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

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1 THE HONG KONG INSTITUTE OF CHARTERED SECRETARIES THE INSTITUTE OF CHARTERED SECRETARIES AND ADMINISTRATORS International Qualifying Scheme Examination HONG KONG CORPORATE LAW DECEMBER 2012 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 1. Hong Kong Natural Rubber Ltd. (HKNRL) is a private company incorporated in Hong Kong trading under the name Woolala Rubber. HKNRL adopted Table A as its articles of association and had an objects clause to import natural rubber from Brazil and resell it in Hong Kong. The articles of HKNRL also provided that the managing director of HKNRL was only authorised to borrow up to $1 million on behalf of the company. Any loan exceeding $1 million had to be approved by an ordinary resolution in a general meeting. Peter owned 25% of the issued share capital of HKNRL and Jody owned the remaining issued shares. Peter and Jody were the only two directors of HKNRL while Jody was also the managing director of HKNRL. In an attempt to protect HKNRL from the rising exchange rate of the Brazilian real (R$, the official Brazilian currency), Jody, without discussing the matter with Peter, entered into some derivative transactions under which Hong Kong Investment Bank (HKIB) would make payments to HKNRL when the R$ exchange rate was high and HKNRL would make payments to HKIB when the R$ exchange rate fell below an agreed level. From , the R$ exchange rate rose and HKNRL received a huge amount of payments from HKIB. Most of these payments were paid to Jody as his bonus for his good performance according to his employment contract with HKNRL. However, in August 2012 the R$ exchange rate began to fall and eventually collapsed, meaning that HKNRL was required to make payments to HKIB. As HKNRL was in financial difficulty, Jody decided, on behalf of HKNRL, to borrow $5 million from Kowloon Bank (KB) which was subsequently paid to HKIB, without passing any ordinary resolution. HKNRL made the requisite payments up the November 2012 but failed to make any further payments. HKIB then brought legal proceedings against HKNRL to recover the sum due, but HKNRL alleged that the derivative transactions were not binding as it had not had the capacity to enter into these derivative transactions according to its objects clause, which stated that the main business of HKNRL is to import and resell natural rubber. As HKNRL s financial position did not improve, Jody decided to wind the company up. When HKNRL entered into creditors voluntary liquidation, Peter found that Jody had permitted Jody Rubber Ltd. (JRL) to trade as Woolala Rubber at a time when HKNRL had also been trading under that name without requiring any payment from JRL for its use. It was found that Jody was the majority shareholder of JRL. Peter also found that Jody had caused HKNRL to pay him an excessive bonus for his good performance as the managing director of HKNRL since As a result, no dividend had been declared since When Peter found out about the loan agreement between HKNRL and KB, he wanted to challenge the agreement on the ground that Jody was not authorised to sign any loan agreement exceeding $1 million without an ordinary 2

3 resolution. It was also found that just before HKNRL was wound up, Jody had caused HKNRL to transfer its business and its goodwill in the name Woolala Rubber to JRL for only $50,000, which was only enough to pay the liquidation fee. REQUIRED: 1. (a) Advise HKIB as to whether the derivative transactions between HKIB and HKNRL were valid. Ans (a) Candidates are expected to discuss the ultra vires rule. An objects clause is an optional clause in a company s memorandum of association, which states the purpose of setting up a company. Section 5(1A)(b) If a company does not have an objects clause it has all the rights and powers of a natural person. Section 5A If a company acts outside its objects clause, the transaction is an ultra vires transaction. The members of the company can then take out an injunction to stop the company from acting ultra vires. Section 5B(2) Any ultra vires transaction carried out by the company remains legally valid. Section 5B(3) Candidates may argue that the derivative transactions were not within the objects clause and were ultra vires. However, even though the derivative transactions were ultra vires, the transactions were still valid. 1. (b) Advise HKNRL as to whether it may successfully sue Jody for any breach of his duty as a director of HKNRL by transferring HKNRL s business and goodwill in the name Woolala Rubber to JRL. Ans (b) Candidates are expected to discuss the rules about directors duties. Directors of companies owe directors duties to their companies but not to individual shareholders. Directors duties may be classified into two main duties: fiduciary duty and duty of skill and care. 3

