sugar for
himself and then sold it to the refinery at an inflated price – the
principal recovered the agent’s profit.
(c) must not use confidential information gained as an agent –Robb v
Green [1895] 2 QB 315 – the court restrained employee from using
client lists taken from former employer when he (the employee) left to
set up his own Co. Note however that agent cannot be prohibited
from using general skill and experience, even if obtained working for
principal.
Agents may not sub-delegate without express or implied authority to do so.
Where an agent breaches any of their duties to the principal, the principal may
recover damages from the agent – eg where, contrary to the principal’s
instructions, the agent has disregarded limitations on their authority but the 3rd
party was not aware of such limitations, as in Watteau v Fenwick, and as a
consequence the principal has found himself bound by a contract he did not want.
(2) The principal’s duties to the agent:
to pay the agent remuneration for the agent’s services
to reimburse the agent for reasonable expenses.
J. Undisclosed principals
A contract is formed between 3rd party and principal even if agent does not
disclose that he or she is acting on behalf of a principal (‘undisclosed principal’).
The 3rd party is still liable to perform to the principal but
may set off against the principal any debt owed by the agent to the 3rd
party, and
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is absolved from liability to the principal if, ignorant of the agency
relationship between agent and principal, the 3rd party has settled with (ie
has already given performance to) the agent.
Finally, and very importantly, in cases of undisclosed principals, the 3rd party
may always elect from whom to demand performance (ie may obtain performance
from either the agent or the principal) – this is called the ‘doctrine of election’ –
Siu Yin Kwan v Eastern Insurance Co Ltd [1994] 2 AC 199. This is often
important where the 3rd party entered into a contract with the agent (believing the
agent to be acting on his own behalf) because the agent possessed a particular
skill. In that circumstance, when it is revealed that the agent was acting on behalf
of a principal, the 3rd party will usually demand performance from the agent rather
than from the principal with whom he discovers he has a contract.
K. Termination
Termination of the relationship is governed by the express and implied terms of
the contract between agent and principal.
Note however that even where the agency relationship has been terminated, the
principal may still be liable under the rules of ostensible authority if, from 3rd
parties’ perspective, the agent still seems to have authority.
Exercise
Pam, a sole trader and the owner of ‘Pam’s flower wholesalers’,
employs Judy as a ‘flower purchaser’. Tom is a flower producer
and often sells flowers to ‘Pam’s flower wholesalers’. Consider the
following scenarios and determine the legal implications that arise
out of them:
Scenario 1
The agency agreement between Pam and Judy places no limit on
the amount for which Judy can purchase flowers.
a. Judy tells Tom that she is contracting on behalf of Pam and
purchases flowers from Tom.
b. Judy tells Tom that she is contracting on behalf of Pam and
purchases a painting from Tom.
c. Judy purchases flowers from Tom. (Judy does not disclose
that she is in fact acting on behalf of Pam. Thus Tom thinks
he is contracting with Judy.)
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Scenario 2
Assume that Pam and Judy had explicitly agreed that Judy would
not have the authority to buy flowers in excess of $ 10 000 per
transaction. Pam does not inform Tom of the limitation on Judy’s
authority. Judy tells Tom that she is contracting on behalf of Pam
and, in a single transaction, purchases flowers from Tom for $ 12
000.
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Topic 13 Partnership
Learning Objectives
After completing this topic, you should be able to:
1. Define partnership;
2. Name the sources of partnership law;
3. Understand how a partnership is formed and terminated;
4. Understand the relationship between partners and third
parties and apply this knowledge to practical legal
situations;
5. Understand the relationship between partners inter se and
apply this knowledge to practical legal situations.
A. Definition
Each State and Territory has its own Partnership Act. They are by and large the
same, but there are variations. For convenience we will use the Partnership Act
1892 (NSW).
Web Content
The following link will take you to the Partnership Act 1892
(NSW). However, for the purposes of this subject, you need be
familiar only with the sections mentioned in the Study Guide.
The essential elements of a partnership are stated in s 1 of the Act
a relationship between persons
carrying on a business in common
with a view to a profit
Section 1(2) specifically excludes bodies corporate from the definition of
‘partnership’.
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Section 115 of the Corporations Act 2001 (Cth) limits the maximum number of
members of a partnership to 20 except in the case of some professional
partnerships which Commonwealth regulations permit to have higher numbers
 1000 for accountants
 400 for legal practitioners
 100 for architects, pharmaceutical chemists, veterinary surgeons
 50 for actuaries, medical practitioners, patent attorneys, trade mark
attorneys and stockbrokers.
If there are over 20 partners then the firm must incorporate (i.e. form a company)
– this is discussed below
Note that because it lacks legal personality, a partnership could not be a member
of a Co. A Co. could however be one of the legal persons belonging to a
partnership.
The existence of a partnership usually proved by the existence of a partnership
agreement. Such an agreement can be either written or oral.
In the absence of such an agreement, whether a partnership exists (i.e. whether the
essential elements in s 1 of the Act have been satisfied) can be difficult to
determine.
The issue is commonly litigated either (i) by parties seeking to enforce partnership
obligations against the other alleged partners, or (ii) by 3rd parties seeking to hold
all the alleged partners liable in contract or torts. In general the courts look at any
agreement between the parties as well as all surrounding facts. In other words, the
court may find that a partnership existed on the facts, even though some of the
members of the partnership were unaware that that was the nature of the legal
relationship they were in.
Section 2 of the Act contains various criteria for what does and does not constitute
evidence of a partnership:
Section 2(1) states that joint ownership of property (eg a share of a unit trust fund)
or share in income from property is not in itself the carrying on of business: In
Smith v Anderson (1880) 15 Ch D 247 investors gave money to trustees to invest
for them but there was no communication between members of the fund. The
court held that the investors were not engaged in joint business merely by holding
a share in a trust fund – the fund thus did not constitute a partnership.
Section 2(2): sharing gross returns does not in itself create partnership.
Section 2(3): sharing in net profits is a prima facie indication of partnership, but
there are certain circumstances in which the presumption does not operate – (e.g.
employees, s 2(3)(b)) – i.e., it is a presumption which may be disproved.
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Remember ‘profits’ does not mean gross profits, but rather net profits (gross
profits less expenses). Thus partners share joint liabilities of enterprise, as well as
the receipts. For example, in Cox v. Coulson [1916] 2 KB 177 two people staged
a play for profit. They shared the gross takings but one party hired the actors and
paid all the associated expenses and the other party hired the theatre and paid all
the associated expenses. All expenses were taken out of their respective shares of
the takings. The court held that there was no partnership – each party did their
own thing and it was possible for one person to make a profit while the other
made a loss. This was a joint venture. This question was important on the facts
of the case: One of the actors had fired a gun that he thought was not loaded,
injuring a member of the audience. That person then sued the actor and wanted to
sue both the person who employed the actor and the person who hired the theatre
on the basis that they were jointly vicariously liable for the actor’s tort. However,
because they were not partners, the spectator could only sue the actor and the
person who had hired him, and could not join the person who had hired the
theatre.
Remember that courts will not accept as definitive how persons label their
relationship – rather they look at the reality of the relationship in its entirety –
Canny Gabriel Advertising v Volume Sales (Finance) Pty Ltd (1974) 131 CLR
321 – the HC held that relationship described by parties as ‘joint venture’ was in
reality a partnership.
B. Relationship between the partners
Remember that a partnership does not have a separate legal personality – so
although partners may trade under a firm name (s 4), Supreme Court rules permit
one to sue in partnership name, and partners may agree that certain property
belongs to the partnership, ultimately all partners are personally liable for
partnership debts. This is the greatest disadvantage of being in a partnership.
Partnership can be formed without formality, but a written agreement is obviously
desirable.
A partnership does not have perpetual succession – it lasts only as long as
common purpose does (this is called a partnership ‘at will’).
Unless the partners agree to contrary, a partnership is ‘at will’ which means that it
automatically terminates when membership changes (s 26) – eg by resignation (s
32(c)) or death or bankruptcy of a partner (s 33(1)). So to prevent the dislocation
that would result from automatic termination, partners can agree upon fixed
duration of partnership (s 32(a)), which may be extended by agreement – which
can be implied – s 27(1). Note that after the extension period terminates, the
partnership reverts back to being ‘at will’. More usually however, the partnership
agreement will provide that partnership carries on indefinitely (despite
resignations and deaths) until all current partners agree to dissolve it.
Shares of both profits and losses are equal among all partners – s 24(1) (even if
unequal amounts of capital were contributed at establishment) unless a partnership
agreement provides to the contrary. Most partnership deeds thus usually provide
that share of profits and losses will equal the shares of capital contribution.
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No remuneration is paid to partners for work done – s 24(6) – in the absence of
agreement to the contrary.
All partners are presumed to participate in the management of the firm – s 24(5) –
unless there is agreement to the contrary.
Section 24 also provides that, unless the partnership agreement states to the
contrary, all partners shall take part in decisions to admit new partners, all
decisions shall be made by the majority and each partner has a right to inspect the
books.
Expulsion of a partner is not possible (s 25) unless there was a pre-existing
express agreement permits this – failing this, the only other remedy is an
application to court for dissolution (s 35).
Partners are entitled to be refunded expenses incurred in conduct of partnership
business – s 24(2).
C. Partnership property
It is important to make clear what property is ‘partnership property’ because:
The increase in value of personal property belongs to its owner, but increase in
value of partnership property will be divided among partners in proportion to their
share in profits.
What is partnership property affects the order in which property can be attached –
a partnership asset will be the first property claimed by creditors, while an asset
owned as personal property by a partner may be claimed by creditors only if there
is insufficient partnership property, furthermore, the partner who owns the
property has a right of recourse against fellow partners to reimburse him for his
loss in proportion to their shares of the partnership.
In the absence of agreement Act provides that property brought into the firm or
acquired during course of firm business (s 20(1)) or with partnership money (s 21)
is presumed to be partnership property until the contrary is proved.
D. Assignment of interest
If a partner assigns his interest in the partnership to a 3rd party, that party has
rights only against the assigning partner, not against the other partners, and cannot
participate in the management of the partnership (s 31).
A partner’s interest may be alienated involuntarily – a partner’s interest in the
partnership forms part of his or her assets so it can be attached – s 23(2). A
creditor will become entitled to receive partner’s profits (and capital on
dissolution). However, in these circumstances, the other partners have the option
to dissolve the partnership – s 33(2).
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E. Fiduciary duty
Partners owe each other a duty of utmost good faith. This fiduciary duty derives
from nature of relationship and the fact that each partner is an agent for all the
others. Thus partners must
render account in respect of dealings affecting the partnership (s 28),
disclose benefits received through the business (s 29), and obviously not
make secret profits (Birtchnell v Equity Trustee, Executors & Agency Co
Ltd (1929) 42 CLR 384).
not compete with the firm unless this is otherwise agreed (s 30).
F. Relationship between partners and outsiders
Essentially this is governed by the law of agency as modified by ss 5 – 9 of the
Act, which you should read.
The partners may, in a written or oral partnership agreement, stipulate what their
authority is. In that case, they all have express authority to that extent, and
contracts entered into by each partner to the extent of that authority will bind all
the other partners.
However, it is also important to take into account s 5(1) of the Act, which
provides as follows:
5 Power of partner to bind firm
(1) Every partner in a partnership other than a firm that is a limited
partnership or incorporated limited partnership is an agent of the firm and
of the other partners for the purpose of the business of the partnership; and
the acts of every partner who does any act for carrying on in the usual way
business of the kind carried on by the firm of which the partner is a
member, binds the firm and the other partners, unless the partner so acting
has in fact no authority to act for the firm in the particular matter, and the
person with whom the partner is dealing either knows that the partner has
no authority, or does not know or believe the partner to be a partner.
This provision has two important effects:
First, even in the absence of an express conferral of authority by the partners, s
5(1) means that each partner has implied authority as an agent for all the other
partners in respect of partnership business. The same would hold true if the
partners had not subjectively intended to form a partnership, but had allowed each
other to act as if they were partners – in which circumstance each of them would
have ostensible authority. Note, however, that the authority conferred by s 5(1)
applies only in respect of partnership business – ie the implied or ostensible
authority of partners is obviously restricted by the nature of the business. So, for
example, a transaction in which a lawyer purchased a dental chair would not be
binding on the other partners of the law firm. (Acts lying outside firm’s business
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would bind the other partners only if they conferred special express authority on
the partner concerned – s 7). Assuming that a transaction lies within the express,
implied or ostensible authority of a partner, s 6(1) of the Act provides that each of
the partners is bound by the others’ acts.
The second important aspect of s 5(1) is that even if a partner contracts beyond
his or her express authority (eg because they disregard some internal limitation on
authority), a 3rd party can still succeed in holding the partnership liable if he is
able to show that the transaction was one lying within the usual implied authority
of a partner of a firm carrying on that type of business, unless other partners can
prove that the 3rd party was aware of the partner’s lack of authority or that he did
not know the person to be a partner. So s 5(1) protects a 3rd party in the sense
that, as long as the transaction is within what would be the normal implied
authority of an agent of a firm engaging in that type of business, the 3rd party can
still hold the other partners liable, even if the partner the 3rd party was dealing
with was exceeding his or her express authority.
To reinforce this, the Act expressly states in s 8 that any internal agreement
between partners limiting their authority will affect 3rd party rights only if the 3rd
party was aware of the agreement. An example of the application of these rules is
provided by Mercantile Credit Ltd v Garrod [1962] 3 All ER 1103, where two
partners in a garage business had agreed that they would not buy and sell cars.
However, one of them did sell a car which the business did not own, to a 3rd party.
The 3rd party obviously had to return the car to its rightful owner, and then sued
both of the partners for breach of contract of sale in that clear title had not been
transferred. The partner who had not participated in the transaction sought to
avoid liability on the basis of the agreement between the two partners limiting
their authority. However the court held that the buying and selling of cars was
within the normal scope of business of a garage, that there was no evidence that
the 3rd party as aware of the agreement, and so both partners were liable.
Where a partner with authority does not reveal the partnership to the 3rd party, the
partners will still be bound to the 3rd party under the doctrine of the undisclosed
principal. But of course where such a partner acts outside his actual (express or
implied) authority, the firm will not be bound, because there can obviously be no
ostensible authority if the principal is undisclosed, because for ostensible
authority to exist, a 3rd party must be able to show reliance on a representation by
the principal.
The Act draws a distinction between partners’ liability in contract and in tort:
Section 9(1) imposes joint liability for partnership contracts, this means that if a
plaintiff formally releases one partner from liability, all are released. Under the
common law it also meant that all partners must be sued individually by name – if
a plaintiff omitted a partner (as distinct from actually releasing him), a subsequent
separate action against that partner was not permitted. However, Supreme Court
rules now permit a plaintiff to bring an action against the firm, which has the
effect that all individual partners are sued, thus effectively eliminating the risk of
accidentally failing to join a partner in the action. Note that once the 3rd party has
a judgment against all the partners, the 3rd party can execute the entire judgment
against one, any or all of them, and that if, for example, the 3rd party recovered the
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entire amount from one partner, that partner would have to pay the full amount
and would subsequently have to recover shares from the other partners.
Section 10 states that the firm (that is, all the partners) is liable for torts of partners
arising out of partnership business, and also (s 11) for misapplication of money
and property received from 3rd parties. This liability is joint and several (s 12),
which means that a 3rd party can proceed against partners in separate actions (if
more partners discovered) until the whole claim satisfied. An example of a
partnership being found liable in tort is provided by Polkinghorne v Holland &
Whitington (1934) 51 CLR 143, where a partner in a law firm had defrauded a
client of money by establishing a sham company in which he told the client he
was investing the client’s money. Since the fraud was conducted within the
course and scope of the work of the law firm, all the partners were held liable for
the tort committed by one of them.
A partner will not be liable for debts arising from transactions before he or she
entered the firm (s 17(1)), but will be liable for debts incurred while a member of
the firm even after he or she has left – s 17(3)- unless released by other partners
and the firm’s creditors – s 17(5).
G. Limited partnerships and incorporated limited partnerships
Part 3 of the Act permits the formation of limited partnerships and incorporated
limited partnerships.
A limited partnership consists of ‘general’ (i.e. ordinary) partners and ‘limited’
partners (there must be at least one of each). The general partners have unlimited
personal liability, as usual. The limited partners are liable only to contribute
specified capital share. The firm must end its name with ‘a limited partnership’ or
‘LP’- s 75. A limited partnership is effective only if a certificate listing partners
and including the partnership agreement is lodged with Registrar of Limited
Partnerships.
Limited partners may not take part in the management of the business (s 67(1)), so
limited partnership is ideal for sleeping partners who want to invest but not
engage in management or be exposed to personal liability. Limited partners lose
protection if they participate in the business (s 67(2)).
An incorporated limited partnership is similar in all respects to a limited
partnership, except that it is a separate legal entity (s 53) with perpetual
succession. It has the same powers that a corporation does (s 53A). In other
respects it is like a partnership – i.e. its general partners will be personally liable
for the debts of the partnership, while its limited partners will be liable only up to
a specified amount.
Exercise
Agatha and Christie are both graduates of the School of Interior
Design at the University of Sydney. They see a market for
providing home-owners with household fittings, cushions and
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wallpapers etc. They locate premises in the northern suburbs of
Sydney. After some careful research they conclude that they would
need $ 100 000 to open a shop there. Agatha contributes $ 70 000
and Christie $ 30 000. They use the money to fit out the premises
and to buy stock. They also open a bank account in the name of
“A&C Designs’. The shop starts making sales, and profits are
deposited into the A&C Designs Bank account. Nothing is written
between Agatha and Christie, but they orally agree that Agatha can
draw 70% and Christie 30% of the amounts deposited into the
account.
Agatha and Christie start to argue about the market they should
target. Agatha wanted to stock a range of expensive wallpaper,
costing $ 60 per metre, but Christie disagreed. A few weeks later,
when Christie was away at a trade fair in Adelaide, Agatha placed
an order for 100 metres of this wallpaper. When Christie arrived
back she was furious, and refused to pay the bill, contacting the
supplier to say that she was returning the wallpaper. However the
supplier has refused to take back the paper saying “A deal is a deal”
and has said he will sue to obtain payment of the $ 6 000.
In addition, a customer suffered a broken ankle after tripping over a
loose piece of carpeting in the shop which Christie knew about but
had failed to attend to, and has said that he will be lodging a claim
for $ 10 000 in damages.
Determine what legal relationship (if any) exists between Agatha
and Christie and then state what liabilities that arise out of these
facts, giving reasons for your conclusions and citing all relevant
statute and case law
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Topic 14 The concept of incorporation
Learning Objectives
After completing this topic you should be able to:
1. Understand the source of the Commonwealth’s power to
enact laws relating to corporations;
2. Understand the role of ASIC and the remedies available to
enforce the Corporations Act 2001 (Cth);
3. Appreciate the concept of incorporation and its legal
consequences;
4. Recognise the circumstances in which the law will lift the
veil of incorporation;
5. Write my Essay Online Writing Service with Professional Essay Writers – Explain the process used for registering companies;
6. Differentiate between different types of company according
to their liability and whether they are public or proprietary;
7. Understand what liability a promoter acting on behalf of an
as yet unregistered company has for contracts entered into
on behalf of the company.
Web Content
The Australian Securities and Investments Commission website is
at www.asic.gov.au, and contains general information about
companies – their formation, characteristics, rights and obligations.
The full text of the Corporations Act 2001 (Cth) can be found on
the Austlii site. However, for the purposes of this subject, you need
know only the sections of the Act mentioned in this Study Guide.
A. Introduction
The Commonwealth can legislate with regard to corporations by virtue of s 51(xx)
of the Constitution but in New South Wales v Commonwealth (Incorporation
case) (1990) 169 CLR 482, the High Court held that while the Commonwealth
Parliament could enact legislation regulating companies once they were formed, it
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did not extend to the actual formation of companies, rested with the States. This
raised the possibility of a company having to register in a multiplicity of
jurisdictions.
The problem was solved by each of the States agreeing in 2001 to use the
provisions of s 51(xxxvii) of the Commonwealth Constitution to give to the
Commonwealth Parliament the power to legislate on corporations. This enabled
the Commonwealth to enact the Corporations Act 2001 (Cth), so that now there is
a single, national Corporations Act.
In these notes the abbreviation ‘CA’ refers to the Corporations Act.
B. ASIC’s enforcement role
Corporations are regulated by ASIC (Australian Securities and Investments
Commission) which is itself governed by Australian Securities and Investments
Commission Act 1989 (Cth) (ASIC Act).
ASIC has numerous roles including to
act as a companies’ registry – lodgment of documents, availability of public
searches (using the ASCOT database)
protect potential investors (by requiring the lodgment of prospectuses under
Pt 6D of CA)
to protect shareholders (ASIC can bring actions under s 50 of the ASIC Act
– e.g. on behalf of a against malfeasant directors)
regulate trading in securities (e.g. in relation to stock market trading Parts
7.2 and 7.3 of the CA and takeover bids under Pt 6.5 of CA)
Pt 3 of the ASIC Act confers wide powers on ASIC which it uses to enforce the
CA, including by means of criminal prosecutions (s 49 of the ASIC Act).
ASIC can apply for an injunction under s 1324 of the CA to stop existing or future
breaches of the CA.
Contraventions of the CA can have differing consequences:
criminal offence: doing what the CA forbids or failing to do what it
requires amounts to a criminal offence under s 1311,
but note that under s 1311(1A), contraventions of
certain Parts of the CA are offences only if a penalty
for such a contravention is mentioned in Schedule 3.
Successful conviction requires proof on the criminal
standard – beyond a reasonable doubt.
civil penalty: sections for which a civil penalty declaration can be
made by a court are listed in s 1317E
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a penalty order may be applied for by ASIC s 1317J
in addition, a pecuniary penalty can be imposed under
s 1317G if the contravention materially prejudices the
corporation, its members or the corporation’s ability to
pay creditors.
civil standard of proof (on a balance of probabilities) is
all that is required for ASIC to succeed when it brings
civil proceedings: s 1317L
ASIC or the Co can also apply for an order under s
1317H to recover compensation for the Co where it has
suffered loss as a result of someone contravening a
section listed in s 1317E
ASIC can apply to court for an order under s 206C
prohibiting a person from being involved in the running
of a corporation for a specified period
the court can grant relief from civil penalty liability
where it thinks this is equitable – s 1317S
Whether ASIC will chose to initiate civil penalty proceedings or to ask the
Commonwealth DPP to initiate a prosecution depends on (i) how serious the
breach was (ii) whether it was intentional and (iii) whether the available evidence
can support a finding beyond reasonable doubt (criminal standard) or on a balance
of probabilities (civil standard).
C. The concept of incorporation
Section 119 of the CA provides that a Co comes into existence as a body
corporate upon registration – i.e. becomes a legal person. This means that it has
the attributes of a body corporate at common law including:
Legal existence separate from its members
Perpetual succession – ie continued existence until de-registered (confirmed
by s 601AD(1)), irrespective of the changing identities of its shareholders.
Capacity to own property – the shareholders of a Co have no legal interest
in property, only the Co does: Macaura v Northern Assurance Co Ltd
[1925] AC 619
Capacity to sue and be sued in its own name – also note, only Co, not
members, can sue on its behalf, and note that the members can sue the Co.
Section 124(1)(a): a Co has the legal capacity and powers of an individual (i.e. a
natural person) and the powers of a body corporate.
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The powers of body corporate are listed in s 124(1).
Section 22 of the Acts Interpretation Act 1901 (Cth) states that a ‘person’ includes
a body corporate, unless the contrary intention appears. Thus generally a
corporation can do whatever a natural person can do, and is subject to the same
prohibitions as is a natural person.
