Week 5 ACCG2051 - Company Constitution, Relationship to Outsiders, Financing, Dividends

Evolution of Constitutional Documents before July 1998

• Before July 1998:

  • Companies had Memorandum of Association + Articles of Association .

  • Proprietary companies often adopted Table A (a default set of articles).

Evolution of Constitutional Documents after July 1998

• After July 1998 (Company Law Review Act 1998):

  • Memorandums abolished; Articles largely replaced.

  • Companies now use:

    • Replaceable rules (default rules in the Corporations Act),

    • A company constitution, or

    • A mix of both.

  • Companies formed pre-1998 may keep their existing documents.

What are replaceable rules and what is the related section in the Corporation Act?

• Automatically adopted on registration, these function as the basic rules of internal management or corporate governance.

• Section 141

Examples of replaceable rules

• those concerning the transfer of shares (s 1072F),

• directors' discretion for dividend payments (s 254U),

• refusal to register share transfers in proprietary companies (s 1072G).

What is a company constitution?

 A document setting out the internal rules and governance structure of a company, which can displace or modify replaceable rules.

• A company can adopt a constitution at registration or after registration via a special resolution

What percentage of members are needed to pass a special resolution?

75% majority of members

Is the constitution and are replaceable rules a contract?

Yes, both the constitution and replaceable rules operate as a contract:

• between the company and each member;

• between the company and each director and company secretary;

• between a member and each other member;

Do members get protection against company constitutional amendments?

Yes, under Section 140 part 2, a member is generally not bound by a post-membership modification of the constitution that:

• Requires additional share uptake.

• Increases liability to contribute to share capital or pay money.

• Imposes or increases restrictions on share transfer rights (with specific exceptions).

What are the three requirements for making an amendment to a company constitution?

1. Amendments require a special resolution (75% majority).

2. The amendment must be for a proper purpose.

   A "proper purpose" means securing the company from "significant detriment or harm." Financial and administrative benefits alone are not considered a proper purpose for expropriation.

3. Its exercise must not operate oppressively in relation to minority shareholders (requiring fairness in both procedure and price). Lack of compensation for forfeited shares, even if for a proper purpose, can render the amendment oppressive and invalid.

Which case study established a critical test for amendments involving the expropriation of minority shares or valuable rights

• The Gambotto v WCP Ltd (1995) case

What is Expropriation of Minority Shares?

Majority shareholders force the minority shareholders to sell their shares, often to consolidate control or change the company’s structure.

Who in the company has authority to contract on behalf of the company itself?

The board of directors has primary actual authority to contract on behalf of the company under section 198A.

The board can appoint a managing director (s 201J) and delegate those powers (s 198C).

How can actual authority be given?

• Express

• Implied

• Apparent (Ostensible) Authority

What is a common seal?

A common seal is a company's official stamp used to sign documents and is no longer mandatory for companies to have or use.

How must companies sign a document without a common seal?

Must be signed by

(a) 2 directors; or

(b) a director and a company secretary; or

(c) for a sole director/secretary proprietary company,that director must sign under section 127(1).

How must companies sign a document with a common seal?

Seal affixed and witnessed by

(a) 2 directors; or

(b) a director and a company secretary; or

(c) for a sole director/secretary proprietary company, that director must sign under section 127(2). Electronic witnessing is permitted

What are the key assumptions an outsider of a company can makke under section 129 of the Corporations Act?

• Authority of Officers and Agents – Directors, secretaries, and persons from the company are duly appointed and have customary authority.

• Execution of Documents – Documents are validly executed whether signed without a seal or signed with the company’s common seal

• Compliance and Duties – The company is assumed to comply with its constitution/replaceable rules, and officers or agents are presumed to properly perform their duties.

• Authenticity of Documents – Outsiders dealing with the company can rely on that document without having to double-check inside the company whether it was properly approved or not.

Are outsiders of the company allowed to rely on assumptions about the company in regards to following rules?

Yes, outsiders dealing with a company are entitled to rely on assumptions in s 129, and the company cannot assert they are incorrect. This applies even if an officer of the company acts fraudulently or forges a document (s 128(3)).

What are the limits to assumption of a company from an outsider?

• Under section 128 (4), an outsider cannot rely on assumptions if they "knew or suspected" the assumption was incorrect at the time of dealings.

• "Suspected" requires actual knowledge or suspicion, not merely that suspicion "should have been aroused."