4 The fiduciary duty of directors are: 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. Directors must only use their legal powers under the AA for the purpose for which they were given; they must not use their powers for their own interests. In Regal Hastings v Gulliver [1942] 1 All ER 378, R Ltd. owned a cinema. The directors decided that to make the business more profitable they needed to expand and the company should acquire two more cinemas. R Ltd. could then be sold at a profit. A new company was formed to buy the two cinemas, which was to be wholly owned by R Ltd. But a problem arose as R Ltd. could not raise enough money itself to inject into the new company. The new company needed 5,000 but could only raise 2,000. One of the directors of R Ltd. bought some of the new shares himself so the scheme could go ahead. Later, R Ltd. and its subsidiary were sold at a profit to Mr. X. The new owner of R Ltd. then began a case on behalf of R Ltd. to sue the director for breach of duty and for him to hand over the profit that he had made. The court agreed, saying that even though the original deal could not have gone ahead without the director buying some of the shares in the subsidiary, he should have formally disclosed his interest and obtained formal consent from all the members of R Ltd. He did not do so and this was in breach of his duty, so he had to hand over his profit on the transaction. (Candidates may use any relevant cases to support.) Candidates are expected to apply the above rules to our case study and discuss. Candidates may argue that, in transferring HKNRL s business and goodwill to JRL for only $50,000, Jody was in breach of his directors duty as there was a conflict of interest between Jody s personal interest and HKNRL s interest. 4

5 1. (c) Advise KB as to the validity of the loan agreement between KB and HKNRL. Ans (c) Candidates are expected to discuss Turquand s rule. Outsiders are entitled to assume all internal regulations and procedures are complied with and have no duty to check any internal irregularity of a company. In Royal British Bank v Turquand (1856), the board was allowed by the company's MA to borrow money on behalf of the company if authorised by an OR. The board borrowed money from the bank via a contract bearing the company's seal without obtaining an OR. The court held that the contract was valid even though the OR had not been obtained as the bank was not able to discover from the public register whether the internal procedures had been followed and it was usual for a company to borrow in this way. However, there are exceptions to Turquand s rule. (1) Where the person seeking to rely upon it is not a true outsider In Howard v Patent Ivory (1888), the AA allowed the directors to borrow up to 1000 on behalf of the company without GM consent and more with GM consent. The directors lent 3,500 to the company and the company borrowed the money without GM consent. Could the directors get their money back? It was held they could only reclaim up to the 1,000 limit and no more. They were insiders and knew or should have known of the restriction. Candidates may cite any relevant case to support. (2) Where the outsider has actual notice of some internal irregularity. (3) Where the outsider is on inquiry (due to suspicious circumstances). In our case, KB may rely on Turquand s rule and assume all internal procedures have been complied with, i.e. an ordinary resolution already been passed to authorise the loan agreement. As a result, the loan agreement between KB and HKNRL was valid. 5

6 1. (d) Advise Peter as to whether he may take any legal action under section 168A of the Companies Ordinance if HKNRL has not been wound up. Ans (d) Candidates are expected to discuss the rules about unfairly prejudicial acts under section 168A of the Companies Ordinance. Section 168A(1) provides that any member of a specified corporation who complains that the affairs of the specified corporation are being or have been conducted in a manner unfairly prejudicial to the interests of the members generally or of some part of the members may make an application to the court by petition for an order under this section. Peter may apply to the court and complain that the affairs of HKNRL were being conducted in a manner unfair and prejudicial to his interests. The Companies Ordinance does not define an unfairly prejudicial act, while some cases may be helpful in understanding the concept. In Re Taiwa Land Investment Co. Ltd. [1981] HKLR 297, it was held that unfairness and prejudice must co-exist with respect to the complained conduct. Unfair discrimination against a minority may be unfair prejudice. In Donaldson Investment v Anglo Transvaal [1979] 3 SA 7`13, the court said that the minority must show that the majority acted in such a way as to prevent the minority exercising a fair participation in the running of the company's affairs. An example of unfairly prejudicial conduct can be shown in Re Tai Lap Investments [1999] 3 HKC 660 (CA), in which the minority complained that company money had been used to subsidise the majority shareholders family members businesses in Canada. It was held that this was clear unfair prejudice. Candidates may use any relevant cases to support. If an unfairly prejudicial act is proved, the court may grant remedies under section 168A(2). Section 168A(2) provides that if the court is of opinion that the specified corporation s affairs are being or have been conducted in a manner unfairly prejudicial to the interests of the members generally or of some part of the member: (a) the court may, with a view to bringing to an end the matters complained of (i) make an order restraining the commission of any such act or the continuance of such conduct; (ii) order that such proceedings as the court may think fit shall be 6

