australian business text book sample

IIIThe legal system: legal foundations, the Constitution and statue law CHAPTER 1

COMPLIANCE AND PRACTICE

Roger Vickery Wayne Pendleton

with contributions by MaryAnne Flood

6th edition

AUSTRALIANBUSINESSLAW

Vickery 6e Prelims 19/9/08 11:56 AM Page iii

Copyright © Pearson Education Australia (a division of Pearson Australia Group Pty Ltd) 2009

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National Library of Australia Cataloguing-in-Publication entry

Author: Vickery, Roger.

Title: Australian business law : compliance and practice / Roger Vickery, Wayne Pendleton ;with contributions by MaryAnne Flood.

Edition: 6th ed.

ISBN: 9780733991622 (pbk.)

Notes: Includes index.

Subjects: Business law—Australia.Commercial law—Australia.

Other Authors/Contributors:Pendleton, Wayne.Flood, MaryAnne

346.9407

Every effort has been made to trace and acknowledge copyright. However, should anyinfringement have occurred, the publishers tender their apologies and invite copyright owners tocontact them.

An imprint of Pearson Education Australia (a division of Pearson AustraliaGroup Pty Ltd)

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CONTENTS

VI

Preface xiv

About the authors xvi

What is compliance? xviii

List of abbreviations xxi

How to use your textbook xxii

How to study law xxiv

PART 1LEGAL FOUNDATIONS1 The legal system: legal foundations, the

Constitution and statute law 3What are laws? 4

The major sources and categories of law 4

What is business law? 5

The development of British law 6

Self quiz 8

Was Australia settled legally? 9

Landmark developments in native title 10

From penal colony to independent nation 14

Three levels of government 15

Separation of powers under the Australian Constitution 17

Division of powers: exclusive, concurrent and residual 18

The ACT Human Rights Act—Australia’s first bill of rights 21

Charter of Human Rights and Responsibilities for Victoria 22

How can the Constitution be changed? 22

Ways of increasing federal powers 22

Commonwealth dominance over state powers 23

Self quiz 24

How is legislation passed? 24

Understanding an Act of Parliament 26

How to interpret an Act 28

Common law rules of statutory interpretation 29

Delegated legislation 32

International law 33

Self quiz 34

Summary 36

Guidance questions 39

Review questions 40

Compliance activities 42

2 The legal system: the courts, case law anddispute resolution 43

The court system in the states and territories 44

State and federal tribunals 49

The federal court system 49

The appeal system 51

Cross-vesting: when can federal courts hear state cases? 53

Self quiz 53

Precedent 54

Self quiz 57

How to use a law report 57

The adversary system of trial 59

The main participants in the adversary system 60

The standard of proof in criminal and civil trials 64

Class actions in Australia 65

Typical stages in a civil trial 65

Alternatives to courts 66

Government tribunals and related bodies 66

Tribunals for investigation and enforcement 68

Arbitration 70

Mediation 71

Government ombudsman 71

Industry dispute resolution schemes 71

Self quiz 72

Summary 73


Review questions 77


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VIICONTENTS

PART 2 TORT LAW3 Civil liability: tort of negligence 83What is a tort? 84

Criminal, contract and tort actions 84

The impact of negligence on business life 85The Ipp Report: radical statutory reforms to negligence law 86Common law negligence actions 871. Does the defendant owe a duty of care? 882. Did the defendant breach the duty of care? 923. Did the defendant’s breach harm the plaintiff? 96What are the defences to negligence? 98Self quiz 100Tort actions absorbed by negligence law 102Special categories of negligence 104Self quiz 115Overview of the civil liability reforms 115Self quiz 118Summary 119Guidance questions 121Review questions 122Compliance activities 124

4 Civil liability: intentional torts and defamation 125

Direct (intentional) torts 126Defences to intentional torts 130A new tort of privacy? 133Self quiz 134The tort of defamation 134Defences to defamation actions 140Alternative dispute resolution: offers of amends

and apologies 143Remedies for defamation 143Role of juries in defamation trials 144Criminal libel 144Injurious falsehood 145Self quiz 145Summary 145Guidance questions 147Review questions 148Compliance activities 150

PART 3BUSINESS ENTITIES5 Business structures 153Choosing a business structure 154Sole traders 154

Partnerships 155

Self quiz 156

Companies 156

Self quiz 164

Reporting and disclosure 168

External administration 171

Self quiz 172

Corporate governance 172

Trusts 173

Franchises 175

Self quiz 180

Associations 181

Protection for business names and company names 183

Compliance 186

Self quiz 191

Summary 191


Review questions 198


6 Agency law 201What is agency? 202

Agency distinguished from other relationships 203

Types of agents 203

Creation of agency 204

Self quiz 209

Duties of an agent to the principal 209

Remedies of the principal 212

Relevance of the law of agency to companies and

partnerships 212

Rights of an agent against the principal 213

Liability of the principal to third parties 214

Liabilities of an agent 215

Self quiz 217

Termination of agency 217

Common types of commercial agents 218

Statutory controls on real estate agencies 219

Self quiz 222

Summary 223



Compliance activity 229

7 Partnerships and joint ventures 230Nature of a partnership 231

What is a partnership? 231

Determining when a partnership exists 233

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AUSTRALIAN BUSINESS LAW—COMPLIANCE AND PRACTICEVIII

Self quiz 235

Relationship between partners and outsiders 236

Relationship between the partners 239

Self quiz 241

Dissolution of a partnership 241

Distribution of assets on dissolution 241

Limited partnerships 242

Drafting a partnership agreement 242

What is a joint venture? 243

Self quiz 246

Summary 246




PART 4CONTRACT LAW8 Introduction to contracts 255Tips for studying contract law 256

What is a contract? 256

Formal contracts 256

Simple contracts 257

Essential elements of a valid contract 259

What happens when a contract is invalid? 260

Self quiz 262

Different types of contracts 262

Quasi-contracts 263

What are the differences between formal and simple

contracts? 263

Self quiz 265

Summary 265

Guidance question 266


9 Intention to create legal relations 268Essential element no. 1: intention 269

The test for intention is objective 269

Two presumptions about legal intentions 269

Domestic and social agreements 270

Self quiz 272

Business agreements 272

Self quiz 273

Summary 273



10 Agreement 276Essential element no. 2: agreement 277

Rules regarding offers 277

Self quiz 285

Rules of acceptance 286

Rules of offer and acceptance by post 290

Rules on revocation of offers 290

Rejection of offers 291

When will an offer lapse? 291

Alternatives to the offer and acceptance approach 292

Self quiz 293

Summary 294



11 Consideration 299Essential element no. 3: consideration 300

What is consideration? 300

Three main categories of consideration 300

Rules of consideration 301

Self quiz 306

Part payment of debts 306

Promissory or equitable estoppel 308

Self quiz 311

Summary 311



12 Capacity 315Essential element no. 4: capacity 316

Minors under common law 316

What types of contracts with minors lack capacity? 316

Valid contracts 316

Voidable contracts with minors 318

Void contracts with minors 320

Minors under New South Wales legislation 322

Minors under South Australian legislation 323

Self quiz 324

Mentally unsound and intoxicated persons 324

Companies (corporations) 326

Bankrupts 326

Self quiz 326

Summary 327



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IXCONTENTS

13 Genuine consent 330Essential element no. 5: genuine consent 331

Mistake 331

Misrepresentation 337

Self quiz 339

Duress 340

Undue influence 340

Unconscionable (unjust) conduct 342

Self quiz 345

Summary 346



14 Legality 351Essential element no. 6: legality 352What are the effects of illegal and void contracts? 352Four types of unlawful contracts 352Restraint of trade 353Self quiz 358Self quiz 360Summary 360Guidance question 362Review questions 362

15 Terms of a contract 364What are terms? 365When does a representation qualify as a term? 365Collateral contracts 366Extrinsic documents are not usually valid 367The parol evidence rule 368Is a term a condition or a warranty? 369Intermediate terms 371Implied terms 371Uncertain terms 373Meaningless terms 373Condition precedent 373Condition subsequent 374Self quiz 374Exclusion clauses 375Self quiz 380Summary 380Guidance questions 382Review questions 384

16 Transfer and termination 386Privity of contract 387Assignment 388Self quiz 389Transfer of rights in personal property 389Discharge of a contract 389

Self quiz 396Summary 396Guidance questions 398Review questions 399

17 Remedies for breach of contract 401Main types of remedies 402Damages 402

Self quiz 404

What types of damages are available? 405

Self quiz 407

Equitable remedies 407

Statutory limitations 412

Self quiz 412

Summary 413




PART 5REAL ESTATE LAW18 Property law: real property and mortgages 421Legal meaning of property 422

Distinction between property and personal rights 422

Distinction between legal and equitable property interests 423

Property (ownership) and possession 424

Personal property 425

Real property 425

Estates in land 428

Self quiz 430

Other interests in land 430

Claims for adverse possession 432

Title systems 432

Caveats 436

Strata title 437

Community, precinct and neighbourhood title 437

Company title 437

Self quiz 438

Mortgages over land 438

Legal and equitable mortgages 438

What are the rights of the mortgagor? 439

Unconscionable mortgage contracts 440

What are the remedies of the mortgagee? 442

Power of sale: mortgagee’s duty of good faith 442

Statutory requirements for the sale of corporate property 444

Security interests in personal property 445

Self quiz 446

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AUSTRALIAN BUSINESS LAW—COMPLIANCE AND PRACTICEX

Summary 446




19 Leases and transfer of real property 454What is a lease? 455

Residential tenancies 459

Major differences between residential and commercial

tenancies 461

Retail leases 461

Self quiz 463

Transfer of land 464

Sale of real property by auction 473

Self quiz 475

Summary 476




PART 6FINANCE LAW20 Negotiable instruments and electronic funds

transfers 483Negotiable instruments 484

Bills of exchange 484

Self quiz 484

Cheques 485

Duties of a paying (drawee) institution 488

Duties of the customer 488

Defences of a paying institution 490

Duties of a collecting institution 491

Other forms of transferring money 492

Self quiz 493

Summary 494




21 Credit law and the Anti-Money Laundering and Counter-Terrorism Financing Act 499

The National Consumer Credit Code 500

What essential criteria must be satisfied? 500

What types of credit contracts are regulated by the Code? 500

What types of credit are excluded? 501

Self quiz 502

Regulation of pre-contractual matters 502

Pre-contractual key requirements 503

Requirements regarding statements of account 504

Notification of variations to credit contracts 504

Debtors in default—when can providers take legal action? 504

Related transactions: mortgages and guarantees 505

Liability of a linked credit provider for a supplier’s contract 505

Civil penalties and remedies 506

Self quiz 508

Privacy protection in credit reporting 508

Anti-Money Laundering and Counter-Terrorism legislation 508

Extensive powers of AUSTRAC 513

Self quiz 514

Summary 515




22 Bankruptcy and debt recovery 522What is bankruptcy? 523

Scope and purpose of the Bankruptcy Act 523

Requirements for a sequestration order 525

Main act of bankruptcy: failure to comply with a

bankruptcy notice 525

Other important acts of bankruptcy 525

Self quiz 527

What are the rights of secured creditors? 527

What property is available to creditors? 527

What property is not available? 527

Recovery of property from third parties: five main powers 528

Self quiz 533

Powers of the trustee 533

Restrictions on a bankrupt 534

Order of payment of debts: which creditors are paid first? 534

Discharge of bankruptcy 535

Alternative to bankruptcy: Part X agreements 535

New Alternatives: Personal Insolvency Agreements (PIAs) 536

Alternatives to bankruptcy: Part IX agreements 536

Self quiz 537

Debt recovery 538

Self quiz 541

Summary 542




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XICONTENTS

PART 7CONSUMER PROTECTION AND COMPETITION LAW23 Sale of goods 553What are Sale of Goods Acts? 554

What are goods? 554

Can the supply of work and materials be a sale of goods? 554

Sales and agreements to sell 555

Types of goods 555

When does ownership pass from seller to buyer? 556

The nemo dat rule: a non-owner cannot transfer good title 559

Self quiz 562

Duties of sellers and buyers 562

Implied terms 563

Implied warranties 567

Remedies for breach of contract 568

Self quiz 569

Summary 570




24 Consumer protection 577The main aims of the Trade Practices Act 578

Why the need for consumer protection legislation? 578

The constitutional basis of the TPA 578

The Fair Trading Acts 578

Who is most likely to take action under the TPA 579

Australian Competition and Consumer Commission 579

Australian Competition Tribunal 580

Bodies responsible for consumer affairs in the states

and territories 580

Jurisdiction of trade practices disputes 582

Self quiz 582

What are the main consumer protection provisions? 582

Who is a consumer? 584

1. Unconscionable conduct—ss 51AA, 51AB 584

2. Unconscionable conduct against a small business

—s 51AC 586

3. Misleading or deceptive conduct—s 52 587

How do you prove a breach of s 52? 588

Self quiz 594

4. False representations—s 53 594

5. Other false or misleading statements 599

6. Other prohibited practices 601

Self quiz 602

7. Protection for implied terms in consumer contracts 603

8. Product safety and information 604

9. Liability of manufacturers and importers 605

10. Strict liability of manufacturers 607

11. Protection against price exploitation—s 75AV 609

Remedies for breaches of consumer protection provisions 609

Legislation to protect consumers against unfair contracts 611

Self quiz 612

Small claims or consumer tribunals 613

Self quiz 616

Summary 616




25 Restrictive trade practices 626Constitutional limitations on the TPA 627

Australian Competition and Consumer Commission 627

Australian Competition Tribunal 627

National Competition Council 628

Federal Court 628

Developments in competition reform 628

Self quiz 629

What restrictive trade practices are prohibited? 630

1. Anti-competitive arrangements—s 45 630

2. Price fixing—s 45A 631

3. Primary boycotts—s 45(2), 4D 633

4. Secondary boycotts—ss 45D–45E 634

5. Misuse of market power—s 46 635

6. Exclusive dealing—s 47 637

7. Resale price maintenance—s 48 638

8. Mergers and takeovers—s 50 639

Self quiz 640

Statutory exceptions—s 51 641

Authorisations—s 88 641

Notification—s 47 641

Enforcement and remedies 641

Self quiz 643

Summary 643




PART 8MARKETING, E-COMMERCE ANDPRIVACY LAW26 Privacy and e-commerce law 651Privacy 652

Federal regulation of private information 652

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AUSTRALIAN BUSINESS LAW—COMPLIANCE AND PRACTICEXII

National Privacy Principles 652

Role and powers of the Privacy Commissioner 653

Main types of private information regulated under

federal law 654

State and territory privacy legislation 657

No statutory privacy protection for business 657

What privacy protection is available to businesses? 658

Surveillance in the workplace 658

New federal powers to monitor Internet communications 659

Self quiz 659

E-commerce law 660

1. Equality of electronic transactions with written

documents 661

2. Contractual negotiations 661

3. Compliance with consumer protection laws 662

4. Defamation 664

5. Intellectual property rights 664

6. Obligations of Internet and electronic communication

providers 666

7. Privacy rights 667

8. Spamming 667

9. Cybercrime offences 668

10. Statutory limits on access to pornography 668

11. Interactive Gambling Act 669

Self quiz 669

Summary 670



Compliance activiities 672

27 Marketing law and ethics 673Marketing law: the four Ps 674

Product 674

Promotion 674

Price 675

Place 676

Special areas of concern in marketing and advertising 676

Intellectual property 676

Section 52 and passing-off actions 677

Defamation 678

Comparative advertising 678

Disclaimers: ‘conditions apply’ 680

When can advertising agencies be liable? 681

Ambush marketing may be legal 681

Ten commandments of marketing law 682

Self quiz 683

Trade lotteries, competitions and promotions 684

Trading stamp promotions 686

Loyalty schemes and frequent flyer points 686

Labels and packaging 687

Trade measurement legislation 688

Poisons and dangerous goods 688

Drugs, therapeutic goods and cosmetics 688

Self quiz 688

Marketing ethics 689

Special areas of ethical concern 691

Self-regulation in the marketing industry 692

Self-regulation in the advertising industry 695

Mass media regulation 696

Self quiz 697

Summary 698




Reference material 704

PART 9INTELLECTUAL PROPERTY28 Intellectual property: copyright, designs,

patents, trademarks and other types ofprotection 707

What is intellectual property? 708

Specific protection under federal statutes 708

Copyright 709

Self quiz 720

Designs 721

Patents 723

Trademarks 725

The Trade Marks Act 726

International protection for intellectual property 730

Self quiz 731

Alternative statutory and common law protection 731

Self quiz 735

Summary 736




PART 10INSURANCE LAW29 Insurance law 747Two main types of insurance contracts 748

Main sources of insurance law 748

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XIIICONTENTS

Regulation and voluntary codes of practice 748

How is an insurance contract formed? 749

The four common law doctrines of insurance law 749

1. Insurable interest 750

2. Utmost good faith 750

Self quiz 751

Self quiz 755

3. Indemnity 756

4. Subrogation 757

Insurance agents and brokers 758

Insurance cover for business organisations 758

Self quiz 759

Summary 760




PART 11WORKPLACE ENVIRONMENT LAW30 Employment law and industrial relations 769Legal rights and obligations of employers and employees 770

Categories of employment 772

Self quiz 775

Common law duties of employers 775

Common law duties of employees 775

Termination of a contract of employment 776

Remedies for breaches of employment contracts 777

Unfair dismissal 777

Self quiz 780

Statutory regulation in the workplace 780

Equal opportunity legislation 781

Self quiz 784

Industrial relations 785

Trade unions and employer organisations 786

Influential High Court decisions 787

Self quiz 787

Workplace Relations Act 1996 (Cth) 788

Key legislative provisions of the Workplace Relations Act 789

What alternative employment agreements are available? 791

Independent Contractors Act 2006 793

Self quiz 793

Key features of state and territory industrial relations

systems 794

Summary 794




31 Occupational Health and Safety 803How dangerous is the workplace? 804

Who is responsible for workplace safety? 804

Occupational Health and Safety legislation 805

Main aims of the NSW OHS Act 806

Duties of employers 807

Penalties for breaches 809

Criminal penalties for workplace deaths in ACT and NSW 811

Duties of manufacturers, designers, suppliers and users

of machinery 812

Registration and regulation of plant and equipment 813

Hazardous and dangerous substances 813

Construction work 814

Self quiz 814

Duty to consult 815

Duties of employees to take reasonable care 816

Industry codes of practice and standards 816

Powers of inspectors 817

Accident notifications 818

Self quiz 818

Workers compensation 818

Occupational rehabilitation 822

Self quiz 823

Summary 823




Answers to self quizzes 828Glossary 838Table of Cases 846Table of Statutes 853Acts of the British Parliament 857Index 858

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AUSTRALIAN BUSINESS LAW—COMPLIANCE AND PRACTICEXIV

The new cover design of Australian Business law (ABL) underscores its abiding purpose—tohelp our users to navigate successfully through the shoals and the often bewildering flotsamand jetsam of business law.

The sixth edition also includes several innovations. The new title Australian Business Law:Compliance and Application points to ABL’s strong focus on assisting organisations and individ-uals to comply with their legal obligations. A key element in this fresh direction is MaryAnneFlood, who has become the first new co-author of ABL in its 15 year existence. Since 1998Roger Vickery has been prime author of ABL and the update material, with Wayne Pendletonacting in an advisory/reviewer role. MaryAnne brings many years experience as law teacher,solicitor and writer to the team and most importantly, a very strong interest in compliancematters. She re-wrote Part 3 Business Entities (Chs 5–7) and Part 5 Real Estate Law (Chs 18–19)and has been an active reviewer of most other chapters.

The importance of legal complianceCompliance is a new label for the age old requirement that organisations and individualsmust comply with (follow) the laws that apply to their business areas. The main drivers forbest practice in compliance areas in recent years have been government regulators, such asthe Australian Securities and Investment Commission (ASIC) and the AustralianCompetition and Consumer Commission (ACCC). However, there are many other motiva-tors and rewards for establishing good compliance strategies, including proven savings in time, money, stress and brand image that arise from identifying and avoiding key areas of risk.

