Peters' American Delicacy Co Ltd v Heath

Aust H Ct(1939)

Editor's introduction

This case concerns a dispute between shareholders of a company about an amendment to the company's articles of association.

Some background info re the company

The company is a company limited by shares.

The company has two constitutional documents: a memorandum of association and articles of association. The memorandum is similar to that of Motibhai and Co Ltd (see Unit 6 documents folder).

Inter alia, the memorandum states the company's authorized capital (also known as nominal capital) and the par value of shares.

The currency unit in Australia at the time of the case was pounds, shillings and pence (.s.d.) (At the time, this was also the name for the currency unit in many South Pacific island countries.) To simplify matters I have converted the currency units to dollars and cents.

We are told the company's authorized capital was $525,000 divided into 750,000 shares of 70 cents each. The company had issued 511,364 shares fully paid, and 169,247 shares paid up as to one third (i.e.231/3 cents).

Using the information in the preceding paragraph we can calculate the company's issued capital (also known as subscribed capital) and paid up capital.

[The issued capital and the paid up capital will be the same $ figure if all shares issued are fully paid. If some shares are only partially paid, paid up capital will be a lower $ figure than issued capital.]

Issued cap:680,611 shares @ 70 cents per share = $476,428 (nearest whole dollar)

Paid up cap:511,364 shares @ 70 cents plus 169,247 shares @ 231/3 cents

= $357,954.80 + 39,491

= $397,446 (nearest whole dollar)

Cash dividends and bonus shares

During its life, a company may make distributions to members. This is called a dividend. A company may only pay a dividend if it has undistributed profits. (Additionally the company must be solvent before and after the dividend is paid.)

Dividends are normally paid in cash (i.e. money form) but they could be paid in other forms. If the company has a copra business it could pay the dividend in coconuts if it chose.

Where payment is in a form other than cash there will typically be two resolutions.

First: that the company pay an aggregate dividend in the amount of $...

Second: that payment be effected in coconuts, the nuts to be valued at market value.

Where we have a cash dividend (whether it be paid in money or coconuts) there is an outflow of real resources from the company. Following the distribution the company is poorer.

A company may also make what we call a 'bonus issue' of shares to members.

A bonus issue is also known as a 'share dividend'.

In a share dividend, retained profits are used to fully pay up shares (new shares) of the company. The fully paid shares are then distributed to members.

In a bonus issue (share dividend) the company's issued capital and paid up capital increases but there is no outflow of real resources from the company.

In a bonus issue, the net worth of the company does not change but the number of shares on issue increases. In consequence, the value of a share of the company in the secondary market should fall. In colloquial terms, the size of the cake stays constant while the number of slices into which the cake is divided increases.

Shareholders will generally be indifferent to a bonus issue provided they share equally on a pro rata basis in the bonus issue.

Peters' American Delicacy Co Ltd optic's problem

We are told the company is very profitable and annually pays members a healthy cash dividend. This has produced an optic's problem. The annual cash dividend expressed as a percentage of issued capital is 16%. This is thought to be too high. The company's directors wish to halve this figure but without reducing the actual $ sum of the annual dividend. The plan is to double the company's issued share capital by means of a bonus issue (share dividend) paid up from retained profit.

Implementing the director's plan will involve a couple of steps.

First: the company's authorized capital figure in the memorandum needs to be increased. This requires a special resolution.

Second: per the company's articles dividend decisions are made by the shareholders acting on the recommendation of the directors. Thus there needs to be an ordinary resolution of the members that the company make a bonus issue or share dividend of fully paid shares.

To this point the story is straightforward. But there is a twist in the tail. The directors propose that the company's article 120 concerning share dividends be amended, and that this be done prior to the declaration of the share dividend. The proposed amendment is contrary to the interests of the members who own partially paid shares.

Under the NSW Companies Act a company's articles of association can be amended by a special resolution. (This is the standard rule. In the Cos Act 2015 see s.46(7).) Shareholders owning partially paid shares oppose the amendment to art 120 but are out-voted by a special majority. The minority are upset. They feel like the goalposts have been moved in the middle of the game. (In fact, moved just before they were about to kick a goal!) They bring this court action. They want the court to declare that the amendment to art. 120 is invalid. The minority win at trial and win again when the company appeals to the NSW Supreme Court. The company then appeals to the Australian High Court. The decision below is that of the Aust H Ct.

