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The LP Company Directors’ Decision: Case Study Report

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Updated: Apr 15th, 2022

Executive Summary

The Australian corporation regulations specify different duties that directors must uphold in their day-to-day operations. The duties comprise exercising care, conscientiousness, and proficiency when discharging functions for the position of a company director. The obligations are indebted to the corporation in question. However, the corporation law seeks to protect the interest of the shareholders both in the future and in the current company’s operations. The statute law and common law provide for these duties. Failure to offer this provision attracts personal liability and a criminal penalty. This paper discusses the case of LP Company directors’ decision that led to the winding of the company. The decisions were made in the quest to increase the company’s competitive advantage in an environment that was characterised by increasing competition. Based on the discussion of the circumstances that led to the financial collapse of LP, the paper recommends the company to sue the directors for breach of the provisions of the Company Law with reference to the duty of care that the directors must demonstrate.

Introduction

The Australian corporate law borrows its provisions from the United Kingdom corporate decrees. Currently, the country bases its permissible framework of the Company Law on a solitary ruling that is applicable to all states. The decree is termed as the Corporate Act of 2001 (Nicole & Kaitlyn 2014). In the discussions of this paper, the term ‘the Act’ exclusively refers to the 2001 Corporation Declaration. Although the Act mainly borrows its provisions from the United Kingdom Company Law, in the administration of legal procedures under the Act, judicial precedence is mainly based on the judgment that is made in the United Kingdom courts of law. Some selected cases, as they may apply to a case study that this paper uses to, are also found important in the analysis section. The focus of the paper is on the legal liability of company directors who may engage in some practices, which may oppose the interest of the company, which they oversee its operations. The paper bases its claims on the issue of purchase and reorganisation decision at the LP Company. The goal is to show various issues that the Australian companies, directors, and boards encounter in their operations.

Background to the Case Study

LP (LP Pty Ltd) is a company that engages in the business of making kids’ costumes. It has six people who serve in its board of directors (Andy, Brian, Chris, David, Evans, and Faith). Apart from having diverse experiences and educational backgrounds, the directors also serve different functions within the company. However, their collective contribution is important in decision-making processes. Increasing competition compels the directors to start thinking of a strategy for increasing LP’s competitive advantage. They plan to restructure the company’s operations to reduce its running costs. Andy, who is also in charge of overseeing the daily operations of the company, also thinks that moving the organisation to larger premises and in an area that is far away from competitors can help to improve the company’s situation. Ultimately, the organisation relocates to the premise without considering various alternatives, despite the premises costing the organisation more than its previous premises. In the end, the organisation suffers various challenges. It ends up being wound up. Do the directors have any legal liability for this collapse under the Australian Company Law? The analysis section responds to this interrogative.

Issues that Australian Companies, Directors, and Boards Encounter

In the case that involves the six directors, any liability will arise upon proof of breach of any duty that is owed to the company. Indeed, directors may take personal legal liability for any decision they make while serving in the capacity of a company director. For example, as Langford (2013) confirms, they have to exercise a duty of care by acting in an honest manner. They need to act in utmost good faith and in the good interest of an organisation (Tomasic 2006). To this extent, any decision that a director makes such that it amounts to the exposure to an unevaluated risk that could have otherwise been foreseen constitutes a breach of the duty of care that directors owe a company. While it is not legally sound to conclude that Andy breached this duty without considering facts of the case, from a hypothetical position, Andy and the other directors (Brian, Chris, David, Evans, and Faith) have a duty of care to ensure that their decisions do not influence negatively the operations of the LP Company.

According to Barravecchio (2013), a breach of the duty of care translates into committing a tort. A tort may be deliberate or inadvertent. In the case of intentional tort, a proof that an act that amounted (or could amount) to harm to a second party (in this case, the LP Company) and that the act was done with a purposeful intent of causing the harm that the company suffers is necessary. For intentional tort to hold, no harm to the plaintiff necessarily needs to be caused (Morgan 2006). Only the proof of intent is required. Intent is proved by the testimony that the person to whom an action that had a possibility of causing harm to his or her person was owed a duty of care, which the plaintiff was well aware of when acting in the manner that he or she acted (Langford 2013). From the case study, although Andy’s decision was supported by the other directors without their full knowledge of the impact of relocating to a new premise on the financial position of the LP Company, the move may amount to a tort of negligence. However, the prejudiced and purposeful investigations for the intention to commit the offense may fail.

