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 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 Win Win Limited is a private company incorporated in Hong Kong. The company adopted model articles for private companies limited by shares as its articles. Winnie is the chairman of the board of directors. According to the company s articles, the company may appoint a managing director. However, the company has not formally appointed a managing director since the retirement of the former managing director, Isabella. Since Isabella s retirement, Winnie has simply acted as if she was the managing director and the board has allowed Winnie to do so. Over the last few months, Winnie has signed loan agreements with different banks on behalf of the company on several occasions. Although these loan agreements have to be signed by the company s managing director, the board has simply approved the agreements. 1. Early this month, Winnie signed a new loan agreement with Kowloon Bank on behalf of the company. In order to obtain the loan, Winnie asked the company s auditor, Renee, to audit the company s financial statements and prepare an audit report. Renee was told that these audited financial statements and report would be sent to Kowloon Bank for the company s loan application. However Renee overlooked some of the company s hidden liabilities. In her report, Renee was of the view that the company was in a healthy financial position while the company was in fact insolvent. Unknown to Renee, Winnie also gave the same audited financial statements and report to Shatin Bank and successfully obtained another loan of $1 million. Due to the company s poor recent performance, some board members were unhappy with Winnie s performance and decided to formally appoint a new managing director. The board refused to approve the recent loan agreements signed by Winnie with Kowloon Bank and Shatin Bank, arguing that Winnie had no such authority to sign any loan agreements. Christy, one of the company s directors, is of the view that the company is insolvent and she would like to wind up the company. She has found that the company created two charges, in favour of City One Bank (COB) and City Two Bank (CTB), on 15 March 2016 and 25 March 2016 respectively. COB s floating charge was created over the company s general undertaking and duly registered 2

3 on 14 April CTB s fixed charge was created over the company s machinery and duly registered on 10 April Christy also found that there was an automatic crystallisation clause in the debenture between COB and the company. The clause provides that COB s floating charge would crystallise if any subsequent charge were created over any of the company s assets. In addition, Fanling Bank would like to wind up Win Win Limited since it has failed to repay its loan to the bank despite persistent demands. REQUIRED: 1. (a) Advise Kowloon Bank as to whether Winnie has apparent authority to sign the loan agreement on behalf of Win Win Limited. (10 marks) Ans (a) Candidates are expected to discuss the rule about apparent authority. Directors are legally the agents of their companies. The company has no corporeal (bodily) existence so it must act through human persons. App arent authority arises from a representation of such authority by the board or by reference to the company s public documents. Candidates are expected to discuss Hely-Hutchinson v Brayhead Ltd [1968] 1 QB 549. In this case, the chairman of the board acted as if he was the managing director but he had not been appointed as such. The board allowed him to act as a managing director. He signed letters of guarantee on behalf of the company. It was held that the company was liable. The chairman had apparent authority as a result of the board allowing him to act as a managing director. Per Lord Denning M.R at p. 583: Ostensible or apparent authority is the authority of an agent as it appears to others. It often coincides with actual authority. Thus when the board appoint one of their members to be the managing director, they invest him not only with implied authority, but also with ostensible authority to do all such things as fall within the usual scope of that office. Other people who see him acting as managing director are entitled to assume that he has the usual authority of a 3

4 managing director. To establish apparent authority, there must be a representation by the principal that a particular person is his agent, with authority to make certain transactions. However, no representation by the agent as to the extent of his authority can amount to a holding out by the principal. A representation can be made by express words, or implied from the conduct of the principal. The third party, in making the contract, must have relied on the agent s authority to make the contract as an agent. The principal must have intentionally represented to the third party that the agent has certain authority. Freeman & Lockyer v Buckhurst Park Properties (Mangal) Ltd [1964] 2 QB 480. In our case, even though Winnie had not been formally appointed as the company s managing director, since the company allowed her to act as if she were the managing director Kowloon Bank may argue that Winnie had apparent authority to sign the loan agreement on behalf of the company. 1. (b) Advise Renee as to whether she may be liable to Kowloon Bank and Shatin Bank if the company fails to repay the loans. (10 marks) Ans (b) Candidates are expected to discuss the rules about an auditor s liability. In the absence of a contractual relationship, users of audit reports may assert action only in the tort of negligence against the defaulting auditor if they have relied on an audit report which contains wrongful and incorrect information, and they have suffered a financial loss as a result. Hedley Byrne and Co Ltd v Heller and Partners Ltd [1963] 3 WLR 101: Compensation can be made for negligent misstatement under a special relationship leading to economic loss. 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 Al Saudi Banque v Clarke Pixley [1990] BCLC 47, the court held that auditors of the company owed no duty of care to the company's lending banker, be it an existing or prospective creditor. This is in contrast with AGC (Advances) Ltd v 4

