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I have a presentation needed to be done next week. Company Law course.

there is an article to read and summarize so I can present in 4 to 5 minutes.

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2005 COlporate Donations 69 CORPORATE DONATIONS, THE BEST INTEREST OF THE COMPANY AND THE PROPER PURPOSE DOCTRINE ELIZABETH KLEIN* AND JEAN J DU PLESSIS" Corporate philanthropy is illegitimate spending by powerful corporate elite of someone else's money; an attempt to bypass democratic allocation of taxes; philanthropy by individuals is laudable, but not by corporations. 1 Just as 1 wouldn't want you to implement your personal judgments by writing checks on my bank account for charities of your choice, I feel it inappropriate to write checks on your corporate 'bank account' for the charities of my choice. 2 I INTRODUCTION Objections to the use of corporate resources for anything other than promoting the interests of the company have a strong historical tradition. Milton Friedman, for example, famously declared in 1970 that 'the social responsibility of business is to increase its profits'.3 More recently, Sir Gerard Brennan commented that the choice should remain with the individual investor when he or she obtains his or her share of the distributed profits. From the moral standpoint, there is no virtue in a director's resolution to dispose of corporate assets to a charitable object 4 * *' 2 3 4 LLB (Hons) (Deakin University); B.Agr.Sc. (Hons) (Univcrsity of Melbournc). We would likc to thank the referees and the board rcview for their constructive criticism on the first drati. this articlc submitted for publication in the University afNew South Wales Ltn... Journat. BProc, LLB, LLM, LLD (UOFS). Professor of Law, School of Law, Deakin University, Australia. PP McGuinness, 'Corporate Philanthropy, Govcrnment and Blackmail' (2003) 47(6) Quadront2. Warren Buffct1, 'Berkshire Hathaway Jnc - Shareholder Designated Contributions' (1981), at 8 August 2004. Milton Friedman, 'The Social Responsibility of Business is to Jncrease Its Profits', The New York Times Magazine (New York), 13 Septembcr 1970. 'Law, Values and Charity' (2002) 76 Australiarl Law Journal 492,497. A similar view was expressed by thc Australian Shareholders' Association in 2004. See Australian Shareholders' Association, 'Statement of Corporate Governance Principles' (2004), [6] at 28 March 2004: or Copyright of Full Text rests with the original owner and, except as permitted under the Copyright Act 1968, copying this copyright materialis prohibited without the permission of the owner or agent or by way of a licence from Copyright Agency Limited. For rnformatlOn about such licences. contact the Copyllght Agency Limited on (02) 93947600 (ph) or (02) 93947601 (fax) _ 70 UNSW Law Journal Volume 28(1) What is the law on this issue? Some assume that it is legal for businesses to make charitable donations, S at least up to a reasonable amount, whether or not the company will gain from this commercially. For example, the Chainnan of the Telstra Foundation has said: Philanthropy is not sponsorship. Philanthropy is giving without the expectation of reward. We will give with integrity, judging all grant applications fairly. Decisions made for the Foundation will always drive towards meeting our mission - to make a positive and lasting d!!Jerence to children andyoung people_ 6 This understanding is echoed in the following comments by Telstra representative Mr Bill Scales who, lamenting public scepticism regarding corporate philanthropy, said: 'We think that over time people will come to understand that this is not for commercial gain.' 7 Others are aware that this approach may be problematic from a legal point of view. Mr David Gonski, a prominent businessman and advocate of philanthropy, has called for the law on corporate philanthropy to he clarified. 8 One of the most famous statements on ex gratia payments was made as early as 1883 in the case of Hutton v West Cork Railway Co. 9 In that case Bowen 11 made the point, in a now famous passage, that the Court should recognise that a certain amount of largesse is conducive to good business. This comment had a very important qualification: '[t]he law does not say that there are to be no cakes and ale, but that there are to be no cakes and ale except such as are required for the benefit of the company. ' 10 Social Policy_ It is not the responsibility of business to indulge in uneconomic activities to urging from the government of the day_ [1' govenllTIcnt is convinced that a service is has the structure to implement an appropriate policy, and it has the taxation system BLLsiness should not be expected to do so on a 'voluntary' basis. Companies have uneJectcd and unpaid implementers of social policy. 5 6 7 8 9Q in response required, it to fund it. no role as This statement is no longer available on the ASA's website_ A position statement entitled 'Shareholders Expect' is expresscd in more moderate languagc, and explicitly recognises that '(dJirectors arc clected by shareholders to ovcrsee the management of companies in the interest of the company itsclf and its stakcholders'. See at 10 JLLly 2005. See also Adolf Berle, 'The Impact of the Corporation on Classical Theory' in Thomas Clarke (cd), Theories o/CO/porole Governance_- The Philosophical Foundalions o/C0I1JOrate Governance (2004) 45, 49-51. For purposes of this article the terms 'gratuitous (ex gratia) payments', 'corporatc donations', and 'gifts' are used synonymously_ Herb Ellio!!, Message,/i-ol11 the Chairman, Telstra Foundation at 22 May2005 (emphasis added). Petcr Munro and Ben Wyld, 'Busincss Begs for Gratitude - Not Attitude', The Sydney Morning Herald (Sydney), 18 March 2003, 3_ Wc acknowledgc that this approach is more likely to be valid in a company such as Tclstra, which is part-owned by the government, than in a public company_ However, it is submitted that this aUitude would not be uncommon in companies which are wholly puhlicly owned. David Gonski, 'Restoring Faith: Leadership and the Bottom Line' (Speech delivered at the Australian Jnstitute of Company Directors, Sydney, 26 September 2003). (1883) 23 Ch D 654, lbid 672. 2005 Corporate Donations 71 The statement made by Bowen LJ remains an accurate summary of the law on corporate donations. In this paper, it is argued that if corporate donations are made other than for the benefit of the company, directors will be in breach of their directors' duties. However, it is also submitted that in practice almost any donation could be justified as being in the interests of the company, for example, because the donation improved the company's reputation. A distinction needs to be made between donations which are justifiable in this way and are therefore not in breach of directors' duties and donations which cannot be so justified. The latter may be referred to as altruistic donations. It is argued that it is illegal in Australia for a corporation to make an altruistic donation, unless the corporation's constitution specifically allows it. The legal position, which requires companies to be self-interested, can be contrasted with the expectations expressed by two out of three citizens in a survey of 25 000 people in 1999, who said that they 'want companies to go beyond their historical role of making a profit, paying taxes employing people and obeying all laws; they want[ed] companies to contribute to broader societal goals as well'. 11 The difference between what the law requires and the expectations reflected in that survey puts directors in a difficult position: they are under pressure for their companies to make altruistic donations, yet such donations are proscribed by the law. This problem is particularly acute for directors of listed companies, who are required to account to shareholders for their actions. An illustration of the importance of ensuring legal certainty in this area was the Indian Ocean tsunami of 26 December 2004 which, by some estimates, killed approximately 288 828 people. 