Question 1.        Darren and Samantha met at culinary school and shared a common goal to own a restaurant specializing in desserts.  Three years after graduation they opened the ‘Sweet Tooth’.  They each contributed 50% of the starting capital and verbally agreed to share all profits and loss of the business equally. Initially the business does very well, but begins to lose custom after two years, at which point Darren and Samantha engage Tabitha, a very famous pastry chef, paying her salary and 15% of any increased profit she generates.  Business quickly improves and Tabitha gradually assumes increasing managerial responsibility within the business.  Six months after commencing work at the Sweet Tooth, Tabitha confronts Darren and Samantha and demands her existing partnership share be increased to one third, and she be placed on an equal partnership footing.  Darren and Samantha are shocked.

 

(a)    Can a partnership exist between Darren and Samantha if there is no written agreement?  Give reasons for your conclusion.

(b)   Is Tabitha already a partner?  Give reasons for your conclusion.

 

Answer 1

The present problem is based on the Partnership law existing in South Australia.

a)      A Partnership can exist between Darren and Samantha even if there is no written agreement because what is important is the intention to get into a partnership and not the documentation of it. Contract law in Australia is particularly guided by the common law. Under Contract law, contracts or agreements can be formed when a proposal is made and accepted, giving rise to a promise. Every set of promises forming consideration for each other gives rise to an agreement. In law, verbal contracts are valid contracts though it might be difficult to prove its existence in the court of law. However, in this particular case, there is clear indication that Darren and Samantha wanted to share the profits and losses arising out of the partnership and they had each invested 50% of the starting capital for this venture. Partnership in Australia is guided by the Partnership Act, (SA) 1891, common law and the law of equity. Under Section 1 of the Partnership Act, partnership will exist between two people when the persons carry on business in common with a view to share profits and losses. However, the partnership firm is not a separate legal entity as compared to a company.

This particular business is a partnership because Darren and Samantha are carrying on the restaurant business under the agreement to share profits and losses. In Smith v Anserson[1], it has been held that carrying on of business needs to be a continuous process with repetition of action. Similarly held in Ballantyne v Raphael[2] that one of the essentials of a partnership is carrying on of business.  Further, in Keith Spicer Ltd. V Mansell[3] it was held that persons should be carrying on business in common and not for individual personal gain. As held in Plummer v Thomas[4], intention to share profits and losses is also a strong indication of partnership relationship. In this particular case, carry on business for over two years. They have been sharing the profits and losses equally and it clearly indicates that there was partnership between the two persons. Under the Partnership Act, (SA) 1891, partnership can be formed by verbal agreements as an express agreement.

b)      Tabitha is not already a partner as she has been introduced into the firm only to bring along good business opportunities. She is paid salary and even though she is given 15% of any increased profit that she generates, however, that agreement does not amount to a partnership. In this case, there is no consent of the other two partners to introduce Tabitha as a partner and there is no implied or express contract regarding that. Under Partnership Act, 2 (b), the sharing of gross returns does not itself create a partnership. Besides, under 2 (c), the receipt of profits from the business does not of itself make the person a partner in the business. Especially, under 2 (b) (ii), a contract for remuneration of a servant or agent by sharing of profits does not itself make the person a partner. Further, under the Act, Section 24 (g), no partner may be introduced into the firm without the consent of all the existing partners. The remuneration received by Tabitha is no proof of sharing of profits in the partnership. It has been stated that any presumption of partnership arising from such receipt of salary is displaced when there are other facts, as has been held in Badeley v Consolidated Bank[5] and Elkin & Co. Pty Ltd. V Specialized Television Installations Pty Ltd[6].  Thus from the above discussion it is evident that Tabitha is not already a partner.

 

 

Question 2.        Peter, Lois and Stewie have owned and operated the ‘FamilyRock’ restaurant in partnership for 10 years.  Recently, declining custom and some business decisions have caused conflict between the partners.

