Contrasting decisions in favour of shareholders Should company directors be overly concerned Law Repo

Two decisions, one in the Federal Court of Australia and the other in the New South Wales Supreme Court have seen very different results for the complaining shareholder.

Should company directors be overly concerned?

Two decisions, one in the Federal Court of Australia and the other in the New South Wales Supreme Court have seen very different results for the complaining shareholder.

Both decisions - Shelton v National Road and Motorists' Association Ltd & Ors (2004) 51 ACSR 278) and Carpenter v Pioneer Park Pty Ltd (in liquidation) (2004) 51 ACSR 299) - were handed down on 29 October 2004 in Sydney but in different courts (although probably in the same building).

Both decisions although they show a different result for the plaintiff, may reflect a trend that our courts are becoming "more generous" in evaluating the different remedies provided by the Corporations Act (and perhaps some of those provided by the common law as well) at a time when there is growing concern about the way in which companies should be organised and run.

This of course is no reflection on the general behaviour of companies and their directors, but merely an indication that when genuine concerns are raised in the courts perhaps a more generous attitude will be taken by judges in evaluating relevant facts.

Shelton was one of a continuing number of members to act against the NRMA in its long and chequered history. Perhaps no other Australian organisation has been litigated against as much as the NRMA.

These proceedings concerned the conduct by the NRMA and its board of directors attwo annual general meetings in 2002 and 2003 and a special general meeting in 2002. It also concerned the election of the board of directors and the adoption by the NRMA of a new constitution.

Shelton had more than one "opportunity" to bring proceedings. This particular action was one under which he sought declarations that various resolutions passed by the NRMA and its 2002 annual general meeting were invalid by virtue of the operation of its constitution, that the removal of certain directors had been achieved improperly, that the conduct of its affairs was contrary to the interests of NRMA members as a whole, and that generally speaking the way in which the annual general meeting and the special general meeting were held (including the adoption of the new constitution and the election of the board of directors) was oppressive, unfairly prejudicial to and unfairly discriminatory against him and other members pursuant to section 232 of the Corporations Act.

Shelton sought orders from the court that the new constitution was invalid. He also wanted to restrain certain directors from remaining as directors of the organisation. He wished the old constitution to be implemented in relation to the 2005 election of the board of directors and that the court appoint an independent person to review the ballot to be conducted with respect to those elections.

The defendants asked Tamberlin J in the Federal Court to strike out the statement of claim and rule that the proceedings should be dismissed because there was no basis for Shelton to continue to seek remedies.

Although Tamberlin J was troubled by the various arguments raised in this case, and may have had a predilection to support the proposition that the statement of claim was defective in more than one respect, nevertheless felt the applicant should be allowed to pursue the matter through an amended statement of claim. He felt that the application was not so hopeless as to support the claim that the action by Shelton had no chance of success. Therefore, he dismissed the application but made it clear that in re-framing the statement of claim Shelton should be very careful.

What is interesting and important for company directors, is the helpful summary by Justice Tamberlin of how the oppression remedy might be interpreted. He recognised that this was an important remedy provided by the statute. It had been the subject of some interesting interpretation in previous cases. In his view it was necessary for the pleadings to be structured in a disciplined and relevant fashion to permit a court to adjudicate on the particular matter. But, having said all of that, he also suggested that the remedy under s232 was one that would be given a wide interpretation by the court.

He started his overview by suggesting that it was not practicable for the court to identify the many ways in which oppressive conduct could be established. He agreed that the court:

"will generally look at the overall course of conduct and consider whether it is so unfair that reasonable directors would not consider it fair. If directors exercise a power so as to impose a disability or burden on a member that is unfair according to ordinary standards of reasonableness and fair dealing, then such conduct may be described as oppressive. The question is one of fact and degree for the court to determine, having regard to the view that directors have formed themselves, and allowing for any special skill or knowledge possessed by the directors. The test of unfairness [is an objective one]." (at para 23).

After quoting from the High Court decision in 1985 in the Rugby League case (Wayde v New South Wales Rugby League Ltd) he added:

"The court should not take a narrow approach to cases of oppression. It is necessary for the court to come to a conclusion that there has been conduct unfairly prejudicial to or unfairly discriminatory or oppressive to a member before it makes an order to this effect ..."