12 There was a real expectation that large corporations would donate to the disaster funds 13 and many Australian companies contributed generously,14 but were these donations made legally? Were they done for 'the benefit ofthe company'? The Australian Shareholders Association (the 'ASA') recently discovered the strength of feeling in the community on this issue when it was forced to retract its statement that corporate donations to tsunami relief efforts should not be made II 12 13 14 Environics International Ltd. The Milleniul11 Poll on COtpOrale Social Responsibility: Executive Briefing (J 999) 2, International Business Leaders FOlum at 30 June 2005. 'Tsunami Dead and Missing Rises to 288,828', The Sydney Morning Herald (Sydney), 18 February 2005. at 10 June 2005. See. ego John Howard, Prime Minister of Australia, who stated: 'I obviously would like to sce as many big donations as possible from Australian companies - business conditions are good, many companies can afford lo make significant donations and many are': Geoff Elliott, 'Call for Companies to Give'. The Australian (Sydney), 3 January 2005, 9. Eleven days after the tsunami struck, corporate donati(lllS were estimated to have reached A$16 000 000: Geotf ElliOll, 'Corporate Donations Hit $16111', The Australian (Sydney), 7 January 2005. 7. UNSW Law Journal 72 Volume 28(1) without prior shareholder approval. The ASA had not had a bigger response to comments on any other issue over the last five years. 15 This article will show that while the law on this point may be complex, it can be explained by focussing on the interplay between several well-known doctrines and tests of corporations law including the doctrine of the supremacy of the company's constitution (previously called a company's charter, memorandum and articles of association); the doctrine that a power conferred upon a particular organ is an exclusive power of that organ; the allocation of powers; the proper purpose doctrine; and the 'best interest of the company' test (or 'benefit to business') test. 16 The article commences with a discussion of various core principles of intemal company law before proceeding to a detailed analysis of the proper purpose duty, and the duty to act in the best interests of the company. The well-known case of Parke v Daily News Lldl ? and related cases are discussed in order to extract the principles that a court would apply in deciding whether or not corporate donations are valid. With regard to gratuitous payments, the application of a twolimbed test, which incorporates the principles laid down in Pm-ke v Daily News Ltd, is proposed. The overlap of the duty to act in the best interests of the company and the duty to act for proper purposes is also dealt with. It is argued that where the validity of corporate donations is at stake, the 'proper purpose' requirement is conflated into the concept of the 'best interests of the company'. These principles are then applied to corporate donations, explaining how the duty to act in the best interests ofthe company does not necessarily prevent companies from making large donations, or hom having extensive philanthropic programs. Finally, the future of the law on corporate donations is discussed, as well as some practical issues for directors to consider when making corporate donations are identified. II A CORE PRINCIPLES AND DOCTRINES OF INTERNAL COMPANY LAW 18 The Doctrine Of The Supremacy Of A Company's 'Constitution' Although we have a system of 'replaceable rules' in the COlporations Act making it unnecessary for a company to adopt a constitution, many companies that were in existence on I July 1998 when the law changed may still 2001 (Cth), 15 J6 17 18 Malcolm Maiden, 'Tsunami: The Backlash', The Age (Melboume), 12 February 2005, J. HUI/on v West Cork Railway Co (I H83) 23 Ch D 654; Parke v Daily News Lld [J 962] 2 All ER 929. See also Part IV below. [1962] 2 All ER 929. For the application of some of these doctrines and tests in a difrcrenl conlcxt, see Jean J du Plessis, 'Directors' DUly to Use Their Powers for Proper Or PemJissible Purposes' (2004) J 6 SOl/th Afi-ican Mercantile Lall' Jourl/o/30S. 2005 CO/porate Donations 73 have memoranda of association and articles of association. There may also be good reasons why companies would consider the 'replaceable rules' inappropriate and choose to adopt a constitution. 19 It is therefore still of considerable importance to realise the important legal consequences of provisions in a company's constitution. The legal effect of the constitution and its binding nature formed the core issue in several older company law cases. It was held, almost without exception, that the provisions of the constitution would bind the company and the shareholders as if the constitution were signed personally by each member. These sentiments are also contained in the COlporations Act 2001 (Cth), which clearly states that a company's constitution fonns a contract between the company and its members, the members inter se and the company and its directors. 2o This is a unique contract as it may be altered by a special resolution of the shareholders 21 but, as long as it is not altered, the provisions of the constitution are considered to be supreme. Because of these considerations, authors started to refer to the 'supremacy of the articles of association',22 that will nowadays apply equally to the company's 'constitution'. This principle has been recognised by courts in other jurisdictions. In South Africa, the Supreme Court of Appeal in LSA (UK) Ltd v 1mpalo Platinum Holdings (Ltd)23 explained as follows: What it amounts to is that the founding members, and also a later body of members by special resolution, may order the internal affairs of their company in the way that suits them best, subject to such prohibitions as may exist in the Act or any other law, statutory or common. This dispensation is unsurprising when one statute govems many diverse fonns of company.24 A vely specific consequence of this doctrine is that powers conferred upon a certain organ by the constitution are within the exclusive power of that organ, until altered by special resolution, and that such powers cannot be usurped by any of the company's other organs. 25 19 20 21 22 23 24 25 l-J A J Ford, RP Austin and j M Ramsay, Ford's PrinCiples of Corporalions Law (12'" ed, 2004) 184, 182. Corporalions ACI2UO] (Oh) s 140(1). In Australia. there arc cven limitations to the company's powcr to change the constitution if such a change would give rise to a conJlict of interests and advantages. Sec Gambollo v WCP Lld (1995) 182 CLR 432. See especially imlllcdiately after the heading, 'The test for dctcrmining whethcr an expropriation is valid' (444). S C Scn, Company AClions in lhe Modem Sel-Up (1969) 19,22. Given the transition in Australia from 'atticlcs of association' 10 'constitutions', it is now more appropriate to refer to the doctrine as 'thc supremacy of the constitution'_ (222/1998) (28 March 2000) Supreme COUlt of Appeal of South Africa. Ibid. See Scoll v Scoll [1943] I All ER 582; John Shaw & SOI1S (Sa!(ord) Lid v Shall' [1935] 2 KB 113, 134 (Lord Green); l-J S Cilliers et al, Ci/liers & Benade: Co/porale Law (3rd ed, 2000) 87 and cases quolcd therc. See also 7I1e Duke Gro1lp Lld (i/7 liq) v Pilmer (1998) 144 FLR 1. Sec gcnerally L S Sealy. 'Bona Fides and Proper Purposcs in Corporate Decisions' (1989) 15 Monash Universily Law Review 265, 272. UNSW Law Journal 74 B Volume 28(1) The Doctrine Of Non-Interference With Internal Matters Of A Company Closely linked with the doctrine of supremacy of the constitution is the principle that the courts are reluctant to interfere with the internal affairs of companies. 26 It has been held on several occasions that the courts will not second-guess the decisions properly taken by directors as part of powers conferred upon them by the constitution. 