Queries on Critical Analysis of Corporate Law


Question: Corporate Law

Facts of the Case

Under the scheme of National Innovation and Science Agenda (NISA), Australian Government has decided to invest $250 million in different research facilities across the country in order to encourage entrepreneurship and innovation. The aim of the Government was to make health and medical research commercial. Therefore, a company called Medco Ltd. got interested in this scheme as its business was to invest in new avenues regarding alternative medicine. After that Brenda, who is one of the executive directors (Director, Innovation) in Medco Ltd. applies to avail the Government funding from NISA on the basis of research on medicinal properties of Lanolin which is a natural compound found in sheep fleece. But the truth was something else that this research trial was going on in another company called Merino Pty Ltd privately owned by another director of Medco Ltd David. Brenda signs EOI on behalf of Medco Ltd to seek a funding of up to $500,000 and submitted to NISA. After that four of the five directors had a meeting and the company made an announcement to ASX regarding the so called agreement of the company with Government under NISA. Brenda, then purchased 1,000 more shares of Medco Ltd by topping up. The fifth director, Frank warns the other directors that the announcement was a premature one, but he anyways sold his shares that were increased by 45% after the announcement. However, later on Brenda incurred a significant loss due to the 60% reduction in the prices of the shares because NISA decided not to fund Medco Ltd. research.

Critical Analysis

The above scenario presents a clear case of the contraventions of Corporations Act 2001 (Commonwealth) in many aspects. 
Under the Section 1041 A of Corporation Act 2001 , there are different provisions drafted for the event of market manipulation. The Act lays down the rules as follows: 
If a person involves in any of the unscrupulous activities directly or indirectly and in the current jurisdiction or anywhere else. Such activities can be described with the help of the following provision:
A transaction or more transactions that have the propensity to have an effect of generating a price artificially in order to trade in financial products belonging to a financial market coming under that jurisdiction. Also, maintaining an artificial level of the price regarding trade or transaction in financial instruments belonging the financial market that runs in that particular jurisdiction.

