In consideration of the situation with Party Products Ltd (PP Ltd), several legal issues need to be addressed. These include whether Carol should be held liable for entering into a contract beyond her legal authority; whether Kate has breached a duty to the company by accepting the $4000; whether Kate has breached a duty to the company by a failing to have the company’s financial records audited; whether the directors breached their duty by being unable to pay their suppliers’ accounts; and whether the directors breached their duty by issuing further share capital. Each of these issues will be considered individually below.

Issue: Carol’s potential liability for entering a contract beyond her legal authority.
The rule of law for this issue is in regard to two potential issues. S 180 (1) provides that directors have a requirement to exercise reasonable care and diligence in their duties for the company. The objective test for this is whether a reasonable person would have acted differently under those circumstances. [Reference: ASIC v Adler, 2002 NSWSC 171]. In addition, an overlapping rule between statutory law and common law pertains to the requirement to exercise fiduciary duty of care and diligence, as shown in the recent case of Vines v ASIC, 2007, NSWCA 75. The common law expands on the objective test of a reasonable person’s actions. The basic standards for such are established by the case of Daniels v Anderson, 1995, 37 NSWLR 438. This includes such a duty to avoid acts of corporate misconduct and avoid risk from such actions. A third issue is the breach of agency for the company. Section 140(1) read in conjunction with the company’s constitution imposes a duty to not enter into contracts beyond $50,000.

In the first case, statutory duty of care, by her lack of care in not checking the order, Carol breached S 180(1) by conducting the business of the company without reasonable care and diligence, resulting in negligence. In addition to the objective test of whether a reasonable person would have acted thus, common law also states that ignorance does not protect her from such negligence. In the second part of this, the fiduciary care and diligence, Carol did not have consent from the board of directors to act in a contract of $55,000. This action did breach the duty of care and fail the similar reasonable person test stated in S 180(1). Common law implies she should have exercised more care in the order placed. Failing to do so also is a breach of the minimum standards of care. In the third aspect, acting outside her agency with the company, she had the power to enter into contracts up to $50,000; therefore, it would be unjust to impose the full burden of the $55,000 contract on her. It is likely she will be held liable to make up the difference between her actual authority and the price of the contract, or the $5,000 which was in excess of her authority. In this case, Carol did not sign the contract with the other company as an agent because she did not sign the contract as “an agent” or “for behalf of.” Therefore, she would be liable and could be sued. [Reference Watteau v Fenwick (1893) ] If Kid’s Costumes Pty. Ltd is unable to claim the $5,000 due to the deficiency in Carol’s agency, Carol may be held liable to Kid’s Costume Pty Ltd for this amount due to a breach of warranty of authority.

Thus, Carol failed to execute reasonable care, failed her requirement to act with fiduciary care and diligence, and exceeded her express grant of agency. Based on the above, it is likely that Carol will be held liable for the $5,000 which was outside her authority. She has ignored her duty to exercise reasonable care, to exercise fiduciary care and diligence, and stay within her authorized agency for the company [Reference: Mintor Investments Pty Ltd v General Accident Fire & Life Assurance Corp (1984) ] She may be held liable to the company for breach of statutory contract pursuant to s140(1) if the contract is upheld in full. Alternatively, if the contract is avoidable due to the deficiency in Carole’s agency, she will be held liable to Kid’s Costumes Pty Ltd for breach of warranty of authority.
Issue: Kate’s potential breach of duty to the company by accepting the $4,000.

In general, directors of a company must not have an interest in a transaction with another company unless the director makes full disclosure of the nature of that interest to members of the company in a General Meeting, and they approve that interest by ordinary resolution. [Reference: Aberdeen Railway v Blaikie Bros (1854) 1 Macq 461 ; Woolworths v Kelly (1991) 4 ACSR 431 ] The objective test for this is that this obligation is breached when a reasonable person looking at the circumstances of the case could see a “real sensible possibility of conflict” [Reference: Phipps v Boardman (1967) 2 AC 46 ] In addition, there is a general duty not to misuse one’s position or information. In this regard, the director must account to the company for any benefit which is received by use or reason of his or her position. [Reference: Furs Ltd v Tomkies (1936) 54 CLR 583]

The Corporations Act specifies this duty explicitly. S 181 specifies that directors must use their powers to discharge their duties in good faith and in the best interests of corporation and for proper purposes. S 182 specifies a director using his or her position to gain advantage for themselves is in breach of their obligations to the company [Reference s182 (1) (a)] S 183 specifies that using business information for personal advantage is also a breach of obligation. The objective test of an improper use of a position is whether the actions consist of a breach of the standard of conduct expected by reasonable persons who have knowledge of the duties, powers, and authority of a director. [Reference: Chew v NCSC (1984) 2 ACLC 676

As applied to this case, Kate has a general duty to avoid a conflict of interest. In this situation, Kate has entered into a transaction relating to the company by which she gains $4,000. She has not disclosed the transaction to the company and therefore will be held liable to account for that profit. She also has a general law duty to avoid a conflict of interest. In terms of the Corporations Act, there would also be an improper use of her position as director. It is also clear that Kate derived personal benefit in the form of the $4,000 as a result of her position.

Thus, the conditions for a breach of duty are clearly satisfied. Furthermore, as per s 191 (1A) she had a duty as a director to disclose material of personal interest. In the above mentioned case, Kate never disclosed and actively hid her personal interest. Therefore, the breach in disclosing her interest leads to strict liability, and s 191 (1A) applies, leading to s 6.1 of the criminal code. (See schedule3).
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