The sixth edition has been written specifically to meet the requirements of all the relevantlaw based national competencies, including the units FNSCOMP601B: Interpret and managestatutory, legislative and regulatory obligations for organisational compliance.

We have tried to address key compliance issues in more detail in the section that followson from this Preface, ‘What is compliance?’

Compliance features in ABLOne of the greatest challenges to good compliance is how to identify the key risks in businessareas that matter. (Many people are afraid of things that are not real threats but relaxed aboutthings that should keep them awake at night.) The other is how to locate relevant and valu-able examples of templates, policy guides, case studies etc.

The chief features in ABL that address these needs include:• Website links and references: several hundred of them that cover finding the law, compliance

guidelines and manuals, industry and professional codes of conduct as well as compliancetraining packages and templates.

PREFACE

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• Over 90 Compliance Checks that sum up key danger areas and direct readers to websites thatoffer detailed self-assessment content.

• Over 60 Compliance Activities, mostly web-based, that offer a range of self-directed assess-ments that are equally suitable for groups and individuals. We have tried to emphasisepractical and attainable skills. This feature continues ABL’s long held emphasis on self-paced,self-directed learning activities for flexible delivery situations.

Other changes to ABLAdding compliance content and updating the law are comparatively easy. The challenge is howto fit this new material into the previous page length while trying to maintain a clear and livelywriting style. We achieved this through the following strategies: • Every sentence/paragraph/margin note/self quiz etc has been evaluated and trimmed down

wherever possible.• Several new cases have been added and some less relevant ones have been shed or condensed

with the full versions being available on the ABL website, <www.pearsoned.com.au/vickery>. • The use of more clutter-free layout and design features, including scores of improved

figures and flow charts.

Updates and improvementsApart from the compliance features the main new content areas are outlined below: • Part 1: Legal foundations: various updates including a new table on equity versus common

law; the Victorian Human Rights Act; native title claims; increased federal Constitutionalpowers; jurisdictions of courts and tribunals; judicial procedures and the new FinancialServices Ombudsman Service.

• Part 2: Torts: updates on civil liability reforms, improved figures, a revised approach to neg-ligent misstatement; new post Cook v Cook precedent; developments in common law actionfor privacy and a major re-write on national defamation laws.

• Part 3: Business entities: • Ch 5: new material on different structures; tax aspects; new cases on corporations law;

internal governance and reporting; role of auditors, reporting requirements of ASIC;trusts, associations and franchises as well as nine compliance checks.

• Ch 6 Agency: new cases and new material on real estate agents (also followed up in Ch 19); stockbrokers and duty not to accept secret commissions.

• Ch 7 Partnerships and joint ventures: new cases and amplified coverage on the Partnership Act. • Part 4: Contract law: re-written to provide more condensed explanations and range of com-

pliance sources; some new cases, including Smythe v Jones (the new important eBay case)and more on standard contracts and unfair contract legislation.

• Part 5: Real estate law: • Ch 18: extended sections on types of property; legal and equitable rights; easements;

profits à prendre; new cases; security interests in personal property and residential andcommercial leases.

• Ch 19: significantly amplified explanation of conveyancing, new cases and figures; newstatutory obligations in auctions and the sale of real property.

XVPREFACE

Vickery 6e Prelims 19/9/08 11:56 AM Page xv

• Part 6: Finance law: new coverage on payday loans and Anti-Money Laundering/CounterTerrorism Financing legislation; updates on bankruptcies; revised section on recovery ofassets from third parties; updates on personal insolvency agreements and Part IXAgreements and a new section on avoiding credit risks.

• Part 7: • Ch 24 Consumer protection: updates on personal liability of employees (Houghton v Arms);

unfair contracts; restrictions on negligence and consumer protection tribunals.• Ch 25 Restrictive trade practices: new cases, especially ACCC v Visy; anti-cartel proposed

legislation and proposed legislative changes.• Part 8: Marketing, e-commerce and privacy law: new Victorian workplace surveillance laws;

case on Internet auctions; updated table on lotteries and labelling of loose food; new out-line of Do not call register and first ACCC action on ‘meta stuffing’.

• Part 9: Intellectual property: criminal prosecutions and a case on moral rights.• Part 10: Insurance law: replacement of Insurance (Agents and Brokers) Act 1984 with the

Corporations Act 2001; s 21A of the Insurance Contracts Act. • Part 11: Workplace environment law:

• Ch 30: Employment law: new federal constitutional powers; important post-WorkChoices legislation—actual and proposed and reforms to administrative, judicial andcompliance bodies.

• Ch 31 Industrial relations: reforms under the Victorian OH&S Act 2007 and extendedliability for senior executives, including international CEOs.

AcknowledgementsThe sixth edition continued to draw upon the work of previous contributors and in particular,Barry Wall. We are also grateful to Kim Vickery and Mark Vickery for their assistance withresearch and general administrative support. Three professionals bore the brunt of theinevitable delays with impeccable skills. Andrew Brock, the publishing editor has been hisusual cool, calm, and unfailingly pleasant self. Loretta Barnard, the best production editor inAustralia, ignored the canny advice of her family and again agreed to take on the task of steer-ing ABL through our legal Sargasso seas. Loretta, we could not do it without you. KathrynLamberton, our new copy editor, x-rayed every sentence with intelligent diligence. Thank youalso to the skills and expertise of the design team designBITE and to Wendy Bayliss for thecover design . . . And thanks too for the hard work of our long standing typesetter, MidlandTypesetters, Australia.

To the best of our knowledge the law in this edition is accurate as of 18 August 2008.

About the authorsRoger Vickery is a Senior Head Teacher, Marketing, Property and Law with NSW TAFE. Healso lecturers in commercial law and corporations law with various universities. Prior to obtain-ing a law degree and being admitted as a barrister in the Supreme Court of NSW, Roger gainedextensive commercial experience in training, marketing and human resource management. Heis a Fellow of the Australian Institute of Management (NSW). Roger has scripted and directed

AUSTRALIAN BUSINESS LAW—COMPLIANCE AND PRACTICEXVI

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documentaries and is an award-winning fiction writer. He has co-written and presented a tele-vision series on marketing law, Navigating the Maze!

Wayne Pendleton is a lecturer at James Cook University, Brisbane Campus, specialisingin Business Law and Management Accounting. His academic qualifications include Masterof Applied Law, Certificate of Specialisation in Dispute Management Law, Bachelor ofCommerce and Business Administration, and Bachelor of Education in Vocational Education.Wayne has extensive experience in Queensland with private and public educational providersin the VET, university and secondary sectors.

MaryAnne Flood has enjoyed teaching business and property law in Sydney TAFE collegesfor 15 years. She has also written learning materials for external students, and collaborated onother writing projects for the Department of Education and Training. MaryAnne came toteaching from legal practice in the corporate world as well as small business and propertyareas, and brings the benefit of this experience to both her teaching and writing. MaryAnnehas a special interest in the needs of students from a non-English speaking background, andin addition to her legal and general education qualifications holds university qualifications inthis area.

XVIIPREFACE

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AUSTRALIAN BUSINESS LAW—COMPLIANCE AND PRACTICEXVIII

All business organisations operate within an increasingly complex legal and regulatory frame-work. Legal and regulatory requirements originate from a range of sources including legisla-tion, government regulations and the common law, as well as industry codes of conduct andother self-regulatory arrangements. Compliance is what an organisation does to ensure that it meetsthe legal and regulatory requirements applicable to its business activities. This applies equally to theindividuals within the organisation.

Compliance with externally imposed law and regulation, i.e. law and regulation adminis-tered and enforced by government regulators, industry associations and other outside bodies,is sometimes described as regulatory compliance. Not all compliance activity however, isconcerned with external regulatory requirements. Contracts for instance, are the basis of com-mercial transactions and underpin the viability and security of any business organisation, largeor small. Identifying the major issues in relation to its contracts and avoiding the major pit-falls, is very much a part of an organisation’s compliance management. Effective proactivemanagement of contracts should also have the added benefit of preventing the possible inter-vention of regulators, such as the Australian Competition and Consumer Commission(ACCC), over alleged unconscionable conduct or misleading provisions.

Similarly, these same proactive compliance standards should reap significant commercialbenefits in terms of ‘savings’ in time, money, stress, brand image, good customer relations . . .the list goes on.

Compliance also extends to the organisation’s internal rules, policies and proceduresincluding those regulating the relationships between individuals within the organisation.

The basic concept behind compliance therefore is simple—‘compliance’ is a new label forthe age old idea that an organisation must, in its day-to-day business operations, comply withthe law. The sticking point for many organisations is working out how to do this.

It is not the purpose of Australian Business Law to provide a ‘how to’ on the managementof compliance. Although there is some overlap in the roles of lawyer and compliance pro-fessional, they perform different functions in ensuring organisations comply with the law.Lawyers are engaged for their legal knowledge and skills, and act in both an advisoryand representative capacity. Lawyers draw up contracts and other legal documents andrepresent parties in negotiations and legal proceedings. They identify, and provide legaladvice on, the laws that govern an organisation’s business operations and relationships.Compliance professionals then develop systems and procedures, internal controls andmonitoring, to ensure the organisation complies with these laws. It is the role of the com-pliance professional, more so than the lawyer, to provide the ‘how to’ on the managementof compliance.

The website of the Australasian Compliance Institute <www.compliance.org.au> pro-vides a useful introduction to the compliance profession and the role of lawyers in compliance.

WHAT IS COMPLIANCE?

Vickery 6e Prelims 19/9/08 11:56 AM Page xviii

Readers will find a link to this website, and many others relating to legal compliance, on theABL website for Ch 5.

The first step in compliance clearly involves identifying the laws that apply to the business,the regulators who have jurisdiction in specific areas, the risks the business faces and legalissues that may arise. And it is not just a matter of putting together a one-off compliance pro-gram. Regular reviews, tracking changes to law and ongoing effective education of staff abouttheir legal obligations is essential for legal compliance and building ‘a culture of compliance’.

Building a compliance culture is a central theme in the compliance publications availablefrom regulators such as the Australian Taxation Office, the ACCC and ASIC. (See the links tothese publications on the ABL website for Ch 5.) Despite its growing profile the concept of acompliance culture is still difficult to define. The ACCC sees the culture of an organisation asa system of values, attitudes and beliefs that affect the way the individuals, at all levels withinthe organisation, behave. And a good compliance culture, according to the Commission, isreflected in individuals adopting a positive attitude to compliance, and proactively seeking tounderstand and comply with the legal obligations affecting their work.

To achieve this it is important that individuals working in business have some understand-ing of: • the Australian legal and regulatory system • government regulators and industry bodies• the main areas of business law and regulation, and• the legal environment in which particular businesses operate.

Everyone who is in business life, whether public, private or semi-public, must also havesome skills in finding the law and regulations affecting their business and recognising legalsituations and issues. Armed with this knowledge and awareness they can seek legal advicewhen necessary, and ask the questions that need to be asked.

The purpose of Australian Business Law is to introduce readers to these areas of knowledgeand provide the opportunity to start developing these skills.

WHY IS THERE SUCH A STRONG INCREASED INTERESTIN COMPLIANCE?From the 1980s onwards the major political parties supported the de-regulation of many busi-ness sectors, such as the banking and financial sector, and the introduction of self-regulation.By the 1990s the number of insolvencies and cases involving misleading or fraudulent conductoccurring under self-regulation, led to increased concern about how effectively businesseswere complying with government regulations and self-regulatory arrangements. Governmentregulators, in particular the Australian Securities and Investment Commission (ASIC) and theACCC became more proactive in investigations and the fines for breaches were significantlyincreased. The regulators also invested effort and resources into assisting businesses meet theircompliance obligations and build ‘a culture of compliance’.

In 1996 the Association of Compliance Professionals of Australia (now the AustralianCompliance Institute) was formed and two years later, following a request by the ACCC, anAustralian Standard AS 3806 was introduced to provide guidance on the development andoperation of effective compliance systems. AS 3806 was revised in 2006. The Standard is

XIXWHAT IS COMPLIANCE?

Vickery 6e Prelims 19/9/08 11:56 AM Page xix

generic and can be applied in any regulatory setting. It has become a benchmark for regula-tors including the ACCC and ASIC, when considering an organisation’s compliance program.Readers will find links to publications relating to the Standard on the ABL website for Ch 5.

It is now recognised that effective compliance systems are an integral aspect of good gov-ernance and that compliance also results in other benefits, including building good businessreputations and ensuring satisfied customers. In addition, compliance is beginning to demon-strate its value as a defence against regulatory breaches.

Organisations that neglect compliance can expect greater penalties. In the recent ground-breaking restrictive trade practices decision in ACCC v Visy Industries (see Chs 5 and 25), oneof the factors taken into account by the court in deciding the penalty was whether the com-pany had a ‘corporate culture conducive to compliance with the Trade Practices Act’. And whatdid the court determine about this culture? The much quoted view of the trial judge was: ‘TheVisy Trade Practices Compliance Manual might have been written in Sanskrit for all the noticeanybody took of it.’

The ACCC’s new tagline sums it up: ‘Compliance is common sense and good business’.

AUSTRALIAN BUSINESS LAW—COMPLIANCE AND PRACTICEXX

Vickery 6e Prelims 19/9/08 11:56 AM Page xx

AUSTRALIAN BUSINESS LAW—COMPLIANCE AND PRACTICEXXII

The 6th edition of Australian Business Law—Compliance and Practice contains a number offeatures that highlight concepts and illustrate how these apply to business situations. The new design of the text makes these features easy to identify.

HOW TO USEYOUR TEXTBOOK

Chapter

LEARNING OBJECTIVESAfter successfully completing this chapter, you will be able to:• state the characteristics of sole traders, partnerships, limited liability companies,

trusts, incorporated associations;• outline the legal requirements for each type of organisation and the conditions

imposed by law on the individuals who comprise the organisation;• identify the extent of liability of the parties involved in each type of business

organisation;• explain the reasons for, and the importance of, business name registration and

the legal restrictions placed on the use of a business name;• identify regulatory compliance issues on starting a business.

SETTING THE SCENEMarley is married to Bella, and they have two childen. Marley is a licensed property agent andBella is an accountant. Conor, who has various business qualifications, is their best friend.

The three friends are thinking about going into business for themselves. Marley is talking aboutbuying into a real estate franchise, which also interests Conor. Bella likes the idea of a home-based investment advice business. Each is keen to learn something about the choice of businessstructure and the legal issues that may arise.

5BUSINESSSTRUCTURES

169Business structures CHAPTER 5

Who has to prepare an annual financial report and directors’ report?Public companies and large proprietary companies must prepare a financial report and a direc-tors’ report: s 292. A small proprietary company need only prepare these two reports ifrequested to do so by at least 5% of its members or by ASIC, or if it is controlled by a foreigncompany and it is not consolidated in that company’s financial statements. Small proprietarycompanies under foreign company control are generally treated by the Act as if they are largeproprietary companies.

What is included in the financial report and the directors’ report?Under s 295 a company’s annual financial report must comply with the standards set by theAustralian Accounting Standards Board (AASB). These standards, which are made under s 334, are available at <www.aasb.com.au>. Currently, the annual financial report mustinclude:• the financial statements:

– a statement of financial position (balance sheet) – a statement of comprehensive income – a statement of cash flows– a statement of changes in equity (share of ownership)

• the notes to the financial statements (disclosures required by the accounting standards andregulations and any other notes required to give a true and fair view);

• the directors’ declaration (about the statements and notes and solvency of the company).See Financial Reports—The Basics at <www.asic.gov.au>.

The financial statements must comply with the accounting standards and the corpora-tion’s regulations and must give a ‘true and fair view of the financial position and performanceof the company’: ss 296–297.

ASIC has power under Part 2M.6 to exempt individual companies, or classes of companies,from some or all of the financial reporting and audit requirements in the Act. Mazda AustraliaPty Ltd & Ors v ASC (1992) 8 ACSR 613 concerned an application for relief from compliancewith certain requirements of the accounting standards. The Administrative Appeals Tribunalrelied on AASB Statement of Accounting Concepts SAC 2 to deny Mazda’s application forrelief from compliance with an accounting standard concerning related party transactions.SAC 2 sets out the objective of general-purpose financial reporting. See the ABL website.

The directors’ report must contain (i) the general information about the operations andactivities set out in s 299, and (ii) the specific information about such matters as dividends,details of directors, options granted over shares set out in s 300.

Audit and audit reportWith some exceptions, all companies that must prepare financial reports are required by s 301to have the financial reports audited by a registered company auditor, and to obtain an audit

Mazda Australia Pty Ltd& Ors v ASC (1992)

COMPLIANCE CHECK

Bella is the accountant for the new family company. What records must she set up to comply with s 286? ASIC, with

help from professional associations, has compiled a schedule of appropriate books and records. See What Books

and Records Should My Company Keep? at <www.asic.gov.au> or go to the ABL website.

Public and largeproprietary companiesmust prepare a financialreport

Learning objectives focus students on important issues andare tied to outcomes.

Setting the scene are examples from business wherecompliance issues are brought into focus.

Law in action describes howthe law works in practice,using real examples.

Case examples are realexamples from case law.These provide students with a summary of the facts of thecase and the issues involved.

Self quiz allows students tocheck their progress at eachstage; answers are found atthe end of the book.

Compliance checks sum up key danger areas and direct readers towebsites that offer detailed self-assessment content.

Key terms with a specific legal meaning are highlighted in the text. Allterms and definitions are consolidated in the Glossary at the end of the text.

Websites point students to legal and business websites relevant to thechapter. This gives students the opportunity to explore the web and use it for research. It also guides students to the website for this book at<www.pearsoned.com.au/vickery>.

PART 3 Business entities164

Business judgment rule: test case

In early 2007 ASIC began civil proceedings against the former and current directors and former executives of James

Hardie for breach of the duty of care (s 180). ASIC is asking the court to consider imposing fines and banning these

individuals from managing companies. Former HIH directors Rodney Adler and Ray Williams were banned, as was

former Telstra director Steve Vizard. In these cases, however, the directors acted dishonestly or misused their posi-

tions. In the case against the James Hardie directors’ negligence alone is alleged. See James Hardie file—Media

Releases <www.asic.gov.au>.

LAW IN ACTION

In 2000, $10 million was transferred from a subsidiary of HIH Insurance Ltd to a unit trust controlled by Rodney Adler,who was a non-executive director of HIH. The money was used to buy $4 million of HIH shares (to prop up their value),acquire unlisted investments from an Adler-associated company and make loans to Adler-associated companies.

After the collapse of HIH, ASIC took action against Adler, Williams (HIH chairman and chief executive officer) andFodera (executive director and finance director of HIH and the subsidiary involved) for breaches of ss 180–183. Allthree relied on the business judgment rule defence.

The Federal Court held: All three directors had breached their duties. Adler was personally liable for 101 breaches,including:• failing to act with reasonable care and diligence (s 180);• acting without good faith (s 181); and• misusing his position to gain a personal advantage or to cause detriment to the company (s 182).

Re penalties: Adler and Williams were ordered to repay civil penalties of $8 million in total to the companiesinvolved (now in liquidation), fined $900 000 and $250 000, respectively, and disqualified from managing a companyfor 20 and 10 years, respectively.