7 brought in the name of the specified corporation against such person and on such terms as the court may so order; (iii) appoint a receiver or manager of the whole or a part of a specified corporation s property or business and may specify the powers and duties of the receiver or manager and fix his remuneration; and (iv) make such other order as it thinks fit, whether for regulating the conduct of the specified corporation s affairs in future, or for the purchase of the shares of any members of the specified corporation by other members of the specified corporation or by the specified corporation and, in the case of a purchase by the specified corporation, for the reduction accordingly of the specified corporation s capital, or otherwise; and (b) the court may order payment by any person of such damages and interest on those damages as the court may think fit to any members (including the member who presented the petition) of the specified corporation, whose interests have been unfairly prejudiced by the act or conduct. Candidates may argue that entering into the derivatives transactions and paying most of the payments from it to Jody as his bonus might not be in the company s interest, and that allowing Jody Rubber Ltd. (JRL) to trade as Wahaha Rubber without any payment and transferring HKNRL s business and goodwill to JRL for only $50,000 were unfairly prejudicial acts; as a result and Peter should be entitled to the remedies under section 168A(2). 7

8 SECTION B 2. Danny was an executive director of Fastest Internet Ltd. (FIL), a private company incorporated in Hong Kong which provided IT services. Andy had been engaged as FIL s auditor for many years. Recently, Danny found that Andy had failed to report alleged accounting irregularities to him and failed to advise him of any financial uncertainty at the company. Danny also suspected that Andy had removed some adverse comments from his final audit report without giving reasons. As a result of these omissions, FIL got into serious financial difficulty and Danny lost his job as an executive director of the company. REQUIRED: 2. (a) Advice Danny as to whether he may take any legal action against Andy for his breach of duty as an auditor of FIL. Ans (a) Candidates are expected to discuss the duty of care that an auditor owes to a party, other than the company appointing him. In the absence of contractual relationship, a party may assert only action in the tort of negligence against the defaulting auditor if they suffer any loss as a result of an auditors breach of duty. Hedley Byrne and Co Ltd v Heller and Partners Ltd [1963] 3 WLR 101. Caparo Industries plc v Dickman [1990] 2 AC 605. Candidates may cite any relevant case to support. Negligent mis-statement under special relationship, leading to economic loss was established as compensatable. This duty was expanded further from the special relationship to the two-stage test in Anns v Merton London Borough Council [1978] AC 728. In a recent Hong Kong case, Guang Xin Enterprises Ltd. (In liquidation) v Kwan Wong Tan & Fong (A firm) [2002] 2 HKC 613, the Court of First Instance held (at 622D-625B): An auditor was not a business advisor. His position in relation to the shareholders of a limited company arose from the relevant provisions of the Companies Ordinance (Cap 32). His duty was to investigate and form an independent opinion on the adequacy of the company's accounts and to report to the company's members whether in his opinion the company's accounts gave a true and fair view of its financial position. He was not employed by the company to advise on how the company should be run. Still less was it the auditor's duty to advise on whether or not the company 8

