Corporate Law 2011 Primary Exam
QUESTION 1 (15 Marks in Total)
The board of directors of the ASX-listed Axiom NL wants to make the company as
‘takeover proof’ as is legally possible. The company’s managing director has sought
your advice in relation to each of the following strategies.
(a) Axiom NL will form a wholly owned subsidiary, tentatively known as Security
Pty Ltd. Axiom NL will then lend $10m to Security Pty Ltd at a commercial rate of
interest. Security Pty Ltd will use the funds to acquire shares in Axiom NL on the
ASX. Security Pty Ltd will provide a fixed charge in favour of Axiom NL over the
Axiom NL shares it acquires.
(6 marks)
Relevant Issues:
1 Does s 260 empower Axiom NL to financially assist Security Pty Ltd to acquire
shares in Axiom NL? For the purposes of s 260A(1), Security Pty Ltd would be a
‘person’. The provision of the loan would financially assist Security to acquire shares
in Axiom. That is the purpose of the loan.
Given that the loan is to be secured and is to be at a commercial rate of interest, it is
not obvious that it will materially prejudice Axiom or its shareholders for the
purposes of s 260A(1)(a)(i). The fact that Axiom would contravene s 259B(1) in
taking a fixed charge over its own shares does not necessarily mean that the interests
of Axiom or its shareholders would be materially prejudiced. This is because the
contravention would not affect the validity of the security: see s 259F(1)(a). Nor
would Axiom be guilty of an offence: see s 259F(1)(b).
There is no evidence that the loan would materially prejudice Axiom’s ability to pay
its creditors for the purposes of s 260A(1)(a)(ii).
If, on the facts, the financial assistance would not be protected under s 260A(1)(a), the
giving of it would be improper unless either s 260A(1)(b) or (c) applied. Of the
exemptions in s 260C, only that in s 260C(2) might be available. However, that
provision would only apply if:
(a) Axiom’s ordinary business includes providing finance; and
(b) the finance was given in the ordinary course of that business and on ordinary
commercial terms.
Axiom NL is a no liability company. It is required to have a constitution which states
that its sole objects are ‘mining purposes’: s 112(2)(b). It is very doubtful that the
envisaged loan to Security would be reasonably incidental to the achievement of any
of the purposes in the s 9 definition of ‘mining purposes’. Even if Axiom’s ordinary
business included providing finance for mining purposes, the loan to Security would
not be given for those purposes. Further, the Privy Council in Steen v Law [1964] AC
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287 said that it is hard to see how the provision by a company of financial assistance,
for the express purposes of assisting a person to acquire its shares, could ever be said
to be in the ordinary course of business. A no liability company, that acts outside its
mining purpose objects, contravenes s 112(3) but the contravention would not affect
the validity of what it had done: s 112(5).
If s 260A(1)(a) and (c) are unavailable, the assistance could only be given if it was
approved by a general meeting passing a special resolution under s 260B: see s
260A(1)(b). If no approval was given, and s 260A was contravened, the only
consequence might be that those involved in the company’s contravention could be
held to have contravened the civil penalty provision s 260D(2) or the criminal
provision s 260D(3). The validity of the financial assistance, and any contract or
transaction connected with it, would not be affected: s 260D(1)(a).
2 Is Axiom able to take a fixed charge from Security over the Axiom shares that
Security acquires with the loan moneys? As indicated above, this would contravene s
259B(1) unless the exemption in s 259B(3) applied. For the same reasons as given in
the context of s 260C(2), s 259B(3) would seem to be unavailable. In taking the
fixed charge, Axiom would immediately acquire an equitable interest in the charged
assets. That would mean that Axiom acquired units of its own shares: see s 9
definition of ‘unit’. That in turn would mean that Axiom contravened s 259A. Those
involved in the company’s contravention would contravene the civil penalty provision
s 259F(2) and, if their involvement was dishonest, the criminal provision s 259F(3).
Axiom, however, would commit no offence: s 259F(1)(b).
3 Could Axiom enforce the fixed charge? The charge would be valid notwithstanding
the contravention of s 259B(1): see s 259F(1)(a). However, query whether Axiom
would again contravene s 259A when the charge was enforced.
4 Could Security be registered as a member of Axiom if it purchased Axiom shares on
the market? The issue or transfer of shares of a company [Axiom] to an entity it
controls [Security; see s 259E for when a company is taken to control an entity] is
void unless one of the exemptions in s 259C(1) applies. No relevant share issue by
Axiom to Security is contemplated on the facts. However, Security might seek to have
Axiom register it [Security] as the owner of Axiom shares that it purchased on the
market. Section 259C(1) would render any such transfers void. None of the
exceptions in s 259C(1) would apply. Because the transfers to Security would be
void, Security could not lawfully become a member of Axiom. It could not therefore
acquire a legal interest in the Axiom shares.