Re business judgment rule: Justice Santow rejected their business judgment rule defence on several grounds,including: Williams as a major HIH shareholder had a ‘material personal interest’ in encouraging the purchase of itsshares; Fodera’s failure to declare the transfer to the HIH board was an omission, not an act, and therefore did notqualify for consideration under the rule. ASIC v Adler, Williams & Fodera (2002) 42 ACSR 80

CASE

Indicate whether each of the following statements is true or false.TRUE FALSE

SELF QUIZ

14 Companies come into existence when they are registered by ASIC. ^ ^

15 The ‘corporate veil’ separates the company from its shareholders, directors and other officers. ^ ^

16 The corporate veil may be lifted if a company is formed so that someone could avoid legal obligations. ^ ^

17 Directors are personally liable for the company’s debts. ^ ^

18 Every company must have a company secretary. ^ ^

19 Only directors owe fiduciary duties to the company. ^ ^

10 A public company must have at least three directors and one shareholder. ^ ^

11 A proprietary company must have at least one director and one separate shareholder. ^ ^

ASIC v Adler (2002)

Vickery 6e Prelims 19/9/08 11:56 AM Page xxii

XXIIIHOW TO USE YOUR TEXTBOOK

In ACCC v Kyloe Pty Ltd [2007] FCA 1522 the court decided that a drink machine distri-bution arrangement and trade mark licence was not a ‘franchise agreement’ as it did notincorporate the ‘system or marketing plan determined, controlled or suggested by the fran-chisor’—a necessary element of the definition in clause 4 of the Code. The ACCC failed in itsaction for breach of the Code and was ordered to pay Kyloe’s legal costs.

Requirements of the Code prior to the making of a franchise agreement• Full disclosure. Prospective franchisees must be given a disclosure document that includes

details of directors and associates, their business experience, commissions they have beenpaid, trademarks, franchise territory details, and financial statements including the last twoyears of profit and loss accounts and balance sheets. A full account of any marketing orcooperative fund, including an audit report, must also be included. The document mustalso clearly set out the obligations of franchisor and franchisee. It must not contain anypromotional material.

Following amendments to the Code on 1 March 2008, details of the history of the fran-chise site and territory (including why the previous franchisee ceased to operate) must alsobe provided to the franchisee.

• Franchisees must receive the disclosure document at least 14 days before they enter or renew the contractor pay a non-refundable deposit. They are also entitled to a seven-day cooling-off period.

• Proof of independent advice. The agreement is not valid unless the franchisor receives a signedstatement from the franchisee saying they have received or have waived independent advicefrom a legal, business or accountant adviser.

• Copies of a retail lease must be provided if the landlord is the franchisor or an associate of thefranchisor.


ACCC v Kyloe Pty Ltd[2007]

Disclosure documentmust be provided to thefranchisee

Failure to comply with Code makes franchise agreement illegal.

The franchisor failed to obtain the franchisee a statement in accordance with clause 11(1) of the Code. Under this

clause the franchisor must obtain a written statement that the franchisee has received, read and had a reasonable

opportunity to understand the disclosure document and the Code, before entering into the agreement.

The NSW Supreme Court of Appeal held: Non-compliance with clause 11(1) made the franchise agreement illegal

and unenforceable. As a result the franchisor was unable to claim money owed to it by the franchisee under the fran-

chise agreement. Ketchell v Master of Education Services Pty Ltd [2007] NSWCA 161

CASE

Non-disclosure of vital information by a franchisorEXAMPLE

The Will Writers Guild Pty Ltd sold will-writing franchises across Australia for $65 000 per territory. Its directors failed

to disclose that the business could only be carried on by a qualified legal practitioner. They were fined $105 000,

ordered to pay over $360 000 in compensation and permanently restrained from offering franchises that did not

comply with the Franchising Code. ACCC Media Release, 14 April 2003

Disclosure document 14 days before contract

Ketchell v Master of Education Services Pty Ltd [2007]

ComplianceCompliance refers to an organisation’s obligations to comply with the law. This involves identifying

the law that applies to the business and the areas of risk, and then developing a compliance program.

There is no generic compliance program as each organisation’s circumstances are different. Australian

Standard AS 3806 has been developed to assist business in developing compliance programs.

Regulatory compliance issues on starting a business include compulsory registrations (including

taxation), recording keeping, business licences and permits, and local government approvals.

GUIDANCE QUESTIONSQuestion 1Allan Megson is unmarried and has no living family. He has dedicated the past ten years to his sole-

trader computer-software business that specialises in software to control pattern-making equipment.

Allan realises that his long-term success now depends on attracting and keeping the right employees.

Advise Allan which business structure would best serve his purpose.

ANSWERAllan has three main options.

1. To form a partnership with one or two people with the types of skills Allan lacks. Allan’s personal

assets would be at risk from any bad debts or unwise decisions made by the other member(s) of the

firm.

2. To form a trust. A trust (discretionary or fixed) would not attract and keep employees and Allan does

not have family members to whom he could distribute the profits of the business.

3. To form a company. Allan could offer shares to employees, which would grow in value as the company

prospered. Later, Allan could raise capital by selling shares. Provided Allan remains the majority share-

holder, he can control who is selected for key management positions. A company is more expensive

to establish than a partnership and is subject to more restrictions and scrutiny by ASIC.

CONCLUSIONBoth a partnership and a company would suit Allan’s plans fairly well. The company provides better

long-term advantages and allows him to protect his personal assets from creditors should his business

fail. However, he will probably be required at times to give a personal guarantee to lenders, which will,

once more, place his personal assets at risk.

Question 2Allan Megson wants to convert his sole-trader software business into a company, but he is not sure

what kind. He would like to include his own name in the company name and wonders if he should

register a separate business name for trading purposes. Advise Allan.

ANSWERAllan should form a proprietary company. He can name himself as the sole shareholder and director and

thereby avoid unnecessary meetings and paperwork. If the company qualifies as a small proprietary

company, it will not have to lodge an audited financial report with ASIC.


Trusts15. Define a trust and list its key characteristics.16. Give three examples of occasions when it is likely a trust would be created.

Associations17. Are members of an association liable for the debts of the association? Why or why not?18. David operates a basketball club for underprivileged teenagers in an inner-city suburb. Each player

pays a membership fee or a service club pays it. The treasurer disappears with all the funds, leavingthe club with debts of $12 000. Who is liable for this debt? Would your answer be different if the clubwas an incorporated association?

Business name protection19. How could the names of the following types of businesses be protected?

(a) a sole trader; (b) a partnership; (c) a company.20. Greg ‘the Moose’ promotes kick boxing in Queensland under the registered business name of ‘Kick

Start’. Greg wants to form a company using the same name. When he searches the ASIC websitefor company and business names he finds the following registered names. (a) ‘Kick Start’, a business name registered in Victoria that is used by a kick-boxing promoter;(b) ‘Kick Starter’, a business name registered in New South Wales;(c) ‘Kick Static Pty Ltd’, a company name registered to a company based in Western Australia.Explain, giving reasons, whether each name could prevent Greg from registering his preferred

company name.

COMPLIANCE ACTIVITIES21. Remember Marley and Bella from the introduction to this chapter? Bella will operate from home as

a sole trader under the name, Camelot Financial Planners. Marley has registered a proprietarylimited company with his friend, Conor, and bought into the real estate franchise known as LJWinger. They employ a receptionist and one salesperson.(a) Do a search of the National Names Index at <www.asic.gov.au> and find out whether the name

Camelot Financial Planners is available. (b) Make a checklist of any (i) licences and permits, (ii) industry codes of conduct, and (iii) basic tax

registrations that may apply to each business.(c) Bella has looked at the publication, What Books and Records Should My Company Keep? at

<www.asic.gov.au> (see Compliance Check). Make a list of the records she must set up inorder that Marley’s company complies with s 286.

22. Marley and Connor are having problems with their franchisor LJ Winger. They claim Winger:• refuses supply of essential products to them;• competes with them within their franchised territory;• requires them to buy items from Winger that they could buy cheaper elsewhere.Locate the Best & Fairest compliance training package on the website of the ACCC. Go to Module

6 and then answer the following questions:


could seek fines (for breaches apart from ss 52 and 51AA) and orders such as corrective advertis-

ing, injunctions and compliance programs. See ACCC v Top Snack Foods (1999).

REVIEW QUESTIONSSole traders1. List the key characteristics of a business operated on a sole-trader basis.

2. Compare and contrast the advantages and disadvantages of a sole trader.

Partnerships3. List the key characteristics of a business operated as a partnership.

4. What are the advantages and disadvantages of a partnership? Give examples.

Companies5. Define a company and list its advantages and disadvantages. Give examples.

6. What is the meant by ‘the corporate veil’? Describe three situations where the courts may ‘lift’ the

veil to establish whether company members have breached common or statutory laws.

7. What are the differences between a small and a large proprietary company? How many sharehold-

ers and directors are required to form (a) a private company and (b) a public company?

Duties of directors8. List and briefly explain six common law or statutory duties of a director.

9. Megson Software Pty Ltd appointed Nicholas Jones as a director responsible for marketing.

Nicholas persuaded customers of Megson Software to take their business to NPJ Electronic

Patterns, which Nicholas controls through his parents. What common law or statutory duties has

Nicholas breached? What remedies are available?

Raising capital10. Explain the ways in which companies can raise capital by (a) equity finance and (b) debt finance.

11. Explain the differences between fixed charges and floating charges. Give an example of each.

Franchises12. Dimitri, a retired school teacher, is interested in becoming a franchisee with Perfect Score Educa-

tion Centres Pty Ltd which runs a high school tutoring business. The franchisor claims Dimitri will

earn $60 000 per year within two years. Advise Dimitri about what should be included in a franchise

agreement and how he can best protect his interests.

13. See the facts in Question 12. Dimitri entered a franchise agreement with Perfect Score. After one

year in business Dimitri has learned that Perfect Score’s profit projections were highly inflated and

it was badly in debt when Dimitri bought the franchise. What remedies are available to Dimitri and

what are his chances of success?

14. Explain, giving examples where possible, what possible conflicts could arise between a franchise

agreement and Part IV of the Trade Practices Act.


Margin notes focus students’ attention and provide arunning reference to the main points within the chapter.

Examples are fictitious and have been written to illustratepoints of law.

Summaries provide aconcise picture of whatthe chapter covered.

Guidance questions andanswers illustrate how the lawis applied in everydaysituations.

Review questions allowstudents to consolidatetheir learning.

The main types of business entities or structures are:

• sole trader

• partnership

• company

Business structures CHAPTER 5 191CHAPTER 5

REGISTERS AND FINANCIAL FINANCIAL

ENTITY MINUTE BOOKS RECORDS REPORTING AGM AUDIT LODGE

Sole trader No legislative requirement for record keeping, financial reporting or audit – other than compulsory recordsPartnership under tax, workers compensation, workplace or industry specific laws.

Corporations Act 2001 (Cth)

Public company Yes Yes Yes Yes Yes Yes

Large proprietarycompany Yes Yes Yes No Yes Yes

Small proprietary Yes Yes Only if directed by No Only if directed by No*company ASIC or members* ASIC or members*

Associations Incorporations Act 1984 (NSW)

IncorporatedAssociation Yes Yes Yes Yes No Yes

Trust No legislative requirement for record keeping, financial reporting or audit, other than compulsory recordsunder tax, workers compensation, workplace or industry specific laws.

* Or the company is controlled by a foreign company and is not consolidated in that company’s financial statements.

Legislative requirements for record keeping, financial reporting and auditsTABLE 5.8


SELF QUIZ

23 The senior officers of an unincorporated association could be personally

liable for its debts and legal obligations. ^ ^

24 An incorporated association has limited liability. ^ ^

25 An incorporated association can return profits to members. ^ ^

26 A business name must be displayed at each place of business. ^ ^

27 If a business name is registered in Queensland it is automatically registered

in all jurisdictions. ^ ^

28 Legal compliance applies only to large businesses. ^ ^

SUMMARY

Compliance activities offer a range of self-directed assessments, equally suitable for groupsand individuals, that emphasise practical andattainable skills.

Vickery 6e Prelims 19/9/08 11:56 AM Page xxiii

3part

5 Business structures 153

6 Agency law 201

7 Partnerships and joint ventures 230

BUSINESSENTITIES

Vickery 6e Part 3 19/9/08 11:38 AM Page 151

Chapter

153

LEARNING OBJECTIVESAfter successfully completing this chapter, you will be able to:• state the characteristics of sole traders, partnerships, limited liability companies,

trusts, incorporated associations;• outline the legal requirements for each type of organisation and the conditions

imposed by law on the individuals who comprise the organisation;• identify the extent of liability of the parties involved in each type of business

organisation;• explain the reasons for, and the importance of, business name registration and

the legal restrictions placed on the use of a business name;• identify regulatory compliance issues on starting a business.

SETTING THE SCENEMarley is married to Bella, and they have two childen. Marley is a licensed property agent andBella is an accountant. Conor, who has various business qualifications, is their best friend.

The three friends are thinking about going into business for themselves. Marley is talking aboutbuying into a real estate franchise, which also interests Conor. Bella likes the idea of a home-based investment advice business. Each is keen to learn something about the choice of businessstructure and the legal issues that may arise.

5BUSINESSSTRUCTURES


When setting up a new business or taking over an existing one, there are six main businessstructures to choose from:• sole trader• partnership• company• trust• franchise• association.This chapter outlines the nature of each structure, and its relative advantages and disadvan-tages. We start with a sketch of the factors to consider when choosing a structure and, as thechoice of structure dictates how the law will affect the business, we finish with an outline ofsome basic legal compliance issues. Supplementary notes and cases, as well as links to thewebsites referred to in this chapter, are also provided.

CHOOSING A BUSINESS STRUCTURESome of the factors to consider when choosing the structure are:• Liability: the extent of the personal liability of the owner to third parties, and capacity to

protect personal assets. • Management and control: the extent to which the owner desires to retain managerial

and administrative control of the business, and the knowleldge, skill and experience of theowner.

• Capital: the financial resources available to the business including start-up capital, capacityto raise finance, availability of assets to use as security.

• Profits and taxation: the ownership and division of profits, calculation of and differentrates of tax, legitimate tax minimisation, income splitting, superannuation contributions,payroll and other state taxes.

• Fees and costs: set-up fees and ongoing costs.• Restructuring/retirement/admission of extra people: flexibility to restructure in

changing circumstances, retire and/or admit new people, saleability of the business.• Family needs and estate planning: distribution of profits, income splitting, impact of

structure on eligibility for social security or other government support, ease of transferringownership interests, succession (business bequeathed in a will).

• Regulation: complexity of regulation, costs of compliance, penalties for breach, and extentof mandatory disclosure and reporting affecting privacy of business.The business owner is not locked into the structure chosen for the life of the business. The

structure can be changed as the business grows or changes. A successful sole trader might, forinstance, register a company to reduce taxation or gain access to capital for expansion. Changeof business structure might, however, raise other legal issues such as stamp duty and capitalgains tax liabilities. A comparative table of the advantages/disadvantages of the differentbusiness structures can be found on the ABL website.

SOLE TRADERSSole traders are people who own and operate their own business enterprise for profit.


Sole traders own andoperate their own

business



About 95% of businesses in Australia are small businesses and most of them are sole traderoperations. They cover every type of business, occupation and profession. This form of businessownership operates under the control and management of one person, though the proprietor canhave employees like any other type of business structure. For legal purposes there is no distinc-tion between the owner and the business. On the death of the owner, the business may be sold bythe executor of the sole trader’s will, but this may be difficult if all goodwill attaches to the owner.

The advantages and disadvantages of the sole trader business structure are outlined inTable 5.1.

A sole trader’s liability isunlimited

Partners should have awritten partnershipagreement

Partners are liable foreach other’s businessconduct

ADVANTAGES DISADVANTAGES

1. Relatively easy and cheap to set up and run Unlimited liability

2. Retains ownership and control Lack of management skills or expertise

3. Keeps all profits Limitation of business life

4. Maximum privacy Limited access to funds

5. Flexibility in changing business Inability to split income with family

6. Legal compliance relatively simple Limited opportunity for tax minimisation

Advantages and disadvantages of the sole traderTABLE 5.1

PARTNERSHIPSA partnership is the relationship that exists between two or more people carrying on a business incommon with a view to making a profit. Partnership is the business structure frequently used bysome professions such as accountants and lawyers, and is also popular with small family businesses.

The partners share the profits and losses according to an agreed percentage. Disputes canbe substantially reduced by a clear, detailed written partnership agreement. Where there is noclear arrangement between the partners, the Partnership Act in each state and territory regu-lates the rights and obligations of the partners.

A partnership is not a separate legal entity, and all assets of the partnership are ownedjointly by the partners. Each partner is fully liable to third parties for debts and liabilities ofthe firm (despite any agreement among the partners). Each partner is a principal and an agentfor the other partners, and therefore they are equally liable for each other’s business conduct.

The advantages and disadvantages of a partnership are outlined in Table 5.2. Partnershipsare covered in detail in Ch 7.


1. Relatively cheap and easy to set up Unlimited liability

2. Sharing of responsibility Difficulties in transferring ownership

3. Additional assets, expertise and input No continuity when the partners split

4. Relative flexibility to make changes Potential for conflict

5. Less stringent legal compliance Limits on maximum number of partners

Advantages and disadvantages of the partnership structureTABLE 5.2


Reforms by FinancialServices Reform Act

2001


COMPANIESA company is a separate ‘legal person’ with all the legal capacity of an individual (that is, ahuman person). This means the company does business in its own right, and it holds assets,borrows money and enters into contracts in its own name. Also, unlike a sole trader or a part-nership, a company has a continuous life. There is no limit on how long a company can carryon operating, provided it pays its creditors and complies with its major statutory requirements.The owners of the company are the members (shareholders) and the company is managed bythe directors. In small business, it is not unusual for the members and directors to be the samepeople.

There are usually greater legal and taxation compliance issues involved in using thecompany structure. This drawback, however, may often be offset by the advantages offeredby companies, such as tax benefits, limited liability and asset protection.

In Australia companies are governed by the Corporations Act 2001 (Cth) and the AustralianSecurities & Investment Commission (ASIC) administers and enforces the Act. In recent yearsthere have been numerous amendments to the legislation aimed at reforming and modernisingcorporate regulation. The most recent reforms stem from the Corporate Law EconomicReform Program (CLERP) which was initiated in 1997 as a program for simplifying companyoperations and imposing higher standards of corporate governance.

The Corporations Act was substantially amended in 2001 by the Financial Services Reform Act2001 and related legislation. This established a standard of conduct for financial sevicesproviders and a new disclosure regime. It also brought various financial services under the onelicensing scheme. All businesses that offer financial services must now hold an AustralianFinancial Services Licence. In 2004 the CLERP 9 package extensively expanded the rulesrelating to audit and corporate disclosure.

A very useful resource is the Small Business Guide in Part 1.5 of the Corporations Act.This guide summarises the main rules in the Act that apply to proprietary companies limitedby shares—the most common type of company used by small business. The guide gives ageneral overview of the law as it applies to those companies and directs readers to the appli-cable sections in the Act. A detailed examination of the Corporations Act is beyond the scopeof this book, but supplementary material, case studies and links are provided on the ABLwebsite.

The advantages and disadvantages of the company structure are outlined in Table 5.3.

The Small BusinessGuide summarises rules

for private companies


SELF QUIZ

1 If a sole trader dies the business comes to an end. ^ ^

2 A partner’s personal assets cannot be taken by a creditor of the partnership. ^ ^

3 Partners are liable for each other’s business conduct. ^ ^

A company is a separatelegal person



Concept of incorporationThe principle that a company is a separate legal person is a cornerstone of company law. Thiswas firmly established in the landmark case of Salomon v Salomon & Co. Ltd in 1897. A ‘veilof incorporation’ or ‘corporate veil’ is said to separate the company from its shareholders,officers and employees. This veil means the shareholders and directors should not be heldpersonally responsible for the debts of the company. Once a company is registered, the courtsusually do not look behind the veil to enquire why the company was formed or who reallycontrols it.

Despite criticism of the decision in Salomon’s Case, the principle that a company is aseparate person has been confirmed and applied in many important cases, including Lee v Lee’sAir Farming Ltd [1961], which is explained on the next page.