The fact that a Co is separate from its members has certain consequences:
 The liabilities of Co are its own. Shareholders of a limited liability
company (which 99% of companies are) have no liability for Co debts –
their liability is limited (hence ‘limited liability’) to pay for their shares (s
516).
 The Co is not the agent of its shareholder(s). They merely own parts of it,
but it is the Co (acting through its board of directors, who are agents of the
Co) which does things on its own behalf.
How much control the shareholders in general meeting have over the directors
depends on the Co’s constitution.
The concept of separate personality and limited liability of shareholders was
established in Salomon v Salomon & Co Ltd [1897] AC 22
Salomon formed a company (Salomon & Co Ltd). He transferred the assets of his
business (a shoe shop) to the Co – the company paid him with shares and a
debenture. So, Salomon changed from being the owner of a shoe store to being
the shareholder and secured creditor of a company which owned a shoes
store. A debenture is a certificate indicating that someone has provided capital to
a Co in the form of a loan, and that the loan is secured by company assets. This
means that that if the Co becomes insolvent, the debenture holder has to be
satisfied out of company assets first, before any unsecured creditors got anything.
Debentures can also be traded – i.e. the holder can sell the debenture to someone
else.
Note that Salomon acting in three capacities: 3rd party seller of business to the Co
(in exchange for shares and the debenture), majority shareholder in the Co and
M.D. elected by majority shareholder. Salomon later sold debenture to a 3rd party.
Subsequently the company went insolvent.
The creditors of the Co (i.e. people who had supplied goods to Salomon & Co
Ltd) sought to have debenture holder denied preference on basis that company
which issued debenture was a sham, that the debenture was thus invalid, and that
Salomon was thus personally liable to them and to the debenture holders as
equally ranking creditors. The court rejected the creditors’ argument, holding that:
 The company was an entity separate from Salomon, its majority
shareholder.
 Publically-lodged documents were available to creditors to discover the
existence of the debenture.
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 There was no indication of any fraud – ie intent to deceive – in the
establishment of company.
In this way, the principle of ‘corporate veil’ was established.
Salomon was affirmed for NZ in Lee v Lee’s Air Farming Ltd (1961) AC
12. Lee formed and owned a crop-spraying company. As MD of the Co, he
employed himself as pilot. The court held that, even though he was owner of
the Co and its MD, he was an employee under worker’s compensation
legislation, and his wife could claim compensation when he was killed in an
aircraft. The court held that the fact that Lee as shareholder was behind the
company veil was irrelevant – it had still employed Lee. This case also
shows that a shareholder can contract with the Co in which he / she owns
shares.
In Walker v Wimborne (1976) 137 CLR 1, HC held that fact that several
companies belonged to a corporate group did not entitle the directors of any
particular Co to move funds between them and to use property of one as
security for liabilities of another – a director owes fiduciary duty to the
specific Co of which he is a director, not to the group as a whole.
Industrial Equity Ltd v Blackburn (1977) 137 CLR 567 – the mere fact that
group accounting statements were prepared did not entitle holding Co to pay
dividends out of subsidiary profits.
The separate legal existence of a company means that it is the company, not its
shareholders, own company assets, and harm to assets of Co may be sued for only
by Co, not by the shareholders:
Macaura v Northern Assurance Co Ltd [1925] AC 619 a timber estate
owner sold estate to company in exchange for shares (like Salomon). He,
not company, took out an insurance policy on the timber. Sixteen (!!) days
later, a fire destroyed the timber. The policy holder sought to recover on the
policy. The court held that only the company (as owner) had an insurable
interest in the timber. (If you want to use incorporation to protect your
personal estate from business losses, why should you still be entitled to an
interest in what is now company property?). The shareholder has an interest
in a Co., but only the Co. has an interest in its property.
D. Lifting the corporate veil
In certain limited circumstances, the law ‘lifts the veil’ – i.e. will allow the courts
to take cognisance of the human controllers of the Co, and to impute the Co’s
actions to them.
Gilford Motor Co Ltd v Horne [1933] Ch 935 – avoidance of contractual
obligations: An employee of the plaintiff had agreed to a restraint of trade.
However, he then began engaging in the same line of business, signing
contracts in the name of a company formed by him, of which his wife and
another former employee were shareholders. The court held that the
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restraint had been broken, looking behind the Co and identifying him as its
controller.
Jones Re Darby; Ex parte Brougham [1911] 1 KB 95 – lifting the veil where
fraud has occurred – i.e. where a company is formed for the purpose of
defrauding investors or creditors, the court will attribute the intentions of its
owners to it.
Daimler Co v Continental Tyre and Rubber Co [1916] 2 AC 307 – where
the courts lift the veil because a company is being used to escape the effect
of a law – here during WW1 trading with Germany was prohibited, and the
courts held that to trade with a UK registered Co with German shareholders
was really to trade with the enemy.
Green v Bestobell Industries Ltd [1982] WAR 1 – Green formed a Co, C
Ltd, to tender for a project. B Ltd (of which he was a director, and thus
owed a fiduciary duty) was also tendering. The establishment of the
competing business (C Ltd) was an obvious breach of the fiduciary duty
owed by Green to B Ltd. When proceedings were brought for breach of
fiduciary duty, C Ltd was held liable to B Ltd, as C Ltd had participated in
the breach. In other words, although the competing bid had been made by C
Ltd, the court looked behind C Ltd and attributed its acts to Green, its
controller.
There is also a statutory instance where the veil is lifted:
The CA looks behind the Co – in s 588V-X, which provides that, in the
context of a corporate group, a holding Co may be liable for its subsidiary’s
insolvent trading where the holding Co failed to prevent the subsidiary
incurring a debt where there were reasonable grounds for the holding Co to
suspect that the subsidiary was insolvent.
Apart from the above specific circumstances, which have an element of
wrongdoing or deceit common to all of them, the courts in Australia will not lift
the veil.
Here it is important to note that, unlike courts in the UK, Australian courts have
not accepted the argument that, just because a holding company wholly controls a
subsidiary, the subsidiary should be viewed as the agent of the holding company,
and that therefore the holding company can be held liable in contract or tort for
the acts of the subsidiary – see Briggs v James Hardie & Co Pty Ltd (1989) 16
NSWLR 549 and ACN 007 528 207 Pty Ltd (in liq) v Bird Cameron (Reg) (2005)
91 SASR 570. That would wholly undermine the Salomon doctrine, a cornerstone
of which is that a shareholder (be they a human being or a holding company) is
not liable for the acts of a company in which they own shares.
E. Formation of companies
A person may purchase an already existing shelf Co from a firm that owns them
(i.e. the purchaser simply purchases all the shares in the Co from the lawyer).
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Alternatively, a person may register a Co themselves.
The applicant (sometimes called a ‘corporator’ lodges an application with ASIC
under s 117(1), giving the information required in s 117(2).
Types of companies (s 117(2)(a)) – governed by s 112, discussed below.
Note the requirement for consents by directors and the company’s secretary
– s 117(2)(c)-(f) and (5) – a private company (Pty Co) must have at least 1
director. Public companies (Ltd) must have at least three and a company
secretary (can be the same person).
If a Co is to have a constitution, it must lodge a copy – s 117(3). The Co
may however decide simply to regulate its affairs by the default ‘replaceable
rules’ contained in the CA.
Note that under s 22 of the Acts Interpretation Act 1901 (Cth) (defining ‘person’)
as read with s 231, a body corporate may be a member of a Co – i.e. one Co may
own shares in another.
A Co must have at least one member – s 114. If it ceases to have at least one
member, ASIC can apply to court for winding up on 1 month’s notice – s 462(2A).
Upon receipt of application, ASIC may register the Co under s 118, assigning an
Australian Company Number (ACN). ASIC gives a certificate of registration
stating info in s 118(c).
The certificate is conclusive evidence of valid incorporation – s 1274(7A).
Under s 119, the Co comes into existence upon registration, and directors and
secretary automatically take office – s 120(1).
F. Company name
Under s 148(1) a Co can have a name requested upon registration or may simply
use its ACN as its name.
It is possible to reserve a name for up to two months prior to registration – s 152.
Whether Co has a name or uses ACN, it must indicate what type of company it is
whenever it uses its name (types of companies are dealt with below). So it must
have
‘Limited’ (or Ltd) after its name if a limited liability public Co, or
‘Proprietary Limited’ (Pty Ltd) if it is a limited liability private Co –
s 148(2)
just ‘Company’ (Co) if it is an unlimited public company
‘Proprietary’ (Pty) if it is an unlimited proprietary Co – s 148(3)
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‘No Liability’ (NL) if it is a no liability Co – s 148(4)
The requirement to use ‘Ltd’ enables 3rd parties dealing with the Co to be aware
of its members’ limited liability.
Abbreviations as provided in s 149 may be used (Ltd, Pty, Co, NL)
The terms ‘Limited’, ‘Proprietary’, ‘No Liability’ + abbreviations thereof cannot
by businesses that are not companies – s 156
The Co must set out name + ACN on all public documents (defined in s 88A) and
negotiable instruments – s 153
The Co can change its name by special resolution and application to ASIC under s
157 (provided name is available under s 147).
G. Types of companies
Under s 57A ‘corporation’ is defined as including a ‘company’, which is in turn
defined in s 9 as meaning a Co registered under the CA. Thus a company
registered under the CA is just one type of corporation.
Types of companies are listed in s 112:
There are four different classifications pertaining to types of liability
Co limited by shares
Co limited by guarantee
Unlimited Co
No liability Co
We will deal with companies limited by shares, as the overwhelming majority of
companies are of this type.
There are two classifications pertaining to status
Public Co (can be of any of the above 4 types of liability)
Private Co (can be either limited by shares or unlimited)
(i) Company limited by shares
This is the most common form of Co (98% of companies are limited by shares).
The shareholders’ liability is limited to paying into the Co whatever amount they
agreed upon in return for shares – s 516. If this amount was not fully paid by
shareholder upon acquisition of shares, the Co can call for the amounts
outstanding.
A holder of unpaid shares may sell them to someone-else, in which case the new
owner takes the liability to pay what is owing. However, a past members’ liability
to contribute capital for unpaid shares continues for 1 yr after selling their shares
but only if
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 the company is being liquidated (s 521),
 the company does not have capital to pay for any liability incurred before
the past member ceased to be a member (s 520), and
 the subsequent shareholder is unable to pay what is owing (s 522).
The fact of limited liability indicated by use of ‘Ltd’ after Co’s name.
A share = a bundle of rights, most importantly to:
attend and vote at meetings
receive dividends (if declared)
receive return of contribution when Co is wound up (assuming it is able to
meet its debts)
Shares can be of different classes with different rights.
Companies limited by shares can be either public or private.
(ii) Proprietary (private) and public companies
All companies, whatever their type of liability must be either proprietary or public
– s 9 defines ‘public Co’ as any Co which isn’t Pty.
Pty companies used where the corporators do not wish to offer shares to the
public.
Section 112(1) – a Pty Co must be limited by shares, or
an unlimited Co.
Section 113 requires that proprietary companies
Have no more than 50 non-employee shareholders
Not engage in any fundraising activity that would require the lodging of a
prospectus under Part 6D (which means make any offer other than one
excluded from Part 6D), offers to existing shareholders or employees
excepted.
If a Pty Co infringes s 113, ASIC can compel it to convert to a public Co (s 165).
Proprietary companies can be classified as either Large or Small Proprietary
Companies. Under s 45A a company is a small proprietary company if it satisfies
at least two of the following criteria.
a. consolidated gross operating revenue is less than $ 25m
b. value of consolidated gross assets is less than $ 12.5m
c. it has fewer than 50 employees.
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If a company cannot satisfy two of the three it is a large proprietary company.
There are advantages in being classified as a small Proprietary Company. Large
Pty Companies and public companies have to prepare financial reports (s 292) and
must have these financial reports audited (s 301). Small Pty companies need only
prepare audited reports if requested by ASIC or shareholders holding at least 5%
of the total shares. Large Pty companies must send copies of financial report,
directors’ report and auditor’s report to members (s 314) and must lodge financial
reports and directors reports with ASIC (s 319).
Essentially the Pty Co exists to provide a simpler vehicle for business than the
public Co. Because it does not solicit investments from the public, it is subject to
less rigorous control than are public companies. Some of these are:
Only 1 director required, whereas public companies require 3: s 201A(2).
No need to hold an AGM.
Informal procedure of passing resolutions without meeting is available: s
249A.
Certain restrictions on appointment and removal of directors apply only to
public companies (see ss 201D and ss 203D and E).
Directors of public companies must be individually voted onto the board,
unless by unanimous agreement of GM – s 201E.
Directors of public companies must be able to be removed by resolution of
shareholders in GM – s 203D(1) – Pty companies can deal with this in their
constitution, otherwise replaceable s 203C gives power to GM.
A director of Pty Co can be present at board meeting and vote on matter in
which he is interested (s 194) subject to disclosure of interest (s 191),
directors of public companies cannot attend or vote – s 195(1) – unless
exempted by board – s 195(2).
A company may change its type by special resolution in accordance with the
options permitted in s 165.
Application is made to ASIC under s 163, which approves change under s 164.
Section 165 states that ASIC itself can direct change from Pty to public Co if s
113 no longer being complied with.
H. Holding and subsidiary companies – corporate
groups
A subsidiary is defined in s 46(a) as a Co in respect of which another Co
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controls the composition of the board – i.e. can control appointment or
removal of a majority of its directors – s 47. This must be a legally
enforceable (not merely de facto) power, or
can cast or can control the casting of 50% of votes at AGM, or
holds more than 50% of share capital by value (excluding preference
shares).
If C is a subsidiary of B which is in turn a subsidiary of A, then C is also a
subsidiary of A – s 46(b).
Also important is the concept of a related body corporate – s 50, which makes
different subsidiaries of the same holding Co related to each other.
In practice, many companies are part of a group of companies. A group occurs
when one or more companies is in the hands of another company. There are many
reasons for conducting business through a group
 different aspects of the enterprise can be separated,
 one part can be isolated through the limited liability doctrine. It will not
then be liable for debts of another part and vice versa.
Corporate groups are very common. Most large public companies will have at
least one controlled entity.
Within corporate groups each company is treated as a separate entity by the law.
I. Foreign companies
A body corporate incorporated outside Australia cannot do business in Australia
unless it is registered under the CA – s 601CE.
J. ASX listing
It is important to understand the difference between a listed company and an
unlisted company. A listed company is one whose shares are listed for quotation
on Australian Stock Exchange Limited (ASX). This means that people who wish
to do so can buy and sell those shares from or to other investors through the stock
market conducted by ASX.
Of over one million companies in Australia, only about 1,300 are listed. Note that
only a public Co can be listed on the ASX.
The ASX Listing Rules are rules drafted and imposed by the Australian Stock
Exchange. When a company applies to be admitted to the Official List of ASX,
and to have its securities quoted, it agrees to abide by the Listing Rules. The
Listing Rules contain requirements additional to those contained in the
Corporations Act and the general law, which are designed to protect public
investors and promote a transparent and informed market in securities.
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Only listed companies are bound by the Listing Rules. Sometimes the listing rules
operate to impose restrictions on entities controlled by listed companies.
K. Promoters and pre-incorporation contracts
Even though companies can be registered fairly quickly, it still sometimes occurs
that the people who are setting up the company enter into arrangements and
contracts in anticipation of the company coming into existence – e.g. leasing
premises and buying furniture. These people are called promoters. This creates an
area of legal risk for them, because the issue arises as to who – the promoters or
the company – will be liable on any contract entered into by the promoters on
behalf of the as yet unregistered Co.
One way (and the safest way) of avoiding this problem is for promoters to buy an
already existing shelf Co, elect themselves as directors and then enter into
contracts as agents of the Co. In this way there will be no doubt that it is the Co
and not the promoters personally which will be liable.
But what of the situation where the Co does not exist and the promoters enter into
contracts? How can it be made liable for pre-incorporation contracts?
Under the common law, a promoter could not be an agent because the principal
did not exist, nor could the Co ratify once it came into existence, because under
the law of agency, the principal must have existed at the time the agent purported
to contract on its behalf.
The promoter would be personally liable on the basis of breach of warranty of
authority – i.e. when someone purports to contract on behalf of another, they
impliedly warrant that they have authority. And if the other person (the principal)
does not yet exist, the ‘agent’ clearly could not have had authority.
This area has now been reformed by s 131, which now covers this issue
exclusively (s 133) where a person acts on behalf of an as yet unregistered Co:
Under s 131(1) a Co may ratify pre-incorporation contracts within the time
specified in the contract or within a reasonable time. Note that if a time is
specified and no ratification occurs, the contract is not binding on the Co.
If (i) the Co is never registered or (ii) is registered but does not adopt the
contract, then the promoter is liable to 3rd party in the same way as the Co
would be for non-performance – s 131(2).
If the situation is one where the Co has been registered but refuses to adopt
a pre-incorporation contract, then in order to deal with the situation where
the company has received some benefit under the contract, the court may,
under s 131(3) order the Co to give any remedy it feels appropriate,
including requiring the Co to pay a proportion of the damages for which the
promoter is liable, transfer property received by virtue of the contract or pay
an amount to the 3rd party.
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Under s 131(4), if the Co does adopt the contract but fails to perform, the
court may order the promoter to pay some of the damages for which the Co
is liable.
Exercise
Otis Lillicrap is a scallop fisherman in NSW. Stocks of scallops
are dwindling, and so the State Parliament has enacted legislation
which provides that
“Each person wishing to fish for scallops must obtain an
annual licence, may be granted one licence only and is
limited to taking 50 scallops from the sea per month”.
Otis has incorporated three companies – Otis’ Fishing Pty Ltd,
South Coast Scallops Pty Ltd and Lillicrap’s Fishing Pty Ltd, and
as managing director of each applies for 3 licences, as well as a
licence for himself. Assume that you are legal adviser to the NSW
Fisheries Department. What would you advise in relation to the
four applications? Cite relevant case law. (Do not look at fisheries
legislation when researching this problem – consider it only from
the perspective of corporations law principles).
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Topic 15 Company liability in crime, tort and
contract
Learning Objectives
After completing this topic you should be able to:
1. Understand how a body corporate can be liable in crime;
2. Appreciate the different theories that have been used to affix
criminal liability onto a company;
3. Understand how the doctrine of vicarious liability operates
to make a company liable in tort;
4. Identify who are the agents of a company, and what express,
implied and ostensible authority they have;
5. Understand the Turquand rule;
6. Be able to explain the operation of the statutory regime in ss
125-129 of the Corporations Act 2001 (Cth).
A. Introduction
The law faces a problem in that in order to enforce civil and criminal liability
against a Co, some way has to be found round the conceptual problem of how to
impute liability to an entity that has no physical existence. Obviously this must be
through the actions of its human representatives.
B. Company liability in crime
Many statutes, for example environmental and OH + S statutes impose criminal
liability in cases of breach. Under what circumstances can a company (as distinct
from the person who performed the Act) be found liable for an offence?
The starting assumption is that because under the general law (s 22 Acts
Interpretation Act (Cth)) ‘person’ includes a body corporate, companies can be
criminally liable for any crime for which a natural person can be prosecuted.
In addition, s 12.1(2) of the Criminal Code (Cth) provides that a body corporate
can be found guilty of an offence, and s 4B of the Crimes Act 1914 (Cth) provides
that where an offence is stated as being punishable only by imprisonment, a Co
may nevertheless be found guilty of the offence and fined.
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The key question which determines whether a Co is liable under criminal statutes
for the acts of its employee or agent is whether the act (actus reus) and fault (mens
rea) of the employee or agent will cause the company to become liable along with
that person. In this context, ‘fault’ can mean intent, recklessness or negligence,
depending on what the elements of the offence are.
Section 12.2 of the Commonwealth Criminal Code states that whether the
actus reus of an offence has been performed by a company depends on
whether it was performed by an employee, agent or officer of the Co, acting
within the actual or apparent scope of their employment or authority.
According to s 12.3(1), the mens rea element of an offence will be attributed to a
company if
it expressly, tacitly or impliedly authorised or permitted the commission of
the offence. The evidence for this can, under s 12.3(2) be provided by the
fact that the board or ‘high managerial agent’ expressly, tacitly or impliedly
authorised the offence, unless the board can show that it exercised due
diligence to prevent the conduct.
a corporate culture existed that directed, encouraged, tolerated or led to the
unlawful conduct or
the body corporate failed to create and maintain a culture that required
compliance.
For the purposes of these provisions s 12.3(6) states that ‘high managerial
agent’ means an employee, agent or officer with duties of such
responsibility that their conduct may fairly be assumed to represent the body
corporate’s policy, while ‘corporate culture’ means an attitude, policy, rule,
course of conduct or practice.
Whether a corporate culture requiring compliance exists often depends on whether
due diligence has been adhered to by the officers of the corporation. In SPCC v
Kelly (1991) 5 ACSR 607 the court held that whether ‘due diligence’ has taken
place depends on the facts of each case and requires that the defendant took such
steps as a reasonable person would have in his or her circumstances.
Note that, as is stated by s 3.1(2) of the Criminal Code, some offences may not
require that fault be proved. In other words, in relation to those offences, liability
arises without intent, recklessness or negligence, and the mere performance of the
act amounts to a breach of the law. In such cases, the company is liable
irrespective of the fault of any of its human employees. All that is required is than
an officer or employee have performed the act.
C. Company liability in tort
As is true of any employer, a Co is vicariously liable for the torts of its employees
committed within the course and scope of their employment:
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In Citizens Life Insurance Co Ltd v Brown [1904] AC 423, a Co was held
liable in defamation for a defamatory letter sent out by one of its employees.
In Hollis v Vabu Pty Ltd (2001) 207 CLR 21, a Co was held liable for
injuries caused by one of its employees, a bicycle courier, to a pedestrian.
D. Company liability in contract
The question to be addressed in the subsequent sections of this topic is: who has
the authority to bind a Co in contract? The theories discussed earlier that are
used to determine corporate liability in crime and tort are not at all relevant
to liability in contract.
The answer to this question is given by the rules of agency. You should refer
back to the Topic in which we discussed the law of agency. In order for an agent
to bind a principal the agent must have authority to do so. In the context of a Co
this means that some human agent must have authority from the Co. Section
126(1) provides that a Co may exercise its power through an agent. However, the
common law has been superseded in this area by the statutory provisions
contained in ss 126-130 of the CA.
(i) Express authority
In the context of a Co, actual authority will be conferred by the Co constitution or,
in its absence in accordance with the replaceable rules of the CA.
In general, in the case of any Co with more than 1 director, authority is vested in
the board collectively – s 198A In the case of a single-director company, that sole
director has the power to bind the company – s 198E(1).
Any act lying outside the authority of the directors or the board can be performed
by the members in general meeting – s 198A(2)
(ii) Implied authority of Co officers
The board may appoint one of its members as Managing Director (conferring on
that person the powers of the board – s 198C(1)), or may delegate its powers to
someone-else (s 198D(1)(d)), who is usually referred to as the CEO.
In the absence of any explicit conferral of power, the MD / CEO is taken as
having such authority as the common law implies in that position which, as was
stated in Entwells Pty Ltd v National and General Insurance Co Ltd (1991) 5
ACSR 424 means generally being in charge of the business of the Co, including
the authority to bind the Co.
Note however that the MD’s authority is limited to acting within the normal
course of business of the particular Co of which he is MD – thus he could not do
something as radical as sell the Co’s entire undertaking. The fact that authority
relates to the particular Co concerned means that the type of transaction which
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could be entered into by the MD of BHP would be far larger than one entered into
by the MD of a small family concern.
Thus in Re Tummon Investments Pty Ltd (in liq) (1993) 11 ACSR 637 the
court upheld the liquidator’s rejection of a claim by L Ltd which had lent 2
x $ 6 000 to T Ltd, represented by its MD Mr T, because loans of that size
did not lie within the authority of an MD of a Co of that size.
