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Reading(notes(for:((
Commercial Law
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Topic(11:(Managing(a(business(
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Reading Notes for Commercial Law

 Reading Notes for Commercial Law

!
Disclaimer(
!
This!subject!material!is!issued!by!RMIT!on!the!understanding!that:!
!
1.! RMIT,!its!directors,!author(s),!or!any!other!persons!involved!in!the!preparation!
of!this!publication!expressly!disclaim!all!and!any!contractual,!tortious,!or!other!
form!of!liability!to!any!person!(purchaser!of!this!publication!or!not)!in!respect!
of!the!publication!and!any!consequences!arising!from!its!use,!including!any!
omission!made,!by!any!person!in!reliance!upon!the!whole!or!any!part!of!the!
contents!of!this!publication.!
2.! RMIT! expressly! disclaims! all! and! any! liability! to! any! person! in! respect! of!
anything!and!of!the!consequences!of!anything!done!or!omitted!to!be!done!by!
any!such!person!in!reliance,!whether!whole!or!partial,!upon!the!whole!or!any!
part!of!the!contents!of!this!subject!material.!
3.! No!person!should!act!on!the!basis!of!the!material!contained!in!the!publication!
without!considering!and!taking!professional!advice.!
4.! No!correspondence!will!be!entered!into!in!relation!to!this!publication!by!the!
distributors,! publisher,! editor(s)! or! author(s)! or! any! other! person! on! their!
behalf!or!otherwise.!
!
All!details!were!accurate!at!the!time!of!printing.!

ii Reading Notes for Commercial Law

Contents(
!
1.!Introduction!
2.!Defining!‘business’!and!‘organisations’!
3.!Choosing!a!business!structure!
4.!Managing!a!business:!sole!proprietor!(sole!trader)!
5.!Managing!a!business:!partnership!
6.!Managing!a!business:!trusts!
7.!Managing!a!business:!companies!!
8.!Corporate!governance:!fundraising!
9.!Corporate!governance:!the!relationship!between!
corporate!organs!
!
1.(Introduction((
This!topic!will!consider!relevant!matters!concerning!the!needs!of!a!business!and!
suitable!business!structures.!The!materials!will!explore!the!range!of!possible!legal!
business!structures!that!are!available,!including!a!sole!trader,!partnership,!trust,!
franchise!and!corporation.!!
In!relation!to!the!corporate!structure,!the!following!sub!topics!will!be!canvassed:!
v! What!are!the!advantages!and!disadvantages!of!the!corporate!structure?!
v! How!does!the!law!regulate!fundraising!by!companies?!
v! How! does! the! law! regulate! the! relationship! between! directors! and!
shareholders?!

2.(Defining(‘business’(and(‘organisations’(
Defining(an(organisation((
This! topic! covers! the! types! of! structures! for! holding! investments,! including!
operating!a!business!as!a!sole!trader,!a!partnership,!a!company,!a!trust!or!in!a!
joint! venture.!For! the! purposes! of! this! subject,! the! focus! is! the! corporation;;!
however,!the!corporation!is!not!the!only!legal!organisation!available!for!people!to!
use!to!conduct!business!activities.!!

The!term!“organisation”!means!the!arrangement!of!things!within!groups!–!often!
the!arrangement!of!people!within!a!socially!recognised!group.!The!arrangement!
of! people! can! be! based! on! a! variety! of! factors! —some! of! these! can! include!

1
 Reading Notes for Commercial Law

arrangements! based! on! age! (such! as! a! “Probus”! group! of! retired! business!
people),!political!power!(such!as!a!political!party),!education!(such!as!University!
alumni!group),!and!religious!status!(such!as!religious!institutions!of!a!variety!of!
denominations! and! faiths).! An! arrangement! can! also! be! made! based! on! the!
business!activities!being!conducted!by!that!group!of!people!–!which!is!the!ultimate!
focus!of!this!subject.!!

While!we!as!a!community!can!identify!a!variety!of!different!organisations,!only!a!
few!of!those!are!recognised!as!a!separate,!distinct!entity!at!law.!Some!of!these!
legally! recognised! organisations! are! public,! such! as! a! State! or! Federal!
Parliament.!Other!organisations!operate!in!the!private!sphere,!and!have!a!greater!
focus! on!conducting!business!activities.! While!legal!organisations!are!used!for!
charities!and!other!social,!communal!activities,!their!most!common!use!by!far!is!
in!the!realm!of!business!–!and!consequently,!the!focus!of!this!course!will!be!on!
the!business!uses!of!these!legal!organisations.!!

