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Business Law IRAC




Question

Aksum Centric Enterprises Ltd (‘ACE’) is a small ASX listed mining company which focusses on gold exploration. The non-executive chair of ACE's board of directors is Leno, who also serves as chair of the audit and risk management committee of the board. The managing director and chief executive officer of ACE is Jennifer. The three remaining directors are all non-executive independent directors.

 

ACE's main assets consists of rights to explore and exploit potential gold reserves in South Australia. The market for gold has boomed in recent times. The extensive market interest in gold presents an opportunity for ACE to expand its operations and hopefully attract either a friendly takeover that will deliver big returns to shareholders or a big contract with an overseas customer that will provide increased revenue.

 

Jennifer is very active in seeking out funding opportunities to enable ACE to expand its operations but is unable to receive support from the banking community who are already over-extended in their loan exposures to the mining and resources industry and Jennifer has been unable to attract further loan funding from the banks. Jennifer's frustration at being unable to attract further bank finance is widely known in the South Australian business community, where Jennifer is a well-known and independently wealthy businessperson.

 

Jennifer is approached by an independent financing firm, Besloe Capital Ltd (‘Besloe Capital’), based in South Australia who proposes to extend sufficient funds to ACE to enable it to expand its operations. Besloe Capital is backed by large institutional investors from around the globe and therefore has access to funds that may otherwise be unavailable to ACE. The chief investment manager of Besloe Capital pitches a proposal to Jennifer that would involve establishing a new company (BTS Associates Pty Ltd) that will provide approximately $100 million in loan funds to ACE. A condition of the loan is that Jennifer buys a 25% stake in BTS Associates Pty Ltd to ensure that her interests are aligned with that company's and to encourage her to remain in her position at ACE into the future. Jennifer agrees to do this as long as her name is kept out of the press and so she provides the funding to purchase the shares in BTS Associates through an anonymous family trust. Jennifer does however disclose her interest in BTS Associates Pty Ltd to the ACE board of directors, by stating that she has "a minor stake in BTS Associates Pty Ltd".

 

The loan will carry a 20% interest rate, which is well above commercial lending rates but reflects the current lack of financing available to mining companies and the risk of lending to a small speculative company such as ACE. The terms of the loan provide that if ACE defaults on the loan BTS Associates Pty Ltd will be eligible to exercise an option to purchase ACE 's interest in the gold reserves at a valuation determined by reference to ACE 's current share price. This is a risky deal that could result in ACE losing its major asset, potentially at a discount if ACE's shares are trading below their real value, but Jennifer considers the potential economic benefits that could be gained from obtaining the funding is worth the commercial risk to the company. After agreeing to seek the approval of ACE's board of directors for the funding deal from BTS Associates, Jennifer does not pursue any further funding options, nor does she obtain any further independent expert advice on the value/risks associated with the loan, although she does have significant information on the deal that was provided by Besloe Capital. Jennifer puts the funding deal to ACE’s board and after a 2-hour meeting the board of directors approves the proposal with Jennifer voting in favour of the deal. The board also has a very extensive report prepared by Besloe Capital and an external mining and engineering consulting firm that states that the funds to be provided by the funding deal should be sufficient to expand the operations.

 

Three months later, a shortage of specialist labour and equipment in South Australia results in massive cost overruns on ACE's exploration project. It is unable to meet its exploration schedule and, after disclosing this to the ASX, ACE 's share price slumps to less than lc per share which triggers a clause in its loan contract with BTS Associates Pty Ltd and puts it in default on its loan. BTS Associates Pty Ltd then exercises its rights to purchase the gold exploration rights. Jennifer resigns the following week and is subsequently announced as the new CEO of BTS Associates Pty Ltd. Six weeks later, labour markets in South Australia have loosened and BTS Associates Pty Ltd is able to complete its exploration of the site and finds a huge gold deposit. Soon after it sells its interests in the site to a large European energy company for A$5 billion.

 

The shareholders of ACE are outraged at the conduct by ACE’s board. They have been pressuring. Leno to resign from the board and for a new Chair and CEO to be appointed.

 

Question 1A. Advise ACE Ltd of its legal rights and any action available under general law and the Corporations Act 2001 (Cth)

Question 1B. Joseph is a member of ACE Ltd. He seeks your advice about any legal action available to him in this case.

 

Answer 1A

Issue 1- Whether the actions of the Board of Directors of ACE constitute a breach of duty of care and diligence under section 180 of the Corporation Act, 2001 (the Act)?

