Corporation Law – Case Study Stately Funeral Homes Ltd Essay

Stately Funeral Homes Ltd is an unlisted public company that offers luxurious funeral services for the high-end market in the family’s “Manor”. The executive directors are Morticia (she is also CEO) and Gomez Addams, and Thing T. Thing. Each holds 20 shares. Fred and Lillian Munster, and Wednesday and Pugsley Addams, all hold 10 shares each. Both the Board and shareholders recognise Morticia’s “excellent and most successful management.” However, another lavish funeral home, Hampshire Haven, opens in the neighbourhood and competition becomes fierce. Stately decides it needs to expand its operations to get some competitive advantages.

At the next Board meeting, Morticia makes a convincing business case for Stately to incorporate a subsidiary to buy Highway to Paradise Pty Ltd (“H2P”), a business that runs 3 hearses in the local area. With H2P, and some modifications to the family Manor, Morticia tells the Board that Stately could “process” triple the number of “clients” per day. Morticia assumes everyone knows that, through one of her companies, Morticia owns a 5% stake in H2P. So she simply says “if we go ahead with this, remember I’m interested.”

Stately incorporates a subsidiary, Freeway to Paradise Pty Ltd (F2P) to acquire H2P. However, F2P needs another $90,000 to complete the purchase. Gomez and Thing each purchase 45,000 $1 shares in F2P, so that it has sufficient funds. The deal goes through and, although they pay top market value for H2P, Stately immediately triples its daily funeral services. Business is very good.

Stately’s success comes to the attention of Simple Serenity Ltd, a large ASX-listed no-frills funeral operation with 113 locations nationally. Atrophia Alldown, the CEO of Simple Serenity, tells Gomez she wants to acquire some luxury funeral homes to expand Simple Serenity’s range of services. She says Simple Serenity has already signed a deal to buy Hampshire Haven Ltd, and wants to buy Stately as well. She tells Gomez to think seriously about the deal as “Stately couldn’t possibly compete with Hampshire now that Simple Serenity is running the show.”

Worried, Gomez calls a company meeting and presents the deal. The company constitution requires a 75% resolution of members before a decision on selling Stately or its subsidiaries can be made. Gomez and Thing want to sell. Morticia and the other shareholders are against it, so the resolution to sell cannot be passed. Gomez and Thing get together later and agree the company must be sold, so they cause the company to issue another 100 shares each to them. Thing then calls another meeting, and with the extra shares, he and Gomez are able to push the sale resolution through. Morticia is furious. As part of the deal with Stately, Simple Serenity also buys all shares in F2P. Gomez and Thing sell their shares in F2P for $90,000 each, making a profit of $1 per share.

The Board of Simple Serenity then file proceedings alleging that Gomez and Thing breached their fiduciary duty to Stately by making a secret profit when selling their shares in F2P, and seeking an account of their profits. Gomez considers that if he has to pay back his profits on the subsidiary, he might as well get the whole deal rescinded. He files a counter-suit requesting the court set aside the share issue to Thing and himself, invalidate the resolution to sell Stately and F2P, and asking the court to rescind the sale of Stately and F2P.

Advise on the following issues:

(1) Did Morticia act with improper purpose, in breach of general law or statutory duties, or fail to disclose her interests in the purchase of Highway to Paradise (H2P)? What are the consequences? (7 marks)

(2) Could Simple Serenity obtain a court order for Gomez and Thing to account for their profits in F2P? (4 marks)

(3) Could Gomez succeed in an action to have a court set aside the share issue to Thing and himself, invalidate the resolution to sell Stately and F2P, and order rescission of the sale of Stately and F2P?

(9 marks)

Question 1: Morticia’s purpose and disclosure

Facts/Issues: Whether Morticia acted with an improper purpose, and failed to disclose her interests, in the deal with H2P, and the consequences of this.

Law:

Directors owe an equitable fiduciary duty to act for proper purposes: Mills v Mills.1 The “but-for” test asks whether, but for the collateral purpose, the directors would have performed the act: Permanent Building Society v Wheeler (PBS).2 Section 181(1)(b) of the Corporations Act 2001 (CA)3 also requires directors act for a proper purpose; courts are guided by the fiduciary cases.4

Directors must disclose their personal interests to the members in meeting: Furs v Tomkies,5 and under s191(1),(3), to the directors. Under s193 CA, the s191 requirement is in addition to the general law.

Application

Proper purpose: Applying the PBS test, “but for the collateral purpose of Morticia owning 5% of H2P, would the directors have purchased H2P?” It seems they would; even though they paid top price, there was no deliberate over-inflation: PBS.6 H2P was a good acquisition that tripled Stately’s business.

There are no facts suggesting Morticia’s purpose was to benefit herself. The Board and shareholders recognise Morticia’s excellent management: this is reminiscent of Mills v Mills,7 where it was held that if directors truly believe they act in the company’s best interests, they are not in breach just because when they do so, it also promotes their own interests. Courts are guided for s181 by cases on the equitable duty. A court would not find Morticia breached her fiduciary or s181 CA duty.