5 Would Security have to dispose of the equitable interests it acquired as a
consequence of acquiring Axiom shares? Seemingly not. Note that s 259B(4) would
not apply because the units of shares would not have been acquired as a consequence
of Axiom exercising ‘rights under a security permitted by s 259B(2) or (3)’. Further,
none of the limbs of s 259D would seem to apply.
6 Would Axiom have to dispose of the equitable interests in its own shares that it
acquired by taking a fixed charge over Axiom shares acquired by Security?
Seemingly not; s 259B(4) would not apply because the security was not permitted by
s 259B(2) or (3).
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Conclusion: Axiom could lawfully form a wholly owned subsidiary. Further, it could
provide financial assistance to the subsidiary under cover of either s 260A(1)(a) or
(b). However, Axiom would contravene s 259A and s 259B(1) in taking a fixed
charge over any shares in Axiom that were acquired by Security. This could result in
persons involved in the contraventions contravening s 259F(2) and, possibly, s
259F(3). Security could not be registered as the owner of any shares it purchased in
Axiom. Thus the strategy is fraught.
(b) Axiom NL will grant an unsecured $15m line-of-credit to the ASX-listed Jade Ltd
to allow Jade Ltd to acquire shares in Axiom NL from time to time over the next 10
years. Jade Ltd will pay interest to Axiom NL on funds drawn down on the line-ofcredit. The interest rate will be nominal and well below current market rates for
equivalent loans. Jade Ltd does not currently hold any shares in Axiom NL.
(b) Discussion:
The main issue relates to s 260. Would Axiom NL contravene s 260? Adler v ASIC
(2003) 46 ACSR 504, CA(NSW), although distinguishable, is clearly relevant here.
An unsecured loan at materially below market interest rates would probably be
materially prejudicial to the interests of Axiom and its members: cf s 260A(1)(a)(i).
None of the exemptions in s 260C would seem to be available. As to s 260C(2), see
the earlier discussion and note that, for the purposes of that provision, this line of
credit would not be given on ordinary commercial terms.
Axiom NL would therefore contravene s 260A(1) unless the giving of the financial
assistance was approved under s 260B. The consequences of such a contravention are
set out in s 260D.
QUESTION 2
The constitution of Kilton Pty Ltd contains the following relevant provisions:
(i) Subject to this constitution, the directors may from time to time issue shares in the
company on such terms as they see fit.
(ii) Any preference shares issued by the company shall confer upon their holders only
the following special rights:
(a) the right to receive a cumulative dividend, at the rate determined by the
directors on the issue of the shares, in priority to the ordinary shareholders
receiving any dividend;
(b) the right to exercise one vote per share on a poll on a resolution to reduce
the company’s issued share capital or alter the company’s constitution.
The constitution does not contain any variation of class rights provision.
Kilton Pty Ltd currently has 20 members. Fifteen of the members hold, in aggregate,
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60% of the company’s fully paid 1 million issued ordinary shares. The holder of each
ordinary share is entitled to exercise one vote on a poll at a general meeting.
The remaining five members hold, in aggregate, the remaining 40% of the company’s
ordinary shares and all of the company’s 500,000 issued and fully paid preference
shares. The preference shares were issued with an annual dividend entitlement of 10
cents per share. All of the company’s shares were issued for $1 a share.
Recently, the company has been trading at a loss. No dividends have been paid in
each of the last 5 years. Despite this, all of the company’s paid up share capital is
represented by net assets and the company is solvent.
The company’s business is returning to profitability. The directors believe that it may
be possible and prudent for the company to pay a dividend in either 2013 or 2014.
However, they are concerned that the continued existence of the preference shares
may preclude any dividend being paid to the ordinary shareholders for many years.
The directors of Kilton PtyLtd have sought your advice on what, if anything, may be
done to eliminate the preference shares.
Your advice should deal with:
(a) the available options including, where necessary, the procedure required by law to
effect each option;
(b) the likelihood of each option working; and
(c) whether the company could readily improve its position by issuing additional
preference shares exclusively to the 15 members who currently hold only ordinary
shares.
(20 marks)
(a) Main options:
1 A selective reduction of share capital under s 256B. This would be a selective
reduction as it relates to preference shares and therefore cannot be an equal reduction:
s 256B(2). An equal reduction must be approved by either (a) a special resolution of a
general meeting on which no votes were cast in favour by any member who would
receive consideration pursuant to the reduction, or by any of their respective
associates; or (b) a resolution agreed to at a general meeting by all ordinary
shareholders. Preference shareholders could vote against but not for the special
resolution as they have the class right to vote on share capital reductions.
Because the preference shares would be cancelled under the proposal, s 256B(2) also
requires the reduction to be approved at a separate class meeting of the preference
shareholders. All preference shareholders could vote for or against the resolution. The
other requirements set out in ss 256B(1) and (3)-(5) would also have to be complied
with.
