The Corporate Constitution and Decision Making by the Board of Directors

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Contents

Required Reading

Redmond, Paul Corporations and Financial Markets Law 6th ed, 2013, LBC, pp. .

Introduction

A company traditionally needed to have its own constitution (‘article of association’) in addition to its incorporating document (‘memorandum of association’). This was recently abolished and the Corporations Act now has a series of default provisions for internal management – the ‘replaceable rules’ - which any company may use.

  • A table of replaceable rules is contained in s 141.
  • If a company chooses to adopt its own constitution, this will displace the application of any inconsistent replaceable rules, except a rule which is expressed to be mandatory and which operates therefore as an ordinary provision of the Act.

A company has three options:

  • No constitution - means relying solely on replaceable rules.
    • Advantages: simplicity - replaceable rules are easily accessible in the Act and are revised from time to time.
  • Constitution - means wholly/partly displacing replaceable rules.
    • Advantages: most companies use this option as the replaceable rules are seen as too simple
  • If it was created prior to 1 July 1998, it can use its constitution to the exclusion of inconsistent replaceable rules.

Altering the constitution

A company's constitution can be altered. The default rule in the replaceable rules is that a company can vary its constitution via a 'special resolution' (as opposed to an 'ordinary resolution'). Note that this rule too can be changed in the constitution.

  • An ordinary resolution requires only a mere majority for the resolution to be successful
  • A special resolution (s 136(1)), requires 75% of the votes cast by members entitled to vote on the resolution who have notice of the intention to propose the special resolution and of its terms: s 9.
  • A constitutional provision can be entrenched against alteration by a special provision by specifying in the constitution a further requirement for its alteration: s 136 (3), (4). Examples include:
    • A greater majority than 75%
    • Particular condition must be fulfilled

The corporate organs

A company used to be described as having “no physical existence and exists only in contemplation of the law”: Continental Tyre and Rubber Co v Daimler Co. Historically, two groups of individuals have been recognized as having authority to act for companies - members assembled in a general meeting and its board of directors.

  • Companies legislation constitutes a board of directors and general meeting, leaving the division of corporate powers between these organs to the replaceable rules or constitution of a company.
  • The boundary between the roles is apt to become confused in private companies in which the members are partners and involved in company management - the formal distinction between shareholder and director roles, and the obligation to act as either one or the other, is compromised.
  • In smaller companies the board may function as an organ to take the active direction of company affairs.

The Corporations Act now requires a company to appoint a secretary: s 204A

The derivation of the corporate organs

The general meeting has primarily been the primary corporate organ. The acts of either organ, within authority, are acts of, and not merely for the corporation.

  • In Australia, management structure and allocation of power between and organs is not determined by legislation but is left to the design of the incorporators, with the assistance of some basic replaceable rules.
  • The Corporations Act vests a few specific powers in the general meeting, but otherwise only determines the minimum size of the directorate and no other particular powers or functions for it
  • Three directors are required in public companies. One director in proprietary companies: s 201A.
  • Directors are required to be natural persons aged at least 18 years: s 201B.

Original powers of the general meeting

Where no provision is made by the Act or a company’s constitution as to which organ shall exercise a particular corporate power, the rule remains from the general law of corporations that shareholders assembled in general meeting may act by ordinary resolution for the company: Clifton v Mount Morgan Pty Ltd. However:

  • Section 198A(2) states that directors are able to exercise all the powers of the company except any powers that the Act or the company’s constitution requires the company to exercise in a general meeting. This means that the board of directors is the organ which exercises most of the powers of the company.
  • Powers of the general meeting principally relate to the constitutional and capital structure, the composition of the board and certain fundamental changes (see Textbook, p. 225).
  • The powers vested in the general meeting are exclusive to that organ and do not revert to the board when the general meeting is unable to act. On the contrary, the powers of the board revert to the general meeting when it is deadlocked or otherwise unable to act.
  • Only shareholders possess voting rights and have the power to appoint and remove directors, however:
    • The board and management usually enjoy a large measure of de facto power over the election process and therefore the corporation.
    • The influence of other participants may be such that they are granted a right, by contract or constitutional provision, to board membership.