            

             Lois decided that the FamilyRock needed greater promotion and so without consulting Peter and Stewie, she entered into a contract with the local commercial radio station for radio advertising for a total sum of $30,000.  The partnership ran a similar advertising campaign three years ago. When Peter and Stewie hear the radio commercials and receive the invoice they are very unhappy and contact the radio station, stating that they had not given permission for the contract to be entered into and the partnership refuses to pay for the advertising.

Meanwhile, Peter has decided the restaurant requires a fresh look and so, without the knowledge of Lois and Stewie, contracts with Brian the Painter to repaint the premises for a sum of $35,000. When Lois and Stewie are informed of the contract with Brian the Painter they are furious and inform Brian the Painter that they are not bound by the contract as there is a term in their partnership agreement which limits each partner’s authority to enter into contracts on behalf of the firm to $30,000.  Stewie has customarily been responsible for purchasing the beverage supplies on behalf of the partnership from the local supplier, Meg. At Stewie’s last purchse, the amount outstanding and owed to Meg was $20,000.

 

Stewie decided to resign from the partnership on the 1st of May to travel overseas.  No one outside the partnership has yet been informed of his resignation.  Meg has continued to supply the FamilyRock with beverages but now demands payment of her outstanding account which has risen since the 1st of May to $40,000. After Stewie left the partnership, the business of the FamilyRock has deteriorated.

 

(i)                       Are Peter and Stewie correct in arguing the partnership is not bound to the contract with the radio station?  Give reasons for your answer.

 

(ii)                     Are Lois and Stewie correct in arguing the partnership is not bound to the contract with Brian the Painter?  Give reasons for your answer.

 

(iii)                    Discuss the liability of all of the partners in relation to the debts owed to the radio station and Meg.

 

(iv)                  Would your answer be different if Peter was personally very wealthy but Stewie and Lois had no assets?

 

 

Answer 2

  1. Peter and Stewie are not correct in arguing that they are not bound to the contract with the radio station. The contract entered into by Lois and the local commercial radio station was for advertising and promotion of the ‘FamilyRock’ restaurant. Under the Partnership Act 1891, every partner acts as an agent of the partnership firm and the firm will be held responsible for the work done by him to carry on business in the usual way. Every partner has the implied authority to take decisions in favour of the firm. Under Section 5 of the Partnership Act 1891, every partner is an agent of the firm and of the other partners for the purpose of the business of the partnership. Under Section 6 of the Partnership Act 1891, the firm would be bound by the decisions taken by the partner who has the authority to take such decisions and when such decisions are taken in the usual way of carrying on business. As held in Bank of Australasia v Breillat[7], if a partnership be of general commercial nature then the partner may borrow money, contract debts and pay debts, he may draw, make, sign and endorse on account of partnership. In Higgins v Beaucamp[8], it was also held that only in non-trading business can the partner be held not liable for the actions of the partner in borrowing sums of money. In this particular case, the firm had already run a similar advertising campaign three years ago. This definitely implies that the firm was in the business of advertising for profits and promotion. This was done in the usual course of business. Thus, Peter and Stewie would be held liable for the total sum of $30,000.
  2. In the second instance, Lois and Stewie are correct to argue that they are not bound to the contract with the Brian the Painter. This is so, because there is an express term in the partnership contract that no partner can enter into contracts on behalf of the firm exceeding $30,000. Peter’s decision to repaint the premises of the restaurant for a sum of $35,000 was taken without permission from the other two partners. There was no implied or express authority for entering into such a contract. The contract was not entered in the ordinary course of business and thus Lois and Stewie cannot be held responsible for the same. As has been held in Hirst v Etherington and Another[9] that a partner cannot be held responsible for the acts of others that are taken without authority. In this case, Etherington, a partner in a law firm, was acting for the borrower of money from a bank. He gave an undertaking to the bank guaranteeing the loan. The bank’s solicitor requested and received confirmation from Etherington that this undertaking was given in the ordinary course of the business of the firm. When the loan was not paid by the client, the bank sued Etherington’s partner, as Etherington had been adjudicated bankrupt. The Court of Appeal held that it was not within the ordinary course of business of a solicitor, without more, to give a guarantee to a third party regarding a debt incurred by a client. The question under s 5 of the Partnership Act 1891 was whether a reasonably careful and competent lender would have concluded that there was an underlying transaction of a kind which was part of the usual business of a solicitor. It was not open to the lender to accept the bare assurance of the partner that the undertaking was within the ordinary course of business of the firm. Accordingly, Etherington’s partner was held not to be liable on the undertaking. Thus it is evident that Peter’s actions cannot bind Lois and Stewie to the contract with Brian the Painter.
  3. As already stated in answer i), the entire firm will be liable for the amount of $30,000 owed to the radio station. In the third instance, Stewie was in charge of purchasing the beverage supplies on behalf of the partnership from the local supplier, Meg. It was clearly a function within the terms of the business and he had the implied authority to get into legal contracts with third persons to buy beverages. Till the time Stewie decided to resign, the amount outstanding and owed to Meg was $20,000. There can be no denial of the fact that the firm owed this amount to Meg and each partner was liable for it. Under Section 26 of the act, any partner may retire after giving notice to the other partners. However, when Stewie resigned, none of the partners were aware of it. Stewie therefore was not officialy resigned and he continued to be a partner of the firm. Thus, Meg was still in contract with the firm and the expenses upto $40, 000 has to be paid by the firm. Accordingly under Section 9 of the Partnership Act, 1891, each partner will be jointly liable with all other partners for all debts and obligations of the firm
  4. The answer will not be any different even if Peter was personally very wealthy compared to Stewie and Lois. However, if Stewie and Lois were to be declared insolvent then Peter would be solely responsible to pay all the debts incurred before they were declared insolvent. However, the Partnership will come to an end if Stewie and Lois were declared insolvent as held under Section 33 of the Partnership Act 1891.