• The responsibility is on the company to prove the outsider's knowledge or suspicion.

What is the Common Law Indoor Management Rule (Turquand Rule)?

When a company signs a contract with an outsider, the outsider can assume the company followed its internal rules (like getting a board resolution).

The company cannot later cancel the contract just because those internal rules weren’t followed.

This protects outsiders dealing with companies in good faith.

What are the exceptions to the Common Law Indoor Management Rule?

If the transaction is unusual or suspicious, an outsider might be expected to check whether internal procedures were followed.

What is Direct or Organic Theory?

It means that the actions of the company’s key decision-makers, usually the board, are legally treated as the actions of the company itself, representing its ‘directing mind and will” and “organs of the company”.

If such a person commits an offence, it's attributed to the company.

What does the Criminal Code Act 1995 (Cth) have in relation to company law?

It provides a framework for corporate criminal liability, requiring both a:

• physical element (s 12.2) - refers to the conduct or action that constitutes the offence.

• fault element (s 12.3) - whether the person acted intentionally, knowingly, or recklessly, or authorised/permitted the offence.

Are there any defences to corporate criminal liability?

Defences under the Criminal Code Act:

• 9.2 - reasonable mistake of a fact can excuse liability if conduct wouldn’t be an offence had facts existed, and belief is honestly and reasonably held based on past consideration.

• 12.5 - a corporate body may avoid liability if an employee, agent, or officer acted under a reasonable mistake of fact and the company exercised proper due diligence to prevent the conduct.

Definition of Promoters

• A person who forms companies and attend to matters necessary to commence the company’s business operations.

• Can also include those who merely "profit from the venture without taking any active part."

What are the fiduciary obligations of a promoter?

• Disclosing if they are selling their own property to the new company.

• Placing the company in a proper position to decide by appointing an independent board and making full disclosure of the whole position.

• Disclosing all personal profits.

• Act in good faith

• Avoid conflicts of interest

• These apply after directors are appointed especially if they remain passive and act in the interest of the promotor

What is a pre-registration contract?

A contract is made on behalf of an unregistered company.

What happens when pre-registration contracts occur?

Under section 131 of the Corporations Act, if a contract is made on behalf of an unregistered company:

• The company is bound and entitled to benefit if it registers and ratifies within an agreed or reasonable time.

• If the company is not registered or fails to ratify, the person who entered the contract is liable.

• If the company ratifies but fails to perform, the person who entered the contract may still be liable if the court determines.

• The person who entered the contract can avoid liability if released by the other party (s 132) but has no right of indemnity against the company.

What are the sources of capital?

Equity and Debt

What is equity capital?

Selling shares to the public (shareholders) or using retained profits.

What is debt capital?

Borrowing from banks or other financiers, or issuing debentures to multiple individual investors.

What is a gearing ratio?

A gearing ratio is a financial metric that measures how much debt a company uses to finance its assets and operations relative to its equity. It also serves a purpose for investors to indicate risk.

What is a shareholder and their features?

Shareholders (Equity Providers) are members of the company with attendant rights (vote, dividends, bring actions).

• Are participants in the company enterprise.

• Return is via dividends, dependent on company fortunes. No automatic right to a dividend for ordinary shareholders (s 254U is a replaceable rule).

• Shares are personal property and transferable (s 1070A), but proprietary companies' directors can refuse registration for any reason (s 1072G).

• Shareholders' claims rank after creditors' claims in insolvency (s 563A).

What is a debenture holder?

Debenture Holders (Loan Capital Providers) are creditors of the company, "outsiders." Rights depend on the contract terms, providing certainty of return (interest).

• Debts are generally not transferable.

• Have a right to be paid before members in insolvency (s 563A).

In the context of fundraising, what is security?

Securities are the financial instruments that companies offer to investors to raise capital. Under section 761A, this includes shares (equity), debentures (debt) or options to acquire both.

What does “options to acquire both” mean in the context of fundraising and securities?

An option is a financial instrument that grants its holder the right, but not the obligation, to purchase shares or debentures at a future date.

What is the Disclosure Requirement under section 706 of the Corporations Act?

An offer of "securities" for issue requires disclosure to investors, unless an exclusion under s 708 or s 708AA applies.

What are the exclusions from disclosure in terms of fundraising under section 708?

• Small-scale offerings (20 investors/$2 million ceiling).