The powers of the board

The replaceable rules confine to the board of directors some specific powers:

  • That the business of the company is to be managed by or under the direction of the directors: s 198A(1).
    • That directors may exercise all the powers of the company except any powers that the Act or the company’s constitution requires the company to exercise in general meeting: s 198A(2)

The above provisions are nearly always restated in the company’s constitution. According to Campbell v Rofe,the power contained in s 198A(2) gives the directors power to do everything that the company could do except where the authority of the general meeting is expressly prescribed

Other variations and restrictions

There often various restrictions to the organs of a company:

  • Constitutions may give management powers to one or more directors exclusively (ie, a managing director).
  • Constitutions may allocate all corporate power to the general meeting.
  • ASX Listing Rules restrict directors of listed companies from exercising particular powers without the approval of the company in general meeting (see p. 227)

Visual representation of powers

Board of directors

Shareholders (general meeting)

Bring legal proceedings in the name of the company

Alter the company’s name: s 157

Borrow money for the company and grant security over company property

Adopt a constitution for the company and repeal or modify its terms: s 136

Issue negotiable instruments

Change the company’s type: s 162(1)

Grant bonuses to employees and pensions to their dependents

Convert all or any of its shares into a larger or smaller number of shares by ordinary resolution: s 254H

Dispose of company assets, perhaps even the whole undertaking

Reduce share capital or approve a buy-back of shares: ss 256B, 256C, 257A, 257C, 257D

Declare dividends and capitalize profits - requires prior recommendations by directors

Appoint a person as director: s 210G

Determine the remuneration of directors: s 202A

Appoint and remove company auditors: s 327A, 327B, 329

Wind up voluntarily (s 491) or by a court order: s 208(1)(a)

General principles of interpretation of constitutional provisions

The old common law principle was that, where the statute or constitution makes no provision as to which organ has the power with respect to a particular matter, or the organ is unavailable, the general meeting may by ordinary resolution, act so as to bind the corporation: Clifton v Mount Morgan.

  • However, this old corporation principle has been restricted by s 198A(2) to circumstances in which the board is deadlocked or lacks a minimum vote - indicates that the general meeting’s control over the board in the exercise of its powers has been significantly eroded
  • The degree of independence from shareholders that directors have in relation to the exercise of their powers depends upon the terms in which the powers are expressed in the company’s constitution or replaceable rule applicable to it

This was discussed in Automatic Self-Cleansing Filter Syndicate Co Ltd v Cuninghame:[1]

  • Facts: M, a shareholder in A, arranged for sale of assets and prepared agreement for sale to another company for execution by the company. At general meeting convened at M’s request, a resolution was passed that the company sell its assets. Directors said the agreement was not in company’s best interests and refused to comply with resolution. M brought suit in his own name and that of other company seeking an order that director’s bound by resolution.
    • A’s constitution vested the powers of management in the directors’ subject to “such regulations not being inconsistent with these presents, as may from time to time be made by extraordinary resolution”: cl 96. Clause 97 said directors were empowered to sell and deal with company property on such terms as they think fit. Clause 81 empowered the company by special resolution, to remove any director before expiration of term of office.
  • Issue: whether directors could stop resolution by shareholders to sell company property (looks at s 198A equivalent, cl 96).
  • Held: directors are given the power to do all things other than those expressly required to be done by the company. In this case, this is limited by clause 96 which effectively states that if it is desired to alter the powers of the directors, this must be done by an 'extraordinary resolution'.
    • Court argued that this provision would be pointless if the directors’ decisions could be overridden by a mere majority at an ordinary meeting - wouldn’t need any special power to remove directors’ powers/directors themselves if you can do it without them and differ from their opinion and compel them to do something other than their view.
    • Shareholders have, by their express contract, mutually stipulated that their common affairs should be managed by certain directors to be appointed by shareholders in the manner described by other articles, such directors being liable to be removed only by special resolution - what right is there to interfere with this contract, apart, of course, from any misconduct on part of the directors which is not the issue in this case
    • Thus, directors cannot be told what to do by the shareholders – “Directors alone manage”.
    • Approved in Australia in Howard Smith Ltd v Ampol Petroleum Ltd.