5 Lowe Lippmann Figdor & Franck [1992] 2 VR 671, an Australian case, in which the court was prepared to hold that the auditor owed a duty of care to a finance company that granted credit facilities to the company if the auditor knew or should have known the purpose for which the audit report or certification would be used by the finance company. In Yue Xiu Finance Co v Dermot Agnew (formerly t/a Deloitte Haskins and Sells) [1996] 1 HKLRD 137; [1996] 2 HKC 122 (CA), 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. In our case, as Renee was told that Kowloon Bank would rely on the audited financial statements and her audit report, as a result there was a special relationship between Kowloon Bank and her and she may be liable for the loss Kowloon Bank suffered. However, as Renee did not know that Shatin Bank would rely on the audited financial statements and her audit report, there was no special relationship between Shatin Bank and her and she is not liable for the loss Shatin Bank suffered. 1. (c) Advise the following parties as to the proper procedures they may use to wind up the company: i) Christy as a company director; and (5 marks) ii) Fanling Bank as a company creditor. (5 marks) Ans (c) i) Candidates are expected to discuss the proper procedures to wind up a company. Candidates are expected to explain the procedures under section 228A of the Companies (Winding Up & Miscellaneous Provisions) Ordinance. Section 228A(1) provides that the directors of a company or, in the case of a company having more than two directors, the majority of the directors, may, if they have formed the opinion that the company cannot by reason of its liabilities continue its business, resolve at a meeting of the directors and deliver to the 5

6 Registrar a statement in the specified form (the winding-up statement), signed by one of the directors, certifying that a resolution has been passed to the effect that: (a) the company cannot by reason of its liabilities continue its business; (b) they consider it necessary that the company be wound up and that the winding up should be commenced under this section because it is not reasonably practicable for it to be commenced under another section of this Ordinance; and (c) meetings of the company and of its creditors will be summoned for a date not later than 28 days after the delivery of the winding-up statement to the Registrar. A winding-up statement shall have no effect unless it is delivered to the Registrar for registration within seven days after the date on which it is made (section 228A(3)). Any director of a company signing a winding-up statement without having reasonable grounds: (a) for the opinion that the company cannot by reason of its liabilities continue its business; or (b) to consider that the winding up of the company should be commenced under section 228A because it is not reasonably practicable for it to be commenced under another section of the Companies (Winding Up & Miscellaneous Provisions) Ordinance, shall be liable to a fine and imprisonment (section 228A(4)). In this case, if the majority of the company s directors have formed the opinion that the company cannot by reason of its liabilities continue its business, and they resolve this at a meeting of the directors, Christy may make a winding up statement to wind up the company voluntarily and deliver the statement to the Registrar for registration within seven days. 6

7 (ii) Candidates are expected to explain the procedures under section 177(1)(d) 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. Section 177(1)(d) provides that a company may be wound up by the court if the company is unable to pay its debts. Section 178(1) provides that a company shall be deemed to be unable to pay its debts: (a) if a creditor, by assignment or otherwise, to whom the company is indebted in a sum then due equal to or exceeding the specified amount, has served on the company, by leaving it at the registered office of the company, a demand under his hand requiring the company to pay the sum so due, and the company has for three weeks thereafter neglected to pay the sum, or to secure or compound for it to the reasonable satisfaction of the creditor; or (b) if execution or other process issued on a judgment, decree or order of any court in favour of a creditor of the company is returned unsatisfied in whole or in part; or (c) if it is proved to the satisfaction of the court that the company is unable to pay its debts, and, in determining whether a company is unable to pay its debts, the court shall take into account the contingent and prospective liabilities of the company. In this case, Fanling Bank may serve a statutory demand to the registered address of the company and wait for 21 days. If Win Win Limited fails to comply with the statutory demand, it will be deemed to be unable to pay its debts and Fanling Bank may petition to wind up the company under section 177(1)(d). 1. (d) The company is going to be wound up very soon. Assuming both charges were valid, advise the liquidator as to the priority between COB s charge and CTB s charge. (10 marks) (Total: 40 marks) 7