Lifting the veil under common lawIn some exceptional circumstances such as fraud or where a company is established to avoidan existing obligation, the courts will ‘lift’ or ‘pierce’ the corporate veil’. This means the court


1. Separate legal entity Significant set-up and maintenance costs

2. Limited liability of members Limited management role for members

3. Continuous life Control of the company can change

4. Transferability of shares Strict reporting and disclosure requirements

5. Taxation benefits Penalties imposed on defaulting officers

6. Easier access to capital More onerous legal compliance issues

Advantages and disadvantages of the company structureTABLE 5.3

A company is separate from the person who controls it.

Aaron Salomon sold his sole-trader boot-making business to Salomon and Co. Ltd, a limited company in which he

was the major shareholder. Members of his family owned the remaining shares. As part of the purchase price

Salomon received a debenture (see p. 165), which made him a secured creditor to his own company. Salomon

continued to run the business. When the company went into liquidation during the depression of the 1890s, the

liquidator argued that Salomon’s debenture should not be paid out before the unsecured creditors. Since Salomon

controlled the company, the company should be treated as his agent, and its debts were effectively Salomon’s

personal debts.

The House of Lords held: Salomon and the company were separate legal persons according to the law. Even

though Salomon controlled the company, the company was not his agent. The company operated the business

in its own right, and consequently Salomon was not personally liable for the company’s debts. He had the right

to be paid ahead of the unsecured creditors. Salomon v Salomon and Co. Ltd [1897] AC 22

CASESalomon’s Case [1897]



will treat the company and a director and/or shareholder as the same person. See, for example,Gilford Motor Co v Horne [1933] Ch 935. Horne’s employment contract with Gilford MotorCo provided that he would not solicit (contact) any of their customers if he left their employ-ment. Horne resigned and began working for a rival company run by his wife. The courtlooked behind the veil and found that Horne was its true controller. It granted an injunctionto restrain Horne as the company was competing with Gilford Motors.

The principle from Gilford Motor Co v Horne was applied in the recent case of Artedomus vDel Casale [2006] NSW 146 where the NSW Supreme Court found that the defendant hadused a company as ‘a cloak’ or ‘sham’ to breach his contract with the plaintiff. See the casestudy on the ABL website.

Lifting the veil under statute law—insolvent tradingSeveral provisions in the Corporations Act have the effect of lifting the veil, most impor-tantly s 588G which imposes personal liability on directors for insolvent trading by thecompany. A director will be liable if he or she fails to prevent the company incurring a debtwhen there are reasonable grounds for suspecting the company is insolvent. Directors havea defence if they can prove they (i) reasonably believed the company was solvent, or(ii) expected on the basis of information provided by a competent and reliable person thatthe company was solvent, or (iii) did not take part in management because of illness orsome other good reason, or (iv) they took reasonable steps to prevent the company incur-ring the debt: s 588H.

Cases on insolvent trading• Statewide Tobacco Services Ltd v Morley (1990) 8 ACLC 827

Mrs Morley was the director of a family company run by her son. She took no part in themanagement apart from signing the annual returns. When the company became insolventshe was made liable for its debts as she had indirectly approved the insolvent trading.

• DFC of T v Clark (2003) 21 ACLC 1063In 2003 the New South Wales Court of Appeal confirmed that a director, such as the wifeof the managing director of a family company, could not escape liability for insolventtrading although she took no part in company affairs and relied on advice from her husbandwho was the active director.

Gilford Motor Co v Horne[1933]: forming a

company for fraudulentpurposes

Artedomus v Del Casale[2006]

Directors can bepersonally liable for the

insolvent trading of theircompany

Statewide TobaccoServices Ltd v Morley

(1990)

DFC of T v Clark (2003)

A company can employ its main shareholder and director.

Mr Lee was employed to fly crop-duster planes in New Zealand by a company in which he was a director and the

controlling shareholder. When he was killed in a plane crash the Worker’s Compensation Board claimed that Lee had

effectively been self-employed and refused to pay compensation to his wife, Catherine.

The Privy Council held: Since Lee and the company were separate legal persons he could have a dual role as

director and an employee of his company. Therefore, his wife was entitled to compensation. Lee v Lee’s Air Farming

Ltd [1961] AC 12

CASELee v Lee’s Air Farming Ltd [1961]



• ASIC v Plymin & Ors (2003) 21 ACLC 700John Elliott, a former non-executive director of Water Wheels Pty Ltd, was liable for thecompany’s insolvent trading. Elliott unsuccessfully argued he had relied on informationsupplied to him by the managing director. Given his extensive experience as a directorand business person, it was not reasonable that he had relied on the skill and expertise ofthe officers who ran the company. Elliott was disqualified from managing corporationsfor four years, fined $15 000 and ordered to pay $1.43 million compensation.

Formation of a companyThe Corporations Act provides a one-step procedure for registering a company by lodging aform with ASIC. The form sets out certain information, including details of every personwho has consented to be a member, director or secretary of the company and the addressof its proposed ‘registered office’. The company comes into existence when ASIC issues aCertificate of Registration and gives the company an ACN (a nine-digit AustralianCompany Number). See the ASIC publication How to Register a Company on the ABLwebsite.

Types of companies Most companies can be classified as shown in Figure 5.1.

A company comes intoexistence when ASICissues a Certificate ofRegistration

Insolvent trading: bad odds for directors

Once a case goes to court the odds are stacked against the director. Of the 103 ‘insolvent trading’ cases from 1961

to 2003, 75% resulted in findings against the directors. Of these companies, 91% were private companies. The

median amount of compensation ordered was $110 600 and the largest was $96.7 million. See Insolvent trading

odds stacked against directors, 16 June 2004, Clayton Utz (law firm) <www.claytonutz.com>.

LAW IN ACTION

Phoenix companies: fraudulent misuse of the corporate veil

Phoenix activity involves individuals using a company to accumulate large debts, then go into liquidation only to ‘rise

from the ashes’ and carry on business through a newly formed company. In a media release in January 2007 ASIC

announced it had banned 40 directors who have engaged in repeat phoenix activity for a total of 144 years. Phoenix

activity, which amounts to tax fraud, can also result in lengthy prison terms for directors.

LAW IN ACTION

COMPLIANCE CHECK

Marley has just registered his new family company. ASIC (the company law watchdog) now expects him to get to

know his legal obligations. Compliance is not optional. See ASIC publications, Get to Know Your Legal Obligations

and Your Company and the Law at <www.asic.gov.au> or go to the ABL website.

ASIC v Plymin & Ors(2003)


Companies by liabilityThere are four main types of companies in this classification. 1. A company limited by shares. The liability of members for the company’s debts is limited to

any amount unpaid on their shares. This is the most common type of company.2. A company limited by guarantee. The liability of members is limited to the amount each one

has agreed to contribute if the company is wound up. NRMA Motoring & Services is acompany limited by guarantee, as is the Australian Society of Certified Practising Accoun-tants. Non-profit bodies, such as sporting associations with significant assets, may also formthis type of company. Smaller organisations are more likely to form an incorporated asso-ciation (see p. 181).

Unless exempted by ASIC, a limited liability company must include ‘Limited’ or ‘Ltd’ inits name.

3. Unlimited companies. The members have no limit on their liability. Unlimited companieshave been used as ‘mutual funds’ (investment companies) and professional firms where therules of the profession do not permit limitation of liability. Otherwise unlimited companiesare generally not used for trading purposes.

4. No liability companies. The members have no liability to pay calls made on their shares, butthe shares can be forfeited. Only a mining company can be a no liability company and itmust have ‘No Liability’ or ‘NL’ in its name.

Public and proprietary companiesCompanies are formed for many different purposes and exist in many different sizes. At oneend of the scale is the small family proprietary company (which may be a ‘one personcompany’). At the other end are large public companies engaged in large-scale trading opera-tions. The shareholders in these large companies represent a cross-section of the communityand often include institutional investors such as finance corporations. 1. A proprietary company must:

• be limited by shares (or be an unlimited company with a share capital);• have at least one shareholder (but no more than 50 non-employee shareholders) and

one director, who may be the same person;• not do anything that would require disclosure to investors (except in limited circum-

stances). This means there are restrictions on the company raising funds from the public.The Act distinguishes between large and small proprietary companies for financialreporting purposes. A company is a small proprietary company, and has reduced


The company limited byshares is the most

common form ofcompany

Proprietary companiesneed only one

shareholder and onedirector

A proprietary companymust not engage in

activity that requires aprospectus

Distinction betweensmall and large

proprietary companiesfor reporting purposes

Types of companiesFIGURE 5.1

Proprietary

By liabilityExtent of members’ liability

By membershipPrivate or public?

Public

Large Small

Limitedby shares

Limited byguarantee

Noliability

Unlimited



reporting requirements, if it satisfies at least two of the following at the end of itsfinancial year:• gross operating revenue is less than $25 million; • consolidated gross assets are less than $12.5 million; • group employees total less than 50 full-time equivalent employees.

2. A public company is any company other than a proprietary company. A public company:• need not have a share capital, so it may be a company limited by guarantee;• must have at least one member (with no upper limit) and at least three directors;• can raise funds from the public (subject to the disclosure provisions in the Act);• may be listed on the stock exchange (not all public companies choose to be listed).A listed company is a public company whose shares and debentures (and other securities)can be bought and sold on the stock exchange. The company enters into an agreement withthe ASX and must comply with the ASX ‘listing rules’. There are also special rules in theCorporations Act—for example, a listed company is a ‘disclosing entity’ for the purposes ofthe Act and must prepare a financial report and a directors’ report each half year. Thespecial rules for listed companies are not detailed in this chapter.

Internal governance rulesReforms in 1998 abolished the requirement for a company to have a formal constitution andallowed a company instead to rely on ‘replaceable rules’. These rules are set out in the Act andrelate to such matters as the appointment and power of directors, inspection of books, direc-tors’ meetings, members’ meetings, members’ rights and transfer of shares. A company may,if it chooses, adopt a constitution which can modify or replace the replaceable rules, or it mayrely entirely on the rules to regulate its internal management. The replaceable rules do notapply to sole director/shareholder proprietary companies.

The replaceable rules and constitution have the legal effect of a contract between thecompany and the members, member and member, and the company and its officers. Theconstitution can be altered by passing a special resolution, but alterations that are oppressiveor made for an improper purpose under common law are invalid.

Some companies still require a constitution: for example, no liability mining companies anda company limited by guarantee that wishes to omit ‘Limited’ from its name. Public compa-nies wanting to list on the ASX must adopt a constitution that is consistent with the ASXlisting rules.

DirectorsWho is a director?Under the definition in the Corporations Act, a director is not just a person appointed to thatrole. A person who has not been formally appointed will also be regarded as a director if theyact in the position of director, or the directors act in accordance with their instructions. Thesepeople are sometimes called ‘de facto’ or ‘shadow’ directors.

In any company there may be different types of directors, although the Act does notdistinguish between directors in relation to duties and management of the company. One ofthe main distinctions is between executive directors and non-executive directors. Executive

A public company musthave at least onemember and threedirectors

Companies may choosea constitution or thereplaceable rules. Theserules do not apply tosole director/shareholder Pty Ltdcompanies

Executive directors arefull-time employees


directors are employees of the company and devote their working time to managing thecompany. A non-executive director is not an employee and attends board meetings on apart-time basis. Non-executive directors are sometimes called ‘independent’ directors andin Australia it is considered good corporate governance for directors to be non-executiveand independent, especially in listed companies. See Roles, Duties and Responsibilities<www.companydirectors.com.au>.

All public companies must have a company secretary. A person can be both a director anda secretary. The secretary is responsible for important administrative and reporting functions,while the directors are responsible for management of the company.

Directors’ power of managementCompany constitutions (and the replaceable rules) give to the board of directors the power tomanage the business of the company. The directors are given wide powers to exercise all thepowers of the company, except any powers that are reserved to (left with) the members by theAct or the company’s constitution. Because of their extensive powers, the law imposes dutieson directors, including the duty to exercise their powers for a proper purpose. The memberscannot override a management decision of the board if the decision comes within the powerof the board. If the members are dissatisifed with management, they may be be able to alterthe company’s internal governance rules to restrict the directors’ powers. In public companiesthe members can remove directors from office. If directors act improperly and control themajority of votes at the general meeting, the members might obtain a remedy under theoppressive conduct provisions. See pp. 167–168.

Duties of directorsDirectors and other senior executives are in a fiduciary relationship with the company. Thismeans they are expected to act in the best interests of the company and owe a common lawduty of loyalty and good faith. This can be divided into four specific duties:• the duty to act in good faith (honestly) in the interests of the company;• the duty to act for a proper purpose;• the duty to retain discretions;• the duty to avoid conflicts of interest.

Under the common law, directors also owe:• the duty of care, skill and diligence.

Executive directors may also owe specific duties under their contracts with the company. The company’s remedies include damages, injunctions, rescission of contracts and account-

ing to the company for profits made from the director’s breach of duty.The Corporations Act also imposes duties on directors and other officers, including the

company secretary and senior executives. The main statutory duties are:• the duty to act with reasonable care and diligence: s 180;• the duty to act in good faith in the best interests of the company and for a proper purpose: s 181;• the duties not to make improper use of position or information: ss 182 and 183,• the duty to disclose any significant personal interest in a matter that relates to the affairs of the

company (applies only to directors): s 191;• the duty to prevent insolvent trading (applies to directors only): s 588G.


The company secretaryis the chief

administrative officer

The company delegatesmanagement power tothe board of directors

Directors owe fiduciaryduties to the company

Statutory duties ofdirectors



To some extent these duties overlap with the common law duties. The statutory duties,however, are enforced by ASIC. An action for breach of a statutory duty may result in:• Civil Penalty Orders—disqualification from management of companies, civil penalties up

to $200 000 or compensation to the company. The standard of proof in a civil penaltyaction is ‘the balance of probabilities’.

• Criminal Penalties—if dishonesty is found to be a factor in an officer’s breach of any of theduties to act in good faith, for a proper purpose and not to misuse the officer’s position orinformation, then the officer has committed an offence: s 184. Similarly, if a director’sfailure to prevent the company from trading while insolvent is dishonest, the director hascommitted an offence: s 588G(3). Criminal penalties include fines of up to $220 000 and/orimprisonment for up to five years. The issue of directors’ duties and liabilities has gained importance over the past few years

with the high-profile cases around the collapse of such companies as HIH Insurance Ltd andOne.Tel Limited. In separate cases during 2005, Rodney Adler and Ray Williams were eachsentenced to four and a half years imprisonment after pleading guilty to several criminalcharges brought by the Director of Public Prosecutions (DPP). The respective charges relatedto their conduct as directors of HIH and in each case included a charge under s 184: ASIC vAdler [2005] NSWSC 274, ASIC v Williams [2005] NSWSC 315.

In ASIC v Rich (2003) 21 ACLR 672 civil proceedings were brought against the executivedirectors of One.Tel (Jodee Rich, Brad Keeling and Mark Silbermann), for breach of the statu-tory duty of care and diligence under s 180(1) of the Act. Proceedings were also broughtagainst the non-executive chairman, John Greaves, with ASIC arguing that Greaves’s dutieswere greater than those of the other non-executive directors. ASIC’s views on the duties of thechairperson are outlined in the media release, ‘Landmark decision on chairman’s duties’ inASIC’s One.Tel file <www.asic.gov.au>.

In September 2004 ASIC reached an agreement with Greaves, and the court ordered thatGreaves be prohibited from managing a company for four years, pay compensation of $20 million to One.Tel and pay ASIC’s costs of $350 000. As part of the agreement, Greavesadmitted he failed to ensure that he and the board of One.Tel properly monitored manage-ment and were aware of the true financial position of the company.

Defences of directorsUnder the ‘business judgment rule’ in s 180(2) directors or other officers will satisfy the statu-tory duty of care and diligence regarding a decision if they can prove that they:• made a judgment in good faith (honestly) for a proper purpose;• did not have a material personal interest in the subject matter;• informed themselves about the subject matter to the extent they reasonably believed

to be appropriate; and• rationally believed the decision to be in the best interests of the company.

This rule, which was only introduced in 2000, is consistent with the long-standingcommon law view that courts should leave business judgments to business people.

Civil Penalty Orders andCriminal Penalties forbreach of statutory duty

ASIC v Rich (andGreaves) (2003) Dutiesof company chairman

A director cannot befound to have brokenthe law because acompany loses moneyif the director was usingreasonable commercialjudgment.



Business judgment rule: test case

In early 2007 ASIC began civil proceedings against the former and current directors and former executives of James

Hardie for breach of the duty of care (s 180). ASIC is asking the court to consider imposing fines and banning these

individuals from managing companies. Former HIH directors Rodney Adler and Ray Williams were banned, as was

former Telstra director Steve Vizard. In these cases, however, the directors acted dishonestly or misused their posi-

tions. In the case against the James Hardie directors’ negligence alone is alleged. See James Hardie file—Media

Releases <www.asic.gov.au>.

LAW IN ACTION

In 2000, $10 million was transferred from a subsidiary of HIH Insurance Ltd to a unit trust controlled by Rodney Adler,who was a non-executive director of HIH. The money was used to buy $4 million of HIH shares (to prop up their value),acquire unlisted investments from an Adler-associated company and make loans to Adler-associated companies.

After the collapse of HIH, ASIC took action against Adler, Williams (HIH chairman and chief executive officer) andFodera (executive director and finance director of HIH and the subsidiary involved) for breaches of ss 180–183. Allthree relied on the business judgment rule defence.

The Federal Court held: All three directors had breached their duties. Adler was personally liable for 101 breaches,including:• failing to act with reasonable care and diligence (s 180);• acting without good faith (s 181); and• misusing his position to gain a personal advantage or to cause detriment to the company (s 182).

Re penalties: Adler and Williams were ordered to repay civil penalties of $8 million in total to the companiesinvolved (now in liquidation), fined $900 000 and $250 000, respectively, and disqualified from managing a companyfor 20 and 10 years, respectively.

Re business judgment rule: Justice Santow rejected their business judgment rule defence on several grounds,including: Williams as a major HIH shareholder had a ‘material personal interest’ in encouraging the purchase of itsshares; Fodera’s failure to declare the transfer to the HIH board was an omission, not an act, and therefore did notqualify for consideration under the rule. ASIC v Adler, Williams & Fodera (2002) 42 ACSR 80

CASE


SELF QUIZ

14 Companies come into existence when they are registered by ASIC. ^ ^

15 The ‘corporate veil’ separates the company from its shareholders, directors and other officers. ^ ^

16 The corporate veil may be lifted if a company is formed so that someone could avoid legal obligations. ^ ^

17 Directors are personally liable for the company’s debts. ^ ^

18 Every company must have a company secretary. ^ ^

19 Only directors owe fiduciary duties to the company. ^ ^

10 A public company must have at least three directors and one shareholder. ^ ^

11 A proprietary company must have at least one director and one separate shareholder. ^ ^

ASIC v Adler (2002)


Companies can raise capital (funds) through equity financing or debt financing.

Equity financing—sharesA company can raise funds by selling shares. Shares can be issued fully paid or partly paid, andthe directors determine the issue price. A shareholder is a member of the company, and thecapital contributed by the members is referred to as equity capital.

Many companies choose to issue shares of two classes—ordinary shares and preferenceshares. Ordinary shareholders typically have a right to vote at general meetings, to receive adividend after preference shareholders, to be repaid their capital on a winding up (after allother claimants have been paid) and to share in any surplus assets on a winding up (after all other claimants have been paid). Preference shareholders usually have a right to a fixeddividend (dividend at a fixed percentage of the issue price of the shares) and to be repaid theircapital ahead of the ordinary shareholders on a winding up, but they have only limited votingrights and no right to share in any surplus on a winding up.

A company may also issue redeemable preference shares. These are shares the company canbuy back from the shareholders at a specified date.