Having clearly identified a predilection to be generous in evaluating the rights of members, he then went on to make these observations:

"The onus of establishing unfairness rests on the applicant asserting the conduct that is contrary to the interests of the members as a whole, or that is oppressive, unfairly prejudicial or discriminatory. An applicant must actually prove oppression before obtaining relief. It is not established simply by showing that the majority are in control of the company, or that the applicant is consistently out-voted, or that the majority have made some questionable decisions from a business point of view. The mere disadvantage of being in a minority does not in itself constitute oppression. It is necessary for each single allegation in an oppression case to be pleaded clearly in order to assess whether the totality may amount to oppression ... Disagreement with the decision by a majority of shareholders and directors on the part of a minority shareholder does not entitle that shareholder to relief under the section ..." (at para 24)

As noted earlier, he was not satisfied that the statement of claim pleaded by Shelton provided him with any guidance to what it was that he should rule oppressive or unfair. He then discussed the nature of pleadings in a court case and suggested that Shelton needed to recast his statement of claim in order to proceed in this matter. Despite the significant deficiencies (which he recognised were extensive) he nevertheless felt that the matter should be allowed to be re-pleaded - recognising the importance that Parliament has signalled in this and other similar legislation.

It will be interesting to see how Mr Shelton progresses in this matter.

The second case in the New South Wales Supreme Court, Carpenter v Pioneer Park Pty Ltd (in liquidation), saw success for the applicant and in the context of an even more difficult statutory remedy than the oppression remedy.

Readers may recall that under the general law it is virtually impossible for a shareholder to bring an action in the company's name against the directors or against the company in relation to activities that the shareholder believes is being conducted inappropriately or improperly.

The rule in Foss v Harbottle (1843) created so many difficulties for minority shareholders that Parliament decided at the end of 1999 to create a statutory remedy enabling shareholders to bring actions in the name of the company where they allege that the company is doing something inappropriate and where it is clear that the directors will not bring such an action.

The so-called statutory derivative action has not been the subject of many successful court cases. Furthermore, this particular case concerned a company that was in liquidation. This made it even more difficult for Carpenter, who was a director and shareholder of the defendant company Pioneer Park to obtain leave from the court (as a shareholder must) under s237 of the Corporations Act if he wanted to bring proceedings on behalf of the company.

In this case the action was against the Australia and New Zealand Bank because in his view the ANZ bank had wrongfully terminated certain financial facilities that it provided to Pioneer. He further alleged that without justification it had proceeded to call up the indebtedness of the company, to appoint administrators and to sell certain property in purported exercise of the power of sale under a mortgage that had been given by the company to the ANZ. Certain proceedings were also pending by the ANZ against Carpenter by virtue of his position as a guarantor of the financial facilities provided by the ANZ to Pioneer.

The liquidator, who had been appointed by the ANZ, also brought proceedings against Carpenter alleging that he had breached his duties as a director and to set aside certain commercial transactions which it was argued were non-commercial in essence. The relevant proceedings against Carpenter had been funded by the ANZ but had been delayed pending the examination by Carpenter of certain ANZ personnel under provisions in the legislation. If leave were to be granted to Carpenter under s237 of the Corporations Act, the ANZ and the liquidator wanted it to be subject to terms which would protect the liquidator (the company).

In particular it was argued that Carpenter should indemnify the company or the liquidator from any adverse order as to costs should the action be unsuccessful.

Barrett J in this case had to determine whether leave should be granted pursuant to the operation of the statutory derivative action provisions contained in Part 2F.1A of the Corporations Act.

Before leave is granted to a person to bring action it is important that the applicant establish that the proceedings are in the interests of the company. Furthermore, it has to be shown that the applicant was acting in good faith. One of the problems faced by Carpenter was that the company was in liquidation and the question that had been raised as to whether a statutory derivative action could be brought in the context of a company in liquidation.

Barrett J held that as a result of a number of cases, some of which were divided on this particular issue, but the majority of which expressed views in favour of the proposition, that the relevant provisions applied to a company in liquidation.

He then had to consider whether Carpenter, was "serious", and whether this action was in the best interests of the company.

He was satisfied that the information before him confirmed that the action was serious and then he went on to consider whether the action was in the best interests of the company. There was no rebuttable presumption that simply because the action was one against a third party that it was not in the interests of the company. As corporate decision-making had been taken out of the hands of the company directors and now vested in a liquidator, if a shareholder was able to finance an action which the liquidator may not be able to finance, this was certainly a factor in favour of allowing the action to continue.

As Palmer J had decided in the earlier decision of Swansson v RA Pratt Properties Pty Ltd ((2002) 42 ACSR 313) it was not necessary to delve into whether the action would have a potential for success or a possibility of success. The onus was on the applicant to show that the particular legal action would positively serve the best interests of the company.

The main question before Barrett J was therefore "whether pursuit of the proceedings ... presents genuine prospects of benefits to creditors and of enhancement of their welfare" (at para 19). He was satisfied that unsecured creditors would receive nothing unless the action by Carpenter was successful. If the action was being financed by Carpenter there could be no disadvantage to the company if the action was allowed to proceed. Furthermore, as the defendant was a company of real financial substance, and as opinions had been expressed that the action might be successful, he concluded that it was in the best interests of the company that Carpenter be allowed to initiate the proceedings.