8 Ans (d) Candidates are expected to explain the rules about priority of charges. The priority between two charges depends on the nature of the charges and the dates of creation of the charges. The dates of registration are not relevant as long as the charge is registered within one month after creation. The priority between COB s floating charge and CTB s fixed charge depends on the notice of CTB at the time of creation of its fixed charge. Notice includes actual notice and constructive notice. 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. Section 335 now requires a copy of a charge document to be registered with the required particulars, so that 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 over a subsequently created fixed charge. However, in our case, when CTB s fixed charge was created (25 March 2016), COB had not registered its charge. COB only registered its charge on 14 April 2016, which was after the creation of CTB s charge. Even if CTB had inspected the public record at the time of creation of its charge, it would not have been able to find out about COB s charge. Therefore, CTB did not have constructive notice of COB s charge. As a result, CTB s charge may still have priority over COB s charge, provided that CTB did not have actual and constructive notice of COB s charge. 8

9 SECTION B 2. Chan Kee Holding Limited (CKHL) is an investment holding company incorporated in the Cayman Island and which is not registered in Hong Kong. CKHL does not have any business in Hong Kong, except that it ultimately owns Chan Kee Restaurant, a Hong Kong restaurant, through a complex intermediate corporate structure. Following the death of CKHL s founder, Albert, the relationship between his two daughters, Betty and Catherine, broke down. Betty and Catherine both own 50% of the issued shares of CKHL. Betty is very unhappy with Catherine s management style and alleges that CKHL s affairs are being conducted in a manner which is unfairly prejudicial towards Betty. Betty wants to sell her shares to Catherine, or, alternatively, for CKHL be wound up on just and equitable grounds. REQUIRED: 2. (a) Advise Betty as to the required elements she needs to prove to establish an action for an unfairly prejudicial act under the Companies Ordinance (Cap 622) and whether she may successfully apply for such an order if CKHL is not registered in Hong Kong. (10 marks) Ans (a) Candidates are expected to explain the rules about unfairly prejudicial acts. Section 724 provides that the court may exercise its powers to give relief if, on a petition by a member of a company, it considers that: the company s affairs are being or have been conducted in a manner which is unfairly prejudicial to the interests of the members generally or of one or more members (including the member); or an actual, or proposed, act or omission of the company (including one done or made on behalf of the company) is or would be so prejudicial. Unfairness and prejudice must co-exist with respect to the conduct being complained about: Re Taiwa Land (1981). Unfair discrimination against the minority may be unfair prejudice. In Donaldson Investment v Anglo Transvaal (1979) the court said that the mino rity must show 9

10 that the majority had acted in such a way as to prevent the minority exercising fair participation in the running of the company s affairs. In Re Tai Lap Investments [1999], 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. This must be conduct which departs from the accepted standards of fair play, or which amounts to an unfair discrimination against the minority. To establish unfairly prejudicial conduct, the petitioner did not have to show that the persons controlling the company knew they were acting unfairly, or that they acted in bad faith. The test was whether a reasonable bystander, observing the consequences of the conduct, would regard it as having unfairly prejudiced the petitioner s interests. Section 724 applies to a company incorporated in Hong Kong and a non-hong Kong company. In Re Yung Kee Holdings Ltd (2014), an order was sought under section 168A (now section 724) to buy out a minority shareholder but the Court of Appeal held that the company had not established a place of business in Hong Kong and was not a non-hong Kong company; therefore section 724 did not apply. In this case, as CKHL is only an investment company and has not been registered in Hong Kong, section 724 does not apply. As a result, Betty will not succeed in her application under section (b) Advise Betty as to whether she may successfully wind up CKHL under the Companies (Winding Up & Miscellaneous Provisions) Ordinance (Cap 32) if the company is not registered in Hong Kong. (10 marks) (Total: 20 marks) Ans (b) Candidates are expected to explain the rules about winding up an unregistered company in Hong Kong. Part X of Cap 32, sections A, provides for the winding-up of unregistered companies. Section 326(1) states that for the purposes of this part an 10