An ordinary director has no authority implicit in that position, the only exception
being where there is only 1 director: The sole director / shareholder of a Pty Co
has authority to represent the Co – s 198E(1)
The Chairman of the board does not, by virtue of that office alone, have any
implied authority.
The Co Secretary has such authority as is implied in his job as chief
administrative officer of the Co, s was held in Panorama Developments (Guilford)
Ltd v Fidelis Furnishing Fabrics Ltd [1971] 2 QB 711 where the court held that a
Co was bound by its Secretary’s contracts to hire luxury cars.
The board might appoint other executives to positions which carry implied
authority (likely to be a very large number of people) as in
AWA Ltd v Daniels t/as Deloitte Haskins & Sells (1992) 7 ACSR 759 where
the court held that someone appointed as forex dealer had the authority to
enter into contracts to buy forex from banks.
It is important to realise that the vast majority of company contracts are entered
into by employees who are very low down in the company hierarchy, but
nevertheless have authority to bind the Co by virtue of the position they have been
appointed to. Thus while the MD of a large chain of supermarkets has plenary
authority (that is the authority to enter into any type of contract binding the Co), it
is equally true to say that the worker at a check-out binds the company when they
sell groceries to a customer.
(iii) Ostensible authority
As stated above, ostensible / apparent authority may arise through acquiescence
by the board in conduct by someone who acts on their behalf without express
authority and without being appointed to a position which carries implied
authority. The classic case of ostensible authority is Freeman and Lockyer v
Buckhurst Park Properties (Mangal) Ltd [1964] 2 QB 480
The board knowingly (this would have to be proved by the 3rd party seeking
to hold the principal – in this case the board – liable) allowed an ordinary
director (Kapoor) to act as M.D on several occasions. The Co. was held
bound by contract Kapoor had entered into with a firm of architects.
Remember that the representation of ostensible authority must be made by
someone with actual authority. Usually this will be by the board, but it could be
by the single director of a single-director Co or anyone else vested with actual
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authority, as held in Brick and Pipe Industries Ltd v Occidental Life Nominees Pty
Ltd [1992] 2 VR 279.
E. The Turquand rule
Although now of only historical interest in view of the fact that it has effectively
been replaced by the statutory regime contained in the CA (and so you must
answer questions on this area of law by referring to the provisions of the Act
and cases that have arisen under it), it is necessary to examine the Turquand
rule in order to understand the background against which ss 126-130 of the CA
were enacted.
Because the conferral of authority on a Co agent requires compliance with
formalities (eg the convening of the board, the presence of a quorum, the passing
of a board resolution to confer authority etc) which it would be very difficult for a
3
rd party to verify, the court in
Royal British Bank v Turquand (1856) 119 ER 886 developed a rule (known
as the Turquand rule or sometimes as the ‘indoor management’ rule) which
is to the effect that a 3rd party is entitled to assume that internal formalities
have been complied with when dealing with Co agents, and that the Co is
estopped from pleading that they have not. This case involved a Co, the
constitution of which required that the board could borrow money only if
authorised by a resolution passed at a GM. No resolution had been passed,
but the court held that the bank was entitled to assume, without inquiring,
that it had, because the Directors collectively, as the board, had authority to
bind the Co.
A practical example of the operation of the Turquand rule would be where the
MD of a large Co is prohibited from entering contracts of over $ 10 000 – a sum
which lies within the authority usually implied in his position as MD of a large Co
– without a resolution passed at a GM. In that situation his express authority is
less than his implied authority. Even if a 3rd party is aware of the restriction, he
can contract safely with the Co, as he / she is able to assume that the GM
resolution has been passed.
The Turquand rule would however not apply where a person has knowledge –
either actual or constructive – that a formality has not been complied with.
In Northside Developments Pty Ltd v Registrar-General (1990) 170 CLR
146, Mr X, who was a Director of N Ltd, had signed a document purporting
to pass a mortgage over land which was N Ltd’s major asset as security for a
loan for another unrelated Co of which he was also a director. The
document had been attested by his son Y as Co Sec (even though he had not
been appointed as such). Under N Ltd’s constitution a director could pass a
mortgage only if the board had passed a resolution giving authority to do so
and the mortgage was also signed by the Co Secretary. The court held that
the lender of the money could not rely on the Turquand rule because in the
circumstances it should have been put on its inquiry to check the director’s
and Sec’s authority given that the transaction appeared to be unrelated to N
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Ltd’s business and not to its benefit – in other words, there was something
suspicious about the transaction.
The Turquand rule was undermined by the doctrine of constructive notice in terms
of which 3rd parties were presumed to know of the Co’s public documents, and
thus had to inquire whether any limitations contained therein had been complied
with. Subsequently however the doctrine of constructive notice was abolished (s
130), and so 3rd parties are not presumed to know of the existence of limitations
even if they appear in a Co’s constitution (in any event note that only public Co’s
are required to lodge their constitutions – s 117(3)).
Note also that the Turquand rule did not relieve the 3rd party seeking to bind the
Co to show that the person they were dealing with had some kind of authority –
express, implied or ostensible. All the rule did was exempt them from checking
that formalities have been complied with.
F. The statutory regime
The Turquand rule has effectively been replaced by the statutory regime
contained in the CA. For this reason it is the Act and not the Turquand rule
that should be applied when answering problems dealing with this area of the
law. In particular, the Act contains a different standard of knowledge required on
the part of 3rd parties before they are denied the right to rely on fulfilment of
indoor management restrictions than was set in cases such as Northside
Developments Pty Ltd v Registrar-General (1990) 170 CLR 146
Video
The CA effectively adopts the Turquand rule, in that under s 128(1) a person
dealing with the Co is entitled to make s 129 assumptions, which include
s 129(1) that the company representative is complying with the Co’s
constitution and replaceable rules
s 129(2) that a person named as D or Sec of the Co in publicly available
documents (such as the ASIC register) has been validly appointed and has
the authority of a director or Sec of a similar Co
s 129(3) that a person held out as officer or agent has been validly appointed
and has authority of that kind of officer or agent of a similar Co (ie note that
the scope of the authority that an agent can be assumed to have will be
limited by the size and scope of the company’s business)
s 129(4) that officers and agents properly perform their duties to Co – ie are
complying with any restrictions imposed by the Co
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s 129(5) that a document has been validly executed without seal if s 127(1)
appears to have been complied with
s 129(6) that a document has been validly executed under seal if s 127(2)
appears to have been complied with
Section 128(2) protects those who acquire interests in property from those who
have in turn acquired them from a Co by providing that the first party is entitled to
make the s 129 assumptions in respect of the Co and the other party.
Section 128(3) provides that the s 129 presumptions are available even in cases of
fraudulent conduct or forgery – in other words, the fact that a company
representative has forged someone’s signature on a document during the course of
engaging in a transaction with a 3rd party does not prevent a 3rd party from
presuming that that signature is genuine.
Section 128(4) is the statutory equivalent of the exception to the Turquand rule
relating to a person’s knowledge – those who ‘knew or suspected’ – that the
assumptions were incorrect. The onus of proving such knowledge or suspicion
would lie on the Co.
One must analyse very carefully the meaning of the words ‘knew’ and ‘suspected’
– they are different from what applied under common law cases such as Northside
Developments:
‘knew’ – means actual knowledge – it does not include constructive
knowledge.
suspected’ – requires that 3rd party must have formed a positive opinion, no
matter how weak, that an assumption is incorrect. Mere ignorance as to
whether it is correct (which might put the 3rd party on their inquiry under the
old common law doctrine) would not suffice.
In Oris Fund Management Ltd v National Australia Bank [2003] VSC 315
the court held that the word ‘suspect’ in s 128(4) should be interpreted
subjectively – that is, as requiring that the 3rd party be shown to have
actually suspected that an assumption was not true. It would not be enough
to show that the 3rd party ought objectively to have suspected (ie that a
reasonable person in his position would have suspected). The same
interpretation was applied in Sunburst Properties Pty Ltd v Agwater Pty Ltd
[2005] SASC 335.
Notwithstanding the courts’ interpretation that ‘suspected’ requires proof of
subjective suspicion on behalf of the 3rd party, if the company wishes to
evade liability under s 128(4), practically speaking there will hardly ever be
evidence of what the 3rd party’s state of mind was – unless the 3
rd party
admits to having had suspicions (which of course is highly unlikely, given
that the 3rd party will be trying to hold the company liable on the contract).
This means that whether the 3rd party suspected something really depends
on an analysis of all the circumstances of the case to determine whether
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the 3rd party must have suspected that a s 129 assumption was not true. In
other words, a suspicion on the part of the 3rd party will often be inferred
from the facts. If the facts were such that suspicious circumstances would
have been evident to the 3rd party, then the courts will find that s 128(4)
applies.
Note that where in ss 129(2) and (3) the CA states that a person is entitled to
assume that someone named in documents lodged with the ASIC as a director or
held out by the Co as such has authority, it is such authority as is held by a
director of a similar Co. In other words, the statute incorporates the common law
position re the existence of implied and ostensible authority – i.e. that it relates to
the size and business of the Co.
A director who purports to bind a 3rd party to a Co but who turns out not to have
authority will be liable to the 3rd party for breach of implied warranty of
authority.
G. The ultra vires rule and restrictions on a corporation’s
capacity in its constitution
Statutory assumptions are also relevant to the removal of the ultra vires rule from
corporations law.
Company constitutions sometimes have clauses in them that restrict the
company’s operations to certain activities. But what happens if a company officer
engages in a transaction which lies beyond the scope of (ultra vires) the
constitution? Under s 125(1) and (2) acts are not invalid merely because they
contravene a restriction in the Co’s constitution or fall outside a clause which
restricts the objects of the Co.
Furthermore, under s 129(1), 3rd parties can assume that the Co’s constitution and
provisions of the CA applying to the Co as replaceable rules have been complied
with.
A 3rd party can safely contract with a Co without concern that the contract may lie
outside the Co’s self-imposed powers or objects.
A 3rd party is not deemed to have constructive notice of such restrictions merely
because they are discoverable in public documents – such as the constitution –
obtainable from ASIC – s 130(1).
However, under s 128(4) a 3rd party is not entitled to make a s 129 assumption
where the 3rd party ‘knew or suspected’ that the assumption was incorrect. Thus
everything will depend in such cases on the facts of the case in determining
whether the 3rd party had actual or constructive knowledge of the infringement of
the constitution. If that was the case, then the contract would be voidable by the
Co.
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H. Executing documents
Another way for a company to be bound to a contract or by the contents of a
document is to use the procedure contained in s 127, either with or without using a
company seal. This is just one way (and in fact a very infrequent way) for a Co
to enter into a contract. Most company contracts are entered into by individuals
without any formality of the type covered by s 127. For example, a checkout
operator in a supermarket enters into contracts on behalf of the corporation they
are employed by, because selling groceries lies within the implied authority of a
checkout operator.
A Co does not have to have a common seal – s123 makes having a seal optional.
If a Co has a common seal it must reflect the wording prescribed in s 123(1). Use
of a seal not carrying the prescribed info is an offence – s 123(3).
When used, s 127(2) requires that the seal be attested by
2 directors or
1 director and the Co Sec or
where a Pty Co has only 1 director who is also Co Sec, that person
When a Co assents without using a seal, then s 127(1) requires signature by
2 directors or
1 director and the Co Sec or
where a Pty Co has only 1 director who is also Co Sec, that person
Section 127(3) states that a Co may execute a document as a deed in either of the
ways stipulated in ss 127(1) or (2).
A person is entitled under s 129(6) to assume that a doc has been executed under
seal if the seal appears to have been affixed under s 127(2) and to have been
witnessed as required by that section.
Similarly under s 129(5) a person can assume that a document has been assented
to without seal if s 127(1) appears to have been complied with.
Note that the s 128(3) assumptions can be made even where a sealing or
attestation are forgeries.
Exercise
Fred was appointed as a salesman by Silver Star Motors Ltd, which
sells luxury cars. One of the conditions of his appointment was that
he could not give discounts of more than 5% on cars without the
approval of his regional Sales Manager. One Friday, towards the
end of the financial year, Fred was approached by Tom, who is the
Vehicle Purchasing Manager for Hyatt Hotels Australia Pty Ltd.
Tom has been given the job of buying a new fleet of cars to take
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hotel guests to and from the airport. He says that he is willing to
purchase six Mercedes Benz 450SE cars. Fred is desperate to make
his sales quota for the year and says he can give Tom a 15%
discount. Tom says that he will get back to Fred later that day.
Tom goes back to the hotel and tells a colleague, Michael, about
the potential deal. During the course of the conversation Tom says
‘This discount seems huge – in fact, too good to be true. I’ve never
heard of a 15% discount before, do you think the salesman can
offer it?’ but Michael says ‘Look, think of how great it would be if
you were able to get these cars at such a great price.’
Tom phones Fred and agrees to the deal. It is agreed that delivery
of the cars and payment of the money by bank draft will take place
on the following Tuesday. However, when Tom goes to the Silver
Star Motors showroom on Tuesday, the manager refuses to accept
the bank draft or hand over the cars, saying that Fred did not have
authority to give a 15% discount.
Advise Hyatt Hotels Australia Ltd as to their legal position. You
should assume that all the facts in the question are provable in
court.
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Topic 16 Corporate governance – the constitution
Learning Objectives
After completing this topic, you should be able to:
1. Distinguish between those parts of the Corporations Act
2001 (Cth) which are mandatory and those which are
replaceable;
2. Write my Essay Online Writing Service with Professional Essay Writers – Explain the process whereby a corporation adopts a
constitution;
3. Appreciate who is bound by the constitution;
4. Be aware of the limitations on the power of a corporation to
amend its constitution.
A. Internal governance
In this topic we will examine the rules which govern the relationship between the
participants of a company – called the internal governance rules.
We know that a company is a separate legal entity and we know that one of the
functions of company law is to regulate how this separate entity operates. Internal
governance involves rules agreed between the members to govern the internal
workings of the company. That is, the relationship between the company and its
members and officers.
B. Replaceable rules and the company constitution
The requirements for internal rules were changed in 1998 with the passing of the
Company Law Review Act 1998 (Cth). Prior to 1998 a company’s internal rules
consisted of two documents
 memorandum of association
 articles of association
In 1998 the requirements for memorandum and articles were abolished.
Now, under s 134 of the Corporations Act 2001 (Cth), internal governance of Co
is controlled by
those parts of the CA are mandatory, in that they cannot be replaced or
excluded by a Co
the common law, some of which cannot be evaded
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the replaceable rules contained in the CA – i.e. those rules which can be
varied by a Co (under s 135(2))
the Co’s constitution – i.e. the variations to the replaceable rules it has
chosen to make.
Thus it is quite likely that a Co will be governed by a combination of: those of the
replaceable rules it has not chosen to alter and those rules it has altered by its
constitution as permitted by s 135(2).
Under s 135(1)(a) rules can be
replaceable in respect of all companies, or
replaceable for Pty Co’s and mandatory for public Co – eg s 249X relating
to appointment of proxies to vote at meetings – Pty companies can exclude
right to appoint proxies, but shareholders must be able to appoint proxies in
the case of public companies
The replaceable rules are tabulated in s 141.
The constitution can be adopted either
By members agreeing to its terms upon registration of Co – s 136(1)(a)
By special resolution (defined in s 9 of the CA as 75% of votes cast) after
registration – s 136(1)(b)
Infringement of the replaceable rules in the CA (s 135(3)) or the Co constitution is
not a contravention of the CA (so the CA provisions re criminal and civil liability
and injunctions do not apply) but under s 140(1) the replaceable rules and the
constitution act as a contract, compliance with which is enforceable by
contractual remedies as between
the Co and its members – so Co can get an injunction to compel members to
adhere to constitution (Hickman v Kent or Romney Marsh Sheep Breeders’
Assoc [1915] 1 Ch 881) and members can similarly enforce their rights as
members against Co
the Co and its Directors and the Co Sec
the members inter se
It is however important to note that the provisions of a Co constitution are not
enforceable by outsiders, or by members in a capacity other than as member. In
other words, members are able to enforce the constitution only in relation to their
rights as members – they cannot enforce other rights that the constitution might
give them in a different capacity unrelated to their status as a member:
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Eley v Positive Government Life Assurance Co Ltd (1875) 1 Ex D 20, held
that where a clause in a Co’s constitution said that one of the members of
the Co would be the Co’s solicitor, but then deprived him of that role, he
could not enforce the clause, as he was not seeking to enforce rights relating
to his status as a member
In Forbes v. NSW Trotting Club [1977] 2 NSWLR 515, the plaintiff was a
professional gambler and the club excluded him from its racetracks. He
tried to have the decision overturned on the basis that it did not comply with
the club’s constitution. The court said that, as an outsider, he could not take
measures to make the club abide by its constitution.
A problem often arises as to whether the conditions of service of directors are
governed by the Co constitution or by a separate contract that the director has with
a company. If a director has no separate service contract with a Co, then his rights
derive solely from the constitution, and he can enforce them under s 140 if he is a
member. However, if the Co alters the constitution so as to change those rights,
the director is subject to the changes – Shuttleworth v Cox Bros & Co
(Maidenhead) Ltd [1927] 2 KB 9.
If, however, the director has a separate contract of service, a change in the
constitution can have no effect on his contractual rights – Allen v Gold Reefs of
West Africa Ltd [1900] 1 Ch 656. Although a Co may remove a director in such
circumstances the Co remains liable for any contractual breach that might thereby
have occurred.
If both the constitution and the contract are dependant on each other, then even if
the constitution is amended so as to permit dismissal of the director, he can still
claim damages arising out of breach of the contract – Carrier Australasia Ltd v
Hunt (1939) 61 CLR 534.
C. Limitations on the power to amend the constitution
A Co may repeal or modify its constitution by special resolution – s 136(2).
Under s 9 of the CA, a special resolution requires approval by 75% of the votes
cast. However, if the Co wants to, its constitution can require a higher majority or
other special procedure (s 136(3)).
A Co cannot however deprive itself completely (either in the constitution or by
separate contract) of the statutory right to amend as this would be inconsistent
with s 136(2).
Amendments cannot increase liabilities of existing shareholders or restrict their
rights to transfer shares, unless consented to in writing – s 140(2).
If the rights of a specific class of shareholders are varied, and the constitution
does not specify a special procedure for variation, then a variation will be valid
only if approved of by a special resolution of the shareholders of that class and a
special resolution of the shareholders as a whole (s 246B(2)).
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The general rule is that a majority of shareholders is free to amend the company’s
constitution by special resolution. The test for whether an amendment is valid is
whether the amendment is ‘bona fide in the best interests of the company’ in Allen
v Gold Reefs of West Africa. This test is easy to satisfy because, as was held in
Peters’ American Delicacy Co Ltd v Heath (1939) 61 CLR 547, the test means
that that the courts would not interfere unless the decision to amend was such that
no reasonable group of shareholders could have arrived at it – ie was absurd.
However, special considerations apply when an amendment treats a minority
unfairly. In Gambotto v WCP Ltd (1995) 182 CLR 432, the HC held that
(i) amendments to the constitution that give rise to conflicts of interest between
majority and minority shareholders by permitting expropriation of shares or
of valuable property rights in shares are prima facie invalid – i.e. the onus is
on majority to justify them, also note that
such amendments must be exercised for proper purpose, and
must not operate oppressively against minority
(ii) other amendments which give rise to conflict of interest between majority
and minority are prima facie valid but
such amendments will be voidable if shown they are for an improper
purpose in light of the constitution or are oppressive (the concept of
‘oppression’ is discussed under the Topic relating to members’
remedies).
In so far as (i) is concerned, and specifically expropriation, this will be for a
proper purpose only where the continued minority shareholding is detrimental to
the Co and it is reasonable to address it by expropriating. Examples of proper
purpose would be where the minority shareholders is competing with the Co –
Sidebottom v Kershaw, Leese & Co Ltd [1920] 1 Ch 154 or where the Co would
not legally be able to continue functioning (e.g. eliminating foreign shareholding
if required by law)
Note that the Gambotto decision restricted amendments to company constitutions
only where the amendment treats a majority and a minority differently – in all
other circumstances, the majority is free to amend the constitution by special
resolution.
Because of the difficulty posed by the Gambotto decision, Parliament enacted a
set of provisions contained in Pt 2J.1 (ss 256B-C) of the Act, which now permit
companies to compulsorily acquire shares from, provided that certain procedures
laid down in the Act are complied with. This area is technical and is outside the
ambit of this subject.
Exercise
Mr Rebel and Mr Penfold are the majority shareholders of Hunger
Wines Pty Ltd, owning 98% of the issued shares between them.
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The remaining 2% are held by a number of small shareholders.
The company needs more capital for expansion, and Rebel and
Penfold state that they are willing to lend the required funds to the
company if the 2% shareholding is eliminated. They approach you
for advice as to whether they can alter the constitution in order to
achieve this objective. (In answering this question do not concern
yourself with Pt 2J.1 of the Act – answer with reference to
the Gambotto decision).
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Topic 17 Members’ meetings
Learning Objectives
After completing this topic, you should be able to:
1. Write my Essay Online Writing Service with Professional Essay Writers – Explain how a person becomes a member of a company;
2. Understand the procedures for calling members’ meetings;
3. Understand the statutory remedies that are available when
irregularities occur in relation to members’ meetings.
A. Introduction
As we saw in the preceding Topic, generally the directors may exercise all the
powers of the company except any powers that the Corporations Act or the
company’s constitution (if any) requires the company to exercise in general
meeting. Therefore, the voting rights of members are limited to matters expressly
reserved for member’s decision-making in the:
a. internal governance rules,
b. the CA, and
c. the common law.
B. Membership of a company
The members of a company are its shareholders. Every company must have at
least one member (s.114). Proprietary companies can have a maximum of 50
non-employee members. There is no limit on the number of members for a public
company.
Any person who is capable of holding property in their own name may be a
member of a company. This includes artificial persons, so a company may be a
shareholder of another company.
A person under the age of 18 years may be a member of a company.
A person becomes a member when their name is entered on the register of
members.
A person will cease to be a member when they sell their shares and their name is
removed from the register of shareholders, partly paid shares are forfeited if they
fail to pay a call; or when the company ceases to exist (ie is wound up).
The constitution of a company not listed on the ASX can impose restrictions on
the transfer of shares. This is common in proprietary companies because the
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existing members want to restrict who can be involved in the business. This is
especially so when a family is involved. Listed companies cannot restrict the
transfer of shares.
C. Members’ meetings
What power the shareholders have is governed by the CA, the common law and
the specific corporation’s constitution. Under the Act, the default position is that
it is the board that is responsible for the running of the business of Co – s 198A.
As stated in Automatic Self-Cleansing Filter Syndicate Co v Cuninghame [1906] 2
Ch 34, this means that the directors are not subject to the direction of the
shareholders in their running of the Co.
This rule has been interpreted very strictly in cases such as NRMA v Parker
(1986) 6 NSWLR 517 and Australasian Centre for Corporate Responsibility v
Commonwealth Bank of Australia (2016) 113 ACSR 600 as meaning that
shareholders do not have the right even to express an opinion about how the board
and management exercise their powers, which demonstrates how restricted the
rights of shareholders are in Australia.
It would be possible for a company’s constitution to over-ride s 198A (because
that section is a replaceable rule), by giving a GM of shareholders the power to
direct the board in matters relating to the running of the Co, but this is very rare.
However, under the CA, certain matters must be decided by general meeting.
These are the most important:
alteration of constitution – s 136
altering rights attaching to shares, unless the constitution specifies another
method – s 246B
changing the type of Co – s 162(1)
in the case of a public Co, removing a Director – s 227
Shareholder meetings can be by phone or video – s 249S.
