Australia: When is a director not a director? — primacy of the company constitution
Addisons Insolvency Update

• Directors must be appointed in strict accordance with the company constitution — reliance on saving provisions of Corporations Act not a safe bet
• One who acts as a director, and whom everyone fully believes to be a director, is not necessarily a director
• Executive escapes personal liability for breach of OHS responsibilities by good luck rather than company's good management

The decision of the Full Bench of the Industrial Court of New South Wales in Inspector James v Ryan (No 3) [2010] NSWIRComm 127 (the Ryan case) reminds us of the need to comply with the requirements of a company's constitution in the appointment of a director.

In this case the court held that Justin Ryan was not a director at the relevant time as he was not appointed a director in accordance with the requirements of the relevant company's constitution, which required that a director be appointed by a written notice from the holding company to the company. In coming to this conclusion, the Full Bench unanimously af? rmed the decision of Marks J in Inspector James v Ryan [2009] NSWIRComm 215.

This was good news for Mr Ryan. Because he was not a director at the relevant time, he could not be held to be liable for breaches of the Occupational Health and Safety Act 2000 (NSW) (OHS Act) arising from the death of an employee at the factory of the relevant company, Dekorform Pty Ltd (Dekorform).

Both Marks J and the three judges of the Full Bench came to this conclusion notwithstanding other evidence that Mr Ryan had acted as a director of Dekorform.

This article looks at the primacy of the constitution, examines the Ryan case and discusses whether the failure to appoint Mr Ryan as a director was an irregularity that would be validated as a procedural irregularity under s 1322(2), or otherwise able to obtain the bene? t of an order from the court under s 1322(4), of the Corporations Act 2001 (Corporations Act).

Primacy of a company's constitution

A company's constitution is a statutory contract between:

1. the company and each member
2. the company and each director and the company secretary and
3. a member and each other member.²

Unlike an ordinary contract between consenting parties, a company's constitution cannot be rescinded or recti? ed ³ by the members and can only be amended in accordance with the requirements of the Corporations Act. ⁴ In addition, a company's constitution cannot be overridden by another agreement between shareholders. ⁵

Failure to follow the strict requirements of a company's constitution can sometimes lead to invalidity. Some examples are:

1. lack of a quorum as required by a company's constitution may result in the meeting being invalid⁶
2. a meeting convened without the required notice under the company's constitution may lead to the meeting being invalid⁷
3. failure to follow the procedure for nomination of candidates for election of directors as set out in a company's constitution may lead to the nomination being invalid⁸ and
4. failure to have a chairman of a meeting as required by the company's constitution may mean the meeting is invalid.⁹

There are provisions in the Corporations Act which will automatically validate, without a validating order, a proceeding that is not strictly in compliance with the requirements of a company's constitution provided that that proceeding can be characterised as a procedural irregularity and the court is not of the opinion that the irregularity has caused or may cause substantial injustice that cannot be remedied by any order of the court.¹⁰

In addition, under s 1322(4) of the Corporations Act, a court is given wide discretion to make validating orders in respect of irregularities generally, not just procedural irregularities. I will return to s 1322(4) after a consideration of the Ryan case.

The Ryan case

The Ryan case concerned two charges made under the OHS Act against Justin Ryan, as a director of Dekorform, after an employee of Dekorform was fatally injured on 3 July 2006 in the course of employment. In determining whether Ryan was liable, one of the key issues was whether Ryan was in fact a director of Dekorform.

Relevantly, clause 3.2 of Dekorform's constitution provided that 'The Holding Company [Alesco Corporation Limited (Alesco)] may by notice to [Dekorform] appoint a person to be a director ...' [emphasis added].

Clause 13.6 further provided that: [Alesco] may exercise a power by ... notice in writing:

1. executed by [Alesco]; or
2. executed on behalf of [Alesco] by a director, secretary or executive of? cer of [Alesco], and delivered to or sent by facsimile or other electronic means to [Dekorform].[emphasis added]

Moreover, the replaceable rules were expressed displaced and inapplicable to Dekorform by clause 13.5 of its constitution.

On a strict interpretation and application of the above provisions, Marks J found, and the Full Bench agreed, that:

1. Alesco had failed to deliver notice of Mr Ryan's appointment to Dekorform and
2. Alesco had not in fact appointed Mr Ryan as a director of Dekorform by any valid means,

and thus, Mr Ryan was not a director of Dekorform and therefore not personally liable for the company's offences against the OHS Act.

In coming to this conclusion, the structure and wording of Dekorform's constitution was of importance. In particular, the Full Bench noted:

1. that clause 13.5 placed a blanket exclusion against the replaceable rules and thus precluded the appointment of a director by ordinary resolution of Dekorform's members or directors¹¹ and
2. therefore, the giving of notice (as de? ned by clause 13.6) under clause 3.2 of Dekorform's constitution was 'the only means under Dekorform's constitution by which [a director's] appointment could be made.'