27 The court can, in actual fact, not interfere with internal decisions arrived at bona fide and honestly, as explained by Lord Wilberforce in Howard Smith Ltd v Ampol Petroleum Ltd28 ('Howard Smith'): Their Lordships accept that such a matter as the raising of finance is one of management, within the responsibility of the directors: they accept that it would be wrong for the court to substitute its opinion for that of management, or indeed to question the correctness of management's decision, on such a question, if bona fide arrived at. There is no appeal on merits from management decisions to courts of law: nor will courts of law aSSume to act as a kind of supervisory board over decisions within the powers of management honestly arrived at. 29 The reason a court will not interfere with duly exercisedjnternal decisions of. directors is summarised neatly by Kirby P in Darvall v North Sydney Brick & Tiles Co Ltd: 30 Courts properly refrain from assuming the management of corporations and substituting their decisions and assessments for those of directors. They do so, inter alia, because directors can be expected to have much greater knowledge and more time and ex~ertise at their disposal to evaluate the best interests of the corporation than judges. I 26 27 28 29 30 3J Lord]l The Governor & Co of Copper Miners (J 848) 41 ER 1129, I J34; MacDougall ]I Gardiner (1875) 1 Ch 0 13,23 (lames LJ); isle of Wighl Railway Co ]I Tahonrdin (J 883) 25 Ch 0320,333 (Lindley LJ); Bainbridge v Smilh (1889) 41 Ch 0462,474 (LindJey LJ). This principle is fimlly embedded in South Afi'ican law: see Adams ]I North 1933 CPO 100, J08; Cooper v Carratl 1945 WLD 137, 148, 152; and cases cited in Makhuva ]I LukolO BlIs Sen'ice (PM Lid 1987 (3) SA 376, 393-5. See gencrally 'Reccnt Cases: Ampol Petroleum v 11 W Miller (Holdings)' (1974) 48 Auslralian Law Journal 319. See especially f100le v Grea! Weslern Railroad Co (1867) LR 3 Ch App 262, 268, 275 (Lord Cairns LJ); Bond ]I Barrow Haemalile Steel CO [1902J 1 Ch 353, 368 (Farewell l); cases cited in Australian Metropolilan Life Assurance Co Ltd v Ure (1923) 33 CLR 199,217 (lsaacs J); Shllllleworlh ]I Cox Brothers & Co (Maidenhead) Lld [1927J 2 KB 9,23-4 (Scrutton LJ); Re Smilh & Faweell Lld [1942] Ch 304, 306 (Lord Greene MR); Hogg ]I Cramphorn Lld [1967] Ch 254, 268 (Buckley l); Wayde ]I NSW Rugby League Lld (1 985) 180 CLR 459, 469 (Brellnan J). See also Sealy, above n 25, 277; Robert Baxt. 'Second Guessing Direetors' Dccisions on Takeovers - A Mixcd Message from the New South Wales Court of Appear (1990) 8 Company and Seeurilies Law Journal 26, 27. [1974JAC821,832. Ibid. See also Wayde v NSW Rugby League Ltd (1985) 180 CLR 459, 469-70 (Brennan l); Harlowe's Nominees Pty Lld v Woodside (Lakes Entrance) Oil Co NL (1968) 121 CLR 483, 493 (Balwick Cl, McTieman and Kilto JJ). (1989) 16 NSWLR 260. [bid 281. Sec also Harlowe 's Nominees Ply Ltd v Woodside (Lakes Enlranee) Oil Co NL (1968) 121 CLR 483, 493 (Barwick Cl, McTieman and Kino JJ): 'Directors in whom are vested the right and duty of deciding where the company's interests lic and how they are to bc served may be concerned with a wide range of practical considerations, and thcir judgment, if exercised in good faith and not for irrelevant purposes, is not open to rcview in the courts.' C017JOrate Donations 2005 75 Thus, there are formidable obstacles in the way of shareholders who want to challenge the validity of actions taken by directors under powers conferred upon them by the constitution. First, the courts will consider the provisions in the constitution as the dominant document for detennining who would have the power to fulfil a particular internal function under the principle of the supremacy of the constitution. Second, if the powers were prima facie exercised within the limits of the powers confened upon the organs and were exercised bona fide and honestly, the courts will not, and in fact cannot, second-guess the wisdom of decisions relating to these powers. C Allocation Of Powers Directors usually have the power to exercise all of the company's powers,32 except those powers which are explicitly required to be exercised by shareholders, either by the constitution, or by the Corporations Act 2001 (Cth).33 Some of the powers that are not reserved for the general meeting may also be explicit, for example, where the constitution specifically allocates the power to issue shares to the board. In most cases, the power to make donations would not reside with shareholders. Neither would there be an explicit power granted to directors to make such donations. This means that directors who make corporate donations are acting pursuant to the same power that they would use to make other management decisions: the general power of management, as set out by the constitution (if any). Section 198A of the COIporations Act 2001 (Cth) could be replaced by a provision in a company's constitution, as it is a replaceable rule, but is a typical example of a statutory power conferring general managerial powers upon directors: 'The business of a company is to be managed by or under the direction of the directors'. This means that, provided directors can justify corporate donations as being made in the interests of the company, they have the power to make them without having to obtain shareholder approval. 34 III THE PROPER PURPOSE DOCTRINE A Overview The 'purpose' behind directors' decisions can be relevant in several distinct ways. First, there is the question of whether the directors were acting in what they believed to be the best interests of the company. To assess directors' intentions, the court will often need to consider the objectives that the directors 32 33 34 Sce Ford et aL above n 19.214. COIToralions Acl 2001 (Cth) s 198A. Sce below Parl VI(D). UNSW Law Journal 76 Volume 28(1) were trying to achieve. Second, there is the question of whether the directors have abused a power by using it for a purpose other than that for which it was conferred. 35 B Types Of Actions Challenged Based On Improper Use Of Powers The classic cases involving the duty to act for a proper purpose deal with the power of directors to issue shares. 36 Several other decisions by directors have also been challenged on this basis: for instance, where directors used company funds to defend their position and to justify why shareholders should not vote for a proposed takeover. 37 Other examples include cases where directors transferred a major asset of a company just after a takeover offer was announced, alleging that they did this as an exercise of their power to manage the business of the corporation; 38 directors incurring substantial debts (purchasing of trading outlets of competing companies) and making a huge rights issue to fund the purchase shortly after a takeover offer of the company was announced, alleging that it was a commercial transaction and a natural expansion of the business of the company;39 and directors refusing to register a person as shareholder, relying on a provision in the constitution that they had the power to refuse registration as a shareholder without giving any reasons for such a decision. 4o In the last three cases the parties alleging misuse of powers were unsuccessful, as the courts were not prepared to set aside decisions taken by directors without clear substantiation that the directors exercised their powers for an improper purpose. 