Some! organisations! can! be! established! through! conduct! of! individuals! and!
without! formal! documentation! (such! as! unincorporated! associations! and!
partnerships),! while! other! organisation! types! require! greater! formality! in! their!
establishment!(such!as!trusts!and!corporations).!

Defining(a(business((
In!the!context!of!commerce,!business!is!the!use!of!assets!for!the!generation!of!
profit.! In! this! way,! the! term! ‘business’! does!not! refer! to! any! transaction! where!
there!is!a!giving,!receiving!or!exchange!of!money:!there!must!be!a!use!of!assets.!
Business!so!defined!does!not!make!a!distinction!based!on!ownership.!Take!for!
example,!an!automobile.!This!asset!can!be!used!as!a!family!vehicle!or!taxi.!The!
asset!by!itself!does!not!constitute!a!business.!In!the!first!case,!it!is!not!used!to!
make!a!profit!and!so!not!a!business.!In!the!second!case,!it!is!to!make!a!profit!and!
so!is!classified!as!a!business.!!

The!asset!can!be!anything!that!allows!generation!of!a!profit.!It!can!be!a!skill!or!
ability!to!polish!cars,!mine!gold,!or!program!computers,!or!it!can!be!an!asset!like!
mobile! telephone! microwave! rights,! telecommunication! satellites! and! office!
towers.! The! key! identifier! of! a!business! is! the! existence! of! income! generating!
assets.!!

Business(Organisations(
!

Following! the! above,! ownership! is! not! mandated.! Any! means! of! organising!
ownership!is!acceptable!at!law.!Ownership!can!be!by!an!individual,!a!family,!a!
group! of! people! putting! in! money! to! buy! a! taxi! licence,! or! a! company! owning!
shares! in! another! company.! The! decision! about! organisation! occurs! as! an!
afterthought,!however!at!law!it!is!of!paramount!importance.!The!legal!form!of!the!
organisation! is! critical! in! terms! of! liability! and! rights! of! all! parties! involved! or!
associated!with!the!activities!of!the!organisation.!!

It!is!important!to!distinguish!legal!and!managerial!terms!relating!to!organisational!
form.!Managers!may!refer!to!‘joint!ventures’,!‘projects’!and!other!such!terms.!Law!

2 Reading Notes for Commercial Law

does! not! recognise! these! as! independent! legal! forms! of! organisation.! At! law,!
there! is! no! organisation! called! a! ‘joint! venture’.! Such! legal! relationships! are!
subject!to!the!law!of!contracts,!not!the!law!of!organisations.!The!law!of!contract!
bears! remarkably! little! resemblance! to! the! law! of! organisations! in! terms! of!
governing!relationships!and!assigning!rights!and!duties.!Accordingly,!there!is!no!
substitute!for!precision!in!the!use!of!language!in!law.!!

3.(Choosing(a(business(structure(
The!selection!of!the!best!type!of!business!structure!will!depend!upon!a!variety!of!
factors.!Some!useful!questions!in!assisting!a!client!to!determine!an!organisational!
structure!through!which!to!conduct!business!activities!include:!!
Ø! How!easy!is!it!to!establish!the!business!activities?!!
Ø! What!is!the!cost!is!setting!up!the!business!activities?!!
Ø! Are! funds! from! third! parties! (such! as! banks! or! investors)! required! to!
establish!or!conduct!the!business!activities?!!
Ø! What! are! the! applicable! laws,! and! who! will! control! management! of! the!
activities?!!
Ø! What!taxation!rate!will!apply!(noting!that!personal!income!tax!rates,!and!
company!tax!rates!differ)?!!
Ø! What!is!the!expected!size!of!the!business!activities,!and!is!it!intended!to!
conduct!business!activities!on!a!national!basis?!!
Ø! Is!the!goal!of!the!business!activities!to!generate!a!profit?!!
Ø! What!is!the!personal!liability!or!risk!exposure!of!the!individuals!involved!in!
conducting!the!business!activities?!!
Ø! What!is!the!process!of!termination!of!the!business!activities?!!

4.(Managing(a(business:(sole(proprietor(
(sole(trader)(
A!sole!proprietor!(sometimes!referred!to!as!a!‘sole!trader’)!is!where!one!person!
conducts! business! activities! without! setting! up! a! particular! organisational!
structure,!such!as!a!company.!The!person!and!the!‘organisation’!conducting!the!
business! activities! are! considered! the! same,! meaning! that! the! law! does! not!
consider!them! to!be!different!entities,! and!the!person! conducting!the!business!
activities! is! personally! liable! for! all! debts! incurred! because! of! conducting!
business.!!