11 unregistered company includes any partnership, whether limited or not, any association, and any company. In Re China Tianjin International Economic and Technical Cooperative Corp (1995), it was held that a foreign company could, by virtue of section 326, be regarded as an unregistered company and therefore wound up under section 327. The court also held that the jurisdiction to wind-up a foreign company is flexible. What is important is that there is a sufficiently close connection with the jurisdiction and that there is a reasonable possibility of benefit for creditors from the winding-up. The court must also be able to exercise jurisdiction over one or more persons interested in the distribution of the company s assets. The foreign company in question was formed in Mainland China. It owned one share in a Hong Kong company and claimed to have established offices in Hong Kong and business operations all over the world. It could therefore be presumed that the company did have assets in Hong Kong which could be recovered if a winding-up order were made. Any unregistered company may be wound up under Part X of Cap 32 if: a) the company is dissolved, or has ceased to carry on business, or is carrying on business only for the purpose of winding-up; b) the company is unable to pay its debts the company is deemed to be unable to pay its debts if: - a creditor is owed $10,000 and serves notice on the company requiring it to pay within the following three weeks and it neglects to pay, or secure, or compound it to the creditor s satisfaction; - an action is brought against any member for any debt due from the company or from him in his character of member, and notice of the action is served on the company and it does not respond within the following ten days by paying, securing, or compounding the debt, or staying the proceedings, or indemnifying the defendant to his reasonable satisfaction; - any execution or order obtained in any court in favour of a creditor against the company or any member is returned unsatisfied; or - it is proved to the court s satisfaction that the company is unable to pay its debts; c) the court is of the opinion that it is just and equitable to wind the company up (section 327). 11

12 In Re Solar Touch Ltd (2004) the court was required to consider its discretion to wind-up a foreign unregistered company under section 327 and held that there are three core requirements: (i) there has to be a sufficient connection with Hong Kong, which could, but did not have to, consist of the existence of assets within the jurisdiction; (ii) there has to be a reasonable possibility of benefit to those applying for the winding-up order; and (iii) there had to be one or more persons over whom the court could exercise jurisdiction who were interested in the distribution of the company s assets. In Re Yung Kee Holding Ltd (2014), the court reiterated the requirements of such connection: a sufficient connection does not necessarily consist of the presence of assets within the jurisdiction, a reasonable possibility that the winding up order will benefit those applying for it, and one or more persons interested in the distribution of the company s assets are person over whom the court has jurisdiction. In this case, even though CKHL was not incorporated in Hong Kong, it could be wound up under Part X of the Companies (Winding Up & Miscellaneous Provisions) Ordinance provided that the above connections can be proved. 12

13 3. Danny was employed as a director of Wonderful Life Limited (WLL). As part of Danny s employment contract with WLL, he agreed not to seek the company s customers business once he left his employment. Early this week, Danny was removed as a director of WLL. He immediately set up a new company, Super Wonderful Life Limited (SWLL), which employs him and his wife. Danny, acting on behalf of his new company, then sought to get the business of WLL. As a result, SWLL made huge profits. REQUIRED: 3. (a) Explain whether Danny is in breach of his duty as a director of WLL even though he is no longer the director of the company. (10 marks) Ans (a) Candidates are expected to discuss the rule about breach of directors duties. Directors of companies always owe the following duties to their companies: 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 Any contract entered into by a director in breach of fiduciary duty is voidable at the company s option, but is not void automatically. In Industrial Development Consultants Ltd v Cooley [1972] 1 WLR 443, the managing director of IDC attempted to secure a contract on IDC s behalf with the Eastern Gas Board (EGB). EGB indicated to him that they were not prepared to deal with IDC but might be prepared to contract with the director (Cooley) personally. Cooley told IDC that he was ill and was allowed to terminate his contract at short notice. He then negotiated with EGB and obtained the consultancy for himself. The court held that Cooley must account to IDC for the profit he obtained for the contracts. He was in breach of duty and it was immaterial that IDC could not have obtained the contract itself. 13