A document signed by all members of a Pty Co will be effective as a resolution –
s 249A.
Every public Co (other than one with only 1 member) must hold an AGM (annual
general meeting) – s 250N. Not required of Pty Co’s.
The directors of a public Co must lie before meeting financial report, a directors’
report and an auditor’s report – s 317.
A reasonable opportunity for questions must be provided to shareholders: s 250S
and T.
Resolutions can be put before GM on notice by 5% of votes that may be cast or
100 members of Co entitled to vote at a GM, whichever is the lesser.
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Apart from the AGM, other ‘extraordinary’ GM’s may be called by
the board – as part of its general running of Co
an individual director – s 249C (replaceable)
members with 5% of votes that may be cast or 100 members that can
attend may request the directors to call a meeting under s 249D – giving
notice to Board stating any resolutions to be proposed. The meeting must
be for a proper purpose, remembering that in accordance with NRMA v
Parker (1986) 6 NSWLR 517 and Australasian Centre for Corporate
Responsibility v Commonwealth Bank of Australia (2016) 113 ACSR 600
a meeting would not be for a proper purpose if it was to interfere in
management.
The directors may refuse to call a meeting (NRMA Ltd v Parker (1986) 6
NSWLR 517). However, if the directors fail to issue a notice for meeting
within 21 days, members with >50% of votes that may be cast may
convene it themselves – s 249E, and the Co is required to pay expenses of
meeting, which it may recover from the directors jointly and severally
(unless a director can prove reasonable steps to try to get other directors
to comply). In other words, while the directors do not expose themselves
to any liability if they refuse to call a meeting requested by shareholders
controlling between 5 and 50% of the votes, they would be very foolish
to refuse a request by members controlling more than 50% of the votes,
as the directors, rather than the Co, would end up paying the costs of it.
Members with between 5% and 50% of the votes that may be cast may
themselves call a GM at their own expense if one is refused by the
directors – s 249F. This provision is not replaceable and so the members’
right to call meetings cannot be denied.
The court may call a meeting – e.g. under s 1322 where the directors have
failed to do so under s 249D, or under s 249G where it is impracticable
for meeting to be called any other way (eg deadlock in small Co).
Notice provisions for meetings (generally 21 days – s 249H(1)).
Note that shorter notice provisions are available under s 249H (if all members
agree beforehand in the case of an AGM, or if 95% in the case of any other GM (s
249H(2)) – but this is unavailable when meeting is to remove D or auditor
(s 249H(3) and (4)).
A company is obliged to send notice of general meetings to each individual
shareholder in writing – s 249J(1). The only circumstance in which more than
one shareholder may be covered by a single notice is where shares are held
jointly.
The directors have a fiduciary duty to provide info regarding business to be
discussed at meetings – Fraser v NRMA Holdings Ltd (1995) 55 FCR 452.
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Notice must be given of proposed special resolutions when the directors call a
meeting on members’ request (s 249D), where members call meeting (s 249F) or
where members wish to propose resolution at meeting (s 249N).
Special notice (2 months) must be given for resolution removing a director of a
public Co (s 227) or auditor of any Co (s 329). However, if notice was given but
the meeting was called for a date before the 2 months expires, the resolution can
be dealt with (s 203D(2) and s 329(1A)).
Ordinary resolution = simple majority of those voting.
Special resolution = 75% of votes cast (s 9)
Special resolutions are required for matters including:
 adoption or amendment of the constitution – s 136
 change in Co name – s 157
 change in Co type – s 162
 variation of class rights where constitution doesn’t specify procedure – s
246B
 giving of financial assistance for acquisition of shares – s 260B
 voluntary winding up – s 491
The constitution may in addition require special resolution for other matters, but
note that s 203D resolution for removal of a director of a public Co must be by
ordinary resolution.
Under replaceable rule s 250E, voting at GM of Co with share capital is as
follows:
on show of hands, each member has 1 vote, irrespective of shareholding
on a poll each share has 1 vote – subject to variations in class rights
A poll must be granted if demanded – s 250K. A poll may be demanded by at
least 5 members entitled to vote, members with at least 5% of the votes that may
be cast or the chairperson; the constitution can specify lesser number – s 250L.
When shares have been sold, the price paid but the shares not transferred, the
seller is required to vote as directed by the purchaser. If the price has not been
paid, the seller continues to vote his mind, unless the contract stipulates otherwise.
A member may become contractually bound to a 3rd party to vote shares as
directed by the 3rd party, and this can be enforced by a mandatory injunction as
between the member and the 3rd party, but will have no effect against the Co or on
the validity of votes cast.
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A member can appoint a proxy to vote his shares – s 249X (mandatory rule for
pub Co’s, replaceable for Pty Co’s).
D. Irregularities
Section 1322 governs the consequences of irregularities.
Under s 1322(2), a mere ‘procedural irregularity’ will not invalidate a proceeding
unless an application is made to court and the court finds that the irregularity has
caused or may cause substantial injustice that cannot be remedied by any other
order. What is a ‘procedural irregularity’? Section 1322(1) gives a non-exclusive
definition as including absence of quorum, or failure to comply with the Act in
relation to notices of meetings or time periods.
The effect of this provision is that a person who wants to overturn a proceeding or
a meeting because of a procedural irregularity bears the onus of proving that
allowing the irregularity to stand would cause a substantial injustice. In practical
terms this means that they have to prove that the outcome would have been likely
to be different if the irregularity had not occurred, but if the same outcome would
have occurred, the courts will not intervene.
Exercise
The annual general meeting of Sparx Ltd is held on 1 July.
Vladimir and Anushka, who are married and who live at the same
address, are both shareholders in the company. Vladimir owns
30% of the shares in the company, and Anushka 5%. The company
had sent out a notice on 23 June stating that the meeting was to take
place on 1 July. However, it sent only one notice to Vladimir and
Anushka’s address, and that notice was addressed to Anushka.
Anushka did not tell Vladimir about the meeting and so he did not
attend. Several motions are agreed to at the meeting, including an
amendment to the company’s constitution. When Vladimir hears
of the meeting and the amendment (which he says he would
certainly have voted against), he is furious, and approaches you for
legal advice.
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Topic 18 Members’ remedies
Learning Objectives
After completing this topic, you should be able to:
1. List the common law and statutory remedies available to
members;
2. Appreciate the limited nature of common law remedies;
3. Write my Essay Online Writing Service with Professional Essay Writers – Explain the circumstances in which common law and
statutory injunctions are available;
4. Determine when members are able to access a company’s
financial records;
5. Understand the importance of the statutory derivative action
which members can bring on behalf of the company to
remedy harm done to it;
6. Understand the concept of ‘oppression’ and in what
circumstances the remedy for oppression is available;
7. Understand the circumstances in which compulsory winding
up is available as a remedy and its drastic nature.
A. Common law remedies
The common law offers a remedy where there has been an infringement of the
rights a shareholder enjoys in their capacity as a shareholder, as held in Hickman
v Kent or Romney Marsh Sheep Breeders’ Association [1915] 1 Ch 881.
Thus a shareholder could take action to prevent expropriation of their shares,
interference in their voting / dividend rights, or improper conduct of shareholder
meetings. Note however that a shareholder cannot enforce provisions of the
constitution which confer a personal right on them unrelated to their status as a
shareholder (see Eley v Positive Government Life Assurance Co Ltd (1875) 1
Ex D 20, discussed in a previous Module).
A shareholder can also use the common law injunction to prevent breaches of the
company constitution in so far as such breaches relate to the running of the
company, as s 140(1) states that it has the effect of a contract between the
members, the Co and its directors. Thus, for example, a shareholder could seek an
injunction if the board was breaching a provision of the constitution which
restricted the company’s activity to certain areas of business.
Other than that, where disputes arise in relation to the running of the company, the
general common law principle is that the majority rules. This means that the
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majority may use its voting power to determine issues arising within the Co and
that it will be the majority which determines whether an action needs to be
brought to vindicate Co rights. Thus the common law offers little to assist
members wanting to prevent harm to a company:
Foss v Harbottle (1843) 67 ER 189 – the plaintiffs sought to bring an action on
behalf of Co. The court held that shareholders could not bring an action on behalf
of company where Directors refused to do so because
(i) the Co. is separate entity, it (acting through its Board) must bring
actions on its own behalf.
(ii) the Co. is ultimately governed by majority rule – if shareholders
challenge what the Board has done / not done, the majority decides
when the Co. should act, and so a meeting of all the members is thus
the mechanism to use to control the board. If the majority at such a
meeting ratifies a certain action, then the disgruntled minority cannot
challenge it.
B. Statutory remedies
To address the lack of common law remedies available to shareholders wanting to
challenge wrongdoing in relation to how a company is run, the CA provides a
number of statutory remedies to shareholders.
It is very important, when dealing with problems in this area of the law, to analyse
the facts of the problem, to determine exactly what wrongdoing has occurred and
to select the correct remedy or remedies that are available to address that
specific wrong. In other words, one needs to recognise at the outset that each
remedy deals with a specific type of wrongdoing. It is not sufficient simply to
state that ‘a statutory remedy is available’ without identifying what wrong has
occurred and which remedy is available.
Video
(i) Injunction
An injunction is a court order requiring someone to stop doing something
unlawful – in other words, it exists to stop or prevent current or future
wrongdoing. It is of no assistance in relation to events that have already occurred.
The s 1324 injunction is available where someone is, or is about to, infringe the
Corporations Act.
Note that this is different from the common law injunction used to prevent
infringements of the company constitution as a contract, as a breach of the
constitution is not a breach of the Act.
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The s 1324 injunction can be brought by ASIC or anyone whose interests may be
affected by conduct complained of. In Airpeak Pty Ltd v Jetstream Aircraft Ltd
(1997) 23 ACSR 715 – held that a shareholder had standing to seek an injunction
for any breach of the CA, such as a director’s failure to comply with ss 180-183
duties.
(ii) Statutory derivative action
Normally, when harm has been done to a company, it is only the board, or its
delegate, who can initiate legal action on behalf of the company against the
wrongdoer (be they someone inside the company or a 3rd party). This is in
accordance with the principles enunciated in Foss v Harbottle (1843) 67 ER 189.
An ordinary shareholder cannot bring actions on behalf of the company, because
the company is run by the board, not the shareholders.
Normally one would expect a Co to initiate legal action against a person who has
harmed it, and this is what happens in 99% of cases. However, where the
company (not the shareholders) has been harmed and the board has refused to
take action after having been given an opportunity to do so, a shareholder or
group of them can, after seeking permission of a court, bring a statutory derivative
action on behalf of the Co – s 236(1).
Standing to apply to court for permission to bring the action is conferred upon
members, former members or person entitled to be registered as a member, or an
officer or former officer.
The classic example of where it will be necessary to bring the statutory derivative
action is where someone harms the Co and the board refuses to take legal action
against that person – eg where a director expropriates Co property by taking a
corporate opportunity, and the rest of the board will not act against him or her:
In Cook v Deeks [1916] 1 AC 554 a railway Co. had four directors who
were each 25% shareholders. Three directors knew a certain contract would
be beneficial to Co, but formed their own Co. to enter into the contract! An
action was brought by other Director. The court held that the three had
misappropriated Co. property (the opportunity), and ordered them to
surrender their profit. Furthermore, their conduct was not ratifiable by the
board or even by a GM a majority cannot strip a Co. of its assets, as that
affect both the company and the minority adversely.
Because the action departs from the normal rule that it is the board which decides
whether to launch legal action on behalf of the Co, it is necessary to obtain leave
of court to bring the derivative action – s 237. Research Topics – Criteria used by the court in
determining whether to give leave – s 237(2) are:
it must be probable that the Co will not itself bring the proceedings
the applicant must be acting in good faith
it is in the best interests of the Co that the applicant be granted leave
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there is a serious question to be tried
the applicant gave 14 day’s notice to Co
Perhaps the most important of these will be the issue of whether the action is in
the best interests of the Co – will be used as a filter by the courts to exclude
actions based merely on mere commercial disagreements between minority and
majority: there must be some harm to the Co.
Note that where the action is between the Co and a 3rd party (NB defined in s
237(4) as excluding related parties of Co’s as defined in s 228 – thus the directors
are not 3
rd parties for the purposes of s 237), a rebuttable presumption arises under
s 237(3) that it would not be in the best interests of the Co to grant leave if all the
directors who participated in the decision not to bring an action
acted in good faith and for proper purpose
had no material personal interest in the decision
informed themselves to a reasonable extent about the subject matter
rationally believed the decision not to bring the action was in the best
interests of the Co – such a belief is rational unless it is one that no-one in
the position of the Ds’ could hold it
Note that the court can appoint an investigator to report on Co’s situation in order
to assist court in coming to a decision – s 241(1)(d).
The GM has power to ratify a director’s breach of duties, but only in certain
circumstances:
In Bamford v Bamford [1970] Ch 212, the court held that it was competent
for GM to ratify the directors’ exercise of share issuing power for improper
purpose (fending off takeover).
However, ratification contrary to wishes of a minority is not possible where
the director who committed the wrong is also a shareholder and uses their
voting power as a shareholder to ratify their own wrong, as in Cook v Deeks.
Similarly, a purported ratification was invalidated by the court in Parke v
Daily News Ltd [1962] Ch 297, where the directors used their majority
shareholding to ratify their giving of large payouts to certain employees.
In other words, a party whose acts are being ratified cannot use the votes
attaching to their shares (if they are a shareholder) to help ratify their own
breach – they must abstain from the vote when the shareholders meet to
decide whether to ratify the wrong done by the director.
In any event, under s 239 ratification in any circumstances (i.e. whether the Co
has been harmed or not) is not an impediment to granting leave, but is only one
factor to be taken into account by the court, bearing in mind how well informed
the members were and whether they were acting for a proper purpose – s 239(2).
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The court has a discretion re orders about costs – s 242 enables the court to order
that the company bear the costs of the action by the minority.
(iii) Member’s remedy for oppressive or unfair conduct
The remedy for oppression is provided by s 232.
This is a very broad remedy and is available where the Co’s ‘affairs’ (defined in s
53) are being conducted, or act or omission, or proposed act or omission, is /
would be oppressive or unfairly prejudicial to members or unfairly discriminatory
against them or contrary to interests of members as a whole. Note that the same
set of facts can potentially give rise to a number of alternative actions. For
example, a course of conduct by directors could contain elements which harmful
to the Co (which would be remedied by the s 236 derivative action) and elements
which were oppressive to shareholders (which would be remedied using s 232) –
but one must remember that the s 232 remedy deals with a different type of harm
than does s 236-7. Section 232 deals with unfair or oppressive conduct towards
shareholders, whereas s 236-7 deals with harm to the company.
It is therefore always important, when dealing with problems in this area, to firstly
determine who has been harmed (the company or the shareholders) and then to
select the appropriate remedy (s 236 or s 232).
The s 232 action can be brought by member (even in respect of acts before he
became a member) or by ASIC.
The courts have interpreted ‘oppressive…etc’ very broadly – it is a composite
expression – not a set of individual wrongs – and points to an overall concept of
unfairness / injustice.
The test for unfairness is that of the objective bystander. The applicant does not
have to show that defendants knowingly acted in an unfair manner. Fairness is
looked at from the perspective of all interested parties.
In Scottish Co-operative Wholesale Society Ltd v Meyer [1959] AC 324 a
court found oppression where a holding Co. nominated three directors of a
subsidiary. They used their power to strangle the subsidiary by refusing to
supply it with raw materials. The court held the holding Co. was acting
oppressively in its capacity as shareholder of the subsidiary.
To what extent will the court’s scrutinise commercial decisions? In Wayde
v NSW Rugby League Ltd (1985) 180 CLR 459 the court suggested that a
commercial decision might be unfair / oppressive even if bona fide and for
proper purposes if it could be shown that no reasonable Board could have
arrived at it. However, more usually the courts are reluctant to impugn
business decisions. In other words, mere disagreement by a group of
minority shareholders relating to the commercial direction of the Co will not
in itself lead to a finding of unfairness.
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In Thomas v HW Thomas Ltd (1984) 2 ACLC 610 a shareholder wanted to
be bought out of a conservative Co which paid few dividends. A general
meeting had refused to sell company assets in order to get capital to
repurchase his shares. Many employees were also shareholders, and the
company was run with the primary objective of keeping members of the
family who owned it in employment. The court refused the application. It
held that the elements of the statutory definition of ‘oppressive conduct’
definition overlap with each other, and the overall effect is to prevent
conduct which is ‘unjustly detrimental’ – i.e. unfair – a ‘visible departure
from standards of fair dealing in light of reasonable expectations’. The
court held that it is not necessary for a plaintiff to adduce evidence of
illegality or bad faith, but failure to demonstrate absence of probity or good
faith makes the order less likely. The court must also be satisfied that
granting order is ‘just and equitable’ – i.e. fairness is a two-way street – it
must be fair to other shareholders and Co. Held not unreasonable, in the
case of a family Co. for the Co. to be operated primarily to give
employment rather than dividends. It was also premature to say that the
plaintiff was ‘locked in’ – no objection would be raised by the Co to a
purchaser who was not a member of the family.
Exclusion from management can be found to be oppressive, as in Fexuto Pty
Ltd v Bosnjak Holdings Pty Ltd [2001] NSWCA 97, where the court found
that a closely held family Co (Bosjnak), with directors who were two
brothers + their sister-in-law, had acted oppressively towards one of the
brothers by excluding him from board discussions. There are interesting
aspects of this case: (i) the court said that the Co should be equated to a
partnership in which all three directors had a right to participate, even
though it was a Co and (ii) the application was brought by Fexuto, the Co
controlled by the excluded brother through which he held his interest in
Bosnjak, rather than by the brother himself – this emphasises that a
shareholder (in this case Fexuto, who had elected the brother as D of the Co)
does not need to show that it has been unfairly treated, only that there has
been unfair treatment in relation to the affairs of the Co.
The court can grant various orders – s 233(1) – and it is important to determine
which of these orders is most suitable – ie will address the specific type of
oppression that has occurred.
winding up, provided that this does not prejudice the oppressed members –
note that because this is the most drastic order available, it is also the one
least likely to be granted (s 233(1)(a))
an order regulating conduct of Co’s affairs (s 233(1)(c)) – can even include
removing or appointing persons as directors (Spargos Mining).
a reduction in Co’s capital and payment to applicant (ie the company
purchases a person’s shares from them) – s 233(1)(e)
an order directing Co to institute proceedings against someone (s 233(1(f))
or authorising member to do so on Co’s behalf, with the court at actual
hearing having the power to indemnify the member for the costs of the
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action, irrespective of outcome). A court would usually require its consent
for discontinuance or settlement of action – s 233(1)(g).
an order restraining someone from doing something – s 233(1)(i)
an order requiring someone to do something – s 233(1)(j)
Where the order is for purchase of shares, valuation must be fair – Dynasty v
Coombs (1995) 13 ACLC 1290. Various accounting methods have been used to
determine a fair value.
Note that relief under s 232 will not be granted where the situation is simply one
of deadlock over the direction of the Co with no-one at fault – in such
circumstances winding up on the basis of deadlock is the appropriate remedy
(s 461(k)). Similarly s 232 cannot be used as a way for a member to force buy-out
in a way not prescribed by the constitution where he / she is unable to find a buyer
for his / her shares.
(iv) Winding up
Members may petition the court to compulsorily wind up a Co. Because winding
up is a drastic remedy, it will be used only where court is satisfied that no other
remedy is available – s 467(4).
Circumstances in which the order can be given are:
where it is ‘just and equitable’ to do so – s 461(k)
where the directors are running Co in their own interests rather than in those
of members as a whole or in an unfair or unjust manner- s 461(e)
where Co affairs are or will be run in an unfairly prejudicial manner or in a
manner contrary to shareholders as a whole- s 461(f) and (g)
Note the overlap between s 461(f) and (g) and the same remedy in s 233(1)(a)
An example of winding up on the basis of ‘unfair and oppressive conduct’ is
Kokotovitch Constructions Pty Ltd v Wallington (1995) 17 ACSR 478 in
which the court held that the ‘moral partnership’ which existed between the
two shareholders had broken down because the one had tried to dilute the
shareholding of the other.
An example of winding up on the ‘just and equitable’ ground is provided by
Ebrahimi v Westbourne Galleries [1970] AC 360, E and N were partners in
rug business. Then converted the business into a Co, with E, N and N’s son
as shareholders. N and son used majority power to freeze E out of business.
The court granted order to wind up – it held that the Co was ‘quasipartnership’
and was formed on basis that both E and N would continue to
run business. For this reason it was just an equitable to wind up. (Note
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similarities with Fexuto Pty Ltd v Bosnjak Holdings Pty Ltd [2001] NSWCA
97).
Note that a Co originally formed as a quasi-partnership may cease to be treated as
such as new members join.
The ‘just and equitable’ ground has also been used where a Co was formed with
the intention of defrauding the investing public, where a majority has denied the
minority access to info, or where a dispute between shareholders has resulted in
deadlock as in Re Yenidje Tobacco Co Ltd [1916] 2 Ch 426, where two people
who were equal shareholders and the only directors of a Co were hostile to the
extent that they could not communicate with each other. Note that in such cases
there is no need for to prove oppression or unjust or inequitable conduct on either
side.
(v) Miscellaneous statutory remedies
Under s 50 of the ASIC Act, ASIC may, following an investigation, bring an
action for damages for fraud, breach of duty etc and for recovery of property in
the name of any person, including the Co.
Exercise
Space Optics Ltd is a business that provides components for
telescopes. The business was originally formed in 2005 as a
partnership between Bridget, Adeline, Mark and Daniel, all of
whom were graduates in optical engineering. They divided the
country up between them, and each marketed the firm’s products in
distinct geographic areas, returning to their Canberra base for a
monthly meeting of the partnership. In 2010 they incorporated the
business, each holding an equal 1/4 share in the company, and each
being named a director.
The company’s constitution, which requires a 90% vote to be
changed, contains the following provision:
23 The objects and business of this company are restricted
to the manufacture, sale and servicing of optical
equipment.
Daniel finds out that in January 2017, Bridget, Adeline and Mark
had a secret meeting at which they decided to move into the area of
property development.
He also discovers that Bridget has not visited customers in South
Australia and Western Australia (the areas of the country allocated
to her) since the beginning of the year, and has instead spent her
time investigating the property market in Queensland with a view
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to finding suitable investment opportunities for the company. As a
result of Bridget’s carelessness, Space Optics Ltd has lost orders
worth $ 800 000 from established clients in Perth and Adelaide.
Daniel confronts the other three directors at a board meeting in
March 2017. The meeting is acrimonious. Adeline, Bridget and
Mark presenting a united front against Daniel, and state that they
are adamant that, in their opinion, it would be in the best interests
of the company that it abandon optics and move into property
speculation, and that they will carry on taking steps towards that
end.
Adeline, Bridget and Mark also vote against a motion proposed by
Daniel calling for legal action to be taken against Bridget to recover
the $ 800 000 in losses she cased.
The meeting approves a dividend of 25c per share but subject to a
motion that Daniel’s share of the dividend will be withheld.
Finally, Daniel has also learnt that Adeline is about to take a
holiday to the Gold Coast, using company funds.
Advise Daniel as to what remedies are available to him, specifying
each type of harm that has occurred and what the appropriate
remedy is.
(In answering this question, you should assume that Bridget’s
actions regarding the customers breached s 180(1) of the Act and
that Adeline’s proposed use of company funds for the holiday
would breach s 181).
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Topic 19 Directors
Learning Objectives
After completing this topic, you should be able to:
1. Understand the division of powers between directors and
members of a corporation;
2. Define who is a director, de facto director and shadow
director;
3. Define who is an officer of a corporation;
4. Understand the process for appointing directors and how
they vacate office.
