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Chapter 3 – The benefits of the ratification doctrine

Temporary tables of contents

ContentsI. Introduction..................................................................................................................2II. The beneficial aspects of the doctrine under the Corporations Act.............................2

A. Protection of third parties dealing with companies.................................................2B. Shareholder regulation of a company’s affairs and shareholder control to determine whether a particular breach should be ratified................................................5C. The protection of honest directors...........................................................................6D. Prevention of vexatious proceedings.......................................................................7

1 The relevance of a ratification resolution to an application for leave.................9E. Protection of trustees.............................................................................................12

III. Other beneficial aspects of the doctrine.................................................................12F. Ratification of the commencement of proceedings...............................................12G. Ratification of payments made for a company......................................................13

IV. Conclusion.............................................................................................................15

I. INTRODUCTION

In this Chapter, the benefits of the doctrine of ratification to companies governed by the

Corporations Act are considered. The doctrine was first applied to companies in North-

West Transportation Company Ltd v Beatty.1 The contract under consideration was

determined to be fair in its terms and the Court held that one of the directors who was the

owner of the asset being purchased by the company was entitled to exercise his voting

power as a shareholder in general meeting to ratify the contract. There was in this case

no mischief by the directors and the doctrine enabled the company to resolve the matter

at a general meeting of the shareholders in an economically and efficient manner.

There are however numerous other reasons why the doctrine is beneficial to companies

governed by the Corporations Act. The principal benefits which will be discussed in this

Chapter are firstly, that a company will be bound under section 128 of the Corporations

Act for the protection of third parties dealing with the company when a ratification

resolution is approved. Secondly, when a payment is made on a company’s behalf, this

will result in a discharge of the company’s debt to a creditor and this may be relevant in

an insolvency context. Thirdly, it avoids a situation where a director would be liable for

every breach of duty to the company by allowing the shareholders to ratify or authorise a

breach since the breach may have been beneficial to the company. Fourthly, it may

protect directors whom have acted honestly consistent with sections 1317S and 1318 of

the Corporations Act. Finally, following the approval of a ratification resolution, a court

has a greater discretion to prevent vexatious derivative proceedings.

II. THE BENEFICIAL ASPECTS OF THE DOCTRINE UNDER THE CORPORATIONS ACT

In this section, this Chapter discusses the beneficial aspects of the doctrine under the Corporations Act

A. Protection of third parties dealing with companies

In the context of ratification, the beneficiaries of the effect of section 128 are the third

parties dealing with the company. This will include creditors and financial institutions.

1 (1887) 12 App Cas 589

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An example of some significance in the context of ratification is the enforcement of third

party securities including guarantees,2 charges and security interests under the Personal

Property Securities Act.

A third party may be entitled to rely on a prospective authorisation resolution for the

purposes of section 129 of the Corporations Act, however, whether that is correct turns

on the lawfulness of an attenuation of statutory duty and this question is addressed in

Chapter 5 of this Thesis which considers the limited authorities on the issue.

It should now be doubted that a third party is entitled to rely upon a retrospective

ratification resolution for the purposes of section 128 of the Corporations Act. If this

were correct, this would indicate that there is an assumption that the ratification

resolution is valid, however, following the decision in Angas Law Services,3 it is not

possible to ratify a breach of statutory duty.4 Accordingly, a ratification resolution cannot

result in a third party knowing or suspecting that the assumption that there has been no

breach of statutory duty was incorrect. There are no reported cases in Australia which

consider the issue.

The doctrine of ratification also seeks to avoid unfairness the third parties in their

dealings with companies.

To avoid unfairness to a third party, the law developed a general principal that a third

party may not be unduly prejudiced when a contract is ratified. Specific examples of the

unfairness to a third party include:

(i) where an agent, without the authority of the landlord, gives a tenant notice to quit,

that notice cannot be made binding on the tenant by ratification by the landlord

after the time for the giving of the notice has expired;5 and

2 see Qintex3 4 cf. Horrigan, 242; Ford’s Commentary [17.3] as at 4 February 20185 Doe d Mann v Walters (1830) 10 B and C 626, Doe d Lyster v Goldwin (1841) 2 QB 143 and Right d Fisher, Nash and Hyrons v Cuthell (1804) 5 East 491); Dibbins v Dibbins (1896) 2 Ch 348, Bird v Brown

