The allotment and issue of the shares
115 In his reasons Austin J said as to this -
"218 Far East and Capital contend that the issue of shares to Mr Kirwan was made for an improper purpose, and is therefore invalid. Therefore, they say, the Court should rectify the share register of Securities. In developing their submission, they invoke the familiar principles governing the issue of shares by company directors for an improper purpose, such as the purpose of perpetuating their own control: Howard Smith Limited v Ampol Petroleum Ltd [1974] AC 821; Ngurli Ltd v McCann (1953) 90 CLR 425, at 439-440. They say that here the power to issue shares (if it existed) was used to wrest control of the company from Capital, and to make the proprietary right of Capital valueless without any demonstrable benefit to Securities: Kokotovich Pty Ltd v Wallington (1995) 17 ACSR 478. I agree with this submission.
219 A contrary argument is that in resolving to allot and issue the shares, the directors were merely discharging their duties having regard to the terms of clause 5.1 of the DCA and s 445G. I disagree. It is unnecessary to decide whether, by causing the company to execute the DCA, the directors placed an invalid fetter upon the future exercise of their discretion: see Ford's Principles of Corporations Law (looseleaf), para [8.300]. This is because the resolution to allot and issue the shares should not be assessed in isolation from the directors' activities leading up to that event. The evidence shows that Mr Kirwan and Mr MacPherson, two of the three directors, were engaged in a course of conduct directed towards acquiring a controlling shareholding in Securities for many months before the creditors approved the DCA. It would be misleading to focus on a single step in that course of conduct, namely the allotment and issue of the shares, and to investigate in isolation the directors' purpose in taking that single step. Regardless of whether they had placed themselves under an obligation to allot and issue the shares, the directors were motivated by their overall purpose in embarking on the course of conduct which led to the share issue.
220 When their attempts at a negotiated acquisition failed early in the year 2000, Mr Kirwan and Mr MacPherson developed the proposed DCA as an alternative strategy. Their purpose was to wrest control of Securities from Capital by using Part 5.3A when negotiation failed. That purpose, clearly an improper one, infected their operative decision to allot and issue the shares. Their purpose emerges from the chain of events that I have described. Mr Kirwan persuaded Mr Gould that Mr Hedge had treated him unjustly various ways, and that the proposed DCA would be fair notwithstanding its effect on the control of Securities. Mr Gould was willing to be persuaded without making adequate investigations.
221 Under the DCA fresh capital was subscribed for shares in a manner that would deliver a controlling interest to Mr Kirwan. There is no evidence to show that alternative forms of capital injection, which would not have diluted the control of the existing shareholder, were explored. The proposed DCA required Mr Kirwan to subscribe enough fresh capital to permit Mr Gould to pay employees and trade creditors. The support of those creditors for the proposed DCA was therefore assured. The obstacle posed by the inevitable opposition of Far East, a creditor for a much greater debt than all of the employees and trade creditors, was handled by Mr Gould exercising his casting vote in favour of the proposed DCA. The new shares were issued at half a cent each, with the same rights as the existing shares, ensuring that Capital's existing shareholding would be swamped.
222 I have reached my conclusion as to the directors' purpose by inference from the chain of events that I have described, and the terms of the DCA itself. Mr Kirwan did not give evidence to rebut the inference of improper purpose that arises from this chain of events. Nor did any other director. Although one must be careful to avoid indiscriminate application of the principle in Jones v Dunkel (1959) 101 CLR 298 (see Commercial Union Assurance Company of Australia Ltd v Ferrcom Pty Ltd (1991) 22 NSWLR 389; White Industries (Qld) Pty Ltd v Flower & Hart (1998) 156 ALR 169) in my view this is a proper case for inferring from the directors' lack of evidence that they had no evidence to give that would assist their position.
223 I reject the contention that the directors' purpose was to obtain the best deal for the creditors as a whole, including employees and trade creditors. That submission is untenable because the essential feature of the DCA was an allotment of shares that swamped the controlling shareholder's interest. An issue of shares was not a necessary ingredient of a scheme for the benefit of employees and trade creditors."