A. Introduction
A Co exists to enable those who own and control Co (through shareholders’
meeting) to separate themselves from running the Co. This is the responsibility of
the board of Directors, who are elected in terms of the constitution. Of course, in
the case of some companies, major shareholders may also elect themselves as
directors, but this is more common in the case of small, family companies,
whereas larger companies with many thousands of shareholders will often elect
boards on the basis of expertise and industry knowledge whose members are not
necessarily shareholders in the Co.
Another distinction in the way companies are governed is between those where
members of the board do not involve themselves in the day to day management of
the co, which is done wholly by executive managers given authority by the board
(in which case the directors are described as ‘non-executive directors’), and those
where the directors are ‘executive directors’ who, along with being members of
the board, actually work in and run the Co from day to day. Most boards consist
of a mixture of non-executive (sometimes called ‘independent’) directors and
executive directors.
B. Division of powers
Every Co must have Directors: Pty Co 1 – s 201A(1), public Co 3 – s 201A(2)
The initial directors are those named when Co is registered – s 120(1).
Subsequent directors are appointed under replaceable rules ss 201G and H, or the
rules in the particular Co’s constitution.
Under the Act, the default position is that it is the board that is responsible for the
running of the business of Co – s 198A. As stated in Automatic Self-Cleansing
Filter Syndicate Co v Cuninghame [1906] 2 Ch 34, this means that the directors
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are not subject to the direction of the shareholders in their running of the Co.
It would be possible for a company’s constitution to over-ride s 198A (because
that section is a replaceable rule), by giving a GM of shareholders the power to
direct the board in matters relating to the running of the Co, but this is very rare.
The vesting of management powers in the board under s 198A means that the
shareholders are excluded from running the Co – the only way shareholders can
get the board to do what they want is (i) through a change to the Co constitution in
a general meeting so as to restrict the power of the directors, or (ii) by removing
the directors whose policies the shareholders disapprove of, using the processes
provided for by s 203C or 203D.
C. How are the terms ‘director’ and ‘officer’ defined?
As we will see in the next Module, what are commonly referred to as ‘directors’
duties’ bind not only people who have that title, but to other officers of a company
as well. It is therefore necessary to understand the definitions of the terms
‘director’ and ‘officer’.
Under s 9, a director includes
someone appointed to the position of director (whatever called), and
someone not validly appointed as director but who
(i) acts as a director or
(ii) is someone upon whose directions the directors are accustomed to
act
Point (i) covers de facto directors – ie people who act as directors even though
they are not as in
Corporate Affairs Commission v Drysdale (1978) 141 CLR 236 – director
appointed to fill temporary vacancy on board – not reappointed at GMtechnically
no longer a director, but continued to act as such – held to be a
de facto director.
Deputy Commissioner of Taxation v Austin (1998) 28 ACSR 565, where the
court found A to be a de facto director because as a matter of fact he
controlled the Co even though he had formally retired from his post as
director. The court stated that whether someone is found to be a director
will be a matter of degree, relevant considerations including
the size of Co – in large Co mere employees might have significant
authority without being directors
internal practices of Co – was person working as an expert
employee rather than as a director?
how the person was reasonably viewed by outsiders
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The key issue is whether the person exercises ‘top level management functions’
Point (ii) covers ‘shadow directors’ (note exclusion in s 9 re professional and
business relationships – eg lawyers, accountants, management consultants)
In Bluecorp Pty Ltd (in liq) v ANZ Executors and Trustee Co Ltd (1994) 13
ACSR 386 the court held that before a person could be found to be a
shadow director, the board would have to be found to act on instructions of
shadow director, not merely stand aside for him and acquiesce in his
actions.
Under these provisions, a person who is not formally appointed as a director, but
who is found to be a de facto or shadow director, will nevertheless be affixed with
all the duties and liabilities of a director. Therefore, when determining whether
someone is subject to directors’ duties, one must bear in mind the broad definition
of ‘director’ contained in s 9.
‘Officer’ is defined very broadly in s 9 as including
(a) a director or secretary of the corporation; or
(b) a person:
(i) who makes, or participates in making, decisions that affect the
whole, or a substantial part, of the business of the corporation; or
(ii) who has the capacity to affect significantly the corporation’s
financial standing; or
(iii) in accordance with whose instructions or wishes the directors
of the corporation are accustomed to act (excluding advice given
by the person in the proper performance of functions attaching to
the person’s professional capacity or their business relationship
with the directors or the corporation).
Section 9 goes on to state that receivers, administrators and liquidators are also
officers of corporations (this is discussed in the Module on liquidation).
The people mentioned in (b)(i) – (iii) can be a broad category, extending below
the level of the board and including senior managers. In Shafron v ASIC (2012)
247 CLR 465, the High Court, focussing on people falling within the scope of
(b)(i), held that in every case it will be a matter of degree as to whether what a
person does within a corporation amounts to participating in decisions which
affect the whole of a corporation or a substantial part. The court also emphasised
that ‘participation’ in the making of decisions can occur even if the ultimate
decision is made by some other person or body, and held that when the appellant,
who was in-house legal counsel in a company, formulated negligent advice to the
board on which the board then acted he was someone who was ‘participating’ in
the board’s decision-making within the meaning of (b)(i). The court also held that
in determining whether a person is an officer within the meaning of (b)(i), the
focus is not solely on whether that person was involved in the making of the
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particular decision which was a breach of directors’ duties– a person may be
found to be an officer on the basis of making other decisions and, for that reason,
be found to be an officer of the company and liable for the decision under
scrutiny.
Note however that the mere fact that a person has the capacity to affect a
company’s financial position does not make that person an officer. In Buzzle
Operations Pty Ltd (in liq) v Apple Computer Australia Pty Ltd (2010) 77 ACSR
410, the court held that even though Buzzle was reliant for its survival on the
transfer of contract rights to it by Apple, whose executives made requests of
Buzzle in relation to how Buzzle conducted its business, that did not make Apple
an officer of Buzzle – otherwise any bank upon which a corporation depended for
finance would be considered an ‘officer’ of the that corporation.
The practical implication of the wide definition of ‘officer’ is that it is preferable
to err on the side of caution in determining whether someone is an ‘officer’, and to
recognise that, depending on the scope of their roles, many senior executives will
fall within the definition of an ‘officer’ of a corporation and will therefore be
bound by what are conveniently referred to as ‘directors’ duties’.
D. The board
When the CA imposes a duty on the Co, it is presumed that it is performed by the
board collectively, the same applies to any powers given the board under the
constitution.
As a matter of practicality, the board usually cannot involve itself with day to day
running of the Co, and so there is usually one person who is appointed as chief
executive of the Co. If this person is a member of the board, they have the title of
Managing Director (MD), or sometimes ‘MD and CEO’. If they are not also a
member of the board, they have the title of CEO. Under law of agency, the MD
has implied plenary authority to bind Co in contract.
The power to appoint the MD / CEO rests with the board.
Section 201J empowers the board to appoint one of their number as MD and to
delegate their powers to him or her (s 198C).
Alternatively, the board may delegate its powers to someone who is not a member
of the board – s 198D(1)(d) – and this person has the title of CEO. In Australia
this is now more common than having an MD as CEO.
E. Appointment of directors
There is no requirement that a director hold shares in the Co.
Initial directors are appointed by people consenting to be directors under s 117
and becoming such upon registration – s 120.
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The method by which subsequent directors are appointed will, in the absence of a
constitution provision, be regulated by the replaceable rules –
replaceable rule s 201G gives the power to appoint to the GM
replaceable rule s 201H states that directors may appoint additional
directors, subject to confirmation by GM
Subject to those parts of the CA which are non-replaceable, the Co’s constitution
may make any provisions it likes on this matter – the constitution may provide for
elections by shareholders (which means that the majority shareholders control the
board – proportional representation is not generally used in Australia), or may
give a particular shareholder the power to appoint directors irrespective of
shareholding (indeed, even an outsider could be given this power), or state that a
specified person is a director.
If a public Co chooses to appoint its directors by resolution at a GM (which is the
procedure used in almost all cases) then each director must be appointed
individually by separate resolution – s 201E, unless the GM has first agreed
unanimously to allow more than one director to be appointed with a resolution – s
201E(1). Appointment contrary to this is a nullity.
In the case of public companies, s 203D(1) requires that the shareholders must
always have the power to dismiss directors by ordinary resolution, irrespective of
what is in the Co constitution.
Eligibility to be a director:
an individual (i.e. a natural person, not a body corporate) least 18yrs old –
s 201B(1).
not be disqualified from holding office:
various offences – s 206B(1)
bankruptcy – s 206B(3)
court order for contravention of civil penalty provision – s 206C /
s 1317E
court order for past management of insolvent corporations – s 206D
court order for repeated contraventions of CA – s 206E
ASIC’s power to disqualify based on liquidator’s report – s 206F
these disqualifications make it an offence under s 206A for someone to
become a director, to carry on in office if already a director and prevent
them from ‘managing a corporation’ – this includes any policy and decisionmaking
relating to Co or substantial part thereof (see s 206A), including by
executives who are not directors – Commissioner for Corporate Affairs v
Bracht (1989) 7 ACLC 40.
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F. Vacation of office
There are a number of ways in which a director can cease to hold office.
The first is compulsorily operation of law – s 206A(2) (essentially becoming
disqualified)
The most usual way for a director to cease to hold office is by resignation, which
is permitted under the replaceable rule in s 203A.
Section 203D(1) requires that a director of a public Co must be able to be
removed by ordinary resolution – note special notice requirements. Pty Co’s are
governed by replaceable rule s 203C to the same effect, but otherwise the
constitution can provide a different rule.
A director of public Co cannot be removed by the board – s 203E.
A court can remove a director under s 233 as a remedy to protect an oppressed
minority.
G. Remuneration
Because they owe the Co a fiduciary duty, which includes not profiting from their
position, under the common law directors were not entitled to any benefit unless it
is expressly permitted by members, replaceable rules or the Co constitution – Re
George Newman & Co [1895] 1 Ch 674.
The default replaceable rule in s 202A is that remuneration is permissible and is to
be fixed by the GM. Company constitutions often provide that MD / CEO’s
salary will be determined by board.
H. The company secretary
A public Co must have a secretary – s 204A(2). A director of a Co may also be its
secretary.
Essentially the Secretary is the Co’s chief administrative officer. He is an officer
of the Co under s 9 and is thus affixed with fiduciary duties. Note the specific
duties secretaries must fulfil under s 188(1).
Exercise
A group of environmentally-conscious shareholders in XYZ Ltd
are concerned that one of the members of the Board, Mr Tuckey,
will persuade the board to sign a contract to purchase an area of
native forest in Tasmania for the purpose of felling the trees and
converting them into timber pulp. The next AGM is 10 months
away. These shareholders approach you for legal advice to see if
there is anything that can be done to prevent this occurrence.
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Topic 20 Directors’ duties
Learning Objectives
After completing this topic, you should be able to:
1. Understand the interaction between common law and
statutory duties;
2. Understand the content of the various duties – to act in good
faith and in the best interests of the company; to act with
due care and skill; not to fetter discretion; to exercise
powers for a proper purpose; not to allow the company to
trade while insolvent and not to allow a conflict of interest
to develop with the company;
3. Be able to apply the ‘but for’ test in determining whether a
director has exercised powers for a proper purpose;
4. Understand the circumstances in which the business
judgement rule applies;
5. Understand the operation of the statutory prohibition against
insolvent trading in s 588G;
6. Be familiar with the requirement that directors disclose any
interests in company contracts and, in the case of public
companies, to receive shareholder approval for any financial
benefits received from the company;
7. Be able to identify the circumstances in which the corporate
opportunity doctrine applies;
8. Understand in what circumstances members may approve
of, or condone, breaches of directors’ duties;
9. Understand the range of common law and statutory
remedies available for breaches of directors’ duties.
A. Introduction
This topic will examine the duties that attach to directors and other officers of a
corporation.
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Before we start, we should remember the wide definition of ‘director’ in s 9 of the
CA, discussed in the earlier Module on directors, which included not only persons
actually appointed as directors, but also shadow and de facto directors.
However, it is also important to note that what, for the sake of convenience we
refer to as ‘directors duties’, apply not only to directors (as defined above) but
also to ‘other officers’, as is stated in the directors’ duties provisions found in ss
180-183 of the Act.
Directors have long been affixed with a number of duties under the common law,
and these duties are also reflected in the Act (the statutory equivalents are noted in
brackets).
Four of these duties derive from the fact that directors are in a position of trust
towards the company and owe it a duty of good faith. They are therefore
described as fiduciary duties. In Hospital Products v United States Surgical
Corp (1984) 156 CLR 41 it was held that owing a fiduciary duty means that a
person owes a duty always to act in the best interests of the party to whom they
owe the duty rather than in their own interests. The fiduciary duties recognised
under common law are:
duty to act bona fide for best interests of Co (s 181)
duty to exercise powers for proper purpose (s 181)
duty not to fetter discretion (s 181)
duty to avoid conflicts of interest with Co (s 182 + 183)
The fifth common law duty derives from the fact that a director owes his or her
company a duty of care, this is therefore not classified as a fiduciary duty, as it
derives from the law of negligence:
duty to exercise reasonable care, skill and and diligence (s 180)
Although these duties have all now been put into statutory form by ss 180 – 183,
the common law duties remain in existence (s 185), and so case law that was used
to interpret the common law duties can be used to interpret the statutory duties.
The statutory duties are:
duty to exercise care and diligence – s 180
duty to act in good faith in the best interests of the corporation and to use
powers for a proper purpose – s 181
duty not to make improper use of position in such a way as to gain
advantage for themselves or anyone-else, or to harm Co – s 182
duty not to make improper use of corporate information to make gain for
themselves or any other person or to harm the Co – s 183
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It is clear that the common law duties are mirrored in the CA. The important
thing to note is that under s 185 common law duties carry on in parallel with the
statutory duties (except note that the common law duty of care is modified by the
s 180(2) business judgment rule). Thus when a director breaches his duties, the
Co can bring an action either under the common law (usually referred to as the
‘general law’ in the CA) or under the statutory provisions of the CA (see the
discussion on remedies at the end of this section).
Video
B. Duty to act in good faith and for the benefit of the Co
as a whole
Under a director’s fiduciary duties, he must act in the best interests of the Co as a
whole. Although the duty simply requires a director to genuinely believe that they
are acting in the best interests of the Co, that does not mean that the duty is wholly
subjective (i.e. that all a director needs to do is believe that they are acting in the
best interests of the Co). In ASIC v Adler [2002] NSWSC 171 the court held that
the duty has an objective element, and will be breached if no reasonable director
could believe that the conduct in question was in the best interests of the Co.
In ASIC v Adler [2002] NSWSC 171, Adler, who was a director of HIH and also
an officer of HIHC, its wholly-owned subsidiary, engineered an unsecured $ 10m
loan from HIHC to a company called PEE, which he controlled. $ 4m of that
money was then used by PEE to buy shares in HIH in order to prop up its price
(thereby benefiting Adler, who was a shareholder in HIH), $ 4m was used to buy
shares at above-market price from companies controlled by Adler, and $ 2m was
lent to Adler on an unsecured basis. The making of the $ 10m loan was clearly
not in the best interests of HIH or HIHC.
The interests of the Co = the interests of the shareholders as a whole – i.e. it does
not mean the interests of particular groups of shareholders.
Remember that in some circumstances, directors are required to take into account
the interests of creditors when they make decisions, in that if they permit the Co to
become insolvent, the Co may be liquidated by creditors seeking to recover what
they are entitled to. Furthermore, under s 588G creditors may in certain
circumstances recover losses from directors, as is discussed later in this Topic.
The equivalent statutory duty is the duty to act in good faith found in s 181.
In whose interests do directors of two competing Cos or nominee directors act?
In theory, directors can sit on the boards of rival Co’s, as was held in Bell v Lever
Bros Ltd [1932] AC 161. In reality, however, their positions are likely to become
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untenable, as they obviously cannot use or disclose information about one Co in
their capacity as director of the other, and so they would have to resign from one
Co or the other.
Nominee directors – that is directors who are appointed to a board to represent the
interests of a particular shareholder – eg those of a majority holding Co in its
subsidiary – are also in a difficult position.
In Scottish Co-operative Wholesale Society Ltd v Meyer [1958] 3 All ER 66
a holding Co. nominated three directors to the board of a subsidiary in
which it had a majority shareholding. The directors used their position to
strangle the subsidiary. The court held that a nominee director should
uphold the interests of the Co. to whose board he has been appointed, not
those of the appointor. The three directors were found to be in breach of
their duty to the subsidiary. Note also that in this case the court found that
the holding Co. was acting oppressively in its capacity as shareholder of the
subsidiary.
Note however that the onus is on the person alleging that the directors are
acting in the interests of the holding Co rather than the subsidiary and that
these conflict – in Re Broadcasting Station 2GB Pty Ltd [1964-1965]
NSWLR 1648 the court held that even where nominee directors appointed
by Fairfax Ltd to represent their interests as shareholders of a subsidiary
radio station, 2GB Pty Ltd, had not informed the other directors of 2GB Pty
Ltd of negotiations being conducted by Fairfax to seek continuation of
subsidiary’s licence, those directors had not acted oppressively, because
even though the nominee directors were acting in the interests of Fairfax
(the holding Co), their acts were also in the best interests of the subsidiary
radio station.
Note also that the director of a Co which is part of a group may not subordinate
the interests of the Co to those of the group as was held in Walker v Wimborne
(1976) 137 CLR 1, an application of the Salomon principle.
This principle becomes particularly important where directors try to move
funds from a healthy Co in the group to another which is in difficulty – in
Jenkins v Enterprise Gold Mines NL (1992) 10 ACLC 136 it was held to be
oppressive conduct where directors had moved funds in this way to the
detriment of E Ltd.
It may however be that it is in the interests of a Co that it assists the rest of
the group – in Equiticorp Finance Ltd v BNZ (1993) 11 ACLC 952 the court
held that where the dominant director in the group had transferred funds
from two Co’s to a related Co, his act was permissible because (i) it was for
the benefit of the two Co’s that the group survived, (ii) the two Co’s would
be compensated for their loan (i.e. interest was payable), and (iii) the
holding Co guaranteed the loan.
Finally, under s 187 of the CA, a director of a wholly owned subsidiary is
permitted to act in interests of holding Co where
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(i) the subsidiary’s constitution expressly permits this,
(ii) the director acted in good faith in best interests of holding Co, and
(iii) the subsidiary was not insolvent when the director acted, nor did the
director’s action make the subsidiary insolvent.
C. Duty to exercise powers for proper purpose
A director must exercise powers for a proper purpose. It is possible for a director
to subjectively believe an act to be in the best interests of a Co and yet for the act
not to be for a proper purpose, eg to issue of shares to shareholders who are
friendly to the board in order to avoid a takeover by those who are not. The
constitution may specify what the proper purposes for the exercise of various
powers are, but failing this, one must be guided by the case law.
Most cases re exercise of powers have arisen in respect of issue of shares, but note
that any exercise of power by directors, including entry into contracts (eg
purchase of an unneeded asset even if at fair value), can raise the issue of
improper purpose.
Note however that even if the issue of shares is not tainted by an attempt by a
director to advance his own interests, it may still be an improper use of powers, as
in Hogg v Cramphorn Ltd [1967] Ch 254:
Courts require that powers be exercised for a proper purpose – that purpose
being determined on an objective basis by the courts. In Hogg v Cramphorn
Ltd [1967] Ch 254 the board authorised the issue of shares with special
voting rights. Its purpose was to defend the Co from a take-over – their
bona fide belief that this was in the best interests of the Co was not
challenged, but the court held that even if the board believed the issue to be
in the best interests of the Co, the purpose of issuing shares is not to retain
power but to raise capital.
In Howard Smith v Ampol Petroleum Ltd [1974] AC 821 the directors of M
Ltd issued shares to H Ltd. At the time, A Ltd, which was another
shareholder of M Ltd, was buying up shares on the market with a view to
taking over M Ltd. A Ltd challenged the issue of shares to H Ltd. The
directors of M Ltd claimed the purpose was to raise capital, but this claim
rejected by the court: M Ltd had plenty of capital and it was clear that the
primary purpose to remove A’s majority and to defeat its takeover bid. The
directors’ statement that they bona fide believed that this course of action
was in the best interests of the Co was irrelevant.
In Whitehouse v Carlton Hotel Pty Ltd (1987) 5 ACLC 421 where a father,
who was director of the Co, had issued shares to his sons in order to prevent
their mother having majority voting power and had then sought to revoke
the issue when his sons turned against him, the court held that his initial
share issue had been invalid, holding that the use of a power for an improper
purpose will be invalid even if the directors genuinely believe the exercise
to have been in the best interests of the Co.
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It may be that the directors issue shares for more than one motive – some proper,
some improper. In such circumstances one has to determine whether the main
purpose was unlawful or not. This is done by applying the ‘but for test’.
In Whitehouse v Carlton Hotel (1987) 5 ACLC 421 the court held that
where there are a number of motives for a share issue, the issue will be for
an improper purpose where the impermissible purpose was causative in the
sense that ‘but for’ its presence, the issue would not have taken place.
The ‘but for’ test was also applied in Darvall v north Sydney Brick and Tile
(1989) 16 NSWLR 260 where the court adopted a similar approach where
the directors arranged a joint venture with an outsider, consideration for
which would be the outsider offering a better price for the Co’s shares than
had been offered by another Co making a takeover bid. The court found
that entry into the joint venture for the purpose of allowing shareholders the
choice of alternative bid which the directors bona fide believed to be in the
best interests of the Co did not infringe the proper purpose rule. Note that in
this case: (i) the director’s strategy did not involve the issue of more shares
and thus the dilution of existing shareholders rights, (ii) the directors did not
intervene to prevent a takeover, merely to present the shareholders with
another takeover offer and (iii) the joint venture would, even leaving aside
the takeover issue, have been entered into by the board because they
genuinely believed it to be in the best interests of the Co.
Remember also that shares will be issued for a proper purpose when issued as
payment for property by the Co or to employees – ie raising capital is not the only
possible proper motive.
A director may be liable for board’s improper use of a power if he knew of the
other director’s act and yet failed to intervene. In Permanent Building Society
Ltd v Wheeler (1994) 12 ACLC 674, the board authorised the purchase of land at
over-value – the motive being to provide vendor with money to meet obligations
to other Cos of which board members were also directors. These directors plus
the one who failed to intervene found to have breached their duty as directors –
see s 79 of the CA, which defines what ‘participation’ means.
The statutory duty to act for proper purpose is found in s 181.
D. Duty to retain unfettered discretion
Under the common law, a director must retain their discretion to act in the best
interests of the Co (this duty is also contained in s 181). This means that they
cannot enter into any agreements to exercise their powers in accordance with the
wishes of a 3rd party.
The position of nominee directors has already been discussed.
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E. The duty of care, skill and diligence
This duty differs from the others in that it arises from the law of negligence. The
issue of what standard of care to impose on directors involves balancing of
preservation of Co assets and risk-taking.
What does the case law reveal re the standard of care required of directors?
The old, and now superseded approach is exemplified by Re City Equitable
Fire Insurance Co Ltd [1925] Ch 407 in which directors had lent company
funds on an unsecured basis. The court that the level of care expected
depended on qualifications and skill of the particular director. It held that a
director was entitled to delegate powers and to assume that delegates were
acting lawfully, and in this case were entitled blindly to sign cheques
presented by the delegates. The court also held that directors not obliged to
give constant attention to Co – directors who didn’t attend meetings were
not responsible for what occurred.
The position now however is far more onerous that in the days of City Equitable.
