LAW BALANCING COMPETING INTERESTS IN CORPORATE CONTRACTS

I. Introduction

As an abstract entity, a company can enter into contracts[1] only as a principal through the actions of a natural person (agent) exercising powers within the company’s express or implied authority.[2] Since outsiders and shareholders rarely transact directly, the agent may act opportunistically for their personal benefit.[3] Therefore, the appropriate objective of the law may be balancing in allocations of the risk of fraud and the costs of its avoidance.[4] In other terms, the rule must balance between the business convenience[5] for the outsider and commercial morality factors[6] to prevent fraud.[7] This essay attempts to answer whether the Australian law has got the balance right by analysing the issues relating to remained uncertainties in current statutory provisions.

II. Innocent Parties

According to the general law of agency, the contract will not bind the company if its agent or organ enters into the contract without actual or apparent authority.[8] This may have harsh outcomes for the outsider who may suffer significant loss (e.g. cases of loan transactions). Therefore, outsiders are always in risky position because of uncertainty of the agent’s authority to enter the contract and unawareness of company’s internal irregularities.

On the other hand, if the contract would be binding to the company, the shareholders, who have not authorised the agent to enter into that contract, may also suffer detrimental consequences of binding transaction (e.g. secured loan transactions).[9] Depending on the circumstances, the both parties may turn up as innocent victims of unauthorised actions of the agent, in terms that they acted or relied in good faith. Mason CJ in Northside emphasised the need of balance between protection of outsiders in promotion of business convenience and over-extensive application of the rule which may facilitate the commission of fraud and unjustly favour those who deal with companies at the expense of innocent creditors and shareholders who are the victims of unscrupulous persons acting on behalf of companies.[10]

III. Indoor Management Rule

To protect the interests of outsiders who could not establish the regularity of company’s internal proceedings, the Common Law (CL) developed the ‘Indoor Management Rule’ (IMR),[11] which affects application of the agency principles to companies. The rule provides that persons dealing with a company and contracting in good faith may assume that “acts within its constitution and powers have been properly and duly performed and are not bound to inquire whether acts of internal management have been regular.”[12] The IMR balances between the company’s obligations to comply with its mandatory rules, and the outsider’s inability to check the extent of that compliance.[13]

The statutory formulation of the IMR is expressed in the form of assumptions set out in s 129 and is subject to the limitations in s 128.[14] However, the statutory provisions do not cover some business transactions (e.g. actions by third parties[15] or situations that fall outside the scope of ss 128-9[16]). Therefore, the statutory provisions operate cumulatively in conjunction with the CL, repairing the apparent failings of the CL.

IV. Shift of Balance

At the CL, to prevent an over-balance in favour of outsiders, the scope of operation of the IMR was limited by the number of doctrinal exceptions (the knowledge of outsiders,[17] ultra vires,[18] constructive notice[19] and forgery[20]). The following statutory reforms[21] significantly tilted the balance in favour of outsiders by abolishing or reducing the operational scope of these exceptions.[22] Additional feature favouring the outsiders is that the onus of proof lies on the party seeking to disentitle the reliance on the assumptions in s 129.[23] Furthermore, the amendment of qualifying circumstances[24] for the assumptions made the rule more accessible.[25] Thus, the legislature, has adopted a "business convenience" to protect outsiders dealing with companies above the interests of the innocent shareholders and creditors of the company.[26]

V. Whether the Balance is Right

To answer this question, I will discuss uncertainties in current statutory provisions requiring careful examination.

A. Apparent Authority

The requirement of authorised representation of the agent with apparent authority[27] still does not relieve the outsider from the obligation to verify both the identity and the position of the person with whom they are dealing. At best, the rule allows the outsider to assume either customary authority (s 129(2)) or apparent authority (s 129(3)). However, it is often almost impossible for an outsider to discover who has actual authority to make representations for the company.[28] To enhance the outsider’s protection under s 129(3) and meet the original purpose of the statutory amendment, Chapple has suggested broadening the assumption to cases where a representation is made by someone with actual or apparent authority.[29] Arguably, this suggestion puts the shareholders under the great risk of impossibility to control the company’s transactions.

