Australia: Invalid contract by director saved by shareholder approval

Where a director purports to enter into a contract on behalf of a company without authority or contrary to the company constitution, disputes can arise as to the enforceability of the contract.

The other party to the transaction or another shareholder or director of the company may seek to rely on the defect in the director's authority to argue that the agreement is invalid and unenforceable. If successful, this could expose the director to a claim for damages on the grounds that the director acted without authority.

However, the doctrine of shareholders' unanimous assent may be available to validate a purported transaction entered into by a director who lacked the necessary authority to enter into the agreement.

Akierman Holdings

This doctrine was applied in Akierman Holdings Pty Ltd v Akerman [2019] NSWSC 1486, where:

• the constitution required the company to have at least two directors, but Mr Akerman was the only director of the family business
• purporting to act as a sole director, Mr Akerman, who was also a shareholder, entered into an agreement for the sale of company property
• the company's other shareholder argued that the transaction was invalid because the company was not a sole director company, Mr Akerman was not a managing director, and he did not have authority to enter into the agreement on the company's behalf
• the other shareholder had signed the agreement expressly on behalf of the company, to signify the company's assent.

The Court decided Mr Akerman did not have authority to execute the agreement on behalf of the company because:

• he was not validly appointed as sole director of the company for the purposes of section 127 of the Corporations Act as the company's constitution did not provide for sole directorship
• he was not acting with the company's express or implied authority under section 126 of the Corporations Act because his authority as director did not extend to management of the company's business
• he did not otherwise have authority under the constitution.

However, Mr Akerman, relying on the doctrine of unanimous assent, argued that his lack of authority was irrelevant because the other shareholder had agreed to the sale.

In considering the application of the doctrine, the Court relied on the 'well-known' statement of principle established in Re Duomatic Ltd [1969] 2 Ch 365, which provides that

Re Duomatic concerned payments that should have been approved by the shareholders in general meeting. The payments were not approved by any formal resolution at a general meeting, but all of the shareholders were aware of the payments and assented to them.

Applying the doctrine

Authorities have established that the following factors must be present for there to be unanimous assent:

• all shareholders having a right to attend and vote at a meeting have assented
• assent is given with full knowledge and consent
• the transaction is one that could have been effected by the shareholders in a general meeting.

In Akierman Holdings, the Court found that the principle applied because:

• the two shareholders of the company had agreed to the transaction
• all 'matters of substance' and 'essential terms' of the transaction had been disclosed to the other shareholder
• it would have been open to the shareholders in a general meeting to have the company effect the sale and authorise Mr Akerman or the other shareholder to execute the relevant documents on its behalf.

The Court said it was significant that the other shareholder had signed the agreement expressly on behalf of the company to signify the company's assent.

Although there was no formal resolution at a general meeting approving the entry into the agreement, the other shareholder was aware of the essential terms of the transaction and had assented to the transaction.

Limitations on doctrine

The Court in Akierman Holdings left open the question of the limits of the doctrine, which remains unsettled in Australian law. Noting distinctions between various lines of authority on this point, the Court ultimately held that it was not necessary on the facts to decide this issue.

Court decisions have recognised limitations on the application of the doctrine, including that:

• the decision must be for a proper purpose (for example, the doctrine may not be relied upon to validate a transaction that would cause loss to a company's creditors)
• the doctrine will not apply to a decision that has the effect of varying substantive rights.

Comments

It is common to see a contract challenged on the basis that it was not validly entered into by a company, with such arguments often being raised by shareholders or where the other contracting party, having buyer's remorse, is seeking to escape the contract.

The decision in Akierman is a reminder that you may be able to rely upon the doctrine of unanimous assent to argue that the exercise of corporate power is binding, despite there being a failure to comply with formalities.

However, even if all the shareholders entitled to participate in that decision have given their unanimous assent, it is important to remember that there are limitations on the application of the doctrine.

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