In Daniels v Andersen (1995) 13 ACLC 614 a Co (AWA Ltd) had sued its
auditors for negligence in not informing the board of suspect foreign
exchange deals it had noticed. The auditors claimed contributory
negligence on the part of the Co (on the basis that the negligence of the
CEO were the acts of the Co). The court found contributory negligence and
held that directors are expected to familiarise themselves with the Co and be
satisfied that the business is being run properly. Ignorance and failure to
inquire are not a protection against negligence. The duty of care is not
limited by a director’s knowledge and experience – ie don’t become a
director unless you are capable – and directors are required to obtain an
understanding of the financial position of the Co by reviewing statements
even though they may not be able to audit them. Non-executive directors
are not exempt from owing a duty of care to the company. Directors cannot
just rely on information provided to them by delegates – they must make
inquiries if this is warranted by the situation, although if they do make such
inquiries but are misled by those they could be expected to trust then they
will not be liable (see s 189 of the CA). The board must meet as often as is
necessary to carry out its job properly and directors should attend regularly
(note that in Vrisakis v ASC (1993) 11 ACSR 162 it was held that a director
should attend all meetings unless exceptional circumstances prohibited him
from doing so, and see also s 300(10) which requires that in the case of
public Co’s the the directors’ report must state how many meetings each
director attended).
Note that one cannot become a non-executive director on the basis that one
will be a ‘sleeping director’, not involved in the Co’s affairs. In Sheahan v
Verco [2001] SASC 91 it was held that the duty of care imposes a minimum
level of responsibility on all directors, including the responsibility to ask
questions of management.
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The conduct of a non-executive director who has special skills will be tested
according to what would be reasonable conduct by a director with such
skills – Gold Ribbon (Accountants) Pty Ltd v Sheers [2005] QSC 198; and
also that the Chairman of the board is, because of his / her general oversight
position, affixed with a higher standard of care than an ordinary nonexecutive
director – ASIC v Rich [2003] NSWSC 85.
Executive directors, and indeed any officers vested with executive
responsibilities are, because of their day to day management role within the
Co, expected to display a higher level of care than non-executive directors
in relation to their particular area of responsibility – see Vines v ASIC [2007]
NSWCA 75 where it was held that officers of GIO acted negligently in
preparing a profitability statement of the insurance Co when they omitted
info relating to anticipated liabilities arising out of a hurricane which they,
as executives, ought to have taken into account. The court also held that
Vines, the CFO, had been negligent in blindly accepting the advice of other
officers when a reasonable person would have taken steps to verify the info
in the circumstances the Co faced.
A Co will be able to bring an action in tort to recover losses by a negligent
director. Failure of Co to act will lead to statutory derivative action as in
Daniels v Daniels [1978] 2 WLR 73, where the directors controlling a Co.
sold an asset to one of them at undervalue. A huge profit was made by the
director on resale. The court held that minority shareholders were entitled
to bring a derivative action on behalf of the Co against the directors to
recover the loss sustained by the Co (ie, the difference between what the
property was worth and what the directors sold it for).
Section 180(1) sets out the equivalent statutory obligation in relation to the duty
of care and diligence. It provides that a director or other officer 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 other officer in the
corporation’s circumstances and occupied the office held by and had the same
responsibilities within the corporation as the director or officer. An example of
such a breach is provided by
ASIC v Adler [2002] NSWSC 171, where it was held that Williams, who
was a director of both HIH and its subsidiary HIHC, breached his duty of
care to both Co’s when he allowed HIHC to lend PEE, a Co controlled by
Adler, $ 10m on an unsecured basis without any appraisal of the transaction,
which, objectively speaking, was clearly detrimental to HIHC.
Apart from breaching the duty of care and diligence through reckless business
decisions, directors can also find themselves liable for breach of the duty if they
allow the company to make misleading statements to the public. This is shown by
ASIC v Macdonald (No 11) (2009) 71 ACSR 368, in which ASIC successfully
brought civil penalty proceedings against directors of James Hardie who had
approved the release of a statement to the effect that the company had set up a
fund to cover liabilities for asbestos-related claims. The release of the statement
was found to be negligent in that the directors had ignored expert advice that the
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fund was inadequate to cover liabilities. The reason that misleading statements to
the market amount to a breach of the s 180(1) duty of care to the corporation is
because they potentially make the corporation liable to the public and also harm
its financial interests and reputation. Liability of directors to investors arises
under different provisions and is dealt with in Module 22.
The duty of care is qualified by the business judgment rule contained in s 180(2).
It operates in relation to the duty of care and diligence as it exists under both the
Corporations Law and the common law. The concept of the business judgment
rule is designed to give directors a measure of protection by recognising that
directors are required to be entrepreneurial and make commercial decisions which
sometimes with the benefit of hindsight were not the best decisions. The business
judgment rule creates a presumption that a director will have fulfilled the duty of
care and diligence if 4 things are satisfied:
(i) the judgment is made in good faith and for a proper purpose,
(ii) the director does not have a material personal interest in the subject matter
of the judgment,
(iii) the director informs him / her self about the subject matter of the judgment
to the extent they reasonably believe to be appropriate, and
(iv) rationally believe that the judgement is in the best interests of the
corporation – note that the belief is taken to be rational unless it is one
which no reasonable person in that position would hold, in other words, the
onus is on the person challenging the conduct to prove that it was not
reasonable.
The requirement that directors inform themselves about the subject matter has the
effect of casting a positive duty on directors to be active rather than passive in
carrying out their duties. This is illustrated by ASIC v Adler [2002] NSWSC 171,
where it was held that neither Adler nor Williams had a defence under s 180(2) in
relation to the loan made by HIHC (of which Williams was a director and Adler
an officer) to PEE, controlled by Adler: Adler had a personal interest in the
decision, and Williams had not reasonably informed himself of the risks involved
in the transaction, as he had not referred the transaction to the Co’s investments
committee.
Note that the s 180(2) defence applies only to actions for breach of the duty of
care and not to actions for breaches of other directors’ duties.
In addition to the s 180(2) business judgment rule, directors can also take
advantage of
Section 189, which states it will be taken to be reasonable for a director rely
on information given by another director or committee of directors or
persons whom the director believes on reasonable grounds to be reliable and
competent, provided that the director acted after making an independent
assessment of the facts concerned (bearing in mind the level of the
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director’s knowledge and expertise). Not making inquiries and leaving
everything to the MD or Co officers will not suffice to provide a defence for
directors under s 189 as was held in Sheahan v Verco [2001] SASC 91.
Similarly, if a reasonable director would have thought it was prudent to
enquire into the accuracy of the information being given, then failure to do
so will mean that the s 189 defence is not available – ASIC v Flugge (2016)
119 ACSR 1.
Section 190(1) states that a director is responsible for the acts of a delegate
but that under s 190(2) a director is not responsible where he believed on
reasonable grounds and after making such inquiry as circumstances
required, that the delegate was reliable and competent – ie delegates must be
monitored.
Note that whereas breach of the other statutory duties can lead to criminal
liability, this is not the case in respect of breach of the duty of care, which is
excluded from the ambit of s 184 (the criminal liability provision).
F. The duty to avoid insolvent trading
Section 588G imposes a statutory duty on directors to prevent insolvent trading –
a departure from Salomon in that it makes directors liable for Co’s debts in certain
circumstances.
Under s 588G(1) liability arises where:
the person was a director at the time the debt was incurred
the Co was then insolvent or was made insolvent by the liability
there were reasonable grounds for the director to suspect insolvency
the debt was incurred after the section came into force.
Proof of liability and of the existence of a defence is on a balance of probabilities.
Note that under s 588G(1)(b) a debt will be taken to have caused insolvency when
it + other debts incurred simultaneously caused insolvency, even though it, as an
individual debt, wouldn’t have had that effect. ‘Inability to pay debts’ is not a
simple matter of proof that a creditor’s debt has not been paid – in Metropolitan
Fire Systems Ltd v Miller (1997) 23 ACSR 699 it was held that the court must
look at the Co’s overall financial position and determine whether it is suffering
from a temporary lack of liquidity or is in fact non-viable.
Liability arises only if there were reasonable grounds for suspecting that the
insolvency existed or would be created by the debt.
For the director to be liable he must have been aware that there were reasonable
grounds for suspecting insolvency or a reasonable person in a like position in a Co
in the Co’s circumstances would have been so aware – an objective test of
standard of director of ordinary competence – see Metropolitan Fire Systems Ltd v
Miller (1997) 23 ACSR 699 and ASIC v Plymin [2003] VSC 123.
Section 588H provides 4 defences to directors:
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s 588H(2) – an expectation of solvency on reasonable grounds – the director
can prove facts which provide reasonable grounds for expecting the Co to
be solvent (i.e. which contradict s 588G(1)(c)). Because the expectation has
to be ‘reasonable’ in the circumstances, the court will take into account not
only what the director did know but also what he ought to have known – i.e.
the director who takes no steps to inform himself of Co affairs (and thus
does not know that it is trading while insolvent) cannot rely on the defence –
Morley v Statewide Tobacco Services Ltd (1992) 10 ACLC 1233.
s 588H(3) – reasonable reliance on a delegate – the director can escape
liability if he reasonably believed that a competent person was responsible
for supplying him info relating to solvency, reasonably believed that person
was fulfilling their responsibility (this requires monitoring of the person),
and expected, on the basis of that person’s info, that the Co was solvent.
Note that the defence requires directors to inquire as to financial reporting
when they join a Co – they must have some level of involvement and
knowledge of what goes on – Metropolitan Fire Systems Pty Ltd v Miller
(1997) 23 ACSR 699. See also ASIC v Plymin [2003] VSC 123 where the
court held that Elliott, non-exec director of Water Wheel Mills, was not
entitled to plead that he had left the running of the Co to its MD and was
therefore not required to enquire into its solvency, as a reasonable person in
Elliott’s position would have realised that the MD was not reliable because
he was not complying with board requirements for the provision of financial
info.
s 588H(4) – justifiable non-participation in Co affairs at the time the debt
was incurred – eg illness, going on leave, non-involvement because of
personal interest (s 195).
s 588H(5) – taking all reasonable steps to prevent Co incurring the debt –
note that under s 588H(6) one of the factors the court will examine is
whether the director took steps to have an administrator appointed. If this
fails, the director’s best course is to resign.
The remedies for insolvent trading are as follows:
Section 588G is a civil penalty provision (s 1317E(1)(e)) and so a civil
penalty may be imposed (s 1317G) as well as criminal liability if the
element of dishonesty is present (s 588G(3)).
In addition, when a civil penalty order is applied for, the court may order
the director to pay compensation to the Co in the amount of the debt which
the Co’s creditor has lost due to the Co’s insolvency whether or not it makes
a civil penalty order – s 588J(1). This money will then be used to satisfy the
debt owed to the creditor.
Note the power of a court under s 206D to prevent a person managing any
future Co where they were involved, within the last seven years, in two or
more companies which failed and where the management of a Co caused it
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to fail, and s 206F in terms of which ASIC can prohibit future management
of corporations where the Co of which the person was a director was subject
to an adverse liquidator’s report.
G. The duty to avoid a conflict of interest
As fiduciaries, directors must avoid any situation where a conflict of interest
might arise between them and the Co.
Aberdeen Railway Ltd v Blaikie (1854) 1 Macq 461 – B was a director of
company purchasing furniture and a partner of the firm selling it – the price
was fair but the mere possibility of unfairness vitiated the contract.
From a statutory point of view, such a breach of the fiduciary duty may involve a
contravention of s 181 (duty to act in good faith), s 183 (improper use of
information) and s 182 (improper use of position).
(i) Having an interest in a company contract
The most obvious example of conflict of duty is where a director has an interests
in a contract entered into by the Co – i.e. stands inside the Co as director and
outside the Co as the 3rd party with whom it is contracting.
In Transvaal Lands Co v New Belgium (Transvaal) Land & Development
Co [1914] 2 Ch 488, S and H were directors of Transvaal Lands, both also
had shares in New Belgium. S advised Transvaal Land’s board to buy
shares owned by New Belgium. Both were found to have breached their
fiduciary duty by not revealing their interest. It was immaterial that S had
not voted on the contract.
The CA imposes disclosure requirements on directors in respect of material (ie
excludes trifling interests) financial interests in respect of the affairs of the Co:
Under s 191(1) a director who has such an interest must make disclosure to
the board when such an interest arises, subject to the exclusions in s 191(2)
– e.g. interests which arise because the director himself is a shareholder (i.e.
in the Co to which he would disclose) interests arising from the director’s
remuneration by the Co, interests arising merely because director is
guaranteeing a loan to the Co.
Standing notice may be given under s 192 – eg where the Co regularly
contracts with an entity in which the director has an interest.
Contravention of ss 191 and 192 do not affect the validity of any transaction
– ss 191(4) and 192(7), (compare with the common law in Abderdeen
Railway) but breach constitutes an offence by the director.
Note that ss 191 and 192 supplement and do not replace the common law – s
193 – thus statutory disclosure may not suffice to exempt a director from
liabilities at common law (eg where disclosure may need to be made to
shareholders as well).
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A director is restricted in relation to voting on contracts in which he has a material
interest.
In the case of public companies, s 195(1) prohibits directors from voting or
being present when matters which would need disclosure under s 191 are
considered.
The board may however vote to permit the director to attend and vote – s
195(2).
Provision exists for general meeting (s 195(4)) or ASIC (s 195(3)) to grant
permission to vote if a quorum of the board cannot be mustered.
Failure to comply with s 195 does not invalidate any transaction – s 195(5)
but is a breach of the CA by the director.
In the case of Pty Companies – replaceable rule s 194 permits directors to be
present and vote if they have disclosed their interest under s 191, and the
director may retain any benefit from the transaction and the Co may not
void the transaction because of the director’s interest.
(ii) Related party transactions – public companies
In the case of public companies, special additional rules contained in Pt 2E of the
CA apply where a related party of the Co receives a financial benefit from the Co
or from an entity which the Co controls
The rule in s 208(1) is that the approval of the members must be obtained in
accordance with procedures in ss 217-227 for the giving of a financial benefit to a
related party. Note also that the approval must be given within 15 months prior to
the benefit.
The key concept in relation to conflicts of interest is ‘financial benefits’, defined
in s 229(3), as including:
giving finance or property
buying, selling or leasing an asset
acquiring or supplying services
issuing shares or granting options
taking up or releasing the person from an obligation
Note that the reality not the legal form will be looked at and that no regard will be
paid to any consideration given for the benefit even if that consideration was
adequate – s 229(1). Note also that indirect / informal ways of giving a benefit
are covered – s 229(2).
Who is a ‘related party’ to whom a Co may not give a benefit? This is defined
very broadly in s 228 as including:
(a) a controlling entity of the Co
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(b) directors of a the Co or its controlling entity, and such a director’s spouse,
de facto, parent or child
(c) an entity controlled by a related party
(d) an entity which was a related party during the previous 6 months
(e) an entity acting in concert with a related party
Certain financial benefits (listed in ss 210-216) are exempt from the s 208
requirement.
The only way in which a non-exempt financial benefit can be given is under
authority of a resolution of a general meeting under passed within 15 months
before the benefit was given, in accordance with the procedures prescribed by ss
217-227. Note that under s 224, if the related party is a shareholder, they may not
vote at the meeting.
(iii) Making a personal profit from one’s position as a director
A director’s fiduciary duty extends to situations other than those in which the
director or a related party is contracting with the Co. The requirement that there
be no conflict of interest also applies where the director uses his position in the Co
for his own benefit. This applies whether the Co is harmed or not.
In Regal (Hastings) Ltd v Gulliver [1942] 1 All ER 378 a Co wanted to buy
cinema but lacked capital. The directors provided the capital required and
took shares in the Co. Subsequently there was a change in ownership of the
Co. The directors profited from their share of the sale price. The new
owners successfully reclaimed the directors’ profit on behalf of the Co – the
profit was held to be incidental to, and derived from, their office-holding.
The rule in Regal (Hastings) seems harsh in that the Co actually benefited from
the directors having invested money in it, so as to enable the Co to buy additional
cinemas and which caused its shares to be more attractive to potential purchasers.
Perhaps nowadays the courts would exercise their s 1318 discretion to relieve the
directors of liability for breach of the statutory duties.
Sections 182 (improper use of position) and 183 (improper use of information) are
effectively a statutory embodiment of the rule, in that it prohibits improper use of
position by directors, officers or employees in order directly or indirectly to
make a gain for themselves or someone-else (irrespective of whether the Co
suffers harm), or
harm the Co.
There are many examples of circumstances in which improper use of information
or position can occur:
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Improper use of position obviously occurs where a director is paid a bribe or
secret commission – in Boston Deep Sea Fishing & Ice Co v Ansell (1888)
39 Ch D 339 it was held that a director had used his position for improper
purpose where he had been paid a ‘commission’ by a shipbuilder when the
Co of which he was director had contracted with it to build ships, and when
he received a bonus in his capacity as shareholder in two other companies
when he had caused Boston to contract with them. In such circumstances,
the director must surrender his profit to the Co of which he is a director.
In Furs Ltd v Tomkies (1936) 54 CLR 583 an MD was required to account
for amounts paid to him when he entered an employment contract with the
purchaser of part of the Co’s business. Tomkies had a conflict of interest in
that he was negotiating the employment contract with the purchaser of part
of the business of the Co of which he was director. He was required to
surrender his profit to Furs Ltd – note that it was irrelevant that Furs Ltd
suffered no harm.
In ASIC v Adler [2002] NSWSC 171, Adler was found to have improperly
used his position as a director of HIH and an officer of its subsidiary HIHC,
to engineer an unsecured loan by HIHC to PEE, a Co he controlled, which
PEE then used to benefit Adler. Note that Adler also breached his duties to
PEE in that he used his position as a director of PEE to get it to buy shares
that he held in other Cos at far more than they were worth.
(iv) The corporate opportunity doctrine
A director cannot take up an opportunity which belongs to the Co. According to
the strict equitable rule in Regal Hastings v Gulliver, an opportunity can never be
exploited by the director if it is learned of through being a director. In applying
the Regal Hastings rule, the courts have said as follows in circumstances where
directors have taken corporate opportunities:
It does not matter that Co would not have obtained the contract – in Green v
Bestobell Industries Pty Ltd [1982] 1 WAR 1 the court held that where G
had used knowledge he had obtained of B Ltd’s bid for a hospital
construction project and had won the contract for his own Co, he had still
breached his duty even though B Ltd would not have got the contract which
was won by a wholly unrelated Co.
In Industrial Development Consultants Ltd v Cooley [1972] 2 All ER 162 a
gas board said they wouldn’t contract with Co that Cooley worked for, but
would contract with him personally. He feigned illness to retire and took
the contract. He was held liable to surrender profits – ie the duty persists
even after ceasing to be a director.
More recently in Australia the court in Gemstone Corp of Australia Ltd v
Grasso (1994) 13 ACSR 695 held that the fact that a Co is unable to exploit
an opportunity does not entitle the director to take it.
But when does a corporate opportunity rightfully belong to the Co? In Canadian
Aero Services Ltd v O’Malley (1973) 40 DLR (3d) 371 a director was in the
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process of negotiating an aerial survey contract in Guyana. He resigned, formed
his own Co and too the contract for himself. The court held him liable to his
former Co, saying that a Co can recover if director takes for himself a ‘maturing
business opportunity that the Co. is actively pursuing’ (at 382 of report). The test
in Canadian Aero has been applied and expanded in the following cases:
Pacifica Shipping Co Ltd v Andersen [1986] 2 NZLR 328 – a shipping Co.
was considering the purchase of second vessel. The director resigned,
formed his own Co. and chartered a vessel to carry cargo on the same route.
The court distinguished between specific and global opportunities – ie,
whereas it would have been permissible for the director to resign and form
his own shipping company which was not competing in the same market,
here he was trying to take a route that he had learned of only through being
a director of the Co .
The leading case in Australia is SEA Food International Pty Ltd v Lam
(1998) 16 ACLC 552, in which the court held that the test to be used in
determining whether an opportunity belongs to a Co is whether there is a
sufficient link between the opportunity taken by the director and the nature
and extent of the Co’s current operations and those in which it might
‘reasonably be expected to expand’ in the future.
Does it matter whether the Co does not wish to take the opportunity – can it
relinquish it to the Director ?
It is clear that in Australia the consent of the board alone is not enough
(although that is still required) – the director must make disclosure to and
receive permission from, the shareholders – Furs v Tomkies (1936) 54 CLR
583 – see the section below relating to disclosure of interests and
condonation.
Note also that if the director is also a shareholder, he / she may note vote his
or her shares at the meeting of shareholders (Cook v Deeks [1916] 1 AC
554).
Note that such permission from the shareholders will be invalid if the
director does not disclose all relevant information, as was held in Southern
Cross Mine Management Pty Ltd v Evensham Resources Pty Ltd [2005]
QSC 233.
In Queensland Mines Ltd v Hudson (1978) 52 ALJR 399 an MD was found
not liable for profit from mining licences that Co. had decided not to exploit
and which he disclosed to them he would take up – in this particular case
unanimous assent by directors happened to also be unanimous assent by
shareholders – the court emphasised all depends on facts of the case – if
directors hold all shares, unanimous assent by board will be valid, because
their assent amounts to assent by all shareholders and so there is obviously
no fraud on minority.
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(v) Misuse of corporate information
The fiduciary duty not to misuse Co info will often overlap with corporate
opportunity rule.
Section 183 is this aspect of the fiduciary duty in statutory form.
Note that a director may misuse Co info when trading in its shares, in which case
the insider trading provisions will also be relevant – as an example of which one
can cite ASIC v Vizard [2005] FCA 1037, where Vizard used information
obtained as a non-executive director of Telstra to his own advantage, establishing
a front Co to buy and sell shares in Telstra, the price of which he knew would be
affected by decisions by Telstra.
Although in theory a director can sit on the boards of competing companies, in
reality it will be very difficult for a director to avoid a conflict of interest given
that they would have to act in the best interests of each company. A director
obviously cannot use or disclose information about one Co in their capacity as
director of the other. In Riteway Express Pty Ltd v Clayton (1987) 10 NSWLR
238 the court held that a former employee may use and disclose general
information and skills for the benefit of subsequent employers, but that
confidential information, such as trade secrets, may not be used or revealed.
H. Disclosure of interests and condonation
To what extent can a director avoid liability under the conflict of interest
provisions (and other breaches of directors’ duties) by prior disclosure, and to
what extent can the Co condone after the fact breaches which were not disclosed
before they occurred?
(i) Relief from liability under the common law
Where a director seeks prior permission to breach one of the fiduciary duties or
seeks ratification of a past breach, then the following common law rules apply:
 Under the common law, director must disclose to the shareholders and have
GM ratify, as was held in Furs v Tomkies (1936) 54 CLR 583. Such
ratification (prospective or retrospective) can be effective.
Shareholders must be fully informed for their consent to be validly obtained
– Southern Cross Mine Management Pty Ltd v Ensham Resources Pty Ltd
[2005] QSC 233 – the consent of shareholders for lease of mining
equipment from another Co in which their CEO had an interest was invalid
because he had misrepresented the details of the contract.
 However ratification by the GM will prima facie not be effective if it is a
fraud on the minority or is oppressive. A prime example is where a director
obtains some benefit at the expense of the Co in circumstances where he or
she is also a shareholder in the Co. Such a director may not use his or her
voting power to condone his or her own breach of duty. This would be
‘fraud on the minority’:
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In Cook v Deeks [1916] 1 AC 554 three directors of railway Co. knew a
contract would be beneficial to it, but formed their own Co. to enter into
contract! The court held that they had misappropriated Co. property (i.e. the
opportunity), ordered to surrender profit. The action was not ratifiable – a
majority cannot strip Co. of assets. In Australia such conduct could be
remedied by s 237 derivative action, because s 239(1) provides that
ratification by members does not in itself prevent s 237 action being
brought, but note that it is a factor the court must take into account in
determining liability – s 239(2).