116 The first sentence in para 221 in this passage requires comment. Earlier in his reasons Austin J had accepted that "as a practical matter, the only real alternatives for the creditors at the second meeting were the proposed DCA or liquidation". His Honour had noted that Mr Hedge had attempted to sell the business of Securities to others and that the only offer he had received was Mr Kirwan's offer. He had said that this implied "that no-one other than Mr Kirwan was interested or prepared to inject sufficient capital into Securities to rescue it". It is not easy to reconcile with this undoubtedly correct assessment his Honour's apparent acceptance, in the first sentence in para 221, of the possibility of alternative forms of capital injection.
117 There can be no doubt that Mr Kirwan wanted to obtain shareholding control of Securities, and that the other directors shared his wish. Mr Kirwan and Mr MacPherson had offered to buy Capital's shares in Securities, and Mr Kirwan had entered into the sale of shares deed of 24 December 1999. Mr Kirwan's interest in acquiring shareholding control, with a view to continued trading by Securities, can only have been enhanced by his then lending $160,000 to Securities. He had sought to bring the liquidators of Capital to performance of the sale of shares deed notwithstanding Mr Cohen's objection and the liquidators' disinclination to waive the condition, and although the details are not known had sought otherwise to reach agreement with the liquidators on the sale of the shares. For whatever reason, this had come to nothing. There is no valid ground for concluding that Mr Kirwan's purpose was not the same when, as the moving party in the DCA, he supported it at the meeting of 21 July 2000.
118 As a negotiated sale of the shares in Securities, in December 1999 there was no question of wresting control of the company from Capital. By July 2000 the negotiated sale was well and truly in the past, and whether the issue and allotment of the shares was in the eyes of the law for an improper purpose must be judged in the circumstances at the time of the DCA.
119 Austin J saw the DCA as part of a substituted strategy to obtain shareholding control of Securities, with the directors exercising a relevantly unfettered power to issue shares rather than acting under the compulsion of the DCA. The exercise of the power to issue shares was thereby exposed to impropriety of Mr Kirwan's purpose, and was not protected by the preceding adoption of the DCA. In Mr Kirwan's appeal it was faintly suggested that the directors were doing no more than implement the DCA, but it is unrealistic to divorce the issue and allotment of the shares from the circumstances of approval of the DCA. I do not think that in the end Mr Kirwan submitted otherwise, and he focussed on the DCA being for the benefit of the company as a whole as the measure of the director's exercise of their power to issue shares.
120 Before going further, it is important to note what Austin J did not rely on for the improper purpose. Although he referred to persuasion of Mr Gould and to Mr Gould handling the opposition of Far East, there was no finding that Mr Kirwan acted in some manner wrongly in influencing Mr Gould. Nor was there a finding that Mr Kirwan's purpose in gaining control of Securities was, or was in part, to preclude investigation of his acquisition of the Virotec shares and action to recover any profit he had made following their acquisition. Although critical of Mr Gould for failing adequately to enquire into "the circumstances surrounding" Mr Kirwan's acquisition of the Virotec shares, his Honour said expressly that he did not "suggest that the known facts establish any breach of duty or statute [by Mr Kirwan], or even that they give rise to a prima facie case of breach". At times in his Honour's reasons there was what was described in the appeals as a flavour that Mr Kirwan wanted to gain control of Securities to preclude action against him in relation to his acquisition of the Virotec shares, but the absence of a finding that he was seeking to avoid enquiry into his acquisition of the Virotec shares is marked. On the evidence in the proceedings, such a serious finding could not be made.
121 In Ngurli Ltd v McCann (1953) 90 CLR 425 Williams ACJ and Fullagar and Kitto JJ said (at 438-9) -
"Voting powers conferred on shareholders and powers conferred on directors by the articles of association of companies must be used bona fide for the benefit of the company as a whole. In Greenhalgh v. Arderne Cinemas Ltd , Evershed M.R., in a case relating to a special resolution altering the articles of association, said: 'In the first place, I think it is now plain that bona fide for the benefit of the company as a whole' means not two things but one thing. It means that the shareholder must proceed upon what, in his honest opinion, is for the benefit of the company as a whole. The second thing is that the phrase, the company as a whole,' does not (at any rate in such a case as the present) mean the company as a commercial entity, distinct from the corporators: it means the corporators as a general body. That is to say, the case may be taken of an individual hypothetical member and it may be asked whether what is proposed is, in the honest opinion of those who voted in its favour, for that person's benefit'."
