THE HONG KONG INSTITUTE OF CHARTERED SECRETARIES THE INSTITUTE OF CHARTERED SECRETARIES AND ADMINISTRATORS

Transcription

1 THE HONG KONG INSTITUTE OF CHARTERED SECRETARIES THE INSTITUTE OF CHARTERED SECRETARIES AND ADMINISTRATORS International Qualifying Scheme Examination HONG KONG CORPORATE LAW JUNE 2016 Suggested Answer 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 Peter has been carrying on business as a sole trader importing and reselling antiques for many years. Early this year, Peter met his friends, Alan and Betty, who were interested in joining his business. Betty proposed forming a partnership while Peter and Alan believed that it would be more appropriate to incorporate a company. After consulting their accountant, they agreed to form a private company, Friends Ltd, which adopts the model articles for a private company limited by shares as its articles except that the object of the company is to import and resell antiques. The company s certificate of incorporation was issued on 1 March Peter, Alan and Betty were all appointed directors of the company while Peter was also appointed the managing director. 1. After the company's incorporation, Peter sold his business to the company for $1 million. Of this amount, $0.5 million was paid in cash, and 500,000 shares were allotted to Peter as fully paid shares at $1 each. Alan subscribed for 500,000 shares in the company at $1 each and Betty subscribed for 200,000 shares at $1 each. The business was solvent when it was converted into a company and Peter made a profit of $0.5 million out of the conversion. However, Peter did not disclose his profit to Alan and Betty ( Transaction 1 ). After the conversion, the company s business started not to do so well and the company urgently needed more money. Peter decided to invite his brother-in-law, Calvin, to join the business. In order to enable Calvin to have enough cash to subscribe for 500,000 shares of the company at $1, Peter caused the company to create a floating charge over its trading stock in favour of New World Bank to secure a $0.5 million loan for Calvin. Calvin then used the $0.5 million loan to subscribe for 500,000 shares in Friends Ltd ( the Arrangement ). Calvin has been trading in diamonds and jewellery for many years. After joining the company, Calvin persuaded Peter to expand its business to include the import and resale of diamonds and jewellery. Peter knew that Alan and Betty would not support the expansion as they thought that the new business was too risky. However, Peter honestly believed that the expansion was in the company s best interests. Without discussing the matter with Alan or Betty, Peter, on behalf of the company, contracted with some diamond and jewellery suppliers in South Africa and rented a new shop in Tsim Sha Tsui to resell diamonds and jewellery. It was 2

3 later found that the purchase price for these diamonds and jewellery and the rent for the shop were much higher than the market price. As a result, Friends Ltd suffered a huge loss and became insolvent ( Transaction 2 ). Peter wondered whether he could appoint his son, who is studying at an overseas university, to be the company secretary. In addition, the company has to hold its first annual general meeting soon and Peter did not know the time limit for this first AGM. Peter has been told that Friends Ltd has to comply with many additional legal requirements under the Companies Ordinance and now he wonders whether it was appropriate to incorporate his business. REQUIRED: 1. (a) Explain the major distinctions between a company and a partnership and advise Peter as to whether it was appropriate to incorporate his business, rather than forming a partnership with Alan and Betty. (5 marks) Ans (a) Candidates are expected to compare the advantages and disadvantage of companies and partnerships. A company is an artificial legal entity with separate personality while a partnership has no separate legal entity. Shareholders of a limited company may enjoy limited liability while partners in a partnership have unlimited liability. A company has perpetual succession while a partnership has no perpetual succession. A company is managed by directors while shareholders of the company generally do not have the management powers of the company. Partners in a partnership are both investor and managers. 3