Maintenance of capital rule and dividendsThe maintenance of capital rule, established in Trevor v Whitworth (1887), prohibits acompany from reducing its equity capital while the company is in operation. The CorporationsAct s 254T, which states that dividends may only be paid out of profits of the company, is amodern application of this rule. There are some circumstances where a company is permittedto reduce its capital, for example, the provisions dealing with permitted share buy-backs.

Transfer of sharesShares are personal property and, subject to the company’s constitution, they may be sold,bequeathed (left in a will) and used as security like other items of property. The CorporationsAct no longer requires that a proprietary company have a restriction on the right to transfershares, but many proprietary companies still require approval of the board of directors to atransfer of shares.

Debt financingFor many companies the most important source of finance is money borrowed from financialinstitutions, members of the investing public or its own shareholders. The capital a companyraises by borrowing is known as debt or loan capital.

DebenturesCompanies can issue debentures. The common law defines ‘debenture’ as any documentwhich is evidence of a debt. The Corporations Act no longer uses the term ‘document’,instead defining a debenture as ‘a legally binding undertaking’ by a company to repay a debt.This takes into account electronic commerce where there may be no ‘document’. Underboth definitions, a debenture may be secured or unsecured. ‘Secured’ means that the deben-ture holder (creditor) has rights over specific assets of the borrower company. If thecompany defaults in repaying the loan, the debenture holder can seize the assets and sellthem to recover the amount of the loan. ‘Unsecured’ means that if there is a default, the


Rights of shareholders

Two classes of shares—ordinary shares,preference shares

Dividends may only bepaid out of profits

A debenture may besecured or unsecured



debenture holder can sue the borrower company for breach of contract, but cannot directlyseize the company’s assets.

In company law, the term charge is used to describe a security given by a company over itsassets in favour of a debenture holder (creditor). A charge may be a legal mortgage or some-thing less than this. Charges are either fixed or floating.

A fixed charge attaches to specific assets, for example, a charge over land, plant and equip-ment, or motor vehicles. The borrower company cannot dispose of the assets without the lender’sconsent. A floating charge does not attach to specific assets but ‘floats’ over a particular class ofassets such as stock-in-trade, inventory, or raw materials. The benefit of a floating charge is thatsecurity can be given over assets that are constantly changing, and the company is free to disposeof the assets in the ordinary course of business. If the company defaults under the terms of theloan, the floating charge is said to crystallise. This means the charge stops ‘floating’ and becomesfixed on all the assets within the class of assets that is the subject of the charge. Once crystallisa-tion occurs, the company is unable to dispose of the assets without the lender’s consent.

A charge is a security

A fixed charge appliesto specific assets, such

as land

A floating charge floatsover a class of assets,

such as stock

Creditors should ensuretheir charges are

registered

Directors must oftengive a personal

guarantee

A floating chargeEXAMPLE

Racing Motors Pty Ltd (RM) borrows $100 000 from Eversure Finance Ltd (EF) and the loan is secured by a floating

charge over the cars owned from time to time by RM. If RM defaults on the interest payments or allows the total

value of the stock to fall below a minimum value of $150 000, the charge will ‘crystallise’ and ‘attach’ to all RM’s

cars. EF runs the risk that the combined value of the vehicles at the time of the crystallisation may be worth far less

than $100 000.

Registration to protect creditorsA company is required under the Act to register certain charges (including floating charges)within 45 days. An unregistered charge is still valid, but if the company goes into liquidationor voluntary administration the charge will be unenforceable as a security against the liquida-tor or administrator. This means the charge will rank with the ordinary unsecured creditors.Priority between competing charges (charges over the same assets) is also generally determinedaccording to the dates of registration. For these reasons it is important for the creditor toensure that its charges are registered at ASIC. Anybody dealing with a company is deemed tobe aware of any registered charges.

Additional rights of creditorsLenders often also require directors to give a personal guarantee, which makes them person-ally liable if the company defaults.

Fundraising and disclosureUnder Chapter 6D of the Act a company wishing to raise funds by offering shares or deben-tures usually must provide investors with a disclosure document (usually a prospectus). Thedisclosure rules are intended to ensure that potential investors have adequate and accurateinformation about the company. False or misleading statements in prospectuses could resultin fines, damages and other remedies against the company and other persons involved. Oneof the charges that resulted in a jail sentence for Ray Williams, former head of HIH



Insurance Ltd, was that he had authorised the issue of a prospectus that contained a materialomission. R v Williams [2005] NSWSC 315.

Except if it is raising funds from its own employees or shareholders, a proprietary companymust not engage in any fundraising activity that would require disclosure to investors underChapter 6D. It may, however, raise funds from its own employees or shareholders. Disclosure isnot required in relation to several exempt offers—for example, an offer to an individual person toinvest at least $500 000 or an offer to a professional investor, such as a person who holds a financialservices licence. A proprietary company could take advantage of these exemptions to raise funds.

Insider tradingInsider trading involves the use of ‘price sensitive information’ which is not generally availableto buy or sell shares (or other securities). Price sensitive information is information that wouldbe likely to affect the value of the shares or debentures if it were known to the public. A persondoes not need to have a connection with the company (be an officer or employee, for example)to be guilty of insider trading. If a person contravenes the prohibitions on insider trading, civiland criminal penalties may apply.

There are restrictionson fundraising by aproprietary company

Insider trading isprohibited

ASIC v Vizard [2005]

Minority shareholdersare protected againstoppression

Mr Rivkin was found guilty of insider trading in relation to the purchase of 50 000 Qantas shares by his company,

Rivkin Investments. The jury found that Mr Rivkin bought the shares after being told by Mr McGowan (the CEO of

Impulse) of a proposed merger between Impulse and Qantas. McGowan warned Rivkin that he should not trade in

Qantas shares as the information was not available to the market, it was confidential. Rivkin was fined $30 000 and

sentenced to nine months’ periodic detention. He was also banned from managing companies for five years, except

with the permission of the court. Rivkin’s conviction and the sentence were both upheld by the NSW Court of

Criminal Appeal. R v Rivkin (2004) NSWSC 447

CASE

In 2000, when he was a director of Telstra, Steve Vizard used confidential information tobuy shares in three dot.com companies, in an attempt to gain an advantage for himself. ASICbrought civil proceedings against him under s 183(1). Vizard admitted his guilt and wasdisqualified from managing companies for ten years, and ordered to pay pecuniary penalties of$390 000. At the time, ASIC was criticised for its ‘soft’ treatment of Vizard and its decision notto bring criminal proceedings under s 184 and/or the insider trading prohibitions in the Act.ASIC v Vizard [2005] FCA 1037

Protection of minority membersThe members in general have little power to interfere with the management decisions of thedirectors. The directors may also be the majority shareholders. In this situation they are in aposition to pass resolutions which are in their own interests, and also use their voting power toprevent the company taking any action against them. The Corporations Act provides the follow-ing remedies where there is an abuse of power.• Oppression remedy: ss 232–233—where the conduct of the company is oppressive,

unfairly discriminatory or unfairly prejudicial, a member can make an application to the

Rivkin’s Case (2004)


Court’s broad powerscould include replacing

elected board


court. The court has very broad powers including making orders to regulate the futureconduct of the company, to buy out the shareholder, modify the company constitution orwind up the company. So broad are the powers that in Re Spargos Mining NL (1990)3 ACSR the judge ordered the replacement of the elected board of the company with aboard of his own choosing. The oppression remedy is commonly used in family disputes,or other disputes in small companies over management issues.

• Compulsory winding up: s 461(k)—the court can order the company be wound up if thecourt is of the opinion that it is ‘just and equitable’ to do so.

• Statutory derivative action: ss 236–242—members can sue on behalf of the company (fora wrong done to the company) where the company is either unwilling or unable to start thelegal action.

REPORTING AND DISCLOSURE This section outlines the reporting and disclosure requirements in the Corporations Act. Penal-ties for non-compliance may be imposed on company officers.

Registers and minute books Every company must maintain:• Registers of (i) members (ii) option holders (iii) debenture holders and (iv) charges. • Minute books in which it records within one month, resolutions (decisions) passed by the

members and resolutions passed by the directors.

What financial records must companies keep?Every company is required by s 286 to keep written financial records that:• correctly record and explain its transactions and financial position and performance;

and • would enable true and fair financial statements to be prepared and audited.The definition of financial records includes invoices, receipts, documents of prime entry,working papers, other documents needed to explain the methods by which financial state-ments are made up, and adjustments to be made in preparing financial statements.

A director who fails to take all reasonable steps to ensure the company complies with s 286contravenes the Act. Civil penalty orders may be made against the director and, if the contra-vention was dishonest, criminal penalties may be imposed: s 344. In addition, for the purposesof an insolvent trading case, the director of the company is presumed to have been insolventduring any period it failed to keep financial records: s 588E(4).

In ASC v Fairlie (1993) 11 ACLC 669 the managing director was successfully prosecutedfor failing to take reasonable steps to ensure the company kept proper accounting records.The company was having problems in changing from a manual to a computerised account-ing system and a number of senior staff left the accounts department. The director employednew accounting staff and outside consultants to assist them put the accounts department inorder. The Supreme Court of Tasmania held that this action was not sufficient, and that thedirector should have taken more interest and further action to resolve the accountingproblems.

All companies mustkeep registers, minute

books and financialrecords

ASC v Fairlie (1993):new accounting staff did

not exempt director



Who has to prepare an annual financial report and directors’ report?Public companies and large proprietary companies must prepare a financial report and a direc-tors’ report: s 292. A small proprietary company need only prepare these two reports ifrequested to do so by at least 5% of its members or by ASIC, or if it is controlled by a foreigncompany and it is not consolidated in that company’s financial statements. Small proprietarycompanies under foreign company control are generally treated by the Act as if they are largeproprietary companies.

What is included in the financial report and the directors’ report?Under s 295 a company’s annual financial report must comply with the standards set by theAustralian Accounting Standards Board (AASB). These standards, which are made under s 334, are available at <www.aasb.com.au>. Currently, the annual financial report mustinclude:• the financial statements:

– a statement of financial position (balance sheet) – a statement of comprehensive income – a statement of cash flows– a statement of changes in equity (share of ownership)

• the notes to the financial statements (disclosures required by the accounting standards andregulations and any other notes required to give a true and fair view);

• the directors’ declaration (about the statements and notes and solvency of the company).See Financial Reports—The Basics at <www.asic.gov.au>.

The financial statements must comply with the accounting standards and the corpora-tion’s regulations and must give a ‘true and fair view of the financial position and performanceof the company’: ss 296–297.

ASIC has power under Part 2M.6 to exempt individual companies, or classes of companies,from some or all of the financial reporting and audit requirements in the Act. Mazda AustraliaPty Ltd & Ors v ASC (1992) 8 ACSR 613 concerned an application for relief from compliancewith certain requirements of the accounting standards. The Administrative Appeals Tribunalrelied on AASB Statement of Accounting Concepts SAC 2 to deny Mazda’s application forrelief from compliance with an accounting standard concerning related party transactions.SAC 2 sets out the objective of general-purpose financial reporting. See the ABL website.

The directors’ report must contain (i) the general information about the operations andactivities set out in s 299, and (ii) the specific information about such matters as dividends,details of directors, options granted over shares set out in s 300.

Audit and audit reportWith some exceptions, all companies that must prepare financial reports are required by s 301to have the financial reports audited by a registered company auditor, and to obtain an audit

Mazda Australia Pty Ltd& Ors v ASC (1992)

COMPLIANCE CHECK

Bella is the accountant for the new family company. What records must she set up to comply with s 286? ASIC, with

help from professional associations, has compiled a schedule of appropriate books and records. See What Books

and Records Should My Company Keep? at <www.asic.gov.au> or go to the ABL website.

Public and largeproprietary companiesmust prepare a financialreport



report. Under ASIC Class Order CO 98/1417 large proprietary companies are exempted froman audit if that decision has the unanimous approval of the directors and shareholders not tohold an audit. Certain conditions apply. A small proprietary company preparing a report at thedirection of members need only have it audited if directed to do so by the members.

The role of the auditor is to act as an independent safeguard of the interests of themembers. Auditor independence is fundamental to an effective audit. The rules and standardsgoverning audit independence have been tightened following recent corporate collapses.

An auditor has a common law duty (in contract and tort) to use reasonable care and skill.See Ch 3 p. 111. The judgment in Pacific Acceptance Corporation v Forsyth (1970) 92 (NSW) 29analyses the auditors’ duty of care and skill in the conduct of a company audit. Justice Moffittheld that while ‘auditors are not insurers’—that is, they are not expected to detect any and allerrors and fraud that may occur in company financial statements—the auditor must, inplanning and carrying out an audit, ‘pay due regard to the possibility of error or fraud’. Theauditor has a duty to go behind the company’s books and determine the true financial positionof the company. This involves designing and carrying out procedures which have a reasonableexpectation of detecting ‘a substantial or material error or fraud’ in the company’s affairs.

In Arthur Young & Co v WA Chip & Pulp Co Pty Ltd (1989) 7 ACLC 496 it was held that anauditor will breach their duty of care if, having detected a possible irregularity not amountingto a suspicion of fraud, the auditor fails to investigate further. The auditor must also report thematter to the appropriate officers of the company.

Auditor’s statutory function In carrying out the audit, the auditor has a statutory duty to form an opinion about:• whether the financial report complies with the accounting standards, and gives a true and

fair view of the financial position of the company;• whether the auditor has been given all necessary information and assistance;• whether the company has kept sufficient financial records to enable a financial report to be

prepared and audited; and• whether the company has kept the other records and registers required by the Actand to report these matters to the members. If the auditor is not of the opinion that the finan-cial reports comply, the audit report must state the reasons for this opinion. The audit reportmust also describe any defect or irregularity in the financial reports, and any deficiency, failureor shortcoming in relation to the other matters listed above.

Auditors also have a statutory duty to notify ASIC if they have reasonable grounds tosuspect that a company has contravened the Act, and they believe that the contravention willnot be adequately dealt with by bringing it to the attention of the directors.

Auditing standardsThe Auditing and Assurance Standards Board (AUASB) has authority to make auditing stan-dards for the purposes of the Corporations Act s 336. The auditing standards are available fromthe AUASB <www.auasb.gov.au>.

Annual financial reporting to membersThe financial report, the directors’ report and the audit report must be sent to the members atleast 21 days before the AGM or four months after the end of the financial year, whichever isearlier: ss 314–315. A public company must lay the reports before the AGM for consideration.

The financial reportmust be audited by a

registered companyauditor

Pacific AcceptanceCorporation v Forsyth

(1970)

Arthur Young & Co v WAChip & Pulp Co Pty Ltd

(1989)

The auditor has astatutory duty to report

to members


EXTERNAL ADMINISTRATIONCompanies are sometimes taken over by an outsider controller. This may happen, for example,when the company is insolvent. The three main types are:1. Receivership. A receiver is a person appointed to take control of some or all of a company’s

assets. A receiver may be appointed by a court or a secured creditor.2. Voluntary administration. The aim of voluntary administration is to see if the company and

its creditors can work out a solution to the company’s financial problems. A voluntaryadministrator may be appointed by the company, a liquidator or a substantial securedcreditor. Within 21 days of the administration beginning, a meeting of creditors is calledto decide whether the company should (i) sign a deed of company arrangement, (ii) bewound up, or (iii) control returned to the directors.

3. Winding up. A winding up involves a liquidator selling off the company’s assets and distrib-uting the proceeds among the creditors and, if there is anything left, among the members.The company is then deregistered and its existence comes to an end. The liquidator may beappointed by order of a court or voluntarily by the shareholders passing a special resolution.

Until recently, shareholders were ‘ranked below’ unsecured creditors when a companybecame insolvent and was wound up. They were not entitled to receive any payment unlessthe unsecured creditors had been paid in full. In 2007 the High Court ruled that share-holders would enjoy equal ranking with unsecured creditors if they were induced(persuaded) to purchase their shares as a result of misleading or deceptive conduct by thecompany. See Sons of Gwalia Ltd v Margaretic [2007] HCA 1


Lodging reports and information with ASIC1. The financial report, directors’ report and audit report must be lodged with ASIC within

four months of the end of the company’s financial year. Certain large proprietary compa-nies (companies that were formerly ‘exempt proprietary companies’ under the earlier Act)are exempted from lodgment under Class Order CO98/99. A small proprietary companywhich has prepared a financial report in response to a shareholder direction or a directionfrom ASIC also need not lodge the report.

2. CLERP 7 replaced company annual returns with a new annual review process. On the reviewdate (the anniversary of the company’s registration) ASIC now sends an annual statement tothe company. The annual statement includes an invoice and a statement of the company’sdetails for review by the company. If the information is correct, no further action is required.If any information is incorrect, the company must notify ASIC of the necessary changeswithin 28 days. Directors of companies which do not have to lodge financial reports withASIC must, within two months of the review date, pass a resolution that in their opinion thecompany is solvent. If the directors are not able to do this, they must inform ASIC.

3. Companies must keep ASIC informed of certain events in the company’s life, such aschange of registered office, change of officers or issue of new shares. See Keep Us Informedof Changes in Your Company’s Details at <www.asic.gov.au>.

Every company issubject to an annualreview process

Aim of voluntaryadministration is tomaximise the chancesof the companysurviving

Sons of Gwalia Ltd vMargaretic [2007]

COMPLIANCE CHECK

Companies must comply with their financial reporting obligations under the Corporations Act 2001. Uncertain of

what needs to be done? See What’s New in Financial Reporting at <www.asic.gov.au>.



CORPORATE GOVERNANCEWhat is corporate governance? Corporate governance is interconnected with management.Management is concerned with the day-to-day affairs and procedures in running a company.Corporate governance concerns how a company is directed and controlled. Issues in corporategovernance include (but are not limited to):• the systems by which the business of the company is run, including the board of directors’ duty

to ensure that the business is properly and honestly managed;• the relationship between the directors, management, shareholders and other ‘stakeholders’, and the

balance of power between these groups (stakeholders may include employees, suppliers,customers, banks and other lenders, regulators, the environment and the community atlarge);

• the legal duties of directors and executives, including fiduciary duties (to act in good faith for aproper purpose and to avoid conflicts of interest);

• the composition of the board, including the need for an effective chairman and for the manage-ment of issues relating to directors’ independence;

• the maintenance of confidence in the company’s financial integrity;• risk management and internal control systems, and an effective audit committee;• auditor independence and the appearance of independence.

Regulators stress that corporate governance is not just about setting up a corporate gover-nance model, ticking boxes and adding further pages to the annual report. Good governanceis about behaviour and relationships, values and ethics, and the integrity with which directorsand management go about the business of running the company.

Commissioner Owen in the inquiry into the collapse of HIH wrote of the danger of a ‘tickin a box’ mentality. HIH did have a corporate governance model. The problem was that theboard did not periodically assess the effectiveness of the company’s governance practices.Where they did exist they were ignored. There were relatively few clearly defined andrecorded policies and guidelines. Commissioner Owen considered that there was a clear causallink between poor corporate governance and mismanagement. See Phillip Lipton, ‘Thedemise of HIH: corporate governance lessons’, Keeping Good Companies, June 2003,<www.australian-corporate-governance.com.au>.

ASX Corporate Governance Principles The Australian Securities Exchange Corporate Governance Council (ASX CGC) first releasedits Principles of Good Corporate Governance and Best Practice Recommendations in March2003. After two years an extensive review was undertaken and in August 2007 the Councilreleased revised Corporate Governance Principles and Recommendations. The CGC definescorporate governance as:

Corporate governance isabout how a company is

managed and directed

The danger of a ‘tick abox’ attitude


SELF QUIZ

12 A company can issue fully paid or partly paid shares. ^ ^

13 A floating charge crystallises and becomes fixed when a company defaults. ^ ^

14 A company must always lodge a prospectus before fundraising. ^ ^

15 Every company must prepare and audit a financial report. ^ ^



the framework of rules, relationships, systems and processes within and by which authorityis exercised and controlled in corporations. It encompasses the mechanisms by which compa-nies, and those in control, are held to account. Corporate governance influences how theobjectives of the company are set and achieved, how risk is monitored and how performanceis optimised.

