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Requirement
Harry, Minh and Jackson have been appointed by the general meeting as directors of Mobile Technology Ltd (MTL), an unlisted public company limited by shares. When MTL was formed it adopted an objects clause as part of its constitution; this clause restricts the company to the manufacture, purchase and sale of plasma televisions and DVD players. The company was incorporated in Melbourne where its head office is situated, and it has manufacturing facilities in ShanghaiChina. Shareholders in MTL are unhappy with the way in which the directors are running the business and are critical of the low level of dividends that they have declared and the unresponsive attitude of directors to the concerns of shareholders. The directors justify their approach, and point to the stable and slowly increasing share price of the company to the disgruntled shareholders.
1. James and Jenny Lee are husband and wife (who together hold 60% of the shares in MTL) and they seek to take a bigger role in the management of the company. They advise the directors that they should change their business strategy and pay more attention to their wishes as majority shareholders. They threaten to sack the directors if they do not comply with their wishes. They also threaten to take over the management of the company.
2. Martin Lu is a minority shareholder in MTL (holding 5% of the shares) and he is concerned that the directors will run down the company and drain it of its assets. The directors have not shown themselves to be troubled by Martin’s concerns and say that the minority shareholders like Martin should mind their own business. Martin seeks an extraordinary general meeting of shareholders to discuss these concerns, but the board is reluctant to call a meeting.
3. In response to the shareholders’ concerns, and without consulting the shareholders, the directors of MTL seek to change the business of MTL to focus on manufacture and distribution of Smart phones and I Pods as they believe that the television and DVD market is saturated and demand will start declining if it has not done so already. The directors propose to enter into contracts for MTL to acquire a mobile phone manufacturing firm in Shanghai with a view of implementing their strategy.
4. The directors seek to avoid these pressures from the shareholders by setting up another company (Stan Mobile Pty Ltd) that they control and plan to sell the television business of MTL Ltd to their new company. At the same time, a Chinese company has come to the directors with a generous offer to buy the television assets of MTL at a significantly higher price than the amount that Stan Mobile Pty Ltd is prepared to pay MTL for these assets. The shareholders are not advised that this major asset is to be disposed of in this way or that the directors’ private company is involved.
Required:
Advise what are the various legal issues and causes of action that are available to the shareholders arising from the directors conduct in the above circumstances. Students should answer this question with reference to the relevant provisions of the Corporations Act 2001 and the relevant case law.
Solution
Abstract:
The following paperlooks at the way in which a company can legally reset its business direction and respond to changing market forces, without overstepping on any shareholders rights. Also it is to be discussed the legal fallouts of the directors’ unilateral action regarding divestment of part of the business, and the remedies that the Corporations Act of 2001 presents to the shareholders.
Introduction
The company at hand is Mobile Technology Ltd. (Henceforth referred to as MTL). MTL, at its incorporation, adopted an objects clause in its constitution. This clause limits its area of operation to manufacture, purchase and sale of plasma televisions and DVD players. The company has its head office at Melbourne, and is incorporated there. The manufacturing facility is situated at Shanghai, China. MTL has been announcing low levels of dividends and the shareholders are unhappy about the fact that the directors do not address this issue. It seems the directors are too unresponsive and not at all interested in the business.
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Scenario 1:
James and Jenny Lee are husband and wife (who together hold 60% of the shares in MTL) and they seek to take a bigger role in the management of the company. They advise the directors that they should change their business strategy and pay more attention to their wishes as majority shareholders. They threaten to fire the directors if they do not agree to their wishes and also threaten to take over the management of the company in case of noncompliance.
Analysis
As per Corporations Act 2001, the directors can be replaced or removed by a resolution in a proprietary company. Now, as in this case, the Lees are the majority shareholders, with 60% net ownership. They can call for a resolution to be passed, at any of the scheduled meetings, or the annual general meeting of shareholders. However, this needs to be a general meeting and this needs to be placed on the agenda of the proceedings. It must receive a clear majority in the voting by the present shareholders. Hence if James and Jenny Lee chooses to do so, they can legally replace the board of directors. However, they cannot directly get nominated, as that will cause a potential conflict of interest and the minority shareholders may object to that.Any such changes, need to be informed to the Australian Security and Investments Commission on the form490 and by paying the requisite fees.
Scenario 2
Martin Lu is a minority shareholder in MTL (holding 5% of the shares) and he is concerned that the directors will run down the company and drain it of its assets. The directors have not shown themselves to be troubled by Martin’s concerns and say that the minority shareholders like Martin should mind their own business. Martin seeks an extraordinary general meeting of shareholders to discuss these concerns, but the board is reluctant to call a meeting.