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(ii) where the right to the ownership of goods had vested.6

The general principle is recognised by the following principles concerning ratification:

(i) ratification must take place within a reasonable time;7

(ii) unfair prejudice,8 it would seem, is always present if the effect of a purported

principal’s ratification would be to divest a third party of vested proprietary

rights9 but not where the ratification merely has the effect, or possible effect, of

affecting the rights of a third party;10

(iii) an estate once vested cannot be divested;

(iv) a lawful act at the time it was done cannot be rendered unlawful by the operation

of ratification;

(v) ratification of a transaction after the expiry of an ordained time limit may give rise

to unfair prejudice to a third party;11 and

(vi) ratification cannot take place where nothing remains to be ratified.12

As can be seen from the above, the doctrine of ratification protects third parties dealing

with the company and limits inconvenience to the company.

(1850) 4 Exch 786; Lord Audley v Pollard (1597) Cro Eliz 561.6 Bird v Brown (1850) 4 Exch 786; Dibbins v Dibbins (1896) 2 Ch 348.7 In re Portugese Consolidated Copper Mines Ltd [1891] 3 Ch 28. What is a reasonable time depends upon the circumstances of the case.8 In the context of members’ remedies in respect of unfairly prejudicial conduct, the test of unfairness is free from technical considerations of legal rights and to confer a wide power upon the court to do what is just and equitable (O’Neill v Phillips [1999] 2 All ER 961). Prejudice is not unfair where it occurs in the bona fide exercise of a power to prejudice (Wayde v NSW Rugby League Ltd (1985) 180 CLR 459). In the context of ratification the meaning of ‘unfair prejudice’ has not been authoritatively determined by a Court in Australia or the United Kingdom. See for example in Adams v Elphinstone [1993] TASSC 67, [25] (Zeeman J) approved Attorney-General v Wylde (1946) 47 SR (NSW) 99 that ratification cannot operate in destruction of rights that have accrued by reason of the acts sought to be ratified, having been done without authority and therefore being ineffective and not having been ratified at any time when the acts could have been done effectively.9 See, eg, Bird v Brown (1850) 4 Exch 786; N M Superannuation Pty Ltd v Baker (1992) 7 ACSR 105; R Munday, Agency law and principles (Oxford University Press, 2010), 129 cf Adams v Elphinstone [1993] TASSC 67, [26] (Zeeman J) where the correctness of the use of prejudice and unfairness were the relevant tests. It was stated that ‘It may well be appropriate to describe the relevant tests as falling into an overall category of unfair prejudice to a third party but only in a descriptive sense rather than as a test by reference to which the validity of a purported ratification is to be determined.’.10 Adams v Elphinstone [1993] TASSC 67. See also Trident General Insurance Co Ltd v McNiece Bros Pty Ltd (1987) 8 NSWLR 270 where a contract of insurance entered into by an agent without authority may be ratified even after loss.11 Smith v Henniker-Major [2003] Ch 182.12 Walker v James (1871) LR 6 Ex 124.

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B. Shareholder regulation of a company’s affairs and shareholder control to determine whether a particular breach should be ratified

The doctrine of ratification is permissive of the regulation of a company’s affairs by the

shareholders in two main ways. Firstly, the shareholders may modify the terms of the

company’s constitution to seek to attenuate the duties of the directors. Secondly, the

shareholders in general meeting or pursuant to the Duomatic principle may approve an

authorisation or ratification resolution.

The control of whether an attenuation of duties, or ratification of conduct is thereby

within the control of the current shareholders of the company.

The right of the shareholders to regulate the affairs of the company provides a range of

benefits.

Firstly, majority shareholder control of the issue of authorisation or ratification permits a

decision to be made efficiently and inexpensively when compared to seeking a decision

of a court.

Secondly, the decision which is taken by the shareholders may be to not ratify the

director’s breach of duty and a remedy is sought against the director personally.

Thirdly, the operation of the doctrine of ratification in this way avoids a situation where a

director would be liable for every breach of duty to the company. The relevant breach

may have been beneficial to the company at the time of the relevant breach (eg. the

issuance of shares during a hostile takeover bid).

