Mualim v Dzelme: a dispute over the transfer of company control

Mualim v Dzelme [2021] NSWCA 199

Part 1: What is the evidentiary value of minutes?

Part 2: Can shareholders ever consent to a director’s breach of duties?

The NSW Court of Appeal recently considered whether parents had consented to the transfer of control of the family company to their son (the sole director).  The transfer took place when the son caused the company to issue shares to himself.  The parents claimed this was without their consent.  The Court found that the parents had not given fully informed consent, and that the share allotment was invalid.

Although the Court considered many issues, two in particular stand out:

• The evidential value of minutes of a company, which is the subject of this case note. This was particularly important as the share issue took place in 2004 and the son had since died.
• The doctrine of informed consent. Can the company’s members authorize the company’s directors to engage in acts that might otherwise be a breach of their fiduciary duties?  We will examine that complex issue in our next edition to Corporate Insights.

The decision highlights the importance of good corporate record-keeping.  Company officers should ensure the minute book is maintained in compliance with law, so the minutes are legal evidence of the proceedings, resolutions or declarations that they document.

Legal background

When parties dispute the validity of an event, the courts’ decisions must be based on the evidence presented.  In this case the Court examined the legal weight of different types of evidence; the factual basis of evidence; and the onus on each party to produce evidence.  In particular, the Court reviewed the evidential value of minutes of a company.

Minutes that are signed and recorded with strict compliance with the Corporations Act are presumed to an accurate record of the proceedings and resolutions recorded, unless proven to the contrary.

Background

The parents lived in Indonesia.  In 2000 they loaned $800,000 to a newly established company Pacific Springs Pty Ltd, which owned the business Nice Cream.  The parents, with 100 shares each, were at that time the only shareholders in Pacific Springs.  Their son was the sole director of the company, and managed the business in Australia.

In 2004, the son passed a director’s resolution to issue 1,800 shares to himself, becoming the majority shareholder.  The son subsequently restructured the business in 2009/2010, and bought property in the name of another, newly created, company, controlled by him and his partner.

After the son’s death (following a period of ill health), the son’s partner appointed himself to the role of director and secretary of Pacific Springs.

The parents brought proceedings against the partner and Pacific Springs, claiming that the 2004 allotment of shares was invalid as it was made for an improper purpose.  Namely, to dilute their interests in the capital of the company and to pass control to their son.

At first instance, the Court found against the parents.  However, on appeal, the Supreme Court overturned that decision, as there was insufficient evidence to establish the parents’ informed consent had been obtained.

The Law

It is well established at law that directors may not issue shares for the purposes of diluting existing shareholders or creating voting power for a new majority.   Where a director uses his or her power to issue shares for this purpose, this may be a breach of the director’s fiduciary duties.  The director’s fiduciary duty is to act in the best interests of the company and its shareholders. The second part of this case note in the next issue will explore this legal principle in more detail.

However, fully informed consent is a legal defence to a claim against a director for a breach of fiduciary duty.  What constitutes fully informed consent depends on the circumstances of each case.  Fundamentally, this means the person is fully informed of their rights, and knows all of the material facts and circumstances.

The primary judge reasoned that there had been no breach of fiduciary duty by the son in exercising his director power to issue shares, as it was done with the consent of the existing shareholders of the company, ie the parents.  One of the issues at appeal was a factual dispute over whether the parents had given the necessary consent to the share issue.

To make out a defence of informed consent, the Court of Appeal decision stated that the relevant facts that must have been disclosed to the parents were:

1. The proposed allotment would dilute their interest in the capital of the company from 100% to 10%; and
2. The effect of that dilution would be a change in control of the company and as a consequence preclude the parents from controlling a general meeting of the company.

Many types of evidence were presented.  In particular, the respondents submitted that the parents’ knowledge and consent to the transfer of control of the company was inferred from a change in attendance at AGMs.  The AGM minutes recorded the parents’ attendance prior to the 2004 share issue but not afterwards.  Were the minutes evidence from which it could be inferred that the parents knew that control of the company had transferred from them to their son in 2004, meaning as minority shareholders their attendance was no longer necessary?

The evidentiary value of minutes

As above, minutes that are strictly compliant with provisions in the Corporations Act are taken to be evidence unless the contrary is proven.  To be strictly compliant with these provisions, the minutes must be:

• recorded in a minute book, within one month of the meeting or resolution;
• signed within a reasonable time by the chair of that, or of the next, meeting (for minutes of a meeting); or by a director (for minutes of a resolution passed without a meeting); and
• kept in a minute book at the company’s registered office, or its principal place of business, or another place approved by ASIC.

In 2021, provisions for the electronic storage of minute books were added to the Corporations Act.  Particularly, information recorded in an electronic minute book must be readily accessible for subsequent reference.  Only immaterial changes and endorsements may be added to electronic minutes.  An electronic minute book is taken to be kept at a place if:

• an electronic form of the minute book is open for inspection at that place;
• the method of generating the electronic form of the minute book reliably assures the maintenance of the integrity of the information contained in the minute book;
• at the time of generating the electronic minute book, it was reasonable to expect that the information contained in the electronic form of the minute book would be readily accessible so as to be useable for subsequent reference.

What is a minute book?

The NSW Supreme Court considered what comprises a minute book in an earlier case, ASIC v MacDonald (part of the James Hardie litigation).[1]  It decided that records of proceedings and resolutions are not the same thing as a minute book.  Specifically, a document must be signed and recorded in a minute book.

The Corporations Act states that a ‘book’ includes:

• making entries in a bound or looseleaf book; or
• recording or storing the matters concerned by means of a mechanical, electronic or other device; or
• in any other manner approved by ASIC.

Also, the time-limit of a month to record the minute in a minute book is strictly applied by the courts.  In MacDonald, the Court noted that contemporaneous documents are ‘more reliable’, as human memories are prone to ‘dim’, and ‘other interests’ may arise after proceedings.

Application of the law to the AGM minutes in this case

In this case, there was no evidence that the Pacific Springs AGM minutes were recorded in a minute book within one month of the meeting.  Hence they were not strictly compliant with the statutory provisions, and were not presumed to be accurate evidence of whether the parents had attended meetings before or after 2004.

After making this important finding, the Court considered the factual nature of the minutes.  The AGMS were recorded as occurring at 5pm on New Year’s Eve on the two years (2002 and 2003) that the parents’ attendance was minuted.  On the facts, the Court considered that the minutes were unlikely to be accurate records of the meetings, and that the Indonesian-based parents were unlikely to have physically attended at those dates and times.

Additionally, there was no evidence that Pacific Springs had sent the parents a Notice of Meeting for the disputed meetings.

Take away messages

In this case, a share issue eight years earlier was invalid, because there was inadequate evidence that the parents had given fully informed consent.

This case highlights that:

• All companies should keep meticulous and timely records of corporate proceedings. This includes copies of documents, emails, and notes made of oral consent.  Records should be as contemporaneous as possible.
• In order for minutes to have value as evidence, they must be stored in a minute book within a month, and must be signed within a reasonable time of the meeting. A minute book may be hard copy or electronic; it must comprise a format where the minutes are stored together; it must be in a form that is accessible; and it must ensure the integrity of the stored documents and information.

In our next edition of Corporate Insights we will consider another aspect of this case; namely, the doctrine of informed consent by shareholders to approve what would otherwise be a breach of a director’s fiduciary duty.

[1] (2009) 256 ALR 199.