4 A company is governed by the Companies Ordinance while a partnership is governed by the Partnership Ordinance, which is more flexible. A company may raise capital by issuing shares or creating a floating charge while a partnership cannot. Powers and duties of directors are more closely regulated by legislation while partners have more freedom to carry out business with less legislative control. There is greater publicity in a company while privacy is generally protected in a partnership. There is no absolute answer whether a company or a partnership is more appropriate for the parties. Candidates are expected to make arguments to support their conclusions. Marks should be given for any relevant arguments made. 1. (b) Advise Peter of any legal implications of the Arrangement and the proper procedures which Peter should follow in order to avoid any challenge to the Arrangement. (15 marks) Ans (b) Candidates are expected to discuss the rules about giving financial assistance to subscribe for the company s shares. Section 274 provides that financial assistance includes a guarantee, security or indemnity. Therefore, providing a floating charge over the company s trading stock in favour of New World Bank to secure a loan to Calvin is regarded as financial assistance to Calvin. Section 275(1) provides that if a person is acquiring or proposing to acquire shares in a company, the company or any of its subsidiaries must not give financial assistance directly or indirectly for the purpose of the acquisition before or at the same time as the acquisition takes place, except as provided by Companies Ordinance. 4

5 Section 275(4) provides that if a company contravenes 275(1), the company, and every responsible person of the company, commit an offence, and each is liable to a fine of $150,000 and to imprisonment for 12 months. Section 283 provides that financial assistance not exceeding 5% of the paid up share capital and reserves of the company (as disclosed in the most recent audited financial statements of the company) may be approved by the directors. However this section does not apply in this case, as the financial assistance exceeds 5% of the company's share capital. Section 284(1) provides that a company may give financial assistance for the purpose of the acquisition of a share in the company if: (a) the directors resolve, before the assistance is given, that: (i) the company should give the assistance; (ii) giving the assistance is in the best interests of the company; and (iii) the terms and conditions under which the assistance is to be given are fair and reasonable to the company; (b) on the same day that the directors pass the resolution, the directors who vote in favour of it make a solvency statement that complies with the Companies Ordinance in relation to the giving of the assistance; (c) the giving of the assistance is approved by written resolution of all members of the company before the assistance is given; and (d) the assistance is given not more than 12 months after the day on which the solvency statement is made under paragraph (b). Section 285(1) provides that a company may give financial assistance for the purpose of the acquisition of a share in the company if: 5

6 (a) the directors resolve, before the assistance is given, that: (i) the company should give the assistance; (ii) giving the assistance is in the best interests of the company; and (iii) the terms and conditions under which the assistance is to be given are fair and reasonable to the company; (b) on the same day that the directors pass the resolution, the directors who vote in favour of it make a solvency statement that complies with the Companies Ordinance in relation to the giving of the assistance; (c) the company sends to each member of the company a copy of the solvency statement made under paragraph (b) and a notice containing the following information: (i) the nature and terms of the assistance and the name of the person to whom it will be given; (ii) if it will be given to a nominee for another person, the name of that other person; (iii) the text of the resolution of the directors; (iv) any further information and explanation that would be necessary for a reasonable member to understand the nature of the assistance and the implications of giving it for the company and the members; (d) the giving of the assistance is approved by resolution of the company before the assistance is given; and (e) the assistance is given: (i) not less than 28 days after the day on which the resolution is passed under paragraph (d); and (ii) not more than 12 months after the day on which the solvency statement is made under paragraph (b). 1. (c) Advise Peter whether he can appoint his son as Friends Ltd s company secretary and the time limit for holding the company s first annual general meeting. (10 marks) 6

7 Ans (c) Candidates are expected to discuss the rules about appointment of a company secretary and the time limit for annual general meetings. Section 474(4) provides that a company secretary of a company must: (a) if a natural person, ordinarily reside in Hong Kong; and (b) if a body corporate, have its registered office or a place of business in Hong Kong. In this case, Peter s son is studying overseas and does not ordinarily reside in Hong Kong. As a result, Peter cannot appoint his son to be the company secretary. Section 610(1) provides that, subject to sections 610(2) and (3), a company must, in respect of each of its financial years, hold a general meeting as its annual general meeting within the following period (in addition to any other meetings held during the period): (a) in the case of a private company or a company limited by guarantee, nine months after the end of its accounting reference period by reference to which the financial year is to be determined; and (b) in the case of any other company, six months after the end of its accounting reference period by reference to which the financial year is to be determined. Section 610(2) provides that if the accounting reference period mentioned in section 610(1) is the first accounting reference period of the company and is longer than 12 months, the company must hold a general meeting as its annual general meeting within the following period: (a) in the case of a private company or a company limited by guarantee: (i) nine months after the anniversary of the company s incorporation; or (ii) three months after the end of that accounting reference period, whichever is the later; and (b) in the case of any other company: (i) six months after the anniversary of the company s incorporation; or (ii) three months after the end of that accounting reference period, whichever is the later. 7