122 Their Honours later said (at 439-40) that the power to issue new shares -
" … must be used bona fide for the purpose for which it was conferred, that is to say, to raise sufficient capital for the benefit of the company as a whole. It must not be used under the cloak of such a purpose for the real purpose of benefiting some shareholders or their friends at the expense of other shareholders or so that some shareholders or their friends will wrest control of the company from the other shareholders. In the present case Horace Southcott was the donee of this fiduciary power. It was still a fiduciary power although he could issue the new shares to the trustee company, if it agreed to accept them on trust for himself to the exclusion of the McCanns. He could take advantage of the power to benefit himself if such a benefit was incidental to a bona fide exercise of the power but he could not use the power ostensibly to benefit the company but really to benefit himself at the expense of the McCanns."
123 But capital raising per se is not essential. In Howard Smith Ltd v Ampol Petroleum Ltd (1974) AC 821 the Privy Council said (at 835) that it is "too narrow an approach to say that the only valid purpose for which shares may be issued is to raise capital for the company". In Harlowes Nominees Pty Ltd v Woodside (Lakes Entrance) Oil NL (1968) 121 CLR 483 the company had no immediate need for capital, but the issue of shares to cement a business partnership survived challenge. Barwick CJ and McTiernan and Kitto JJ said (at 493-4) -
"The principle is that although primarily the power is given to enable capital to be raised when required for the purposes of the company, there may be occasions when the directors may fairly and properly issue shares for other reasons, so long as those reasons relate to a purpose of benefiting the company as a whole, as distinguished from a purpose, for example, of maintaining control of the company in the hands of the directors themselves or their friends. An inquiry as to whether additional capital was presently required is often most relevant to the ultimate question upon which the validity or invalidity of the issue depends; but that ultimate question must always be whether in truth the issue was made honestly in the interests of the company: Richard Brady Franks Ltd. v. Price; Mills v. Mills; Ngurli Ltd. v. McCann . Directors in whom are vested the right and the duty of deciding where the company's interests lie and how they are to be served may be concerned with a wide range of practical considerations, and their judgment, if exercised in good faith and not for irrelevant purposes, is not open to review in the courts. Thus in the present case it is not a matter for judicial concern, if it be the fact, that the allotment to Burmah would frustrate the ambitions of someone who was buying up shares as opportunity offered with a view to obtaining increased influence in the control of the company, or even that the directors realized that the allotment would have that result and found it agreeable to their personal wishes: Mills v. Mills . But if, in making the allotment, the directors had an actual purpose of thereby creating an advantage for themselves otherwise than as members of the general body of shareholders, as for instance by buttressing their directorships against an apprehended attack from such as Harlowe, the allotment would plainly be voidable as an abuse of the fiduciary power, unless Burmah had no notice of the facts."
124 The phrase "for the benefit of the company as a whole" has been widely used to express the criterion for valid exercise of directors' powers, see also Mills v Mills (1938) 60 CLR 150 at 187-8; Whitehouse v Carlton Hotel Pty Ltd (1987) 162 CLR 285 at 299-300, and in this Court Kokotovich Pty Ltd v Wallington (1995) 17 ACSR 478 at 491. It is a difficult phrase. As was pointed out in Gambotto v WCP Ltd (1995) 182 CLR 432 at 443-4, 452, in connection with alteration of a company's articles, it is not a satisfactory criterion when there is a conflict of interests. Deciding what is for the benefit of the company as a whole may require selection between competing interests, and the phrase masks the problems of determining when an exercise of the power is vitiated.