Question 3.        Olivia is a director of Beds For All Pty Ltd, a company whose business is owning and managing a chain of hotels. Olivia has not attended the last three board meetings of the company and does not know that the company is about to become insolvent.  Olivia enters into a contract with Elliot, the managing director of Greedygood Ltd to supply computers to Beds for All Pty Ltd for $100,000.   Elliot has heard rumours in the market place of the poor financial position of Beds For All Pty Ltd, but he is very keen to meet his sales budget and agrees to the contract.  Elliot, who is an old friend of Olivia, also informs her of the intention of Greedygood Ltd to merge with another very successful company LotsforMe Ltd and suggests she buy shares as quickly as possible, as he has done.

 

Six weeks later, the computers have been delivered and installed, but no payment has been made and Beds for All Pty Ltd is insolvent and going into liquidation.  The merger has occurred between Greedygood Ltd and LotsforMe Ltd and both Olivia and Elliot have made a $40,000 profit.

 

 

(a)                Could Olivia, the director of Beds for All Pty Ltd be held personally liable for the unpaid debt and if so why?

 

(b)               Could Elliot, the managing director of Greedygood Ltd be personally liable for the unpaid debt, and if so why?

 

(c)                Have Olivia and Elliot properly fulfilled their duties as directors?  If not what duties have they breached and what are the possible consequences of their conduct?

 