The approval by the shareholders in general meeting of a ratification resolution is an

economically and practically efficient method for dealing with a ratification of a breach

of a director’s duties.

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C. The protection of honest directors

In connection with a ratification resolution, sections 1317S13 and 1318 of the

Corporations Act are relevant to the question of the extent of liability to be imposed upon

a director by reason that it is relevant to determine whether a director acted improperly14

or dishonestly.15

The criteria for determining whether a director has acted honestly for the purposes of

section 1317S(2)(b)(i) or section 1318 of the Corporations Act was considered in Hall v

Poolman16 as follows:

the court should be concerned only with the question whether the person has acted

honestly in the ordinary meaning of that term, that is, whether the person has acted

without deceit or conscious impropriety, without intent to gain improper benefit or

advantage for himself, herself or for another, and without carelessness or imprudence to

such a degree as to demonstrate that no genuine attempt at all has been to carry out the

duties and obligations of his or her office imposed by the Corporations Act or the general

law. A failure to consider the interests of the company as a whole, or more particularly

the interests of creditors, may be of such a high degree as to demonstrate failure to act

honestly in this sense. However, if failure to consider the interests of the company as a

whole, including the interests of its creditors, does not rise to such a high degree but is

the result of error of judgment, no finding of failure to act honestly should be made, but

the failure must be taken into account as one of the circumstances of the case...17

Section 1317JA of the former Corporations Law (now section 1317S of the Corporations

Act) was considered in Forge v Australian Securities & Investments Commission.18 The

Court held that section 1317JA supports the proposition that contraventions of the civil

13 Formerly section 1317JA of the Corporations Law.14 See ASIC v Maxwell [2006] NSWSC 1052; (2006) 59 ACSR 373. See also ASIC v Adler and 4 Ors [2002] NSWSC 483 at 173 per Santow J. See generally Harris, J, ‘Relief from liability for company directors: Recent Developments and their implications’, (2008) 21(1) University of Western Sydney Law Review.15 See generally Schmierer and Anor v Taouk [2004] NSWSC 345.16 (2007) 65 ACSR 123.17 Hall v Poolman at 193-194 per Palmer J cited with approval in McLellan, Re; Stake Man Pty Ltd v Carroll per Goldgerb J at [190].18 [2004] NSWCA 448.

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penalty provisions (such as the statutory duties imposed upon directors) cannot be ratified

by shareholders. The only relief available to avoid or reduce liability is that for which the

legislature provided.

A director’s honest breach of their statutory duties is not a bar to a liability being imposed

under a civil penalty provision. Pursuant to section 1317S(2)(b) of the Corporations Act,

the Court must also have regard to all the circumstances of the case to determine whether

the person ought fairly to be excused from the contravention, in whole or in part. It will

be recalled that under the general law there is no requirement in Australia for a

ratification resolution to be approved by an independent majority of shareholders and

accordingly, a director (and their fellow directors and any associates of the directors) may

vote as shareholders to ratify a breach of a director’s duty.

In Australia, there is no authority on the question of whether subject to the ratification

resolution being approved by a non-independent majority of shareholders, what weight

should be attributed to the ratification resolution being approved. In light of the general

law, it is very likely that a court would disregard which of the shareholders voted to

approve a ratification resolution in exercising its discretion to relieve a director from the

liability to the company. This highlights the prejudice which may be suffered by

minority shareholders in these circumstances.

D. Prevention of vexatious proceedings

A court has a greater discretion to prevent vexatious derivative proceedings following the

approval of a ratification resolution by the shareholders in general meeting.

A shareholder does not have an inherent statutory right to commence or intervene in

proceedings on behalf of a company or intervene in proceedings. Pursuant to section

237(2) of the Corporations Act, the Court must grant a shareholder leave if the Court is

satisfied of the 5 enumerated matters in that section. The Court’s jurisdiction to grant

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leave is grounded upon the same principle on which a beneficiary of a trust could always

have commenced proceedings in the old Court of Chancery against the trustee to be

allowed to use his or her name to recover the trust property.19

In a circumstance where a majority of shareholders in general meeting have approved a

ratification resolution or authorised the directors to engage in particular conduct, section