Its revised Principles and Recommendations are:Principle 1 Lay solid foundations for management and oversightPrinciple 2 Structure the board to add valuePrinciple 3 Promote ethical and responsible decision makingPrinciple 4 Safeguard integrity in financial reportingPrinciple 5 Make timely and balanced disclosurePrinciple 6 Respect the rights of shareholdersPrinciple 7 Recognise and manage riskPrinciple 8 Remunerate fairly and responsibly

These Principles and Recommendations apply only to listed companies, but it is the view ofthe CGC that other smaller organisations can also benefit from the underlying philosophy.The documents are available from the ASX website at <www.asx.com.au>.

TRUSTSA trust, unlike a company, is not a separate legal entity. A trust is an arrangement wherebyan individual or entity (the trustee) holds property (the trust property) on behalf of others(the beneficiaries). It can be used as a business structure with a trustee (usually a company)carrying out the business on behalf of the members of the trust (the beneficiaries). Trustsare often used in connection with small family businesses. The owner of the business estab-lishes the trust to distribute income or assets or both from the business to family memberbeneficiaries. Once distributed the income/assets belongs entirely to the beneficiaries whoreceive it.

A trust is a structurerecognised by equitylaw. The trustee is thelegal owner of the trustproperty; beneficiariesare the equitableowners.

In the shadow of the coporate veil*: James Hardiecorporate governance

The consumer lawyers association has strongly criticised the corporate governance style of Australia’s biggest

asbestos products manufacturer: ‘If James Hardie is able to avoid its responsibilities to the thousands of Australians

it injured by ignoring clear warnings of the lethal nature of the asbestos products it manufactured, it will go down in

history as Australia’s worst example of morally disgraceful corporate governance’. It has also called for a review of

the circumstances in which companies could use the protection of limited liability to avoid providing for their future

liabilities. See media release, ‘Lawyers call for end to “Pty Ltd” protection in wake of James Hardie fiasco’,

31 October 2003, <www.lawyersalliance.com.au>.

* P. Prince, J. Davidson and S. Dudley, ‘In the Shadow of the Corporate Veil: James Hardie and Asbestos Compensation’, 2004,<www.aph.gov.au/library>.

LAW IN ACTION


Duties of the trusteeA trustee does not own the trust property in its own right. It holds the assets on behalf of thebeneficiaries. The primary duty of the trustee is to carry out the terms of the trust. Otherduties include:• Duty of loyalty and good faith. A trustee is a fiduciary and owes duties to act honestly in the

best interests of the beneficiaries, and not make profits out of the trust.• Duty to administer the trust personally. The trustee must not delegate its duties.• Duty of care. The standard of care is that of the ordinary prudent business person. • Duty to preserve the trust property and to invest in accordance with the trust deed, and any appli-

cable legislation such as the Trustee Act. If the trust has been formed for superannuationpurposes, it must also comply with the federal Superannuation Industry (Supervision) Act1993 (the SIS Act) and other legislative requirements.

• Duty to keep accounts and provide information to beneficiaries as required. Proper records are alsoessential so that it is possible to determine which part of the trust property and income thetrustee is entitled to, and which part the beneficiaries are entitled to. This is necessary inorder to properly calculate the amount of tax the trustee and beneficiaries are required to pay.

Limited liability company as trusteeThe trustee is personally liable for all the liabilities of the trust. Therefore, a company iscommonly used as trustee to gain the benefit of limited liability, as well as the other advantagessuch as continuity of existence. The trustee usually has an indemnity (cover for costs and damages)payable from the trust assets for liabilities properly incurred in managing the trust. Under s 197of the Corporations Act the directors of a trustee company may be personally liable for debts of thetrust. This applies if the trustee company is not entitled to an indemnity from the trust assetsbecause it has breached the trust, or the trust deed removes or limits the right to an indemnity.

Most trusts relating to business are express trusts which means they are intentionally setup in a written document, such as a will or a trust deed. Many are created for the purpose ofsuperannuation funds. Commonly used express trusts include:• Discretionary trusts where the trustee has discretion (choice) when distributing income

or assets to the beneficiaries. The trustee has the choice of distributing in a way that willsplit and reduce the income tax paid by the trust and/or the beneficiaries. See Figure 5.2.

• Unit trusts where unit holders have a number of units in the trust. Distribution from thetrust is on the basis of the number of units held. This type of trust is often used for largeshared investments and by public companies that offer units to investors.

• Fixed entitlement trusts where the trustee has no discretion regarding the distribution ofprofits and assets. Each beneficiary is entitled to a fixed equal share.

Any trust that carries on a business is a trading trust. The business is the trust property.Trading trusts are normally discretionary trusts. Sometimes a trading trust may be a unit trust.


Company trustee gainsbenefit of limited

liability

In discretionary truststhe trustees decide howto distribute the assets

or income

COMPLIANCE CHECK

A trustee must ensure investments comply with the trust deed and the Trustee Act. The trustee of a self-managed

superannuation trust must comply with the SIS Act and Regulations. A Compliance Checklist is provided in the publi-

cation, Role & Responsibilities of Trustees, at <www.ato.gov.au>.

A trustee is a fiduciaryand controls property

for the benefit of others



Table 5.4 outlines the advantages and disadvantages of trading trusts.

A franchise can beoperated as a soletrader, partnership,company or trust

Discretionary trustFIGURE 5.2

Broadwater Auto Sales (run by Tony Wilder)

Placed in trust e.g. Wilder Family Trust

Managed by trustee e.g. AP Wilder Pty Ltd

Profits distributed to beneficiaries e.g. familymembers and charities

Tony Wilder Tracy Wilder(Tony’s wife)

10%

Ben Wilder(son)30%

Note: The size of the profit distribution to each member could vary from year to year.

Eunice Cullen(daughter)

30%

Nicholas Cullen(grandson)

10%

Fred HollowsFoundation

15%

SalvationArmy5%


1. Flexibility of profit distribution Establishment and ongoing costs

2. Possible tax minimisation Limited rights of beneficiaries

3. Asset structure survives death of members Laws regarding trusts may be complex

4. Limited liability (if trustee is a company) Higher compliance costs

Advantages and disadvantages of trading trustsTABLE 5.4

FRANCHISESA franchise is not a separate business entity but a licence to operate a business. It is a businessarrangement in which a franchisee contracts to market the product, process, service or systemthat is the ‘intellectual property’ of the franchisor. The franchisee pays a licence fee and contin-uing royalties for the right to use and/or sell the subject matter of the franchise. In a franchise,there is the same choice of ownership structure as there is in operating any other business.

There are two main types of franchise: (i) Product and trade name franchises, where the fran-chisee distributes a special product line, such as a brand of motor vehicles; and (ii) Businessconcept franchises, where the franchisee operates a ‘packaged’ business concept, such as fast foodrestaurants like McDonald’s and Hungry Jack’s. Franchising is very popular in Australia. TheFranchise Council of Australia <www.franchise.org.au> estimated in 2006 that there wereabout 960 franchisors in Australia, up from 850 in 2004.

Main features of a franchise agreementThe main terms usually outlined in a franchise agreement are:• the key ‘intellectual property’, such as a recognised name or product line;


• the rights and obligations of each party;• the franchisor’s degree of control over marketing, equipment and fixtures;• the duration of the agreement and the geographical location;• the rights of the franchisor to inspect the accounts of the franchisee;• the conditions of termination.

Franchising Code of Conduct The Franchising Code of Conduct is a mandatory (compulsory) industry code prescribedunder the Trade Practices Act 1974 which applies to all franchise agreements, including foreignfranchisors. The ACCC administers and enforces the Code. Valuable resources available fromits website at <www.accc.gov.au> include:• The Franchisee Manual, a plain English guide to the Code designed to provide simple

guidance material for franchisees on their rights and obligations; • Checklist for buying a franchise;• Franchising Code of Conduct Compliance Manual (available in CD ROM), which provides

guidance on how to comply with the Franchising Code and the Trade Practices Act. It assistsbusinesses to establish a framework for an effective compliance program and satisfyminimum business conduct and disclosure requirements.

The ACCC has also set up a new section on its website explaining its role in relation to fran-chising complaints and investigations and detailing some matters the ACCC has investigatedand taken to the courts.

When does a licence to use intellectual property or a supply agreement become afranchise?The following case demonstrates that the Franchising Code applies to all commercial agree-ments that operate as franchises, including businesses that claim to be issuing licences for theuse of intellectual property.


ACCC administers andenforces the Franchising

Code of Conduct

COMPLIANCE CHECK

Do not assume an arrangement is simply a licence or merchandise supply agreement. Check to see if the arrange-

ment may be defined as a ‘franchise agreement’ in the Franchising Code of Conduct. The ACCC is increasingly

checking these types of agreements for compliance with the Code. Penalties apply for non-compliance.

Any business operating like a franchise must conform with the Franchising Code.

The Synergy company sold a business training and development program to 31 people who each paid $20 000 forfive days of training and a workshop kit. Synergy claimed its ‘licensees’ would become accredited business devel-opment specialists and implied they could earn more than $100 000 a year without experience. The licensees signedan agreement that they were not entering a franchise relationship.

The Federal Court held: Synergy had marketed and controlled a franchise. Its directors were ordered to (i) ceasemarketing their system as a franchise, (ii) give clients a 14-day cooling-off period in which they were entitled to a fullrefund, (iii) implement a compliance program, and (iv) pay the ACCC’s costs. ACCC v Ewing [2004] FCA 5

CASEACCC v Ewing [2004]


In ACCC v Kyloe Pty Ltd [2007] FCA 1522 the court decided that a drink machine distri-bution arrangement and trade mark licence was not a ‘franchise agreement’ as it did notincorporate the ‘system or marketing plan determined, controlled or suggested by the fran-chisor’—a necessary element of the definition in clause 4 of the Code. The ACCC failed in itsaction for breach of the Code and was ordered to pay Kyloe’s legal costs.

Requirements of the Code prior to the making of a franchise agreement• Full disclosure. Prospective franchisees must be given a disclosure document that includes

details of directors and associates, their business experience, commissions they have beenpaid, trademarks, franchise territory details, and financial statements including the last twoyears of profit and loss accounts and balance sheets. A full account of any marketing orcooperative fund, including an audit report, must also be included. The document mustalso clearly set out the obligations of franchisor and franchisee. It must not contain anypromotional material.

Following amendments to the Code on 1 March 2008, details of the history of the fran-chise site and territory (including why the previous franchisee ceased to operate) must alsobe provided to the franchisee.

• Franchisees must receive the disclosure document at least 14 days before they enter or renew the contractor pay a non-refundable deposit. They are also entitled to a seven-day cooling-off period.

• Proof of independent advice. The agreement is not valid unless the franchisor receives a signedstatement from the franchisee saying they have received or have waived independent advicefrom a legal, business or accountant adviser.

• Copies of a retail lease must be provided if the landlord is the franchisor or an associate of thefranchisor.


ACCC v Kyloe Pty Ltd[2007]

Disclosure documentmust be provided to thefranchisee

Failure to comply with Code makes franchise agreement illegal.

The franchisor failed to obtain the franchisee a statement in accordance with clause 11(1) of the Code. Under this

clause the franchisor must obtain a written statement that the franchisee has received, read and had a reasonable

opportunity to understand the disclosure document and the Code, before entering into the agreement.

The NSW Supreme Court of Appeal held: Non-compliance with clause 11(1) made the franchise agreement illegal

and unenforceable. As a result the franchisor was unable to claim money owed to it by the franchisee under the fran-

chise agreement. Ketchell v Master of Education Services Pty Ltd [2007] NSWCA 161

CASE

Non-disclosure of vital information by a franchisorEXAMPLE

The Will Writers Guild Pty Ltd sold will-writing franchises across Australia for $65 000 per territory. Its directors failed

to disclose that the business could only be carried on by a qualified legal practitioner. They were fined $105 000,

ordered to pay over $360 000 in compensation and permanently restrained from offering franchises that did not

comply with the Franchising Code. ACCC Media Release, 14 April 2003

Disclosure document 14 days before contract

Ketchell v Master of Education Services Pty Ltd [2007]



Franchisors are prohibited from inserting into their franchise agreements general waivers(exclusion clauses) regarding written or verbal pre-contract representations. A term that givesthe franchisor the unilateral right to vary or terminate the agreement may, under the Code,indicate unconscionable conduct.

Requirements of the Code during the life of the franchise agreement• Free association. Franchisees cannot be prevented from forming an association or meeting

other franchisees for a lawful purpose.• Mandatory mediation. Franchisors must set up a complaints handling procedure. If the

parties cannot resolve a dispute within 21 days, either of them may refer it to a mediatoror ask the Franchising Code Mediation Adviser (see below) to appoint one. Parties have theright to take legal action at any time.

• Notification of changes and litigation. The franchisor must notify the franchisees of anychanges in the ownership of the franchise and any litigation it faces.

• Marketing funds must be audited. Most franchisees are required to make regular paymentsinto a fund that is used to pay for the costs of advertising and special promotions.

• Notice of termination. A franchisor who wishes to terminate the franchise must give reason-able notice. If the termination is based on a breach by the franchisee, the franchisor mustnotify that person and give them 30 days to rectify the problem.

• Franchisors cannot refuse to approve the transfer of a franchisee’s interest to another person withoutreasonable grounds. This is an important protection, as approximately 72% of franchiseesexit by selling to a new franchisee.

Remedies for breaches of the CodeThe main remedies available for breaches of the Code are orders for damages, correctiveadvertising and other appropriate orders, such as compliance programs.

Protection for franchisees under common lawIn addition to any rights they might have under the Code and contractual remedies, fran-chisees may have remedies under the equitable doctrines of undue influence or estoppel, orthe common law doctrines of unconscionable conduct or misrepresentation. See Ch 13.

Protection for franchisees under consumer protection legislationFranchisees have primarily taken action under the Trade Practices Act or the state and territoryFair Trading Acts. The main grounds have been unconscionable conduct, misleading anddeceptive conduct (s 52) and false representations (ss 53, 59). Franchisees may also take actionunder s 51AC which prohibits unconscionable conduct by a big business against a smaller one.See Ch 24.

Franchise cases under the Trade Practices Act1. The Simply No Knead Case [2000]

In 2000 the Federal Court ruled that a Melbourne-based franchisor Simply No Knead(Franchising) Pty Ltd (SNK) had breached the new s 51AC of the Trade Practices Act byacting unconscionably towards its franchisees. Breaches by SNK included refusing to deliver

Parties retain the rightto take legal action

Franchisor cannotterminate without giving

notice

Wide range of remediesfor franchisees

The Simply No KneadCase [2000]


products to the franchisees, producing advertising material that omitted their names andaddresses, and competing against the franchisees by selling SNK products in areascontrolled by them. See ACCC v Simply No-Knead (Franchising) Pty Ltd [2000] FCA 1365

2. ACCC v Top Snack Foods (1999) ATPR 41-708Top Snack Foods Pty Ltd sold franchises to distribute boxes of snack food to commercialand industrial sites. It was held to be in breach of ss 52 and 59 of the Trade Practices Act asit had no reasonable basis for certain profit projections it had given to franchisees. Thecompany was ordered to cease advertising its current franchises and pay damages of over$400 000. It was held not to be in breach of s 51A as there was insufficient evidence toprove its conduct was ‘deliberate and systematic’.

3. Poulet Francais Pty Ltd v The Silver Fox Company Pty Ltd [2005] FCAFC 131The franchisees entered a franchise agreement to operate a retail poultry outlet. After thebusiness failed they took action against the franchisor claiming breach of s 52 of the TradePractices Act in relation to pre-agreement representations about possible turnover andprofit. The full Federal Court held that the franchisor was not liable as the franchisees hadbeen made aware from disclaimers in the agreement that the projections were not to berelied upon.

Possible conflicts with the Trade Practices Act 1974 (Cth)Since franchisors control the supply, marketing and distribution aspects of a franchise they alsorun the risk of breaching Part IV of the Trade Practices Act. Part IV prohibits restrictive (anti-competitive) practices. See Ch 25. Possible conflicts include:• Anti-competitive agreements: s 45. A franchise agreement which substantially lessens compe-

tition in a market is unenforceable. The purpose of this section is to ensure there iseffective competition in markets. Section 45A prohibits price fixing, and in relation to fran-chises would prohibit a supplier who was also a distributor from entering into a franchiseagreement. This is because the parties would be in competition with each other.

• Misuse of market power: s 46. This section prohibits franchisors from controlling the produc-tion and distribution of a substantial part of a market by using their market power to lessencompetition.

• Exclusive dealing: s 47. This occurs when suppliers attempt to restrict the freedom of theircustomers to buy or sell, or vice versa. Exclusive dealing is a big issue for franchises becausea large part of a franchise’s operation is based on agreements to keep all businesses in iden-tical form. It is prohibited only if it would substantially lessen competition. Third lineforcing, however, is prohibited outright. See Ch 25.


ACCC v Top Snack Foods(1999)

The Poulet FrancaisCase [2005]

COMPLIANCE CHECK

Franchisors are at particular risk of breaching the Trade Practices Act. The Franchising Code of Conduct Compliance

Manual has been designed by the ACCC to help franchisors understand and comply with their obligations under the

Act and the Code, and to establish a framework for an effective compliance program. Go to <www.accc.gov.au>or the ABL website.



• Resale price maintenance: s 48. This occurs where a distributor sets or enforces minimumretail prices for goods or services. A franchisor is only allowed to recommend retail pricesto its franchisees. In theory, a McDonald’s franchisee may set lower prices for Big Macsthan those of other McDonald’s operators.If a franchisor gives notification to the ACCC that it is engaging in exclusive dealing it

cannot be held liable for breach of the Act unless the ACCC takes further action. See the Noti-fication Register at <www.accc.gov.au>. The ACCC can also grant an authorisation (that is,authorise conduct that would otherwise breach the Act).

Breaches of Part IV could result in severe fines for corporations and for individuals, as wellas the usual range of remedies under the Trade Practices Act. See Ch 25.

The advantages and disadvantages for the franchisee are outlined in Table 5.5.

Table 5.5

A comprehensive list of advantages and disadvantages is available from the website ofthe Franchising Council of Australia <www.franchise.org.au>.

ACCC can authoriserestrictive trade

practices


1. Product name is established, and there is an immediate Operational and marketing structure is often rigid andentry into the market inappropriate for some areas

2. Established marketing and organisational expertise, Reliance on the expertise and assurances of the franchisorsharing of advertising costs

3. Business site, area and layout provided, also ongoing Few opportunities to influence the business system andtraining and technical support agreements often favour the franchisor

4. Innovative marketing techniques can thrive in the Increased financial risk if franchisee must provide a personalfranchise environment guarantee to franchisor or lender

Advantages and disadvantages for the franchiseeTABLE 5.5


SELF QUIZ

16 A trustee has a duty to obey the terms of a trust deed and to act in good

faith and in the best interests of the beneficiaries. ^ ^

17 In a discretionary trust the trustee must distribute the income in the same

way each financial year. ^ ^

18 A trading trust is one that imports or exports goods and distributes the

income to its beneficiaries. ^ ^

19 A franchise is an agreement in which the franchisor contracts to market

the product, process, service or system of the franchisee. ^ ^

20 The Franchising Code applies to all franchises in Australia. ^ ^

21 A disclosure statement by a franchisor to a franchisee may contain

promotional material provided it is in plain English. ^ ^

22 A franchisee agreement is not valid unless the franchisee receives

independent advice or hands the franchisor a written waiver (rejection)

of independent advice. ^ ^



ASSOCIATIONSAn association is a group of people organised for a common purpose, such as sporting,cultural, religious or trade, usually for non-profit purposes. It may, however, make a profit. Forexample, a sporting association may conduct fundraising activities. Associations may be incor-porated or unincorporated. If they choose a company structure, charitable or not-for-profitorganisations will generally be registered as a public company limited by guarantee.