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 Reading Notes for Commercial Law

The!structure!and!activities!of!the!organisation!are!intertwined!with!the!person,!
for!instance!any!income!from!the!business!is!deemed!to!be!the!personal!income!
of!the!sole!proprietor.!The!death!of!the!person!means!the!end!of!the!business!
activities!and!the!termination!of!the!organisation.!!

There!is!no!specific!legislation!which!governs!the!activities!of!a!sole!proprietor.!!

5.(Managing(a(business:(partnership(

A! partnership! is! defined! in! section! 5! of! the! Partnership+ Act+ 1958! (Vic)! as! the!
relationship!between!two!or!more!persons!carrying!on!a!business!in!common!with!
the!view!of!profit.!A!partnership!is!sometimes!referred!to!as!a!‘firm’!(section!8,!
Partnership+ Act).! The! term! “firm”! is! a! technical! legal! term! with! the! specific!
meaning! of! partnership.! The! term! “firm”! is! used! in! economics! and! business!
disciplines!differently!and!care!must!be!used!when!using!it!to!be!correct!at!law.!!

The!law!does!not!recognise!a!partnership!or!firm!as!separate!from!its!partners!so!
partners! are! personally! liable! for! the! debts! of! the! partnership! business! to! an!
unlimited!extent.!A!partnership!is!a!contractual!relationship!and!the!partnership!
agreement!sets!out!the!rights!and!obligations!as!between!the!partners.!A!fiduciary!
relationship!also!exists!between!the!partners!and!the!fiduciary!duties!such!as!the!
duty!to!act!in!good!faith!and!the!duty!of!loyalty!apply!amongst!them.!!

6.(Managing(a(business:(trusts(
A! trust! is! an! organisation! because! it! involves! an! arrangement! of! things! and!
people;;!however,!a!trust!is!not!recognised!at!law!as!an!organisation.!Rather,!it!is!
an!arrangement!between!parties!who!remain!individual!parties!in!their!own!right!
without!creating!a!new!individual!at!law.!!

The!basic!legal!form!of!a!trust!requires!three!parties!and!some!asset.!The!parties!
to! an! express! trust! are! the! settlor,! the! trustee! and! the! cestui! que! trust,! or!
beneficiary.! Some! of! the! key! terms! used! when! referring! to! a! trust! structure!
include:!!

Ø! Trust(Deed:(the!legal!document!which!sets!out!the!relevant!parties!and!
the!terms!and!conditions!under!which!the!trust!relationship!is!established!
and!to!be!maintained!(‘signed,!sealed!and!delivered’!as!a!deed).!!

Ø! Settlor:( the! creator! of!the! trust,! who! transfers! the! legal! title! of! the! trust!
property!to!the!trustee!and!establishes!the!trust!conditions!that!are!binding!
on!the!trustee.!This!person!does!not!usually!have!any!liability!in!relation!to!
the!trustee!for!fees!or!reimbursement!for!trust!expenses.!The!settlor!has!
no!control!over!the!trust!after!its!establishment.!!

4 Reading Notes for Commercial Law

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 Ø! Trustee:(the!person!who!has!the!legal!title!to!the!trust!property!vested!in!
them,!and!who!is!in!charge!of!the!trust!property!and!manages!on!behalf!of!
the!beneficiaries.!!

Ø! Beneficiary:(the!person!who!is!the!equitable!owner!of!the!trust!property,!
and!who!benefits!from!the!trust.!!

Ø! Trust( property:( an! interest! in! some! specific! property! (tangible! or!
intangible,!real!or!personal).!The!trustee! has!the! legal! ownership!of!the!
trust! property! and! the! beneficiary! has! the! beneficial,! or! equitable,!
ownership!of!the!trust!property.!!

Operation(of(Trusts(as(organisations((
The! parties! of! a! trust,! who! are! identified! within! a! ‘trust! deed’! document,! are!
arranged!according!to!their!rights!and!duties.!The!assets!are!transferred!by!the!
settlor!to,!or!‘settled’!on,!the!trustee.!The!trustee!is!the!legal!owner!of!the!trust!
assets;;!however,!they!are!not!allowed!to!use!the!asset!for!their!own!benefit.!The!
trustee!is!constrained!at!law!and!placed!under!fiduciary!duties!to!use!the!asset!
for! the! exclusive! benefit! of! the! cestui+ que! trust! (that! is,! for! the! benefit! of! the!
‘beneficiaries’!under! the! trust!deed)!and! not!for! themselves.!This!arrangement!
allows!a!legal!separation!of!ownership!of!an!asset!from!the!benefit!of!that!asset.!!