 

Rule- Section 180 imposes the duty of care and diligence upon the board of directors and to determine a breach under this section, the objective test laid down in 180(1) needs to be fulfilled.

 

However, the possible defences for this are applying the Business judgement rule highlighted under Section 180(2) of the Act and reliance being placed on someone else who is competent and reliable, as provided under section 189 of the Act.

 

Analysis- in the present case, all the directors did not fulfil the duty of care that they owe under section 180.

 

For Jennifer- The duty of care owed was towards ACE. No reasonable director would have stopped looking for other finance options once they receive an offer for finance, especially when the proposition is so risky as it could lead to ACE losing its major assets at a very low valuation.

 

For other Directors- The duty of care owed by other directors is the same as that of the executive directors, following the case of Daniel (Daniel v. Anderson [1995]). The other Directors too should not have made such a risky and reckless decision as this is not what a reasonable person would do.

 

A reasonable director would have waited for other sources of finances considering the risk involved.

 

The possible defence that Jennifer and other directors might try to use are-

  

  1. Business Judgement Rule- the elements required to be proved for taking this defence include establishing that there was no material personal interest of the director however, Jennifer did have a material personal interest as she was also a shareholder of the company financing the loan and, therefore, she would profit either way. Additionally, another factor required to be proved is that the director should have had a rational belief that the decision was in the Company's best interest. However, there is no way the non-executive directors have believed that Jennifer’s has the company's best interest in mind since she had an interest in the company providing the loan. So, no director shall be allowed to take this defence.
  2. Reliance on others- the directors may plead this defence under section 189 by saying that they did rely on the reports of Besloe Capital and an external mining and engineering consulting firm which concluded that the funds which ACE would get through the deal would be enough for the expansion operations. However, even if it is believed that Besloe Capital is competent, they could not be reliable as they had interest in the deal, which would cloud their conclusions. Further, the facts don’t indicate that the Board analysed the reports' findings as the same could not possibly have done within a 2-hour meeting in which the whole deal was also discussed. Therefore, the directors shall not be allowed to take this defence too,

 

Conclusion- Since there is a clear breach of duty by the Board of Ace, they shall be liable to pay fines, be disqualified from being directors and pay compensation to the company. Further, under general law too, the directors owe a duty of care, diligence and to make decisions in good faith. In the present case, the duty of operating in good faith is breached by Jennifer by taking part in a decision she had direct interest in. Further, all the directors have breached the duty of care, making them liable for equitable compensation and account of profit under general law.

 

Issue 2- Whether Jennifer is liable for using her position in a situation of conflict of interest?

 

Rule- use of position is barred under section 182.

 

Analysis- in the present case, Jennifer has an interest in BTS Associates Pty. Ltd. This meant that she would gain from the deal either way, that is, if ACE is successful in the venture, she will profit from being part of ACE and if it fails, she will profit by the acquisition of ACE’s assets at a low valuation and turning it around for higher profit as a shareholder of BTS Associates Pty. Ltd. Now, Jennifer did benefit from this situation as she had a share in the profit of BTS Associates when it sold the gold mine at a huge profit. The present case is different from Hudson case (Qld Mines v. Hudson [1978]) because in the present case, Jennifer only disclosed to the board that she had a minor interest; however, 25%, though a minor interest, is substantial. Further, she did not have any major risks (as against the facts of Hudson case where Hudson ran all risks).

 

Conclusion- Jennifer should be held liable for taking advantage of a conflict of interest.

 

Answer 1B

Being a member of the Company, Joseph can bring action against the directors who breached section 232 of the Act by being oppressive. He would have to do so after taking consent from ASIC.

 

Joseph, in this case, would have to prove that the action of the Board was oppressive. An oppressive decision involves commercial unfairness. As held in the Spargo case, when the directors fail to act in the Company's best interest, they can say to have made a commercially unfair decision that would result in a breach of section 232 of the Act. In the present case, the actions of the board would pass the objective test laid down in the case of Wayde (Wayde v New South Wales Rugby League [1985]), that is, there is an unfair decision, and the board could not have made that decision (as observed in 1A). The remedies could include the removal of management and order to purchase shares.

 

Additionally, on behalf of ACE, Joseph can bring a Statutory Derivative Action under Section 236 for which he would have to show a cause of action and would not get any personal gains, as the compensation would go to ACE.

 

BIBLIOGRAPHY

Daniel v. Anderson [1995] 37 NSWLR 438

Qld Mines v Hudson [1978] 52 ALJR 399

Wayde v New South Wales Rugby League [1985] HCA 68

 

 


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