14 However, just because a director obtains information as a result of his position this does not always mean that if he pursues it personally and makes a profit that he will have to hand it over. In Peso Silver v Cropper (1966) 58 DLR (2d) 1, C was a director of a mining company. The board decided not to proceed with a project as they thought it was too risky. C thought the board was wrong and told them that he wanted to pursue the project himself. He resigned and did so. The project was a great success. The company then sued him to hand over the profit he had made. The court refused saying that the company had rejected the project, C had been honest and thus he could keep the profit. In this case, even though Danny is no longer a director of the company, he may still owe a fiduciary duty to the company and not be allowed to use the company s information for his own benefit. Otherwise, he is in breach of the duty he owes to the company as a director. 3. (b) Advise WLL as to whether it may claim the profits made by SWLL. (10 marks) (Total: 20 marks) Ans (b) Candidates are expected to explain the rules 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: Salmon v Salmon 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 was a separate legal entity from its owners, the company had to pay Mr Salmon for the value of the business transferred to it from him. The company paid him partly in shares in itself and partly by way of a secured loan from Mr Salmon to it, which it promised to repay at a later date. Before the company had repaid its debt to Mr Salmon, it went into insolvent liquidation. Mr Salmon claimed all the assets of the company to repay the loan but the other creditors said this was all a fraud and that Mr Salmon and the company were in reality the same. Thus, they said Mr Salmon should not have priority in to getting his loan back. However, the court did not agree. Lord Halsbury said:...it seems to me impossible to dispute that once a company is legally 14

15 incorporated it must be treated like any other independent person with rights and liabilities appropriate to itself, and that the motives of those who took part in the promotion of the company are absolutely irrelevant in discussion what those rights and liabilities are. If a company is used as a sham or means to commit fraud or to avoid liabilities and/or legislation, the court may lift the corporate veil. In Gilford Motor Co v Horne (1933) Ch 35, Horne had been employed as a director of Gilford Motor and as part of his conditions of employment he agreed not to seek the company s customers business once he left his employment. After Horne left the company, he set up a new company, which employed him and his wife. Horne, acting on behalf of the new company, then sought to get the business of Gilford s customers. The court held that the new company was a sham and ordered both the new company and Horne not to approach Gilford s customers. Lord Hanworth said: I am quite satisfied that this company was formed as a device, a stratagem, in order to mask the effective carrying on of a business by Mr E B Horne. In this case, the court may lift the corporate veil if SWLL was used as a sham to evade an existing obligation. As a result, SWLL may be liable to account to WLL for the profits it makes. 15

16 4. Best Coffee Limited is a private money-lending company incorporated in Hong Kong. The company has adopted the model articles for private companies limited by shares as its articles. Eva, Fanny, and Gina are the company s three shareholders and they own 3,000 shares, 7,000 shares and 40,000 shares respectively. Eva and Fanny are the two directors. In a recent board meeting, it was resolved that the company would issue 50,000 shares of $100 each by way of a rights issue. The latest audited financial statements show that the company s net assets were worth $6.5 million. REQUIRED: 4. (a) Explain the meaning of a rights issue. Ans (a) Candidates are expected to discuss the rules about rights issues. (5 marks) Any company can sell its shares by way of a rights issue. This means that existing members are offered shares in proportion to their existing holding subscription on a pro rata basis. The members do not have to buy more shares if they do not want to. If they refuse, the company may then offer the shares to other investors. No shareholders approval is required for rights issues: section 140(2)(a). A company may send a letter of right to its existing shareholders inviting them to subscribe for more shares on a pro-rata basis. The letter of right may be renounceable, i.e. it may allow the members to transfer the letter; any holder may then exercise the right to subscribe. Or, the letter may be non-renounceable, i.e. only the person to whom it is addressed is allowed to subscribe for the shares. A private company is not allowed to invite the public to subscribe for its shares, but it can use a rights issue, provided that the letters of right are non-renounceable. 4. (b) Eva does not have sufficient cash to subscribe for the shares. Advise the company as to whether and how it may make a loan of $300,000 to Eva in order to allow her to subscribe for the shares. (15 marks) (Total: 20 marks) Ans (b) Candidates are expected to discuss the rules about loans to directors and financial 16

17 assistance under the Companies Ordinance. Section 500 provides that a company is prohibited from: making a loan to a director or controlled company, or giving a guarantee or providing security in connection with a loan made by any person to a director or to a controlled company. There are many exceptions to this prohibition under sections of the Companies Ordinance. Section 505(1) provides that a company is not prohibited from making a loan if the aggregate of the value of the transaction in question and the value of any other relevant transaction or arrangement does not exceed 5% of: (a) the value of the company s net assets as determined by reference to the relevant financial statements of the company; or (b) if no such relevant financial statements have been prepared, the amount of the company s called-up share capital. Section 511(1) provides that a company is not prohibited from making a loan if: (a) the company s ordinary business includes the making of loans; (b) the loan is made by the company in the ordinary course of its business; and (c) the amount of the loan is not greater, and the terms of it are not more favourable, than what is reasonable to expect the company to have offered to a person of the same financial standing but unconnected with the company. In this case, if the $300,000 loan falls within the above two exceptions, the loan may be allowed. Section 275 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 the Companies Ordinance. 17