In Hannes v MJH Pty Ltd (1992) 10 ACLC 400 the court held that only a
vote of disinterested shareholders could validate a director’s breach of
duties (in this case issue of shares for an improper purpose).
Note also that ratification by shareholders will be ineffective in the particular
circumstance of insolvency, as here the Company must consider the interests of
creditors – in Kinsela v Russel Kinsela Pty Ltd (1996) 4 NSWLR 722 the court
held that the shareholders could not ratify the directors’ failure to consider the
rights of creditors. The Co was approaching insolvency; the directors transferred
its business and leased some of its property to family members on terms
advantageous to them. This was designed to ensure that when Co went into
liquidation creditors would obtain little value and family could continue to occupy
premises during lease. The court invalidated lease as a breach of duty to creditors
which family shareholders could not ratify. Note also that the Directors will be
liable under s 588G if they allow the Co to trade while insolvent.
A Co or its related body corporate cannot indemnify officers and auditors or
exempt them from liability to the Co – s 199A.
In addition, under s 199B Co or related corporate body cannot pay officers’
liability insurance premiums for wilful breach of duty to the Co or for a breach of
ss 182 or 183 (but insurance for breach of duty of care – s 180 – can be paid for).
Note that the courts may relieve an officer from common law liability for
negligence, default, breach of trust or breach of duty where it appears that they
acted honestly and ought fairly to be excused – s 1318(1).
(ii) Relief from liability for breach of statutory duties
Whereas the GM may be able to condone breaches of common law and fiduciary
duties (subject to the rule about fraud on the minority), different considerations
apply in respect of the statutory duties:
If the directors receive advance authorisation to engage in conduct which
would amount to a breach of ss 182 and 183, their conduct would not
constitute ‘improper’ use of information or position and so the sections will
not have been breached.
If however the directors breach the provisions without authorisation, the Co
is not able to condone breaches of the statutory duties, as these are
mandatory civil penalty provisions.
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However, where the Co has condoned the parallel general law duty, the
courts may well exercise their 1317S discretion to grant relief from the civil
penalty provisions, and the Co’s condonation may disentitle it from seeking
compensation under s 1317H for breach of statutory duties.
I. Remedies
Various remedies can be brought against directors who breach their duties to the
Co.
The ss 180-183 statutory duties are civil penalty provisions, and under s 1317J(1)
ASIC can apply (1) for a declaration of contravention (s 1317E) and (2) a
pecuniary penalty order (s 1317G).
ASIC can also obtain a s 206C disqualification order, which would prevent the
director or officer from being involved in the management of any corporation for
a specified period.
The Co or ASIC can also apply for a s 1317H compensation order to recover
damages on behalf of the Co under s 1317J(1) and (2) (whether or not a pecuniary
penalty order is made). Note that because s 185 states that the statutory directors’
duties regime complements and does not replace the general law, s 1317H
represents an alternative avenue for compensation by the Co, which could elect to
proceed under the common law instead (see below).
Breaches of the statutory duties of good faith, best interests, proper purpose and
use of information or position (but not the duty of care) will lead to criminal
liability – s 184 – when recklessness or intentional dishonesty are proved.
Criminal proceedings may be initiated even if a civil penalty order has been
obtained (s 1317P), but note the provision re the exclusion of evidence used in the
civil penalty action (s 1317Q).
If a civil penalty order has not been sought and a criminal prosecution is
successful, civil proceedings cannot subsequently be instituted (s 1317M),
however if the prosecution is unsuccessful, civil penalty civil penalty proceedings
can be launched (s 1317N).
Note that a court can grant relief from liability in proceedings (other than criminal
proceedings) for breach of the statutory duties where the director acted honestly
and it is fair that they should be relieved of liability – s 1317S.
In cases where one seeks to enforce the duties, the s 1324 injunction is available.
Exercise
Regional Air Transport Ltd (hereafter referred to as ‘RAT Ltd’),
operates a regional airline which serves the ACT and NSW,
conducting flights, using small propeller-driven aircraft, between
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Canberra, Sydney, Newcastle, Bathurst and Wagga Wagga. RAT
Ltd has 4 Directors – Jack, Jill, Victoria and Rhett, each of whom
own 20% of the shares. The remaining 20% of the shares is split
between small investors. RAT Ltd has very large capital reserves
and is looking for new routes.
Rhett is manager of the Canberra office of RAT Ltd, and is in
charge of the airline’s day to day operations. Rhett is sent by RAT
Ltd to attend a conference in Darwin on small-airline operation.
While attending one of the conference functions he meets Ashley,
who is Section Chief of the NSW Civil Aviation Authority (CAA).
Ashley tells Rhett that the CAA is about to offer an air transport
licence for the Newcastle – Coffs Harbour Route.
One of Rhett’s functions is the approval of invoice payments of
more than $ 100 000. This he does by signing an authorization form
which is attached to the contract that the payment relates to. One
Friday afternoon, Melanie, who works in the company’s accounting
department, presents Rhett with an authorization form for $ 500
000. There is no contract attached to it. Rhett wants to get to the
golf course, and does not bother to enquire about the absence of a
contract.
Rhett soon resigns from the board of RAT Ltd, and shortly
thereafter sets up his own airline, Sunair Ltd, to fly between
Newcastle and Coffs Harbour. A few weeks later, Gerald O’Hara,
Managing Director of RAT Ltd, reads an article in the Sydney
Morning Herald which states that Sunair Ltd has just made a profit
of $ 1million on the Newcastle-Coffs Harbour route. Gerald also
finds out that Rhett is the major shareholder in Sunair. He is also
informed by RAT’s auditors that Melanie has been defrauding the
company over the past year, that the $ 500 000 cheque did not relate
to any company contract and was in fact deposited into Melanie’s
personal account. She has now drawn the money and is unlocatable
– it is thought that she fled to Argentina. The board now
approaches you for advice on the legal issues arising out of Rhett’s
conduct.
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Topic 21 Corporate finance: shares and debentures
Learning Objectives
After completing this topic, you should be able to:
1. Be aware of the different types of finance available to
companies;
2. Appreciate the distinction between equity finance (shares)
and loan finance (debentures);
3. Understand the nature of shares and the rights attaching to
them;
4. Understand the differing rights that attach to different
classes of shares and, in particular, the rights in relation to
which shares may be preferent;
5. Appreciate that dividends may be paid only out of profits;
6. Understand the circumstances in which the prohibition on
insider trading applies and the remedies available when
insider trading occurs;
7. Understand the nature of debentures;
A. Introduction
This topic aims to introduce and explain the various types and sources of capital
available to companies and provide an understanding of how this capital must be
treated.
All companies require funding to carry on their activities.
In general terms this funding is made up of two types of capital, equity and debt.
B. Sources of company finance
Companies can fund their activities from two main sources:
Equity is share capital. A company limited by shares obtains equity by the issue
of shares in return for contributions of capital from members. A company has the
power to issue shares (s.124(1)(a))
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Debt is capital obtained by borrowing money privately (e.g. from a bank) or
publicly (e.g. from members of the public in return for debentures in the
company). Interest will be paid on this money.
Section 92 of the CA uses the generic term ‘securities’ to refer both to equity
securities (shares) and loan securities (debentures and notes).
C. Shares
The share capital of a Co the amount of money (in cash or other value) the
members have paid, or have promised to pay, to the Co.
Section 117(2)(k) requires that when a Co is formed, ASIC must be advised of
what shares it has issued. This becomes an on-going obligation to report changes
in shareholding throughout the life of the Co – s 254X(1).
D. Classes of shares
A Co can divide its shares into different classes: Birch v Cropper (1889) 14 App
Cas 525.
Section 246F(1) – ASIC must be given notice of division of shares into classes.
(i) Ordinary shares
Ordinary shares will normally have the following rights
 the right to share equally in any declared dividends
 the right to vote at general meetings
 the right to be repaid capital on winding up (if there is any left)
 the right to share in surplus on winding up
(ii) Preference shares
A company can issue shares which are preferent in relation to dividend payment,
repayment of capital on liquidation or payment of any surplus on liquidation. A
share can be preferent in relation to one or all of these rights, but note that
preference share rights are interpreted restrictively, and that a share is preferent in
relation to one right, it is presumed not to be preferent in relation to all others.
Thus a preference right has to be expressly stated to exist. The following are the
rights attaching to preference shares:
 A share that is preferent as to voting rights gives the holder more than one
vote per share.
 Shares that are preferent in relation to dividend are entitled to a guaranteed
dividend based on a fixed percentage of the issue price of their shares (NB:
assuming that a dividend is declared). This is a preferential right to be paid
ahead of other shareholders. If the company is not making a lot of profit,
the preference shareholders may be paid while the ordinary shareholders
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may receive little or no dividend. In a good year, however, ordinary
shareholders may receive a larger dividend that the preference shareholders.
 Shares that are preferent in relation to repayment of capital enjoy priority
for repayment of capital before other shareholders when the Co is wound
up.
 Shares that are preferent in relation to payment of surplus capital receive a
defined percentage of any surplus capital that may be left once the face
value of all shares has been paid to investors upon winding up.
In addition to these rights, preference shares can also be
 participating or non-participating. Preference shares that are preferent as to
dividend and / or capital repayment will, if they are participating
preference shares have the right to receive an dividend and / or an ordinary
share in capital repayment along with individual shareholders as well as
their preferential entitlements – in effect, they get two bites of the cherry.
However remember that preference in relation to a particular right is
presumed to be exhaustive, and in accordance with this rule, shares are
presumed to be non-participating: Will v United Lankat Plantation Co Ltd
[1914] AC 11, Scottish Insurance Corp Ltd v Wilsons & Clyde Coal Co Ltd
[1949] AC 462.
 cumulative or non-cumulative as to dividend. If a company does not pay
dividends in a particular year, holders of cumulative preference shares are
entitled to have the right to be paid arrears of dividends in subsequent years
ahead of ordinary shareholders. Preference shares are presumed to be
cumulative if nothing is stated.
A Co may issue redeemable preference shares – i.e. shares that can be bought
back after a specified time (s 254A(3)). They may be redeemable:
(a) at a fixed time or on the happening of a particular event; or
(b) at the company’s option; or
(c) at the shareholder’s option.
A Co may also issue convertible preference shares. These shares carry
preferential rights for a period of time and then revert to ordinary shares at the end
of that period.
E. Dividends
A dividend is that part of a Co’s profits it decides to distribute to members.
Under s 254U(1) the directors may declare dividends.
However, even once a dividend has been announced, it is not a binding debt and
can be reversed at any time before the due date for payments 254V(1) (unless the
constitution provides for a binding declaration – ss (2))
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In Burland v Earle [1902] AC 83 it was held that shareholders cannot force a Co
to use profits to pay a dividend if it has made a profit – it is a decision at the
discretion of the board.
The key rule relating to dividends is contained in s 254T(1), which states that a
company may not pay a dividend unless:
a. the company’s assets exceed its liabilities immediately before the dividend
is paid and the excess is sufficient for the payment of the dividend;
b. the payment of the dividend is fair and reasonable to the company’s
shareholders as a whole; and
c. the payment of the dividend does not materially prejudice the company’s
ability to pay its creditors.
Under s 254T(2) whether a company’s assets exceed its liabilities is determined in
according with accounting standards.
Note that requirement (a) is designed to ensure that the company’s assets exceed
its liabilities both before and after the dividend is paid.
Remember also that under s 588G(1), the payment of a dividend can amount to
insolvent trading – ie where the payment of a dividend occurs while a Co is
insolvent, or in circumstances where the payment pushes it into insolvency, s
588G will be breached and the directors will be personally liable for the debt
incurred by the Co.
F. Insider trading
The problem of insider trading, where a person who is privy to confidential
information obtained from within a company uses the information to buy or sell
shares to the disadvantage of the other contracting party, arose in an early case
about directors’ duties:
In Percival v Wright [1902] 2 Ch 421 shareholders in a Co offered to sell shares to
the Co’s directors. The directors were already negotiating to sell their own shares
at much higher price but did not inform shareholders, and made a huge profit at
the shareholders’ expense. The shareholders were however unable to recover
damages from the directors. Although the directors would have been liable to pay
their profit to the company, as they had made a profit as result of their position as
directors, such duties they owed were owed to the Co and not to the shareholders,
and so they could not recover.
Although it may often be that directors use their inside information in this way,
insider trading can obviously be engaged in by anyone who discovers confidential
information.
The insider trading provisions seek to deal with these deficiencies in the law.
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First, the CA contains a very broad definition of inside information in s 1042A,
which defines inside information as information
(i) not generally available which
(ii) would reasonably be expected to affect price – i.e. it is an objective test and
a breach of insider trading laws does not require proof that the trader
subjectively knew the info was not generally available – Hannes v DPP (No
2) [2006] NSWCCA 373.
The primary prohibition is contained in s 1043A(1) an insider (that is, someone
who has inside information – the term does not relate to whether the person has
any position inside the Co) – may not purchase or sell shares in Co while the
information is not publically available. An example of the prohibition in action is
provided by R v Rivkin [2003] NSWSC 447. Rivkin was told by McGowan, CEO
of Impulse Airlines, that Qantas was about to acquire control over Impulse, thus
removing one of its competitors. Rivkin then purchased shares in Qantas, which
went up in value when its acquisition of Impulse became public. Rivkin was
convicted of breaching s 1043A(1). For liability to arise, it is not necessary to
show that the insider’s decision to buy or sell shares was because they were in
possession of the information – mere possession of the information is enough to
give rise to the prohibition against trading, as held in R v Farris (2015) 107 ACSR
26).
The second prohibition is that an insider may not get any-one else to trade in
shares on his or her behalf.
The third prohibition relates to ‘tipping’ – s 1043A(2) prohibits one (tipper) from
passing on inside info to another (tippee) whom he reasonably knows would be
likely to use info to trade. Note that it does not matter whether the tippee used
the info or not.
‘Information not readily available’ is defined in s 1042C, which says that
information is readily available if it is readily observable or has been made known
in a way readily ascertainable to investors for a period permitting its
dissemination among them – i.e. the law does not penalise research into sources
that anyone could access.
Information has an effect on price if a reasonable investor would think that it
would – s 1042D
Note that s 1042G deems corporations to know what their officers found out in the
course of their employment, similar re partnerships – s 1042H.
Excluded from definition of info (most important exclusions):
the insider’s own intention to trade (which could itself affect price) – s
1043H.
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circumstances where a “Chinese wall” is in place in a Co (s 1043F) or
partnership (s 1043G) – an administrative arrangement preventing transfer
of inside information.
Breach of prohibitions against trading and tipping are criminal offences – s 1311
and Sch 3.
Defences under s 1043M
that the information was generally available
that the other party to transaction knew or ought reasonably to have known
the info (so was not taken advantage of).
Civil liability is imposed by s 1043L: Anyone who suffers loss as a result of
insider trading may recover damages from inside trader – explained in s 1043L as
the difference between what would have been paid had the other party known the
inside info.
Note overlap with ss 182 / 3 where the inside trader is also a Director – the Co will
also be able to recover the director’s profit using s 1317H – in other words, the
director will be liable twice.
G. Misleading or deceptive conduct
Apart from insider trading, the Act prohibits a number of other types of
misconduct relating to share trading in ss 1041A – 1041I. Perhaps the most
important of these is the prohibition in s 1041H against misleading or deceptive
conduct in relation to a ‘financial product’ (defined very broadly in s 763A as
covering virtually any type of investment).
The effect of this is to make any person who engages in such conduct liable under
s 1041I to any person who suffers a loss as a result of relying on that statement.
The typical example being where a company issues a misleading statement to the
market which leads to investors buying shares, as in ASIC v National Exchange
Pty Ltd (2003) 47 ACSR 128. This can lead to the company being liable to the
investors, and the directors in turn being liable to the company under s 180(1) for
its losses because by permitting the statement to be issued, the directors would be
breaching their duty of care to the company.
H. Debentures
When a Co raises loan finance it issues debentures. A debenture is defined in s 9
of the Act as a chose in action (that is, a right to bring a legal action) that includes
an undertaking by a body corporate to repay a loan – in simple language, an
acknowledgement of debt.
A critical issue for lenders to a company is whether the company is providing
security for the loan – that is, whether the company is conferring on the
borrower(s) a right in property owned by the company. If a loan is unsecured, the
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lender ranks equally with other creditors, which obviously provides no protection
for the borrower. The answer is for the Co to use its property as security for its
borrowings, which it can do by virtue of s 124(1)(f) of the CA.
The issue of debentures is regulated by Ch 2L. In order for lenders to have clarity
as to the basis upon which they are lending money to a Co, s 283BH regulates the
use of terminology by a Co by providing that a debenture can be described by the
borrowing Co as a ‘mortgage debenture’ only if it is secured by a mortgage over
land, and as a ‘debenture’ only if it is secured by personal property. In all other
circumstances the debt finance must be referred to as an ‘unsecured note’ or an
‘unsecured deposit note’.
The fact that a debenture is secured by a publicly registered interest over land or
personal property means that anyone buying or taking any other interest in an
asset from a Co in circumstances where a lender has a registered interest over the
asset has only themselves to blame if the holder of that interest successfully
initiates proceedings to get the purchaser to give up the property. In other words,
a lender who secures a loan to a Co by taking a registered interest over its assets
can get hold of the property even if it has been alienated by the Co to a 3rd party.
For this reason, it is crucial before buying a substantial asset from a Co, or taking
some other interest in the property, to check the public register of mortgages as
well as the register of interests maintained under the Personal Property Securities
Act 2009 (Cth) so as to make sure that a lender does not have a prior interest in the
property. If, for example, bank A lends money to a Co, and the debt is secured by
an interest over vehicles owned by the Co, and that interest is registered under the
PPSA, and then bank B lends money to the Co, accepting security over those
same vehicles without checking the PPSA register, if the Co defaults on the debt,
bank A can have the cars sold and take as much of the proceeds as is required to
cover its loan, leaving bank B with whatever is left.
Exercise
Capital Technologies Ltd (CT Ltd) is an electrical engineering
company. It is listed on the ASX. Its research department has
developed a new type of battery. The research is presented to a
Board meeting on 1 July. It is agreed that a public announcement
about the battery will be made on 15 July.
On 2 July, Don Trump, a director of CT Ltd, telephones his stock
broker and buys 10 000 shares in CT Ltd from Sean Young at the
current market price of $ 2.00 each. That same night, he tells his
friend Gordon Gecko, who he knows is a regular trader in shares,
about the new battery but Gecko does not act on the information.
Upon the public announcement of the news about the battery, the
price of shares in CT Ltd climbs to $ 22.00 each.
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A few weeks later, another shareholder, Sam Speed, who is an
amateur scientist, reads an article in the latest issue of
the International Journal of Chemistry which is available in his
local library which says that an acid which Sam recognizes is one
used in the batteries made by CT Ltd, is unstable. He sells his
shares to Frank Jones for $ 22.00 each. Subsequently, when news
reaches the market that customers of CT Ltd are complaining that
the batteries have stopped working due to the unstable acid, the
price of shares in CT Ltd falls to $ 15.00 each.
Advise as to the liabilities arising from these facts, citing relevant
legal authority.
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Topic 22 Fundraising by public companies
Learning Objectives
After completing this topic, you should be able to:
1. Understand the obligation that public companies have under
Ch 6D of the Corporations Act 2001 (Cth) to make
disclosure of various matters to the market when raising
funds from the public;
2. Appreciate what exemptions there are in relation to the
obligation to provide disclosure;
3. Understand the nature prospectuses and their contents;
4. Understand the restrictions relating to shares issues;
5. Appreciate the purpose and operation of the prohibition
against hawking and the consequences of its breach;
6. Understand the restrictions on advertising of offers of
securities;
7. Determine what the criminal and civil liabilities are for a
breach of the rules contained in Chapter 6D.
A. The obligation to provide disclosure
Companies raise money by issuing shares and debentures. Only public companies
can raise money from the public – s 113.
Chapter 6D of the CA seeks to protect the investing public by requiring disclosure
of information to investors.
Section 700(1) refers to the broad definition of ‘securities’ in defining what
financial products Ch 6 D applies to. This definition includes interests in
managed investment schemes as well as options to acquire securities.
Note that s 700(2) makes Ch 6D applicable to both offers and invitations to make
an offer.
The extent to which disclosure is required essentially depends upon who is
receiving the invitation / offer and the size of the offer.
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Video
The basic provision is s 706 which states that an offer of securities requires
disclosure unless one of the s 708 exemptions apply. The s 706 requirement is
given force by the following:
An offer of securities without prior lodgement of the appropriate disclosure
document with ASIC is an offence under s 727(1).
Similarly, any form which can be used by the public to respond to / make an
offer for securities must be accompanied by a disclosure document or
appear in it – breach being an offence – s 727(2).
No person may issue or transfer securities requiring lodgement of a
disclosure document unless the application was on a form which the issuer /
transferor believed on reasonable grounds to have been accompanied by a
disclosure document – s 723(1).
It is an offence to offer securities in a body that does not yet exist – s 726.
What types of offer are exempt under s 708? Most important are:
Section 708(1) – (7) small scale offerings, where the Co will not have issued
securities to more than 20 people or for more than $ 2 million in the past 12
months);
Section 708(8) – offers to ‘sophisticated investors’. Under this exception, offers
may be made without disclosure to investors who are assumed to be experienced
enough to take the risk of making such investment decisions. This exception
applies where the amount payable on acceptance is $ 500 000 or more, or the
amount payable plus any amounts previously paid by the investor for securities in
the Co is $ 500 000 or more, or the investor has net assets of $ 2.5m or gross
income for the last 2 financial years of $ 250 000 pa.
Section 708(10) – offers to experienced investors through licensed dealer. This
exemption applies where the offer is made through a licensed dealer to a person
whom the dealer believes on reasonable grounds has the experience to assess the
investment and provides the investor with a written notice to that effect (e.g. Co
places shares with a broker who then contacts his clients).
Section 708(13) and (14) – offers to existing share or debenture holders.
If disclosure is required, then the type of disclosure document to be used depends
upon the circumstances of the offer. Four types of disclosure document are
contemplated by the CA :
prospectuses
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short form prospectuses
profile statements
offer information statements
for the purposes of this subject, we will look at prospectuses, which are the most
important type of disclosure document.
A disclosure documents must be lodged with ASIC – s 718.
All directors must give written consent to the lodgement – s 720 – and thereby
become liable for its contents.
Disclosure documents may be circulated to investors as soon as lodgement has
taken place, but note that in the case of non-quoted securities (that is, securities
not listed on the ASX) no offers can be accepted or securities issued until at least
7 days after lodgement (extendable to 14 days by ASIC) – s 727(3).
B. Prospectuses
There is certain specific information which must be disclosed in all prospectuses –
listed in s 711(1) – (8) – pertaining to details of the offer, the identity of persons
involved in the offer, the expiry date of the offer (note offers cannot be accepted
more than 13 months after prospectus is published ss (6)).
In addition to this specific information, a prospectus must comply with the general
disclosure requirement in s 710(1) of containing all information which an investor
or his / her advisor would reasonably require to make an informed assessment of
matters laid out in the table in s 710.
Misleading or deceptive statements or omission of information from a disclosure
document amounts to a contravention of the CA – s 728(1), and is an offence on
the part of the Co if investors are materially disadvantaged – s 728(3).
Note that for purposes of s 728 liability, forecasts (ie predictions) which turn out
not to be correct will be regarded as misleading if the person making them did not
have reasonable grounds for the prediction (s 728(2)).
Persons who suffer loss as a result of misleading or deceptive statements or
omissions can recover under s 729.