A! trust! arrangement! can! work! well! in! a! number! of! situations.! For! example,!
ownership!of!an!asset!such!as!an!income!generating!piece!of!real!estate!may!be!
better!in!the!hands!of!an!experienced!business!person,!than!the!hands!of!a!young!
person!who!has!other!things!occupying!their!attention.!A!testamentary!trust!(one!
established!under!the!terms!of!a!will)!may!have!settled!a!piece!of!land!on!a!trustee!
to!be!held! in!trust! for!a!minor,! who! would!only!take! the!legal!ownership!of! the!
asset!of!the!trust!upon!reaching!the!age!of!majority.!Or!as!another!example!of!the!
use!of!a!trust!organisational!form,!a!person!interested!in!charity!work!but!unable!
to!attend!to!doing!that!work!may!decide!to!settle!a!certain!asset!on!a!trustee!for!
charitable! purposes.! In! times! past,! wealthy! nobles! settled! funds! on! religious!
orders! for! such! purposes.! Today,! organisations! such! as! the! Bill+ and+ Melinda+
Gates+Foundation+and!the!Meyer+Foundation+are!arranged!in!the!same!way.!!

A!brief!mention!of!the!trust!as!a!business!structure!may!be!useful.!With!trading!
trusts,!the!trust!asset!is!a!business!which!is!vested!in!the!trustee.!Unit!trusts!are!
the!main!type!of!trust!used!in!business!ventures.!Another!type!of!trust!structure!
used! by!business!is!the! ‘managed’!trust!which!allows! investors!to!spread!their!
risks!as!this!type!of!business!structure!gives!the!unitdholder/beneficiary!an!indirect!
interest! in! varied! types! of! companies.! The! trustees! of! many! of! these! types! of!
trusts!are!companies.!As!its!tax!benefits!have!waned,!the!use!of!trading!trusts!in!
Australia! has! declined! and! hence! little! discussion! of! this! form! of! organising!
business!is!merited.!!

! (

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 Reading Notes for Commercial Law

7.(Managing(a(business:(companies(
The! Corporations+ Act! 2001! (Cth)! governs! the! registration! and! use! of! different!
types! of! companies,! classified! by! reference! to! the! basis! and! the! extent! of! the!
members’! liability! and! according! to! whether! they! are! public! companies! or!
proprietary!companies.!The!Corporations+Act+contains!provisions!including:!
•! directors’!duties!&!liabilities;;!
•! shareholders’!rights!&!remedies;;!
•! financial!reporting!provisions;;!and!
•! requirements!for!company!meetings.!
!

The(concept(of(‘separate(legal(entity’,(or(‘corporate(personality’(!
Once!registered!under!the!Corporations+Act,!a!company!becomes!a!‘legal’!person!
and!obtains!very!broad!powers!to!operate,!similar!to!but!different!from!an!actual!
person.!A!company!can:!!

•! enter!into!contracts;;!
•! own!property!in!its!own!name;;!!
•! sue!and!be!sued;;!!
•! have!perpetual!succession!(exist!forever,!unlike!a!person!)!
!
Upon! registration,! the! law! recognises! a! company! as! a! separate! entity! distinct!
from! its! members,! which! is! the! most! important! and! fundamental! concept!
underpinning! Australian! Company! Law.! This! principle! came! from! the! famous!
case!of!Saloman+v+Saloman+&+Co.!The!concept!of!‘separate!entity’,!or!‘corporate!
personality’! is! also! referred! to! as! the! ‘corporate! veil’,! as! once! a! company! is!
registered!a!fictional!‘veil’!separates!the!company!from!its!members!and!directors.!
This! means! that! as! long! as! the! directors! or! members! have! not! engaged! in!
wrongdoing,!the!courts!cannot!‘see’!the!owners!or!managers!of!a!company,!which!
means!their!personal!assets!will!not!be!at!risk!of!being!used!to!pay!for!the!debts!
of!the!company!if!the!company!becomes!insolvent.!!

Proprietary(Companies((‘private(companies’)(
A!proprietary!company,!often!called!a!‘private’!company,!is!typically!recognised!
through!the!abbreviation!‘Pty!Ltd’,!and!is!a!common!structure!adopted!by!smaller!
businesses,!such!as!family!run!organisations.!A!proprietary!company!has!certain!
limitations! placed! upon! it:! it! can! only! have! a! maximum! of! 50! members! (or!
shareholders)! and! it! cannot! engage! in! fundraising! activities! which! require!
disclosure,! which! means! that! this! type! of! company! cannot! acquire! funds! from!
public!shareholders!in!the!same!way!that!a!public!company!listed!on!the!stock!
exchange!can!do.!!Proprietary!companies!can!be!small!or!large,!depending!on!
the!amount!of!revenue!they!make,!how!many!assets!they!hold,!and!how!many!
employees!they!have.!A!proprietary!company!can!limit!the!liability!of!its!members!
by! shares.! Small! proprietary! companies! are! not! usually! required! to! prepare!
financial!statements.!!