And also in Marshall’s Valve Gear Co Ltd v Manning Wardle & Co Ltd:[2]

  • Facts: Patentee (Marshall) sold his patents to company formed for purpose of taking them over at price which included allotment to him of fully-paid shares. Subscribed cash capital of company was found by others persons and nobody really interested in company except for four directors who include, as managing director, the patentee. He had shares which gave him controlling vote but not such as would give him 75% to allow passing of special resolution.
    • Articles of association provide for assurance of position of directors which can only be altered by a special resolution. Also vested management powers in directors subject to “such regulations, not being inconsistent with these presents, as may from time to time be made by resolution”.
    • This was the standard Table A provision at time (reg 55) unlike article in Automatic (above) which added adjective “extraordinary” to clause.
    • Other directors, after inception of company, took out patent for construction of valves similar to that of valves of Mr M’s patent and said their patent is infringement of his intellectual property. Since the patents were owned by the company, the company alone could litigate against it. He tried to get the company to litigate it, the directors didn't want to, and he passed a resolution in the general meeting for them to do it.
  • Issue: whether there is a duty as directors to protect interests of original patent which is property of company, but personal interest to maintain validity of similar patent which belongs to them
  • Held: distinguished Automatic on the basis that the company’s articles in that case expressed the board’s management power to be subject to regulations made by ‘extraordinary’ resolution
    • In this case, the articles allowed the general meeting to control the action of the company through a normal resolution - the articles here only necessitated a special resolution when the directors were to be removed..
    • Thus, since an ordinary resolution was achieved and it was what was required, the directors had to bring the claim.
    • Note p 234 inconsistency with this case and Shaw: Massey.

This was also discussed in John Shaw & Sons (Salford) Ltd v Shaw :[3]

  • Facts: family company’s articles contained delegation of management clause in terms identical with standard Table A clause, but other articles effectively vested all powers of directors in 3 permanent directors. The permanent directors commenced legal proceedings in the name of the company against 2 ordinary directors for recovery of debts allegedly owing to company (the defendants). The general meeting directed that proceedings be withdrawn, and the defendants sought to have action against them dismissed on ground that instituted without authority of plaintiff company.
  • Held: “If powers of management are vested in the directors, they and they alone can exercise these powers. The only way in which the general body of the shareholders can control the exercise of the powers vested by the articles in the directors is by altering their articles, or, if opportunity arises under the articles, by refusing to re-elect the directors of whose actions they disapprove.”
    • This case is clear authority that non-intervention policy in Automatic applies equally where delegation of management clause is in same terms as standard Table A provision broadly corresponding to s 198A.

Appointing and removing directors

The appointment and removal of directors is found in Part 2D.3. For appointment see ss 201A – 201M and for removal see ss 203C – 203F (pp 248 – 52).

  • These rules aim to strike a balance between the goals of assuring directors tenure of office so as to encourage independence and vigour, and on the other hand, insinuating a structure of management accountability.
  • Powers over the appointment and removal of directors are the principal controls that shareholders enjoy over directors, qualified by the powers given to directors to appoint managing directors and subordinate managers.

The personnel of company management

As mentioned before, the Act stipulates that there must be a minimum number of directors (3 for public, 1 for private): s 201A. The directors may appoint one or more of their number to the office of managing director and confer any of their powers upon her or him: s 198C.

  • In most companies the day-to-day administration of company affairs is left to one or more managing directors and to the staff appointed by them.
  • Such directors are called executive directors since they serve the company both as normal directors and employees, usually under a formal contract of employment.
    • There may be specialist directors appointed, eg, finance or marketing directors.
    • Alternative director may be appointed to exercise some or all of the director’s powers for a specified period: s 201K(1).
    • “Officer” includes not only the directors and secretaries of a company but also persons who participate in making decisions affecting a substantial part of the company’s business, have the capacity to affect significantly its financial standing or are in a position to communicate instructions or wishes to the directors with the intention that they will be acted upon and are in fact acted upon: s 9.
    • “Senior manager” is used in contexts where forms of business associations other than corporations are used.

Appointment of directors

The first directors are appointed by naming them, with their consent in the application to register the company: s 120. Under the replaceable rules, directors may be appointed in the following ways:

  • By the company in general meeting: s 201G
  • By the directors themselves: s 201H(1)
    • This must be confirmed by the general meeting within two months in the case of a proprietary company or at the next annual general meeting for a public company: s 201H(2) – (3).