125 In the context of shareholding control the limitations of the criterion have been recognized. In Whitehouse v Carlton Hotel Pty Ltd Mason, Deane and Dawson JJ said (at 289-90) -
"As the Privy Council pointed out in Howard Smith Ltd v Ampol Petroleum Ltd , it is impossible to define in advance the exact limits beyond which the directors of a company must not ordinarily pass in exercising a fiduciary power to allot shares:
'[It] clearly cannot be done by enumeration, since the variety of situations facing directors of different types of company in different situations cannot be anticipated. No more, in their Lordships' view, can this be done by the use of a phrase - such as bona fide in the interest of the company as a whole,' or for some corporate purpose'. Such phrases, if they do anything more than restate the general principle applicable to fiduciary powers, at best serve, negatively, to exclude from the area of validity cases where the directors are acting sectionally, or partially: ie improperly favouring one section of the shareholders against another.'
However, one thing does emerge clearly enough from their Lordships' judgment in that case and from the numerous cases in this and other courts dealing with the validity of an impugned allotment of shares. It is that the directors of a company cannot ordinarily exercise a fiduciary power to allot shares for the purpose of defeating the voting power of existing shareholders by creating a new majority: see, eg, Fraser v Whalley; Ngurli Ltd v McCann; Harlowe's Nominees Pty Ltd v Woodside (Lakes Entrance) Oil Co NL; Ashburton Oil NL v Alpha Minerals NL; Howard Smith Ltd v Ampol Petroleum Ltd .
The reason why, as a general rule, it is impermissible for the directors of a company to exercise a fiduciary power to allot shares for the purpose of destroying or creating a majority of voting power was identified by the Privy Council in Howard Smith Ltd v Ampol Petroleum Ltd. It lies essentially in the distinction between the indirect proprietorship and ultimate control of the shareholders on the one hand and the powers of management entrusted to the directors on the other. It is simply no part of the function of the directors as such to favour one shareholder or group of shareholders by exercising a fiduciary power to allot shares for the purpose of diluting the voting power attaching to the issued shares held by some other shareholder or group of shareholders. As their Lordships said (29):
'The constitution of a limited company normally provides for directors, with powers of management, and shareholders, with defined voting powers having power to appoint the directors, and to take, in general meeting, by majority vote, decisions on matters not reserved for management. Just as it is established that directors, within their management powers, may take decisions against the wishes of the majority of shareholders, and indeed that the majority of shareholders cannot control them in the exercise of these powers while they remain in office ( Automatic Self-Cleansing Filter Syndicate Co Ltd v Cuninghame) , so it must be unconstitutional for directors to use their fiduciary powers over the shares in the company purely for the purpose of destroying an existing majority, or creating a new majority which did not previously exist. To do so is to interfere with that element of the company's constitution which is separate from and set against their powers'."
126 In the present case, the articles of Securities provided that the directors could issue shares as they thought fit (art 3.1). That power was not one they could exercise in their own interests, although an otherwise valid exercise of the power could have the effect of benefiting them.
127 The description of the power as a fiduciary power is because it must be exercised in the interests of another or others. Who or what is or are the other or others? To refer to the company as a whole leaves much unanswered. In law the company has an existence separate from its shareholders. But, as the passage from Greenhalgh v Arderne Cinemas Ltd (1951) Ch 286 at 291 approved in Ngurli Ltd v McCann shows (para [118] above, the directors do not exercise their power according to the interests of the company as a separate commercial entity. To refer to the corporators as a general body, however, is obscure and incomplete guidance to the interests.
128 If the interests are those of the existing shareholders only, there is no doubt what Capital thought its interests were. This was not a case of conflict between existing shareholders. By July 2000 the negotiated sale was dead. As earlier noted, it was a case of the DCA or liquidation. Capital had not proposed injecting capital into Securities, and almost certainly could not do so, and at the meeting of 21 July 2000 the representative of Far East said in terms that Far East wanted Securities put into liquidation. It is all but irresistible that, although they had held back from it prior to Securities going into administration, Capital and its liquidators wanted to have Securities go into liquidation rather than have the DCA approved. Capital did not want dilution of its shareholding and continued existence of a company in which it held a small stake. Nor was it objectively for Capital's benefit that it be locked in as a small shareholder in Securities.