Answer 3

a)      This questions deals with companies and are guided by the Corporations Act 2001. This Act has codified the common law in respect to the duties and liabilities that directors have to the company that they manage. Under the Act, any person who has attained the age of 18 years can become a director. Whether an executive director or not, all directors will have the same duties and obligations under the Law. In this particular case, Olivia, the director of Beds for All Pty Ltd cannot be held personally liable for the unpaid debt as her actions were taken in good faith. However, since the company went insolvent, under Section 197 of the Corporations Act, Olivia can be forced to pay for the unpaid debts. Directors are to some extents trustees of the company and they are supposed to act in good faith, held by Lindley, L.J. in Lands Allotment Co., Re[10].  Under Section 180 (1) of the Act, a director or other officer must exercise their duties with a degree of care and diligence that a reasonable person would exercise in their position and they must not do anything negligently as to be in the breach of a statutory duty. Under Section 181(1) of the Act, Directors must exercise their functions in good faith and for a proper purpose. Under Section 588G, a director is held to commit an offence if the company incurs a debt and the company becomes insolvent due to that debt. However, under Section 588H (4), if the director was absent from management of the company and he had reasonable grounds to believe that the company would be solvent and there are no reasons for panic then the director cannot be held personally liable for the debts. In this particular case, Olivia was absent from the last three board meetings and she had no reason to believe that the company as heading towards insolvency. In People v Manusco[11], it was held that if the directors act diligently then they cannot be held liable. Further, in Lagunas Nitrate Co. V Lagunas Nitrate Syndicate[12], it was held that if the directors’ act within their powers, if they act with such care as is reasonable expected from them having regard to the knowledge and experience that they have. Then, if they act honestly for the benefit of the company they discharge both their equitable as well as legal duty to the company. Thus under such circumstances, Olivia cannot be held to be negligent but since the company has gone insolvent and going into liquidation, therefore Olivia can be personally liable for the debts incurred along with other directors.

b)      However, in Elliot’s case, the position is exactly the opposite. In this case, Elliot acted as the director of Greedygood Ltd. and he entered into the contract with Olivia to supply computers to Beds for All Pty Ltd for $100,000. He knew that the company was heading towards bankruptcy but still he went ahead and contracted with Olivia as she was his friend. There is a personal interest in the contract and Elliot can be held liable for the debt. Every director acts under a fiduciary duty and when there is any breach the director can be penalized. Under the fiduciary duty, the director is not supposed to use their position to gain an advantage for themselves or some else. They are also not supposed to cause detriment to the corporation. Under section 588G directors are not supposed to engage in insolvent trading. Further, under section 183 of the Corporation Act, directors are not supposed to use the information for personal advantage. In this particular case, Elliot used the information of Beds for All Pty Ltd. Going bankrupt and used it to his advantage as Oliva was unaware of this fact. Thus, Elliot can be held responsible for the unpaid debt.

c)      Olivia and Elliot are both negligent in their duties as directors. Olivia has breached Section 182 of the Corporations Act 2001 as she has entered into buying shares for herself out of the information given by Elliot about a merger happening between Greedygood Ltd and LotsforMe Ltd. Both Elliot and Olivia have breached this section as they acted to gain advantage for themselves by using the position that they were given as Directors. Therefore they can be held for civil penalty under Section 1317E of the Act and the Court may seek a pecuniary penalty under Section 1317G or a disqualification order under Section 206C.

Further, Elliot can also be held liable under Section 183 of the Act for using his position to gain information about the impending merger between Greedygoods Ltd and LotsforMe Ltd. He can be disqualified from being a director or he may be forced to forfeit the profit of $40,000 earned from the merger. The advantage gained by Elliot himself and for helping Olivia to gain profit out of the merger is in serious contravention of Section 183 of the Act. Therefore, he can also be fined for his acts under Section 1317G of the Act. Further, under Section 184 of the Act, Elliot can be help for criminal offence of acting dishonestly into contracting with Olivia even though he knew that the company Beds for All was heading towards insolvency. So, both civil and criminal actions can be taken against Elliot. Every director has a duty to disclose personal interest to the board of directors under Section 191 of the Corporations Act. Otherwise, the director would be held strictly liable for his actions. In Boston Deep Sea Fisihing & Ice Co. V Ansell[13], it was held that if a director makes profit on a transaction entered into on behalf of the company then the benefit belongs to the company. Thus from the above circumstances and discussion it is clearly evident that the profit of $40,000 made by Elliot was malafide and therefore he can be held liable criminally as well as in civil courts.

 

[1](1880) 15 CH D 247

[2](1889) 15 VLR 538

[3]1970

[4](2002) NSWSC 118

[5](1888) 38 ChD

[6](1960) 77 WN (NSW)

[7](1847) 6 Moc PC 152

[8](1914) 3KB 1192

[9] (1999) TLR 546

[10](1891) All E.R. 1032

[11]255 GY 463

[12](1899) 2 Ch 292

[13] (1886) ALL E.R. 65 (C.A.)

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