18 Section 274(1) provides that financial assistance means: (a) (b) (i) (ii) (c) (i) (ii) (d) (i) (ii) financial assistance given by way of gift; 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; 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 other agreement referred to in subparagraph (i); or any other financial assistance given by a company if: the net assets of the company are reduced to a material extent by the giving of the assistance; or the company has no net assets Section 277 provides that the following transactions are not prohibited: (a) (i) (ii) (b) (c) (d) the distribution of a company s assets: by way of dividend lawfully made; or in the course of winding up the company; the allotment of bonus shares; the reduction of a company s share capital in accordance with Division 3 of the Companies Ordinance; the redemption or buy-back of a company s own shares in accordance with Division 4 of the Companies Ordinance; (e) anything done in accordance with a court order under Division 2 of Part 13; (f) (g) anything done under an arrangement made under section 237 of the Companies (Winding Up and Miscellaneous Provisions) Ordinance (Cap 32); anything done under an arrangement made between a company and its creditors that is binding on the creditors because of section 254 of the Companies (Winding Up and Miscellaneous Provisions) Ordinance (Cap 32). 18

19 Section 279 provides that, subject to section 282, the above restriction does not prohibit the lending of money by a company in the ordinary course of business if the lending of money is part of the ordinary business of the company. There are further relaxations for financial assistance not exceeding 5% of shareholders funds (section 283); financial assistance with approval of all members (section 284); and financial assistance by ordinary resolution (section 285). Section 283(1) provides that a company may give financial assistance for the purpose of the acquisition of a share in the company or its holding company or for the purpose of reducing or discharging a liability incurred for such an acquisition if: (a) (i) (ii) (iii) (b) (c) (d) the directors resolve, before the assistance is given, that: the company should give the assistance; giving the assistance is in the best interests of the company; and the terms and conditions under which the assistance is to be given are fair and reasonable to the company; 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 Division 2 in relation to the giving of the assistance; the aggregate amount of the assistance and any other financial assistance given under this section that has not been repaid does not exceed 5% of the paid up share capital and reserves of the company (as disclosed in the most recent audited financial statements of the company); and the assistance is given not more than 12 months after the day on which the solvency statement is made under paragraph (b). Section 283(4) provides that within 15 days after giving financial assistance under section 283, the company must send to each member of the company a copy of the solvency statement made under section 283(1)(b) and a notice containing the following information: (a) (b) (c) the class and number of shares in respect of which the assistance was given; the consideration paid or payable for those shares; the name of the person receiving the assistance and, if a different person, the 19

20 name of the beneficial owner of those shares; (d) the nature, the terms and the amount of the assistance. Section 284(1) provides that a company may give financial assistance for the purpose of the acquisition of a share in the company or its holding company or for the purpose of reducing or discharging a liability incurred for such an acquisition if: (a) (i) (ii) (iii) (b) (c) (d) the directors resolve, before the assistance is given, that: the company should give the assistance; giving the assistance is in the best interests of the company; and the terms and conditions under which the assistance is to be given are fair and reasonable to the company; 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 Division 2 in relation to the giving of the assistance; the giving of the assistance is approved by written resolution of all members of the company before the assistance is given; and 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 or its holding company or for the purpose of reducing or discharging a liability incurred for such an acquisition if: (a) (i) (ii) (iii) (b) (c) the directors resolve, before the assistance is given, that: the company should give the assistance; giving the assistance is in the best interests of the company and is of benefit to those members of the company not receiving the assistance; and the terms and conditions under which the assistance is to be given are fair and reasonable to the company and to those members not receiving the assistance; 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 Division 2 in relation to the giving of the assistance; 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: 20