Note that under s 729(1) such recovery can be from the Co, its Directors and
anyone (such as accountants and expert consultants) whose reports are included in
a disclosure document with their consent.
If a prospectus (or any other disclosure document) has been lodged and it is then
realised that it is in some way misleading or deceptive or there is an omission, or
that new circumstances have arisen which means that other information would
have been included had they obtained when the original document was issued then
a supplementary or replacement document must be lodged with ASIC –
s 719.
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investors must either have their money returned to them or be given 1 month
to decide whether to take shares (or keep them if already issued) after
receiving the replacement document – s 724
The general disclosure requirement is relaxed in respect of listed disclosing
entities who must make continuous disclosure under ASX rules because they are
subject to “enhanced disclosure” (ED) requirements – alternate disclosure
requirement for them under s 713, which requires only that such disclosure as is
reasonably required by an investor / professional advisor must be given – the
matters in the table of s 710 are not required, as the market knows these already.
C. Restrictions on the issue of securities
If securities are offered subject to the condition that none will be issued unless a
minimum number are subscribed for, then
moneys received before the minimum is reached must be held in trust be the
issuer (s 722)
no shares must be issued until the minimum target is reached ( s 723(2)) and
if it is not reached, subscribers must have their money refunded or must be
given a new prospectus revising the offer and giving them one month to
decide whether to withdraw the offer, or must be issued with the shares but
be given a new prospectus and one month to return the securities for a
refund – s 724.
If the disclosure document states that the securities will be listed on a stock
exchange and that does not happen within three months of the date of the
document, the issue is void and refunds must be sent to subscribers – s 723(3).
A prospectus expires (becomes stale) after 13 months – ss 711(6). If securities
are issued in respect of applications received after expiry, the issuer must either
refund investors their money or give them 1 month to withdraw their applications
– s 725(3).
D. Hawking of securities
Section 736(1) is designed to protect pressurisation of members of the public, by
prohibiting offers of securities during unsolicited meetings or telephone calls.
It covers both issue of new securities and sale of existing ones, and offers to
purchase as well as invitations to offer.
Exemptions apply where the offer wouldn’t need disclosure because
the ‘sophisticated investor’ exemption applies – s 708(8)
the professional investor exception would apply – s 708(11)
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the offer is of securities listed on the ASX made on the telephone by a
licensed dealer
the offer is made even of unlisted securities to an established client by a
licensed dealer
An issue or transfer of securities consequent upon a breach of the anti-hawking
provision can be rescinded by the purchaser – s 738.
E. Liabilities
An investor who has suffered loss after purchasing shares where prospectus was
false, misleading or incomplete can use the common law of misrepresentation to
obtain
rescission
damages in tort for misrepresentation
In the alternative to the above common law remedies, the CA imposes statutory
civil and criminal liability – these are now used in preference to the common law:
(i) Criminal liability
It is a criminal offence on the part of the Co and individuals involved to breach s
727 by
making an offer or distributing an application form for securities without
lodging a disclosure document
making offers other than with a form accompanying a disclosure document
or
accepting applications for unlisted securities within the 7 day cooling off
period given by s 727(3)
Section 728(1) prohibits the offer of securities under a disclosure document which
is misleading or deceptive or omits information which it should contain – note
that this applies both where the document was misleading or deficient ab initio or
to continuing to offer securities where new circumstances requiring the inclusion
of new info have arisen.
Breach of s 728 is a breach of the CA, and is also a criminal offence when the
breach is materially adverse from the point of view of the investor – s 728(3).
Note however that the offence is committed only by the “person” issuing or
transferring securities, i.e. the Co issuing securities.
Under s 739(1) ASIC may issue a stop order prohibiting offers, issues and sales of
securities when it believes that s 728 has been breached.
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(ii) Civil liability
Section 729 gives investors are given a right to compensation for loss or damage
resulting from a breach of s 728. An example of such liability is provided by
Cadence Asset Management Pty Ltd v Concept Sports Ltd (2005) 56 ACSR 309,
where the plaintiff purchased shares issued at $ 0.50 each on the basis of a
prospectus which contained forecasts about the respondent company’s financial
performance which were misleading and deceptive under s 728 (in that there was
no reasonable basis for those predictions – see s 728(2)). The plaintiff
subsequently sold the shares at a market value of $ 0.11 each. The court awarded
the plaintiff damages in the amount of the loss they had made.
Note that the table in s 729 makes liable not only the issuer of the securities (ie the
Co) but also its directors and others involved in the contravention. Persons whose
statements are included with their consent in a disclosure document (eg
accountants etc) will be liable for any loss arising from that statement (ie their
liability is limited to the material they were responsible for).
(iii) Defences
Defences are available to those prosecuted under s 728(3) or sued under s 729 as
follows:
Section 731 relates to prospectuses and provides a defence of due diligence
is available to a person who made all reasonable inquiries and believed on
reasonable grounds that a statement was not misleading or deceptive or that
there were no omissions.
Section 733 provides a general defence of reliance in respect of all
disclosure documents, to the effect that a person will not be liable under s
728 where they can show that they reasonably relied upon information given
by someone-else provided that that person was not a director employee or
agent (s 733(1)). Note that a person acting in their professional capacity is
not an agent – s 733(2). It is important to note here that if the company
successfully disclaims liability on the basis of reliance on information
provided by a person, then if a statement or information from that person
was included in the prospectus, then that person will become liable under ss
728 – 729.
Exercise
United Industries Corporation Ltd is a company with a diversity of
business interests. On 1 July 2003 its board resolves to open a
chain of hotels, and to raise capital to do this by issuing shares. On
4 July 2004 Brad Cooper, its Managing Director, telephones his
friend, Camilla Cash and offers her $ 600 000 worth of shares. He
also phones Bob Broke and offers him $ 100 000 worth of shares.
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Both Camilla and Bob accept these offers, but in light of
subsequent events now wish they had not and want their money
back. On 30 July 2004 United Industries issues a prospectus which
includes the following statement:
We confidently predict that a minimum of 50 000 people will
use our hotels’ facilities within the first year and that this
division of our company will be making a profit within two
years.
Unfortunately United Industries did not mention in their prospectus
the fact that their application for liquor licences for their hotel chain
was still being considered by the State Liquor Licensing Board,
which grants the licences 18 months after the hotels open. Because
they have been unable to serve liquor during this period, the hotels
are not yet profitable, and shares in United Industries plummet in
value, and so many investors lose their money.
Advise United Industries Ltd on its liabilities arising out of these
facts, citing full authority for your answer.
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Topic 23 Liquidation
Learning Objectives
After completing this topic, you should be able to:
1. Understand the concept of ‘external control’ and the
difference between receivership, administration and
liquidation;
2. Understand the different circumstances in which liquidation
might occur;
3. Trace the process by which a creditor can apply for
compulsory winding up of a company on insolvency;
4. Understand the role and powers of a liquidator;
5. Identify the ways in which a liquidator can increase the
capital available to a company to satisfy creditors by
pursuing claims on behalf of the company;
6. Understand the nature of voidable transactions, in particular
uncommercial transactions and unfair preferences;
7. Understand the rights of creditors when liquidation is taking
place;
8. Apply the order of when assets of a company are being
distributed;
9. Understand the nature of voluntary liquidation and the
circumstances when it takes place;
10. Appreciate that a company ceases to exist upon
deregistration.
A. External control
There are various circumstances in which a company falls under external control
because it is unable to meet its liabilities. Such control may be exercised by a
receiver, administrator, provisional liquidator or liquidator.
Insolvency practitioners can act as receivers, administrators or liquidators. They
must be registered with ASIC under s 1282.
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Receivership occurs when a secured creditor appoints receiver to enforce a
security interest which the creditor has over assets of the Co. If the interest relates
to all of a Co’s assets the receivership is a general receivership, if it relates to a
specific asset it is a particular receivership. The receiver controls the company for
as long as is required to sell off the secured property.
Voluntary administration occurs when the board of a company suspects that it
might be insolvent, and decides to put the company under administration. This
means that an administrator is appointed to take control of the company and report
to the creditors whether it should
 be allowed to carry on trading;
 come under long term administration regulated by a Deed of Company
Administration (an agreement between the creditors and the company); or
 be wound up.
Note that once a company decides to call in an administrator, the board effectively
surrenders control of the company to the creditors, because they decide, in light of
the administrator’s report, what the fate of the company might be. Voluntary
administration is often taken by directors who are uncertain as to whether their Co
is solvent and want to take steps to avoid possible s 588G liability.
B. Liquidation (winding up)
Winding up can occur either compulsorily or voluntarily.
Compulsory winding up (winding up resisted by the Co) occurs by application to
court
on grounds of insolvency (Pt 5.4), or
on other grounds (s 461).
Voluntary winding up (acquiesced in by Co) can take two forms
members’ winding up (if the Co is solvent). or
creditors’ winding up (if the Co is insolvent).
C. Compulsory winding up on insolvency
Compulsory winding up commences when a creditor applies to court to have the
Co wound up.
When is a Co insolvent? Under s 95A insolvency = inability to pay all one’s
debts as and when they fall due. The court does not simply focus on a company’s
financial position on a particular day, but rather The takes into account:
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debts currently due, and those due in near future, projecting into the future
for a common-sense period, and taking prospective debts and contingent
liabilities into account (s 459D)
the date when debts are due, taking into account a course of conduct by a
creditor that has given a period of grace beyond when debts fall due
assets – but taking into a/c whether those assets are readily saleable – only
assets realisable within a short time will be taken into account
what credit can be realisable by unsecured borrowing is not usually taken
into account
the terms upon which the Co itself extends credit – the extent to which debts
owed to a Co are an asset is obviously affected by this.
In certain circumstances listed in s 459C(2), the CA presumes a Co to be insolvent
– ie the onus will be on the Co to prove that it is not insolvent if any of the
following events have occurred within the three months preceding the application
by the creditor:
the Co fails to comply with a statutory demand to pay a debt of > $ 2 000
execution of a judgment debt is unsatisfied or
a receiver was appointed in order to enforce a security interest over
circulating assets
Failing a statutory presumption, the applicant must prove Co’s insolvency –
s 459P.
In determining whether the Co is insolvent, the court can take into account
contingent and prospective liabilities – s 459D(1): any obligation (including a
contract, trust or judgment) requiring that the Co pay money immediately, at a
future date, or on an event which may or may not happen.
if liability is on a certain date or an event certain to happen it is prospective.
if the event is uncertain (e.g. where Co has stood guarantor for a 3rd party) –
it is contingent.
Note that court’s power is discretionary – the court may decide not to take into
account contingent liabilities which have only a remote possibility of arising –
Brooks v Heritage Hotel Adelaide Pty Ltd (1996) 20 ACSR 61.
Once a Co is being wound up, provable debts include all claims, not just present,
prospective and contingent liabilities and will extend to claims arising under the
law of torts and contracts (eg a claim arising out of an event which has occurred
and which the claimant alleges gave him an action in tort against the Co, or a
claim for damages for breach of a contract which the Co will now not be able to
perform).
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Who can apply for winding up in insolvency under s 459P?
the Co in general meeting
a director or the board (with leave of court under s 459P(2)) so as to avoid
s 588G liability – they could choose the less drastic step of administration,
but may prefer to wind up if they see no hope of solvency
creditors (who are the applicants in 99% of cases)
a contributory (with leave) – defined by s 9 as including any present
member holding fully or part paid shares, as well as any past member still
liable to pay
a liquidator or provisional liquidator (appointed under voluntary winding up
where it becomes apparent that it is preferable to proceed by court winding
up)
ASIC (with leave)
receivers.
D. Compulsory winding up on other grounds
Winding up is also available on the following grounds under s 461:
the Co resolves by special resolution that it be wound up by court
the just and equitable ground – s 461(1)(k) – see the discussion in the Topic
on members’ remedies
where the affairs of Co are being conducted by directors in their own
interests
where the affairs of Co are being conducted in an unfair, prejudicial or
discriminatory manner (also available under s 232)
where an ASIC investigation concludes that it is in interests of public,
members or creditors to wind up or where Co has no members.
E. Procedure for compulsory winding up
Pt 5.7B frequently mentions specific periods before the ‘relation-back day’, which
is defined in s 9 as the day application for winding up was filed.
The date of the beginning of winding up is the day the court order is given, except
where liquidation was preceded by administration, in which case the date of the
administrator’s appointment is the date liquidation is taken to have started:
s 513A.
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A provisional liquidator can be approved at the filing of the winding up
application where necessary to protect Co assets pending hearing of application –
s 472(2).
If the court decides to grant the liquidation application, the provisional liquidator
is confirmed as liquidator.
The consequences of the liquidation order are as follows:
the liquidator takes control of Co, the directors’ powers are suspended
(s 471A)
dividends cannot be declared
unpaid capital can be called
dispositions of Co property and executions against it are invalid (s 468)
proceedings against the Co cannot be continued or begun (s 471B)
employees are discharged (unless their services are retained by the
liquidator)
transfers of shares are void as against Co (s 468)
Co documents must reflect that it is “in liquidation” (s 541).
Liquidation replaces creditors’ individual rights with a right to claim against
liquidator to be paid out of Co assets.
Creditors lodge proof of their claim with liquidator, who either accepts or rejects
it in whole or in part, subject to appeal by creditor to court under s 1321.
F. The role of the liquidator
The liquidator must
take possession of Co assets
realise (i.e. sell) the assets
determine claims against Co
apply Co assets towards the costs of liquidation and claims brought by
creditors
distribute anything left after satisfaction of claims (likely to be nothing if the
Co is insolvent)
dissolve the Co
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The liquidator must notify ASIC of his appointment – s 537.
The directors must give to the liquidator a report on the company’s affairs, its
assets and liabilities – s 475.
The liquidator must investigate the company’s affairs, including any illegalities
and must lodge a preliminary report with ASIC – s 476.
The liquidator must keep books of account – s 531, and must lodge six-monthly
accounts with ASIC – s 539.
The liquidator must do everything in his power to increase Co assets, and may
bring proceedings on behalf of the Co – s 477(2).
He / she has extensive powers under s 477, and may sell Co assets – s 477(2)(c).
The liquidator may carry on Co business, but note s 477(2B) – restriction on
agreements ending or obligations to be discharged > 3 months after being entered
into. Such agreements need the consent of the court or of a creditors’ meeting.
The liquidator must also get creditor or court approval if he / she wishes to
compromise (ie settle) a claim that the company has against a 3rd party that is
valued at > $ 20 000 – s 477(2A).
The liquidator may use assets to fund winding up costs – s 512.
The liquidator may apply to court to restrain the departure of a Co officer from
Australia or for the taking of property of Co into safekeeping – s 486A.
Under s 486B (even more drastic than s 486A) , ASIC, a liquidator or provisional
liquidator can apply for order arresting person who is about to leave Australia in
order to avoid paying money owed to Co, being examined, complying with court
order under Ch 5, or who has concealed Co property or who has destroyed,
concealed or removed Co books.
The liquidator is agent of the Co, and is subject to liability as fiduciary, under ss
180-184.
Section 600F prohibits suppliers of essential services (electricity, water, gas) from
terminating supply to a Co while it is under liquidation.
G. Funds available for distribution
Only assets beneficially owned by Co at the time of the liquidation order or which
come into the Co’s ownership after the order are available for distribution.
There are various avenues open to the liquidator to increase the company’s assets
– and thus provide a larger pool from which to pay creditors. These avenues
include:
invalidation of voidable transactions (Pt 5.7B – see below)
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suing directors (including de facto and shadow directors) for damage to Co
under s 180-184 or s 598 (which imposes liability for fraud, negligence,
default, or breach of trust causing loss to Co)
suing directors for insolvent trading under s 588G
recovering Co property or compensation from constructive trustees (eg 3rd
parties receiving property knowing that directors were breaching fiduciary
duty or participating in breach of duty)
disregarding invalid security interests (s 588FJ, s 588FP)
making calls on partly-paid shares
(i) Voidable transactions
Voidable transactions can be set aside by a s 588FF order, applied for by the
liquidator.
Under s 588 FC the liquidator must show under that the transaction was an
‘insolvent transaction’, which means that it was
an unfair preference or
an uncommercial transaction
entered into when the company was insolvent, or which made the
company insolvent.
An unfair preference is defined in s 588FA(1) as a transaction between the Co and
creditor where the creditor receives more for unsecured debt than would have
been received in winding up
An uncommercial transaction is defined in s 588FB(1) as one which reasonable
person in Co’s position would not have entered into, taking into account the
benefit and detriment to Co and other parties. The object of this provision is to
reverse any depletion of Co assets caused by transactions at under value – eg
excessively generous retirement package for a director or sale of an asset at
undervalue.
It is obviously important for the purposes of s 588FC for the liquidator to work
out precisely when the company became insolvent. This requires a careful
examination of its records. However, assistance is provided by two presumptions
in s 588E that:
If the company is proved to have been insolvent at any time during the 12
month period preceding relation-back day, it is presumed insolvent since
that time.
A company is also presumed to be insolvent for any period that it does not
maintain statutorily-required accounting records as required under s 286.
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Not all uncommercial transactions and unfair preferences are invalid – there is also
a time requirement: Under s 588FE the liquidator must also show that entry into
transaction was within a statutorily prescribed period, which is
6 months before the relation-back day in the case of unfair preferences (s
588FE(3))
2 years before the relation-back day in the case of uncommercial transactions
(s 588FE(2))
Unfair preferences and uncommercial transactions are not the only type of
insolvent transaction that can be voided. Even longer periods apply to three other
types of insolvent transaction, which can be reversed if they occurred
4 years prior to the relation-back day in cases where the transaction was with a
related entity of the company (s 588FE(4)) or was a director-related transaction
(s 588FDA(1))
10 years prior to the relation-back day if the liquidator can prove that the
transaction was entered into for the purpose of defeating a creditor’s claim (s
588FE(5)).
As stated above, the ‘relation-back’ day is the day the application for winding up
was filed with the court.
However, if winding up was preceded by (i) voluntary winding up (ii)
administration or (iii) administration under deed of Co arrangement, then the day
of the passing of the resolution for winding up or the day the he administrator was
appointed = both the relation back day and the day of commencement of winding
up (s 588FE(2A)).
(ii) Void security interests
Under s 588FJ a security interests registered within less than six months before
relation back day is not enforceable against the Co.
(iii) Money not available to settle creditor’s claims
property subject to a security interest or lien
moneys being held on trust by the Co – the liquidator must identify trust
assets and deal with them separately.
moneys paid to Co by insurer to satisfy a 3rd party’s claim against Co –
s 562.
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(iv) Unfair loans
The liquidator can reverse any unfair loans made to the Co – s 588FE(6). An
unfair loan is defined in s 588FD as a loan in respect of which interest or charges
were extortionate.
H. Lodgement of claims
Creditors lodge proof of claims and seek to have the liquidator accept them.
A claim must have arisen before the date of winding up (or the date an
administrator was appointed).
Under s 553B, penalties or fines owing to the Crown do not enjoy priority –
creditors shouldn’t be penalised by Co’s wrongdoing.
Debts owed to members not payable unless their shares are fully paid – s 553A.
Note however that this section applies only to shareholders in their capacity as
shareholders. In Sons of Gwalia Ltd v Margaretic (2007) 232 ALR 232 the High
Court held that where a shareholder had a claim against a Co arising out of a
misrepresentation by the Co which induced the shareholder to purchase shares,
such a claim arose before the person became a shareholder and was thus not a
liability to them in their capacity as shareholder. The shareholder therefore
ranked equally with other creditors in respect of this claim.
Set off of debts owed by a creditor to the Co is governed by s 553C – a creditor
may claim only any excess owed to him by Co once his debt to it has been
counted.
After secured creditors (ie holders of security interests over non-circulating
assets) are paid, the order of priorities set by s 556 applies:
costs of liquidation
employees’ claims (paid pro rata if there is insufficient money to satisfy all –
s 559) and claims of persons who lent money to cover employee’s
entitlements (s 560). Note the limitations on amounts payable to directors in
their capacity as employees under s 556(1) – salaries up to a cap of $ 2 000
(s 556(1A)), leave entitlements up to a cap of $ 1500 (s 556(1B)).
unsecured creditors the general rule of priority is the pari passu rule, which
means that all debts rank equally and if the company’s assets are insufficient
to satisfy all claims, creditors share the assets pro rata – s 555 (eg, if the
company has assets worth $ 1 million and debts of $ 4 million, each
unsecured creditor will get 25c of each dollar they are owed)..
The court may set a final date for proof of claims – s 485(1).
Any surplus then distributed to members. Moneys remaining unclaimed are paid
to ASIC – s 544(1).
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I. Voluntary winding up
A voluntary winding up is one concurred in by the Co – ie it takes place without
an order of court.
If the Co is solvent, the winding up is controlled by the members, who appoint the
liquidator. This is what would happen if a solvent Co has achieved the objective
it was established for, and the shareholders want to realise their investment.
If a Co is insolvent and the members agree to wind it up, the process is controlled
by the creditors, who appoint the liquidator.
The voluntary winding up commences with a special resolution by the
shareholders under s 491.
If a Co was under administration, then the creditors may vote to implement
creditors’ voluntary winding up after receiving the administrator’s report (ss 439C
or 445E). Thus, by putting a Co into administration, the board is impliedly
consenting to the possibility that the creditors might turn it into a liquidation. In
such circumstances winding up is deemed to have started when the administrator
was appointed – ss 513B and C.
J. Deregistration
After any type of liquidation, the Co ceases to exist as an entity on deregistration
applied for by the liquidator – s 601AD(1).
Exercise
Blue Star Hotels Ltd operates a chain of hotels in NSW and
Victoria. Its directors are Tom Sharp, Charles Dickens and Mary
Wollstonecraft. On 1 April Taylor’s Linen Hire Ltd presented a
demand to Blue Star in respect of a $ 2 500 laundry bill owed by
the hotel group. Blue Star was unable to meet this debt. On the
basis of this insolvency, Taylor’s Linen Hire then filed an
application for winding up on 23 April. The application was
successful, and Ivan Trump was appointed as liquidator under a
winding up order granted on 1 May. Ivan has requested that the
directors meet with him on 5 May and provide him with a report on
the company’s affairs. Advise him as to what impact the following
facts have on the liquidation, giving full authority for your answer:
On 12 April Blue Star registered a circulating asset security
interest in favour of Wholesale Liquors Ltd, securing a debt of $
100 000 owed to Wholesale for wine supplied by it in February and
March.
On 2 April the Board of Blue Star, in an attempt to deal with its
cash-flow problems, borrowed an amount of $ 200 000 from
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198
Grasping Bank, paying the bank an application fee of $ 50 000 and
agreeing to a 25% per annum interest rate.
Leonard Royce, who is in charge of the fleet of limousines run by
the hotel, tells Ivan that the contract with Ultra Lube Ltd, which
services the vehicles, is up for renewal. Ultra-Lube requires that its
clients sign a maintenance contract that is of a minimum of 4
months’ duration.
Ivan has found the following in Blue Star’s files: a contract dated 1
February for the purchase of 25 ivory chess sets from Dunhill
Ornaments Ltd (which Blue Star would sell in gift shops in its
hotels) on terms of payment after 6 months, and a letter dated 21
April varying the terms of the contract by adding to it a new clause
in terms of which Blue Star agreed to transfer ownership in the
goods back to Dunhill, and to sell them on consignment from
Dunhill at 20% commission.
Ivan has also discovered a receipt for a one-way ticket for a flight
which leaves for Argentina on 3 May, booked by Mary
Wollstonecraft, who has so far refused to co-operate with Ivan.
Tom, Charles and Mary are owed $ 20 000 each in respect of salary
and $ 5 000 each in respect of leave entitlements. The hotel chain’s
500 employees are owed $ 1 000 000 in respect of salaries and $ 40
000 in respect of leave entitlements.

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