Disclosure: Morticia failed to disclose her ‘material interest’ to the members: Furs v Tomkies.8 She disclosed to the Board – but this wasn’t a case of the shareholders being the same parties as those on the Board (Queensland Mines Ltd).9 Also, her disclosure to the Board per s191(1) was insufficient – in Imperial Mercantile Credit a similar disclosure that the director “was interested” was insufficient for s191(1),(3) CA.10

The consequences of Morticia’s general law breach are that the contract is voidable at the company’s option and the director must account for any secret profits: Hely-Hutchison v Brayhead Ltd.11 Stately would not avoid the transaction as it was a good one, although it could require Morticia to account for her profits. A breach of s191(1) CA does not render the transaction void (s191(4)), but it is an offence of strict liability (s191(1A)). The maximum penalty is $1,100 and/or up to 3 months’ jail.12 (406)

Question 2: Gomez and Thing’s profits in H2P

Facts/Issues: Gomez and Thing bought shares in F2P to allow it to purchase H2P. The issue is whether they were in a position of conflict, and made a secret profit, and so have to account for it.

Law: The Regal (Hastings) case13 is strong authority for Simple Serenity’s request for an account of profits by Gomez and Thing.

Application: in the Regal case, a subsidiary was formed to take on two theatre leases. The subsidiary did not have sufficient capital reserves to satisfy the prospective landlord’s requirements (�5,000). So the directors and others purchased shares in the company to allow it to satisfy the capital requirements. After the company was sold, the new owners sued the old directors for an account of their profits, alleging they breached their fiduciary duty to the company and made a secret profit. It was held the directors had breached their duty, despite their good intentions. Liability did not depend on fraud, or whether the profit should have gone to the company; it arose from “the mere fact of a profit having been made”.14 They should have obtained the members’ approval.

Similarly, Gomez and Thing bought the shares to allow the subsidiary to acquire H2P, but they did not declare full details to the company’s members or obtain their approval. Applying Regal,15 it is likely they would be liable to pay back their profits. (237)

Question 3: The share issue, resolution to sell and sale contracts

Facts/Issues: Thing and Gomez caused Stately to issue 100 shares each to themselves, so they could pass the resolution to sell. If the issue is set aside, the resolution did not have the required 75% member approval and might be set aside. Gomez also wants to rescind the sale.

Law:

Directors have an equitable fiduciary duty to exercise their powers in good faith, and for a proper purpose: Bailey v Mandala Private Hospital Pty Ltd;16 Whitehouse v Carlton Hotel Pty Ltd.17

Section 1322(2) CA allows a court to set aside a resolution where it has procedural irregularities that cause substantial injustice which cannot be remedied any other way.

Where directors breach their fiduciary duty, rescission may be ordered: Transvaal Lands Company.18 The company must seek rescission, as the duties are owed to the company – ‘it is the board of directors, as part of their management power who decide to litigate in the company’s name’.19

Application:

Share issue: The power to issue shares must be used to raise capital for the company’s benefit not to manipulate control: Ngurli Ltd v McCann.20 Both the Bailey21 and Whitehouse22 cases involved an issue of shares to manipulate voting control; the court held the directors breached their duty and set aside the share issue. Gomez and Thing only issued the shares to gain voting power. They did not act in good faith in the company’s best interests. Applying the “but for” test (PBS)23 they would not have issued the shares without their improper purpose. Ordinarily, a court would set aside the share issue, although now Gomez has no basis on which to claim a remedy, as all shares have been sold to SS.

Resolution: If the share issue had been set aside, the sale resolution would not have had the constitutionally required 75% shareholder approval – it was procedurally irregular under s1322(2) CA. However, was there substantial injustice that cannot be remedied any other way? While the sale could not have occurred without the defective resolution, arguably there is no “substantial injustice” because Gomez and the other shareholders received good consideration (a fair purchase price) for the sale of their shares. In any event, if the share issue was not set aside (as is most likely), there would be no irregularity and no basis on which to overturn the sale resolution.