239 of the Corporations Act ensures that the shareholders’ ratification or approval does

not prevent the conduct from being within the scope of a derivative action brought by a

shareholder.20

Pursuant to section 239(2) of the Corporations Act, if a majority of the shareholders of a

company ratify or approve the conduct of a director, the Court has a discretion to take

into account the ratification or approval in deciding what order or judgment to make in

proceedings brought or intervened in with leave under section 237 or in relation to an

application for leave under section 237. The discretionary nature of the Court’s powers

to take into account a ratification resolution is significant because it prevents directors

from obtaining a release from liability from the company other than with the sanction of

the Court. This accordingly means that the introduction of the statutory derivative action

has been largely effective to reduce the role of the doctrine of ratification, however the

Courts are permitted to consider the ratification or approval as a part of the exercise of

the discretion.

Pursuant to section 239(2) of the Corporations Act, in exercising its discretion the Court

must have regard to:

(a) how well-informed about the conduct the members were when deciding whether to

ratify or approve the conduct; and

(b) whether the members who ratified or approved the conduct were acting for proper

purposes.

19 Bl and Gy International Co. Ltd v Hypec Electronics Pty Ltd; Colin Anthony Mead v David Patrick Watson and Ors. [2001] NSWSC 705 at [70] per Einstein J.20 See Roach v Winnote Pty Ltd (in liq) [2001] NSWSC 822; Chahwan v Euphoric Pty Ltd trading as Clay & Michel [2008] NSWCA 52.

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1 The relevance of a ratification resolution to an application for leave

The principle upon which a ratification or approval resolution is relevant to leave being

granted pursuant to section 237 of the Corporations Act is enunciated by section 239(2)

which establishes what matters the court must have regard to in relation to an application

for leave to commence or intervene in proceedings.

Section 239(2) in Part 2F.1A of the former Corporations Law commenced on 13 March

2000 following the enactment of the Corporate Law Economic Reform Program Act

1999 (Cth). The Explanatory Memorandum to the Corporate Law Economic Reform

Program Bill 1998 at paragraph 6.8 on page 24 which concerned the proposed

introduction of section 239(2), explained the principle as follows:

Proposed subsection 239(2) will provide that the Court may take into account a

ratification or approval of conduct in deciding what order or judgment (including as to

damages) to make. However, the provision will make it clear that the Court may only

have regard to ratification if it is satisfied that the ratification was effected by the

company’s fully informed independent members. (emphasis added)

The Explanatory Memorandum indicates that the intention of the Commonwealth

parliament in introducing section 239(2) was to ensure that if the Court exercised its

discretion to take a ratification or approval resolution into account in relation to an

application for leave under section 237, the Court must be satisfied that the shareholders

which approved the resolution were both fully informed and were independent

shareholders from the affected director(s).

The Explanatory Memorandum explained the reason for the introduction of Part 2F.1A

into the Corporations Law was as a result of the practical and legal difficulties faced by

litigants arising from the limited exceptions to the rule in Foss v Harbottle.21 The 3 main

difficulties associated with the common law action were explained as follows:

21 (1843) 2 Hare 461.

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1. the effect of ratification of the impugned conduct by the general meeting of

shareholders (if effective, the purported ratification by a majority of shareholders

could deny the company as a whole, and hence minority shareholders, any right of

action against the directors);

2. the lack of access to company funds by shareholders to finance the proceedings

(where a shareholder seeks to enforce a right on behalf of a company, they are

likely to be disinclined to risk having costs awarded against them in a case which

will ultimately benefit the company as a whole, not just individual shareholders);

and

3. the strict criteria which need to be established before a Court may grant leave.22

The Explanatory Memorandum also explained that there would be appropriate checks

and balances to prevent abuse of the statutory derivative action to ensure that vexatious

proceedings were not commenced and that company funds are not expended

unnecessarily.23 It is not apparent from the Explanatory Memorandum that the principle

supporting the introduction of section 239(2) is contrary to the objective of preventing

vexatious litigation against companies.

