Questions of validity

Professor Bob Baxt details two cases that examine how far a court can extend its discretion on the running of a company.

Even running the affairs of a small company can raise difficult and complex issues because of the need to comply with a range of rules, both under the Corporations Act 2001 (and parallel legislation) as well as the company’s own constitution (or if it is an older company, its memorandum and articles of association). Urgency may lead to errors being made. The speed in reaching decisions, or the need to reach them quickly for various tactical or other reasons, may mean that steps that are required to be taken in an orderly and time-controlled form, may be overlooked or ignored, or mistakes may be made in the conduct of these activities.

In its various forms, the Corporations Act has included a provision that has enabled a court to rectify or forgive these mistakes, or "contraventions" of the relevant legislation, or a failure to comply with the company’s constitution.

The relevant section in the current legislation is section 1322(4). This power is vested in both the Federal Court of Australia and the Supreme Courts of the various states and territories.

Two recent decisions highlight the operation of this important provision. They are Beck v LW Furniture Consolidated (Australia) Pty Ltd [2012] NSWCA 76 (Beck) and Chalet Nominees (1999) Pty Ltd v Murray [2012] WASC 147 9 (Chalet). Both were interesting decisions, although the first is perhaps the more important as it is a decision of the New South Wales Court of Appeal.

The Beck case arose out of a family dispute surrounding the operation of the company LW Furniture Consolidated (Australia). Another case, Weinstock v Beck, which was to have been heard by the High Court of Australia on 21 June, has been deferred so that a special leave application in the Beck case discussed in this note could be heard together.

Weinstock v Beck concerns the rather interesting question of whether a company can issue only preference shares and what value those preference shares have when the company is to be liquidated. The new case, Beck, involved disputes as to whether directors had been properly appointed to run the relevant company.

concerns the rather interesting question of whether a company can issue only preference shares and what value those preference shares have when the company is to be liquidated. The new case, , involved disputes as to whether directors had been properly appointed to run the relevant company.

The family company, owned by the Becks, no longer conducts trading activities. However, it had accumulated significant holdings of one sort or another and was at a stage where the children of the founders wanted their share of the assets on liquidation. The founder and his wife were the original directors of the company.

A year after the company was established, the founder and his wife appointed their two children Ami and Tami as directors. Tami ceased being a director of the company in 2003. This meant that on the death of the founder and his wife, and shortly after that, Ami was the only director of the company. In 2003, Ami sought to appoint his wife Helen as a co-director.

Tami disputed this appointment. She argued that both Helen and Ami had been invalidly appointed. She sought to wind up the company on the basis that it had no directors.

Justice Barrett in the New South Wales Supreme Court agreed that the company had no validly appointed directors. He nevertheless felt it appropriate to validate the appointment of Helen as a director under the powers vested in him by section 1322(4)(a)(ii) of the Corporations Act. Therefore, there was no need for the company to be liquidated.

Tami appealed against this decision to validate the appointment. Helen and the company also appealed against his ruling that Ami was not in fact holding the office of a de facto director when Helen was appointed by him.

In the New South Wales Court of Appeal, Justices Young, Sackville and Campbell were divided in their views on two critical issues. These were:

1. Whether Helen and Ami were in effect validly appointed directors, and
2. Could the court, exercising its discretion under section 1322(4)(a)(ii) of the Corporations Act, have the power to validate the relevant appointment?

I will not address the first question, which required the court to discuss a range of legal authorities.

For Company Director readers’ purposes, the critical question turned out to be the correctness of the order made by Justice Barrett to validate the appointment of Helen as director.

On this question Justices Young and Sackville disagreed with Justice Campbell and ruled that the validation order made by Justice Barrett was incorrect.

The majority wrote separate judgments, but they did agree on certain aspects. They felt that Ami’s purported appointment of his wife Helen did not amount to a contravention of the Corporations Act or of the constitution of the relevant company. Ami had no authority to appoint Helen in the first place. Therefore, there was no power on the part of Justice Barrett to validate this appointment.

The following quotation from the judgment of Justice Sackville (at [239]) provides a useful summary of the power of a court to exercise this discretion: "It is one thing to apply section 1322(4)(a) of the Corporations Act to the purported acts of an invalidly-appointed director and another to apply the provision to the purported acts of someone who has never been validly appointed as a director and cannot be so appointed. If, for example, the appointment of a person as director was invalid because the meeting which resolved to make, the appointment was not properly convened, a fresh appointment could be made at a duly convened meeting and the acts of the de facto director ratified. Where a person has never been appointed as a director (at least after his or her original term expired) and cannot be validly appointed, the purported act of that person, even if performed when he or she was a de facto director, cannot in my view be described as invalid by reason of a contravention of the articles or of the Corporations Act. Nor can it be said that the de facto director’s purported acts are invalid by reason of a failure to take advantage of a revision of the constitution of the corporation or of the Corporations Act."

Justice Young agreed with this interpretation of the law.

In disagreeing with the majority’s conclusions on this point, Justice Campbell adopted a much broader interpretation of this statutory provision. He felt that the word "contravention" was to be read very broadly. In his view, the statutory provision extended to a case, even though Ami had never been a validly appointed director. He noted that there was nothing in the legislation to suggest that one should restrict the usual meaning of the word contravention (see para 140). In his view, the discretion vested in the court to deal with such matters was a very wide one and in this case there was no need to narrow the interpretation of that provision.

As noted earlier, a further judgment dealing with the interpretation of section 1322 has been delivered by the Supreme Court of Western Australia.

In Chalet, Justice Le Miere provided a broad interpretation of the discretion under section 1322. His case involved a narrower question than that in the Beck case. In Chalet, the concern was with the facts surrounding the failure of the company’s board of directors to ensure that a proper quorum was present when a meeting was held at which certain steps were taken, again involving a dispute (this time between two companies owning certain property).

One of the questions that Justice Le Miere had to consider was whether there was any injustice caused by the court ratifying or validating a meeting at which no quorum had been present.

In his view, as this case involved a company with only two shareholders, no injustice could be said to occur if one of the shareholders refused to attend meetings, thus trying to prevent the company from carrying on its formal activities.

In such a case, the willingness of that shareholder to try to undermine the continued existence of the company by trying to block the holding of meetings did not prevent the other shareholder from trying to conduct the business that was believed to be relevant to the company’s performance.

The interpretation of section 1322, especially in the context of the Beck case, suggests that the High Court of Australia may be asked to provide a conclusive view on how far the court’s discretion should extend in situations such as the one that arose in the Beck case.

It will be interesting to see whether the High Court is given an opportunity to consider this question in the next few months.