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Corporate Advisory - Cases Update - February 2018
In this update:
- Federal Court throws into question tax treatment of limited partnerships: Resource Capital Fund IV LP v Commissioner of Taxation  FCA 41
- Beware of sections 115 and 120(1) of the Corporations Act when seeking to remove a nominee director: Shearwood (Trustee), In the matter of Allied Resource Partners Pty Ltd v Allied Resource Partners Pty Ltd  FCA 1451
- Surrounding circumstances in the construction process - is ambiguity needed? Cherry v Steele-Park  NSWCA 295
- The relationship between good faith and reasonableness: Virk Pty Ltd (in liq) v YUM! Restaurants Australia Pty Ltd  FCAFC 190
On 5 February 2018, the Federal Court’s decision in Resource Capital Fund IV LP v Commissioner of Taxation shook the Australian private equity market with a dramatic shift from industry practice. A recent G+T Insight explores the importance of the decision and its implications.
This case illustrates the importance of strictly adhering to any procedure for the removal of directors to minimise the risk that removal of a director (and potentially the subsequent appointment of another director) will be invalid. The case also reminds us that directors appointed on registration of a company are appointed under sections 117 and 120(1) of the Corporations Act 2001 (Cth), and therefore may not (without careful drafting) be subject to any regime in the constitution or any shareholders’ agreement for the removal of nominee directors.
Mr Peters (a director of Allied Resource Partners Pty Ltd (Allied)) sent a Default Notice to the Allied company secretary alleging that Mr Shearwood (another Allied director) had breached the Allied Shareholder’s Agreement. Clause 15.3.1(b) of the Allied Shareholders’ Agreement provided that when a Default Notice is served, “each Director, including themselves, appointed by the Defaulting Shareholder is automatically removed”.
Mr Peters then took steps to:
- remove Mr Shearwood as director; and
- relying on clause 10.11(e) of the Shareholders’ Agreement (which operated only when there was an insufficient quorum of directors), appoint another director in Mr Shearwood’s place.
In holding that the removal of Mr Shearwood (and the appointment of the new director) was invalid, Markovic J in the Federal Court of Australia found that:
- Mr Shearwood was not appointed as a director by a ‘Defaulting Shareholder’ as contemplated by the Shareholders’ Agreement and could not therefore be removed under clause 15.3.1 (b). In fact, Mr Shearwood had become a director upon the registration of Allied under sections 117 and 120(1) of the Corporations Act (which deal with the appointment of directors on registration, and the Allied Constitution and Shareholders’ Agreement did no more than reflect the identity of Allied’s officeholders upon registration (and what had occurred under sections 117 and 120(1)). As such, to remove Mr Shearwood, Mr Peters would have had to comply with other provisions in the Shareholders’ Agreement which required 70% shareholder approval;
- a clause in the Shareholders Agreement which provided that the initial period of a directorship would be 3 years did not of itself serve to automatically remove a director at the end of those 3 years. Something more is required and in this case, did not occur. No steps were taken to convene a meeting to reappoint or replace Mr Shearwood, nor was he removed at that time by any methods set out in the Allied Constitution or Shareholders’ Agreement; and
- as Mr Shearwood remained a director, there was no quorum deficiency and therefore clause 10.11(e) did not operate.
In this case, the NSW Court of Appeal expressed the view that Codelfa does not impose any ‘ambiguity gateway’ before evidence of surrounding circumstances will be considered in contract construction questions (and rather, ambiguity is a conclusion that can only be reached after consideration of surrounding circumstances). However, surrounding circumstances will rarely detract from the language used in the contract.
Bathurst Central Pty Ltd (Bathurst Central) contracted to purchase property from Mr and Mrs Steele-Park (Vendors). The contract was subsequently varied to extend the completion date and immediately before the second variation, Mr Cherry and Mr Sharpe (as directors of Bathurst Central) (Guarantors) signed a guarantee in respect of all monies owing by Bathurst Central under “the Agreement”. The sale contract was never completed and the Vendors subsequently terminated the contract and sold the property to a third party.