129 I do not see how, in the present case, it could be said that the directors' power was exercisable in the interests of future shareholders. The immediate future shareholder was Mr Kirwan. The power could not be exercised for the purpose of making him a shareholder.
130 Directors are obliged in some circumstances to exercise their powers in the interests of creditors. The creditors are not part of the company as a whole when the company is solvent (Kinsela v Russel Kinsela Pty Ltd (in liquidation) 1986 4 NSWLR 722 AT 730; Equiticorp Finance Ltd (in liquidation) v Bank of New Zealand (1993) 32 NSWLR 50 at 145-6). But the duty to creditors arising when the company is insolvent will make the interests of creditors then relevant in considering the exercise of a power for the benefit of the company as a whole. (For a discussion of when the duty arises see Keay, "The director's duty to take into account the interests of company creditors: when is it triggered?" (2001) 25MULR 315.)
131 It is not easy to support the issue and allotment of shares in the present case as the exercise of a power for the benefit of the company as a whole because of the interests of creditors. The creditors at the time of the meeting were already creditors, Securities was already in dire straits, and the directors were not taking a course which would jeopardise Securities' solvency. Future creditors were a non-issue, as liquidation was the alterative. The exercise of the power as an element in the DCA would bring payment to some of the creditors greater, depending on the Newland claim, than they would receive in a liquidation, but Far East as by far the largest creditor would gain no advantage. There was discrimination between creditors. Perhaps Far East as a parent company once removed could be regarded as in a different position from other creditors, perhaps because it chanced its economic arm in different circumstances from employees and trade creditors. But there was still discrimination, and I do not think regard to the interests of creditors permits the issue of shares to be seen as for the benefit of the company as a whole.
132 In Whitehouse v Carlton Hotel Pty Ltd the reason for impugning an allotment of shares was explained and, with reference to Howard Smith Ltd v Ampol Petroleum Ltd, the purpose of the exercise of the power was emphasised: see para [122] above. In Howard Smith Ltd v Ampol Petroleum Ltd at 835 Lord Wilberforce cited with approval the statement of principle, again emphasising purpose, from Hindle v John Colton Ltd (1919) 56 ScLR 625 at 630-31 -
"Where the question is one of abuse of powers, the state of mind of those who acted, and the motive on which they acted, are all important, and you may go into the question of what their intention was, collecting from the surrounding circumstances all the materials which genuinely throw light upon that question of the state of mind of the directors so as to show whether they were honestly acting in discharge of their powers in the interests of the company or were acting from some bye-motive, possibly of personal advantage, or for any other reason."
133 In my opinion, having regard to the interests which could be taken into account in considering the benefit of the company as a whole and the course of events leading to the DCA and the issue and allotment of shares, Austin J was correct in the result. In the circumstances the issue of shares may have been a necessary price for benefiting employees and trade creditors, and to that extent I may differ from his Honour. But neither in fact nor as the directors' purpose was the issue of shares for the benefit of the company as a whole. Judged according to the interests of shareholders and creditors (all creditors) it was not for their benefit, and the directors' purpose was not to advantage shareholders or creditors: it was to deliver control of Securities to Mr Kirwan. It was outside management of the company, and not a valid exercise of the power.
134 I should, however, add this. I have earlier referred (para [25] above) to his Honour's remarks about fraud and fraudulent conduct on the part of Mr Kirwan when considering repayment of the $100,000. The remarks could be misunderstood.
135 That a director is found to have exercised a power otherwise than for the benefit of the company as a whole does not necessarily connote fraud in the ordinary sue of that word, or in an equivalent legal use involving moral turpitude. In the appeals Far East made clear that it had never contended that Mr Kirwan should be treated as guilty of fraud in that sense. So far as in his remarks his Honour suggested that it did so, or that Mr Kirwan's conduct might be classified "as fraudulent in a moral sense", there was an unfortunate venture into an unnecessary area. It is appropriate, in my opinion, to state that although I have concluded that the issue and allotment of shares was not a valid exercise of the directors' power, I do not regard Mr Kirwan's conduct as fraudulent.