9 should carry on its business. In Yue Xiu Finance Co. v Dermot Agnew (1996) (HK), the court held that the relationship of proximity could be established by showing that the defendants knew that the plaintiffs would rely on the audited reports for a particular purpose and intended that the plaintiffs should rely on the reports for that purpose. By applying the above special relationship test to this case study, it seems that there was no special relationship between Danny and Andy. As a result, Danny has no right to sue Andy for his breach of duty as an auditor of the company. 2. (b) Advice FIL as to the proper procedures to remove Andy as the auditor of the company. Ans (b) Candidates are expected to explain the procedures to remove an auditor under section 131(6) of the CO. Section 131(6) provides that a company may by ordinary resolution remove an auditor before the expiration of his term of office, notwithstanding anything in any agreement between it and him. An ordinary resolution is one passed by majority of members who are entitled to, and do, vote in person, or by proxy in a general meeting. Except in the case of a private company, where a resolution removing an auditor is passed at a general meeting of a company, the company has to give notice of that fact in the specified form to the Registrar within 14 days. Section 132(1)(d) provides that special notice is needed for removing an auditor before the expiration of his term of office. Section 116C provides that where special notice is required of a resolution, the resolution is not effective unless notice of the intention to move it has been given to the company not less than 28 days before the meeting at which it is moved, and the company gives its members notice of any such resolution at the same time and in the same manner as it gives notice of the meeting or, if that is not practicable, gives them notice thereof, either by advertisement in a newspaper having an appropriate circulation or in any other mode allowed by the articles, not less than 21 days before the meeting. 9

10 3. Catherine has recently been appointed as a company secretary of High Tech Computers Ltd. which adopted Table A as its articles of association. She was told that there were three classes of shares in the company: Class A, Class B & Class C. Class A shares and Class B shares are ordinary shares while Class C shares are 10% cumulative preference shares. Catherine was also told that Class A shares have five votes per share while Class B shares have only one vote per share. Class C shares have no voting rights. One of the Class B shareholders felt that this was unfair to all Class B shareholders and proposed reducing the voting power of Class A shareholders. However, Catherine does not understand the distinctions between the three classes of shares and the procedures to reduce the voting right of Class A shareholders. REQUIRED: 3. (a) Advise Catherine as to the distinctions between ordinary shares and preference shares. Ans (a) Candidates are expected to discuss the distinctions between preference shares and ordinary shares. Ordinary shareholders are not guaranteed a fixed level of dividend. They generally carry unrestricted voting rights so that ordinary shareholders normally control the company. Dividends are not cumulative; if no ordinary dividend is declared in a particular year, the shareholders rights to dividends in subsequent years are not increased. Preference shares are shares which carry rights in preference to other shares. The usual preferences given are: Payment of dividends Return of capital on winding up of the company A preference share generally confers the right to receive a dividend up to a specified amount, before any dividend is paid on the ordinary shares. The preferential dividend is deemed to be cumulative, unless expressly described as non-cumulative. Cumulative means that the preference shareholder will be entitled to arrears of any dividend not paid out in one year before any dividend can be paid to the ordinary shareholders. Preference shares do not generally have voting powers unless the dividend is in arrears or if a resolution may affect the preference shareholders class 10

11 rights. Preference shareholders usually have their capital returned in priority to ordinary shareholders when the company is wound up. However, they cannot share any surplus assets. Any dividends in arrears when the company is wound up are paid out of capital, but only after all the debts of the company have been settled. 3. (b) Advise Catherine as to the proper procedures to reduce the voting right of Class A shareholders from five votes per share to one vote per share. Ans (b) Candidates are expected to discuss the rules dealing with the variation of class rights under s.63a, 64 of the Companies Ordinance. (1) Section 63A provides that: (1) Where, in the case of a company the share capital of which is divided into different classes of shares, special rights are attached to any such class of shares otherwise than by the memorandum and the articles do not provide for the variation of those rights, the articles shall be deemed to contain provision that such rights shall not be varied except with the consent in writing of the holders of three-fourths in nominal value of the issued shares of the class in question or with the sanction of a special resolution passed at a separate general meeting of the holders of that class. (2) Where, in the case of a company the share capital of which is divided into different classes of shares, special rights are attached to any such class of shares by the memorandum and provision for the variation of those rights is, at the time of the company's incorporation, contained in the articles, those rights shall be capable of variation in accordance with the articles as for the time being in force, even if no reference is made in the memorandum to their variation in that manner. (3) Where, in the case of a company the share capital of which is divided into different classes of shares, special rights are attached to any such class of shares by the memorandum and the memorandum and articles do not contain provision with respect to the variation of the rights, those rights may be varied if all the members of the company agree to the variation. (4) Where the articles of a company contain, or by virtue of this section are deemed to contain, a provision for the variation of the rights attached to any class of shares, those rights shall not be capable of variation otherwise than in accordance with that provision. 11