6 Reading Notes for Commercial Law

Public(Companies((
Any!other!company!is!a!‘public’!company!and!is!generally!recognised!through!the!
abbreviation!‘Ltd’.!Most!large!companies!are!public!companies.!To!be!able!to!list!
and! have! its! securities! (its! shares)! quoted! on! the! Australian! Stock! Exchange!
(ASX),!the!company!must!be!a!public!company.!A!public!company!can!be!limited!
by!shares!or!by!guarantee.!

Company(limited(by(shares((

This! is! the! most! common! type! of! company! as! both! public! and! private!
companies!can!have!the!liability!of!their!members!limited!to!the!amount!of!
money!they!agree!to!invest!by!way!of!the!value!of!their!shareholdings.!Note!
that!the!word!‘Limited’!or!the!shorter!version!of!‘Ltd’!must!be!part!of!the!
company’s!name.!!

Company(limited(by(guarantee((

Note!that!only!public!companies!can!take!this!form.!Members!agree!to!be!
liable!for!a!fixed!sum!in!the!event!the!company!is!wounddup,!that!is,!they!
‘guarantee’!or!promise!to!pay!a!certain!amount!if!the!company!becomes!
insolvent! and! cannot! pay! its! debts.! Members! benefit! by! not! having! to!
contribute!funds!until!the!company!is!wounddup.!!

While! many! of! these! provisions! are! mandatory,! not! all! provisions! are!
prescriptive,! for! instance,! the! internal! management! of! the! company.! ! A!
company!may!choose!to!be!governed!by!a!constitution!or!else!rely!on!the!
default!‘replaceable!rules’!contained!in!the!Act.!
!
In!addition!to!the!Corporations+Act,!there!are!key!principles!established!in!
case!law,!which!will!be!enforced!by!the!courts!if!an!individual!brings!legal!
action! before! the! courts.! An! example! is! the! famous! case! of! Salomon+ v+
Salomon! which! established! the! concept! that! once! a! company! is!
incorporated,! it! becomes! a! separate! legal! entity! from! the! owners! and!
managers!of!the!company.!!
(

The(concept(of(‘limited(liability’(!
The!concept!of!the!‘separate!entity’!reinforces!the!concept!of!limited!liability.!This!
means! that! shareholders! will!not! be! liable! to! pay! more!money! than! they! have!
promised!to!pay,!if!the!company!becomes!insolvent!and!cannot!pay!its!own!debts!
to!creditors.!!

The!terms!‘shareholder’!and!‘member’!are!often!used!interchangeably,!but!can!
mean! different! things.! A! member! is! an! individual! who! has! invested! in! the!
company! in! some! way:! this! may! be! buy! purchasing! shares! and! becoming! a!
shareholder,!or!by! guaranteeing! to!pay! a!certain! amount!of!money! should!the!
company!be!wound!up.!A!shareholder!holds!shares! in!the! company!and!limits!
their!liability!to!the!amount!of!money!they!have!paid!for!their!shares!(or!will!pay,!
if!they!have!bought!partlydpaid!shares).!

7
 Reading Notes for Commercial Law

8.(Corporate(governance:(fundraising(
An(introduction((
There!are!two!ways!that!a!company!can!raise!finances:!through!equity!financing!
or!debt!financing.!With!companies!limited!by!shares,!there!are!two!main!sources!
of!company!finance!–!share!capital!and!debt!finance.!With!the!latter,!it!usually!
consists!of!money!lent!to!the!company!subject!to!the!payment!of!interest!and!the!
repayment!of!the!capital.!!

Debt! financing! involves! the! lending! of! money,! usually! a! bank! or! institutional!
investor,!to!a!company!which!is!then!secured!against!the!assets!of!a!company!
which!may!be!possessed!by!the!investor!if!the!debt!is!not!repaid.!We!will!discuss!
various!instruments!used!for!debt!financing,!including!debentures,!securities,!and!
loan!agreements.!

Debt(Financing!
Section!124(1)!gives!companies!the!power!to!borrow,!issue!debentures,!and!to!
give!security!by!charging!its!uncalled!capital!and!to!grant!floating!charges!over!
the! company’s!property.!Companies!may!raise!debt!capital!by!public!issues!of!
debentures!or!they!may!do!so!privately,!for!example!by!borrowing!from!financial!
institutions!such!as!banks!or!from!private!individuals!who!may!be!a!director!or!
shareholder!of!the!company.!!