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2 A selective buy-back under s 257D. This is a selective buy-back because it is not
one of the other four kinds of permitted buy-back: see s 9 definition of ‘selective buyback’. The procedure for approving a selective buy-back is stated in s 257D(1). There
must either be (a) a special resolution of a general meeting on which no votes were
cast in favour by any member whose shares are proposed to be bought back, or by any
of their respective associates; or (b) a resolution agreed to at a general meeting by all
ordinary shareholders.
Preference shareholders could vote against but not for the special resolution as they
have the class right to vote on share capital reductions. Shares bought-back must be
cancelled: s 257H(3). This will reduce the company’s share capital. Hence preference
shareholders can vote against the resolution even though they have no express right to
vote on buy-back resolutions: see Village Roadshow Ltd v Boswell (2004) 8 VR 38;
49 ACSR 27.
(b) The likelihood of each option working;
(i)



A share capital reduction under s 256B must:
be fair and reasonable to the company’s shareholders as whole;
not materially prejudice the company’s ability to pay its creditors; and
be approved by shareholders under s 256C: s 256B(1).
The return of share capital solely to preference shareholders would be consistent
with the priority given to preference shareholders in a winding up: see, for
example, Scottish Insurance Corpn v Wilsons and Clyde Coal Co [1949] AC 462,
HL; Re Fowler’s Vacola Manufacturing Co Ltd [1966] VR 97. Thus, prima facie,
the reduction would be fair and reasonable. However, the amount that the
preference shareholders would receive for each share would also have to be fair
and reasonable in the circumstances. Thus the amount payable per share would
have to reflect the value of shares in a company which is returning to profitability
and which carry the priority right to receive 5 years of accumulated dividends. In
these circumstances, the shareholders should receive materially more than the
issue price of their shares.
The members who hold all of the preference shares and 40% of the ordinary
shares have the upper hand. They are in a position to defeat a special or
unanimous resolution at a general meeting. They can also determine whether a
special resolution should be approved at a separate class meeting. Thus the
reduction of capital will not happen without their overwhelming support.
(ii) The preference shareholders, between them, hold 400,000 ordinary shares as well
as all of the 500,000 preference shares. Thus they have the capacity to exercise
900,000 of the 1.m votes that might be cast on a poll on the special resolution to
approve a selective buy-back. They are able to vote against [but not for] the
proposal. Thus they are able to prevent a special or unanimous resolution being
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passed at a general meeting. Further, even if a selective buyback offer were to be
made, they could reject the offer.
(c) Could the company readily improve its position by issuing additional preference
shares exclusively to the 15 members who currently hold only ordinary shares?
The proposed issue would bring s 246C(6) into play. If a company issues new
preference shares that rank equally with existing preference shares, the issue is taken
to vary the rights attached to the existing shares unless the issue is authorised by:
(a) the terms of issue of the existing preference shares; or
(b) the company’s constitution (if any) as in force when the existing preference
shares were issued.
Whether the terms of issue of the existing preference shares authorise the issue of
further preference shares is unknown. The provision of the company’s constitution
which empowers the director to issue shares on such terms as they think fit would not
be a sufficient authorisation for the purposes of s 246C(6). Thus the proposed issue
would probably vary the existing class rights of the preference shareholders.
As the company’s constitution does not contain a variation of class rights provision, s
246B(2) would apply.
The proposed issue of further preference shares would have to be approved:
(i) by a special resolution passed at a meeting of the current preference
shareholders; or
(ii) With the written consent of members with at least 75% of the votes in the
class.
Accordingly, the proposed strategy will almost certainly not advance the company’s
position.
As the company is a proprietary company, there is also the possibility that the
replaceable rule s 254D(1) applies. If it does apply [as to which see s 135(1)(a)], s
254D(1) would require the company’s directors to first offer the new preference
shares on a pro rata basis to the current preference shareholders unless the company in
general meeting resolves otherwise under s 254D(4).
QUESTION THREE
Olivia, Walter, Nina and Peter are equal shareholders in Fringe Pty Ltd (‘Fringe’),
which was incorporated in Australia in 2008. Olivia, Walter and Nina are also
directors – Olivia is the Managing Director, and Walter is the Chair of the Board.
Fringe’s sole business is in applications (‘apps’) for use on smart phones. Nina and
Peter are employed by Fringe as programmers, designing and creating the apps.
When incorporated, it was decided by the members to focus the attention of Fringe on
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apps for the eBrick, a particular brand of smart phone. Apps made for use on the
eBrick cannot be used on other types of smart phone without significant alterations
being made, as it uses a close operating system. Nina and Peter have been almost
wholly responsible for programming all of the apps created and sold by Fringe, with
occasional outsourcing to specialist contractors when an app requires some particular
knowledge for completion. Olivia deals with the sales and marketing side, interacting
with the resellers of their apps through the eBrick online sales system, BrickStore, as
well as managing the business generally. Walter is a retired doctor, who sits on a
number of Boards, and invested in Fringe after meeting Nina and Peter through a
friend.