Incorporated associationsAn association may operate with limited liability by qualifying for incorporation under theAssociations Incorporation Act of its state or territory. An association carried on ‘for the object oftrading or pecuniary gain for its members’ is not eligible for incorporation under this legisla-tion. An association with more than 20 members formed for ‘trading purposes’ will probablyhave to incorporate under the Corporations Act 2001 (Cth).

A key advantage of incorporation is that individual office holders, such as the president orthe treasurer, are not personally liable for the association’s debts and other liabilities. Forexample, a sailor who is injured in a race organised by an unincorporated club could success-fully sue the office holders for negligence. If the club’s insurance cover is not sufficient to coverthe damages, they could be personally liable.

The advantages and disadvantages of incorporated associations are outlined in Table 5.6.

An association is a group of peopleorganised for a common purpose

Personal liability ofunincorporatedassociation

Minimum number ofmembers is five


1. It is a separate legal entity Profits cannot be distributed to members

2. Members have limited liability Compliance with statutory obligations

3. It can sue and hold assets in its own name Penalties may be imposed on officers

4. It can enter into contracts in its own right Criminal penalties for insolvent trading

5. It has perpetual succession (continuous life) Stricter financial reporting requirements

Advantages and disadvantages of an incorporated associationTABLE 5.6

The state and territory consumer affairs agencies provide information about incorporationand post-incorporation obligations. For a list of these agencies see Table 19.1 on p. 460, or goto the ABL website. In the Australian Capital Territory this information is provided by theRegistrar General’s Office <www.rgo.act.gov.au>.

Incorporated associations in New South WalesIn New South Wales the relevant legislation is the Associations Incorporation Act 1984 and theAssociations Incorporation Regulation 1999. The Registry of Co-operatives & Associations isresponsible for the administration of the Act.

Steps for incorporation • Five or more people must approve a set of objectives and rules, nominate at least two people

to be the first committee members and then authorise a person to apply for incorporationwith the Office of Fair Trading (OFT). Unless the rules say something different, that


person will become the Public Officer and will be responsible for lodging documents. Theminimum number of members is five. There is no maximum.

• An association will be refused incorporation or directed to transfer its incorporation if theOFT believes that incorporation is inappropriate—because of the scale or nature of itsactivities or property, or its dealings with the public. (The amount of $500 000 as a measureof assets, income or expenditure is the guide used by the OFT to determine whether it isappropriate for the proposed association to be incorporated.)

Rules of the associationAn association may rely on Model Rules contained in the Regulations or draft its own rules.Certain items must be covered: for example, the rules must allow members to inspect thebooks and records of the association. If an association does not cover these items whendrafting its own rules, the corresponding rule in the Model Rules applies by default.

General statutory obligationsImportant obligations imposed under the Associations Incorporation Act include:• The association must not distribute any profits or assets to members or engage in trade that

is prohibited by the Act.• The association’s full name must appear in legible characters on all official documents. • If the position of Public Officer becomes vacant, the OFT must be notified of the vacancy

and the details of the new Public Officer within 14 days.• The association must not incur debts if there are reasonable grounds to expect that the

association will not be able to pay all its debts as and when they fall due. Criminal penal-ties (a fine of up to $5500 and/or imprisonment for up to one year) can be imposed onmembers of the committee.

• The association must not do any act with intent to defraud creditors or any other person. • Any document addressed to the association, which is received by the Public Officer or a

member of the committee, is to be brought to the attention of the committee as soon aspracticable.

• Documents lodged with the Commissioner or to a meeting of members must not be falseor misleading in any material particular.

• The association must have a common seal.

Dispute resolutionThe Registry of Co-operatives & Associations has power to deal with complaints aboutmatters that involve a breach of the Act, such as insolvent trading, but does not have authority to deal with internal disputes, for example, a dispute between two members. Theassociation’s management committee has the task of administering the affairs of the associa-tion, including handling internal disputes. If the association’s rules do not have a mechanismfor dispute resolution, then Model Rule 10 applies. This says that internal disputes are to bereferred to a community justice centre for mediation in accordance with the Community JusticeCentres Act 1983.


Associations must notdistribute profits to

members

Penalties apply forinsolvent trading


Record-keeping and financial reporting obligations• Financial records must be kept which correctly record and explain the transactions of the

association and its financial position: s 28.• Minutes of all committee and general meetings must be kept: s 28. • A register of committee members must be maintained and kept by the Public Officer and

made available for inspection by any person at all reasonable hours. This register must bekept for at least two years after the association is wound up. (The legislation does not setout a period for retention in relation to other records.)

• A register of members must be kept. • An annual general meeting must be held in each calendar year. • At the AGM a financial statement which gives a true and fair view of:

– the income and expenditure of the association– the assets and liabilities of the association– the mortgages and other securities affecting the association’s propertymust be submitted to the members. A penalty for non-compliance of up to $110 can beimposed on committee members.

• An annual statement, a copy of the financial statement and any resolution passed at theAGM in relation to the financial statement must be lodged with the OFT. A penalty fornon-compliance of up to $220 can be imposed on the Public Officer.

Trading and obtaining monetary benefitsBreach of the prohibition on trading or making monetary gain for members may result inprosecution and penalties. The association may also have its incorporation cancelled.However, associations are allowed to undertake certain types of activities without these beingconsidered as trading or making monetary gain—for example, charging an admission fee to anevent organised for the promotion of the objects of the association. See Trading and obtainingmonetary benefits <www.fairtrading.nsw.go.au>.

PROTECTION FOR BUSINESS NAMES AND COMPANYNAMESA business name is a name or title under which a person, or other legal entity, may conduct itsbusiness. Most businesses must register their business name(s) in every state or territory inwhich they operate. Each jurisdiction has an almost identical Business Names Act. The aim ofthe legislation is:• to ensure that customers know who runs the businesses they deal with;• to provide a public record that is easily accessible;• to protect the public from being misled or confused by the use of similar names.

A financial statementmust be submitted tomembers at the AGM


Most businesses mustregister their names

COMPLIANCE CHECK

Members of an incorporated association may enjoy limited liability, but the committee must ensure that the associ-

ation complies with its statutory record-keeping and financial reporting obligations. Penalties apply.


A business name that closely resembles one already registered is likely to be rejected, espe-cially if the applicant is in a similar line of business to the established one. Registering a namedoes not give the business ownership of the name, nor the exclusive right to use the name orpart of the name.

How to find business and company namesASIC keeps details of all current company names and business names throughoutAustralia on the National Names Index. This data can be easily accessed free of chargeat <www.asic.gov.au>. You will have to pay a small fee to ASIC or a private search company

if you want more extensive details.

Which businesses need not register?Businesses do not have to register a business name if they operate under:• the surname and first name or initials of the business owner; or• the name of a registered company (corporation).

In some states, such as New South Wales, you do not have to register and display a businessname if your business trades only via the Internet.

Display of a business nameThe business name must be displayed at each place where the business is carried on under thebusiness name. The owner of the business name must notify the consumer affairs agency, suchas the Office of Fair Trading in New South Wales, of any changes in ownership, addresses andso on. Failure to do this may result in penalties and cancellation of registration.

Registering and using your business name fact sheets are available from the websites of thestate and territory consumer agencies. See Table 19.1 on p. 460, or go to the ABL website.

The business gateway <www.business.gov.au> also provides summaries and links to thestate and territory business name agencies.


COMPLIANCE CHECK

Before spending money on printing, stationery or advertising, check your business name does not infringe a regis-

tered trade mark. See Ch 28. The owner of a trade mark has exclusive rights, and can take legal enforcement action

Registration and disclosure of trading namesEXAMPLE

Xavier D’Amato is a sole-trader electrician who operates under the name Xavier D’Amato Services. He also adver-

tises in the local Yellow Pages directory as Instant Call Electrics. Xavier must register both business names in his

state or territory and indicate on letterheads, invoices and websites that he is Xavier D’Amato Services, trading as

Instant Call Electrics. This applies even if he only occasionally uses each business name.


Additional protection of a business nameBusinesses can further protect their name and image through:• registration of trademarks over their goods or services (see Ch 28). It is a good idea to search

the Register of Trade Marks before registering a business name—to check that the namehas not been registered by someone else as a trade mark. Trade mark registration gives theowner exclusive rights to use or control the mark. Searches can be done free of charge onthe IP Australia website <www.ipaustralia.gov.au>;

• consumer protection laws, principally s 52 of the Trade Practices Act 1974 (Cth), whichprohibits misleading or deceptive conduct (see Ch 24);

• passing off actions, to protect the goodwill an operator has built up in a well-established businessname (see Ch 28). You are likely to rely on this tort action if a rival begins to take customersfrom you by using an identical or similar name to yours. This type of action is difficult toprove if the rival has managed to register the business name in dispute. However, as thefollowing case demonstrates, registered owners may lose their rights if there is a strongerclaim, especially from an Australia-wide user of a similar name.

Restrictions on company namesA company name cannot be registered if:• it is identical to another registered company name or to any other registered business name

in any state or territory; or• it is deemed unacceptable. Names that are specifically excluded include protected words,

such as ‘trustee’, ‘consumer’ and ‘bank’, and names that suggest a connection with govern-ment, the Olympic Games or the British royal family.


A business operator could not use the same name as a well-known car rental company even though he hadregistered it as a business name.

In 1968 BM Auto Sales Pty Ltd (BM) registered the business name of Budget Rent A Car under the Business Names

Ordinance 1963 (NT) and began operating a car hire business in Darwin. BM had no connection with the high-profile

national car rental company (the Budget company) of the same name. In fact, the Budget company’s name and

number had been listed in the Darwin telephone directory before BM registered its business name. In 1971 the

Budget company began operating in Darwin. In 1973 it sued BM for the tort of passing off (see Ch 28).

The High Court held: BM’s registered business name did not give it the right to pass itself off as being associated

with the well-known Budget company. It was significant that the Budget company was well established and listed in

the Darwin telephone directory before the registration occurred. BM was prohibited by injunction from trading under

the Budget name. BM Auto Sales Pty Ltd v Budget Rent A Car System Pty Ltd (1977) 51 ALJR 254

CASE

COMPLIANCE CHECK

A proprietor must notify the Office of Fair Trading within one month of changes to the particulars of a business name.

Non-compliance may result in penalties or cancellation of registration.

Budget Rent A Car Case (1977)


The following Victorian case illustrates the legal issues that arise when companies havesimilar names and operate in the same business area.

Domain namesWhen you apply for a business or company name you may also register an Internet domainname which guarantees no one else in Australia (or countries that recognise yourdomain system) can use it. Domain names are usually only granted to applicants who have aregistered business or company name identical or similar to the chosen domain name. SeeEverything you need to know about domain names, <www.auda.org.au>. Domain names arecovered in more detail in Ch 26.

COMPLIANCECompliance is defined as an organisation’s obligation to comply with the law. It has long beenrecognised that business planning is vital to any business—not just at the outset but alsothroughout its existence. A business plan provides an internal operating plan for the business,strategies relating to key areas like management, marketing, finance and people, and so on.Today it is just as important to develop a strategic plan for compliance. Regulators are increas-ingly watchful for breaches of the law and there have been significant increases in penalties.Whether or not an organisation has taken steps to ensure compliance will be taken intoaccount by courts as to the severity of the penalty imposed: see for example ACCC v Visy Industries [2007] on pp. 632–633.

The compliance process involves identifying:• the laws and regulations that apply to the business• the areas where the business may be at risk of breaching those lawsand then developing systems and procedures to ensure that the business meets its obligationsand complies with the law. This means putting in place a compliance program. In order to satisfythe regulators’ requirement that business organisations achieve a culture of compliance,

Compliance refers to anorganisation’s obligation

to comply with the law

The compliance process


A minor variation in a business name will usually mean the most recent name is valid.

Melbourne Inner City Management Pty Ltd (MICM) was incorporated in 1993.

Melbourne Inner City Developments Pty Ltd (MICD) was incorporated nine years later. It developed apartment

buildings and marketed them under the business name ‘Dominion Lifestyle Tower Apartments’.

After MICM received a letter addressed to MICD it sought an injunction barring MICD from using the name

‘Melbourne Inner City’ to market, develop or sell residential apartments. MICM argued that MICD’s conduct had been

misleading and deceptive under s 52 of the Trade Practices Act (Ch 24) and constituted passing off (see Ch 28).

The Victorian Supreme Court held: The company names were distinguishable because the fourth word in each of

them was different. Melbourne Inner City Management Pty Ltd v Melbourne Inner City Developments Pty Ltd [2003]

VSC 226 924 June 2004

Comment: MICM would probably have succeeded if it had been able to register a trademark that included the

name ‘Inner City Management’. See Ch 28.

CASEThe ‘Inner City’ Case (2003)


compliance really needs to be built into the business operations of the organisation, and educa-tion and training of employees is essential.

Legal obligations may originate from a range of sources—from federal and state legis-lation to industry codes of conduct. Some laws apply to all business organisations. Otherregulations are specific to a particular profession, occupation or industry—for example, thelegislation and codes of conduct governing real estate agents or the regulations governingpeople working within the financial services sector, product safety legislation and prescribedstandards governing the supply of certain types of goods and so on. Various regulatoryauthorities are responsible for administering and enforcing the laws regulating business.These authorities exist at federal, state and local government levels. The main federal regu-latory bodies, and the laws they administer, appear in Figure 5.3. Go to the ABL website formore detailed information.

Core areas of legislation common to most businesses include:• contract and e-commerce;• civil liability, and mandatory insurances (if applicable);• trade practices, fair trading and consumer protection;• revenue, including income tax, superannuation and state taxes;• employment, anti-discrimination and privacy;• industry codes, licensing and standards.

Corporations and partnership legislation will apply to those specific business structures.Business name legislation, intellectual property and local government laws will be an issue, atleast when setting up a business.

Compliance programsThere is no generic (general) compliance program as each organisation’s circumstances aredifferent. Australian Standard AS 3806 has been developed to assist business in developingcompliance programs. AS 3806 is not compulsory but it is a standard the regulators and courtsare familiar with. See the ABL website.

Trade practices compliance programs The Trade Practices Act (or fair trading legislation) applies to just about every aspect of abusiness—including advertising and dealings with consumers and other businesses. In itsGuide to Trade Practices Compliance Programs for Small Business the ACCC recommends thefollowing minimum procedures for implementing an effective small business program:• regular trade practices training for all employees who may place the business at risk of a

trade practices breach;• a complaints handling system;• a product safety and recall program (if applicable);• the appointment of a compliance officer who will be responsible for ensuring that the

business is up to date and complies with its regulatory obligations, and for staff training;• regular compliance reviews.

A trade practices compliance program may stand alone, or be part of a company’s overalllegal compliance strategy to assess and minimise risk.

Other resources available from the ACCC include a free CD, TPA Matters for Small


Core areas of lawcommon to mostbusinesses

Trade Practicescompliance programsfor small business


Business LicenceInformation Service


Business and Best & Fairest Compliance Manual (a training package designed to help businesscomply with the Act), and industry specific publications such as Fair and Square—A Guide tothe Trade Practices Act for the Real Estate Industry: <www.accc.gov.au>; see links on ABLwebsite.

Federal regulatory bodiesFIGURE 5.3

Federal Regulators

ACCCAustralian Competition

& Consumer Commission

Commonwealth laws• competition• fair trading• consumer protection

ASICAustralian Securities &

Investment Commission

• companies,• financial markets• financial services (including investor and consumer protection)

APRAAustralian PrudentialRegulation Authority

• prudential standards and practices of deposit takers (e.g. banks),• insurance companies• superannuation funds

ATOAustralian Taxation

Office

Taxation, exciseand superannuation

systems

Office of thePrivacy

Commissioner

Commonwealthprivacy

protection

Regulatory compliance issues on starting a businessThe following matters need to be considered when setting up a business.

Compulsory registrationsCompulsory business registrations include:• Taxation registration—see Table 5.7;• Business name registration—see p. 183;• Industrial agreements (if applicable)—see Ch 30.

Record keeping The record-keeping regulation requires businesses to comply with:• Regulations specific to different structures—see Table 5.8;• Taxation record keeping—see Table 5.7;• Time and wage records that are required under industrial relations laws, as well as the insur-

ance documents, records, accident and injury registers required by worker’s compensation laws;• Industry specific records—for example, trust account records under the Property Stock &

Business Agents Regulation 2003 NSW.

Business licences and permitsA business licence or permit is often required to carry on a particular business. The BusinessLicence Information Service (BLIS) is a free service that provides details of all licences andpermits that may be required, including Commonwealth, state/territory and local governmentrequirements. The gateway website to the BLIS in each state and territory is<www.bli.net.au>. Another useful resource is business.gov.au, a ‘whole of government’


service providing information on planning, starting and running a business: <www.business.gov.au>.

Local government (councils)Local councils are among the various regulatory authorities that regulate how a business maybe conducted. Local councils manage and enforce such areas as:• zoning, planning and environmental controls over the land on which the business is situated,

including the grant of development approvals for the use of the premises; and• compliance in relation to fire safety, health, building, factories and shops legislation; and • the council may also issue licences and permits relating to specific types of businesses.

Again, depending on the nature of the business, approvals may be required from a waterauthority (e.g. Sydney Water) for removal of sullage, installation of a grease trap, or meteringof excess water usage. Links to each local council within all states and the Northern Territorycan be found on Councils on the Web—Australian Local Government Association<www.alga.asn.au/links/obc.php>.


OBLIGATION WHO MUST REGISTER? WHERE TO GO#

Tax File Number (TFN) A unique once only Sole trader—may use their own individual TFN for Tax Basics for Small identification number issued for each taxpayer. both business and personal ATO dealings. BusinessIt is a confidential tax identification number. Partnership—must apply for a separate TFN for the <www.ato.gov.au>It is used for identification purposes by the partnership. If a partner retires or a new partner enters,ATO and other government agencies. the existing partnership ceases and a new TFN issues.

Company—must apply for a separate TFN. Trust—must apply for a separate TFN. The trustee applies in its capacity as trustee of the trust.

Australian Business Number (ABN) Sole trader, partnership, company and trust—eachA public registration number for GST purposes. one is entitled to apply for an ABN, which is essentialThe Australian Business Register is a central to register for GST purposes. It must be displayedcollection/verification system for identity on business documents, particularly invoices,information about businesses with an ABN. otherwise other businesses must withhold 46.5%

from any payment. The ABN issued to a company isthe company’s ACN plus two extra digits at the startof the number. Companies do not need to display both the ABN and the ACN.

Goods & Services Tax (GST) Sole trader, partnership, company and trust—mustBroad-based tax of 10% on most goods and each register for GST if:services sold or consumed in Australia. • it is carrying on an enterprise and expects to have

annual sales of $75 000 or more; or • it operates a taxi or hire car business.

Basic business tax registrationsTABLE 5.7



Pay As You Go (PAYG) Withholding Sole trader and partners are not employees; they Overview of businessSystem under which amounts are deducted are paid through drawings not wages. No need for incomefrom payments made to workers directly a sole trader or partnership to register for PAYG <www.ato.gov.au>involved in a business, and sent to the ATO. Withholding unless they make payments to

employees or contractors. Company and trust must register for withholding of PAYG for payments made to employees (including directors) and contractors.

Superannuation Guarantee Sole trader and partnership—sole traders and Superannuation—Employers must pay compulsory superannuation partners are not employees and must arrange their A Guide for Small contributions to a complying superannuation own superannuation. Superannuation contributions Businessfund or retirement savings account for eligible must be paid for their employees. <www.ato.gov.au>employees. (The superannuation guarantee is Company—superannation contributions must becurrently 9% additional to wages or salary.) paid for the company’s employees, including the

company directors.Trust—may need to pay superannuation contribution for the trustee/s if they are also employed by the trust. Contributions must also be paid for other employees of the trust. * Businesses must identify eligible employees andregister with acomplying employee (or employer) nominated superannuation fund.