The Full Bench came to this conclusion notwithstanding that Mr Ryan and all relevant persons believed, albeit mistakenly, that he had been appointed as a director of Dekorform, consistent with the documents ? led with the Australian Securities and Investments Commission (ASIC).

The Full Bench concluded, supporting the ? nding of Marks J, that other factual matters pointing to a recognition of Mr Ryan's directorship were trivial, including that:

1. Alesco's intention to appoint Ryan as a Dekorform director was known to the common company secretary of both Alesco and Dekorform
2. the appointment was common 'corporate knowledge' in the sense that the executives of the Alesco group, including other Dekorform directors, had acted on a presumption of Mr Ryan's directorship
3. Mr Ryan had signed a consent to act as a director of Dekorform
4. Mr Ryan had signed documents on behalf of Dekorform as a director, including a power of attorney, deed of cross guarantee and a circular resolution of directors appointing another person to be a director
5. Mr Ryan was widely held out by Dekorform to the community (by way of noti? cation to ASIC) as a director of the company and
6. Alesco had developed a practice of appointing the directors of its subsidiaries by way of circulating resolution without further notice to the relevant company. The court emphasised that:

7. it cannot be right that a practice relating to the important function of appointing directors developed inconsistently with the company's constitution could supplant the requirements of the constitution.

Therefore, the speci? c way in which Dekorform's constitution was framed and open to be construed was determinative to the court's ? nding that Mr Ryan was not formally a director of Dekorform, despite widely held beliefs to the contrary.¹²

In coming to its conclusion, the Full Bench rejected several arguments put on behalf of the NSW WorkCover Authority.

• There is a presumption that ASIC records, which showed Mr Ryan as a director of Dekorform, are prima facie evidence of that fact. This presumption, the Full Bench said, is capable of rebuttal by showing that no appointment was made in accordance with the company's constitution.
• The requirement for notice from the holding company to its subsidiary of the appointment of a director does not have to be in writing but could be an oral notice. This argument was rejected as it did not give effect to clause 13.6 of the constitution and in any event there was no actual evidence of any notice oral or otherwise.
• The principle of 'unanimous consent', which permits the validation by unanimous conduct of shareholders of an otherwise invalid or voidable appointment, should apply. The court said that the inherent power of Dekorform's shareholder to appoint directors by ordinary resolution in general meeting had been displaced by the strict words of the Dekorform constitution.
• Clause 3.2 of the constitution was merely a procedural provision so that any failure to observe that provision did not nullify the appointment. Af? rming the view of the trial judge who quoted Williams J in Grant v John Grant & Sons Pty Ltd(1950) 82 CLR 1 (Grant's case), the Full Bench said:

• That cl 3.2 is a substantive provision in the same way as article 86 was in Grant, is undoubtedly the case. The appointment of a director is a fundamental exercise of power within the corporation or, in this case, by the Holding Company. Dekorform was required to be given notice in writing of that appointment. It is the only means under Dekorform's constitution by which such an appointment could be made.

If he's not a director, what next?

The good news for Mr Ryan was that the prosecution was not able to prove beyond reasonable doubt that he was a director of Dekorform so he could not be found liable to a criminal offence under the OHS Act.

But what about Mr Ryan's acts in purported exercise of his functions as a director? He had signed documents and in certain cases acted as a director on behalf of Dekorform. Are these acts valid or invalid and can a counterparty assume they are valid? For example, can a counterparty to a deed with Dekorform signed by Mr Ryan as a director assume that it has been validly signed, sealed and delivered by Dekorform?

In these circumstances, you might see Dekorform apply to the courts for an order under s 1322 that either Mr Ryan's appointment was valid or that certain acts done on behalf of the company were valid.

As stated, s 1322(2) deals with procedural irregularity and provides:

It is clear from the Ryan case that in the appointment of Mr Ryan, there was no proceeding to make regular as no notice of his appointment had in fact been given. In the words of Williams J in Grant's case, there was no 'slip in the appointment of a director'.¹³

Given that s 1322(2) provides no relief, can s 1322(4) then assist in making things that might be invalid, valid again?

Section 1322 of the Corporations Act enables a court to declare:

provided that the contravention is essentially procedural; or that the person concerned acted honestly; or that it is just and equitable that an order be made, and provided that no substantial injustice has been or is likely to be caused.

In Cordiant Communication, Palmer J said:

I think that the following general proposition may be formulated for the purposes of the application of CA s 1322:

• what is a "procedural irregularity" will be ascertained by ? rst determining what is "the thing to be done" which the procedure is to regulate;
• if there is an irregularity which changes the substance of "the thing to be done", the irregularity will be substantive;
• if the irregularity merely departs from the prescribed manner in which the thing is to be done without changing the substance of the thing, the irregularity is procedural.

Section 1322(4) has been used to regulate a wide variety of substantial errors or irregularities, including:

1. validating the issue of shares or options that would be otherwise invalid¹⁴
2. extending limitation periods¹⁵
3. extending the time for holding a meeting of members¹⁶ and
4. con? rming that a person is a director.¹⁷

Similarly, there are a number of things that Dekorform and its holding company could request the court to do under s 1322(4). They could ask the court to:

1. validate Mr Ryan's attempted appointment as a director from, say, the date that the appointment was noti? ed to the ASIC, which was before the accident and
2. validate any contract that was incorrectly signed by Mr Ryan in the belief that he was a director of Dekorform.