35 36 37 38 39 40 In this aliiele 'proper purpose' is taken as being synonymous with 'pennissiblc purpose'. Conversely, 'improper purpose' and 'impennissible purpose' arc used synonymously. See further du Plessis, above n 18 and Colin Baxter 'Ultra Vires and Agency Untwined' (1970) 28 Camhridge Law Joumal280 for a comprehensive analysis of the various ways in which powers can be exercised in a company law context, with particular reference to older cases decided in this area. Cillicrs et ai, above n 25, 146. See also J T Pretoriuset ai, Hahlo 's South Aji-ican Company Law through the Cases - A Source Book (6th ed, 1999) 292; M S Blackman, 'Companies' in W A Jouberl and J A Faris (cds), The Law of SOUlh Aji-ica - Volume 4. Part 2 (1996) 8; Robert Baxt, Keith Fletcher and Saul Fridman. Corporations and Associations: Cases and Materials (9 1h ed, 2003), 365; .I R Birds 'Proper Purposes as a Head of Directors' Duties' (J 974) 37 Modern Law Review 580, 581Advance Bank Auslralia Lld v FAIInsurance Lld (1987) 9 NSWLR 464,482-3 (Kirby P)_ The Court concludcd that in this case the directors' primary purpose was not to act in the best interest of the company and to inform the shareholders, but 10 secure the re-e1cction of the chairman and the other rctiring dircclors (4~Q-3, 487, 496). The reference to Peel v London and Norlh Weslern Railway Co [1907] I Ch 5 is intcresting (482).1n that case the directors were successful in defending their decision to use company funds to solicit proxies in support of their view on what was in the best interest of the company regarding a management decision. DOI'vall 11 North Sydney Brick & Tiles Co Lld (1989) 16 NSWLR 260, 336 (Clarke JA). Scc also Lee Panavision Lld v Lee Lighting Lld [1992] BCLC 22, 30 (Dillon U). Pine Vale fnveslments Lld v McDonnell & East Ltd (1983) 1 ACLC J294. See Tony Steel, 'Defensivc Tactics in Corporate Takeovers' (1986) 4 Company and Securities Lmv Journai 30, 43--4_ Auslralial7 Melropolilan Life Assurance Co Ltd v Ure (1923) 33 CLR J99, 215-16, 220 (Isaacs .I). See generally R C Nolan. 'The Proper Purpose Doctrinc and Company Directors' in Barry Rider (ed), The Realm of Company Law: A Collection of Papers in Honour of Professor Leonard Sea{v - SJ Berwin Professor ofCOlporale Law al the University ofCamhridge (1998) 23 ff. Corporate Donations 2005 C 77 When Will A Court Be Prepared To Intervene Based On A Power Exercised For An Improper Purpose? It will be clear from the discussion above that there is scope for a company to challenge the validity of a decision taken by the directors under a power conferred upon them by the constitution, on the basis that the power was exercised for an improper purpose. The onus of showing that a power has not been properly exercised is on the party complaining. 41 The reason the courts are prepared to set aside decisions taken by directors if they exercised their powers for an improper purpose is that powers conferred upon directors in the constitution are considered to be fiduciary in nature and if they are exercised for an improper pmpose, it will constitute a breach of the directors' fiduciary duties. 42 It is, however, important to consider how the courts have approached this issue and how they have reconciled the principle of non-interference with intemal matters with the principle that they will set aside certain acts of the directors if directors acted for improper purposes. Another interesting question is to what extent the general meeting can ratify a breach of the directors' fiduciary duty where they have misused their powers. 43 This falls outside the scope of this article. D Tests Developed By The Courts Where Powers Were Misused Or Abused It is often the case that directors exercise their powers partly for a proper purpose and partly for an improper purpose. 44 Thus, it has been necessary for the courts to develop rules to enable them to detemline whether the actions of directors should or should not be set aside. It is submitted that the approach of the Judicial Committee of the Privy Council (on appeal from the Supreme Court of New South Wales) in Howard Smith is a realistic one. The case is based on sound principle and relies on several leading English and Australian cases. 41 42 43 44 Australian Metropolitan Life Assurance Co Ltdv Ure (1923) 33 CLR 199,219 (lsaacs J); Ngurli Ltdv McCann (1953) 90 CLR 425, 445 (Williams ACJ, Fullagar and Kitto JJ). See further cases quoted in Blackman, above n 36, 187. See also Ross Parsons, 'The Director's Duty of Good Faith' (1967) 5 Melbourne University Law Review 395, 425. Ngurli Ltd v McCann (1953) 90 CLR 425, 439, 440 (Williams ACJ, Fullagar and Kitlo JJ); Hogg v Cramphorn Ltd [1967] Ch 254, 268, 269 (Buckley J); Howard Smilh [1974] AC 821,834 (Lord Wilberforce); Lee Panavision Ltd v Lee Lighting Lld [1992] BCLC 22, 29 (Dillon LT); Re a Company (no 00370 of /987); Ex parle Glossop [1988] 1 WLR 1068, 1076-77 (Harman J); Kirwan I' Cresvaie Far Easl Ltd (in liq) (2002) 44 ACSR 21,56 (Giles JA). See also Cilliers et ai, above n 25. 146-7; Nolan, above n 40, 12-17. Sec Bamford v Ba/1?ford [1970] Ch 212 and Hogg ]I Cramphom Lid [1967] Ch 254. These cases are considered by K W WCdderbum 'Going the Whole Nogg ]I Cramphom')' (1968) 31 Modem Law Review 688 and 'Recent Cases: Ampol Petroleum ]I R W Miller (Holdings)', above n 26. See generally Hannes]l MJH Pty Ltd (1992) 10 ACLC 400, 409-10 (Shell er JA). See also Michele Havenga, FidllciQl)' Dulies of Company Directors wilh Specific Regard 10 COlporate OpportuniTies (LLD thesis, University of South Africa, 1995) 67-8. See McGuire \\. Ralph McKay Lld (1987) 5 ACLC 891, 894 (Murray, Gobbo and Southwell JJ). UNSW Law Journal 78 Volume 28(1) In Howard Smith, it was pointed out that there are two steps involved when the exercise of a power by the directors is challenged on the basis that the power was exercised for an improper purpose. The first step is to determine for what purpose the particular power had been conferred upon the directors. 45 Once the purpose of the power has been determined by the court, the second step is to detennine whether, in light of the particular facts of the case, the directors misused that power. 46 The application of the two-step approach adopted in Howard Smith could be summarised as follows: if the decision by directors was primarily or substantially taken within the purpose for which the power was conferred upon the directors, the COUlt will not set such a decision aside, irrespective of the fact that, partially or incidentally, 47 the power might have been exercised for an improper purpose. 48 On the other hand, if the decision were primarily or substantially taken for an improper purpose, a COUlt will set such a decision aside, ilTespective of the fact that, paltially or incidentally, the power might have been exercised for a proper purpose. Once the court has determined that primarily or substantially the power was misused, it will not help the directors to allege that they had not gained personally or that they acted honestly - the conduct of the directors under attack will then be set aside because of the breach of their strict fiduciary duty to exercise their powers for the purpose for which the power was confelTed upon them. In this regard, there is no difference between cases where directors made a profit by reason and in vil1ue of their fiduciary office as directors and cases dealing with the misuse ofpowers. 49 E Improper Use Of A Particular Power: Fundamentally A Value Judgment Over An Internal Matter Is Required By The Court We have already pointed out that the COUlts are nonnally reluctant to interfere with a company's internal matters. However, we have also pointed out that courts will sometimes enquire whether a pal1icular power was exercised for a proper or permissible purpose. In order to make a determination of proper or improper exercise of powers by directors, the court will necessarily have to investigate 'the state of mind of those who acted and the motive on which they acted'. 50 This could be a daunting task as it 'involves an inquiry into motivations of an almost 45 46 47 48 49 50 HOlvardSmilh [1974] AC 821. See fUliher du Plessis, abovc n 18,319-20. Mect/ire \\I Ralph McKay Lid (1987) 5 ACLC 891, 895 (Murray, Gobbo and Southwell J.I). The Court referred to things incidcntally following on the decision of the directors under attack (the issuing of shares) as 'a by"product of the issuc (of shares)'. See also Mect/ire v Ralph McKay Lld (1987) 5 ACLC 891,893-6 (Murray, Gobbo and Southwell JJ) for a comprehensive discussion of the various tests applied by the Australian and English eourt~ in this regard and Maeanie (London) Lld V Cook & Walls (1967) CLY 482 (GoIT .I), as referred to in Havenga, above n 43,67 ri, 89. See Regal (Haslings) Lld V cull/ver [1942] 2 AC 134, 153 (Lord Macmillan). Hindle v John COl1011 Lld (1919) 56 Se LR 625, 630-] (lsaacs .1). as quoted with approval in Aus/ralian Melm!'nlitan Life Assurance Co L/d v Ure (1923) 33 CLR 199,220 and Howard Smilh [J 974] AC 821, 835 (Lord Wilbelforce). 