8 In this case, assuming that the first accounting reference period of Friends Ltd is from 1 March 2015 to 31 March 2016, its first annual general meeting should be held before 1 December 2016 (nine months after the anniversary) or 30 June 2016 (three months after the end of its first accounting reference period), whichever is the later, i.e. 1 December (d) Explain directors duties to Peter and advise him whether he was in breach of his duty as a director of Friends Ltd in relation to Transaction 1 and Transaction 2. (10 marks) (Total: 40 marks) Ans (d) Candidates are expected to explain the rules about directors duties. Directors owe the following fiduciary duties to the company: 1) To act in good faith for the benefit of the company. 2) To exercise their powers for a proper purpose. 3) Not to have a conflict of interest between their private interests and their duties as directors. Section 465(1) provides that a director of a company must exercise reasonable care, skill and diligence. Reasonable care, skill and diligence mean the care, skill and diligence that would be exercised by a reasonably diligent person with: (a) the general knowledge, skill and experience that may reasonably be expected of a person carrying out the functions carried out by the director in relation to the company; and (b) the general knowledge, skill and experience that the director has (section 465(2)). The duty specified in section 465(1) is owed by a director of a company to the company (section 465(3)). In this case, Peter may be in breach of his duties as director for the following reasons: 1) When he sold the business to the company and made a profit, he did not 8

9 disclose this profit and seek the approval of the company. He might be in breach of his fiduciary duty to avoid a conflict of interests. 2) When he signed the contracts with suppliers in South Africa and rented a new shop to resell diamond and jewellery, he might be in breach of his fiduciary duty as he knew that these transactions were beyond the objects clause of the company and so were not allowed. 3) He may also be in breach of his duty of reasonable care, skill and diligence as the contract prices were much higher than the market price, suggesting that he acted below a reasonable standard of care. Candidates are expected to make reasonable arguments to discuss the above incidents. 9

10 SECTION B 2. Kowloon Cafe Ltd is a private company incorporated in Hong Kong. The company has adopted the model articles for a private company limited by shares as its articles except that it has two classes of shares: Class A shares (1,000 preference shares issued at $1) and Class B shares (50,000 ordinary shares issued at $1). The articles also provide that Michael, the only Class A shareholder, has the right to appoint one director as long as Michael keeps his 1,000 Class A shares. Danny and Edward, both of whom own 25,000 Class B shares, would like to cancel Michael s right to appoint one director. REQUIRED: 2. (a) Explain FIVE major distinctions between ordinary shares and preference shares. (5 marks) Ans (a) Candidates are expected to explain the distinctions between ordinary shares and preference shares. Ordinary shareholders are entitled to be paid a dividend on their shares only after all preference share payments have been made. If the preference shares have priority for repayment of capital in a winding up, the ordinary shareholders are entitled to be repaid only after the preference capital has been repaid in full. Ordinary shares are often described as equities, indicating that the holder will only be entitled to payment after the holders of prior charges, such as preference shares and debentures, have been paid what is due to them. Ordinary shareholders expect to receive a larger dividend than preference shareholders. Their loss will be greater if the company fails, but if it prospers they can expect a dividend which reflects that success. Preference shareholders are entitled only to a fixed rate of dividend unless their shares are participating. Most of the voting power at the general meeting will belong to the ordinary shareholders; preference shareholders are usually given a right to vote only on resolutions which directly affect them. The issue of preference shares must be authorised by a company s articles of association while no such approval is required for issue of ordinary shares. The 10