Notwithstanding that section 239(2) of the Corporations Act has been unamended since

its introduction in 2000, the principle upon which section 239(2) was enacted has not

resulted in this section being interpreted by the Courts in accordance with the

‘independent shareholders’ requirement. This may be because the cases which have

considered section 239(2) have not been required to consider whether a ratification

resolution was approved by an independent majority of shareholders.24

The failure of the section to use the words ‘independent’ in relation to shareholders

supports an interpretation that there is no requirement that a ratification resolution be

22 Para 6.15 on page 19.23 Para 6.16 on page 19.24 See especially, William Arthur Forge & 5 Ors v Australian Securities & Investments Commission [2004] NSWCA 448; Massey & Anor v Wales & Ors; Massey & Anor v Cooney & Anor [2003] NSWCA 212; Chahwan v Euphoric Pty Ltd trading as Clay & Michel [2008] NSWCA 52; Ehsman v Nutectime International [2006] NSWSC 887.

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approved by independent shareholders. Since it is a requirement of statutory

interpretation pursuant to section 15AA of the Acts Interpretation Act 1901 (Cth) that in

interpreting a provision of an Act, the interpretation that would best achieve the purpose

or object of the Act (whether or not that purpose or object is expressly stated in the Act)

is to be preferred to each other interpretation.25 A Court may consider extrinsic material

where a provision is ambiguous or obscure,26 however, on the face of section 239(2),

there is nothing ambiguous about the word ‘independent’ being omitted from the section.

If the parliament intended the meaning of ‘members’ to be ‘independent members’ the

word ‘independent’ could have been inserted into the proposed section 239(2). The

wording of the section is consistent with the general law because there is no requirement

for an independent majority of shareholders to approve a ratification resolution. A

further significant difficulty with the reading the word ‘independent’ into section 239(2)

is that the word ‘member’ or ‘members’ is used extensively throughout the Corporations

Act and the word ‘member’ pursuant to section 9 of the Corporations Act has a restrictive

meaning.

However, there is no clear underlying principle enunciated by the Explanatory

Memorandum as to why:

there ought to be any relevance of a ratification resolution to a shareholder

commencing proceedings pursuant to section 236 of the Corporations Act; or

the Court should take into consideration the fact that a ratification resolution was

approved by a majority of shareholders.

The strongest argument for taking into account a ratification resolution of any practical

significance is that if the shareholder was unable to obtain any substantial damages as a

result of the ratification resolution because of the effect of the ratification resolution, then

the granting of leave to commence proceedings would be otiose and only result in the

parties and the Court devoting unnecessary resources to the resolution of the dispute.

25 Acts Interpretation Act 1901 (Cth) s 15AB.26 Acts Interpretation Act 1901 (Cth) s 15AB(1)(b)(i).

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This problem no doubt could be dealt with by the plaintiff shareholder providing security

for the defendant company’s costs of defending the proceedings.

At the time of the commencement of section 239(2) of the Corporations Law, the law in

Australia with respect to the doctrine of ratification was in a more uncertain state.

However, since that time, it is now clear that the shareholders in general meeting cannot

ratify a breach of statutory duty (discussed below) and since the fiduciary duties of

directors are included within the statutory duties pursuant to sections 180, 181, 182 and

183 of the Corporations Act, the Court would be unable to deny a shareholder leave to

commence proceedings with respect to a breach of a director’s statutory duties on the

basis of a ratification resolution be approved by the shareholders since that resolution

could not be legally effective to relieve a director of liability to the company.

E. Protection of trustees

III. OTHER BENEFICIAL ASPECTS OF THE DOCTRINE

F. Ratification of the commencement of proceedings

the ratification of the commencement of legal proceedings.27 A client of a solicitor may

ratify the issuance of a writ after the period for the commencement of proceedings has

expired under a statute of limitations, however, it remains the discretion of the Court to

determine whether an extension of time ought to be granted. The retrospective operation

concerning the irregular issuance of the writ ensures that the client’s legal rights are

preserved;28

27 See, eg. Danish Mercantile Co. Ltd v. Beaumont [1951] Ch 680; Victoria Teachers Credit Union v KPMG [2000] VSCA 23; Alexander Ward & Co Ltd v Samyang Navigation Co Ltd [1975] 1 WLR 673; Australian Liquor Hospitality & Miscellaneous Workers Union (WA Branch) v Gay-Dor Plastics Ltd (1994) 74 WAIG 961; Omega Estates Pty Ltd v Ganke (1962) 80 WN (NSW) 1218.28 Adams v Elphinstone [1993] TASSC 67.