2005 Corporate Donations 79 infinite range of variety'. 51 This is not surprising given the difficulties associated with detennining the subjective purpose of the individual directors, let alone the added difficulty of detennining their collective purpose. The only cases where the courts are able to make decisions reasonably easily are in cases where directors' self-interests are blatant or where they clearly acted dishonestly. In other cases the directors have a wide variety of defences available to them. 52 When the more involved defences are raised, the courts are indeed faced with complicated legal principles, obscured by several cases that are not always easy to reconcile with each other. 53 But, in essence, it is expected of the courts to make a value judgment or second-guess 'the state of mind of those who acted, and the motive on which they acted', as was established more than 80 years ago in Hindle v John Cotton Ltd. 54 The complex nature of such value judgments is tlle reason why the courts have been unsuccessful in developing exact rules. This is also the reason that the courts will continue to have difficulty in detennining appropriate measures to fonn their value judgments. 55 F Defences By Directors To Justify Their Actions In a case where the court must consider whether a particular power, such as the power to issue shares, has been exercised for its proper purpose, the court will not simply hear the directors say that in exercising the particular power they have acted 'in the best interest of the company'. 56 In these types of cases, the fact that directors have acted 'in the best interest of the company' has been held to serve no other purpose than restating the generallawY Another reason that the courts were not simply prepared to accept directors' defences that they have acted in the 51 52 53 54 55 56 57 Pine Vale Investments Lld v McDonnell & East Lid I ACLC 1294, 1303 (McPherson J). See du Plessis, above n 18,323-4 and discussion below, Part IlI(F). Saul Fridman 'An Analysis ofthc Proper Purpose Rule' (1998) J 0 Bond Law Review 164, J 65-6, 179. Hindle v John CotlOn Lid (1919) 56 Sc LR 625, 630--1. Sce generally Sealy above n 25, 276. At 278, Sealy cxplains the conscquence of this approach succinctly: 'It may still be true, in principle, that "business decisions are tor business men", and not a malllT for review by the courts, but for judges of sufficiently robust disposition that principle is not the deterrent that it may once have been.' See also Fridman, above n 53, 166. The substantial or primary purpose test is a more exact measure than the best interest of the company test. Thus, it is submitted that it is a slight overstatement to argue that 'the requirement that directors act for a propcr purpose adds little to the more general rule that directors must act in the best interest of the company'. See Fridman, above n 53, 182. As to the meaning of the phrase 'best interest ofthc company as a whole', sec Pretorius et aI, above n 36, 293, but as Parsons points out 'the concept remains miserably indderrninate': Parsons, above n 41,396. It is submitted that it is still the case: see Kinvan v Cresvale Far Easl Lld (in liq) (2002) 44 ACSR 21, 56 (Giles JA)_ Wc would respectfully agrec with Young Cl's observation in Kirwan v Cresvale Far Easl Lld (in liq) (2002) 44 ACSR 21 that' lilt is of no real use to regurgitate the numerous utterances of past courts on this topic'. See also Fridman, ahove n 53, 90; Re a Company (no 00370 of J987; Ex paNe Glossop [1988} 1 WLR 1068,1076; Sealy, abovc n 25, 269-71Howard Smilh [1974] AC 821, 835 (Lord Wilberforce). In Re Halt Garage (J964) Ltd [1982] 3 All ER 1016, 1039 (read with 1038) Oliver J observed that under certain circumstance 'a test of benefit to the company' (also understood as 'the bcnefit of lhe shareholders as a whole') 'would be largely l11eaningless' . 80 UNSW Law Journal Volume 28(1) best interest of the company is that in cases where a misuse of a particular power (for example, the power to register a transfer of shares) is alleged, the cmcial issue is often not 'the interest of the company', but the interest of shareholders and what is fair between different classes of shareholders. ss The courts have also invariably rejected the defence that directors acted in the best interest of the company where the self-interests of directors were involved. 59 Developments in this area of company law led to the recognition that there was a shift from a requirement that directors must exercise their powers bona fide to a requirement that they must exercise their powers for proper or pem1issible purposes. 60 However, it is suggested that there is still a place for the 'bona fide in the best interest of the company' test. This test is still relevant where the courts must consider whether directors acted within the limits of a general power (for example, power to manage the business ofthe corporation) in contradistinction to a specifIC power (for example, the power to refuse to register a transfer of shares 61 ). The duty 'to act bona fide and in the interest of the company' should be treated as conceptually independent ofthe duty' to act for proper purposes'. 62 58 59 60 61 62 Mills" Mills (1938) 60 CLR 150, 164 (Latham C.1) as quoted with approval in Howard Smith [1974] AC 821, 835 (Lord Wilberforce); McGuire v Ralph McKay Lid (1987) 5 ACLC 891, 894 (MUlTay, Gobbo and Southwell .1.1). See also WhitellOuse v Carlton Hate! Pty Lid (1987) 162 CLR 285, 290 (Mason. Deane and Dawson J.1). See generally Brian Galgul et al (eds), Henochsberg on the Companies Act (Sill ed, 2004) 466: 'Wherc dircctors act in breach of [the duty to act only under available powers] it is irrelcvant whctJlcr tJ1CY belicve they do so in the interest of the company'. The 'bona IIde for thc beneJlt of the company as a whole' test was also pertinently rej"cled in Gomborto " WC? Ltd (1995) 182 CLR 432,444 (Mason C.T, Brennan, Deane and Dawson JJ): 'In the context of a special resolution altering the artieles and giving rise to a conflict of interests and advantages, whether or not it involves an expropriation of shares'. Howard Smith [1974] AC 821, 834 (Lord Wilberforce); Hogg" Cramphorn Lld [1967] Ch 254. 267 fr (Buckley .1); Whitehouse v Carlton Horel Pty Lid (1987) 162 CLR 285, 289-90 (Mason Cl, Deane and Dawson JJ); Southern Resources Lid v Residues Treatment & Training Co Ltd (1990) 8 ACLC 1151, 1164 (Jacobs AC.1, Prior and Mullighan J.1); Lee Pana"ision Lld" Lee Lighting Ltd [1992] BCLC 22, 2930 (Dillon LJ). See also Galgut et al, above n 58, 467-8; Steel, above n 39, 31. It is submined that Blaekman, abovc n 36, 7 states the principle too widely when he argues that directors will 'still be guilty of acling for an improper purpose' (emphasis added). At least a 'self-interest' is required and where there is no sueh self-interest the improper or impermissible purpose must be primary or >ubstantial - see discussion in the body of this altiele below. See Ford Cl ai, above n 19, 358 fn 1, but note the incorrect reference to Sealy's article (the reference should have been to 'Mon ULR', not 'MULR'l. cr Sealy above n 25, 267-8. For earlier view> On this issuc, see Birds, above n 36, 583. At 580-1, Birds gives an exccllent summary of the different doctrines at p lay in this area. Co/pormions ACT 2001 (Cth) s 1072G (replaceable rule). Sarah Worthington, 'Directors' Duties, Creditors' Rights and Shareholder lntervel1lions' (1991) 18 Melbourne Universi(l' Law Rel'iew 121, 122-3 and 123-4; Nolan, above n 40, 3, 7-13. See also Paul Redmond, Companies and SecuriTies Law: CommemGl)' and Materials (3'" cd, 2000) 439-40; J ]-J FalTar 'Abuse of Power by Directors' (1974) 33 Cambridge Law Journal 221,221,224; Havenga, above n 43, 65; Franz .1 Ranero, 'Managed Invcstment Schemcs: The Responsible Entity's Duty to Aet for Propcr Purposes' (1999) 17 Company and Securities LmvJournal422, 425, 427. COIporate Donations 2005 81 IV THE 'BONA FIDE IN THE INTEREST OF THE COMPANY' DUTY A Introduction In Parke v Daily News Ltd,63 most of the company's business was being wound up, and the directors resolved to make ex gratia payments to former employees. Justice Plowman reviewed the cases, particularly Hutton v West Cork Railway Co and Re Lee Behrens & Co Ltd,64 and drew the following conclusions: First, that a company's funds cannot be applied in making ex gratia payments as such; secondly, that the court will inquire into the motives actuating any gratuitous payment, and the objectives which it is intended to achieve; thirdly, that the court will uphold the validity of gratuitous payments if, but only if, after such inquiry, it appears that the tests enumerated by Eve J are satisfied; fourthly, that the onus of upholding the validity of such payments lies on those who assert it. 65 The tests enumerated by Eve J in Re Lee Behrens & Co Ltd, refened to in Plowman J's third conclusion, were: ' (i) [was] the transaction reasonably incidental to the carrying on of the company's business? (ii) [was] it a bona fide transaction? (iii) [was] it done for the benefit and to promote the prosperity of the company?' 