Question

Lily and Morris are the directors and shareholders of Zap Graphics Pty Ltd. Recently, the company began to suffer cash flow problems and needed additional capital. Lily persuaded Rodney to invest $100,000 in Zap Graphics Pty Ltd. Lily and Morris held a directors’ meeting and decided to issue Rodney with two shares in the company. A general meeting of shareholders also appointed Rodney as a director of the company.

The company’s financial position improved as a result of Rodney’s $100,000 investment, as well as the considerable efforts of Lily and Morris. Despite the company’s increased profits, Lily and Morris decide not to increase dividends, leaving them at the same level as the previous year. Instead they gave themselves pay rises and arranged for the company to lease two new Mercedes-Benz cars for their personal use.

Rodney began to attend directors’ meetings and made a number of suggestions to improve the profitability of the business. He also questioned Lily and Morris about their pay rises. Lily and Morris resented these questions and took the following actions:

- they formed another company, Lily, Morris & Carol Graphics Pty Ltd, in which Rodney was not involved, and diverted a valuable government design contract that they had been negotiating to their new company.

- They also called a shareholders’ meeting at which it was resolved that Rodney would be removed from his position as a director. The meeting also approved the diversion of the government design contract to Lily, Morris & Carol Graphics Pty Ltd. Lily and Morris made sure that Rodney did not receive notice of this shareholders’ meeting.

Advise Rodney as to whether:

A) Lily & Morris have breached any of their fiduciary duties to Zap Graphics Pty Ltd or their duties under the Corporations Act 2001 (Cth).

B) Rodney himself can take action against Lily & Morris or Zap Graphics Pty Ltd in relation to Rodney’s removal as a director and the diversion of the contract to a new company.

Answer 1

The legal issue here is whether Rodney as a member and director of Zap Graphics Pty Ltd can take actions against Lily and Morris because of their oppressive and unfair conduct. Member's remedies are provided to members if they can show that the conduct of company’s affairs is contrary to the interests of the members as a whole, or oppressive, unfairly prejudicial to a member or members under Sec 232. The conduct may affect members in their capacity as members or in any other capacity. Under Sec 234(a)," a member of a company, even though the applications relates to an act or omission that is against the member in a capacity as a member or in a capacity other than as a member, can apply for member's remedies".

In this case, due to the fact that in a director’s meeting Lily and Morris issue Rodney with two shares in the company therefore Rodney is a member of the company. Moreover, at the general meeting for shareholders, Rodney was also appointed as a director of the company. Therefore, Rodney can apply member’s remedies because of the oppressive and unfair conduct of Lily and Morris Sec 232 provides a remedy for minority shareholders of the company, if the majority shareholders divert a corporate opportunity to themselves or their associates. In this case, Lily and Morris are the majority shareholders and they formed another company, Lily, Morris & Carol Graphics Pty Ltd, in which Rodney was not involved, and diverted a valuable government design contract that they had negotiating to their new company. Lily and Morris breached director's fiduciary duties and failed to act in good faith, in the best interests of the company and for a proper purpose as per Sec 181(1), Sec 184(1) and duty of care Sec 180(1).

Rodney as a minority cannot represent the BOD to sue other 2 directors. Instead Rodney can apply for Statutory Derivative Action. 1A as a shareholder and officer, and ask for court to sue these 2 directors, void the contract diversion Sec 236(1).

Another oppressive or unfair conduct is diversion of profits that the profits of the business are divided up among themselves in according with the number of shares held. The majority may act oppressively or unfairly because a significant proportion of the profits are paid in the form of high director’s fees and low dividend shareholders, esp for minority shareholders. Lily and Morris decided not to declare a dividend for the current year despite the company’s increased profits, gave themselves pay rises and arranged for the company to lease 2 cars for their personal use. These are business decisions that are within the delegated power of directors Sec198A, so Rodney as a member cannot get involved in these decisions.

The third oppressive or unfair conduct is exclusion from management, which is applied where a quasi-partnership between 2 or more independent investors, it may be oppressive or unfair to exclude one of the investors from the company’s management. Lily and Morris called a general meeting to remove Rodney as a director and approve contract diversion Rodney as a director cannot stop them from calling a meeting, changing resolution, removing directors as members and majority approval of business decision as directors. Rodney can apply Sec 232, Sec 233 asking court to enforce buy-out of his share at market price to and he can get back his investment. The court may even wind up the company under Sec233(1)(a) Sec461(1)(f) & (g) even if it is solvent if there are real risks of further oppressive conduct and the limited nature of the company’s business activities.