Question

Discuss the consequences of a breach of constitutional objects for Truth Enterprises Ltd and its directors and shareholders

Answer 1

Companies are creations of the law. They are brought into being by registration, given the status of separate legal entities with the powers of a natural person and cease to exist on deregistration. Company constitutions are given contractual force by section 140 (1) of the Corporations Act. That section provides that a constitution has the effect of a contract between the company and each member, the company and each director and secretary and between each member and each other member. This is a very different method of creation to contracts in the normal sense, which are formed by an agreement between parties who intend to make their agreement legally enforceable.

                                            Another important difference between a company's constitution and a normal contract is that a company's constitution can be varied by a special resolution of the members in general meeting. While this right is subject to safeguards that are directed to preventing oppression, the variation of class rights and the imposition of additional financial liability, it contrasts to the fact that changes to contracts generally require the consent of all parties.

Consequences of Breach                     

                                 The principal remedies for breach of a contract focus on requiring compliance with the contract or providing compensation for the loss suffered by innocent parties. This is consistent with the notion that contracts constitute a bargain between the parties to it.

1. Shares transferred without compliance with pre-emption provisions contained in the company’s constitution results in the transfers being voidable and give rise to an entitlement to have the register of members rectified.

2. A variation of class rights without compliance with the constitutional provision requiring consent from the party affected results in the variation being invalid and of no effect.

3. An appointment of directors in a manner not provided for in the constitution is of no effect.

4. A resolution of shareholders concerning matters within the scope of the powers of the directors, as identified in a constitution, is of no effect.

                          Some breaches of a company's constitution may be characterized as procedural irregularities and therefore may be validated by the provisions of section 1322 of the Corporations Act.

                                      While company constitutions have contractual effect, they have a number of features that make them quite different from contracts generally. The fact that a constitution can be varied by a special resolution passed by shareholders is an important difference, as is the questionable right to damages as a remedy for breach and the unavailability of rectification. It is therefore a mistake to assume that a constitution can be regarded as the equivalent of a contract in all respects. This conclusion is of particular significance for companies in which the relationship between the company and its shareholders goes beyond an investment in shares, for example co-operative style companies, companies that own assets used by their members and joint venture companies. The more complex nature of membership in these types of companies raises the question of whether all aspects of the relationship between the company and its members can be documented in the constitution. At least in the case of joint venture companies, the common use of shareholders agreements indicates that the constitution may need to be supplemented by a separate contract.