66 It is submitted that all these tests are aimed at determining whether those who approved the gratuitous payment acted in the interest of the company. It is, however, necessmy to focus on the specific requirements refened to in Parke 11 Daily News Ltd. B The 'Reasonably Incidental' Requirement Historical Origin The 'reasonably incidental' test is commonly referred to in cases involving the question of whether the company was acting ultra vires,67 However, the ultra vires rule has been abolished,68 with the result that while the 'reasonably incidental' test is still relevant as a factor to be considered when determining whether a director has acted in the best interests of the company, it no longer needs to stand as a separate test on the same footing as the 'best interests' test. 1 63 64 65 66 67 68 Ibid. [1932) All ER 889. Parke v Daily News Lid [1962] 2 All ER 929, 942. Ibid. A-C v Cl'eat Easlern Railway Ca (1880) 5 App Cas 473. COlpomlions Acl 200; (Oh) ss 124, 125, FUl1her discussion or the issue of ultra vires is heyond the scope of this article. See generally Ross Grantham, 'Ultra Vires: Gone but Not Forgollen' (l993) 10 Auslralian Bar Review 233. 2 Volume 28(1) UNSW Law Journal 82 Application Of The 'Reasonably Incidental' Test In Hutton's Case In the judgments of Bowen LJ and Cotton LJ in Hutton v West Cork Railway Co, the focus of the discussion is very much on whether the payments were reasonably incidental to the carrying on of the business. Justice Plowman, by borrowing Eve J's three pertinent questions,69 seems to have elevated the 'reasonably incidental' requirement to the same level as the 'benefit to business' requirement. It thus appears to operate as the objective constraint on Bowen LJ's now-famous 'amiable lunatic'.70 However, a close reading of the judgments in Hutton v West Cork Railway Co reveals that the reasonably incidental test is subsidiary to the test of whether there is a benefit to business. For example, Bowen LJ expresses the objective test as follows: Whether, as well as being done bona fide, it is done within the ordinary scope of the company's business, and whether it is reasonabl~ incidental to the carrying on of the company's businessfor the company's benefit. I Similarly, Cotton LJ found that the sums paid ... could not be looked upon as an inducement to [the directors] to exert themselves in the future, or as an act done reasonably for the purpose of getting the greatest profit from the business, but must be looked upon simply as a gratuity, perhaps reasonable in itself, but without any prospect of ... in any way reasonably conducing to the benefit ofthe company. n Therefore, it is consistent with Huttol1 v West Cork Railway Co 73 to use 'benefit to business' as the objective test. The 'reasonably incidental' test then becomes a factor to be considered in determining whether a reasonable body of directors could have thought that the action was in the best interests of the company. C 1 The Bona Fide For The Benefit Of The Company Requirement Overview It is submitted that the question whether the directors acted in the 'interests of the company' is assessed subjectively as well as objectively. Provided a court is convinced that the directors really were motivated by benefiting the company, the court will be reluctant to overturn the directors' decision. However, the objective test is there to protect shareholders from the vagaries of directors who are acting in a way which could only be regarded as unreasonable. 69 70 71 72 73 Sce above n 66 and accompanying ICXt. Parke v Daily News Lld [1962] 2 All ER 929_ Hullon v West Cork Railway Co (1883) 23 Ch 0 654. 672 Ibid 666 (emphasis added). Ibid 654, 666. (cmpha~is added). 2005 Corporate Donations 83 2 Su~iective Limb - Were The Directors Motivated By Benefiting The Business? On the issue of bona fides of the directors, the question to be answered is: 'What motivated the directors?' This can be answered by reference to their purpose or objective: that is, what were they trying to achieve? If their primary goal was anything other than promoting the benefit of the company, the decision will be invalid. 74 A company may wish to present its actions as generous and/or charitable, when in fact it is motivated by its own commercial interests. This will not invalidate the action. 75 3 Objective Limb - Could No Reasonable Director Have Thought It To Be OfBenefit To The Business? The directors may well have been acting with an honest belief that what they were doing would benefit the company, but if no reasonable director could have agreed with them, the action will be invalid. 76 The 'no reasonable director' standard is generous because there is no need for any sort of consensus as to reasonableness - the director only has to convince the court that there could conceivably be one reasonable hypothetical director who could think it was in the interests of the company. In order to assess whether no reasonable director could have thought it was in the interests of the company, some or all of the factors outlined below may be relevant: reasonably incidental payments; uncertainty as to whether a benefit would materialise; proportionality - is the size of the payment out of proportion to the potential benefit to the company?; and obvious detriment to the company. (a) Reasonably Incidental Payments Payments that are normal industry practice are less likely to be invalidated on the ground of lack of benefit. This issue commonly arises where payments to employees, fonner employees, or their families, are being challenged. For example, in Hm71pson v Price's Patent Candle CO,77 gratuities to employees were validated on the basis that the effect on staff morale would benefit the business. 74 75 76 77 Mills v Mills (1938) 60 CLR 150. This has bccn descrihed as the '~heep's clothing principle' by Melvin Eiscnbcrg, 'Corporatc Conduct That Docs Not Maximise Shareholder Gain: Legal Conduct, Ethical Conduct, the Penumbra Effect, Reciprocity, the Pri~oner's Dilemma, Sheep's Clothing, Social Conduct, and Disclosure' (1998) 28 Sretson Loll' Review 1, J 4. See, eg, AA T Case V18 (1988) 88 ATC 197. Charterbridge COl])orations Lrd v Lloyds Bank Ltd [1970] Ch 62, 74. (1876) 24 WR 754. 84 UNSW Law Journal Volume 28(1) In Henderson v Bank of Australasia,78 the Court was asked to invalidate a gratuity where the benefit to the company was more indirect. The case involved a pension to be paid to the widow of a bank employee. It was argued that' [giving] money to the family of a deceased well-paid officer who are otherwise well provided for can be of no benefit to the business of the company'. 