Courts can fix mistakes

Professor Bob Baxt urges directors not to get too cocky after the High Court became sympathetic about courts “correcting” defects and contraventions in companies.

In its most recent decision on corporate law, the High Court of Australia has produced a welcome decision concerning the ability of relevant courts to rectify defects, contraventions and other mistakes made in the administration of companies.

While this leading judgment should lead to lower legal costs for companies, there are limits to how far the courts can and should go in rectifying these mistakes.

The case is the second of two involving the Weinstock and Beck families, who were major shareholders in a company, LW Furniture Consolidated (Aust).

In Weinstock and Anor v Beck and Anor [2013] HCA14, the High Court provided a generous interpretation to section 1322(4)(a) of the Corporations Act 2001.

The critical question was whether Mrs Weinstock – who had apparently been appointed as a director of the company many years ago, but whose appointment was not proper – could have her appointment validated, even though her late husband, who had appointed her himself, had himself not been properly appointed as a director at the time.

The company, which had been incorporated in 1971, required in its articles of association (its constitution) that it appoint two directors. If the number of directors fell below two, the remaining director could appoint an additional director.

The initial directors appointed to the company were the parents of the current litigants.

In 1973, two additional directors were appointed until the next annual general meeting. These appointments expired before that meeting. The resolution to appoint retiring directors at that time was an invalid one (for reasons that are not important here).

Over a period of time, the original directors either resigned or died.

One of the appointed directors (Weinstock) continued to act as though he were the only properly appointed director of the company and later purported to appoint his wife, Mrs Weinstock, as a director.

Disputes arose about the administration of the company and Mrs Beck challenged Mrs Weinstock’s appointment, on the basis that because Weinstock himself had not been properly appointed, she could not be a director. The winding up of the company was sought.

In the Supreme Court of New South Wales, Justice Barrett (as he then was) made an order under section 1322(4)(a) of the Corporations Act declaring Mrs Weinstock’s appointment as valid, notwithstanding the fact that Weinstock was himself not properly appointed.

On appeal, the New South Wales Court of Appeal by majority overturned that decision and indicated that the powers under section 1322(4)(a) could not extend to a situation where the basis of Weinstock’s appointment was itself invalid, thus neutralising his attempted appointment of his wife.

Special leave was granted by the High Court from the decision of the New South Wales Court of Appeal.

While the interpretation of section 1322(4)(a) of the Corporations Act has been the subject of a number of interesting decisions over the years, the High Court had not had the opportunity to consider the provision in detail.

Three short judgments were delivered by members of the High Court.

Chief Justice French delivered the longest of these. The joint judgments of justices Hayne, Crennan and Kiefel, and the separate judgment of Justice Gageler, were shorter.

Nonetheless, they all reached the same conclusions, namely that the discretion of the court in dealing with the operation of section 1322(4)(a) is very wide.

The major parts of the relevant section provide as follows: "Subject to the following provisions of this section but without limiting the generality of any other provision of this Act, the court may, on application by any interested person, make all or any of the following orders, either unconditionally or subject to such conditions as the court imposes: an order declaring that any act, matter or thing purporting to have been done, or any proceeding purporting to have been instituted or taken, under this Act or in relation to a corporation is not invalid by reason of any contravention of a provision of this Act or a provision of the constitution of the corporation …"

Subsection (6) of section 1322 of the Corporations Act further provides that a court must not make an order under the relevant section if it is satisfied that those involved have acted dishonestly, or if it is not just and unequitable for an order to be made, or if there is substantial injustice likely to be caused by any such decision. The court is also precluded from making an order if the relevant matter to be addressed is purely of a procedural nature.

Chief Justice French reviewed the history of this dispute (and the decisions in the court at first instance and in the New South Wales Court of Appeal) and discussed in some detail the background to the introduction of the section in earlier versions of the corporations legislation.

He noted at paragraph 39 of his judgment: "Corporations, in contemporary Australian society, serve the purposes of enterprises, large and small, and are operated by men and women, some of whom are sophisticated, knowledgeable and well advised on matters of corporate governance and some, perhaps many, of whom are not.

"[The relevant section and other provisions of the Corporations Act] reflect a long-standing legislative recognition that mistakes will happen in corporate governance and that it is not in the public interest that the validity of decisions made in relation to corporations be unduly vulnerable to innocent errors which may be corrected without substantial injustice to third parties.

"In accordance with its evident purpose, section 1322(4)(a) is to be construed broadly and applied pragmatically, principally by reference to considerations of substance rather than those of form."

He added that the dispensing power vested in the court under this provision was not in the nature of allowing the court to absolve all past errors.

It did, however, allow the court to make an order that something is not invalid by, say, the revision of the legislation or the company’s articles of association.

He added: "The remedy may be sought by a party fearing or suspecting invalidity on such a ground, or as in the present case, to meet a contention of invalidity advanced by another party in adversarial proceedings. The effect of a declaration under the provision is limited to overcoming invalidity flowing from a particular contravention or contraventions" (at [40]).

He ruled that he did have power to make the orders in this case, but that such a power would not be exercised in all cases where difficulties arose in relation to the administration of a company.

So, he noted, it would not be appropriate for a court to "torture a limit out of the language of the [section] against the extreme case of a stranger to accompany purporting to make a decision appointing another stranger as a director".

He added: "Extreme cases are amply covered by the discretionary nature of the power and the strengths upon its exercise … The present case was not an extreme case" (at [43]).

Justices Hayne, Crennan and Kiefel adopted a similar approach without going into detail of examining earlier history and the nature of the matters in dispute.

The third judgment, that of Justice Gageler, was shorter.

He preferred the view of both justices Campbell and Barrett and added: "The order [that the court makes] does no more than to remove the invalidating effect of contravention so as to make valid what would have been valid without contravention.

"It is therefore true that [the subsection] cannot assist to achieve a result that could never be attained under the constitution of a corporation.

"However, section 1322(4)(a) can assist in achieving a result that could in some circumstances be attained under the constitution of a corporation by removing the invalidating effect of any absence of compliance with a requirement necessary for validity in the circumstances that in fact occurred" [at 65].

In the circumstances, Justice Gageler also felt that the interpretation by both justices Campbell and Barrett was to be preferred.

There is a good deal of common sense, with respect, in the way the High Court and justices Barrett and Campbell have approached this matter.

It would be unreasonable to expect a court to be able to validate every mistake that might be made in the running of companies, especially in the case of strangers coming in and trying to uproot the way in which a company was being run to the detriment of the true owners of the company.

In this instance, we have a family company in which the detailed management of the company had somehow or other been overlooked or not been properly attended to by members of the family. Later, disputes arose.

Warnings have, however, been issued in all three of the judgments that directors should not take these matters for granted and assume that in all cases the court will be prepared to validate what has not been done properly.

Greater care must be taken to ensure the proper procedures are followed and that proper steps are taken in the conduct of meetings and the way in which the company is governed.

This will avoid the costs and delays (and there were considerable costs and delays here) of having to progress the matter through not just one court but, as in this case, through three layers of courts.