Carpenter also had to establish whether he was acting in good faith. Endorsing the approach of Palmer J in the Swansson case referred to earlier, Barrett J noted that there were two questions relevant to this issue:

1. whether the applicant honestly believed that a good cause of action exists; and

2. whether the applicant was bringing the action for a collateral purpose that would amount to an abuse of process.

He was satisfied that Carpenter was not being motivated merely because of some personal gain, but that he actually had a "sense of responsibility" to creditors who may have suffered losses - endorsing the approach taken in an earlier case, Charlton v Baber ((2003) 47 ACSR 31), an earlier decision of Barrett J. This was not an action by a shareholder who had a mere token shareholding - it was someone who had a "sufficient interest consistent with the company's interests to warrant a finding that he was not actuated by an improper purpose in pursuing the present application; and this despite the advantage that he will derive [by the relevant action against the ANZ]" (at para 29). In the circumstances, good faith had been established.

While certain terms were imposed on Carpenter, the judge was not prepared to accede to all of the requests on the part of the liquidator that he be given a role in any final decision on how the litigation would be resolved.

There was sufficient guidance in the legislation to permit this matter to be dealt with in the appropriate final orders of the court. Carpenter would have to pay and bear certain costs and charges in relation to the action (including the indemnification of the company), but should he be successful in the context of the action he would be able to seek reimbursement for his costs at the appropriate time.

This quite generous interpretation of the statutory derivative rights vested in shareholders by Barrett J will clearly be regarded by shareholders as a positive signal that their rights under the relevant law are being more generously interpreted.

Valuable right or merely a paper tiger?

The rights of directors to inspect books and records

When section 198F was added to the Corporations Act in 1999 to provide directors with an enhanced right to obtain access to the books of a company so that they could protect their position - especially as they might be sued - it was suggested by many that that statutory right was adding little to the relevant law.

Both at common law, and under what is now s290 of the Corporations Act (the Act), a director does have the right to obtain information to ensure that he or she can properly perform his or her duties and exercise powers in the best interests of the company. As early as 1890 the courts had recognised that a director had a right to inspect and make copies of the company's documents (Burn v London and South Wales Coal and Risca Investment Co (1890) 7 TLR 118).

Chief Justice Street, the then Chief Justice of the NSW Supreme Court, had expressed the common law rights in this fashion in the case of Edman v Ross ((1922) 22 SR (NSW) 351) in these words:

"The right to inspect documents and, if necessary, to take copies of them is essential to the proper performance of a director's duties, and, though I am not prepared to say that the Court may not restrain him in the exercise of this right if satisfied affirmatively that his intention was to abuse the confidence reposed in him and materially to injure the company, it is true nevertheless, that its exercise is, generally speaking, not a matter of discretion with the Court and he cannot be called upon to furnish his reasons before being allowed to exercise it. In the absence of clear proof to the contrary the Court must assume that he will exercise it for the benefit of his company."

Section 290 had been introduced into the statute to supplement this common law right (and to replicate an English provision).

When that case was litigated in the United Kingdom Justice Slade had ruled that the statutory right really conferred no new rights - the purpose of the section was to impose "criminal sanctions in the event of proper books of account not being kept or not being made available for inspection". (Conway v Petronius Clothing Co Ltd [1978] 1 All ER 185). That view was not supported by Mahon J in the New Zealand case of Berlei Hestia (NZ) Ltd v Fernyhough ([1980] 2 NZLR 150).

Now, in the case of Re Tai-Ao Aluminium (Australia) Pty Ltd ((2005) 51 ACSR 465), Finkelstein J has provided a further gloss on the meaning of these provisions. The facts of the case are taken from the Butterworths report.

Tai-Ao Aluminium was a subsidiary of Tai-Ao Aluminium Group, incorporated in Hong Kong. Mr Lei was a substantial shareholder in the holding company as well as a director of the subsidiary. He had petitioned the Hong Kong High Court asking for the company to be wound up on the basis that it was just and equitable to be wound up or because its affairs were being conducted unfairly towards him. This particular action was still pending. The dispute in Hong Kong had spilled over into Australia.

Lei had never exercised his rights as a director of the subsidiary Australian company to inspect the company's books and records. Nor had he attended any directors' meetings. However, because of the litigation in Hong Kong, he felt it was necessary to now exercise these rights and on 31 October 2004 (a Sunday) he travelled to the company's offices in Melbourne to inspect its books and records. However, these books were mainly in the Sydney office. He then travelled to Sydney with his solicitor but was told he would not be given access to the company's records. He was told by another director of the company that he needed to obtain a court order.

The action brought was pursuant to both s290(1) and s198F of the Act. His application was challenged on the basis that he was seeking inspection for an illegitimate purpose - an ulterior motive was argued.

