Directors of companies should be alive to the risk that their company can incur liabilities and obligations without their knowledge or consent.
The Corporations Act 2001 contains provisions permitting those having dealings with a company to rely on a document that 'appears' to have been duly executed, even when it has not.
The recent decision of the Court of Appeal in Australia and New Zealand Banking Group Ltd v Frenmast Pty Ltd  NSWCA 459 considered those provisions and found that the bank was entitled to rely on a guarantee even though one of the director's signatures on the guarantee documents was forged.
Frenmast Pty Limited (Frenmast) was one of three companies involved in the liquorice making business. It was a family business run by three brothers – Robert, Vlado and Steve Tiricovski.
All three brothers were directors of Frenmast. Frenmast owned the liquorice factory building and leased it to one of the other companies, Australian Fresh Confectionary Pty Limited (AFC).
Robert managed the business affairs of the companies. Vlado was unable to read or write English and spoke it poorly. He was the liquorice maker. Steve had little involvement in the business at all. He spent most of his time overseas on unrelated business. In 2006 Steve and Vlado had a falling out with Robert and ceased communicating with him.The business had a long standing relationship with ANZ. Robert, as the business manager, was the principal point of contact for the bank.
In September 2008, after the falling out, Robert approached ANZ to vary the existing arrangements between the bank and the companies and between the bank and he and his wife Slavica. The bank approved the application and forwarded the contract documents to Robert for execution.
At the time of the variation the Frenmast owed ANZ $917,000, AFC owed ANZ $800,000 and Robert and Slavica owed $3,150,000. The main features of the variation negotiated between Robert and ANZ were as follows:
- ANZ was to release Robert and Slavica as guarantors of all AFC and Frenmast facilities
- ANZ was to release the mortgage over Robert and Slavica's property at Taren Point
- Frenmast was to provide an unlimited guarantee for the obligations of AFC
- Frenmast was to provide an unlimited guarantee for the obligations of Robert and Slavica
- The amount secured by the mortgage over Frenmast's property at Carlton was extended to cover the new guarantees.
Robert executed the guarantee documents as one of the directors of Frenmast and forged the signature of his brother Vlado as the other. Vlado had no knowledge of the proposed variation. ANZ accepted the agreements and the variation was effected.
ANZ brought proceedings in the Supreme Court to enforce the new guarantees provided by Frenmast for the obligations of AFC and Robert and Slavica. Frenmast argued that the guarantees were not binding on it as the documents constituting the agreement were not duly executed. Section 127(1) of the Corporations Act sets out the manner in which a company can lawfully execute documentation and bind the company without the company seal. It states that:
'127(1) A company may execute a document without using a common seal if the document is signed by:
- 2 directors of the company; or
- A director and a company secretary of the company; or
- For a proprietary company that has a sole director who is also the company secretary – that director.'
ANZ did not dispute that the signature on the guarantee documents were forged and conceded that those documents were not duly executed. However, it sought to rely on the provisions of section 129(5) of the Corporations Act which it claimed entitled it to assume that the document had been duly executed by Frenmast. Section 129(5) states that:
'129(5) A person may assume that a document has been duly executed by the company if the document appears to have been signed in accordance with subsection 127(1)...'
The Court of Appeal decision reversed the decision at first instance by Adams J. in the Supreme Court. Justice Adams found that ANZ was not entitled to rely on the provisions of section 129(5) because it had failed to meet a necessary pre-condition for reliance on the assumption provisions. That precondition is set out in section 128(1) of the Corporations Act which provides that a person is only entitled to rely on the assumptions set out in section 129 in relation to 'dealings' it has with the company. It states that:
'128(1) A person is entitled to make the assumptions in section 129 in relation to dealings with a company. A person is not entitled to assert in proceedings in relation to the dealings that any of the assumptions are incorrect'
Justice Adams found that ANZ and Frenmast did not have such dealings. His reasoning process in coming to that conclusion was as follows.
ANZ's conducted all its negotiations with Robert alone. Robert did not have authority to bind Frenmast to the guarantees, as the signature of two directors or a director and secretary were required on any contract documentation to give effect to those guarantees. Justice Adams held that, as Robert alone did not have authority to bind the company, he was not able to engage in any 'dealings' with ANZ on behalf of Frenmast.
The Court of Appeal found that Justice Adams' view was based on a 'wrong understanding' of the law.
Justice Adams based his findings on a decision of Hodgson CJ in Eq in a case called Sofyer v Earlmaze  NSWSC 1068 in which his Honour stated that:
'...it is not necessary that the person representing the company have authority from the company to commit the company to the relevant transaction or execute the relevant documents; but in my opinion, it is necessary that the person have authority to undertake some negotiation or other steps, so that the dealings, in relation to which the document is executed, are properly considered to be dealings with the company.'
In a curious step of reasoning, Justice Adams, after citing the above statement, drew the following conclusion:
'...I understand his Honour [Hodgson CJ in Eq] to mean that the person representing the company must have ostensible authority to bind the company to the particular transaction by virtue of his actual authority to take steps of that or a related kind'
Writing the leading judgment for the Court of Appeal, Meagher JA concluded that the statement of Justice Hodgson was to the opposite effect. Justice Meagher held that a person could be authorised to have dealings with a company without having the authority to bind the company.
Applying that reasoning to the facts in the present case Justice Meagher found that Robert had authority to negotiate on behalf of Frenmast. Robert had conducted all communications with ANZ on behalf of Frenmast since 2001 and, at least prior to 2006, he had done so with the knowledge and agreement of his brothers Vlado and Steve. For the period after 2006 Justice Meagher concluded that his brothers must have known that Robert was continuing to act on behalf of Frenmast in its communications with ANZ concerning its ongoing banking facilities. That, in Justice Meagher's view, was sufficient to constitute actual or ostensible authority to undertake communications and negotiations with ANZ on behalf of Frenmast.
What does the decision mean for those involved in the management of a company?
Section 129 of the Corporations Act exists to provide to those dealing with companies a level of certainty that those companies will be bound by the contracts that are executed on their behalf. Without the assumption provisions, dealing with companies would be a risky affair. Forged contracts would be unenforceable. There are clearly benefits for companies too as the cost and time involved in doing business would greatly increase if all negotiations by the company had to be conducted by those that had the power to bind the company.
On the other hand, as this case illustrates, the assumption provisions of section 129(5) of the Corporations Act pose a fraud risk to companies and those involved in the management and control of them.
The error that Vlado and Steve made was to allow Robert free reign to manage the affairs of the business without putting in place safeguards that would ensure that they were aware of the nature and extent of Robert's dealings with ANZ and that ANZ was aware of Robert's authority to negotiate on behalf of Frenmast. The wilful blindness of Vlado and Steve to Robert's management activities was a key element to the Court of Appeal's decision. Despite the fact that there had been no contact between the brothers for two years prior to the variation, the Court of Appeal found that Vlado and Steve must have known that Robert was continuing to deal with the ANZ and thereby tacitly provided their consent to him to negotiate on behalf of the company.
The case serves as a warning to directors that the nature and extent of the authority provided to those who have dealings on behalf of the company are clearly stated and that those with whom the company has dealings are aware of the nature and extent of that authority. Had ANZ been informed that Robert did not have authority to negotiate a restructuring of the facilities and the provision of further security by Frenmast, ANZ would not have been entitled to rely on the assumption provisions.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.