79 The Court focus sed on whether the payment of this kind of pension was normal practice in the industry and, finding that it was, had no difficulty in finding that it was made in order to promote the prosperity of the company. If it is nonnal practice within the industry, this is an indication that it is reasonable to regard the payment as being of benefit to the business. Hutton v West Cork Railway Co was distinguished on the basis that the railway company was not a going concern, so that the payments to the former directors could not benefit the business in the future. In Henderson v Bank of Australasia, on the other hand, the bank was a going concern, and its treatment of the families of employees would be relevant in terms of its reputation and its ability to attract good employees. (b) Uncertainty As To Whether A Benefit Would Materialise In Evans v Brunner, so the Court refused to find that a resolution made by a chemical manufacturing company that authorised directors to make grants to universities was invalid. It was argued that the potential benefits were by no means certain, and that competitors were likely to benefit to a similar degree as the company making the grants. The Court prefened to trust that the directors would exercise their discretion in such a way as to maximise the chances of a benefit accruing to the company. So in this kind of fact scenario, the question is 110t whether all possible decisions made within the terms of the resolution would be to the benefit ofthe company, but rather whether it is possible for the directors to make decisions for the benefit of the company within the terms of the resolution. (e) Proportionality - Is The Size Of The Payment Out Of Proportion To The Potential Benefit To The Company? In Hutton v West Cork Railway Co, Bowen LJ adverted to the existence of an objective limit on the amount of money that could reasonably be given away. In his view, 'the limit is what is necessary in the reasonable management of the affairs of the company'. 81 Thus, in assessing whether a reasonable director could believe a payment to be in the company's interests, the amount of money involved would be a relevant consideration. 78 79 80 81 (1888) 40 Ch D 170, 172 (North J). Ibid. [1921] 1 Ch 359. HuTTon v WesT Cork Railway Co (1883) 13 Ch D 654, 673. 2005 Corporate Donations 85 (d) Obvious Detriment To The Company In some cases, what is proposed may actually be to the detriment of the company concerned. This was the case in ANZ Executors & Trustee Company Ltd v Qintex Ltd82 ('Qintex'), where a tmstee sought to force the subsidiary companies to guarantee debts that had been guaranteed by the holding company. The subsidiaries had not been party to the agreement between the tmstee and the holding company and were not party to the proceedings. They were insolvent, and there was no way that the proposed action could have been to the benefit of the subsidiaries. It was clear that no reasonable director could regard the proposed action as being for the benefit of the companies which were to take on the debt. Thus, it was a clear case of failing the objective 'benefit to business' test. 4 Issues Which Apply To Both The Subjective And Objective Determination Of Whether There Is A Commercial Benefit (a) 'Best' Interests? The language used in the cases is inconsistent in that sometimes the requirement is expressed as 'best interests' of the company and sometimes the word 'best' is omitted. 83 The COIporations Act 2001 (Cth) refers to 'best interests': 'A director or other officer of a corporation must exercise their powers and discharge their duties: (a) in good faith in the best interests of the corporation; and (b) for a proper purpose.' 84 If the test were 'best interests', this suggests that directors would have to consider all possible alternatives, and choose the best one. 85 This does not appear to be the requirement imposed by the courtS. 86 In fact, the threshold may be even lower. What if the directors have failed to turn their minds to whether the benefits will be outweighed by the costs, and the net position is in fact a cost to the company? Since the primary motivation must be to promote the prosperity of the company, this implies that if the directors thought that the net position would be a cost to the company, their action could be impeached. However, it is unlikely that the courts would be as strict as this, unless the failure constituted a breach of the duty of care and diligence. 87 82 83 84 85 86 87 [199IJ2QdR360. The expressions 'interests of the company' and 'best interests of the company' appear to be used interchangeably, which is consistent with there being no significant ditTerence between them. See, eg, WhitehOZlse]l Carllon Hotel Ply Ltd (1987) 162 CLR 285. Corporations Act 2001 (Cth) s 18!. This point is made by Julian Blanehard, 'Honesty in Corporations' (1996) 14 Company and Securities Law Journal 4, 7. Charlerbridge COlp Ltd]l Lloyd's Bank [1970] Ch 62, 75 (Pennyeuiek J). Ibid. 86 UNSW Law Journal Volume 18(1) (b) Onus Justice Plowman makes a definitive statement that 'the onus of upholding the validity of [gratuitous] payments lies on those who asseli it.'88 This burden of proof apparently distinguishes gratuitous payments from the cases where directors' actions were challenged on the basis that they acted for an improper purpose. In the latter group of cases, the doctrines of the supremacy of the constitution and non-interference in internal company matters convinced the comis that the onus of showing that a power has not been properly exercised is on the party complaining. 89 It is an open question whether Plowman J's statement of the law is correct. Far from seeing gratuitous payments as ultra vires, there is nowadays a real expectation that companies fulfil their social responsibility by making such payments. 90 In fact the only question is to determine the limits of such payments. The directors will obviously be liable under the insolvent trading provision if they made gratuitous payments when the company was insolvent or if there were reasonable grounds to sLlspect that the company was insolvent when such payments were made. 91 It will also be difficult to argue that they have acted for a proper purpose and in the interest of the company if they never declare any dividends but consistently use all the distributable profits of the company for gratuitoLls payments. It is, however, acknowledged that it is very hard to detennine the exact boundaries where the courts should set gratuitous payments aside. There is a grey area in which comis may be required to '[inquire] into motivations of an almost infinite range ofvariety',92 however reluctantly. A comprehensive discussion of the rules of evidence is beyond the scope of this article. However, it is worth noting that in Parke v Daily News Lld, the plaintiff had established a prima facie case that the directors were not motivated by a desire to advance the interests of the company. In these circumstances, it is not surprising that the directors would be expected to dispel the suggestion that their motives were improper. 