11 right to dividends may be cumulative, i.e. if no dividend is declared in any year the arrears must be carried forward and paid before a dividend is paid on ordinary shares. 2. (b) Explain whether and how Michael s right to appoint one director can be cancelled. (8 marks) Ans (b) Candidates are expected to explain the rules about alteration of articles and the variation of class rights. Subject to the Companies Ordinance (Cap 622), a company may alter its articles (section 87(1)). A company may alter its articles by special resolution except an alteration in articles to the maximum number of shares that the company may issue, which may be made by ordinary resolution(section 88(2) and (3)). The power to alter must be exercised bona fide for the benefit of the company as a whole. See Citco Banking Corporation N.V. v Pusser s Ltd & Anor (Eastern Caribbean Supreme Court (British Virgin Islands)) [2007] 2 B CLC 483; Allen v Gold Reefs of West Africa Ltd [1900] 1 Ch 656 (CA); Greenhalgh v Arderne Cinemas Ltd [1951] Ch 286 (CA); Brown v British Abrasive Wheel Company [1919] 1 Ch 290. Section 180(1) provides that rights attached to shares in a class of shares in a company may be varied only: (a) in accordance with provisions in the company s articles for the variation of those rights; or (b) if there are no such provisions, with the consent of holders of shares in that class given in accordance with this section. Section 180(3) states that the consent required for the purposes of the section is: (a) written consent of holders representing at least 75% of the total voting rights of holders of shares in the class; or (b) a special resolution passed at a separate general meeting of holders of shares in the class sanctioning the variation. 11

12 Section 182 further provides that where a variation of a class rights is approved by the consent of a proportion of shareholders or the passing of a resolution at a class meeting, the holders of not less than 10% in nominal value of the issued shares of the class may apply to the court to have the variation cancelled. The variation can then have effect only if confirmed by the court. The application must be made within 28 days of the consent/ resolution authorising the variation. In this case, the right to appoint one director is Michael s class right as long as he keeps his 1,000 Class A shares. If Danny and Edward would like to cancel this right, they have to seek approval in a separate class meeting. As Michael is the only Class A shareholder, it is unlikely that he would approve this variation of his class right. 2. (c) Danny and Edward would like to raise additional capital in order to expand the company s business. They have decided to issue 10,000 redeemable shares at $10. Explain to them whether and how they can issue these 10,000 redeemable shares. (7 marks) (Total: 20 marks) Ans (c) Candidates are expected to explain sections 234 and 235 of the Companies Ordinance. Section 235 provides that a company s articles may authorise the directors to determine the terms, conditions and manner of redemption, otherwise the shareholders may pass an ordinary resolution giving the directors such authority. In either case the directors must determine all such terms before the shares are allotted. Any statement of capital which the company thereafter makes must include the relevant terms, conditions and manner of redemption. If the directors are not authorised, then the terms, conditions and manner of redemption must be stated in the company s articles. Article 57 of the model articles for a private company limited by shares provides that, subject to section 235, the company may issue redeemable shares on terms 12

13 that they are to be redeemed, or liable to be redeemed, at the option of the company or the holders of the shares. It also provides that the directors may determine the terms, conditions and manner of redemption of the shares. Section 234 provides that a company may issue both ordinary and preference shares which are redeemable, provided that: its articles do not prohibit or restrict the issue of such shares, and at the time of issue, the company has other issued shares which are not redeemable. As a general rule, the directors of a company may only exercise a power to allot the company s shares if they have approval in advance given by a resolution of the company. Otherwise the directors have no such power. A director commits an offence if he knowingly contravenes, or authorises or permits contravention of, this provision. In this case, Danny and Edward may pass an ordinary resolution in a general meeting of the company in order to issue 10,000 redeemable shares. 13