Penalty provisions of violating Section 1041 A of Corporation Act 2001

If a person is involved in any activity that is forbidden under the provision of this Act or doesn’t do anything that is required for him to do what the provision of this act prescribes or involves in the other contravention of the provision of this Act. He would be found guilty of the offense by virtue of this subsection, unless some different provision of the Act states otherwise. When the person is found guilty of violating this Act, he/she is liable to be punished    or convicted by a penalty not exceeding the required applicable penalty of the offence. The provision of this Act sets the applicable penalty on account of contravention as a specified one which is pecuniary or otherwise. The person who is found guilty of violating the above Act will also come under the clause of getting strict liability . Under this, the person will be disqualified from managing corporations and under section 206F or 206G, he will not be given any permission to manage the corporation any longer. So, if the person ceases to be the director or alternate director, then under section 2, the company is needed to notify ASIC . After the contravention of the civil penalty provision is established in the court, then it is required to make the declaration of the contravention. After that the ASIC is required to seek pecuniary penalty order. It is mandatory that the declaration of contravention should specify a) the Court, b) the civil penalty provision that was declared to have been contravened, c) the person in question, d) the conduct of the person because of which contravention took place.
Civil action to cover damage due to the contravention. If any individual has suffered a loss or damage because of the contravention by another person, he is allowed to recover the amount of damage by taking an action against the person who contravened, whether or not he has been convicted of an offence on account of contravention. Section 1044B limits the amount limits the amount which is to be recovered on account of the contravention by misleading or deceptive information. However, as per the law, under subsection (1), the aggrieved person can claim economic loss or damage to the property being caused by another person . He can also claim the damages incurred by him because of the failure to take reasonable care. In any case, the damages being recovered by the claimant on account of the loss could also be reduced to the extent the court finds it just and equitable according to its discretion. It is the Division 2A that applies for the proportionate liability in order to recover the damages on account of the contravention under section 1041H. An action can be started any time in 6 years from the day of the cause. Also, under this section any other liability of the person of any other law is not affected.
In the present case, there is a clear infringement of the Section 1041 A of Corporation Act 2001 on the part of the directors of Medco Ltd in general and Brenda in particular. All the four directors who were present in the meeting agreed on making an announcement to the Australian Stock Exchange (ASX) that the company has just made an agreement with the Australian Government in a significant investment under NISA. Because of this news, the value of the shares of Medco Ltd was artificially increased on the premise that the company has now the backing of the Government and the fact that investors would have an impression that the company will make profits, the chances are that the prices of the shares will increase even more artificially. So, it is a case of stock market manipulation because it entails an intentional distortion of the market prices of the shares on the part of the directors of Medco Ltd. Finally, when the prices of the shares of Medco were dropped by 60%, then a substantial loss must have been incurred by other shareholders of the Medco Ltd. Therefore, the directors are liable to pay for the damages or losses in the form of penalties. Also, they are liable to face the law and punishment for the manipulation or distortion  of the shares. 
There was a similar case regarding market manipulation that was surfaced in 2013 (15 – 271 MR NSW) after an investigation of ASIC took place in New South Wales. In this case, a man named Nigel Derek Heath was found guilty of the market manipulation charges. The quantum of punishment meted out to him was that of 2 years and three months of imprisonment and a penalty amount of $10,000. Mr. Heath was found to be guilty of two charges of market manipulation that come under Sec 1041A and Sec 1041B of Corporations Act 2001. The Judge in this particular case felt the need to establish a free, open and transparent market which should not have been contaminated by the activities such as that of Mr. Heath’s. Therefore, his conduct was found to have distorted the market and on account of that the value of his own portfolio was increased and eventually it gave rise to the free equity in the CFD trading accounts of Mr. Heath. It was also observed on the part of the court that any activity that manipulates the market leads to the undermining the integrity of financial markets. It is the ASIC that has been conferred the responsibility to protect the financial markets so that it can bring those individuals who are involved in the market misconduct to the justice . The court found that Mr. Heath’s modus operandi was to operate on the a direct access model, in which the issuer of the CFD made a hedging exposure to a client by making a direct position to be taken in the underlying security.  The Corporations Act 2001, Section 1041E also underlines the provisions in the event of false or misleading statements furnished by the officials of corporations. It says that it is strictly illegal on the part of a person belonging to that jurisdiction, to make a statement or disseminate the information, when that statement is false (fully or partially) or is misleading. Because of the false statement or misleading information, the people could be induced or become ready to invest in or apply for the related financial products. People in this jurisdiction would be induced to dispose of or acquire the said financial products. Also, if the given statement or information creates an effect that increases, reduces or stabilizes the price needed for the trade in financial products belonging to the given financial market operating in the current jurisdiction . While making such statements or furnishing the information, the person in question, doesn’t care about the veracity of his/her own statement or information or if he/she knows, or should have known reasonably regarding the falsehood of the statements being made as they are materially misleading.  