• Offers to sophisticated investors (e.g. minimum $500,000 investment, high net assets/income).

• Offers to professional investors (e.g financial services license holders).

• Offers to persons associated with the company (e.g senior managers).

What are the four types of disclosure documents for fundraising?

1. Prospectus

2. Short form prospectus

3. Profile statement

4. Offer information statement (OIS)

What is a prospectus in terms of disclosure documents?

Most detailed type of disclosure document, requiring all the information that investors and their professional advisers would reasonably require to make an informed assessment (s 710). Must be lodged with ASIC.

What is a short form prospectus in terms of disclosure documents?

A type of disclosure document that references information already lodged with ASIC. (s 712)

What is a profile statement in terms of disclosure documents?

A summary of the offer, subject to ASIC approval. (s 714)

What is an offer information statement (OIS) in terms of disclosure documents?

Used for amounts of $10 million or less. Requires less detail than a prospectus, but includes business description, use of funds, risks, and an audited financial report. (s 715)

Purpose of regulation of advertising for fundraising.

Regulated to ensure investors rely on disclosure documents, not advertisements. Strict conditions exist before lodging a disclosure document. (s 734)

Which section of the corporations act prohibits misleading/deceptive statements and who bears liability for this?

Section 728 prohibits misleading/deceptive statements or material omissions in disclosure documents.

Persons liable include directors and named experts (ss 729, 730).

Punishments for misleading/deceptive statements for fundraising.

Contravention can lead to civil penalties, criminal offences (up to 15 years imprisonment, s 728(3)), injunctions, corrective advertising, and stop orders.

Is forecasting numbers in a document misleading?

Forecasting is considered misleading if no reasonable grounds back it or if the assumptions are unclear.

What are the defences for liability for disclosure document being misleading or deceptive?

• Due diligence for prospectuses (s 731): Reasonable inquiries and reasonable belief that statements were not misleading.

• Lack of knowledge for OIS/profile statements (s 732): Didn't know a statement was misleading or an omission existed.

• Reasonable reliance on others for all documents (s 733).

What is crowd-sourced funding and what are its features?

It is a newer regulatory framework for online fundraising, facilitating start-ups and small enterprises.

• Requires a licensed CSF intermediary (licensed Australian financial services provider)

• Eligible unlisted public and proprietary companies (under $25M assets/revenue) can offer ordinary shares to retail investors via a CSF offer document.

• Can raise up to $5 million in a 12-month period.

• CSF shareholders are not counted in the proprietary company shareholder limit (s 113(2)).

Does having shares mean someone has ownership over company assets?

No

Does the corporations act allow reductions of share capital?

Yes, under certain conditions because they, acknowledge its commercial benefits, as long as creditor interests are protected.

What must capital reductions do in term of the General Capital Reduction section 256b of the corporations act?

General capital reductions:

• Must be "fair and reasonable" to all shareholders.

• Must "not materially prejudice the company’s ability to pay its creditors."

• Must be approved by shareholder resolution.

Can a company buy back shares?

Yes, a company can buy back up to 10% of its shares within a 12-month period without ordinary shareholder approval; exceeding this requires an ordinary resolution (for equal access, on-market, employee schemes) or a special/unanimous resolution (for selective).

Types of share buy-backs

• Equal access scheme

• Selective buy-back

• On-market buy-back

• Minimum holding buy-back

• Employee share scheme

Which section of the corporations act covers share buy-backs, and what must they not do?

Section 257B

Must not materially prejudice creditors and follow specific procedures. Directors must ensure solvency (s 257J).

What happens to shares that are bought back?

Bought-back shares are cancelled (s 257H(3)) and ASIC must be notified (s 254Y).

What is a dividend?

A payment to a shareholder, a return on investment, typically paid in cash.

Can be franked (company has paid tax) or unfranked. The imputation system provides tax offsets for franked dividends.

What are the conditions of paying a dividend?

Section 254T states that a company must not pay a dividend unless:

• the company’s assets exceed its liabilities immediately before the dividend is declared and the excess is sufficient for the payment of the dividend;

• the payment of the dividend is fair and reasonable to the company’s shareholders as a whole;

• the payment of the dividend does not materially prejudice the company’s ability to pay its creditors.

Breach can lead to civil penalties for directors (s 256D), and even criminal offences if dishonest. Insolvent trading provisions (s 588G) may also apply.

Who decides on dividends under the Corporations Act, and what rights do shareholders have if dividends are not paid?