Latham C.J.

This is an appeal from a decision of the Supreme Court of New South Wales. The Supreme Court declared that a special resolution passed at a shareholders meeting amending article 120 was invalid. ... The court also granted an injunction restraining the company, its directors, servants and agents from acting upon the resolutions or making any distribution of the assets of the company thereunder.

The action was brought by three shareholders on behalf of themselves and other shareholders in the company holding partly paid shares. ... The special resolutions provided for the alteration of the articles and for a capitalization of profits by a distribution of bonus shares in proportion to the amount paid up on their shares by the respective shareholders.

The difficulties which have led to this litigation arose from the form of the articles of association of the company. Articles 108, 110 and 111 were as follows:

'108. The profits of the company shall be divisible among the members in proportion to the capital paid up on the shares held by them respectively.

110. The company in general meeting may declare a dividend to be paid to members according to their rights and interests in the profits and may fix the time for payment.

111. No larger dividend shall be declared than is recommended by the directors but the company in general meeting may declare a smaller dividend.'

These articles provided for dividends to be paid in proportion to the amount of capital paid up on shares, and they also provided that the company could not declare a dividend larger than that recommended by the directors.

[ed. Art. 108 concerns a cash dividend.]

Article 120 was as follows:

'120. Notwithstanding anything in any other article ... undivided profits ... may with the sanction of the company in general meeting be converted into capital of the company by distributing the same amongst the holders of shares as a share dividend or bonus by issuing ... fully paid-up shares to shareholders in proportion to the shares held by them in the company. ...'

If action were taken under art. 120 by distributing what is described as a share dividend or bonus in the form of shares, the article required that the distribution should be in proportion to the number of shares held by the shareholders in the company and not in proportion to the amount paid up on the shares.

There was unanimous agreement among all concerned that it was desirable to make a distribution of profits in the form of bonus shares. The company had been prosperous and for some years had been paying dividends of 16%. There were obvious reasons of a business character, if it appeared probable that the same amount of money would be available in the future for the payment of dividends, for an adjustment of the rate of dividends to the moneys of the shareholders which were actually used in the enterprise. There were accumulated undistributed profits ... It was therefore proposed to double the capital so as to halve, not the amount of the dividend, but the rate of dividend.

In order to achieve this result a special resolution was proposed for the alteration of the articles under which the original art. 120 would be cancelled and other articles substituted under which it would be possible to make a distribution of new shares proportionately to the amount of capital paid up on the shares.

Another special resolution provided for increasing the capital of the company to $1,050,000 by the creation of 750,000 shares of 70 cents each. ...

A further ordinary resolution was also to be proposed in the event only of the special resolutions being duly passed. Under this resolution a sum of $397,446 would be capitalized and a special bonus dividend declared ... such dividend to be satisfied by allotting to each holder of fully paid shares one new share for each fully paid share already held by him, and by allotting to each partly paid shareholder one new fully paid share for each three contributing shares held by him.

In the case of any particular shareholder the effect of these changes depended upon the character of his shareholding. If he owned only fully paid shares it was entirely advantageous to him. So also it would be advantageous to him if he held fully paid shares and a number of partially paid shares less than one-third of the number of fully paid shares held by him. Without going into details, it is sufficient to state that the evidence shows that there were 94 shareholders to whom the proposals were disadvantageous when those proposals were compared with a distribution under art. 120 in its original form. At the meeting at which the resolutions were passed 257 shareholders were present. Only 19 voted against the resolutions.

The plaintiffs allege that the resolution amending art 120 was invalid because those who voted for the resolutions did so solely for the purpose of benefiting fully paid shareholders to the disadvantage of partly paid shareholders, and not in the interests of or for the benefit of the company or the whole body of shareholders.

[edited]

I propose first to state some relevant principles of law.

(1) The Companies Act 1936 (NSW), s.20, provides:

'Subject to the provisions of this Act and to the conditions contained in its memorandum, a company may by special resolution alter or add to its articles.'