The defendants argued that they were about to remove Lei as a director of the company pursuant to the company's constitution. Therefore, there was no point in the director being able to inspect the documents.

When the matter came on before Justice Finkelstein in the Federal Court of Australia he was told that there was no purpose in making the order because even if he had a legitimate reason for gaining the access to the company's records "he was no longer in a position where he could, in a practical sense, perform any duties of office. Accordingly, he no longer had any need for inspection."

That may well have dealt effectively with the application under s290 of the Act, but under s198F a director may obtain access to documents if the director can show that it was necessary for the purposes of some legal proceeding to which he was a party or which he intended to bring. Apparently the statements made to the court did not outline in sufficient detail what those reasons were.

It appears that Finkelstein J agreed with the argument that insufficient information had been provided by the director to warrant a finding under s198F. However, he held that Lei did have a right of inspection under s290 and under the common law. In those circumstances costs should be awarded against the defendant in relation to the unsuccessful application by Lei.

The case illustrates that the right for inspection under s198F, which remains in place for seven years after a director has lost office, must be supported by strong information and evidence. That is clearly a message for Lei and his advisers if they wish to pursue this matter further.

Of course, the fate of the company may well lie outside Australia and in Hong Kong which may make the relevant proceedings of an academic nature.

It is clearly important for directors to be able to obtain access to books and records if they are to conduct their activities as directors in a proper and effective fashion. The recognition by Finkelstein J that the common law rights, as supported by s290 of the Corporations Act, are fairly powerful, will be a source of relief to many directors.

We will need another case when the terms of s198F are more seriously evaluated before we can decide whether that particular statute does offer a major additional piece of armoury to directors.

The power to postpone general meetings convened by members

A clear vindication for directors conducting companies' affairs in an efficient

and effective manner

An interesting decision of Emmett J in Central Exchange Ltd v Rivkin Financial Services Ltd (2005) 51 ACSR 441 illustrates the proposition that directors should enjoy some considerable discretion in whether to postpone meetings in order to facilitate a more efficient and effective administration of companies' affairs.

The Rivkin company is the subject of other interesting litigation in respect of which Emmett J is the presiding judge; but in this particular case the company and its directors enjoyed a fairly interesting victory.

Central Exchange (Central) had become a significant shareholder in the Rivkin company only recently.

Its "owners" wished to remove the current directors of the company and replace them with its own panel of directors.

When the company's directors were advised of Central's proposal to call a special meeting, they resolved to hold the annual general meeting of the company some 26 days after the proposed date of the special meeting called by Central.

Central commenced proceedings in the Federal Court against the company alleging that the purported postponement of the special meeting was invalid.

The company in its turn alleged that insufficient notice had been given to it for the calling of the special meeting and that it was not obliged to put certain resolutions to the shareholders.

Emmett J ruled that the actual notice of general meeting was valid but that a particular resolution which called for the removal from office of any person appointed as a director of the company on or after the date of the calling of the shareholders' meeting was not valid.

The issue in relation to that question does not raise any special question of law for our purposes.

However, the ability of a board to postpone a meeting, which was clearly being initiated as a means of challenging the administration of the company by the incumbent board, was a matter of some importance.

Confirming the right of shareholders to call meetings (where they have sufficient numbers to warrant such a proposal) Emmett J was concerned about the inconvenience and inefficiency that would be generated by the holding of two general meetings within a very short period of time. The existence of the parallel litigation to which I referred earlier in this note was also a matter of some relevance.

In all of the circumstances it was important, in the view of Emmett J that full disclosure be made to shareholders of relevant information.

If directors did not disclose relevant information to shareholders they would be in breach of their fiduciary duty. But did this obligation also apply to the shareholders? Emmett J responded to that particular question in these words:

"While the [principle of full disclosure] may not apply to members of the company who call a meeting with a view to urging a particular course on fellow members, the directors may well be under an obligation to ensure that all members are provided with the full and correct information necessary to enable them to have an understanding and form a judgment upon the business to be transacted at a meeting called by some of the members. ... each of the directors would be entitled to a reasonable opportunity to formulate a response to a proposal for his removal.

The sending of information to shareholders concerning the business for the proposed meeting [of shareholders on 3 November 2004] as well as the sending of information for the annual general meeting 26 days later would involve additional cost that would be avoided if the two meetings were to be held on the same day." (at para 76)

Under the circumstances the court felt that it was not inappropriate for the directors to postpone the meeting called by the shareholders so that the matters could all be presented at the one time - this would bring to a head the issue of which panel of directors the members should or could support.

There would be no injustice or prejudice to the shareholders if the meeting was postponed in that manner suggested. But, at least, in so far as the company was concerned, the combining of the two meetings would reduce administrative and other costs. Whether it would achieve success for the incumbent board of directors was of course a matter to be tested at a later time.

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