Record keeping Sole trader, partnership, company and trust must Record-keeping for each keep records required to comply with revenue Small Businesslegislation. Records must be kept for five years and <www.ato.gov.au>include records relating to income and GST (e.g. sales records, purchase expense records, year-end income tax records), records relating to payments to employees and records relating to PAYG Withholding.

Superannuation Guarantee records Superannuation Guarantee—there is no required form of record keeping for this, but a business must keep records that adequately explain its Super- annuation Guarantee transactions, including the method of calculation for each eligible employee. Additional record-keeping obligations may apply under relevant awards or other workplace regulations.

# Links to applicable ATO Information Sheets

Basic business tax registrations (continued)TABLE 5.7

OBLIGATION WHO MUST REGISTER? WHERE TO GO#


The main types of business entities or structures are:

• sole trader

• partnership

• company

Business structures CHAPTER 5 191CHAPTER 5

REGISTERS AND FINANCIAL FINANCIAL

ENTITY MINUTE BOOKS RECORDS REPORTING AGM AUDIT LODGE

Sole trader No legislative requirement for record keeping, financial reporting or audit—other than compulsory recordsPartnership under tax, workers compensation, workplace or industry specific laws.

Corporations Act 2001 (Cth)

Public company Yes Yes Yes Yes Yes Yes

Large proprietarycompany Yes Yes Yes No Yes Yes

Small proprietary Yes Yes Only if directed by No Only if directed by No*company ASIC or members* ASIC or members*

Associations Incorporations Act 1984 (NSW)

IncorporatedAssociation Yes Yes Yes Yes No Yes

Trust No legislative requirement for record keeping, financial reporting or audit, other than compulsory recordsunder tax, workers compensation, workplace or industry specific laws.

* Or the company is controlled by a foreign company and is not consolidated in that company’s financial statements.

Legislative requirements for record keeping, financial reporting and auditsTABLE 5.8


SELF QUIZ

23 The senior officers of an unincorporated association could be personally

liable for its debts and legal obligations. ^ ^

24 An incorporated association has limited liability. ^ ^

25 An incorporated association can return profits to members. ^ ^

26 A business name must be displayed at each place of business. ^ ^

27 If a business name is registered in Queensland it is automatically registered

in all jurisdictions. ^ ^

28 Legal compliance applies only to large businesses. ^ ^

SUMMARY



• trust• franchise• association.

Sole tradersSole traders own and operate a business on their own.

Advantages Disadvantages• Relatively easy and cheap to set up and run • Unlimited liability• Retains ownership and control • Lack of management skills or expertise• Keeps all profits • Limitation of business life• Maximum privacy • Limited access to funds• Flexibility in changing business • Inability to split income with family• Legal compliance relatively simple • Limited opportunity for tax minimisation

PartnershipsA partnership is the relationship that exists between two or more people carrying on a business incommon with a view to making a profit.

Advantages Disadvantages• Relatively cheap and easy to set up • Unlimited liability• Sharing of responsibility • Difficulties in transferring ownership• Additional assets, expertise and input • No continuity when the partners split• Relative flexibility to make changes • Potential for conflict• Less stringent legal compliance • Limits on maximum number of partners

CompaniesA company is a separate legal entity with all the legal capacity of an individual. A company is registeredunder the Corporations Act 2001 (Cth) at the Australian Securities and Investments Commission (ASIC) andgiven an Australian Company Number (ACN). Company operations are regulated and enforced by ASIC.

On registration a ‘corporate veil’ comes into existence. The veil protects the members from thecompany’s debts. See Salomon v Salomon & Co Ltd [1897], p. 157

Advantages Disadvantages• Separate legal entity • Significant set-up and maintenance costs• Limited liability of members • Limited management role for members• Continuous life • Control of the company can change• Transferability of shares • Strict reporting and disclosure requirements• Taxation benefits • Penalties imposed on defaulting officers• Easier access to capital • More onerous legal compliance issues

TYPES OF COMPANIES (SEE FIGURE 5.1)1. A company limited by shares.2. A company limited by guarantee—members undertake to contribute a specific sum if the company

is wound up.


3. Unlimited Company.

4. No liability companies—for mining companies only.

A proprietary company must:

• be limited by shares (or be an unlimited company with a share capital);

• have at least one shareholder (but no more than 50 non-employee shareholders) and one director,

who may be the same person;

• not do anything that would require disclosure to investors.

A proprietary company can be classified as small and has reduced reporting requirements if it

passes two out of three tests each financial year: (i) a consolidated gross operating revenue of less than

$25 million; (ii) consolidated gross assets of less than $12.5 million; (iii) fewer than 50 full-time equiva-

lent employees.

A public company is any company other than a proprietary company. A public company must have

at least one member and three directors, and it may list on the ASX.

LIFTING THE CORPORATE VEIL• Under common law the veil will be lifted if the company was formed for fraudulent or improper

purposes. See Gilford Motor Co v Horne [1933], p. 158.

• Under s 588G of the Act, the veil can be lifted for insolvent trading and personal liability imposed on

directors for the debts of the company. Directors can avoid liability if (i) they reasonably believed the

company was solvent; (ii) a competent and reliable person was advising them; (iii) illness or other

good reasons prevented them taking part in management; or (iv) they took reasonable steps to

prevent the debt: s 588H.

INTERNAL GOVERNANCEA company may rely on the replaceable rules in the Act or adopt its own constitution. The management

of the company is vested in the board of directors. Minority shareholders have remedies if the company

is managed in an oppressive manner.

DUTIES OF COMPANY DIRECTORS• Common law duties. The main common law duties are to act in good faith (honestly) and in the best

interests of the company, to maintain confidentiality, not to make secret profits or commissions, to

exercise their powers for a proper purpose and to exercise a duty of care, skill and diligence.

• Statutory duties—civil and criminal law. The civil duties overlap those owed under common law.

Criminal offences include dishonest use of information, and voting without disclosing a material

interest.

• The main defence is the ‘business judgment rule’. The director must prove they acted rationally and

honestly, without personal gain, and believed that the decision was in the company’s best interests.

INSIDER TRADINGInsider trading is prohibited. It involves the use of ‘price sensitive information’ which is not generally

available to buy or sell shares (or other securities).

FUNDRAISINGCompanies raise capital through equity (shares) or debt, which could involve secured or unsecured

debentures, fixed charges or floating charges. A public company cannot invite public subscriptions

unless it issues a prospectus, which must make a full and honest disclosure on specific matters.



Reporting and disclosureEvery company must keep prescribed registers, minute books and financial records. Public and large

proprietary companies must prepare and audit an annual financial report and a directors’ report. The

financial report must comply with the Act and the accounting standards. The auditor must report to

members as to whether the financial report gives a true and fair view of the company’s financial position

and performance. The audit must comply with any applicable auditing standards.

External administrationAn insolvent company may be placed in receivership, voluntary administration or wound up.

Corporate governanceCorporate governance refers to how a company is directed and controlled. The ASX Corporate Govern-

ance Principles and Recommendations apply to listed companies.

TrustsA trust is a business structure where a trustee (usually a company) carries out the business on behalf

of the members of the trust (the beneficiaries). Trustees have a fiduciary duty to act honestly and in the

best interests of the beneficiaries. Beneficiaries, as equitable owners of the trust property, may take

legal action to protect their rights.

EXPRESS TRUSTSThese are set up intentionally in a written will or trust deed. They include:

• Discretionary trust. Generally used in a small to medium family business. The trustees have discre-

tion (choice) as to how they will distribute the trust income.

• Fixed entitlement trust. Each beneficiary shares equally in the distribution of profits and assets. The

trustee has no discretion as to distribution of profits and assets.

• Unit trust. The beneficiary’s entitlement to profits and asset distribution depends on the number of

units held by that person.

Any trust that carries on a business is a trading trust.

Advantages of trading trusts Disadvantages of trading trusts• Flexibility of profit distribution • Establishment and ongoing costs

• Possible tax minimisation • Limited rights of beneficiaries

• Asset structure survives death of members • Laws regarding trusts may be complex

• Limited liability (if trustee is a company) • Higher compliance costs

FranchisesA franchise is an agreement in which the franchisee contracts to market the product, process, service

or system of the franchisor. All franchises are regulated by the Franchising Code of Conduct.

MAIN REQUIREMENTS PRIOR TO THE FRANCHISE AGREEMENT• Full disclosure, including all major obligations, finances and structure, in a non-promotional

document the franchisee must receive 14 days before making the contract. There is a seven-day

cooling-off period.



• Written proof that the franchisee received or waived independent advice.

MAIN REQUIREMENTS DURING THE LIFE OF THE FRANCHISE AGREEMENT• Franchisees may form associations.

• Mandatory dispute resolution system based on mediation.

• Franchisors must give notice about ownership changes and litigation.

• Marketing funds must be audited if franchisees contribute to them.

• Reasonable notice of termination and 30 days’ notice to rectify breaches.

Advantages for franchisee Disadvantages for franchisee• Product name is established • Rigid operational and marketing structure

• Established marketing, sharing of costs • Reliance on the expertise of the franchisor

• Business site, training and support • Few opportunities to influence the

• Innovative marketing techniques can thrive in business system

franchise environment • Increased financial risk if franchisee must

provide a personal guarantee to franchisor

or lender

PROTECTION AND LIABILITIES UNDER CONSUMER PROTECTION LEGISLATIONFranchisees can take action for breaches of the federal Trade Practices Act 1974, usually for uncon-

scionable conduct or misleading and deceptive conduct.

Incorporated associationsA group of people may form an association under the Associations incorporation legislation. A set of

Model Rules for the internal governance may be adopted.

Advantages Disadvantages• It is a separate legal entity • Profits cannot be distributed to members

• Members have limited liability • Compliance with statutory obligations

• It can sue and hold assets in its own name • Penalties may be imposed on officers

• It can enter into contracts in its own right • Criminal penalties for insolvent trading

• It has a continuous life • Stricter financial reporting requirements

Protection for business names and company namesA business must register its business name(s) unless it is a sole trader or partnership operating under

the name(s) of the business owner(s). The business name must be registered in each state and territory

where the business trades.

Businesses can further protect their name and image through:

• registration of trademarks;

• consumer protection laws, mainly s 52 of the Trade Practices Act;

• passing-off actions, to protect the goodwill an operator has built up in a well-established business

name. See The Budget Rent A Car Case (1977).

There are restrictions on company names. Companies cannot register a company name that is

already registered as a company or a business name in any state or territory.



ComplianceCompliance refers to an organisation’s obligations to comply with the law. This involves identifying

the law that applies to the business and the areas of risk, and then developing a compliance program.

There is no generic compliance program as each organisation’s circumstances are different. Australian

Standard AS 3806 has been developed to assist business in developing compliance programs.

Regulatory compliance issues on starting a business include compulsory registrations (including

taxation), recording keeping, business licences and permits, and local government approvals.

GUIDANCE QUESTIONSQuestion 1Allan Megson is unmarried and has no living family. He has dedicated the past ten years to his sole-

trader computer-software business that specialises in software to control pattern-making equipment.

Allan realises that his long-term success now depends on attracting and keeping the right employees.

Advise Allan which business structure would best serve his purpose.

ANSWERAllan has three main options.

1. To form a partnership with one or two people with the types of skills Allan lacks. Allan’s personal

assets would be at risk from any bad debts or unwise decisions made by the other member(s) of the

firm.

2. To form a trust. A trust (discretionary or fixed) would not attract and keep employees and Allan does

not have family members to whom he could distribute the profits of the business.

3. To form a company. Allan could offer shares to employees, which would grow in value as the company

prospered. Later, Allan could raise capital by selling shares. Provided Allan remains the majority share-

holder, he can control who is selected for key management positions. A company is more expensive

to establish than a partnership and is subject to more restrictions and scrutiny by ASIC.

CONCLUSIONBoth a partnership and a company would suit Allan’s plans fairly well. The company provides better

long-term advantages and allows him to protect his personal assets from creditors should his business

fail. However, he will probably be required at times to give a personal guarantee to lenders, which will,

once more, place his personal assets at risk.

Question 2Allan Megson wants to convert his sole-trader software business into a company, but he is not sure

what kind. He would like to include his own name in the company name and wonders if he should

register a separate business name for trading purposes. Advise Allan.

ANSWERAllan should form a proprietary company. He can name himself as the sole shareholder and director and

thereby avoid unnecessary meetings and paperwork. If the company qualifies as a small proprietary

company, it will not have to lodge an audited financial report with ASIC.



A proprietary company is classified as small and has reduced reporting requirements if it passes two

out of three tests at the end of the financial year: (i) a consolidated gross operating revenue of less than

$25 million; (ii) consolidated gross assets of less than $12.5 million; (iii) fewer than 50 full-time equiva-

lent employees.

Allan could incorporate as Megson Software Pty Ltd. The company would be given an ACN. There

are special rules in the Corporations Act 2001 for ‘sole person’ companies (the replaceable rules in the

Act do not apply).

The company could register and trade under a specific business name/s, such as Megson Elec-

tronic Patterns, provided this is disclosed on its official documentation. All business names must be

registered in each state or territory where the company operates.

If the business prospers, it could be converted to a public company. Invitations to invest in the

company must be in the form of a prospectus or a disclosure document.

Question 3Kate Ewen bought a City Day Park franchise from Celia Day Pty Ltd (CD), which leases vacant ware-

houses, converts them into parking stations and subleases them back to the franchisees.

CD’s disclosure material included statements that: ‘Our operation is the best franchise opportunity

in Australia since McDonald’s and is a proven concept’; ‘We have been operating for eight years and

have a current net worth of $14 million’; ‘Our stations are surveyed, refitted and maintained by structural

engineers’; ‘The marketing budget for each station is at least $120 000 per year.’

Two years after Kate became a franchisee her car park sees very few customers because CD has

only spent about $20 000 on marketing her station, and it has often been closed for repairs to advanced

‘concrete cancer’. The expensive maintenance company she is required to use is run by tradesmen, not

engineers, and it is paying CD a 5% commission. Kate now knows CD had only been operating for three

years when she bought her franchise and had debts of $2 million.

(a) What possible breaches of the Franchising Code and the Trade Practices Act have occurred?

(b) What remedies are available to Kate?

ANSWER(a) CD appears to have breached the Franchising Code by:

• including promotional material in its disclosure statement (‘the best franchise opportunity since

McDonald’s’ claim); and making false statements about the duration and financial state of the

company.

CD appears to have breached the following consumer protection provisions of the Trade Practices

Act:

• s 52—‘misleading or deceptive conduct’, through the statements about its duration and finan-

cial status, the qualifications of its maintenance team and possibly its claim to be ‘a proven

concept’. Failure to discover or prevent the concrete cancer could constitute another breach

of s 52.

• CD has probably also breached s 47 of the Trade Practices Act, which prohibits exclusive

dealing, by requiring Kate to use the services of an apparently uncompetitive third party.

(b) Kate could take legal action to recover damages and seek orders to terminate or rewrite the fran-

chise agreement. She could also complain to the ACCC (or the Fair Trading Office in her jurisdiction)

and see if it could take action on her behalf. As well as the remedies referred to above, the ACCC



could seek fines (for breaches apart from ss 52 and 51AA) and orders such as corrective advertis-

ing, injunctions and compliance programs. See ACCC v Top Snack Foods (1999).

REVIEW QUESTIONSSole traders1. List the key characteristics of a business operated on a sole-trader basis.

2. Compare and contrast the advantages and disadvantages of a sole trader.

Partnerships3. List the key characteristics of a business operated as a partnership.

4. What are the advantages and disadvantages of a partnership? Give examples.

Companies5. Define a company and list its advantages and disadvantages. Give examples.

6. What is the meant by ‘the corporate veil’? Describe three situations where the courts may ‘lift’ the

veil to establish whether company members have breached common or statutory laws.

7. What are the differences between a small and a large proprietary company? How many sharehold-

ers and directors are required to form (a) a private company and (b) a public company?

Duties of directors8. List and briefly explain six common law or statutory duties of a director.

9. Megson Software Pty Ltd appointed Nicholas Jones as a director responsible for marketing.

Nicholas persuaded customers of Megson Software to take their business to NPJ Electronic

Patterns, which Nicholas controls through his parents. What common law or statutory duties has

Nicholas breached? What remedies are available?

Raising capital10. Explain the ways in which companies can raise capital by (a) equity finance and (b) debt finance.

11. Explain the differences between fixed charges and floating charges. Give an example of each.

Franchises12. Dimitri, a retired school teacher, is interested in becoming a franchisee with Perfect Score Educa-

tion Centres Pty Ltd which runs a high school tutoring business. The franchisor claims Dimitri will

earn $60 000 per year within two years. Advise Dimitri about what should be included in a franchise

agreement and how he can best protect his interests.

13. See the facts in Question 12. Dimitri entered a franchise agreement with Perfect Score. After one

year in business Dimitri has learned that Perfect Score’s profit projections were highly inflated and

it was badly in debt when Dimitri bought the franchise. What remedies are available to Dimitri and

what are his chances of success?

14. Explain, giving examples where possible, what possible conflicts could arise between a franchise

agreement and Part IV of the Trade Practices Act.



Trusts15. Define a trust and list its key characteristics.16. Give three examples of occasions when it is likely a trust would be created.

Associations17. Are members of an association liable for the debts of the association? Why or why not?18. David operates a basketball club for underprivileged teenagers in an inner-city suburb. Each player

pays a membership fee or a service club pays it. The treasurer disappears with all the funds, leavingthe club with debts of $12 000. Who is liable for this debt? Would your answer be different if the clubwas an incorporated association?

Business name protection19. How could the names of the following types of businesses be protected?

(a) a sole trader; (b) a partnership; (c) a company.20. Greg ‘the Moose’ promotes kick boxing in Queensland under the registered business name of ‘Kick

Start’. Greg wants to form a company using the same name. When he searches the ASIC websitefor company and business names he finds the following registered names. (a) ‘Kick Start’, a business name registered in Victoria that is used by a kick-boxing promoter;(b) ‘Kick Starter’, a business name registered in New South Wales;(c) ‘Kick Static Pty Ltd’, a company name registered to a company based in Western Australia.Explain, giving reasons, whether each name could prevent Greg from registering his preferred

company name.

COMPLIANCE ACTIVITIES21. Remember Marley and Bella from the introduction to this chapter? Bella will operate from home as

a sole trader under the name, Camelot Financial Planners. Marley has registered a proprietarylimited company with his friend, Conor, and bought into the real estate franchise known as LJWinger. They employ a receptionist and one salesperson.(a) Do a search of the National Names Index at <www.asic.gov.au> and find out whether the name

Camelot Financial Planners is available. (b) Make a checklist of any (i) licences and permits, (ii) industry codes of conduct, and (iii) basic tax

registrations that may apply to each business.(c) Bella has looked at the publication, What Books and Records Should My Company Keep? at

<www.asic.gov.au> (see Compliance Check). Make a list of the records she must set up inorder that Marley’s company complies with s 286.

22. Marley and Connor are having problems with their franchisor LJ Winger. They claim Winger:• refuses supply of essential products to them;• competes with them within their franchised territory;• requires them to buy items from Winger that they could buy cheaper elsewhere.Locate the Best & Fairest compliance training package on the website of the ACCC. Go to Module

6 and then answer the following questions:




(a) What are the options available to Marley and Conor?

(b) Could Winger’s conduct be seen as unconscionable?

(c) Can Marley and Conor take legal action against the directors of Winger?

If you have difficulty locating information go to the ABL website for directions.

Note: The case assignments and research assignments that appeared at the end of each chapter in

previous editions are now located in the Instructor’s Manual.