Borrowings!by!companies!may!be!secured!and!unsecured.!Therefore,!the!rights!
of!creditors!vary!depending!on!whether!the!lending!is!secured,!for!examples,!by!
guarantees,!mortgages!over!the!company’s!real!property!or!security!interests!/!
charges!granted!by!the!company!over!its!assets.!!

A(debenture,!in!very!simple!terms,!is!an!acknowledgment!of!a!debt.!The!debt!
may! be! secured! or! unsecured.! Section! 9! defines! it! as! a! chose! in! action! that!
includes! a! binding! undertaking! by! a! company! or! other! body! to! repay! a! debt,!
money!deposited!with!or!lent!to!the!company!or!other!body!and!which!undertaking!
may!be!secured!or!otherwise.!Debenturedholders!are!essentially!creditors!of!the!
company!and!they!are!entitled!to!a!return!usually!in!the!form!of!interest!payments!
during!the!term!of!the!debenture.!The!definition!in!the!Corporations!Act!s!9!states!
a! debenture! is:! “a! legally! binding! undertaking! by! a! company! or! other! body! to!
repay!a!debt!where!that!debt!is!money!deposited!with!or!lent!to!the!company!or!
other!body.”!

Distinguishing(debt(financing(and(equity(fundraising(
Debt!finance/loan!capital!is!to!be!distinguished!from!equity!finance/share!
capital.!These!are!some!main!differences:!
!

•! Shareholders!are!internal!members,!lenders!are!not.!
•! Dividend!payment!depends!on!profit,!Interest!payment!does!not.!
•! Maintenance!of!share!capital!does!not!apply!to!debt!capital.!

8 Reading Notes for Commercial Law

 9.(Corporate(governance:(the(relationship(
between(corporate(organs(
The(internal(rules(of(a(company((
Internal! rules! are! those! rules! which! govern! the! relationship! between! the!
participants!within!a!company!i.e.!between!the!company!itself,!its!members!and!
its!officers.!These!rules!are!sometimes!referred!to!as!internal!governance!rules!
or!internal!rules.!!

For! a! company! incorporated! prior! to! 1! July! 1998,! its! rules! comprised! of! a!
memorandum!of!association!and!articles!of!association!which!were!collectively!
referred!to!as!the!constitution!of!the!company.!These!were!rules!that!were!written!
by!representatives!of!the!company!(such!as!members!or!directors),!and!which!
formed!a!‘rule!book’!in!the!same!way!that!a!piece!of!legislation!will!have!different!
provisions!advising!conduct!that!is!allowed,!not!allowed,!and!what!people!must!
do.!Rules!would!cover!areas!such:!when!and!how!company!meetings!would!be!
conducted;;!the!powers!of!the!board!of!directors;;!requirements!to!produce!reports,!
and!methods!of!financial!reporting;;!and!the!powers!of!members.!A!publicly!listed!
company!on!the!stock!exchange,!who!have!issued!shares!must!have!their!own!
rule!book,!called!a!constitution.!!

After! 1998,! certain! companies! may! no! longer! need! to! write! their! own! rules! –!
generally,!these!are!private!companies!who!do!not!have!the!power!to!issue!public!
shares.!Instead,!the!Corporations+Act!lists!39!‘replaceable!rules’!that!a!company!
can!adopt!as!their!own!rules.!These!are!written!in!a!fairly!broad!way!and!are!not!
tailored!to!the!needs!of!a!company,!so!companies!may!prefer!to!write!their!own!
rules!as!a!better!way!to!manage!their!internal!governance.!Companies!who!are!
able!to!adopt!the!replaceable!rules!can!choose!to!adopt!all!of!them,!or!they!may!
have!a!mixture!of!their!own!rules,!and!the!replaceable!rules.!

The(concept(of(‘separation(of(powers’(!
As!explained,!once!a!company!is!incorporated,!it!becomes!a!separate!legal!entity!
from!the!people!who!own!it!(members)!and!from!the!people!who!manage!it!(such!
as!the!directors).!Members!and!directors!have!different!powers,!and!they!cannot!
use!their!power!to!take!away!the!rights!of!each!other.!

As!discussed!above,!companies!operate!under!a!set!of!rules,!either!through!their!
own!constitution,!or!through!the!adoption!of!the!39!replaceable!rules!within!the!
Act.! Whichever! method! is! chosen,! the! legal! effect! of! the! internal! rules! of! a!
company!is!that!they!form!a! binding!legal!contract! between!the:! company!and!
directors;;!company!and!members;;!and!between!each!member.!

