Directors Wholly Owned Subsidiary Companies

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Directors Wholly Owned Subsidiary Companies

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Question:

Whether Statutory And Equitable Duties Are Breached By Jack, Alice And Francis Towards The Superdry Stores Ltd?

Answer:
Introducation

Generally, company is bound by only those contracts which are signed by the person authorized by the company. In number of cases, authority of the person is denied by the company for ignoring its obligation under the contract. Because of these issues it becomes important for outsiders to confirm the authority of the person who is acting on behalf of the company and also the compilation regarding internal rules of the company before entering into any transaction with the company.
However, those companies which have more than one or two directors imposed the management power not to the single director but to the board collectively for the purpose of managing the affairs of the company and entering into contract with outsiders. These powers are imposed either through the constitution of the company or replaceable rules. In other words, complete management power does not imposed in single director.
Board of directors of the company has power to pass resolution for the purpose of entering into contract on behalf of the company, but it must be noted that these powers are subject to some restrictions also. In other words, board has power to enter into contract but some matters are strictly reserved for shareholder’s approval.

It must be noted that this concept of law is not fair because it make the outsiders liable to check whether company and authorized person complied with all the necessary requirements or not. Therefore, it becomes necessary for law to protect the interest of outsiders.
Common law which protects the outsider’s interest is introduced for balancing the competing policy issues. Two interests are balanced through this law, and both the interests are stated below:

First interest is related to the convenience of business which can be affected outsiders are forced to investigate the internal regulations of the company for the purpose of checking the actual authority of the person acting on behalf of the company.
Second interest is related to the protection of the shareholders and creditors interest in the company. according to the Mason CJ, while applying the first interest it is necessary to prevent over extensive application of the first interest for the purpose of preventing the facility of the fraud and unjust favor to those who deal with the companies at the cost of interest of creditors and shareholders.

Common law introduced doctrine of indoor management and section 128 and 129 of the Corporation Act 2001 for the purpose of protecting the interest of the outsiders while dealing with the company (Krawitz, 2002).
High Court of Australia approved the rule of Indoor Management in case of Albert Gardens (Manly) Ltd v. Mercantile Credits Ltd, and make the comment on this matter in case Northside Developments Pty Ltd v. Registrar-General. Both the cases are considered as important reference for understanding the doctrine of Indoor management.
This doctrine is introduced for those outsiders who are dealing with the company in good faith and they do not have any sufficient reason to believe that person is not authorized to act on behalf of the company and management fails to compile with the internal rules of the company. Outsider who is dealing with the company in good faith is not under obligation to confirm whether person complied with all the rules and regulations or not. Therefore, it is the right of outsider to make assumption that person acting on behalf of the company is duly authorized by the company and compiled with all the rules and regulations of the company. This assumption can only be made regarding the internal matters of the company. If outsider wants protection under doctrine of indoor management then subject matter must be related to the internal management of the company (ILO, 2014).

Following things can be assumed by the outsider while dealing with the company:

There is no procedural defect on the part of the company while appointing the company’s director.
Resolution passed in the board meeting fulfills all the necessary requirements of the company, and meeting held as per the norms of the company and constitution.
Any required approval either board or member has been obtained.

This doctrine is applicable only in those case in which outsider is involved, and it provides guidance to the person who is dealing with the company. However, this doctrine is not applicable on public corporation only but it also applied on private corporations also.
This rule has some exceptions also, which means in some situations this rule is not applicable and these situations are actual knowledge, doctrine of Constructive notice, forgery, and due inquiry. This can be understood through case law Howard v Patent Ivory Manufacturing Co [1888] 38 Ch. D. 156. In this case, Court stated that outsider who are dealing with the company cannot rely on the doctrine of indoor management if such outsider has knowledge that person was not authorized on behalf of the company or does not compiled with the internal requirements of the company. In this directors borrow money from themselves by passing the resolution in the board meeting for the purpose of issuing debentures in lieu of those borrowings under common seal of the company. Court reject the right of directors to recover the money and company was not bound with the borrowings because directors know that approval from members were not taken.
Application:
In this case, Bob signed the contract with Computer Supplies Pty Ltd for the purpose of buying 10 computers for $8000, and Bob also signed contract of $ 50000 with Plastica Pty Ltd. Both the contracts are signed on behalf of the SSA. Constitution of the SSA states that any contract upto $10000 cannot bind the company unless such contract is approved by the resolution passed by board and must be signed by at least two directors.
Part a- contract signed by Bob on behalf of SSA with Computer Supplies Pty Ltd is below the $10000, and as per the constitution any contract below $10000 does not require any approval from board. Therefore, contract signed by Bob with Computer Supplies Pty Ltd is enforceable in nature and binding on the company.
Part b- contract signed by Bob on behalf of SSA with Plastica Pty Ltd is above the $ 10000, and for this purpose Bob fails to take approval from the board as peer the constitution of the company. Contract is enforceable in nature because doctrine of indoor management is applicable in this case. This doctrine allowed the outsiders to make assumption that person acting on behalf of the company is duly authorized by the company and compiled with all the internal rules and regulations of the company.
Rule of Indoor management was introduced in case law Royal British Bank v. Turquand. This case was considered as landmark case in the field of doctrine of indoor management. In this Court decided that power was imposed in the outsiders to make assumption that company compiled with all the internal rules and regulations. In this case, company’s directors take borrowing from the bank, but as per the requirement of the constitution directors fails to take approval from the members in general meeting. After that company refuse to make payment on ground that director of the company fails to fulfill the internal requirement of the company because of which company was not liable to made payment to the bank.
This argument of the company was rejected by the Court, and judge held that bank has right to assume that company fulfill all the internal requirements and borrowing taken by company were authorized by the members. This decision of the Court was named as rule of Turquand’s case and later it was named as the Indoor management rule (Cain, 1989).
In the present case also plastic has right to assume that Bob is duly authorized by the company and compiled with all the internal requirements.
Usually, role of the directors of the company is to oversee the company’s management, and these directors handle the company’s management on behalf of the shareholders because in actual shareholders of the company are the actual owners of the company. The power imposed under directors of the company to manage the company is provided through company’s constitution, article, and by law. In case of wholly-owned subsidiary, generally directors of the parent company are not liable for the management of the subsidiary company, but in some cases directors of the parent company are liable towards the subsidiary company also.