12 Section 64 provides that: (1) If in the case of a company, the share capital of which is divided into different classes of shares, provision is made by the memorandum or articles for authorising the variation of the rights attached to any class of shares in the company, subject to the consent of any specified proportion of the holders of the issued shares of that class or the sanction of a resolution passed at a separate meeting of the holders of those shares, and in pursuance of the said provision the rights attached to any such class of shares are at any time varied, the holders of not less in the aggregate than 10% in nominal value of the issued shares of that class may apply to the court to have the variation cancelled, and, where any such application is made, the variation shall not have effect unless and until it is confirmed by the court. In our case, the company adopted Table A as its articles of association and Article 4 of Table A provides that, if at any time the share capital is divided into different classes of shares, the rights attached to any class may, whether or not the company is being wound up, be varied with the consent in writing of the holders of three-fourths in nominal value of the issued shares of that class, or with the sanction of a special resolution passed at a separate general meeting of the holders of the shares of the class. 12

13 4. Daisy and Edwin are the two directors of Wonderful Life Ltd. On incorporation of the company in March 2012, Daisy, on behalf of the company, borrowed $2 million from Kowloon Bank. Clause 10 of the debenture provided that the company created a fixed charge over all existing and future book debts owed to the company and all monies paid to the company in respect of those debts. In October 2012, the company was in serious financial difficulty and had to pay its suppliers immediately. The company s accountant advised that the company should cease trading. However, Daisy and Edwin ignored the accountant s advice and borrowed a further $2 million from Hung Hom Bank at an extremely high interest rate, creating a floating charge over the company s book debts in favour of Hung Hom Bank. By December 2012, the company was unable to continue business and a petition was presented to wind up the company. REQUIRED: 4. (a) Advise Daisy and Edwin as to whether they may be liable for the debts of the company. Ans (a) Candidates are expected to discuss the rule about separate legal entities and lifting the corporate veil. In law, registered companies are recognised as having their own legal personality and can exist separate and distinct from their members and managers. This basic legal idea was confirmed in Salomon v Salomon and Co. Ltd. [1897) AC 22. The case concerned a man who ran a shoe-making business as a sole trader but then sought to convert the business into the form of a limited company. As the company is a separate legal entity to its owners, the company had to pay Mr. Salomon for the value of the business transferred to it from Mr. Salomon. The company paid him partly in shares in itself and partly by way of a secured loan from Mr. Salomon to it, which it promised to repay at a later date. Before the company had repaid its debt to Mr. Salomon, it went into insolvent liquidation. Mr. Salomon claimed all the assets of the company to repay the loan but the other creditors said it was all a fraud and that Mr. Salomon and the company were, in reality, the same. Thus, they said Mr. Salomon should not get priority to get his loan back. However, the court did not agree and held that once a company is legally incorporated, it must be treated like any other independent person with rights and liabilities appropriate to itself. 13

14 In our case, Daisy and Edwin are directors of the company and the company is regarded as a separate legal entity. As a result, Daisy and Edwin are not liable for the debts of the company. However, under some special situations, the court may ignore the separate legal entity concept and regard the company and its directors as one entity, i.e. lifting the corporate veil. As a result, if the court lifts the corporate veil, a director may be liable for the debts of a company. In our case, one relevant ground which may lift the corporate veil is fraudulent trading (under section 275 of the CO). Section 275(1) provides that, if in the course of the winding up of a company it appears that any business of the company has been carried on with intent to defraud creditors of the company or creditors of any other person or for any fraudulent purpose, the court, on the application of the Official Receiver, or the liquidator or any creditor or contributory of the company, may, if it thinks proper so to do, declare that any persons who were knowingly parties to the carrying on of the business in manner aforesaid shall be personally responsible, without any limitation of liability, for all or any of the debts or other liabilities of the company as the court may direct. In our case, if the court holds that Daisy and Edwin commits fraudulent trading, they may be liable for the debts of the company. 4. (b) Advise the liquidator of the company as to the validity of the charges created. Ans (b) Candidates are expected to discuss section 80, section 266B and section 267 of the CO. Candidates are also expected to discuss the rules about creating a fixed charge over book debts. The court held that if a borrower could collect the debt due without specific consent and use the proceeds in the ordinary course of trade, the charge thus created was a floating not a fixed charge. Therefore, to create a valid fixed charge the lender (bank) must exercise real control over the charged asset and the borrower (company) must not be able to use the asset freely in its business or dispose of it without the lenders consent. The House of Lords in the English case of Smith (Administrator of Cosslett (Contractors) Ltd.) v Bridgend Courty Borough Council [2002] 1 All ER 292 agreed with the decision in Agnew. Therefore, in our case, unless the bank can exercise control over the book debts, the charges created are, most likely, floating charges. 14

