THE HONG KONG INSTITUTE OF CHARTERED SECRETARIES. Suggested Answers

Transcription

1 THE HONG KONG INSTITUTE OF CHARTERED SECRETARIES Suggested Answers Level : Professional One Subject : Hong Kong Corporate Law Diet : December 2009 The suggested answers are published for the purpose of assisting students in their understanding of the possible principles, analysis or arguments that may be identified in each question 1

2 SECTION A 1. (a) Under section 2 of the Companies Ordinance, a company is a subsidiary of the holding company if the holding company: (i) controls the composition of the board of directors of the first-mentioned company; or (ii) controls more than half of the voting power of the firstmentioned company; or (iii) holds more than half of the issued share capital of the firstmentioned company (excluding any part of it which carries no right to participate beyond a specified amount in a distribution of either profits or capital). The composition of a company's board of directors shall be deemed to be controlled by another company if that other company by the exercise of some power exercisable by it, without the consent of any other person, can appoint or remove all or a majority of the directors, and, for the purposes of this provision, that other company shall be deemed to have power to make such an appointment if a person cannot be appointed as a director without the exercise in his favour by that other company of such a power; or a person's appointment as a director follows necessarily from his being a director or other officer of that other company. In addition, a subsidiary of a subsidiary is also deemed as a subsidiary of the ultimate holding company. (b) The indoor management rule, also known as the rule in Turquand s case, has its origin in Royal British Bank v Turquand [ ] All ER Rep 435. This rule states that persons contracting with the company and dealing in good faith may assume that acts within the company s constitution and powers have been properly and duly performed and are not bound to inquire whether acts of internal management have been regular. The indoor management rule can be seen as a presumption of regularity made in favour of outsiders. Insiders such as directors of the company generally cannot make use of the rule to bind the company as they would have the knowledge of whether the necessary internal procedures have been followed so as to give effect to the transactions in question. The rule cannot be invoked if reasonable inquiry that a person ought to make would tell him the necessary procedures might have not been done properly. (c) In principle, a person can only exercise the powers of a director and liable as such if he is appointed to the board of director by the board or shareholders in general meeting. But, a person without a formal appointment could be liable as a director if he in law is regarded as a shadow director or de facto director. A shadow director is a person in accordance with whose directions or instructions the directors or a majority of the directors of the company are accustomed to act (section 2). A de facto director is a person who assumes to act as a director although not validly appointed as such. A shadow director, by contrast, does not claim or purport to act as a director (Re Hydrodam (Corby) Ltd [1994] 2 BCLC 180). Since Ken attends board meetings and takes an active part therein as an equal member and is represented as a director by the company, he is best described as a de facto director. (d) The common law doctrine of ultra vires states the any act or contract of a company is void if it is beyond its object clauses. In a similar vein, section 5B(1) states the a company must not do any anything inconsistent with its object clauses. However, this doctrine was in effect abolished by section 5B(3) which states that an act of a company (including a transfer of property to or by the company) is not invalid by reason only that it contravenes its object clauses. Although a shareholder of a company may bring proceedings to restrain the doing of an act in contravention of section 5B(1), no such proceedings shall lie in respect of an act to be done in fulfillment of any legal obligation arising under a previous act of the company (section 5B(2)). Since the company has already signed the contract in question, the court will not entertain Helen s request to set it aside. 2

