In a previous series of articles we looked at the judicial interpretation of common contractual provisions. This article moves on to the consideration of a particular type of contract, namely the constitution of a company, and reviews the approach adopted by courts to the interpretation and enforcement of the so-called statutory contract.
The Role of a Constitution
Companies are creations of the law. They are brought into being by registration, given the status of separate legal entities with the powers of a natural person and cease to exist on deregistration.1
While all companies share certain fundamental features, each company’s individual “personality” is defined by its constitution (historically known as the memorandum and articles of association). Since the removal of the ultra vires rule, a constitution no longer defines the powers of a company.2 However, the constitution continues to provide the primary source of the internal make up of a company, including things such as the composition of the board of directors, the division of powers between the board of directors and the members in general meeting, the rights attaching to shares and any restrictions on the issue and transfer of shares. Accordingly, the provisions contained in constitutions can be very significant sources of individual rights. A good example of this can be seen in the case of home unit companies, in which the ownership of certain shares confers the right to occupy an identified apartment within a building owned by the company. In the case of joint venture companies, the constitution will often set out particular rights of the joint venture shareholders, including their rights to appoint directors and the attenuation of the fiduciary duties of those directors.3 Even though a company’s constitution no longer defines the company’s powers, the constitution may still have significance to third parties who have dealings with the company.4
A Statutory Contract
Company constitutions are given contractual force by section 140 (1) of the Corporations Act. That section provides that a constitution has the effect of a contract between the company and each member, the company and each director and secretary and between each member and each other member.
This is a very different method of creation to contracts in the normal sense, which are formed by an agreement between parties who intend to make their agreement legally enforceable. While incorporators of a company may, in some instances, reach agreement on the form of the company’s constitution prior to its registration, subsequent members become subject to the terms of the constitution as a result of shares being issued or transferred to them and the company’s directors and secretaries become subject to the contract by virtue of their appointment.5
Another important difference between a company’s constitution and a normal contract is that a company’s constitution can be varied by a special resolution of the members in general meeting.6 While this right is subject to safeguards that are directed to preventing oppression, the variation of class rights and the imposition of additional financial liability, it contrasts to the fact that changes to contracts generally require the consent of all parties.7
In the case of companies limited by shares, section 516 of the Corporations Act limits the financial liability of shareholders to the amount unpaid on their shares. This fundamental principle of limited shareholder liability restricts the financial obligations that may be imposed by companies on their members through their constitution. It is, nevertheless, possible for a constitution to contain provisions that relate to shareholders in some capacity other than as members, for example as suppliers of produce to the company or the users of facilities owned by the company, and those provisions will be treated as a separate “special contract” between the shareholders and the company. The financial liability of members under this type of special contract, such as the liability to pay an annual fee, is not limited by section 516 of the Corporations Act.8
Courts have, historically, expressed reservations about the application of the general principles of contractual interpretation to company constitutions. These reservations arise out of the “public dimension” of constitutions.9 That is, constitutions are documents given contractual force by statute, without the normal elements of a contract having to be established, and on which third parties rely.10 However, the abolition of the ultra vires doctrine, through the introduction of sections 124 and 125 of the Corporations Act, has weakened the view that constitutions should be construed more strictly than other commercial contracts. This was noted by the Full Federal Court in Lion Nathan Australia Pty Ltd v Coopers Brewery Limited11 where the court set out the following updated principles applicable to the interpretation of company constitutions. A company constitution is in the nature of a commercial contract, and should be construed so as to give it reasonable business efficacy and not narrowly or pedantically.12
- Company constitutions, like other commercial documents, must be read as a whole and, where appropriate, having regard to the purpose that, from an objective perspective, they were intended to serve.
- In construing the language of a company constitution, it is appropriate to have regard to not only the text, but also the surrounding circumstances known to the parties and the purpose and object of the relevant constitutional provision. In this respect, company constitutions are not excluded from the range of commercial documents governed by the principles for construction outlined by the High Court in Pacific Carriers Ltd v BNP Paribas13 and Toll (FGCT) Pty Ltd v Alphapharm Pty Ltd.14 However, the range of surrounding circumstances that may be considered may be more limited than in the case of other commercial documents, as the public dimension of a corporate constitution may sometimes constrain the ambit of the matters to which a court has regard.
- The principles applicable to the implication of terms into contracts apply to constitutions, although courts have been slow to imply terms into constitutions.
Consequences of Breach
The principal remedies for breach of a contract focus on requiring compliance with the contract or providing compensation for the loss suffered by innocent parties. This is consistent with the notion that contracts constitute a bargain between the parties to it.
On the other hand, courts have primarily assessed actions that constitute a breach of a company’s constitution by reference to the validity or otherwise of the action. The following examples illustrate this:
- Shares transferred without compliance with pre-emption provisions contained in the company’s constitution results in the transfers being voidable and gives rise to an entitlement to have the register of members rectified.15
- A variation of class rights without compliance with the constitutional provision requiring consent from the party affected results in the variation being invalid and of no effect.16
- An appointment of directors in a manner not provided for in the constitution is of no effect.17
- A resolution of shareholders concerning matters within the scope of the powers of the directors, as identified in a constitution, is of no effect.18
Depending on the nature of the breach and the subsequent action taken, the register of members may need to be corrected. In most instances, this will require an application to the court under section 175 of the Corporations Act by the company or any aggrieved person, which would include a member. The court’s power to order a correction of the register of members is discretionary. However, if there is a genuine dispute as to whether or not an alleged shareholder is really a shareholder, a company may implement a bona fide resolution of the dispute which involves a correction of the register of members without the need for a court order.19
Some breaches of a company’s constitution may be characterised as procedural irregularities and therefore may be validated by the provisions of section 1322 of the Corporations Act.20
In the case of Dungowan Manly Pty Ltd v McLaughlin,21 the New South Wales Supreme Court granted damages to the holders of shares in a home unit company which was redeveloped in a manner that constituted a variation of their class rights. An appeal to the New South Wales Court of Appeal was dismissed, although Bathurst CJ noted that:
“There is some doubt as to whether the statutory contract formed by section 140 of the Act gives rise to a claim for damages for breach.”
In circumstances where a breach of a company constitution also amounts to a contravention of the Corporations Act, such as the failure to comply with provisions relating to the variation of class rights, section 1324 of the Corporations Act gives courts the power to grant injunctions to prevent breach or, alternatively, to order damages.22
The remedy of rectification is not available in relation to company constitutions, even if there has been some mistake made in the wording or the wording does not represent the original intentions of those responsible for the incorporation of the company.23 However it may be that in circumstances such as these, an injunction may be granted to prevent the exercise of a right set out in a constitution which is inconsistent with the original agreement between the incorporators.24
While company constitutions have contractual effect, they have a number of features that make them quite different from contracts generally. The fact that a constitution can be varied by a special resolution passed by shareholders is an important difference, as is the questionable right to damages as a remedy for breach and the unavailability of rectification.
It is therefore a mistake to assume that a constitution can be regarded as the equivalent of a contract in all respects. This conclusion is of particular significance for companies in which the relationship between the company and its shareholders goes beyond an investment in shares, for example co-operative style companies, companies that own assets used by their members and joint venture companies. The more complex nature of membership in these types of companies raises the question of whether all aspects of the relationship between the company and its members can be documented in the constitution. At least in the case of joint venture companies, the common use of shareholders agreements indicates that the constitution may need to be supplemented by a separate contract.