Under a constitution, the Act impinges little upon freedom to frame arrangements for the appointment of directors so there is considerable variety in the proprietary company constitutions.

  • Usually, one third of directors retire at each annual general meeting but are eligible for re-election
  • In public companies a motion to appoint two or more persons as directors by a single resolution may not be made unless the meeting resolves, without any dissenting vote, to do so: s 201E(1)
  • The holders of a bare majority of voting shares will be entitled to select the entire board
  • For stock exchange listed companies, it is rare for a person to be nominated for election as a director other than through the existing board and even rarer for such a person to be elected.

Restrictions upon appointment as director

There are no minimum standards of training, competence or academic qualification are imposed by law upon persons appointed as company directors or secretaries, even of publicly held companies.

  • The Act imposes a minimum age of 18 years for appointment: s 201B(1).
  • No shareholding requirement is imposed by the Act upon directors.

Disqualification from office and from managing companies

Disqualification is designed to protect the investor and public – to prevent fraud and mismanagement, and as an alternative to prosecuting the corporation involved.

There are seven main grounds for disqualification:

  1. If the director is an undischarged bankrupt, including those who enter into a deed of arrangement under the Bankruptcy Act: s 206B(3), (4).
  2. If the person has a criminal conviction including (s 206B(1)):
    • Indictable offences involving decisions that affect a substantial part of the company’s business or its financial standing
    • An offence involving dishonesty which is punishable by imprisonment for at least three months, and
    • Offences punishable by imprisonment for at least 12 months.
    • The period of automatic disqualification is five years: s 206B(2).
      • The court may grant leave to the disqualification person within this period (s 206G), or, upon ASIC’s application, the Court may also extend the period of automatic disqualification by up to 15 years (s 206BA).
  3. If the person was responsible for repeated contraventions of the Act where the person (s 206E(1)):
    • Has at least twice been an officer of a body corporate that has contravened the Act and the officer failed to take reasonable steps to prevent the contravention; or
    • Has at least twice contravened the Act while an officer of a body corporate and the court is satisfied that the disqualification is justified
  4. Where the person has been involved in the management of failed companies, if (s 206D):
    • Within the last seven years the person was an officer of two or more companies that have failed financially;
    • The manner in which they were managed was at least partly responsible for the failure; and
    • Having regard to the person’s participation in management, the disqualification is justified
    • Note: A company is deemed to fail financially if it enters into one of several modes of external administration: s 206D(2)
      • This is a discretionary power conferred upon the Court to disqualify directors who have been involved in the management of companies that have failed - the Court may disqualify a person from managing corporations for a period of up to 20 years
  5. The person is unable to pay unsecured creditors more than 50 cents in the dollar or breached their duty (s 206F),ASIC is given a power to disqualify for up to five years:
    • The officer must be given an opportunity to be heard - criteria includes whether the disqualification would be in the public interest.
  6. The person has contravened a civil penalty provision (s 206C) - the Court may disqualify a person from managing corporations for such period as it considers appropriate if:
    • A declaration is made that the person has contravened a civil penalty provision, and
    • the Court is satisfied that the disqualification is justified: s 206C(1)
    • It is this ground of disqualification that was exercised in ASIC v Adler.
  7. The person committed a breach of Pt IV of the TPA (regarding restrictive trade practices) (s 206EA):
    • A person is disqualified if the Federal Court has, on the application of the ACCC, made an order under s 86E of the TPA if a person has contravened, attempted to contravene or been involved in a contravention of Pt IV.

Note that criminal convictions and bankruptcy are automatic grounds for disqualification whereas the others are discretionary.

How can directors be dismissed?

There are a number of ways in which directors can be dismissed:

  • Removal by members (in proprietary companies): s 203C
  • Removal by members (in public companies): s 203D
  • Directors cannot be removed by other directors in public companies: s 203E

This was discussed in ASIC v Adler:[4]