In October 2010, Olivia is approached by Bell, a representative of Massive Pty Ltd
(‘Massive’), a retailer specialising in stocking the oSlim, a new smart phone which is
being heralded as a breakthrough for the smart phone market, and that is currently
eclipsing all other smart phone sales. Massive is encouraging all app designers to
consider creating applications for the oSlim, which utilises an open operating system
(meaning that any app made for the oSlim can work on other smart phones which also
use an open operating system) and offering free access to the oSlim app sales system
for companies which start to create applications for the oSlim in the next 3 months.
Olivia is impressed with this opportunity, and takes the offer to the next board
meeting of Fringe, but cannot convince the other members of the board to change to
making apps for the oSlim. Nina states at the meeting that, despite the positive media
reports she has seen on this offer and the oSlim generally, the oSlim is a fad and will
not maintain a market presence. She convinces Walter to vote with her against Olivia,
who is in favour of the change. Walter relies on the advice of Nina, as he does not
even own a mobile phone - let alone a smart phone - and does not understand much of
the technical side of the business at all.
A year later, Peter attends a lecture given by Bell at the Society for Application
Designers on the success of the oSlim and the incredible growth in the market for
apps for open operating systems following the offer made by Massive, and wonders
why Fringe did not take Massive up on the offer. Sales of apps on BrickStore have
declined by 50% in the past year, and although Fringe is not yet in financial trouble,
this drop is troubling. He raises his questions with Olivia, who informs him of the
outcome of the vote at the meeting of the directors the previous year. Peter is
irritated, as he knows from conversations with Nina at work that her dislike of the
oSlim stems from having been refused a job with the company which developed it,
rather than any actual flaw with the product itself, and thinks her decision may have
been affected by this. Peter comes to your legal firm seeking your advice. He
believes the decision not to enter the market for oSlim apps a year ago was a mistake,
and if Fringe will still not make the change now, he would like to resign from Fringe
and take up the opportunity himself.
Advise Peter on whether Olivia, Walter or Nina have breached any duties to the
company and, if so what remedies might be available to Peter. Also advise whether
Peter is at risk of breaching any duties himself.
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MARKING GUIDE
The question asks for three responses:
1. Have Olivia, Walter or Nina breached any duties to the company?
2. If yes to 1, what remedies might be available to Peter?
3. Is Peter is at risk of breaching any duties himself?
An answer would not have received an HD in total unless all three responses were
excellent.
At some point in their answer, s 185 should be raised, as it permits the duties at
common law and equity to exist in addition to the duties under the Corps Act. The
duties should be discussed separately if they are different (the ss 180-181 duties as
substantially the same at CL and equity, but the fiduciary obligations probably do
need to be discussed separately from the ss 182-183 duties.) Better answers
highlighted that the duties may be the same at underlying law and statute, but that the
party who enforces them and the consequences for breach are different depending on
the source. If a civil penalty provision is discussed, answers needed to note that ASIC
would have to prosecute any breach, so although these must be advised to Peter as the
question asks, he can’t actually take action for them. There is no question of ‘trading
whilst insolvent’ here.
Olivia: an executive director on the facts.


Has not breached any duty, as long as she tried to the fullest of her abilities to
impress the benefits of the Massive deal on the other directors. As she voted in
favour of the change which ultimately appears (now) to have been the better
decision, her case is slightly different to the others.
Some students attempted to ‘force’ the facts to suggest a breach by Olivia, which
was not appropriate. A number misread Peter’s role, and suggested that Olivia had
failed to keep him informed of meetings of the board – but if Peter failed to attend a
meeting as a director, that is equally likely to be his fault as hers (if he was a
director, which he isn’t!)
Walter: has possibly breached s 180 (care and diligence) and s 181 (good faith in best
interest of the company and for a proper purpose). Section 180 is the best choice for
Walter.


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Section 180: fulfilling his obligations as a director (lack of appropriate knowledge
about this type of business, even if he has general business acumen? Unable to
contribute to votes such as the one which occurred due to his lack of use and
understanding of the relevant technology?); also a possible inappropriate fettering
of discretion?
Daniels v Anderson on the obligations of directors, basic standards etc. Objective
enquiry. Is this a failure to take part in active supervision of the company’s
management a la Daniels v Anderson, Sheahan v Verco?
The BJR should not be available as a defence due to Walter not ‘informing himself
about the subject matter of the judgment to the extent reasonably believe
appropriate’ as required by (2)(c) – no balancing of risk and reward in his decision,
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so this is not the type of display of entrepreneurial flair or acceptable commercial
risk that should be protected by the BJR.
Section 181: is better discussed under Nina due to her conflict of interests, and good
students spotted this. Walter was honest, but subjective honesty will no longer be
enough to exclude liability: ASIC v Adler etc.