15 Section 80(1) provides that every charge created after the fixed date by a company and being a charge to which this section applies shall, so far as any security on the company's property or undertaking is conferred thereby, be void against the liquidator and any creditor of the company, unless the particulars of the charge, together with the instrument, if any, by which the charge is created or evidenced, are delivered to or received by the Registrar for registration in manner required by this Ordinance within five weeks after the date of its creation. If a charge fails to be registered, it is void against the liquidator and other creditors. According to section 267 of the CO, all charges created within 12 months before the winding up of the company are invalid unless the company was solvent at the time of creation of the charges, or any cash paid to the company at the time of creation of the charges, to that extent the charge is valid. According to section 266B, a fixed charge or a floating charge created within six months before winding up may be challenged as an unfair preference. In our case, the charge created in favour of Kowloon Bank may be challenged under section 267 if it is regarded as a floating charge and the charge created in favour of Hung Hom Bank may be challenged under section 266B and section 267 as it was created within six months before winding up. If a charge is invalid, the bank will become an unsecured creditor. 15

16 5. Mandy is the secretary to the managing director of Sino Golf Ltd. (SGL), a company listed on the Hong Kong and Shanghai Stock Exchanges. In October 2012, when Mandy read one of her boss s s, she found that a major debtor of SGL, Pluto Corporation (PC), had filed for Chapter 11 bankruptcy protection in the United States. The also revealed PC s inability to pay its debt ($50 million) to SGL and that this would affect SGL s financial position and share price. Mandy immediately called her boy friend, Michael, and asked him to sell all his shares in SGL. Mandy also sold all her shares in SGL on the Hong Kong Stock Exchange and Shanghai Stock Exchange, before the market was made aware of the impact of PC s bankruptcy on SGL s financial position. In November 2012, SGL announced to the market a decline in net profit of 55%, attributing it partly to the bad debt provision of $50 million as a result of PC s bankruptcy. REQUIRED: 5. (a) Advise Mandy and Michael as to whether they may be liable for insider dealing under the Securities and Futures Ordinance. (No need to discuss Chinese securities laws.) Ans (a) Candidates are expected to discuss the rules relating to insider dealing defined under the Securities and Futures Ordinance. Section 270(1)(a) defines the fundamental act of insider dealing, which shall consist of the following elements: (a) a person is connected with a listed corporation; (b) he is in possession of certain information; (c) he knows the information is relevant information; and (d) he deals in the listed securities of the corporation; or (e) he counsels or procures another person to deal in such listed securities. A person who is connected with a corporation for insider dealing purposes is defined in section 247: (a) one who is a director or employee of the corporation or a related corporation; In this case, Mandy, being the secretary to the managing director of the 16

17 company, is a connected person of the company. Relevant information is defined in section 245 of the Securities and Futures Ordinance as specific information in respect of: (a) the corporation; (b) a shareholder or officer of the corporation; or (c) the listed securities of the corporation or their derivatives, which is not generally known to other potential investors, but if it were known to them, it would materially affect the price of the listed securities in question. Candidates are expected to point out that Mandy is liable under section 270(1)(a) by i) selling all her shares in the company; and ii) procuring Michael to sell all his shares in the company. Candidates are expected to point out that, even though Mandy sold all her shares on the Shanghai Stock Exchange, she is still liable under section 270(2) of the Securities and Futures Ordinance. Candidates may point out that Michael may be liable under section 270(1)(e), which provides that: A person may be liable for insider dealing if he: (a) receives the information whether directly or indirectly from; (b) a person whom he knows is connected with the corporation, (c) which information is known to be relevant information; and (d) he deals in the listed securities of the corporation or counsels or procures another person to do so. (section 270(1)(e)) Candidates may point out that Michael may not be liable in this case as he did not receive any relevant information from Mandy. However, if Mandy has told him about the relevant information, then Michael may be liable as a tippee under section 270(1)(e). 17