14 3. Kowloon Furniture Ltd is a private company incorporated in Hong Kong which adopts the model articles for a private company limited by shares as its articles except that shareholders are required to file their proxy forms no later than 72 hours before a general meeting, instead of 48 hours as stipulated in the model articles. There are four shareholders in the company: Ada, Ben, Cathy, and Daisy. They own 10,000, 40,000, 45,000 and 55,000 of the company s issued shares respectively. Daisy is the only director of the company. After Ada and Daisy recently met informally, Ada now suspects that Daisy is not loyal to the company and would like to call a general meeting to discuss this matter. REQUIRED: 3. (a) Explain to Ada the proper procedures she must follow to request a general meeting under the Companies Ordinance. (7 marks) Ans (a) Candidates are expected to discuss the procedures for a shareholder to request a general meeting under section 566. Section 566(1) provides that the members of a company may request the directors to call a general meeting of the company. Section 566(2) provides that the directors are required to call a general meeting if the company has received requests to do so from members of the company representing at least 5% of the total voting rights of all the members having a right to vote at general meetings. Section 567(1) provides that directors required under section 566 to call a general meeting must call a meeting within 21 days after the date on which they become subject to the requirement. Section 567(2) provides that a meeting called under subsection (1) must be held on a date not more than 28 days after the date of the notice convening the meeting. Article 34(3) of the model articles for a private company limited by shares provides that if the directors are required to call a general meeting under section 566, they 14

15 must call it in accordance with section 567. Article 34(4) provides that if the directors do not call a general meeting in accordance with section 567, the members who requested the meeting, or any of them representing more than one half of the total voting rights of all of them, may themselves call a general meeting in accordance with section 568. In this case, Ada owns 6.7% of the company s issued shares and is entitled to request that the directors call a general meeting under section (b) Assume that a general meeting is called to be held at 11:00 am on 9 June 2015 and Ben is unable to attend the meeting. Ben would like to appoint a proxy and his proxy form reached the company at 10:00 am on 7 June 2015, which is a Sunday. Advise Ben of the validity of his proxy s appointment. (8 marks) Ans (b) Candidates are expected to explain the rules appointment of proxy under section 598. Section 596(1) provides that a member of a company is entitled to appoint another person (whether a member or not) as a proxy to exercise all or any of the member s rights to attend and to speak and vote at a general meeting of the company. Section 598(2) provides that a provision of the company s articles is void in so far as it would have the effect of requiring the appointment or document to be received by the company or another person earlier than the following time: (a) in the case of a general meeting or adjourned general meeting, 48 hours before the time for holding the meeting or adjourned meeting; (b) in the case of a poll taken more than 48 hours after it was demanded, 24 hours before the time appointed for the taking of the poll. Section 598(3) provides that in calculating the periods mentioned in section 598(2), no account is to be taken of any part of a day that is a public holiday. 15

16 In this case, even though the articles of the company provide that shareholders are required to file their proxy forms not later than 72 hours before the meeting, this clause is void. The proxy form reached the company 35 hours before the meeting. Articles 51(1)(a) of the model articles for a private company limited by shares provides that a proxy notice does not take effect unless it is received by the company in respect of a general meeting or adjourned general meeting at least 48 hours before the time appointed for holding the meeting or the adjourned meeting. In this case, as the proxy notice reached the company 35 hours before the meeting, the proxy notice was invalid. 3. (c) Advise Daisy whether Kowloon Furniture Ltd is allowed to have one director only and whether it is required to appoint a reserve director. (5 marks) (Total: 20 marks) Ans (c) Candidates are expected to explain sections of the Companies Ordinance. Section 453 provides that a public company or a company limited by guarantee is required to have at least two directors. Section 454 provides that a private company must have at least one director. Section 455 provides that if a private company has only one member and that member is the sole director of the company, the company may by a resolution passed at a general meeting, despite anything in its articles, nominate a person (other than a body corporate) who has attained the age of 18 years as a reserve director of the company to act in the place of the sole director in the event of the sole director s death. In our case, as Kowloon Furniture Ltd is a private company, it can have one director only. As the company has more than one member it is not legally required to appoint a reserve director. 16