A company cannot deprive itself of this statutory power either by agreement or by a provision contained in the articles. It is not possible, by articles of association, to make an unalterable article. If it is desired to place the rights of particular shareholders beyond the risk of being affected by an alteration of articles it is possible to include a provision in the memorandum of association which will have that effect. [Nothing like that had been done in the present case.]

(2) It follows that the contract between members of the company and between the company and its members which is constituted by the articles must be regarded as containing among its terms a provision that articles may be altered in the manner provided by the Act, that is, by special resolution. ...

(3) It follows that where the rights of members of the company depend only upon the articles it is possible to alter the rights of members or of some only of the members by altering the articles. The fact that an alteration prejudices or diminishes some of the rights of the shareholders is not in itself a ground for attacking the validity of an alteration. ... Any other view would, in effect, make unalterable and permanent any articles of association which conferred rights upon a class of shareholders, or possibly upon any shareholder, if they or he desired that those rights should continue to exist unchanged. The fact that an alteration of articles alters the rights or prejudices the rights of some shareholders is not by itself sufficient reason to prevent the alteration from being validly made.

(4) The power to alter articles must be exercised bona fide. It is generally said that the power must be exercised bona fide for the benefit of the company as a whole. All the recent authorities refer to the statement by Lindley M.R. in Allen's Case:

'The power thus conferred on companies to alter the regulations contained in their articles is limited only by the provisions contained in the Act and the conditions contained in the company's memorandum of association. ... The power conferred by the Act must, like all other powers, be exercised subject to those general principles of law and equity which are applicable to all powers conferred on majorities and enabling them to bind minorities. It must be exercised, not only in the manner required by law, but also bona fide for the benefit of the company as a whole, and it must not be exceeded. These conditions are always implied, and are seldom, if ever, expressed.'

In Allen's Case an article of the company provided that the company would have a lien for unpaid calls on any unpaid shares of a shareholder. This article was amended to extend the lien to any fully paid shares of a shareholder. At the time of the amendment there was only one shareholder with fully paid shares. Thus the alteration was definitely directed against the interests of one particular member. Nevertheless the amendment was upheld. The extended lien was for the benefit of the company. It made it easier to recover moneys due to it. And, as the alteration was found to have been made bona fide for that purpose, it was upheld.

(5) It is not for the court to impose upon a company the ideas of the court as to what is for the benefit of the company. It is for the shareholders to determine whether an alteration of the articles is or is not for the benefit of the company, subject to the proviso that the decision is not such as no reasonable man could have reached. This is not an absolute rule, but it is the prima-facie general rule.

(6) The benefit of the company as a corporation cannot be adopted as a criterion which is capable of solving all the problems in this branch of the law. An alteration which is made bona fide and for the benefit of the company, if otherwise within the power, will be good. But it is not the case that it is necessary that shareholders should always have only the benefit of the company in view. See for example North-West Transportation Co Ltd v Beatty, where it was held that a shareholder may vote as he pleases even when his interests are different from or opposed to those of the company. Shareholders are not trustees for the company or for one another and the relations between them cannot be identified with the relations between partners. But though a shareholder may vote in his own interests, the power of shareholders to alter articles is limited by the rule that the power must not be exercised fraudulently or for the purpose of oppressing a minority.

(7) When the validity of a resolution of shareholders is challenged, the onus of showing that the power has not been properly exercised is on the party complaining. The court will not presume fraud or oppression or other abuse of power. ... It cannot be the law that a resolution of shareholders is to be presumed to be invalid until the defendants in an action positively establish that it is valid.

The result of applying these principles is that the special resolution altering art. 120 cannot be declared to be invalid merely upon the ground that the original art. 120 conferred special rights upon the holders of partly paid shares of which the alteration deprived them, or upon the ground that the holders of fully paid shares were interested in making the alteration adversely to the holders of partly paid shares. If, however, the resolution was passed fraudulently or oppressively or was so extravagant that no reasonable person could believe that it was for the benefit of the company, it should be held to be invalid.

Before considering the specific objections raised in the present case it is necessary to understand the problem which presented itself to the directors after it had been agreed that it was desirable to increase the capital of the company, to make a distribution of bonus shares, and to reduce the dividend rate.