Corporate(Liability((
Companies!may!be!liable!for!civil!wrongs!such!as!torts!(for!example,!negligence)!
and! they! can! also!be!liable!for! crimes.! In! both!cases,!liability! can! be! attached!
either!vicariously,!or!directly!to!a!company.!

9
 Reading Notes for Commercial Law

For!civil!wrongs,!this!may!involve!a!fine,!and!a!Court!may!use!its!powers!to!require!
the!company!to!adopt!a!constitution,!or!have!a!company!meeting,!or!to!stop!a!
director!from!taking!away!the!rights!of!a!shareholder.!!

For!criminal!offences,!clearly!the!company!cannot!go!to!gaol!as!it!is!not!an!actual!
person,!so!instead!the!fines!are!much!higher,!and!as!above,!the!courts!can!use!
their! powers! to! require! the! company! to! make! changes! so! that! it! operates!
according!to!the!law,!which!may!also!require!improving!its!corporate!governance.!
A!company!who!continually!breaches!the!Act!may!run!the!risk!of!being!wound!up,!
even!it!is!operating!at!a!profit!(although!this!is!very!rare).!(

The(role(of(the(Company(Board((
The!board!of!directors!plays!a!crucial!role!in!effective!corporate!governance.!The!
board!is!the!main!decision!maker!for!the!company!and!has!the!day!to!day!control!
of!the!company.!It!controls!the!financial!and!operational!policies!of!the!company!
and!is!involved!directly!in!the!supervision!of!senior!management.!Therefore,!the!
nature! of! corporate! governance! will! be! heavily! influenced! by! board! decision!
making.!!

A! proprietary! company! must! have! at! least! one! director! and! a! public! company!
must!have!at!least!three!directors.!!

ASX(Corporate(Governance(Recommendation(2:((
A! listed! entity! should! have! a! board! of! an! appropriate! size,!
composition,! skills! and! commitment! to! enable! it! to! discharge! its!
duties!effectively.1!
!
Senior! management! (and! also! individual! directors)! may! be! motivated! to!act! in!
their!own!interest!from!time!to!time.!The!board!is!seen!as!the!main!mechanism!to!
ensure! this! does! not! happen.! That! means! the! board! as! a! whole! must! control!
individual! members! of! the! board! and! senior! executives! placing! their! personal!
interest!before!that!of!the!company.!The!board!can!also!be!involved!in!looking!
after! other! stakeholder’s! interests! including! that! of! creditors,! employees,!
suppliers!and!the!wider!community!in!which!the!company!operates.!!

Higher(community(expectations(of(directors(!
In! Overend+ &+ Gurney+ Company+ v+ Gibb2 ,! an! English! case! decided! in! 1872,!
directors!were!only!liable!for!a!breach!in!their!duty!of!care!if!they!acted!with!gross!
!
negligence.! In+ Daniels+ v+ Anderson3 a! case! decided! in! Australia! in! 1995! the!
director! was! to! exercise! only! the! care! which! could! reasonably! be! expected! of!
person!of!his!knowledge!and!expertise.!This!combined!effect!of!a!higher!standard!
than! ordinary! negligence! and! the! subjective! nature! meant! that! directors! were!

1!ASX!Corporate!Governance!Council,!Corporate+Governance+Principles+and+Recommendations+
(3rd!ed,!2014)!http://www.asx.com.au/documents/publicd!consultations/draftdcgcd3rddedition.pdf.
!
2![1872]!LR!HL!480,!487.!!
3!(1995)!16!ACSR!607.!!
10 Reading Notes for Commercial Law
rarely!held!liable!for!a!breach!of!their!duty!of!care,!skill!and!diligence.!!

The!reasons!the!courts!had!in!the!past!been!reluctant!to!expect!high!standards!
of!care,!skill!and!diligence!were:!!

•! Taking!up!a!position!as!a!nondexecutive!director!(NED)!on!a!part!time!basis!
should!not!be!coupled!with!onerous!obligations!!
•! Directors! are! not! specialists,! like! lawyers! and! doctors! o! Directors! are!
expected!to!take!risks!!
•! Courts! cannot! second! guess! business! decisionso! Companies! can!
arrange!their!own!internal!management!!

(
Legal( recognition( of( changed( community( expectations( of(
directors(!
The!courts!for!a!number!of!reasons!have!raised!the!standard!to!which!directors!
4
are!held!to!account. !