  • Facts: Adler was a non-executive director of HIH, a leading general insurer. He was also a director and 50 per cent shareholder of Adler Corp, the other 50 per cent being owned by his wife
    • HIHC, a subsidiary of HIH, paid $10 million to a company controlled by Adler without knowledge of the other directors - $4 million of this was used to purchase HIH shares to stabilise the falling share price and the rest was used to purchase three investments in unlisted technology and communication stocks and the balance used as unsecured loans to interests associated with him
    • ASIC sought declarations against Adler and Williams for contraventions of:
      • Sections 180 – 183 for the provision of financial benefits to related parties without shareholder approval; and
      • Section 260A for the provision of financial assistance in the acquisition of its shares with material prejudice
    • ASIC applied under s 206C for an order disqualifying Adler from managing the corporations
  • Held (Santow J):
    • Discussed the principles arising from the authorities which should be taken into account in cases involving disqualification - included factors such as:
      • Disqualification is designed to protect the public from harmful use of the corporate structure
      • Motive of personal deterrence, not punitive
      • Promotion of the proper role of the company director and the duty of due diligence which is owed
      • The more serious the conduct, the longer the disqualification
      • When determining disqualification period, consideration has to be given to the degree of seriousness, likelihood of similar conduct in the future, and the harm caused to the public
      • Mitigating factor is the likelihood of the defendant reforming
      • Necessary to balance personal hardship to defendant against public interest and need for protection of public from any repeat of conduct - in this case, see reason found against considering this at [70]
      • Eight criteria which govern the exercise of the court’s power of disqualification (Commissioner for Corporate Affairs v Ekamper):
        • Character of offenders
        • Nature of breaches
        • Structure of companies and nature of their business
        • Interests of shareholders, creditors and employees
        • Risks to others from continuation of offenders and directors
        • Honesty and competency of offenders
        • Hardship to offenders and personal and commercial interests
        • Offenders appreciation that future breaches could result in future proceedings
      • Factors which lead to imposition of disqualification of 25+ years:
        • Large financial losses
        • High propensity that defendants may engage in similar activities
        • Activities undertaken in field in which there was potential to do great financial damage i.e. management and financial consultancy
        • Lack of remorse
        • Disregard for law and compliance with corporate regulations
        • Dishonesty and intent to defraud
        • Previous convictions and contraventions for similar activities
      • Factors which lead to imposition of disqualification of 7 – 12 years:
        • Serious incompetency and irresponsibility
        • Substantial loss
        • Defendants engaged in deliberate courses of conduct to enrich themselves at others’ expense but with lesser degrees of dishonesty
        • Continued and willful contraventions of law and legal obligations
        • Lack of acceptance of responsibility but may reform
      • Factors which lead to imposition of disqualification of up to 3 years:
        • Although defendant personally gained from conduct, they had endeavored to repay/partially repay amounts
        • No immediate/discernible future intention to hold position of manager of a company
        • In Donovan’s case had expressed remorse and contrition, acted on advice of professionals and had not contested the proceedings
    • Took into account the reasons for imposing a 25 year disqualification in ASIC v Parker and found that the appropriate disqualification for Adler was 20 years because he lacked the fraud element possessed by Parker
      • Extremely serious breaches
      • Knowledge of impropriety of conduct
      • To advance own interests at expense of companies
      • Dishonesty
      • Pattern of conduct not isolated
      • Persistent lies to hide conduct
      • No contrition manifested
      • Public interest in individuals dealing with company was paramount over A’s private interests

Directors meetings - how does the Board make effective decisions?

  • Circulating resolutions: s 248A
  • Calling directors’ meetings: s 248C
  • Use of technology: s 248D
  • Appointing a chair of directors’ meetings: s 248E
  • Quorum at directors’ meetings: s 248F
  • Passing of directors’ resolutions: s 248
  • Director’s powers are inherently limited to their collective action, the individual director can do nothing - powers deriving from office of director are simply to participate in board decisions: Northside Developments Pty Ltd v Registrar-General (see p 295).
  • Under the general law, directors may act only at a meeting unless constitution makes other provisions: Brick and Pipe Industries Ltd v Occidental Life Nominees Pty Ltd (1990).
  • But, principle so often yields to expediency and we have replaceable rule such as those above

Executive directors’ service contracts

Whilst the directors are legally responsible for the running of the business, in practice (especially in larger companies) this is often delegated to the management and executive staff of the company under the leadership of the chief executive (which comes under that title or appointed as managing director or general manager of the company).

  • Modern company law distinguishes between the two capacities of the managing/executive director - as both a director and an employee of the company. It is clear from cases such as Lee v Lee’s Air Farming that a director can function in dual capacities.