21 (i) (ii) (iii) (iv) (d) (e) (i) (ii) the nature and terms of the assistance and the name of the person to whom it will be given; if it will be given to a nominee for another person, the name of that other person; the text of the resolution of the directors; 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; the giving of the assistance is approved by resolution of the company before the assistance is given; and the assistance is given: not less than 28 days after the day on which the resolution is passed under paragraph (d); and not more than 12 months after the day on which the solvency statement is made under paragraph (b). Section 285(2) provides that the notice and copy of the solvency statement must be sent to each member under section 285(1)(c) at least 14 days before the day on which the resolution under section 285(1)(d) is proposed and may accompany a notice of the meeting at which the resolution will be proposed. Section 286(1) provides that within 28 days after the day on which a resolution for the giving of financial assistance is passed under section 285(1)(d), an application to the court for an order restraining the giving of financial assistance may be made: (a) (b) if the company is limited by shares, by members representing at least 5% of the total voting rights of holders of shares in the company; or in any other case, by members representing at least 5% of the members of the company. In our case, if it falls within any of the above exceptions, the financial assistance of $300,000 loan is allowed. 21

22 5. Modern Vehicles Limited is a private company incorporated in Hong Kong. The company has adopted model articles for private companies limited by shares as its articles, except that the quorum for any general meeting of the company is three. There are three shareholders in the company: Henry, Ian, and Jenny. Each of them owns 10,000 issued shares in the company. Henry is the sole director. As Ian is unhappy with Henry s management style, he would like to call a general meeting to remove Henry from his position as director. REQUIRED: 5. (a) Explain to Ian the procedures under which he may requisition a general meeting. (8 marks) Ans (a) Candidates are expected to explain the rules about convening a general meeting. 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 must call it in accordance with section

23 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. Ian, who holds 33.3% of the company s issued shares, is entitled to request a meeting under section 566 of the Companies Ordinance by following the above procedures. 5. (b) Ian successfully convened a general meeting. However, Henry refused to attend the meeting and the quorum of the meeting was not satisfied. Advise Ian as to whether and how he may apply to the court to order a general meeting. (12 marks) (Total: 20 marks) Ans (b) Candidates are expected to explain the rule about court-ordered meetings. If, for any reason it is impracticable to call a general meeting of a company in any of the manners explained above, or to conduct the meeting in the manner prescribed by the company s articles or Cap 622, the court may, of its own motion or an application by a director or the company or by a member who would be entitled to vote at the meeting, order a general meeting to be called, held and conducted in any manner the court thinks fit (section 570). In Hong Kong Estates Ltd v San Imperial Corporation Ltd (1980), the Official Receiver in his capacity as a member of the company requisitioned the board of directors to convene a general meeting for the purpose of passing resolutions designed to replace the board with his nominees. Before the expiry of 21 days (the period for convening such a meeting) he applied to the court to convene a meeting. The directors subsequently convened a general meeting. It was held that it was practicable to call a meeting and that a court order was therefore not appropriate. In Re Universal Horizon Investment Ltd (2000), the judge in the Court of First Instance held that the company was properly run by the existing directors and there was no justification for the court to order a meeting to facilitate removing the 23

24 directors. But the Court of Appeal held that the judge had erred in approaching the application because the company was in fact frozen ; it had not produced annual accounts or held its annual general meeting, and Rogers JA described the company s situation as a log jam. He explained that, If for one reason or another, the company cannot operate properly by reason of its failure to hold a meeting or a failure of directors either to be able or willing to call a meeting, section 114B can be used to prevent the log jam from continuing. The court may also give directions, such as a direction that one member present at the meeting in person or by proxy is to be regarded as constitution a quorum: section 570. In Re El Sombrero (1958) UK, the company s two directors each held 5% of the company s shares, the remaining 90% being held by A who requisitioned an EGM to pass a resolution removing the two directors and appointing others in their place. The directors failed to comply with the requisition and A convened the meeting himself. The two directors failed to attend. The company s articles provided that two persons was the quorum required for general meetings. A applied to the court for an order to call a meeting and for a direction that one member of the company should be deemed to constitute a quorum at such a meeting. It was held that the court had jurisdiction to order a meeting to be held and for one member present to constitute a quorum. In Re Opera Photographic Ltd (1989) UK, the company had an issued capital of 100 shares; 51 were held by A and 49 by R. The company s articles provided that the necessary quorum for a meeting of shareholders or directors was two. A and R fell out and R refused to attend a meeting summoned by A. It was held that the quorum requirements in the company s articles could not be treated as conferring on R a form of veto to prevent the holding of shareholders meetings. The court granted an order convening a meeting of the company at which one member could constitute a quorum. The Hong Kong courts have shown a reluctance to order a meeting of one shareholder where there is a shareholding: Re Ma On Shan Whitehead Golf Centre Ltd (2001). In this case, Ian may apply to the court to order a general meeting of the company. 24