17 4. Wonderful World Ltd is a private company incorporated in Hong Kong which adopts the model articles for a private company limited by shares as its articles. Fanny is the only director of the company. On 15 February 2015, Fanny, on behalf of the company, borrowed $2 million from Shatin Bank to help with the company s cash flow problem. On 15 March 2015, Shatin Bank credited a further $3 million to the company s bank account and a $5 million floating charge (including the original $2 million unsecured debt) was created in favour of Shatin Bank over the company s book debts by way of a debenture. The debenture provided that the floating charge would automatically crystallise if there were any subsequent charge created over the company s debts. The floating charge was duly registered. REQUIRED: Wonderful World Ltd was compulsorily wound up on 15 December (a) Explain to Shatin Bank the validity of, and the amount covered by, the floating charge. (Ignore interest in your calculation.) (8 marks) Ans (a) Candidates are expected to discuss the validity of a floating charge. Section 267 of the Companies (Winding Up & Miscellaneous Provisions) Ordinance provides that where a company is being wound up, a charge which, when created, was a floating charge on the undertaking or property of the company and which was also created within 12 months of the commencement of the winding up shall, unless it is proved that the company immediately after the creation of the charge was solvent, be invalid, except to the amount of any cash paid to the company at the time of or subsequently to the creation of, and in consideration for, the charge, together with interest on that amount at the rate specified in the charge or at the rate 12% per annum, whichever is the less. In this case, the floating charge was created within 12 months before winding up: the company was compulsorily wound up on 15 December 2015 while the charge was created on 15 March 2015, making the floating charge invalid unless it could satisfy the exception under section

18 As the company had cash flow problems when the charge was created, assuming that the company was not solvent at that time, the floating charge was only valid to the extent of any cash paid to the company at the time of or subsequently to the creation of, and in consideration for, the charge. In this case, Shatin Bank credited $3m to the company s bank account at the time of the creation of the charge and the floating charge was only valid to $3m. 4. (b) The liquidator found that the company had created a fixed charge over its book debts in favour of Fanling Bank on 15 November The fixed charge had been duly registered. Explain to the liquidator the priority between Shatin Bank s floating charge and Fanling Bank s fixed charge over the company s book debts. (12 marks) (Total: 20 marks) Ans (b) Candidates are expected to discuss the validity of a fixed charge and the priority between a floating charge and a subsequent fixed charge. Section 266B of the Companies (Winding Up & Miscellaneous Provisions) Ordinance provides that a charge created within six months before the winding up may be challenged as an unfair preference and may be invalid. In this case, the fixed charge in favour of Fanling Bank was created within six months before the winding up and may be invalid if it is proved that it is unfair preference. In Re Spectrum Plus Ltd (2005), a charge over book debts which purported to be fixed required the proceeds to be deposited into the company s ordinary current account but did not impose any restriction on the operation of the account and allowed the proceeds to be available for use by the company in the ordinary course of its business. The House of Lords held that the company s right to draw freely on the account was inconsistent with the charge being a fixed charge and that the label placed upon the debenture could not be detracted from that right. 18

19 In this case, if Fanling Bank does not exercise any control over the book debt charged, the fixed charge in favour of Fanling Bank will instead be regarded as a floating charge. Assuming that the charge created is a fixed charge, the priority between Shatin Bank s floating charge and Fanling Bank s fixed charge will depend on the notice of Fanling Bank at the time of creation of its fixed charge. In ABN Amro Bank NV v Chiyu Banking Corp Ltd (2001) X granted a floating charge to ABN which provided that in the event that subsequent charges were created the floating charge would automatically crystallise. The charge was duly registered and details of the automatic crystallisation clause were attached to the registration form. X subsequently created fixed charges in favour of CB and the court was asked to determine their priority given that CB did not have actual, inferred, or constructive notice of the automatic crystallisation clause. It was held that CB did not have notice of the clause and that it could claim priority over ABN s crystallised charge. But given that section 335 now requires a copy of a charge document to be registered with the required particulars, a subsequent fixed charge holder would be deemed to have notice of the automatic crystallisation clause and the first crystallised floating charge would still have priority. In this case, assuming that Fanling Bank has constructive notice of the crystallisation of Shatin Bank s charge, Shatin Bank s crystallised floating charge will have priority over Fanling Bank s charge. 19