18 5. (b) Explain to them, if they are liable for market misconduct under the Securities and Futures Ordinance, the penalties/ orders that may be imposed on them under the criminal and civil provisions of the Securities and Futures Ordinance. Ans (b) Candidates are expected to point out that there are both criminal and civil liabilities under the Securities and Future Ordinance. A market misconduct case may go to the court for criminal penalties, while it may go to the Market Misconduct Tribunal for civil orders. Section 303(1) of the SFO provides that a person who commits market misconduct is liable: (a) on conviction on indictment to a fine of $10,000,000 and to imprisonment for 10 years; or (b) on summary conviction to a fine of $1,000,000 and to imprisonment for three years. Section 303(2) provides that where a person is convicted of market misconduct, the court before which the person is so convicted may, in addition to any penalty specified in subsection (1), make one or more of the following orders in respect of the person: (a) an order that the person shall not, without the leave of the court, be or continue to be a director, liquidator, or receiver or manager of the property or business, of a listed corporation or any other specified corporation or in any way, whether directly or indirectly, be concerned or take part in the management of a listed corporation or any other specified corporation for the period (not exceeding five years) specified in the order; (b) an order that the person shall not, without the leave of the court, in Hong Kong, directly or indirectly, in any way acquire, dispose of or otherwise deal in any securities, futures contract or leveraged foreign exchange contract, or an interest in any securities, futures contract, leveraged foreign exchange contract or collective investment scheme for the period (not exceeding five years) specified in the order; (c) an order that any body which may take disciplinary action against the person as one of its members be recommended to take disciplinary action against him. Section 257(1) provides that the Market Misconduct Tribunal may make one of the following orders in respect of a person identified as having engaged in market misconduct: (a) an order that the person shall not, without the leave of the Court of First Instance, be or continue to be a director, liquidator, or receiver or manager of the property or business, of a listed corporation or any other specified 18

19 corporation or in any way, whether directly or indirectly, be concerned or take part in the management of a listed corporation or any other specified corporation for the period (not exceeding five years) specified in the order; (b) an order that the person shall not, without the leave of the Court of First Instance, in Hong Kong, directly or indirectly, in any way acquire, dispose of or otherwise deal in any securities, futures contract or leveraged foreign exchange contract, or an interest in any securities, futures contract, leveraged foreign exchange contract or collective investment scheme for the period (not exceeding five years) specified in the order; (c) an order that the person shall not again perpetrate any conduct which constitutes such market misconduct as is specified in the order (whether the same as the market misconduct in question or not); (d) an order that the person pay to the Government an amount not exceeding the amount of any profit gained or loss avoided by the person as a result of the market misconduct in question; (e) without prejudice to any power of the Tribunal under section 260, an order that the person pay to the Government the sum the Tribunal considers appropriate for the costs and expenses reasonably incurred by the Government in relation or incidental to the proceedings; (f) without prejudice to any power of the Tribunal under section 260, an order that the person pay to the Commission the sum the Tribunal considers appropriate for the costs and expenses reasonably incurred by the Commission, whether in relation or incidental to- (i) the proceedings; (ii) any investigation of the person s conduct or affairs carried out before the proceedings were instituted; or (iii) any investigation of the person s conduct or affairs carried out for the purposes of the proceedings; (fa) where the proceedings were instituted as a result of an investigation under the Financial Reporting Council Ordinance (Cap 588), an order that the person pay to the Financial Reporting Council established by section 6(1) of that Ordinance the sum the Tribunal considers appropriate for the costs and expenses in relation or incidental to the investigation reasonably incurred by the Council; (g) an order that any body which may take disciplinary action against the person as one of its members be recommended to take disciplinary action against him. 19