The question which arose was whether this objective should be achieved under the original art. 120 or by some other means. If it were accomplished under the original art. 120 some holders of partly paid shares would gain at the expense of some holders of fully paid shares. It is obvious that there is room for difference of opinion as to the fairness of distribution upon the basis of shareholdings as opposed to the basis of amounts of capital paid up. On the one hand it can be said that the partly paid shareholders bought their shares on the faith of the existing articles and that, although they had not paid as much towards the capital of the company as fully paid shareholders, they had been subject at all times to the risk of having calls made. On the other hand, as already stated, the contract between the partly paid shareholders and the company must be regarded as a contract which was subject to the statutory provision that its terms could be altered, in effect, by an alteration of the articles. Further, it is quite possible for any person to hold a bona fide opinion that such an article as the original art. 120 is in itself not equitable.

[edited]

In all these circumstances the directors proposed the cancellation of the original art. 120 and the substitution of a new article. The contention of the plaintiffs is that the alteration of art.120 was necessarily unfair to the partly paid shareholders who were deprived of their rights under the original art. 120 ...

In my opinion it cannot properly be held by a court that either the original art. 120 or the new article substituted for it is necessarily unfair. As I have already said, it is a controversial question whether profits are most fairly distributed in proportion to shareholdings or in proportion to the amount of money actually paid (as distinct from put at risk) by the shareholder. Quite reasonable men may hold differing opinions upon such a question.

Further, for reasons which I have already stated, it cannot be said that any alteration of an article of association which diminishes the rights of any class of shareholders is necessarily and as a matter of course outside the powers conferred by the statute to alter articles.

[edited]

In the present case there is admittedly no fraud or trickery. As there is no evidence of oppression, and as the alteration cannot be described as extravagant, so that reasonable men could not regard it as a fair alteration to be made, the case of the plaintiff fails. I therefore think that the appeal should be allowed and that judgment should be entered for the defendant.

Dixon J.

[edited] ... The power of altering the articles of the company is now derived from s.20 of the Companies Act 1936 (NSW), which is a general statutory provision. The section ... empowers a company by special resolution to alter or add to its articles. No limitations or restrictions on the power are expressed, except that it is made subject to the provisions of the Act and the conditions contained in the memorandum of association. ...

... It has never been suggested that the power to amend the company's articles is unrestrained. It is one thing, however, to say that such a power is not unlimited or uncontrolled and another to define the grounds upon which an ... exercise of the power should be considered invalid. ...

The courts sought for a limitation in the ... general doctrine that a power must be exercised bona fide for the end for which the power is designed. Primarily a share in a company is a piece of property conferring rights in relation to distributions of income and of capital. In many respects the proprietary rights are defined by the articles of association, and it is easy to see that a power of alteration might be used [to unduly benefit] a majority at the expense of a minority. For example, if there were no check upon the use of the power, it is conceivable that a three-fourths majority might adopt an article by which the shares which they alone held would participate, to the exclusion of other shares, in the surplus assets in winding up or even in distributions of profit by way of dividend. ...

It has seemed incredible that alterations of such a nature could be made by the exercise of the power. But reliance upon the general doctrine that powers shall be exercised bona fide and not for some sinister purpose brings its own difficulties. The power of alteration is not fiduciary. The shareholders are not trustees for one another, and, unlike directors, they occupy no fiduciary position and are under no fiduciary duties. They vote in respect of their shares, which are property, and the right to vote is attached to the share itself as an incident of property to be enjoyed and exercised for the owner's personal advantage. No doubt the exercise of the right affects the interests of others too, and it may be that an analogy may be found in other powers which though given to protect the donee's own interests affect the property rights of others, as, for instance, does a mortgagee's power of sale. ...

Apart altogether from altering articles of association, the voting strength of a majority of shareholders may be used in matters of management and administration to obtain for themselves advantages which otherwise would enure for the benefit of all the members of the company. In some circumstances such an attempt on the part of the majority to secure advantages to the prejudice of the minority conflicts with ordinary notions of fair dealing and honesty. ... Something that of its own nature is within the power of the members in general meeting may be invalidated because of the effect it produces or is intended to produce in benefiting some shareholders at the expense of others ...

[edited]

[Dixon J. also held that there had been no oppression and that the amendment was to art. 120 was valid.]

Required?

1. State the facts of the case.

2. State the issue of the case?

3. State the judgement of the case?

4. Who won the case?