Reliance on Nina under s 189:


Was it reasonable? Walter relied on Nina, which is ok if it satisfies (a)(ii). May have
been made in good faith, but there is no evidence of an independent assessment of
the advice.
The reasonableness of the reliance may also be questioned, but will be difficult to
disprove.
Nina: improper purposes and not bona fide in best interests of the Co – s 181. (She
probably has breached s 180 also, but, unlike Walter, she actually informed herself
under the BJR – but will probably fail the other components. The s 181 argument is
stronger for her, and better answers highlighted that.)
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In good faith in the best interest of the company: subjective tempered with
objectivity (i.e. good faith alone not enough) but Nina may not even have good faith
here. Comes down to arguing that the motive Peter knows about (i.e. her personal
dislike of the company behind the oSlim) was the motivator for her voting against
the business shift. Facts only tell us that she thought the oSlim was a passing fad,
despite media reports to the contrary (and, now, in hindsight, she looks wrong-er?)
Proper purpose: ‘Substantial purpose’ / ‘but for’ test discussion. Was there a proper
purpose for voting against this point?
If reckless or dishonest, also consider s 184.
Breach of fiduciary obligations too – allowing her personal interest (or dislike) to
conflict with the interests of the company. As such, also consider ss 182-183 –
misuse of position and information to cause detriment to the company. More likely to
be s 182 (position) than information, as the information ‘improperly used’ was private
to Nina (i.e. she disliked the company which made the oSlim due to personal reasons)
and not gained in the course of her work as a director of Fringe. She has likely,
however, improperly used her position by allowing the personal dislike to impact on
Fringe.
Section 191 – disclosure of a material personal interest?

Nina certainly has an ‘opinion’ which may have negatively affected her decision
making as a director, but it that really an ‘interest’ that the Act would need
disclosed? It does seem to have affected her ability to vote impartially.
Remedies available to PeterA preliminary point to consider would be, what would Peter actually want, and is it
achievable? Removal of N and W as directors? Damages? Very few students
actually considered this step.
Injunction under s 1324: not actually helpful (Clearly too late to do anything to “fix”
the missed opportunity). Damages in lieu? Unlikely here as the argument for an
injunction wouldn’t succeed.
Inspecting the books: not helpful.
Call a meeting: might help? Section 249F. P will have enough shares to call if he is a
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25% shareholder, but will have to bear the cost. He could propose discussion of the
offer, give P a chance to ask questions of the Board and understand why the decision
was made, make N discuss her motivations (and the possible improper purpose). Still
clearly too late to do anything to “fix” the missed opportunity though. Might be able
to convince them to make the switch over now – rather than have to resign and set up
his own Co. Very few students noted the usefulness of this option.
If the outcome P obtains from the meeting is unsatisfactory, thenOppression: refusal to change course to the oSlim might be oppressive (both now and
then). Thomas: in light of the structure of the particular company and the reasonable
expectations of its members, is the detriment caused to the complaining member’s
interest as a result of the acts or conduct justifiable? Detriment here is to Co as
whole, not just P’s interest. Wayde: whether a reasonable director, possessing the
skill, knowledge and acumen of the directors and having in mind the importance of
furthering the corporate objective on the one hand and the disadvantage, disability or
burden which their decision will impose on the other, would have decided it was
unfair to make that decision. Standing is fine.
SDA: standing and then leave. Standing is fine, application for leave depends on
whether Co has considered and failed to take action against W and N. P would bring
the proceeding in the name of Fringe against W and N for the common law/equitable
breaches (obviously not the civil penalty provisions) and consequent damage to the
company. Actual ‘damage’ to the company still an issue?
Winding up on J&E grounds: failure of the substratum? Probably not enough here to
go as high as winding up, given that the court considers this the ultimate remedy of
last resort (ASIC v ABC Fund Managers (No 2)). Court could order P be bought out if
Fringe refused to ‘let’ him leave.
Peter’s duties
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
He is not a director, or even an officer under Citigroup or s 9 (evidenced by inability
to effect business of the Co on these facts!)
Just an important employee due to his contribution to the business. He could resign
and set up in competition, depending on his employment contract (which may
contain restraint of trade clauses) and whether or not he would be in breach of
fiduciary obligations.
If he is a sufficiently senior employee, he may owe fiduciary obligations to his
employer (Fringe) – but that is mostly an equitable question based on the facts, and
probably beyond the scope of this course for students to do more than raise it.
Peter should note that s 183 (misuse of information) also applies to employees – so he
would have to take care not to use the company’s information for his own benefit, or
to the detriment of the company. A number of students thought that the ‘opportunity’
provided by M came to Peter as a result of his employment, and that he could never
act upon it without breaching s 183. That is one reading of the facts, although I think
it is probably a little harsh to employees generally.