B. Duties of the officers

Section 129(4) does not expressly provide the scope of the term ‘duties’ of officers and agents. Carroll recognizes two potential meanings of that term: (a) the tasks undertaken by officers as assigned in the constitution or legislation (narrow); and (b) extending to the fiduciary duties attached to that officer (wide).[30] Carroll gives preference to the narrow meaning as it operates within the ambit of the IMR.[31] However, Whincop favours the wide meaning, for that the corporate law to be more responsive and less formalistic.[32] The scope of s 129(4) has not been determined by the courts but the balance of academic commentary favours a narrow ambit of protection provided to outsiders dealing with companies.[33]

C. Knowledge and Suspicion

Section 128(4) precludes reliance on the assumptions where the outsider has actual knowledge or suspicion that the assumption is incorrect.[34] In redrafting the former provisions[35] the Parliament has expressed intention for ‘stricter test’ by replacing the constructive knowledge (objective – ought to know) by actual suspicion.[36] By narrowing the scope of section 128(4), legislature tilted the balance in favour of outsiders and business convenience since it would be harder for companies to prove the subjective (actual) knowledge of outsiders and to deny liabilities under the contract.

This change raised criticism among the academics whether the narrow scope of the provision reflects the good faith or innocence of outsiders.[37] Chapple argues that the actual knowledge does not refer to good faith and removes the safeguards against non-innocent outsiders, which is contrary to the Parliament’s intention[38] to protect persons who are “innocent” and act in good faith.[39] Mason CJ emphasised that the due inquiry exception strikes a fair balance between promoting business convenience and discouraging fraud and dishonesty.[40] It would compel outsiders to act prudently and thereby enhance the integrity of commercial transactions and morality.[41]

Lipton argues that the narrow scope of s 128(4) encourages banks and others dealing with a company to ignore warning signs and restrain them to make reasonable inquiries.[42] This failure, in its turn may unwittingly assist the agent in breaching their duties and acting without authority to the detriment of innocent shareholders.[43] Therefore, to balance the risk allocation in commercial transactions, Lipton suggested objective interpretation of suspicion in s 128(4).[44] Loxton supposes that it will be difficult for outsiders to get a court to believe lack of knowledge/suspicion if the court may inference as a matter of fact that they knew/suspected the obvious or what a reasonable person would conclude from the obvious; a court may also frown on a wilful blindness to the obvious.[45]
Another uncertainty is the meaning of knowledge/suspicion when the outsider is a corporation. How do we determine the company’s knowledge/suspicion?

D. Forgery

To protect the interests of outsiders, s 128(3) allows making assumptions in s 129[46] if an agent (officer) of the company acted fraudulently, or forged a document, in connection with the dealings unless the outsider actually knew or suspected about forgery.[47] In Northside the distinction was made between forgery involving a counterfeit signature or seal (narrow meaning) and forgery with unauthorised use of seal (wide meaning).[48] It was accepted that in case of the narrow meaning the IMR is not applicable due to absence of representation from the company. Kirby P commented that forgery has the strict meaning unless expressly stated by the legislature.[49] Otherwise it would be overlap with situation involving unauthorised affixation of the company seal.[50] Chapple argues that since forgery in the wider sense involves issues of officers’ authority, this is a matter to be resolved by the general rules of agency combined with the statutory assumptions.[51] Chapple concludes that s 128(3) refers to ‘forgery’ in the strict sense only.[52] Tomasic et.al. suggested that the effect of s 128(3) is reinforced by the assumptions in ss 129(4), (5), (6), (7).[53] However, the scope of the provision is still unclear.

