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Director's duties: responding to corporate opportunity and shareholder activism
Date : 13 May 2019
Author/s : Jeff Mansfield, Belle Jing, Adrian Palladino
Type : Focus Paper
 

 

One unlisted Australian public company, CellOS Software Ltd (CellOS), has been spending much time before the Federal Court lately, in one case pursuing former founding director and CEO, Jack Huber, for diversion of corporate opportunity in breach of director’s duty, and in the other, defending the decision of its then incumbent directors to postpone an EGM called by shareholders to spill the CellOS board to the date of CellOS’ next AGM.


Case 1: diversion of corporate opportunity – CellOS Software Ltd v Huber [2018] FCA 2069


In the first case, the court found that CellOS’ former director Mr Huber had breached his fiduciary and statutory duties to CellOS by taking up an equity raising opportunity that should have properly been made available to the company.


This is an interesting decision because generally speaking, absent issues of inside information and insider trading, there is no restriction on a director trading in shares of a company for which they are appointed. Trading in the shares of a company does not usually give rise to a diversion of business opportunity from the company as the company itself does not usually buy and sell shares in itself. Further, absent a particular identified conflict arising out of a directorship, a director’s fiduciary duties do not extend to conduct when acting as a shareholder.


The decision clearly turned on the unique facts of the case. Relevantly, CellOS was not generating sufficient revenue and needed new equity capital and debt funding to continue its operations and its business of software development. Mr Huber was responsible for raising the necessary funds. However, rather than issuing new shares to raise capital directly for the company, Mr Huber secretly purchased shares at a lower price from shareholders anxious to sell, and sold them at a much higher price to persons seeking an equity interest in CellOS. He facilitated this secondary or ‘grey’ market through a web of 47 offshore companies involved in the purchase, transfer and sale of CellOS shares. Further, Mr Huber, through an offshore company and without disclosing his conflicted interest, made uncommercial loans to CellOS from these profits and failed to arrange any equity placement for CellOS during this period.


CellOS alleged that by diverting investors to this ‘grey’ market and away from investing directly in new equity, and by providing uncommercial loans, Mr Huber had acted for his own benefit and to the disadvantage of CellOS. The court agreed.


Justice Beach found that Mr Huber’s conduct breached his fiduciary and statutory duty to CellOS because the share trading scheme undermined, rather than promoted, the equity raising objective of CellOS. In reaching this conclusion, the court articulated a number of principles to illustrate opportunities that a director should generally not pursue by reason of diversion of opportunity:

 

  • the corporation is financially able to exploit the opportunity (CellOS was in a position to issue new shares thereby exploiting the equity raising opportunity);
  • the opportunity is within the corporation’s line of business (a broad approach to the interpretation of CellOS’ ‘line of business’ was adopted so as to include raising capital at the relevant time);
  • the corporation has an interest or expectancy in the opportunity (given CellOS’ reliance on new equity capital or debt funding, it was clearly interested in capital raising opportunities); and
  • by taking advantage of the opportunity, the corporate fiduciary will thereby be placed in a position inimical to their duties to the corporation.

Case 2: postponement of EGM convened by shareholders under section 249F of Corporations Act 2001 (Cth) – Wun v CellOS Software Ltd [2018] FCA 1947


The second case was the product of shareholder activism and intervention arising due to continuing concerns regarding the financial viability of CellOS. In today’s climate of peak shareholder activism, it is becoming increasingly common for shareholders of public companies to call general meetings of their own accord, to consider matters of direct concern to them, in exercise of their rights under section 249F of the Corporations Act 2001 (Cth).1 This was the subject of the second case, where certain shareholders had called an EGM of CellOS to seek the removal of the incumbent board (which, by this time, no longer included Mr Huber and therefore, was not instigated on the basis of Mr Huber’s misconduct discussed above), only for it to be postponed by the CellOS directors.


While the personal interest of the board members clearly conflicted with the purpose of the EGM, the court nonetheless found that the directors had acted in good faith and for a proper purpose in postponing the EGM, and that their power to postpone such meetings, as conferred under CellOS’ constitution, did not unlawfully interfere with the statutory right of its shareholders.2 Importantly, Justice Middleton was satisfied, based on the minutes of the board meeting approving the postponement, that the directors made the decision based on a genuine desire to: (1) wait until CellOS’ audited accounts were finalised; (2) deal with every issue at the AGM; and (3) consider some apparent procedural irregularities with the notice issued by the requisitioning shareholders to call the EGM. His Honour accordingly held that the directors had acted reasonably and for a proper purpose, and did not intend to cancel the meeting, as alleged by the requisitioning shareholders. Although the postponement was lengthy (i.e. approximately 2 months), his Honour considered it reasonable in the circumstances.


The power of members to call general meetings is one of a number of legal mechanisms used by shareholder activists to agitate for change in the management of a company. While the decision in Wun v CellOS Software affords directors some measure of protection from this form of shareholder activism, it also highlights the importance to directors of carefully considering and properly recording their reasons if they decide to postpone an EGM called by shareholders. Provided they act in good faith and for a proper purpose, the court has reaffirmed that directors have the power to postpone a properly convened meeting if the company’s constitution expressly authorises them to do so.
 


1. Section 249F of the Corporations Act 2001 (Cth) empowers members with 5% or more of the votes of a company to call general meetings of the company’s shareholders.
2. The EGM was called by the requisitioning shareholders pursuant to section 249F of the Corporations Act 2001 (Cth) which, on a proper reading, gives shareholders the power to “call and arrange to hold” a meeting, but did not empower the shareholders to direct or override the power of the company board to decide how the meeting would be held or conducted. 

 

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