3 (e) Sections 266 to 266B of the Companies Ordinance apply the unfair preference provisions contained in sections 50 to 51B of the Bankruptcy Ordinance to companies. A company gives an unfair preference to a creditor if it, with a desire to prefer that creditor, does anything or suffers anything to be done which has the effect of outing that creditor into a position which, in the event of the company going into insolvent winding up, would be better than the position he would have been in if that thing had not been done. The unfair preference must have been given at a time when the company was unable to repay its debts and also within six months of the commencement of the winding up of the company. (f) A private company may pass a special resolution: (i) declaring that the company will become dormant either as from the date of delivery of the special resolution to the Registrar or as from a later date as is specified in the special resolution; (ii) authorising the directors of the company to deliver to the Companies Registrar the special resolution; and (iii) declaring that prior to the company ceasing to be dormant, the directors of the company shall deliver to the Companies Registry a further special resolution, declaring that the company intends to enter into a relevant accounting transaction (section 344A(1)). A dormant company is exempt from complying with several statutory requirements such as the holding of an annual general meeting, filing of annual returns, appointment of auditors, preparation of auditors report, and keeping and preparation of financial statements and directors report (section 344A(4)). (g) The pre-emption clause, which generally states that an outgoing shareholder must first offer his shares to the existing shareholders ahead of outsiders, is a common form of restriction on transfer of shares which enables a company to maintain the status of private company under the Companies Ordinance. If an outgoing shareholder disregards the preemption clause and sells his shares directly to an outsider by a valid contract, the benefits under the shares shall go to the purchasers. But the directors have no power to register the purchaser as the new shareholder of the shares in questions (Tett v Phoenix Property and Investment Company [1986] BCLC 149). As a result, the outgoing shareholder will still be treated as a shareholder even though he has sold his shareholder rights to the new purchaser. (Candidates must note that the company is not allowed to take note of the beneficial ownership of the shares under section 101.) (h) A company shall have a registered office in Hong Kong to which all communications and notices may be addressed (section 92(1)). The registered office clause in the memorandum of the association shall state the jurisdiction in which the registered office of the company will be situated and thus fix the company s nationality and domicile. It is not a legal requirement to state the actual address of the registered office in the memorandum. The incorporation form to be submitted to the Companies Registry shall contain the intended address of the company's registered office in Hong Kong (section 14A(2)(b)). The intended address stated in the incorporation form shall be the address of its registered office with effect from the date of its incorporation until a notice of change in respect of the address is sent to the Companies Registry within 14 days after the date of the change (section 92(2) and (3)). Apparently the Companies Ordinance does not provide for a mechanism for amending the registered office clause. (i) The House of Lords in Johnson v Gore Wood & Co. [2002] 2 AC 1 explained that, according to the no-reflective loss principle, where a company suffers a loss caused by a breach of duty owed to it, only the company may sue in respect of that loss. No action lies at the suit of a shareholder suing in that capacity and no other to make good a diminution in the value of the shareholder s shareholding where that merely reflects the loss suffered by the company. A claim will not lie by a shareholder to make good a loss which would be made 3

4 good if the company s assets were replenished through actions against the party responsible for the loss, even if the company, acting through its constitutional organs, has declined or failed to make good that loss. Where a company suffers a loss but has no cause of action to sue to recover that loss, that shareholder in the company may sue in respect of it (if the shareholder has a cause of action to do so), even though the loss is a diminution in the value of the shareholding. (j) Section 162(1) of the Companies Ordinance and regulation 86(1) of Table A require any director of a company who is in any way, directly or indirectly, interested in a contract or proposed contract with the company, if his interest in such a contract or proposed contract is material, to declare the nature of his interest at the earliest meeting of the directors at which it is practicable for him so to do notwithstanding that the question of entering into the contract is not taken into consideration at that meeting. Sam is indirectly interested in the proposed contract because of his brother s shareholding in H Ltd; his family relationship makes his indirect interests material. He should disclose his conflict of interests to the board as soon as possible. At the relevant board meeting Sam shall not vote in respect of any such contract or arrangement in which he is so interested, and if he shall do so his vote shall not be counted, nor shall he be counted in the quorum present at the meeting (Table A, regulation 86(2)). 4