Analysis
Here, reference must be done tothe Corporations Act, 2001. Any kind of activity that is contrary to the interests of a member can be deemed to be oppressive. Any kind of oppressive activities are liable to be legally challenged as per S.232 and S.233 of the Corporations Act. And if the court deems this activity to be oppressive to the minority shareholder, they might take stringent actions. After a detailed look at this case, it seems that the conflict stems from a case of information asymmetry as well as perceived lack of responses. Now, Mr. Lu cannot force the board to call a meeting for his agenda, but he can wait for the next scheduled general meeting of all members. Or, he might move court. Litigation, however will prove to be costly and time-consuming. But since the “oppressive activities” are defined so broadly, the court might just choose to overlook it. Or the court might decide in favor of Martin Lu. And in past courts have decided to rule pretty stringently. In Hallam v Ample Source International the court decided to wind up a solvent company because it deemed the minority shareholders were being wronged. Hence, it is a credible threat. Now, it is needed to take into account the nature of the approach the board members have to Martin Lu’s concerns. It has been a rights-based response from the directors to remind Martin that he cannot force a meeting or an agenda that is only concerning him . However, if this is a duly recognized concern, then litigation might be the only viable option. In the landmark case of Borland v. EarleLord Davey said that as a principle, the court is not going to interfere in the decisions taking place in companies through proper procedure and rule of majority. Only when there is a contravention or an oversight, will the curt be justified in stepping out. However, it must be proved beyond doubt that the said action has, in some way or other, directly or through an agent, and has adversely affected some material payoff of the minority shareholder. Again, in the House of Lords decision on Ebrahimi v. Westbourne Galleries Ltd the Lord Wilberforce decided to abandon the older practices of segregating such cases based on intent and internal working of a company and rather said that the grounds need to be just and equitable. Only then the court of law can properly interfere and rule in favor of the minority shareholder if deemed proper. The court has followed this principle ever since. In Diligenti v RWMD Operations Kelowna Ltd the court intervened based on the fact that equitable action was not being performed by the company in question. By virtue of his shareholding, Lu has a correlative right to be heard, and a legitimate expectation that he will be heard. This is directly demonstrated by Lord Hoffman in In re Saul D Harrison & Sons Plc . According to English law commission’s deliberations on S.459 of UK Companies Act 1985 , unfair prejudice would be such action that will necessarily impose the wills of the others on minority shareholders. However, this does not bind to duly debated and determined upon ideas that the minority shareholder has lost in a free voting or show of consent. It is unfair when unduly his views have not been taken into account. Though there is no appropriate dispute resolution system for conflicts between shareholders and board of directors , it is imperative that the shareholder in question can go for arbitration if both parties agree it is a conflict. If unrequited, Martin Lu can move court for potential damages and unfair oppression.
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In response to the shareholders’ concerns, and without consulting the shareholders, the directors of MTL seek to change the business of MTL to focus on manufacture and distribution of Smart phones and I Pods as they believe that the television and DVD market is saturated and demand will start declining if it has not done so already. The directors propose to enter into contracts for MTL to acquire a mobile phone manufacturing firm in Shanghai with a view of implementing their strategy.
Analysis
The dilemma here is that the business which MTL is currently into, they want to dispose of. They would like to enter the phone business. However, by the constitution adopted during incorporation of MTL by its members, an objects clause was inserted. Inter alia, this objects clause limits the field of interest of MTL to be manufacturing, purchasing and selling of plasma televisions sets and DVD players. A foray into that business will entail overstepping the constitution of the company as registered with the Australian Securities and Investments Commission. One legal recourse is to call for a change of the constitution. This will entail an amendment of the constitution, as per S.601GC of the Corporations Act of 2001. There are two ways to go about that. One is to go for a special resolution by the members, which will essentially mean calling a meeting of members and putting the information out in the open to be debated and voted upon, a notion that is opposed by the directors. The other is to consider the directors to be a responsible body and prove that they have considered the views of everyone involved in the situation. However, that will again mean that the directors have to inform the members regarding the change. In any way if the change is notified with the Australian Securities and Investments Commission, it will be available on demand to any of the members or shareholders on request. This defeats the purpose of not informing the shareholders of the development. Again, as seen in Scenario 2, this might lead to a conflict between shareholders and the directors. In a standoff, the members might seek to replace the directors as per S.203 of Corporations Act of 2001.
Scenario 4
The directors seek to avoid these pressures from the shareholders by setting up another company (Stan Mobile Pty Ltd) that they control and plan to sell the television business of MTL Ltd to their new company. At the same time, a Chinese company has come to the directors with a generous offer to buy the television assets of MTL at a significantly higher price than the amount that Stan Mobile Pty Ltd is prepared to pay MTL for these assets. The shareholders are not advised that this major asset is to be disposed of in this way or that the directors’ private company is involved.
Analysis
Two problems are paramount in this scenario. One is the divestment of the business that was designated in the objects clause adopted in the constitution. The objects clause cannot be contravened. For that there is the need of amending the constitution. That will need a special resolution as per S.601GC of Corporations Act of 2001. The resolution can come about either through a voting by members, in a meeting. Or, it may be brought about by the board of directors acting as an agency, which has duly recognised all the concerns of the affected members. But if the members feel that their interests are being compromised they will be able to litigate as per S.232 and S.233 of the Corporations Act of 2001. Though we have established that there is no universally accepted mechanism for such disputes, the Australian Disputes Redressal mechanism can be used to get arbitration in case of such a dispute. Or the courts, if moved, can properly award on the matter. The second problem is the matter of vested interest. The directors private company being involved in a transaction where the director is involved in price fixing and negotiations is a potential conflict of interest the director may rig the prices to a favourable outcome for Stan Mobile Ltd. Thu, in this case, the director needs to disclose this to all shareholders as per S.191 of the Corporations Act of 2001. Thus the shareholders need to be informed in any case. If not informed, the shareholders might move court, and under S.1311 the director might be penalised.
Conclusion
The major takeaway from all the scenarios is that the withholding of information from the shareholders is not a legally tenable step. It is to be challenged or it will contravene most sections of the Corporations Act.
Bibliography
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