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QUESTION 4
Orpheus has been appointed liquidator of Marble Piles Pty Ltd.(“Marble”), a
construction company, and seeks your advice in relation the following issues:
(i)
He wishes to know the treatment of, and the order of priority between, the
following claims against the company, giving reasons for your advice:

TroyLoans Ltd. is owed $200 000 by Marble advanced by way of loan
facility. TroyLoans Ltd. took a fixed charge over Marble’s freehold
premises which are now worth $100 000, and a floating charge over the
rest of Marble’s business and assets.

Pericles, the managing director, is owed $50 000 salary arrears.

Orpheus is owed $50 000 for remuneration as liquidator.

Xenophone Pty Ltd. is owed $10 000 for internet and phone services
supplied to Marble.
GUIDE:.
Students should receive, say 4 marks if they got the right order of priority, namely:
Fixed charge over freehold for $100 000 can be paid to Troy Loans from freehold
property;
Liquidator’s remuneration is priority under s556(1)(de) (deferred expenses as defined
in (2), but there are no other categories above it here, so it is the highest priority of the
s556 claims)
Pericles, as managing director, is an employee, whose salary would be the next
priority under s556. However, as a director he is an ‘excluded employee’ so the
priority amount would be capped at $2000 (see s556(1A), and 556(2) for excluded
employee)
Next, Troy Loans Ltd can be repaid out of any floating charge realizations for the
remaining $100 000- floating charge realizations are paid after employee priority
claims-s561. We are not given the value of the assets subject to the floating charge.
Lastly, Xenophone is an unsecured creditor for the $10 000. There is no s556 priority
for utlility companies.(There is a provision which says that they cannot insist on
payment of arrears as a condition of any continuing supply to a liquidator, but that
was not the question here)
Unsecured creditors here, who will share under the pari passu principle (s555) are
Xenophone, Pericles for the $48 000 shortfall after the cap; Troy Loans Ltd, to the
extent that there is any shortfall on its recovery under the floating charge.
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An answer which sets out the correct order of priority, and gives correct reasons for
each of the priorities, including recognition of the pari passu principle for the
unsecured claims, and distinguishes the effect of the fixed and floating charge, will
get full marks (7.5 as a working assumption of equal split, though this is just a guide,
a better answer to part (ii) might compensate when assessing the total out of 15).
Common errors: (1) Forgetting the fixed charge, though most people got the floating
part correct.
(2) Forgetting about one set of claimants, eg utility companies, and also that any
unsecured ‘shortfall’ on the bank (and managing director’s) claim would come in as a
pari passu claimant
(3) Not stating that there is a cap of $2000 on the MD’s salary claim
(ii)
Two weeks before Marble went into liquidation, Pericles caused the company
to donate a gift of a marble statue to Zeus, a local MP and a shareholder in
Marble, who was owed unpaid dividends worth $5 000. The dividends had
been declared months earlier when the company was solvent. Orpheus is
advised that the value of the statue at all relevant times was $7 000. Advise
Orpheus whether and, if so how, he can challenge the transaction.
(15 Marks)
Guide: Students should correctly identify the problem here, in that there is a
potential voidable transaction; which voidable transactions might be relevant,
what the basic elements are which might apply. The question does not ask for
advice as to possible defences,
Unfair preference- s588FA- As Zeus is owed unpaid but declared dividends,
he is a creditor (declaration of dividend =debt). The fact that the dividends
were declared when the company was solvent merely serves to show that they
were prima facie validly declared dividends .
Nevertheless the time of payment is important, and that was two weeks before
liquidation- elements of s588FA should be mentioned(continuing business
relationship does not really seem to apply to this unusual transaction):
Effect of putting Zeus in better position than on liquidation, as owed $5000
and receives value of $7000 statue. There is a question-mark here as to
whether Orpheus can challenge the ‘transaction’ (ie the company’s gift of the
statute) as an unfair preference unless it is clear that the statue was being
‘received..in respect of the debt’ (ie the $5000)- if it is a mere gift so that Zeus
still regards the debt of $5000 as still owing.. A good student would notice this
difficulty, citing s588FA(1)(b).
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Likely two weeks out from liquidation that company was insolvent at time of
transaction (‘insolvent transaction’)-s588FC
Company is now in liquidation- (s588FE(1), 588FF)
The transaction is well within the ‘six months’ period for challenge for
preferences (though if it is an uncommercial transaction too, the period is two
years)- time periods are in s588FE(2) and (3).
Uncommercial transaction- The statute is a gift according to the question, or
even if it is in recognition of the debt, it is worth $2000 more than the debt,
hence no reasonable person would have entered into it having regard to
detriment to company and benefit to other party. This does not have the
uncertainty that an unfair preference claim has here.
Again, likely insolvent at the time (some students may mention available
presumptions of insolvency in s588E)
Time period is two years- if it is a preference and transaction at an undervalue,
two years.