5 SECTION B 2. (a) A director is a fiduciary of the company and in this capacity owes a series of common law, fiduciary and statutory duties to the company. The most fundamental fiduciary duty of the director is the duty to act in good faith in the interests of the company as a whole. This duty to act in good faith in the interests of the company is a subjective duty; therefore there is no breach where the directors act in what they honestly believe to be in the interests of the company. The content of this duty was authoritatively set out in Re Smith and Fawcett [1942] Ch 304 that directors must exercise their discretion bona fide in what they consider not what a court may consider is in the interests of the company, and not for any collateral purpose. They must have regard to those considerations, and those considerations only, which the articles on their true construction permit them to take into consideration. The court is generally reluctant to override business judgments of a director because it is not the business of the court to manage the affairs of the company (Shuttleworth v Cox [1927] 2 KB 9) and that the court is not entitled to interfere with a decision with which it merely disagrees (Simon Fireman v Golden Rice Bowl Ltd [1987] HKLR 981). The shareholders may argue that a donation in itself is not in the company s interests because their interests are the company s interests. However, the true common law position is not that narrow, as the board of directors can consider the interests of the community if they genuinely think that it can facilitate the company s interests (Teck Corporation v Millar (1973) 33 DLR (3d) 288). For example, the making of donations can help the company to build a better reputation and thus facilitate an easier entry into the market. The court will not interfere with a decision made by directors if their decision was one which a reasonable board of directors could bona fide believe to be in the interests of the company (Tett v Phoenix Property and Investment Company [1986] BCLC 149). Otherwise the court may infer that the directors did not make the decision in good faith and intervene on that ground (Wayde v New South Wales Rugby League Ltd (1985) 3 ACLC 799). [It] would be a breach of their duty for directors to disregard entirely the interests of a company s shareholders in order to confer a benefit on its employees: Parke v. Daily News Ltd. [1962] Ch 927. But if they observe a decent respect for other interests lying beyond those of the company s shareholders in the strict sense, that will not, in my view, leave directors open to the charge that they have failed in their fiduciary duty to the company (Teck Corporation v Millar (1973) 33 DLR (3d) 288, 314). Therefore there is a good case to argue that the board of directors of R Ltd will breach their bona fide duty because no reasonable board would have donated the whole of its profit at the expense of the benefits of the company. (b) Subject to the provisions of the Ordinance, the memorandum and articles and to any directions given by special resolution, the business and affairs of the company shall be managed by the directors, who may exercise all the powers of the company. No alteration of the memorandum or articles and no such direction shall invalidate any prior act of the directors which would have been valid if that alteration had not been made or that direction had not been given. The powers given by this regulation shall not be limited by any special power given to the directors by the articles, and a meeting of the directors at which a quorum is present may exercise all powers exercisable by the directors (regulation 82 of Table A). Since the donation has not been made yet, the shareholders can try and call a general meeting to pass a special resolution to stop the making of donations 5

6 3. (a) Under the Companies Ordinance, a shareholder may petition the court to wind up a company on the just and equitable ground (section 177(1)(f)). The facts indicate that Bernice and Shu were best friends for many years before they set up the company. It can be argued that their company was set up based on mutual trust and confidence and can be treated as a quasi-partnership. It should be noted that in order to qualify as such it is not necessary that the business had been run as a partnership before it was incorporated as a company (Ebrahimi v Westbourne Galleries [1973] AC 360). Bernice could claim that there is a justifiable lack of confidence in the conduct and management of the company's affairs. The court in Loch v John Blackwood Ltd. [1924] AC 783 emphasised that the lack of confidence must spring not from dissatisfaction at being outvoted on business affairs or on what is called the domestic policy of the company. On the other hand, wherever the lack of confidence rests on a lack of probity in the conduct of the company's affairs, then the former is justified by the latter, and it is under the statute just and equitable that the company be wound up. One of the misconducts in Loch was a failure to produce properly prepared accounts to the complaining shareholder. In Gold Pleasure Industrial Company Limited (unreported, HCCW 49/2006, 21 December 2007), the court said, It seems to me that where a company is in effect a quasi-partnership, founded on a mutual relationship of trust and confidence between its shareholders, acts by one shareholder may potentially be destructive of that mutual trust and confidence even if they do not relate to the affairs of the company. In such cases, if the result of such acts is that the parties cannot be expected to continue to work together, there may be no alternative but to wind up the company in question. (b) Section 193(1) of the Companies Ordinance provides that the court may appoint a liquidator provisionally at any time after the presentation of a winding-up petition. Generally, a provisional liquidator is appointed to take charge of the company s affairs to maintain the status quo pending the court s decision on the petition of winding up. The court has a wide and unfettered discretion of whether or not to appoint a provisional liquidator (Re Five Lakes Investment Co Ltd and Multiford Co Ltd [1985] HKLR 273). To convince the court that there is a case to appoint a provisional liquidator, Bernice should first make out a good prima facie case for a winding-up order at the hearing of the petition, based on just and equitable grounds. If the court concludes that a good prima facie case for a winding-up order has been made out, the court will turn to consider whether it is right that a provisional liquidator be appointed in all the circumstances (Re Boldwin Construction Co Ltd [2003] 2 HKLRD 237). This question has to be decided on the basis of commercial realities, the degree of urgency and need established by Bernice and the balance of convenience according to the circumstances. Since it is conceivable that Shu has all the missing account documents in hand and there is a real risk that Shu may remove assets not documented in the records and destroy evidence that may incriminate her between the presentation of petition and hearing, Bernice should be able to secure an appointment of provisional liquidator. 6