93 It is, however, submitted that where directors make gratuitous payments and they have, prima facie, not acted dishonestly, mala fides or with self-interest, the onus of showing that the gratuitous payment should be set aside should nowadays be on those complaining. The import of the onus issue from a practical point of view is clear: once challenged, directors must demonstrate that according to both a subjective and an objective assessment, the gratuitous payments are valid. Thus it behoves directors not only to have proper motives, but also to be able to demonstrate them. 88 89 90 91 92 93 Parke l' Daily News Lid [1962J 2 All ER 929, 942 (P!owman .I). See above Parts II(B), lI(C). See above nil, above n 13 and accompanying text. C017)orations Act 2001 (Cth) pt 5.7B. See Pine Vale Investments Lid v Mc Donnell & EaSI Lid 1 ACLC 1294, 1303 (McPherson J). Some suggestions as lo factors that a court may take into account are made below, Part VI(E). cr Re Sl11ilh & Fawcetl Lld [1942J Ch 304. Corporate Donations 2005 V 87 THE BONA FIDE AND PROPER PURPOSE DOCTRINES DIFFERENTIATED Does the court need to address two separate questions - whether the action in question was both for a proper purpose and in the best interests of the company? it is suggested that the anSwer to this question is best addressed separately for cases where there is an explicit power and cases where the power is implied. The following discussion illustrates how in the case of gratuitous payments, and other actions which are taken under the general powers of management conferred on the board, it is easy to confuse the duty to act in the best interests of the company, and the duty to act for a proper purpose. This is essentially because (as explained below) in these circumstances, what is in the best interests of the company is both a duty in itself, and a test for whether the proper purpose duty has been breached. As noted above, to detennine whether the duty to act for a proper purpose has been breached, the first question to be answered is: for what purpose was the power confened? Where corporate donations are concemed, the power involved would normally be the general power of management, rather than a specific power. The general power of management will be very broadly construed. It would be likely to be defined in tenns of almost anything that is in the interests of the company. The second question to detennine is whether the power was used for the purpose for which it was conferred, or for some other purpose. In the case of the general power of management, this question becomes: 'Was the action taken in order to advance the interests of the company, or for some other reason?' Thus, the proper purpose duty, in the case of the general power of management, necessarily involves the same question as the 'best interests' duty: were the directors acting in the best interests of the company? It is just that this question is arrived at via a different route, depending on which duty is being examined. The conflation of the two duties is reflected in the comment of Santow J in Re HIH Insurance 94 that 'whether a director has acted for a proper purpose, namely for the benefit a/the company, is to be objectively detennined.'95 Thus, the key test, for both duties, is the same - were the directors acting for the benefit of the company? Confusion often arises because it may not be clear whether the phrase 'the best interests of the company' is being used in the sense of the duty to act in the best interests of the company, or as a test for whether the proper purpose duty has been breached. Whilst acting for a 'proper purpose' (in the sense of not abusing the powers granted) remains an important aspect of the common law and statutory duties of directors, 96 it is not the key issue for assessing the validity of 94 95 96 (2002) 168 fLR 253. Ibid 414 (emphasis added). See, eg, HOll'ard Smith [1974J AC 821; Pine Vale Investments Ltd v McDonnell & East Lld 1 ACLC 1294; CO/POrations Act 2001 (Cth) s 181. UNSW Law Journal 88 Volume 28(1) gratuitous payments. As will be illustrated in the next part, the question of the best interests of the company is the dominant consideration when assessing the validity of gratuitous payments. VI APPLICATION OF PRINCIPLES IN CONTEXT OF CORPORATE DONATIONS A Reluctance Of The Courts To Interfere As noted above,97 once satisfied that the directors have an honest belief that they are acting in the interests of the company, the court will be reluctant to interfere, and will only do so if no reasonable director could have held that view. This gives directors very broad discretion, and in many fact scenarios a donation would have been valid if only the directors had expressed their intentions differently. For example, in Hutton v West Cork Railway Co, Cotton LJ expressly leaves open the possibility of the company resolving to make a payment to the directors provided it is expressed as being for services during the relevant period. 98 Tt is important to note that the court will not impose its own view as to whether the action was in the interests of the company. Rather, it will have regard to what a reasonable director's view would have been. B What Is A 'Benefit To Business'? In this article, the phmses 'benefit to business', 'in the best interests of the company', and 'in the interests of the company' are used synonymously. The benefit that must motivate the directors' actions does not necessarily have to be a direct one, nor a financial one. For example, decisions which are costly yet which lead to an enhanced reputation, or improved employee morale, would be justifiable as being in the best interests ofthe company. C How Broad Is The Definition Of 'The Interests Of The Company'? If the company interests are regarded as encompassing the interests of the recipients of corporate donations, it could be argued that a donation benefits a company even if there is no benefit to the company as an entity in itself. For example, if the company interests encompasses employees, then theoretically a board of directors could make large gratuitous payments to employees, motivated by advancing the interests of the employees rather than the interests of the corporate entity, and their doing so would not breach their duty to act in the best interests of the company. However, the position in Australian law is that the company is taken to be the legal corporate entity. The courts have admitted only 97 98 See above Pari JI(B). Hullon v West Cork Railway Co (1883) 23 Ch 0 654, 668. :l!l\\1 :~I i-- I' 'i CO/porote Donations 2005 89 -I i limited variations on this definition. 99 For example, directors can legitimately consider the interests of future shareholders as well as existing shareholders, lOO and are required to take creditors' interests into account if the company is insolvent or nearing insolvency. 101 This does not amount to a green light to make gratuitous payments to these or any other groups in the absence of a benefit to the corporate entity. 102 There are two other potential ways of extending the definition of the interests of the company. First, the company's constitution may define the interests of the company. For example, the constitution could permit profits to be used for charitable purposes. 103 Secondly, it may be that shareholders of a solvent company could approve actions that would otherwise be in breach of the duty to act in the interests of the company. 104 D Shareholder Approval Given the lack of clarity and potential for controversy 105 over the law with respect to corporate donations, it may be thought that the simplest approach would be to obtain shareholder approval for corporate donations. However, this is not as straightforward as it may seem. First, there is the administrative burden associated with obtaining shareholder approvaL Second, most donations could be argued to be in the interests of the company, albeit indirectly, such that shareholder approval would be unnecessary. As pointed out in Part IV(C) above, the standard is not set very high: to be dismissed as not being in the interests of the company, donations have to be such that no reasonable director would have thought them to be in the interests of the company. Third, in the case of altruistic donations, which at face value would appear to be the area where shareholder approval may be of most relevance, a resolution by shareholders approving the making of a donation would not necessarily solve the problem. The shareholders may have to resolve that making the donations would be in the best interests of the company. It may not be sufficient for the shareholders simply to approve the _ donations because the directors, in proceeding with the donations, may still be in breach of their duty to act in the best interests of the company. An analogous situation arose in Qintex where the shareholders had approved the corporation 99 100 101 102 103 104 105 ;i-"I :J ;i~l 'l.. :-~:: Ford, above n 19,345-6. Provident Intemational Co/poration v In/emotional Leasing Corp Ltd [1969] 1 NSWR 424, 440. Walker v Wimbome (1976) 137 CLR l, 7 (Mason J); Kuwait Asia Bank EC v National Mutual Life Nominees Lid [1991] I AC 187; Addstead Pty Lid (In llq) ]I Llddan Pty Lid (1997) 70 SASR 21. See alRO William H