25 However, the court may be reluctant to make such an order unless Ian can prove that the company is frozen. 25

26 6. Friends Ltd is a private company incorporated in Hong Kong. The company has adopted model articles for private companies limited by shares as its articles. In addition, the company added an objects clause to its articles: this provides that the company s main business is to manufacture computers and related hardware. Karen has recently been appointed as the company s new managing director. She would like to expand the company s business to develop computer software. Although Karen s employment contract is only for two years, the articles provide that every managing director is to be appointed for at least five years. Karen would like to know the legal effect of this clause in the articles. REQUIRED: 6. (a) Advise Karen as to the proper procedures to alter the objects clause of the company, and the consequences if she fails to follow the proper procedures. (10 marks) Ans (a) Candidates are expected to explain the rule about ultra vires and the legal effects of the articles. Section 89(2) provides that a company may, by special resolution of which notice has been given to all the members of the company (including members who are not entitled to such notice under the company s articles), alter the objects by: (a) (b) (i) (ii) abandoning or restricting any of the objects; or adopting any new object that could lawfully have been contained: in the case of a company formed and registered under the Companies Ordinance, in the company s articles when the articles were registered; or in the case of an existing company, in the company s memorandum of association when the memorandum was registered. Section 89(3) provides that if a relevant company passes such a resolution, a notice of the resolution must also be given to all holders of the relevant debentures of the company, and the notice must be the same as the notice mentioned in section 89(2). 26

27 Section 89(4) provides that, if there is no provision regulating the giving of notice to the holders of the relevant debentures, the provisions of the company s articles regulating the giving of notice to members are to apply. Section 89(5) provides that, if a relevant company passes a special resolution altering its objects, an application to cancel the alteration may be made to the court in accordance with section 91, and if an application is made, the alteration does not have effect except in so far as it is confirmed by the court. Section 89(6) provides that, after passing a special resolution altering its objects: (a) (b) (i) (ii) (c) in the case of a relevant company, if no application is made under section 89(5), the company must, within 15 days after the end of the application period, deliver to the Registrar for registration the documents specified in section 89(7); in the case of a relevant company, if an application is made under section 89(5), the company: must immediately give notice of that fact to the Registrar; and within 15 days after the date of any Court order cancelling or confirming the alteration or, if an extension of time is granted under section 89(8), within the extended period, must deliver to the Registrar for registration an office copy of the order and, in the case of an order confirming the alteration, the documents specified in section 89(7); or in the case of a company other than a relevant company, the company must, within 15 days after the date of passing the resolution, deliver to the Registrar for registration the documents specified in section 89(7). Section 89(7) provides that the documents are: (a) (b) a notice of the alteration in the specified form; and a copy, certified by an officer of the company as correct, of the company s articles as altered. Section 89(8) provides that the court may at any time by order extend the period for delivery of any documents under section 89(6)(b). 27

28 Section 89(9) provides that, if a company contravenes section 89(6), the company, and every responsible person of the company, commit an offence, and each is liable to a fine at level 3 and, in the case of a continuing offence, to a further fine of $300 for each day during which the offence continues. Section 91(1) provides that an application under section 89(5) to cancel an alteration of the objects of a company may be made: (a) (b) by the holders of at least 5% in aggregate of the number of the issued shares in the company or any class of the company s issued share capital or, if the company is not limited by shares, by at least 5% of the company s members; or by the holders of at least 5% in value of the company s debentures that are mentioned in the definition of relevant debentures in section 89(10). Section 91(5) provides that an application under section 89(5) may only be made within 28 days after the date of passing the relevant special resolution. Section 91(6) provides that, on an application under section 89(5), the court: (a) (b) (c) may cancel or confirm the alteration (either wholly or in part), on any terms and conditions it thinks fit; may adjourn the proceedings so that an arrangement may be made to its satisfaction for the purchase of the interests of dissentient members; and may give any directions and make any order that it thinks expedient for facilitating or carrying into effect any such arrangement. In our case, Karen should pass a special resolution in a general meeting and file the required documents with the Registrar within 15 days. Otherwise, the company and every responsible person commit an office and are liable for a fine. 6. (b) Advise Karen as to the legal effects of the articles of a company and whether she is entitled to be appointed as the managing director of the company for at least five years. (10 marks) (Total: 20 marks) Ans (b) Candidates are expected to discuss the legal effect of the articles of a company. 28