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Removing Fellow Directors: Not Always The Answer

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By William Riddle, Law Clerk MST Lawyers & Alicia Hill, Principal, MST Lawyers

Earlier this month. the Federal Court of Australia decided that the removal of a director by the only other director of a company was invalid. The Federal Court held this action to be invalid, and the case now serves as a useful lesson to ensure that any corporate documents are consistent with each other and with all applicable legislation.

The case of Shearwood (Trustee) in the matter of Allied Resource Partners Pty Ltd v Allied Resource Partners Pty Ltd decided in December 2017 by Justice Markovic concerned the purported removal of a director of a company by a fellow director.

At all relevant times, Allied Resource Partners Pty Ltd (Allied) had two directors: Mr David Shearwood and Mr Daniel Peters.

On 17 May 2017, Mr Peters sent a “Default Notice” to the company secretary of Allied which was permitted under Allied’s Shareholders Agreement. The Default Notice alleged that Mr Shearwood had provided confidential information to multiple third parties and that he had improperly delegated a power of the board to himself, which were said by Mr Peters to be breaches of Allied’s Shareholders Agreement.

Mr Peters believed that a clause in Allied’s Shareholders Agreement had the effect that upon service of a Default Notice, Mr Shearwood would automatically cease his role as a director. The relevant clause stated:

15.3 Termination of Defaulting Shareholder’s Rights

15.3.1 Despite anything to the contrary in the Constitution, if a Default Notice is served:

b) each Director, including themselves, appointed by the Defaulting Shareholder is automatically removed

Accordingly, pursuant to that Default Notice on 1 June 2017 Mr Peters took the necessary steps to remove Mr Shearwood as a director and also took steps to appoint another person as a director of Allied.

Mr Shearwood did not at any time respond to the Default Notice

Eventually, Mr Shearwood and his associated shareholder companies initiated proceedings in the Federal Court of Australia seeking, amongst other things, a declaration that his removal as a director was invalid.

The parties’ arguments

Mr Peters sought to rely on the above clause in Allied’s Shareholders Agreement that provided for the automatic removal of a director in the company.

The Default Notice is a mechanism contained in the Shareholders Agreement by which a Defaulting Shareholder is notified of offending conduct which amounts to an Event of Default. The Events of Default Mr Peters relied on were the provision of confidential information to third parties and the improper delegation of power.

Although Mr Shearwood contested the substance of the Default Notice, it was not in dispute that Mr Peters had validly issued the Default Notice.

The issue for the Court to determine became: was Mr Shearwood automatically removed as a director pursuant to Allied’s Shareholder Agreement?

Court’s reasons for declaring the removal of Mr Shearwood invalid

The Court held that the purported removal was invalid and that Mr Shearwood continued to remain a director of Allied.

A preliminary question arose after the parties had made their initial submissions: was Mr Shearwood appointed as a director by a “defaulting shareholder”?

In their initial submissions, neither party addressed the actual way in which Mr Shearwood had become a director, which was by operation of section 120(1) of the Corporations Act, which specifies:

(1)  A person becomes a member, director or company secretary of a company on registration if the person is specified in the application with their consent as a proposed member, director or company secretary of the company.

The Court held that because Mr Shearwood had become a director though section 120(1), he had not been appointed by a Defaulting Shareholder and could not be automatically removed as a director pursuant to the terms of Allied’s Shareholders Agreement.

Mr Peters also attempted to argue that section 1322 of the Corporations Act gave discretion for the court to make Mr Shearwood’s removal ‘presumptively valid’. The section can only be enlivened by proceedings that contain procedural irregularities.

The removal of Mr Shearwood as a director was a substantive action and could not be described as simply procedural.

Companies should be aware that section 1322 cannot be retrospectively relied upon to validate any action that may be declared invalid by a court. Rather, it is in place to validate certain actions that may not adhere strictly to the procedural requirements.  This should be kept in mind for anyone who is aware of a procedural irregularity that has occurred that may come back to haunt them in the future.

Key takeaways

A company’s Constitution, Shareholders Agreement and other key documents made upon incorporation will dictate the process for how key officers of the company are appointed and removed. Legal advice is a necessity when preparing these documents so that they work in conjunction with legislation and disputes such as Mr Shearwood and Mr Peters described above are avoided.

The Corporations Act contains replaceable rules which outline how directors can be removed from office, as explained by Markovic J:

(1)          by giving a written notice of resignation to the company at its registered office: s 203A;

(2)          as a consequence of being disqualified from managing corporations under Pt 2D.6 of the Corporations Act, unless ASIC or the Court allows the person to manage the company: s 203B (which is a signpost to the consequence of disqualification); or

(3)          where the members by resolution remove a director from office: s 203C.

Disputes between directors are virtually never able to be resolved upon the whim of one or more directors. It is usually only from a resolution passed by a majority of shareholders that a director can be removed from office. This will vary according to the exact wording of your company’s Constitution. Companies are advised to always seek legal advice before undertaking any controversial actions such as removing a director from office.

Despite clear evidence that Mr Shearwood had acted in ways that were to the commercial detriment of Allied and were in breach of the Shareholders Agreement, Justice Markovic had no trouble finding that his removal was improper, and indeed, substantially unjust. If companies are seeking to restructure the organisation of their board, it should be done within the bounds set by the Corporations Act, the company’s constitution and any Shareholder Agreements.

 If you would like to discuss any aspect of this article further, please do not hesitate to email Alicia Hill or Jack Newton. Alternatively, you can contact them on  +61 3 8540 0200.