1.! !Directors!liability!developed!as!the!body!corporate!evolved!from!a!model!
where!the!managers!and!shareholders!were!more!closely!connected!!
2.! The!modern!concept!of!negligence!and!duty!of!care!is!now!the!acceptable!
basis!for!directors!to!be!liable!for!a!breach!of!their!duty!of!care!!
3.! The! law!of!negligence! has!developed!considerably! since! the!early! cases!
were!decided.!!
(

Board(functions(!
The!division!between!the!functions!of!the!board!of!directors!(executive!directors!
and!nondexecutive!directors)!and!the!CEO!was!explained!in!the!case!of!AWA+Ltd+
v+Daniels.5 !A!board’s!functions!are!to:!

1.! To!set!goals!for!the!corporation!!
2.! To!appoint!the!CEO!!
3.! To!oversee!the!plans!of!managers!to!attain!the!goals!of!the!corporation!!
4.! To!review!progress!towards!obtaining!those!goals.!!
The!board!of!a!large!public!corporation!is!practically!limited!in!managing!the!dayd!
todday!business,!but!it!is!done!under!the!direction!of!the!board.!Because!of!the!
distinction! between! managing! and! directing,! it! is! often! difficult! for! managers!
promoted!to!the!board!to!properly!perform!their!role!as!a!director.!They!also!tend!
6!
to! microdmanage! their! successor. This! is! also! a! strong! argument! against! the!

4
!Jean!Jaques!du!Plessis,!Anil!Hargovan!and!Mirko!Bagaric,!Principles+of+Contemporary+
Corporate+Governance+(Cambridge!University!Press,!2nd!ed,!2011),!74.!
5!
(1992)!10!ACLC!933.!
6
!Jean!Jaques!du!Plessis,!Anil!Hargovan!and!Mirko!Bagaric,!Principles+of+Contemporary+

11
 Reading Notes for Commercial Law

CEO!becoming!the!chairman!of!the!board,!as!they!need!to!detach!themselves!
from!thinking!like!an!operational!manager!and!focus!on!the!responsibilities!of!the!
chairman.! The! notion! of! the! retiring! CEO! becoming! the! chairman! is! attractive!
because!it!is!based!on!continuity!and!the!inside!knowledge!of!the!CEO.!

The!ASX!principles!summarise!the!responsibilities`!of!the!board!in!more!detail.!
The!OECD+Principles+of+Corporate+Governance+(revised!in!2015),!which!we!will!
review! later! in! the! course,! considers! that! the! board! should! provide! strategic!
guidance,!monitor!management!and!be!accountable!to!the!shareholder!and!the!
company.!The!board!is!the!brain!of!the!enterprise.7!The!purpose!of!the!board,!
according! to! the! UK! Institute! of! Directors! (IOD),! is! to! collectively! direct! the!
company!to!secure!its!prosperity!while!meeting!the!interests!of!shareholders!and!
stakeholders.!The!board’s!responsibilities!are!to!direct;;!govern;;!guide;;!monitor;;!
oversee;;!supervise;;!and!comply. 8 !!

Tricker! divides! the! role! of! the! board! into! two! functions:! performance! and!
conformance,!as!follows:9!
Performance(!
•! Contributing!knowdhow,!expertise!and!external!information;;!!
•! Networking,!representing!and!adding!status;;!!
•! Policy!formulation;;!and!
•! Strategic!thinking.!
( ((((((((Conformance(
•! Judging,! questioning! and! supervising! senior! management! (KPIs,!
cash!flow,!budgets!and!projects);;!
•! Watchdog,!confidant!and!safetydvalve!role;;!and!
•! Accountability! (quality! of! thinking,! ethics,! treatment! of!
stakeholders).!!
Boards!need!to!be!careful!they!do!not!focus!on!conformance!to!the!detriment!of!
performance.!Rather!than!seeing!themselves!as!perched!atop!a!pyramid,!Garratt!
argues!that!directors!should!see!themselves!as!the!business!brain!at!the!centre!
!
of!the!enterprise.10 Review!the!Institute!of! Directors!(‘IOD’)!materials!on!board!
effectiveness! at! the! following! link:! Institute! of! Directors,! Board+ Effectiveness,!
<http://www.iod.com/guidance/briefings/bisdboarddeffectiveness>!

Corporate+Governance+(Cambridge!University!Press,!2nd!ed,!2011),!79.!
7
!Jean!Jaques!du!Plessis,!Anil!Hargovan!and!Mirko!Bagaric,!Principles+of+Contemporary+
Corporate+Governance+(Cambridge!University!Press,!2nd!ed,!2011),!80.!
8 Ibid, 81.
9 Ibid.
10 Bob Garratt, The Fish Rots from the Head, P Profile Books, London (2003), 4.

12 Reading Notes for Commercial Law