20 5. Perfect Life Limited is a public company incorporated in Hong Kong which adopts the model articles for a public company limited by shares as its articles. Henry, Ian and Jenny are the initial directors of the company. The company will hold its first annual general meeting very soon and Jenny has been told that she will have to retire at the first annual general meeting. REQUIRED: 5. (a) Explain to Jenny the rules about rotation of directors. Ans (a) Candidates are expected to explain the rules about rotation of directors. (10 marks) Article 24 of the model articles for a public company limited by shares provides that, at the first annual general meeting, all the directors must retire from office. At every subsequent annual general meeting, one-third of the directors for the time being must retire from office. If the number of directors is not three or a multiple of three, then the number nearest to one-third must retire from office. The directors to retire in every year must be those who have been longest in office since their last appointment or reappointment. For persons who became directors on the same day, those to retire must be determined by lot, unless they otherwise agree among themselves. At the annual general meeting at which a director retires, the company may appoint a person to fill the vacated office. A retiring director is regarded as having been reappointed to the office if: (a) the company does not appoint a person to the vacated office; and (b) the retiring director has not given notice to the company of his/ her intention to decline reappointment to the office. 20

21 A retiring director is eligible for reappointment to the office. Article 33(2) provides that a director appointed to the office of managing director is not, while holding the office, subject to retirement by rotation under article 24. While holding the office, the director must also not be taken into account in determining the rotation of retirement of directors under that article. In our case, Jenny has to retire at the company s first annual general meeting. 5. (b) Jenny has been told that there is no rotation of directors for a private company and a private company may be entitled to claim a reporting exemption. Jenny has decided to convert Perfect Life Limited into a private company. Explain to Jenny the distinctions (apart fro m the above) between a private company and a public company and how Perfect Life Limited may be converted to a private company. (10 marks) (Total: 20 marks) Ans (b) Candidates are expected to explain the distinctions between a private company and a public company. Section 11(1) provides that a company is a private company if: (a) its articles: (i) restrict a member s right to transfer shares; (ii) limit the number of members to 50; and (iii) prohibit any invitation to the public to subscribe for any shares or debentures of the company; and (b) it is not a company limited by guarantee. A private company may have only one director and one shareholder, while a public company must have at least two directors (sections 453 and 454). 21

22 Section 456 provides that a private company (not being a member of a group of companies of which a listed company is a member) may appoint a corporate director while a public company cannot appoint a corporate director. Section 457 provides that a private company (not being a member of a group of companies of which a listed company is a member) must have at least one director who is a natural person. Section 460(2) provides that at a general meeting of a public company, a motion for the appointment of two or more persons as directors of the company by a single resolution must not be made, unless a resolution that it may be so made has first been passed at the meeting without any vote against it. However, there is no such restriction for a private company. Section 610(1) provides that a private company has to hold its annual general meeting within nine months after the end of its accounting reference period by reference to which the financial year is to be determined, while a public company has to hold its annual general meeting within six months after the end of its accounting reference period by reference to which the financial year is to be determined. Marks should be given for any relevant point made. If a public company alters its articles so that they comply with section 11, it ceases to be a public company on the date the alteration takes effect and must, within 15 days of that date, deliver to the Registrar a notice of the change of status (section 95). In this case, if Jenny causes the company to pass a special resolution to alter the company s articles and to include the three requirements under section 11 in its articles, and the company delivers the required notice to the Company Registry within 15 days, Perfect Life Limited may be converted into a private company. 22