For the court to rule in favour of the company, any legal proceedings that the company institutes against the directors require a proof of negligence in terms of making decisions. Indeed, the plaintiff (the LP Company) must prove that it was owed a duty of care that Andy needed to have put in the most reasonable contemplation before acting in the manner that he did. Before accepting Andy’s proposal, the other directors also need to have put in their most reasonable contemplations about their duty of care to avoid exposing the company to financial risks. Comparing the applicability of the negligence tort and the intentional tort in the LP case, the tort of negligence does not require a proof of any plan to cause harm. However, for a court to rule in favour of the claimant, it must demonstrate that damage was suffered because of the inattention of duty of care on the accused person’s side (the executives). Here, the harm is the loss of financial resources due to massive operational challenges that LP experiences following the purchase decision by the company directors and the reorganisation decision by the consultant and the directors.

In Australia, under the 2001 Act, directors have an obligation of ensuring that they prevent any conflicts of interest between any organisation and the decision they make (Herzberg 2005). Indeed, they are required to assume both sides of any transaction by giving a full disclosure of the transactions (Tomasic 2006; Nehme 2005). The Act also spells out a criminal penalty for the failure of company directors to act in good faith as spelt out in clause 3 of the Act. The legal liability of the company executives in the Australian context is perhaps well evidenced by the case of The Dukes Business v. Pilmer.

Duke Asset Corporation’s executive was declared Kia Ora Company’s administrator via a turn round conquest. As part of his legal obligations, the director failed to inform Kia Ora Company’s directors about Duke Holdings’ financial status. Opposed to Kia Ora Company’s anticipation, the position turned out to be worse. A legal proceeding was filed against Duke Group’s director. While presiding over the case, Judge Owen held the director liable for breaching the duty of care that was owed to the Kia Ora Company (Austin & Ramsay 2005). Although the facts of the case of The Dukes Group Ltd v. Pilmer are different from the LP Company, the legal provision for the liability of directors for failure to ensure disclosures is clear.

Andy, who is the director in charge of overseeing LP Company’s operations started looking for a new premise for relocating the company without informing the other five directors. Even though the premise is more expensive than what LP would currently afford to pay, he thinks that the fact that no competition is evident in the new location, the profits of the company will grow immediately to make it possible to absorb the extra cost that is imposed on the company by his decision. To make the matters worse, he does not also disclose to the other directors that he had only looked at one property. Therefore, the competitiveness of the property compared to the other alternative properties was not deployed as the basis for making the decision to call the board meeting to inform it about the need to move in a speedy manner before another interested purchaser takes the property. Andy and the rest of the directors did not consider the implications of the decision of evaluating and disclosing the company’s financial status. They were unsure that they are being pushed into specifying their choice without getting enough opportunity to explore other options. This case indicates the foreseeable risk, although the directors went ahead and agreed with Andy. This observation shows slackness in the contractual obligation that is indebted to the business by the administrators.

From the above expositions, the five directors who made a reckless decision with suspicion of problems that lay ahead could have legal proceedings incepted against them on the grounds of failure to play their oversight roles. The objective test of this care is set out in Daniels v. Anderson. In this case, a bank allowed a trader to incur money losses. The financial institution prosecuted Haskins and Sells because of their letdown in terms of unveiling the required information. In their defence, the auditors cited that the institution was inattentive to its actions, which resulted in the loss that was mentioned in the case. A NWS Court Jury held a popular position that the auditors and the bank directors were responsible for failing to offer the appropriate oversight. From the LP case study, the failure by the directors to provide oversight is evident.

The directors failed to consider other alternatives that could serve the interest of the company better, rather than agreeing on relocating the company as suggested and pushed by Andy. They did not table or evaluate various proposals for increased business performance of the company to determine their effectiveness. After purchasing the new premise, the board of directors appointed a consultant who was tasked with coming up with ways in which the operations and the departments of the company should be reorganised. Upon preparing the report, which was then submitted to the board of directors for their review, David and Evans did not read it for authenticity purposes, despite the conviction by Andy, Brian, and Chris, who fully supported it. However, Faith identified mistakes in the report, including spelling errors and ridiculous recommendations that did not provide any rationale on how they would improve the operations of the LP. Although Faith did not support its adoption, the issue of negligence and failure to offer oversight was evident considering that, despite the mistakes, the report was adopted, amid Andy, Brian, and Chris having requisite skills and education training in business.