Often a managing director will be appointed under a written service contract between themselves and the company. If the director is to be removed, distinction should be drawn between the company’s power to break a contract (and such a breach may expose it to liability for damages) and its right to do so (whether the contract authorizes the removal)

  • Power: company, in a general meeting, can alter the constitution pursuant to s 136 by inserting such a power which it can then invoke to remove the director - cannot deprive itself of the power to alter its constitution by contract, even though the alteration may be a breach of contract and expose the company to damages.
  • Right: whether the right to remove a director exists depends on the model of removal and the power that is invoked under the replaceable rule or constitution, and on the terms of any service contract entered into with the director and the relationship between this contract and the constitution.
    • “A company cannot unilaterally vary its contracts by altering its articles unless that is the basis upon which the contract was made”: Bailey v NSW Medical Defence Union

Questions of construction often arise as to whether the service contract has incorporated as one of its terms the provisions of the replaceable rule/constitutional provision, and whether upon terms that the latter is alterable unilaterally by the company.

This was discussed in Read v Astoria Garage (Streatham) Ltd:[5]

  • Facts: the constitution adopted Table A, art 68, which said that a director can be appointed as managing director but this appointment ceases if he ceases to be a normal director. There was no express contract for the appointment, only a board resolution passed at the first meeting of directors of the company that the plaintiff “be and he is hereby appointed managing director of the company at a salary...". When the plaintiff was in ill health and the company was doing badly the directors resolved that the plaintiff’s employment be terminated. Subsequently an extraordinary general meeting of the company was held at which a resolution approving the directors’ action in removing the plaintiff was passed. The plaintiff sued for damages for wrongful dismissal and breach of contract on the basis that he had not been given reasonable notice
  • Held: since the company had the power to dismiss, they could breach the contract because every contract entered into by the company is subject to the power of the company. There is no cause for wrongful dismissal unless it can be shown that the terms of the contract of employment were inconsistent with the powers to determine a MD’s appointment at a GM.
    • The constitution gave no right to receive any particular notice of termination of employment in the event of a resolution at a GM. A managing director who has been dismissed in this way cannot claim for wrongful dismissal unless he can show that an agreement between himself and the company has been entered into, the terms of which are inconsistent with the exercise by the company of the power conferred on it by the article to determine a managing directors appointment in a GM
    • No evidence here of the existence of any such contract so no wrongful dismissal.

This was also discussed in Shindler v Northern Raincoat Co Ltd :[6]

  • Facts: the plaintiff sold the share capital of the defendant company to Lloyds and, as part of the sale agreement, entered into a written agreement with the defendant to serve it as managing director for an agreed salary and a term of 10 years. Shortly after, Lloyds sold the equity in the defendant company to another company and, despite negotiations, made no alternative offer of employment acceptable to the plaintiff. The plaintiff sued for wrongful dismissal. The defendant company’s articles included art 68 from the current Table A whose terms were identical with those quoted in Read v Astoria Garage
  • Held: principle of law as laid down in the case of Stirling v Maitland [7] where Cockburn LJ said “if a party enters into an arrangement which can only take effect by the continuance of a certain existing set of circumstances, there is an implied engagement on his part that he shall do nothing of his own motion to put an end to that state of circumstances, under which alone the arrangement can be operative”.
    • Difference here to Read was that there was a written agreement. It was implied there that there was engagement on the part of the defendant company that it will not of its own motion revoke his appointment as a director, and will not resolve that his tenure of office be determined.
    • Thus, there was wrongful dismissal on behalf of the defendants

What rights to directors have to information?

Molomby v Whitehead (1985): There are limitations placed on access as outlined below à bad faith, ‘need to know’ or ’good reason’ for access. The onus is on the Court.

  • Section 198F: Right to access company books.
  • Section 290: Director access.

End

This is the end of this topic. Click here to go back to the main subject page for Business Associations.

References

Textbook refers to Redmond, Paul Corporations and Financial Markets Law 6th ed, 2013, LBC.

  1. [1906] 2 Ch 34.
  2. [1909] 1 Ch 267.
  3. [1935] 2 KB 113.
  4. (2002) 168 FLR 253.
  5. [1952] WN 185.
  6. [1960] 1 WLR 1038.
  7. (1865) 5 B & S 840; 122 ER 1043.
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