23 6. Hong Kong Group Limited is a public company incorporated in Hong Kong which adopts the model articles for a public company limited by shares as its articles except that the company s objects are stated as the import and export of baby milk powder to Mainland China. Earlier this year, the Hong Kong Government enacted new regulations which restricted exports of baby milk powder to the Mainland. However, it is suspected that the company continued to smuggle baby milk powder to the Mainland. REQUIRED: Vincent is a minority shareholder and he owns 10% of the company s issued shares. 6. (a) Advise Vincent how an inspector may be appointed under the Companies Ordinance. (10 marks) Ans (a) Candidates are expected to explain the rule about appointment of an inspector. Section 840(1) provides that the Financial Secretary may, on application by a company, appoint an inspector to conduct an investigation if the company has by special resolution declared that its affairs ought to be investigated. Section 840(2) provides that the Financial Secretary may appoint an inspector on application by a minority of a company s members. If a company has share capital, the application must be made by at least 100 members or members holding at least 10% of the shares issued. For a company not having a share capital, at least 10% in number of persons on the register of members are required to apply. An application under either of these provisions must be supported by the evidence required by the Financial Secretary to show that the applicant has good reasons for requesting the investigation. The Financial Secretary must also be satisfied that it is in the public interest to do so (section 840(3) and (4)). The applicants may also be required to give security for the payment of the expenses of the investigation (section 840(5)). 23

24 Section 841(1) provides that the Financial Secretary must appoint an inspector to investigate a company s affairs if the Court by order declares that the company s affairs ought to be so investigated, and may appoint an inspector if there are circumstances suggesting that: the company was formed for a fraudulent or unlawful purpose the company s affairs are being or have been conducted (i) in a manner unfairly prejudicial to the interests of members generally or of one or more members, (ii) with the intent to defraud creditors or the creditors of any other person, or (iii) for any other fraudulent or unlawful purpose, or the persons concerned with the formation or management of a company have engaged in fraud, misfeasance, or other misconduct towards the company, its members or its creditors (section 841(2)). In this case, Vincent owns 10% of the company s issued shares and may apply to the Financial Secretary to appoint an inspector. 6. (b) Advise Vincent whether there is any ground to petition for a winding up order under the Companies (Winding Up & Miscellaneous Provisions) Ordinance. (10 marks) (Total: 20 marks) Ans (b) Candidates are expected to discuss section 177(1) of the Companies (Winding Up & Miscellaneous Provisions) Ordinance. Section 177(1) specifies six grounds on which a company may be wound up by the court. - The members pass a special resolution agreeing to be wound up by the court; - The company does not commence business within one year from incorporation, or it suspends business for a whole year; - The company has no members; - The company is unable to pay its debts; 24

25 - The memorandum or articles of the company provide that it is to be dissolved on the occurrence of an event and the event occurs; and - The court is of the opinion that it is just and equitable that it should be wound up. The Companies Ordinance does not define the meaning of just and equitable grounds and cases should be discussed. An order for winding-up on this ground has been made in the following circumstances. - Where the main object of the company has failed (Re German Date Coffee Co (1882); Re Kitson and Co Ltd (1946); Re Chinese Estates Ltd (1976); Re Mediavision Ltd (1993) - Where the company was formed to carry out a fraud or to carry on an illegal business (Re TE Brinsmead and Sons (1897)) - Where the members have formed a company on the basis of a relationship involving mutual trust, understanding, and confidence which no longer exists (Re Yenidje Tobacco Co Ltd (1916); Re Quality International Ltd (1964); Ebrahimi v Westbourne Galleries (1973); Re Comtowell Ltd (1998)) In this case, Vincent may argue that the main object of the company failed as the Hong Kong Government had enacted new regulations to restrict exports on baby milk powder to Mainland China, which is the object of the company. Vincent may also argue that the company is carrying on illegal business if he can prove that the company smuggled baby milk powder to Mainland China. Vincent may then argue that it is just and equitable to wind up the company. END 25