VI. Conclusion

On the basis of outlined analysis, the law reforms have significantly enhanced the protection of interests of outsiders. However, further statutory reforms are required (clarification of correct statutory application) for more effective protection of outsiders as intended by Parliament. The new provisions do not change the threshold problems with unauthorised actions of the agent. Disregard of due enquiry exception deters outsiders to act prudently and lowers the standards of commercial morality in terms of integrity of commercial transactions. The current law is still formalistic rather than responsive. Therefore, it would not be correct to conclude that the Australian law has got the balance right.

BIBLIOGRAPHY

1. Articles/Books/Reports

Carroll, Robyn, ‘Proper Performance of Duties by Company Officers: The Statutory Assumption in s 164(3)(f)’ (1995) 69 Australian Law Journal 200.

Chapple, Larelle, and Phillip Lipton, ‘Corporate Authority and Dealings with Officers and Agents’ (2002) CCH Australia and Centre for Corporate Law and Securities Regulation, University of Melbourne

at 25 August 2011.

Krawitz, Alan, ‘Protecting outsiders to corporate contracts in Australia’ (2002) 9(3) E Law - Murdoch University Electronic Journal of Law,

at 26 August 2011.

Law, Larelle, and Janine Pascoe,’Financiers and Corporate Borrowers: Protection versus Liability’ (2000) 11 Australian Journal of Corporate Law 219.

Lipton, Phillip, and Abe Herzberg, Understanding Company Law (10th ed, Australia: LBC 2001).

Loxton, Diccon,‘One Step Forward, One Step Back: The Effect of Corporate Law Reform on Procedures in Dealing with Companies Borrowing or Giving Guarantees’ (1999) 10 Journal of Banking and Finance Law and Practice 32.

Tomasic, Roman, Stephen Bottomley and Rob McQueen, Corporations Law in Australia (Australia: The Federation Press 1995).

Whincop, Michael J, ‘Liberalism, Conservatism, and Economic Efficiency: Tradition and Change in the Values of Corporate Law’ (2000) 23(2) University of New South Wales Law Journal 111.

Whincop, Michael J, ‘Nexuses of Contracts, the Authority of Corporate Agents and Doctrinal Indeterminacy: From Formalism To Law and Economics’ (1997) 20 University of New South Wales Law Journal 274.

2. Case Law

ACT Pty Ltd v Minister for Transport&Communications (Cth) (1989) 86 ALR 119, 157.

Bank of New Zealand v Fiberi Pty Ltd (1994) 12 ACLC 48.

Crabtree-Vickers Pty Ltd v Australian Direct Mail Advertising and Addressing Co Pty Ltd (1975) 133 CLR 72.

Ernest v Nicholls (1857) 10 ER 1351.

Northside Developments Pty Ltd v Registrar-General (1990) 170 CLR 146

Morris v Kanssen [1946] AC 459.

Royal British Bank v Turquand (1856) 119 ER 886

Soyfer v Earlmaze [2000] NSWSC 1068

Story v Advance Bank Australia Ltd (1993) 11 ACLC 629

3. Legislation

Corporations Act 2001 (Cth)

Corporations Law 1991 (Cth).

Explanatory Memorandum, Company Law Review Bill 1997

Explanatory Memorandum, Companies and Securities (Miscellaneous Provisions) Bill 1983.

The Company Law Review Act 1998 (Cth)