The company is in liquidation now(s588FE(1), 588FF).
Common errors:
(1) Stating that Zeus was party to a ‘director-related’ transaction
(2) Omitting one of the two possible voidable transactions from the discussion
(3) Not recognizing the significance (or misstating it in terms of s254T) of the
fact that Zeus was owed a dividend, in relation to whether it could be an
uncommercial transaction or preference.
Three marks should be awarded if students identify BOTH types of voidable
transaction, (a further mark for identifying the problem with unfair preference
here,) and maximum marks for a student who goes on to identify the necessary
and relevant elements of each here. (7.5 marks working assumption but can be
compensated with better performance on part (i)- markers have some
flexibility here to assess the whole answer)
QUESTION 5
You have been asked to advise two directors, Romulus and Remus, who run the
‘Wolf it Down’ chain of fast-food outlets, through their company Fraternus Pty
Ltd.(“Fraternus”), which they set up in 2005, now expanded to 5 stores in indoor
shopping malls. They are equal shareholders and are the only directors. Their
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philosophy has always been to use Italian ingredients, and that fast food doesn’t
have to be low quality. Romulus is a talented chef, and Remus had wide
experience in marketing fast food outlets, but neither has legal or accounting
experience. They obtained overdraft funding on start-up from Trustus Bank,
which took a charge over all of the business and assets of Fraternus in 2005. The
security document gives Trustus Bank the right to appoint a receiver if any
monies owing to the bank are outstanding at any time, or if Fraternus goes into
any form of insolvency proceedings.
For the last 18 months, business has declined because fewer customers are
coming through the shopping malls, and ingredients have been harder to source
due to the economic problems in Italy.Twelve months ago, Fraternus began
having problems paying its bills on time and had to ask for more generous terms
from key suppliers and utilities. Six months ago, cheques were returned unpaid,
and Romulus purchased a book by Symus and Dunus on insolvency law.
Although the company is struggling, Remus convinces Romulus that, in his
experience of marketing, everything will turn out for the best because the Italian
food festival is about to take place in four Australian cities, and this will result in
renewed exposure and goodwill. Trustus Bank has noticed that the overdraft
terms have been exceeded without authorisation for three months in a row and
earlier insistence on a reduction in the debt has fallen on deaf ears.
Romulus remembers reading something in Symus and Dunus’s book about an
‘administrator’, and in the telephone directory he finds Mark Anthony, who says
that he acts as an administrator or liquidator but that he ‘comes to rescue
companies, not bury them’. Romulus also remembers reading about insolvent
trading, but Romulus does not think it will be a problem for honest directors.
Meanwhile, Trustus Bank has indicated it wishes to put in Caesar as a Receiver.
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Advise Romulus and Remus:
(i)
As to the relative benefits, for the company and them personally, of appointing
Mark Anthony as administrator, as opposed to appointing him as liquidator;
(ii)
Whether, if they appoint Mark Anthony as administrator or liquidator, Trustus
Bank will still be able to appoint Caesar as receiver.
(iii) What defences or relief may be available to either or both of them if any
potential insolvent trading claim is brought against them.
(15 Marks)
GUIDE:
As a working assumption/guide, 5 marks could be allocated to each of the three parts, though
with scope for flexibility to assess the whole answer. There is some potential for overlap and
compensation to mark the whole question, no sub-marks are allocated in the question.
(i) Note advice required on company position, and directors personally.
Company position- Students should identify the main benefits for the company of
appointing administrator- objectives of survival, where possible; wide
moratorium; independent professional investigates company situation.
Liquidator- Investigation of transactions (voidable, insolvent trading), more likely
a quicker dividend distribution to creditors. May be cheaper and quicker
procedure for company/directors to initiate. However, no wide moratorium
(limited to proceedings), and no long-term trading of the business. Limited ability
for creditors to consider any rescue proposal (DOCA in VA).
Voluntary Administration- the main advantage for the company is the
moratorium, at least as regards everyone except Trustus (decision period material
is the subject of question (ii), so there may be some overlap). The prospect of
business improving due to the Italian festival is a main reason to keep the business
trading and possibly survival objective in s435A- this business seems to be failing
because of outside factors, problems with Italian economy, so maybe if it could
change its policy re sourcing of produce, it might improve, provided the debt can
be repaid or restructured with support of creditors- hence VA and a possible
DOCA should be explored.
Directors personally -For the directors personally, they would prefer VA as
directors generally like the business to continue where possible, also they are the
only two shareholders here- but also the admininistrator cannot take proceedings
for insolvent trading/voidable transactions, though does have to report to creditors
on what he finds. Also, placing the company into VA may give them a defence to
future insolvent trading proceedings (see (iii) below- again overlap). If the
directors have given guarantees for the company debt, these cannot be enforced
during a VA (though they can later under the DOCA phase, and they can in a
liquidation)
(ii)
Administration- Generally, a receiver cannot be appointed once an administrator
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has been appointed, because it is enforcement of security that is prevented by the
moratorium, at least without permission of the court or the administrator(s440B).