Rescission: Gomez then wants rescission of the sale agreement. Rescission may be ordered where directors have caused a company to enter a transaction in breach of their duties: Transvaal.24 Here, the shares were issued for an improper purpose, and in the absence of this breach Gomez and Thing could not have secured the resolution to sell or the actual sale. However, Gomez could not apply for rescission because he is not the proper plaintiff. Stately is in the control of the new owners and Gomez would not likely satisfy s237(2) criteria to sue in the company’s name.25 In addition, rescission will not be ordered where the contract has been affirmed or where innocent third parties have acquired an interest.26 Here, the deal has been done and Gomez and the other ex-owners have taken their profits and a court may interpret this as affirming the contract. A third party (SS) has acquired an interest. Gomez will not likely be successful. (555) (1198)

Alternatively, students may have analysed this problem via s232 as follows: Gomez could try arguing that the share issue be set aside under the Bailey27 and Whitehouse28 cases, since his motive (as in those cases) was to manipulate voting control. His problem is that the shares have been sold to the new owners of Stately and, on its own, this action would not likely be successful. Similarly, he would have difficulty in invalidating the resolution under s1322(2) because he may not be able to show substantial injustice that cannot be remedied another way. However, if his ultimate goal is rescinding the sale agreement, he could rely on Hannes v MJH.29 In that case, Hannes and another director resolved (among other things) that the company enter a service agreement for Hannes’ benefit. In that case, the members brought an action for oppression. The court ordered that the agreement be set aside (rescinded).

The difficulty here is that Gomez is no longer a member for the purposes of s232. Gomez would argue under s234 that he has standing to apply under s232 because he is a person who has ceased to be a member, and “the application relates to the circumstances in which [he] ceased to be a member” (s234(c)). That is, the application relates to circumstances surrounding the sale of all Stately and F2P shares to SS. If the court were satisfied as to standing, Gomez would argue that the resolution30 to sell Stateley (s232(c)) was contrary to the interests of members as a whole (s232(d)), and/or oppressive (s232(e)) and the sale agreement should be rescinded (s233) (Hannes).31 Gomez could lead evidence as to the members’ prior resolution not to sell, his improper share issue, and the subsequent forced resolution. He might even argue that the forced resolution was a fraud on the minority, since he was using his votes to ‘secure some personal or particular gain, whether pecuniary or otherwise.’32 If necessary, he could request that he bring the action for rescission in the company’s name (s233(1)(g)). However, the fact remains that the court will not rescind if a contract has been affirmed or third parties acquired an interest. It appears Gomez will still not be successful.

References:

1 Mills v Mills (1938) 60 CLR 150.

2 Permanent Building Society (in liq) v Wheeler (1994) 14 ACSR 109.

3 Corporations Act 2001 (Cth).

4 Harris J., Hargovan A. ; Adams M. (2009). Australian Corporate Law (2nd ed.) (p458-459). Chatswood: LexisNexis Butterworths.

5 Furs Ltd v Tomkies (1936) 54 CLR 583.

6 Above note 2.

7 Above note 1.

8 Above note 5. The interest was material as it could influence the way she voted: Bell Group Ltd (in liq) v Westpac Banking Corp [2008] WASC 239.

9 Queensland Mines Ltd v Hudson (1978) 18 ALR 1.

10 Imperial Mercantile Credit Association v Coleman (1873) LR 6 HL 189, as discussed in Harris et al, above note 4 (p482). Morticia had to disclose the nature/extent of her interest and its relation to the company’s affairs: s191(3).

11 Hely-Hutchinson v Brayhead Ltd [1968] 1 QB 549 at 585, as discussed in Harris et al, above note 4 (p477).

12 See Schedule 3 of the Corporations Act. The penalty is 10 penalty units (each unit being $110).

13 Regal (Hastings) Ltd v Gulliver [1967] 2 AC 134.

14 Above note 13, as discussed in Harris et al, above note 4 (p478-479).

15 Above note 13.

16 Bailey v Mandala Private Hospital Pty Ltd (1987) 12 ACLR 641.

17 Whitehouse v Carlton Hotel Pty Ltd (1987) 162 CLR 285.

18 Transvaal Lands Co v New Belgium (Transvaal) Lands & Development Co [1914] 2 Ch 488.

19 Harris et al, above note 4 (p438).

20 Ngurli Ltd v McCann (1953) 90 CLR 425.

21 Above note 16.

22 Above note 17.

23 Above note 2.

24 Above note 18.

25 Gomez would likely be held not to be acting in good faith (Swansson v RA Pratt Properties Pty Ltd (2002) 42 ACSR 313; [2002] NSWSC 583); alternatively the action may not be in the company’s best interests. **Some students only answered question 3 by analysing s237(2), however this does not address all components of the question that was asked. Nevertheless, I awarded a passing mark if a reasonable discussion and application was made by the student.

26 Harris et al, above note 4 (p255): “the right to rescind may be lost when … the contract has been affirmed.”

27 Above note 16.

28 Above note 17.

29 Hannes v MJH Pty Ltd (1992) 10 ACLC 400.

30 A resolution may form the basis for complaint: Wayde v NSW Rugby League Ltd (1985) 180 CLR 459.

31 Under s233, the court can make ‘any order it considers appropriate’, including any of the orders listed in s233(1). See Hannes above note 29.

32 Peters American Delicacy v Heath (1939) 61 CLR 457, as discussed in Harris above note 4 (p561); Gambotto v WCP Ltd (1995) 182 CLR 432 involved circumstances encompassing conduct “oppressive to the minority.”