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[1] Corporations Act 2001 (Cth) s 124.
[2] Corporations Act 2001 (Cth) s 126.
[3] Michael J. Whincop, ‘Liberalism, Conservatism, and Economic Efficiency: Tradition and Change in the Values of Corporate Law’ (2000) 23(2) University of NSW Law Journal, 128.
[4] ibid.
[5] Northside Developments Pty Ltd v Registrar-General (1990) 170 CLR 146, 164 (‘Northside’).
[6] BNZ v Fiberi Pty Ltd (1994) 12 ACLC 48, 52 (Kirby P).
[7] Larelle Chapple and Phillip Lipton,‘Corporate Authority and Dealings with Officers and Agents’ (2002) CCH Australia and Centre for Corporate Law and Securities Regulation, University of Melbourne at 25 August 2011.
[8]Alan Krawitz,‘Protecting outsiders to corporate contracts in Australia’ (2002) 9(3) E Law - Murdoch University Electronic Journal of Law, at 26 August 2011.
[9] Northside (1990) 170 CLR 146, 164.
[10] ibid.
[11] Royal British Bank v Turquand (1856) 119 ER 886.
[12] Morris v Kanssen [1946] AC 459, 474 (Lord Simonds).
[13] Chapple, above n 7, 79.
[14] Corporations Act 2001 (Cth) ss 128-9.
[15] Krawitz, above n 8, 11.
[16] ACT Pty Ltd v Minister for Transport & Communications (Cth) (1989) 86 ALR 119, 157.
[17] Northside (1990) 170 CLR 146, 163 (Mason CJ).
[18] Crabtree-Vickers Pty Ltd v Australian Direct Mail Advertising and Addressing Co Pty Ltd (1975) 133 CLR 72.
[19] Ernest v Nicholls (1857) 6 HL Cas 401.
[20] Northside (1990) 170 CLR 146, 194 (Dawson CJ).
[21] The Company Law Review Act 1998 (Cth).
[22] Krawitz, above n 8, 19.
[23] Roman Tomasic, Stephen Bottomley and Rob McQueen, Corporations Law in Australia (Australia: The Federation Press 1995) 247.
[24] Corporations Law 1991 (Cth) s 164(1).
[25] Corporations Act 2001 (Cth) s 128(1).
[26] Krawitz, above n 8, 35.
[27] Freeman and Lockyer v Buckhurst Park Properties (Mangal) Ltd [1964] 2 QB 480.
[28] Chapple, above n 7, 79.
[29] ibid.
[30] Robyn Carroll,‘Proper Performance of Duties by Company Officers: The Statutory Assumption in s 164(3)(f)’ (1995) 69 Australian Law Journal 200.
[31] ibid.
[32] M Whincop,‘Nexuses of Contracts, the Authority of Corporate Agents and Doctrinal Indeterminacy: From Formalism To Law and Economics’ (1997) 20 University of New South Wales Law Journal 274, 301–302.
[33] Larelle Law and Janine Pascoe,’Financiers and Corporate Borrowers: Protection versus Liability’ (2000) 11 Australian Journal of Corporate Law 219.
[34] Soyfer v Earlmaze [2000] NSWSC 1068, (Hodgson CJ).
[35] Corporations Law 1991 (Cth) s 164(4).
[36] Explanatory Memorandum, Company Law Review Bill 1998, 8.7.
[37] Chapple, above n 7, 120.
[38] Explanatory Memorandum, Companies and Securities (Miscellaneous Provisions) Bill 1983.
[39] Chapple, above n 7, 118.
[40] Northside (1990) 170 CLR 146, 165.
[41] ibid.
[42] Phillip Lipton and Abe Herzberg, Understanding Company Law (10th ed, Australia: LBC 2001) 132.
[43] ibid.
[44] ibid.
[45] Diccon Loxton,‘One Step Forward, One Step Back: The Effect of Corporate Law Reform on Procedures in Dealing with Companies Borrowing or Giving Guarantees’ (1999) 10 Journal of Banking and Finance Law and Practice 25, 32.
[46] Corporations Act 2001 (Cth) s 129(4), (5), (6).
[47] Story v Advance Bank Australia Ltd (1993) 11 ACLC 629.
[48] Northside (1990) 170 CLR 146, 199 (Dawson CJ).
[49] BNZ v Fiberi Pty Ltd (1994) 12 ACLC 48, 52.
[50] Bank of New Zealand v Fiberi Pty Ltd (1994) 12 ACLC 48, 58.
[51] Chapple, above n 7, 107.
[52] ibid.
[53] Tomasic, above n 23, 243.