Exceptions in VA- (A receiver may be appointed in respect of perishable goods
(s441C).) However the main exception in s441A seems to apply to Trustus Bank
here- Trustus Bank has a ‘decision period’ (see s9) of 14 business days (as it starts
on notice being given to the charge, or the commencement date of administration,
and ends 13 business days after that day). It is well-known as the ’13-day’
decision period, and I have referred to it as that, as have several books. Jim
Hambrook has pointed out that it is technically 14 days, since the initial date is
effectively included.
Students should be able to identify which chargeholder can appoint a receiver in
this decision period, and that in this case, Trustus appears to be such a
chargeholder, as having a charge over all or substantially all of the property; in
addition the charge must be enforceable at the time, and here we are told it is an
event of default if the company goes into any insolvency proceeding, which would
include voluntary administration.
If the chargeholder does not appoint in this decision period, then they will be
precluded from enforcement (by appointing a receiver, for example) thereafter,
without leave of court or consent of the administrator-s440B.
Liquidation- students should be able to identify that a receiver can still be
appointed even if a company is in liquidation, whether or not the liquidation
happens before or after the receivership.
They may also add(though the question did not ask for this information) that the
receiver’s agency to manage the business (in the case of a receiver and manager)
will terminate on liquidation, under s420C, unless the liquidator consents.
Students should be able to distinguish the continuance of receivership from the
termination of the receiver’s agency.
There is no requirement to obtain consent of the liquidator or the court in order for
a receiver to be appointed during a liquidation, and that is the main contrast with
the position in voluntary administration (subject to the decision period issue)
Common errors:
(1) Insufficient discussion in part (i) and in particular, no reference to the facts
given, e.g significance of the upcoming festival for prospects.
(2) In part (ii) omission of the liquidation part of the question, and in some cases,
failure to identify that only a special type of secured creditor can proceed to
appoint a receiver in a VA, not just any secured creditor.
(iii) The question is limited to defences and relief in insolvent trading claims, as may
apply on the facts here.
Students should be able to identify the defences set out in s588H, and the relief
provision in s1317S. They may refer to cases, in particular McLellan v
Carroll(Stake Man), where some of the defences, and relief, were relied upon.
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Also Tourprint v Bott may have been mentioned in lectures (‘expect’ is a higher
threshold than ‘suspect’).
Students may choose to go through each defence in s588H, though some (such as
illness) are not suggested by the facts.
S588H(2)- reasonable grounds to expect solvency- threshold test is higher than
‘suspect’ (Tourprint, Stake Man), hence just because hope that the Italian festival
may lead to recovery, that is not enough to expect that the company was solvent
and would remain solvent. Besides, the company has had problems for 18 months
which have got worse, and has consulted an insolvency book.
H(3) Reliance on other person- note Stake Man point that only where person was
‘responsible for giving advice on solvency’, so narrow defence that does not apply
here, because neither of them had financial or legal background.
H(5)- person took all reasonable steps to prevent incurring of debt, including (6)steps to appoint administrator, timing and results. This is quite wide, but it is ‘all
reasonable’. Merely appointing an administrator is not enough if it is ‘too little too
late’, and insolvent trading started earlier. So could they have done more here.
Where company has been clearly insolvent for up to 18 months, it would be hard
for directors to argue that they had taken ‘all reasonable steps’ to prevent further
debt- however this defence is useful for one director who has tried to do more to
persuade other directors, but that does not seem to be the case here.
S1317S should be mentioned- acted honestly and ought fairly to be excused.
Court has discretion, no suggestion of dishonesty, but Stake Man could be
distinguished as there was heavy reliance on a professional in that case,
notwithstanding H(2) could not be made out. In this case, relying on someone’s
marketing experience of shopping malls is probably not comparable, given
individual director duty under 588G. This is a discretionary relief so is not limited
by the facts of any case, but equally it is doubtful the courts will use it to relieve
honest directors who are clearly incompetent and should have ceased trading
earlier when the signs were obvious and/or brought in expert help or put the
company into VA earlier than they did.
However, for all five marks, it is sufficient if students identify the key
defences in s588H, and s1317S, and give some indication which defences are
most relevant here on the facts, reference to Stake Man is justified by its close
study in class and its relevance here.
Common errors:
(1) ‘Last question syndrome’ meaning not all defences/relief covered
(2) Relief was often omitted
(3) Discussing liability (s588G) when question did not ask for it, meaning less
time available to discuss s588H/1317S
(4) As with previous parts, insufficient attention to the facts- problem questions
give you facts because they are usually relevant, or at least, in order for you to
be able to show you can distinguish the relevant from the irrelevant. A mere
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discussion of the law will not obtain full marks.
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