Therefore, it becomes important for the directors of the parent company to know that they also own statutory and equitable duties towards the subsidiary company also. However, directors of the parent company owned this duty if they are acting as shadow director of the subsidiary company. Term shadow director is introduced in section 9 of the act, and according to section 9 if board of the subsidiary company act as per the directions of the director of parent company then such director is known as the shadow director. Section further states that if person is not duly appointed as director then also such marketing is considered as shadow director if management is bound to act as per the directions of such person (GIA, 2014).
It must be noted that shadow director is also liable to follow statutory and equitable duties as subject to Corporation Act 2001. Following are the statutory duties

Duty under section 180, to exercise due care and diligence. This section states that director must act with due care and diligence while performing management function. This duty is mainly considered as fiduciary duty of the director which mainly deals with the business judgment and states that director must act in good faith and in the best interest of the company while taking any decision. This can be understood through case law ASIC v Vines. In this case, Mr. Vine held liable for breach their duty under section 180 of the Act by providing misleading and inadequate material information to the bard of the company.
Duty under section 181 to perform their functions and discharge their duties with good faith and in the best interest of the company. This duty imposed responsibility on director to act for the benefit of the company.

It must be noted that non-compliance of section 180 and 181 can result in severe civil and criminal consequences stated under section 1317E of the Act. This section state, directors of the company who breaches above stated sections related to statutory duty are held liable by the Court and for this purpose Court made declaration of contravention. If this declaration is made by the Court then ASIC can apply for below stated remedies against the directors:

Remedy under section 1317G related to pecuniary penalty order.
Remedy under section 206 by disqualifying the director from managing the company (Corporation Act, 2001).

ASIC v Adler can be the case which helps in understanding the breach of director duty and consequences of this breach. In this case, directors of the company breached statutory duties under the Corporation Act 2001. Directors of the company were held liable for breach section 180, 181, and 182 of the Act.
In the present case, all three directors of the parent company that are Jack, Alice and Francis can be considered as shadow director of the Superdry stores Ltd, because board of the Superdry Stores Ltd is bound to act as per the directions of these three directors. Therefore, all three directors of the parent company that are Jack, Alice and Francis own statutory duty towards the Superdry stores Ltd. This can be understood through case law Dairy Containers Ltd v NZI Bank Ltd [1995] 2 NZLR 30. In this case, Court held that parent company was not liable towards the wholly-owned subsidiary because board of the subsidiary was not bound to act as per the directions of the holding company.

As shadow director of the Superdry Stores, Jack, Alice and Francis breach following statutory duties:

Shadow directors breach duty under section 180 of the Act by failing to consider the best interest of the company while taking the business judgment. They fail to provide personal guarantee for the amount borrowed by Holdings and manufacturers. Directors while taking the business judgment fail to perform their duties with due care and diligence because for protecting themselves against personal liability they provide the guarantee of superdry stores.
Directors also breach their duties under section 181 of the Act by failing to perform their functions and exercise their duty in the good faith and in best interest of the company. Directors give preference to their personal interest instead of the interest of the company.

Following are the consequences which can be faced by the Jack, Alice, and Francis:
Under section 1317E, Court can make declaration of contravention against the three directors and make disqualification order under section 206 of the Act and pecuniary penalty order under section 1317G of the Act. All three directors are the shadow directors of the Superdry stores and they breach their duties under section 180 and 181 of the Act.

References:
Albert Gardens (Manly) Pty Ltd v Mercantile Credits Ltd, [1973] HCA 60; 131 CLR 60.
Asic v Adler and 4 Ors [2002] business-law (14 March 2002).
ASIC v Vines [2005] NSWSC 738.
Cain, T. (1989). The Rule in British Bank v Turquand in 1989. Viewed at: https://epublications.bond.edu.au/cgi/viewcontent.cgi?article=1015&context=blr. Accessed on 18th September 2017.
Corporation Act 2001- Section 128.
Corporation Act 2001- Section 129.
Corporation Act 2001- Section 1317E.
Corporation Act 2001- Section 1317G.
Corporation Act 2001- Section 180.
Corporation Act 2001- Section 181.
Corporation Act 2001- Section 206.
Dairy Containers Ltd v NZI Bank Ltd [1995] 2 NZLR 30.
GIA, (2014). Guidelines for Directors of wholly-owned subsidiary companies. Viewed at: https://www.governanceinstitute.com.au/media/656514/govinst_guidelines_whollyownedsubsidiary_2014.pdf. Accessed on 18th September 2017.
Howard v Patent Ivory Manufacturing Co [1888] 38 Ch. D. 156.
ILO, (2014). The ‘indoor management rule’ explained. Viewed at: https://www.internationallawoffice.com/Newsletters/Litigation/Canada/Dentons/The-indoor-management-rule-explained. Accessed on 18th September 2017.
Krawitz, A. (2002). Murdoch University Electronic Journal of Law. Viewed at: https://www5.austlii.edu.au/au/journals/MurUEJL/2002/22.html#INTRODUCTION_T. Accessed on 16th September 2017.
Royal British Bank v Turquand (1856) 6 E&B 327.

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