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The fairness of the original share issue Essay Sample

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The fairness of the original share issue Essay Sample

A) The fairness of the original share issue is questionable on two grounds with respect to both directors. The first deals with Bart’s non-cash consideration for his allotment. Although it is legal and commonplace for companies to issue shares for consideration other than cash1, the concern here is that both directors themselves conducted the valuation of Bart’s “intellectual property”. Proper procedure here would require an independent valuation made in good faith as directors have the power to influence decisions and “force” the company to acquire overvalued assets. This could detriment shareholder and creditor interest.

As such, Bart could be liable for breach of his fiduciary duty as a director. The second point deals with Monty’s future consideration for his allotment and involves two issues. Firstly, under his terms of payment, Monty does not provide partial payment but instead forfeits part of his future directorial salary. His lack of present consideration may be unfair but is not illegal.

The illegality lies in that his terms can be interpreted as the company granting him an interest free loan to purchase shares in itself. This is not in compliance with section 260A and is considered as prohibited financial assistance as well as violating the doctrine of capital maintenance. The second issue here would be that Monty’s consideration is not equal to the value of his allotment.2 Consideration enough to suffice a contract is inadequate, it has to represent the worth of the allotment.3

Control on the directors would take the form of mechanisms, which ensure that they make decisions that protects and advances the interests of other members. Assuming that Easy Bucks Pty Ltd was incorporated after the 1st July 1998, it’s lack of a constitution makes it subject to the replaceable rules as set out by the Corporations Act. These rules serve as contractual obligations between the directors (both Bart and Monty) and the company4 by subjecting them to internal governance5.

Another form of control can also be found in the duties they are expected to serve. These duties can be broken down into duties under General Law and Statutory duties. Under General Law, directors’ owe a fiduciary duty6 to act in the interest of the company. While, Statutory duties maintain some similar aspects7, the key difference is that Statutory duties are enforced by ASIC8 while General Law duties by the company. It may also be argued that Bart and Monty’s concentrated level of ownership acts as a control measure by providing them with more incentive to improve performance and thereby act in the interests of George or other potential future shareholders.

With respect to George’s ability to negotiate the subscription price, he does not have much of a choice. The subscription price is a decision reserved to directors. The replaceable rules imposed on Easy Bucks, works on the principle of “majority rule” and as such would not sufficiently protect George’s minority shareholding.9 He could, however, by means of calling a special resolution seek to adopt a constitution to put himself in a more advantageous position.

A constitution would allow the substitution of certain rules and can place restrictions on powers.10 supplement the section 254D11 of the Replaceable Rules to require members’ approval for new share issues. Alternatively, such an arrangement could be set up by means of a members’ agreement. George may also take a pro-active role in protecting his investment by increasing his access to company information. As Easy Bucks is a small proprietary company, it is not required to prepare financial reports. George, in his capacity as a shareholder with more than 5% of the votes can make the company prepare both financial and directors’ reports12. This would enable him to make more well-informed judgments should he choose to actively monitor the company.

George obtains a wide range of benefits through subscribing for shares. As part of his membership rights, he can participate in the company via his voting rights, receive dividends if proposed by directors13 and be repaid his principal through a share in surplus assets in the event of the company winding up. As a creditor, he would have been entitled to a fixed interest rate, priority in repayment of his capital and might have been given the option to obtain a fixed charge over ownership of the “software package”. The superiority of either decision would lie in his assessment of the risks and prospects of Easy Bucks. However, George’s own position as a less than savvy investor might make it more advantageous for him to be a debt holder as opposed to equity holder.

b) If Monty advertised for investors to the general public, his actions were illegal. Under section 113(3), a proprietary company cannot issue new shares if the issue requires disclosure. Hence, there is a restriction in advertising to the general public. However, we are only told that Monty chooses to advertise for “investors”. If by “investors” we can assume that only sophisticated or professional investors14 were targeted, Monty’s act of advertising the issue would not require a disclosure and would be legal. Despite this, the share issue is illegal except on a different point of law. Section 708 exempts small scale offers from providing disclosure. However, the offer violates the definition of small scale as given in section 708 (1)(b) and is therefore illegal on this count.

d) As mentioned earlier in “part a”, shareholder’s of small companies have limited information rights. However, access to company information is crucial for George in two respects- monitoring the directors and seeking remedies if necessary. Despite this, the Corporations Act takes it for granted that in small businesses, shareholders have personal access to information because of a presumed close involvement with the business. George, however, does has some recourse in the Corporations Act.

As mentioned earlier, section 293 allows for him to obtain financial statements and directors’ reports. Had he done so, he could have been alerted earlier of the dire straits that Easy Bucks was in and might have reasonable grounds for suspecting breach of duty. Under Section 247A, he would thus be entitled to inspect the books of the company. Alternatively, he could gain access to company minutes under section 251B. In this sense, Monty is right. George has no real excuse to be ignorant of the company’s direction.

If George did not like what he found out, however, he would not be able to challenge Monty’s decisions. Members cannot override the decisions of the board15. Instead, he could convene a meeting16 with the agenda of removing Monty. Under such an option, he can remove Monty by means of an ordinary resolution. Alternatively, he could seek to alter the company’s internal governance rules to restrict the directors’ power to act without first obtaining member consent. This, however, has to be done by means of a special resolution at a members meeting.

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