It is very unlikely that Dekorform or Mr Ryan would seek recti? cation of his appointment under s 1322(4) at any time in the past. It would be more likely, if Mr Ryan was inclined, for him to consent to the holding company writing to Dekorform appointing him a director from a given point in the future.

Assuming hypothetically however that Mr Ryan would consent to validation of his appointment in the past, could the court do it under s 1322(4)?

It is unlikely, on a strict reading of the section, that the court would be able to do so. Although most of the elements for a favourable order are present, the one element that is not present is the act, or purported act, of appointment of Mr Ryan as a director. The Full Bench held that there was no evidence, written or oral, of Mr Ryan's actual appointment. The best there is from the facts of the Ryan case is a general understanding that Mr Ryan was a director.

Given that there is no act or purported act to validate, s 1322(4) is of no help in seeking to have Mr Ryan appointed as a director at a point in time in the past, if he was mindful to consent to such an action.

The good news for Mr Ryan was that the prosecution was not able to prove beyond reasonable doubt that he was a director of Dekorform so he could not be found liable to a criminal offence under the OHS Act.

But what about Mr Ryan's acts in purported exercise of his functions as a director?

In relation to validating any acts which Mr Ryan did in the mistaken belief that he was a director, a court will look at the situation on a case-by-case basis and is likely to refer any applicant to s 129, which sets out certain assumptions that a person dealing with a company can make, including that:

1. a person who appears, from information provided by the company that is available from the ASIC, to be a director is in fact a director and has the authority to exercise the powers and perform the duties customarily exercised or performed by a director of a similar company and
2. a document has been duly executed by a company if the document has been signed in accordance with the requirements of the Corporations Act.

Given these assumptions, a third party would be able to assume that any agreement signed by Mr Ryan, purporting to be a director of Dekorform, was validly executed and enforceable against the company.

However, conversely, if Dekorform is the one seeking to validate the agreement signed by Mr Ryan, a counterparty to such an agreement wishing to get out of the agreement may argue that it was not validly signed on behalf of Dekorform and Dekorform would not be protected from its own invalid execution of the agreement.

In such circumstances, a court may invoke s 1322(4) and say that the purported execution of the agreement by Mr Ryan in breach of s 127(1)

(Execution without a seal) is not invalid provided Mr Ryan acted honestly. A court can only reach this conclusion if it is satis? ed that no injustice has been or is likely to be caused to any person. This will be something for Dekorform to address in its application to the court. Dekorform would argue that both parties entered the agreement expecting it to be valid and that validating Dekorform's execution would con? rm that expectation. This may be a dif? cult assignment where the counterparty to the agreement is trying to get out of it. How a court would rule in any given situation will depend upon the facts in the case before the court.

Conclusion

There is only one conclusion from the Ryan case: know your constitution and comply with its terms. Having said this, recognise that Mr Ryan would have been very relieved that he was found not to be a director of Dekorform on 3 July 2006.

Footnotes

¹ The author would like to acknowledge Belle Jing, Solicitor, Addisons, for her assistance in preparing this article
² s 140(1) Corporations Act
³ Scott v Frank F Scott (London) Ltd [1940] Ch 794, Santos Ltd v Pettingell (1979) 4 ACLR 110 and NRMA Ltd v Parkin (2004) 49 ACSR 485
⁴ s 136(2) Corporations Act
⁵ Cordiant Communication (Australia) Pty Ltd v Communications Group Holdings Pty Ltd (2005) 55 ACSR 185 at para [131] (Cordiant Communication). See also Duffy MJ, 2008, 'Shareholders Agreements and Shareholders' Remedies Contract versus Statute?' Bond Law Review, Vol 20 No 2, pp 1–27
⁶ Re Chinese Cultural Club Ltd (2004) 49 ACSR 568
⁷ Myer Queenstown Garden Plaza Pty Ltd v Port Adelaide City Corporation (1975) 11 SASR 504
⁸ NRMA Ltd v Gould (1995) 18 ACSR 290
⁹ Colorado Constructions Pty Ltd v Platus [1966] 2 NSWR 598
¹⁰ s 1322(2) Corporations Act
¹¹ s 135 Corporations Act
¹² The Full Bench in the Ryan case also concluded that Mr Ryan was not a de facto or shadow director
¹³ Grant's case at pp 33–34 (Williams J)
¹⁴ Re Golden Gate Petroleum Ltd (2004) 50 ACSR 659; Re Elemental Minerals Pty Ltd (2010) 79 ACSR 277
¹⁵ Super John Pty Ltd v Futuris Pty Ltd (1999) 32 ACSR 398
¹⁶ NRMA Insurance Group Ltd v Spragg (2001) 38 ACSR 174
¹⁷ Gangemi v Osbourne [2009] VSCA 297

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.