Question 1

Jim and Peter are directors of Sambal Pty Ltd. Sambal Pty Ltd has a constitution which
restricts the amount of money the company can borrow at any one time to $10m. The
company already has a bank loan outstanding from the bank in the amount of $10m. The
company recently took out another $2m loan from ABC Bank. The loan contract was signed
by 2 of the companys directors and had been authorised by the board.

The company is now claiming that the loan contract with ABC Bank is invalid as it
contravenes the constitution. The company is refusing to pay interest to ABC Bank in relation
to the $2m loan.

Required:

Advise ABC Bank and Sambal Pty Ltd.

The law states that-

A companys constitution if any and any replaceable rule that apply to company have effect as
a contract

<a> between the company and each member

<b> between the company and each director and company secretory

<c> between a member and each other member

Application of law

According to the section 140 a companys constitution is only an internal governance rule. It
cannot be applied or enforced by outsiders, and also cannot be used and act between a
company member and an outsider (corporations act).

A company acts through its agents, since it is a fictional legal being. Agents include directors,
officers, employees and other official agents. A company does not require a company seal
(Corporations Act 2001 126(1)) to execute a binding contract as long as the agent, employee
or authorized person acts with the authority of the company. Under s 126(1) of the
Corporations Act 2001 an individual acting with the company's express or implied authority
can make, vary, ratify or discharge a contract on behalf of the company.
The doctrine of ultra vires

The doctrine of ultra vires has been abolished. This means that:

no act of the company is invalid merely because it is contrary to or beyond any

restrictions or prohibitions in the company's constitution (e.g. promises, agreements
or contracts that might be contrary to the company constitution (Corporations Act
2001 125(2)).

an outsider is now generally able to assume that any person acting on behalf of the
company has appropriate authority and acts within the constitution (s129).

the holding of a constitution by ASIC will not be constructive notice (s130).

So the constract is valid in this case and sambal pty ltd will have to pay back the interest to
the ABC bank.

Question 2

Ardvaark Ltd's directors would like to return as much capital as possible to its shareholders.
Its share capital consists of class A shares with a $10 issue price per share paid up to $6 and
class B shares which are fully paid.

Required:

Advise these directors of the legal requirements regarding the following proposals:

[a] that the company cancels the $4 unpaid on each class A share; and

[b] that the company buys back 15% of the class B shares.

Would your advice be different if Ardvaark Ltd had financial difficulties? Explain.

(a) Cancel the 4$ unpaid on each class A share

Law
Permitted reductions of share capital (General rule) under s256D (1), a company may
reduce its share capital if the reduction is fair and reasonable and it does not
materially prejudice the companys ability to pay its creditors and is approved by
shareholders under s256C. (S256B (1))

Application

In the case, in ardvaark cancel the $4 unpaid A class shares, directors must prove that
it is fair and reasonable to the shareholders as a whole: Winpar Holdings Ltd v
Goldfields Kalgoorlie Ltd; does not materially prejudice the companys ability
 to pay its creditors and is approved by shareholders: s256B (1). As it is assumed
that in the case all of the shares are ordinary shares, it is an equal reduction, which
requires approval by ordinary resolution. (Follow procedures) S256D requires that the
reduction must follow proper procedures; if directors fail to do so, they are
subjected to penalty. The reduction must be approved by a re solution (special
resolution?) passed at a general meeting, lodge with ASIC a copy of resolution within
14 days after it is passed; provide a statement with the notice of the shareholders
meeting, setting out all known information that is material to the decision on how to
vote on the resolution to approve the capital reduction: s256C (5); and documents
must be lodged with ASIC.
b) Buy back 15% of the class B shares

law

The general rule in Trevor v Whitworth is that a company is generally prohibited from
reducing its issued share capital because a reduction in capital would prejudice the rights of
creditors. Under s257A, share buyback permitted only if no material prejudice to ability to
pay creditors and company follow buyback procedures.

In this case Ardvaark is buying back 15% of the class B shares. It is considered as
selective buy backs as the offer is made to particular shareholders to the exclusion of
others. Ardvaark must follow proper procedures. It must be approved by shareholders either
unanimously or by special resolution (s257D).( F o l l o w p r o c e d u r e P G 1 9 1 ) P r o p e r
p r o c e d u r e s s h o u l d b e f o l l o w e d , t h a t i s , special/unanimous resolution(s257D),
lodge offer documents with ASIC(s257E), notice ASIC within 14 days (s257F),
disclosure relevant information when offer is made (s257G), cancel shares (s257H)
and notify ASIC of cancellation(s254Y).

Difficult financial conditions-

However, if the company is in financial difficulties, both share buybacks and reductions of
share capital will result in material prejudice to ability to pay creditors. As when the company
is insolvent, creditors interest is the prior interest in the company, and they are under
protection by s588G and s1324. It is deemed incurring of debts when directors have
reasonable grounds of insolvent, and not prevent, still do share buyback, directors is
personally liable for share capital transaction:s588G(1A). Reduction in shares and share
buybacks breached s256B (1).

Question 3
The directors of Lipton-Herzberg Ltd and Welsh Ltd agreed to start a new business to be
owned by a new company, New Edition Pty Ltd, whose share capital would be divided into
two classes as follows:

Ordinary shares - $1 issue price

- 400,000 - Lipton-Herzberg Ltd

- 200,000 - Welsh Ltd

Preference shares - $2 issue price

- 100,000 - Phillip (director & 50% shareholder of Lipton-Herzberg Ltd)

- 100,000 - Abe (director & 50% shareholder of Lipton-Herzberg Ltd)

- 100,000 - Michelle (director & 50% shareholder of Welsh Ltd)

It was agreed that Phillip, Abe and Michelle would be the first directors of New Edition, with
Michelle also appointed as secretary. Lipton-Herzberg Ltd and Welsh Ltd also agreed that the
internal governance rules of New edition Pty Ltd should provide that:

- A person nominated by Welsh Ltd must be the chair of New Edition Pty Ltd and that the
chair should have both a vote as well as a casting vote at the directors' meetings.

- A person nominated by Lipton-Herzberg Ltd must be the managing director of New Edition
Pty Ltd and that the person so appointed cannot be removed from that position unless Lipton-
Herzberg Ltd specifically agreed.

- New Edition Pty Ltd's ordinary shareholders would have six votes per share and preference
shareholders, one vote per share at shareholders' meetings.

- A New Edition Pty Ltd shareholder can only transfer their shares to existing shareholders.
The transfer price must be the market price as determined by an independent valuer.

Required:

Should New Edition Pty Ltd rely on the replaceable rules in the above circumstances or
would a constitution be more appropriate? Explain fully.

A constitution will be more appropriate according to the given information to us.