The fiduciary obligation to behave candidly was violated. Under this duty, directors are required to exercise judgment independently and in the light of facts before them when assessing a company’s best interests. However, opposed to this legal provision, David and Evans’ decision to support the consultant’s report was not done autonomously, but based on Andy, Brian, and Chris’ conviction. In this case, the duty to act honestly was breached through reckless decision-making, which was against the interests of the company. Recklessness was evidenced by the adoption of the consultant’s report, despite Faith pointing out its various drawbacks. Who faces personal liability for this misdemeanour? Based on the jury’s decision in the case of Daniels v. Anderson, all the directors should take collective liability for the financial failure of the company, thus leading to its winding up.

Directors are not held liable for breaching the duty of care if they can prove the exercise of good faith to achieve a given purpose (Langford, Ramsay & Ian 2015). In the case of LP, although the purpose was clear, exercising good faith may be disputable since no alternatives were considered with reference to Andy’s proposal. David and Evans could cite their lack of experience and training in business as their defence. However, the Australian Company Law requires such people to make rational decisions after having made reasonable inquiries from the appropriate persons who can inform them on the subject matter that requires decision-making (Hawley, Keith & Waitzer 2011). Andy, Brian, and Chris played the role of informing them (David and Evans) and convincing them to adopt the consultant’s report, which in part led to the failure of the company. Indeed, insufficiency of information that was provided before making their decision could not act as a defence. However, for the directors to take a personal liability, the proof that they made a decision while having a personal interest was also necessary, though not obligatory.

Recommendations/Conclusions

From the analysis section, the six directors owe the LP Company a duty of care to make decisions that promote its best interest. The company should initiate legal proceedings against the directors for acting recklessly in the decision-making process. They made a decision in a manner that did not promote its interest and in contravention of the provisions of the 2001 Company Act. When filling the case, the company needs to isolate itself from the shareholders. As spelt out in Coleman v. Myers and in Percival v. Wright, directors do not owe shareholders any duty. The rulings in these cases help in eliminating the effects of personal relationships between the directors and shareholders, including dependency on them in the process of making decisions on investment, which may lead to clearing the directors from any wrongdoing. However, even upon suing them, the LP Company cannot depend on the court to identify what amounts to its best interest. This role is reserved to the company directors. As set out in the judicial precedence in the case of Eg Mills v. Mills (1938), the court decides whether the power that is conferred on the directors, including setting the direction of the company, is used for the right purpose. In preparation for their defence, the directors should not underestimate the likelihood of being found liable. Therefore, they should not treat the manner lightly as they did while making the purchasing and reorganisation decisions that led to the winding up of the LP Company.

References

Austin, P & Ramsay, I 2005, Company Directors: Principles of Law and Corporate Governance, LexisNexis Butterworths, Sydney.

Barravecchio, J 2013, ‘The Tort Of Negligence’, Legaldate, vol. 25, no. 4, pp. 4-7.

Hawley, J, Keith, J & Waitzer, E 2011, ‘Reclaiming Fiduciary Duty Balance’, International Journal of Pension Management, vol. 4, no. 2, pp. 96-107.

Herzberg, A 2005, Company Directors: Principles of Law & Corporate Governance, University of New South Wales, South Wales.

Langford, R 2013, ‘The distinction between the duty of care and the duties to act bona fide in the interests of the company and for proper purposes’, Australian Business Law Review, vol. 41, no. 6, pp. 337-353.

Langford, T, Ramsay, R & Ian, M 2015, ‘Directors Duty to Act in The Interest of the Company: Subjective or Objective’, Journal of Business Law, vol.1, no. 2, pp. 173-182.

Morgan, J 2006, ‘The Rise and Fall of the General Duty of Care’, Professional Negligence, vol. 22, no. 4, pp. 201- 211.

Nehme, M 2005, ‘Enforceable Undertakings in Australia and Beyond’, Australian Journal of Corporate Law, vol. 18, no. 3, pp. 68-87.

Nicole, R & Kaitlyn, R 2014, ‘Proposed Amendments to the Corporations Act: The End of the 100-Membee Rule’, Governance Directions, vol. 14, no. 11, pp. 700-703.

Tomasic, R 2006, ‘The Challenge of Corporate Law Enforcement: Future Directions for Corporations Law in Australia’, Sydney Law Review, vol. 10, no.1, pp. 18-31.

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