Section 254U – Replaceable Rule:

• Directors generally have the overall authority to determine the amount, time and method of payment of a dividend.

• This can be amended by shareholders via a special resolution.

• Shareholders may seek relief under s 232 if dividends are not paid in a profitable company.

When does a dividend become a debt?

Section 254V

• Companies with replaceable rules (s 254V(1)): A company does not incur a debt merely by fixing the amount or time for payment. The debt arises only when the time fixed for payment arrives. The decision can be revoked before then.

• Companies with a constitution providing for declaration (s 254V(2)): The company incurs a debt when the dividend is declared.

What is debenture?

Broadly defined in s 9 as a "chose in action that includes an undertaking by the company to repay as a debt money deposited with or lent to it."

A debt owed to someone is a chose in action – they don't physically "possess" the money until it's paid, but they have a legal right to claim it.

“undertaking by the company to repay as a debt money deposited with or lent to it.” means a formal promise or obligation by the company to repay borrowed money

When debentures are offered to the public under Chapter 6D of the Corporations Act, what specific requirements apply?

• A trust deed and trustee are required (s 283AA) to protect individual debenture holders.

• Companies must meet various obligations, such as carrying on business properly (s 283BB), informing the trustee of security interests (s 283BE), and providing quarterly reports (s 283BF).

What duties do trustees have?

Exercising diligence, notifying ASIC of breaches, and complying with debenture holder directions. (s 283DA)

Types of debentures

Section 283BH

• Mortgage debenture

• Debenture

• Secured note

• Unsecured note

• Security Interests (PPS Act 2009 (Cth))

Mortgage debenture

Security interest over tangible property in favour of the trustee.

Secured note

Trustees get first ranking security interest over company property.

What is a security interest for debentures?

PPS Act 2009 (Cth)
A security interest is an interest in personal property provided for by a transaction that secures payment or the performance of an obligation.

Basically it’s collateral: The personal property subject to a security interest.

When does a security interest become enforceable?

A security interest becomes enforceable against a grantor (company) when it legally connects to the property or asset (e.g., secured party gives value for the interest and gains rights).

Enforceability against third parties requires attachment, and either secured party possession/control, or a security agreement covering the collateral.

Types of Security Interests (PPS Act)

Non-circulating and Circulating

What is circulating security interests?

A security interest that is attached to a category of assets that may be disposed of in the ordinary course of business (e.g., trading stock; similar to "floating charge").

e.g. A company takes a loan and gives the lender a floating charge over its trading stock.

• Today, the company has 100 computers in stock. Tomorrow, it sells 50 and buys 60 more. The lender’s security automatically applies to the new stock as well.

What is non-circulating security interests?

Attaches to specific, identifiable property (similar to "fixed charge")

Registration and Priority of security interests

A "perfected" security interest takes priority over unperfected ones.

Priority Rules (s 55 PPS Act):

• Unperfected interests by order of attachment

• Perfected interests over unperfected

• Multiple perfected interests by earliest of registration, control, or temporary perfection.

When does perfection occur in security interests and what special clause is now considered a security interest requiring perfection?

Perfection occurs if the security is:

• attached to collateral,

• enforceable against third parties,

• and additional steps taken (e.g., possession/control, or registration on the PPS Register)

Retention of Title Clauses ("Romalpa" clauses): These clauses, where ownership doesn't pass until goods are paid for, are now classified as security interests under the PPS Act and s 51F of the Corporations Act, requiring perfection and registration.

What is the PPS register?

The Personal Property Securities Register (PPS Register) is a public, electronic register administered by AFSA.

How does a circulating security interest become invalid?

Circulating Security Interests (s 588FJ): Generally void against a liquidator if created within six months before the "relation-back day" (e.g., winding up commences).

What is an unregistered security interest and when does it become invalid?

Unregistered Security Interests (s 588FL): If an unregistered security interest isn’t registered in time, and an insolvency event (like liquidation) occurs, the secured party loses their claim over the asset, and it becomes the company’s property for the benefit of all creditors.

When does a security interest in favour of an officer become invalid?

Security Interests in favour of Officers (s 588FP): If a company is in financial trouble, any security interest given to a company officer or their associate (current or past) is invalid if it’s enforced too soon (within six months of being created) unless the court allows it. This is to prevent the officer from jumping ahead of other creditors while the company is in trouble.