7 4. The financing arrangement, namely the loan to be provided by P Ltd to Gary as a purchaser of shares, is illegal because, under section 47A(1) of the Companies Ordinance, the general principle is that it is not lawful for a company to give any financial assistance for the purpose of a person acquiring the company s shares, whether it is given before or at the time of the acquisition or given directly or indirectly (section 47A(1)). A loan is a form of financial assistance (section 47B(1)). If P Ltd provides the loan to Gary, the company would be liable to a fine and the board of directors would be liable to a fine and imprisonment (section 47A(3)). Financial assistance illegally given is void (Heald v O Connor [1971] 1 WLR 497). Two exemptions to the prohibition of the provision of financial assistance are available under the Companies Ordinance. Under section 47C, a company is not prohibited from giving financial assistance for the purpose of an acquisition of shares in it if: (a) the company's principal purpose in giving that assistance is not to give it for the purpose of any such acquisition, or the giving of the assistance for that purpose is but an incidental part of some larger purpose of the company; and (b) the assistance is given in good faith in the interests of the company. Naturally the board of directors of P Ltd would put forward a submission that the principal purpose of providing an interest-free loan to Gary is to facilitate an injection of capital into the company, and they thought in good faith that the provision of the loan is in the interests of the company. However, under Brady v Brady [1989] AC 755 it is very likely that the court may interpret the suggested principal purpose as only a motive, with the principal purpose still being assisting Gary to buy shares in P Ltd. The other exemption is provided under sections 47E, 47F and 47G under which P Ltd as an unlisted company can give financial assistance if: (1) the net assets of the company will not be reduced by the giving of the assistance, otherwise, the assistance is to be provided out of distributable profits; (2) a majority of the directors make a statement in which they are required to state that, among other things, the company will be able to pay its debts as they fall due during the year immediately following the giving of the assistance; and (3) the financial assistance is approved by a special resolution passed on the date on which the directors make their statement, or within 30 days immediately following that date. In view of P Ltd s financial condition, the directors of P Ltd must be sure that the company will not jeopardised by the provision of the loan before they sign off the required statement because a director who makes the required statement without having reasonable grounds for the opinion expressed in it is liable to imprisonment or a fine. Apart from the requirements for the board of directors, a relevant special resolution must be passed. However, a general meeting to pass a special resolution must be convened by a notice the length of which is at least 21 days (section 116(1)). But Gary requires that the loan has to be provided to him within two weeks. Help could be found in section 116B which states that a resolution in writing signed by or on behalf of all members is to be treated as a resolution duly passed at a general meeting of the company. This written resolution procedure can help P Ltd to shorten the time required to complete the whole procedure. 7

8 5 (a). Save in so far as the articles of a company make other provision in that behalf, an annual general meeting may be called by 21 days' notice in writing (section 114(2)(b)). Any provision of a company's articles shall be void in so far as it provides for the calling of an annual general meeting by a shorter notice than 21 days' notice in writing (section 114(2)(a)). On the notice requirement under section116, it was held in Securities and Futures Commission v Stock Exchange of Hong Kong Ltd. [1992] 1 HKLR 135 that fractions of a day must not be taken therefore a day should mean a clear day. The court said: It seems to me quite clear that the words used in s.116 are intended to ensure 21 clear days notice is given. There is no reason why the same logic should not apply to the case of annual general meeting. Accordingly, the day of service of notice and day of the meeting cannot be included in the 21 day period. The practical implication for Ivy as the company secretary is that the notice of meeting must be sent out more than 21 days before the meeting. For a company which has adopted Table A, where a notice is sent by post, service of the notice shall be deemed to be effected by properly addressing, prepaying, and posting a letter containing the notice, and to have been effected in the case of a notice of a meeting at the expiration of 48 hours after the letter containing the same is posted, and in any other case at the time at which the letter would be delivered in the ordinary course of post (regulation 132). If Ivy posts the notice of meeting on 12 December 2009, all shareholders of K Ltd will be deemed to have received it on 15 December And since the day of the meeting is also not counted, K Ltd can have its annual general meeting on 5 January 2010 at the earliest. 5(b) Any provision contained in a company's articles shall be void in so far as it would have the effect of requiring the instrument appointing a proxy, or any other document necessary to show the validity or otherwise relating to the appointment of a proxy, to be received by the company or any other person more than 48 hours before a meeting or adjourned meeting in order that the appointment may be effective thereat (section 114C(4)). A company, if it so wishes, can fix a time shorter than 48 hours for receiving proxies from members because s.114c only invalidates a relevant clause if it requires a member to lodge his proxy more than 48 hours before the meeting. Therefore, the members of K Ltd are free to lodge their proxies not later than 36 hours before the meeting 8