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the ratification of the commencement of legal proceedings by persons not authorised by a

company, such as a liquidator. The liquidator’s ratification is treated retrospectively as

though the company authorised the commencement of the legal proceedings which as

previously, preserves the company’s legal rights;29

Where a solicitor commences proceedings without the authority of a client, the client may

ratify the commencement of those legal proceedings, even in circumstances when the

time for the commencement of the proceedings has expired pursuant to the relevant

statute of limitations. The lack of authority may arise for example, because there was a

defect in the removal of a director prior to the commencement of the proceedings, or a

liquidator was appointed to the company and the solicitors acted incorrectly on the

authority of the directors.30

The irregular commencement of the proceedings is not treated as a nullity for the

purposes of the court’s rules, although the court must consider whether to grant an

extension of time.

In the context of a company, a practice has developed that when an action is brought

without authority it will not be stayed or dismissed forthwith, but the company will be

permitted to convene a general meeting or a meeting of its directors to consider whether

to adopt the action.31

G. Ratification of payments made for a company

The retrospective ratification or prospective authorisation of a payment made on a

company’s behalf by a third party will result in a discharge of the company’s debt to a

creditor.32 29 Alexander Ward and Co Ltd v Samyang Navigation Co Ltd [1975] 2 All ER 424 (the commencement of proceedings was ratified by the liquidator).30 See, eg, Presentaciones Musicales SA v Secunda [1994] Ch 271.31 SBA Properties Ltd v Craddock [1967] 1 WLR 716; McEvoy v Body Corporate for No 9 Port Douglas Road [2013] QCA 168.32 Clarke & Anor v Abou-Samra & Ors [2010] SASC 205, [102] (Kourakis J) citing with authority J Beatson, The Use and Abuse of Unjust Enrichment (1991) chapter 7 at 200-05. See also Goff and Jones, The Law of Restitution (6th ed, 2002) at [1-018]. The proposition that a debt is not discharged unless the payment is made on behalf of the debtor and with the debtor’s authority is accepted by the authors of Restitution Law in Australia: K Mason, JW Carter and GJ Tolhurst, Mason & Carter’s Restitution Law in

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It is a requirement that the third party be recognised as an agent for the company which is

paying for and on behalf of the debtor company before there is a discharge of the

company’s debt by the agent’s payment to the creditor. This is because the third party

must be purporting to act as an agent for the company, ratification is not possible.33

In Porter v Latec Finance (Qld) Pty Ltd,34 Kitto J considered Aiken v Short35 and

expressed the principle as follows:

Aiken v Short would support a proposition that a payment of money by A. to B. on behalf

of C., made with C.'s authority either antecedently given or created retrospectively by

ratification, amounts to two payments, one by A. to C. and the other by C. to B. ; so that

even though A. made the payment under a mistake of fact he cannot recover it back from

B., because the money was received by B. not as A.'s money but as C.'s money. But,

where C. has neither authorized the payment beforehand nor made it his own by

ratification, it is impossible to say that the money is received by B.36 otherwise than as

A.'s and, that being so, the recoverability of the money by A.

The ratification of payments made by an agent on behalf of a company may be relevant in

an insolvency context because, for example, the payment of the company debt may

prevent a finding that the company is or was insolvent under section 95A of the

Corporations Act. Accordingly, this may be relevant to a question of insolvent trading by

the directors under section 588G of the Corporations Act.

Australia (2nd ed, 2008) at [846].33 O3 Capital Pty Ltd v WY Properties Pty Ltd [2016] WASCA 82 at [99] per Newnes, Murphy JJA and Mitchell J citing with authority McLean Bros & Rigg Ltd v Grice(1906) 4 CLR 835at 857 (Griffiths CJ, Barton & O’Connor JJ agreeing); Howard Smith & Co Ltd v Varawa(1907) 5 CLR 68at 82–83 and 87.34 [1964] HCA 4935 [1856] EngR 62136 The judgment of Kitto J incorrectly refers to party “C” being the recipient of the moneys, whereas it should be a reference to party “B”.

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IV. CONCLUSION

counterbalances the strictness of the statutory duties established under the Corporations

Act.

This thesis will now consider the criticisms of and uncertainty in relation to the doctrine

of ratification which provides a criterion to assess whether the doctrine of ratification

remains appropriate to companies governed by the Corporations Act.

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