The issue for the Court was whether the guarantee:
- extended to damages resulting from the failure of Bathurst Central to complete the purchase as agreed in the original sale contract, being almost $150,000 (the difference between the purchase price and the price for which the Vendors subsequently sold the property), or
- was limited to the amount promised by Bathurst Central to the Vendors in consideration for the Vendors subsequently extending the contract’s completion date, being just over $30,000.
The Guarantors argued that various emails between the parties’ solicitors about the extension of the completion date and the guarantee were admissible on the question of construction of the guarantee, and demonstrated that Bathurst Central’s solicitors had understood that the guarantee would only cover the price of the completion date extension, and not damages for failing to complete.
Leeming JA explained that:
- it is not necessary to find ambiguity before a court can consider surrounding circumstances;
- ambiguity in a contract is a conclusion that can only be reached after surrounding circumstances are considered; and
- it will, however, be rare for any contextual material to override the language used in the contract, as there cannot be any judicial re-writing of a contract (even if the court considers the operation of the contract inconvenient or unjust).
In finding that the emails were relevant to the process of construction of the guarantee (and that the trial judge was not correct to exclude evidence of them), Leeming JA (with whom Gleeson JA agreed) found that the emails:
- contained objective facts known to both parties and represented the communicated negotiating position of the parties; and
- gave some evidence of the commercial purpose of the guarantee (namely that the purpose of the guarantee was to be limited to the price for the completion date extension).
However, the Court ultimately dismissed the appeal because even where evidence of surrounding circumstances was considered, that evidence could not override the clear and expansive language which indicated that “Guaranteed Money” included damages for failure to complete, including
- the definition expressly included damages; and
- the definition was broadly expressed and used expansive general words; and
- the phrase “under or in connection with the Agreement” encompassed both the original sale contract and the second variation.
In this case, the Full Federal Court considered the scope and operation of an implied term of good faith and reasonableness in restricting the exercise of a franchisor’s discretion to set prices. It concluded that a requirement of reasonableness was not separate to an obligation of good faith and required a focus on behaviour in exercising the discretion rather than the outcome of the behaviour.
A number of Pizza Hut franchisees (Franchisees) claimed that the Pizza Hut franchisor YUM! Restaurants (YUM) had breached its implied obligations of good faith and reasonableness when it exercised its contractual power to set the price of pizzas down from $9.95 to $4.95 for pick up and delivery.
The trial judge agreed that YUM’s discretionary power to fix maximum prices was subject to an implied obligation that it be exercised honestly and reasonably and with reasonable cause. However, on the facts, the trial judge found that YUM had not acted “dishonestly, or in bad faith or with reckless disregard” for the Franchisees.
The Franchisees did not dispute the findings that YUM had acted honestly but argued that the maximum prices set and the methodology applied in constructing those prices, when considered objectively, were each unreasonable. In other words, the Franchisees argued that good faith and reasonableness were distinct concepts and the finding of lack of dishonesty did not dispose of the matter.
In upholding the trial judge’s conclusions finding that there was no implied obligation for YUM to ensure profitability for the Franchisees, the Full Federal Court explained:
- the implied obligation of good faith and reasonableness is to be considered in a “composite and interrelated" sense. Consideration of the reasonableness of a party’s conduct is directed to the primary component of the obligation, namely good faith;
- reasonableness is not to be approached in terms of producing a reasonable outcome. Rather, it goes to the quality of the conduct (in this case, the exercise of the price setting power) to determine whether it was "capricious, dishonest, unconscionable, arbitrary or product of a motive which was antithetical to the object of the contractual power". Conduct with any of these qualities could never be said to be in good faith; and
- conversely, where there is a finding of good faith (or a finding that there was an absence of bad faith) in connection with the exercise of a contractual power, then the exercise of the power must also have been reasonable.