In the present scenario as well, regarding the stock manipulation incident that apparently happened here, there was a spreading of false and misleading information about Medco Ltd. There was an improper way by which the increased valued shares of Medco Ltd were made available to the public. In this case as well, the quotes presented here were rigged and because of that, the trades and their prices were falsely created. So, it can be said that it was a deceptive picture of demand for the security.  The deceptive picture being created here is because of the premature announcement of the proposal to the ASX. So, by announcing the proposal that had never took place between the company and Government, Medco Ltd straight away got involved into the act of furnishing and spreading the misleading information or statements. Brenda, who took all the decisions with the consultation of her fellow directors to announce the proposal prematurely makes her and others and the company as guilty. In addition to that, Medco Ltd was never a part of any research trial into the medicinal properties of lanolin. Although its business is investing in the field of new and alternative medicines, but it is nowhere near in the research of medicinal properties of lanolin. Therefore, again the directors of the company furnished false information and provided false reports to the Government as well in order to avail a possible funding of $500,000 by the Government under NISA. The Government was therefore kept in the dark by the company directors as to what really constituted their business and which was the very company that involved in the research trial of lanolin (which actually was Merino Pty Ltd in this case). Therefore, the directors are clearly guilty of furnishing the false information about the business of the company as well as about the premature announcement regarding the so called agreement with the Government. So, the company directors are liable for the general penalty provisions  because as per the Sec 1311, they have done and involved in an act which is forbidden under the provision of the Corporation Act. The directors did not do what they were required to do at this point under the provision of the Act. So, their conduct was found to have been dishonest in relation to the submission of the information and also in relation to a financial product or financial service. Now, at this point in time, there is a case of civil action for the loss or damage on account of violation of the Sections 1041E to 1041H by the directors. So, whoever person or persons have suffered loss or damage by the conduct of another person, he/she will be given an opportunity to claim the amount lost or damaged against the directors . There is caveat here, Frank is the fifth director who did not attend the board meeting and which he rarely does. He lives in California and called Arthur from there to inform them (directors) that he was against the proposal because the ASX pronouncement was premature. Therefore, in this case it can be said that he was not part of the conspiracy and be absolved from the charges that are otherwise applicable to all the other four directors. Although, he made profit by selling the Medco shares that he owned when their prices were increased but it cannot be said that it was criminal on his part because it is the personal decision of any shareholder to do what he wants to do with his shares. However, the case in point also presents a peculiar situation here. David who is also one of the five directors of Medco Ltd is also an owner of a proprietary company Merino Pty Ltd. Now this company (not Medco Ltd) is the one that has the interest in sheep breeding and is involved in the research on medicinal properties of the lanolin. Therefore, when the decision was made by the directors of Medco Ltd, it was a conspiracy of conspicuous silence on the part of David. He should have stopped them from using his privately owned company’s business interest so that a huge sum of money could be extracted from the Government for Medco Ltd. Also, there was no mention as to how the funding from NSA will be going to benefit the business interests of his own company. This fact should also be brought to the attention of the court so that the criminality, if there is, on the part of the David could be established.
According to the present constitution of Medco Ltd its core business is to invest in new opportunities in the alternative medicine. However, the company wants to expand its commercial activities and find new avenues in the field of medical imaging. So, as per the provisions of Corporations Act 2001, a company can change the rules of its constitution under the Sections 9, 136, 137, 140, 249H and 249L. The provisions of these sections confer the rights to the company so that it can modify or repeal its constitution . It can also change any particular provision of its constitution by passing a special resolution. As per the law, the special resolution needs not less than 21 days (in case of public companies, the number of days is 28) with an agreement of at least 75% majority of votes to be casted. While, a proprietary company is not required to lodge any copy of its constitution. If in the event of passing a resolution that affects the company’s name, share capital or type, then as per the law an appropriate document is required to be lodged within the required lodging period.
Medco Ltd being a public company is therefore required to pursue the incorporation of relevant special resolutions that are required to change the rules of the constitution so that it can expand its business opportunities. The fact that a company’s constitution somehow restricts its business activities makes it to incorporate the statutory requirements to bring a change in the provisions of its constitutions . It can include a number of object clauses within its present constitution that has so far outlined and restricted the activities the company has been engaged in under the section 125 (2) of the Act. Object clauses are the ones that are not that mandatory but can help in providing an indication about the nature of the business. 
In order to expand the business opportunities, the board of Medco is required to consider the replaceable rules. The Sec 141 of the Corporation Act 2001 provides an entire list of rules that are used to replace the provisions of the constitutions of the company. Also, section 135(1) provides the provision that does not applied to a propriety company.
Under section 136(2), a company’s constitution will not be amended as per the rules of Corporations Act if the constitution specifies some additional requirement that are needed to be conformed with well before any amendment is made effective . The requirement it includes may be an additional condition to be fulfilled as well as the consent of particular authority be obtained and the unanimous passing of the resolution by the shareholders. At this point, it is also noteworthy to understand that Corporations Act provides protection to the shareholders of the company against any variation of class rights. It also protects from expropriating the shares of minority shareholders.       


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