9 6. Jenny may be interested to know that a company may by ordinary resolution remove a director before the expiration of his period of office, notwithstanding anything in its memorandum or articles or in any agreement between it and him (section 157B(1)). Since Jenny owns 5% of the issued shares, she can request that the board of directors convene an extraordinary general meeting of the company (section 113(1)). Within 21 days from the date of receipt of Jenny s requisition the company must send out a notice in order to convene a meeting within 28 days after the date of giving the notice. Together with her requisition made under section 113, Jenny must also send a special notice of the resolution to remove Roman from the board not less than 28 days before the proposed meeting, the company must give its members notice of any such resolution at the same time and in the same manner as it gives notice of the meeting (section 116C). The special notice of the resolution must be given to Roman who is entitled to be heard on the resolution at the relevant general meeting (section 157B(2) and(2a)). Since Jenny holds more than 2.5% of the issued shares, she can, at her own cost, circulate to the other shareholders a statement of not more than 1000 words with respect to the proposed resolution to remove Roman, explaining why it would be in the interests of the company to remove him (section 115A(1)). His 30% shareholding cannot enable Roman to veto the proposed resolution. There is a realistic chance of removing Roman if other shareholders agree to Jenny s view. On the other hand, Jenny may try section 168A(1) which states that a shareholder may submit a petition to the court for remedial orders if the affairs of the company are being conducted in a manner unfairly prejudicial to his interests as a shareholder. What Jenny has to prove is the existence of unfair prejudice which has been interpreted as two related but different concepts, as the court in Re Taiwa Investment Co Ltd [1981] HKLR 297 said: it seems clear that elements of both unfairness and prejudice must co-exist for the section to come into play. Conduct which is intrinsically prejudicial to the interests of a shareholder, without also being unfair, will not be enough; conversely the section cannot be relied upon if the conduct of which complaint is made is merely unfair. The test of unfairness under section 168A is objective, not of unlawfulness and that it is not necessary for the petitioner to prove bad faith of the directors or their conscious intention to act in an unfairly prejudicial way. Prejudice to shareholder interests is proved if the value of a minority shareholder s shareholding has been seriously diminished or at least seriously jeopardized (Re R.A. Noble Clothing Limited [1983] BCLC 290). In an appropriate case the court can find that serious mismanagement of a company s business causes unfair prejudice to the interests of the shareholders (Re Macro (Ipswich) Ltd [1994] 2 BCLC 354). The court is conferred with wide discretion to make such order as it thinks fit. For example, the court can order a person not take any part in the management of the company (Re Bondwood Development Ltd [1990] 1 HKLR 200). The court in Re Mandarin Resources Corporation Limited (unreported, HCCW348/96, 19 November 1999) said that the court must carry out a balancing act between ordinary incompetence which would not warrant intervention and serious mismanagement which would. [Section 168A] does not provide a remedy against poor commercial judgment by the company but is appropriate where there has been a visible departure from the standards of fair dealing and a violation of the conditions of fair play on which every shareholder who entrusts his money to a company is entitled to rely. Without further evidence Jenny may find it hard to prove that Roman s case is not only one of ordinary incompetence but actually of serious management. Roman may argue that the recent dismal performance of the company has been caused by the global recession. In conclusion, there may be a greater chance of removing Roman under section 157B than under section 168A. END 9