20 6. Nancy had been the company secretary of King Development Ltd. (KDL), a private company incorporated in Hong Kong, for many years. Alex, the chairman of the board of directors of KDL, wanted Nancy to become a director and shareholder of the company. Alex told Nancy that the company could offer a loan to help her subscribe for shares in the company, but the company would only offer that loan if Nancy were successfully appointed as a director of the company. However, the articles of association of the company provide that all directors of the company have to be Hong Kong permanent residents: Nancy is currently not a Hong Kong permanent resident. REQUIRED: 6. (a) Advise Nancy as to how she may be appointed as a director of the company. Ans (a) Candidates are expected to explain the procedures for altering the articles of association of a company. Candidates are expected to point out that Nancy may be appointed as a director of the company by passing an ordinary resolution in a general meeting. However, according to the articles of association of the company, a director of the company has to be a Hong Kong permanent resident, so the company has to alter its articles of association first. Section 13(1) of the CO provides that a special resolution is needed to alter the articles of association of a company. The general principle that a company can alter its AA was confirmed in Allen v Gold Reefs of West Africa Ltd (1900). The court held that a company must exercise the power to change the articles in accordance with the ordinance but also bona fide in the interest of the company as a whole and not only purely for the purpose of the majority who can ignore minority shareholders. In Greenhalgh v Arderne Cinemas (1951), the court explained that bona fide for the benefit of the company as a whole meant that a member should vote honestly in what the thinks is for the good for he company. This might be the same as his own self interest. In Brown v British Abrasive Wheel Company (1919) the owners of 98% of the shares in the company were willing to subscribe for additional shares in the company if the AA were changed so that a member had to sell his shares to the company or the other shareholders if 90% of the membership agreed. The company was in urgent need of new funds and 20

21 was not able to borrow. The court held the change was not in the interests of the company as a whole as the change was aimed at removing the 2% minority owner, so could not be in the interests of the whole company. In Sidebottom v Kershaw (1920), the company altered its articles to allow the directors to force a member to sell his shares if he was involved in a competing business at the market value of the shares. A shareholder challenged the alteration. The court held that the alteration was made bona fide in the interest of the company as a whole. 6. (b) Assuming that Nancy is successfully appointed as a director of the company, advise KDL as to the proper procedures which should be followed in providing the loan to Nancy. Ans (b) Candidates are expected to discuss the rules about loans to directors under section 157H of the CO and financial assistance to buy the company s shares under section 47A of the CO. Section 157H(2) provides that, subject to exceptions under section 157H, a a company is not allowed to make any loan to its directors. Section 157HA(2) provides that section 157H does not prohibit a private company from doing anything that has been approved by the company in a general meeting. As KDL is a private company, any loan to a director may be approved in a general meeting. Section 47A(1) provides that it is not lawful for a company or any of its subsidiaries to give financial assistance directly or indirectly for the purpose of any acquisition of shares of that company before or at the same time as the acquisition takes place. Section 47B provides that financial assistance means: (a) financial assistance given by way of gift; (b) financial assistance given by way of guarantee, security or indemnity, other than an indemnity in respect of the indemnifier's own neglect or default, or by way of release or waiver; (c) financial assistance given by way of a loan or any other agreement under which any of the obligations of the person giving the assistance are to be fulfilled at a time when in accordance with the agreement any obligation of another party to the agreement remains unfulfilled, or by way of the novation of, or the assignment of rights arising under, a loan or such other agreement; or (d) any other financial assistance given by a company the net assets of 21

22 which are thereby reduced to a material extent or which has no net assets. Section 47E provides that section 47A does not prohibit an unlisted company from giving financial assistance if the following provisions are complied with. The financial assistance may only be given if the company has net assets which are not thereby reduced or, to the extent that they are reduced, if the assistance is provided out of distributable profits. The financial assistance is approved by special resolution of the company in a general meeting. A majority of the directors of the company proposing to give the financial assistance shall before the financial assistance is given make a statement complying with section 47F. Section 47F(1) provides that the statement shall be in the specified form and shall be signed by the directors and shall state: (a) the form which such assistance is to take; (b) the names and addresses of the persons to whom such assistance is to be given; (c) the purpose for which the company intends those persons to use such assistance; (d) that the directors making the statement have formed the opinion, as regards the company's initial situation immediately following the date on which the assistance is proposed to be given, that there will be no ground on which it could then be found to be unable to pay its debts; and either- (i) if it is intended to commence the winding up of the company within 12 months of that date, that the company will be able to pay its debts in full within 12 months of the commencement of the winding up; or (ii) in any other case, that the company will be able to pay its debts as they fall due during the year immediately following that date. END 22