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 JUNE 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. Jill, the company secretary of A Ltd, a manufacturer of electronic calculators, has a great deal of business experience and good accounting qualifications. Her pinpoint analysis leads the board of directors through complicated matters and helps it make wise decisions. On some occasions, she has managed to win debates on corporate strategy with the chief executive officer and convince the board to overturn its decisions and adopt her proposals. The chairman of the board has told Jill that the board members appreciate her efforts and have agreed to double her salary. Jill is very pleased with her career success though she has been troubled by the following matters. The board is about to accept an offer from a giant US corporation to manufacture smart phones in the Mainland. Jill is not sure whether this was a good proposition for the company, but she has reminded the board that the object clause of the company s memorandum of association does not explicitly authorise the company to enter the mobile phone market. This is understandable because A Ltd was set up at a time when mobile phones were unknown to the world. When Jill told the board that some hostile shareholders were not convinced that the company should make a huge investment in a new business, the chairman said: What can they do? Those doubters will change their mind when they see the profit. No one can stop us from signing the contract next week. Ron, a director who has expressed his intention of leaving the board after his current appointment period, told the chairman that he was discussing his future with L Ltd with a view to being appointed to its board. This information angered the chairman as L Ltd is an established manufacturer of smart phones and would be a fierce competitor of A Ltd. The chairman ordered Jill not to give notice of the board meeting to Ron and not to allow him access to any of the company s information. Ron argues that he is entitled to read any of the company s records as long as he remains as a director. The chairman has clashed with Wendy, another director of A Ltd, on various issues. The chairman came up with a plan to get rid of Wendy. Knowing that Wendy does not have a university degree, the chairman asked Jill to call an extraordinary general meeting for the purpose of requesting shareholders to approve a resolution to impose a new qualification requirement stating that every director must have a university level degree, otherwise his or her appointment would be deemed to be void. When Jill was explaining the rationale of the proposed resolution to the board at a subsequent board meeting, Wendy shrugged her shoulders, and said in a sarcastic tone that the resolution was just an ugly and illegal attempt to kick her off the board. 2

3 REQUIRED: 1. (a) Advise Jill of her legal position in playing an active role in advisory and decision making amongst members of the board while at the same time carrying out her work as a company secretary. Ans (a) Every Hong Kong company must have a company secretary (section 154(1)), though its duties are not legally defined. Once described as a mere servant who is to do what he is told and no person assume that he has any authority to do anything at all (Barnett, Hoares & Co v South London Tramsways Co (1887) 18 QBD 815), the modern view is that the company secretary is an officer of the company with extensive duties and responsibilities (Panorama Developments (Guildford) Ltd v Fidelis Furnishing Fabrics Ltd [1971] 2 QB 711 and chief administrative officer of the company (Club Flotilla (Pacific Palms) Ltd v Isherwood (1987) 5 ACLC 1027). According to the Hong Kong Institute of Chartered Secretaries, the company secretary should provide professional advice to directors to assist them in making decisions. However, the line between providing professional advice and taking part in the board proceedings is a fine one. If a company secretary has been too enthusiastic, he may risk being identified as a de facto director. The court in Re Hydrodam (Corby) Ltd [1994] 2 BCLC 180 states that, to establish that a person was a de facto director of a company it is necessary to plead and prove that he undertook functions in relation to the company which could properly be discharged only by a director. It is not sufficient to show that he was concerned in the management of the company's affairs or undertook tasks in relation to its business which can properly be performed by a manager below board level. A de facto director, I repeat, is one who claims to act and purports to act as a director, although not validly appointed as such. Based on the facts, on several occasions Jill has acted beyond the normal scope of the company secretary s work and has convinced the board with her proposals. It is arguable that Jill has assumed the work of a director because making corporate strategy is not the kind of work that a company secretary or other executive can do. Jill should be advised that she may be liable as a de facto director. And, in principle, if the company goes into liquidation because of insolvency, Jill may even be liable for the company s debts as a knowingly party to the carrying on of business under section 275 of the Companies Ordinance. 3

4 1. (b) Under the doctrine of corporate personality, can the shareholders of A Ltd take any legal action to stop the company from entering the proposed contract to manufacture smart phones? Ans (b) The most fundamental principle of company law is that a company is a separate legal entity (Salomon v Salomon Co Ltd [1897] AC 22). A shareholder as such has no power to interfere in its business regardless of its shareholding. For a company who has adopted Table A, subject to the Companies Ordinance, memorandum of association and articles of association and instructions by shareholders in the form of special resolution, the board of directors can manage the business of the company. Although there is no information about the number of shares that hostile shareholders hold, the fact that the company will enter into the contracts in question a few days later means that there is not sufficient time for the hostile shareholders to call an extraordinary meeting to pass a relevant special solution. Under the common law, object clauses define the scope of business of a company therefore an act or contract of a company which is inconsistent with its object clauses will be void (Ashbury Railway Carriage and Iron Co. Ltd. v Riche (1875) LR 7 HL 653). But this common law position has been modified by section 5B of the Companies Ordinance. A company whose objects are stated in its memorandum shall not carry on any business or do anything that it is not authorised by its memorandum to carry on or do (section 5B(1)). Section 5B applies to all Hong Kong companies no matter when they were incorporated. A shareholder of a company may bring proceedings to restrain the doing of an act in contravention of its object clauses but no such proceedings shall lie in respect of an act to be done in fulfilment of any legal obligation arising under a previous act of the company (section 5B(2)). An act of a company (including a transfer of property to or by the company) is not invalid by reason only that it acts beyond its object clauses (section 5B(3)). Jill should advise the board of directors that the hostile shareholders may apply for an injunction under section 5B(2) to prevent A Ltd from entering into the contracts in question but it is unlikely that the court would accede to such an application because the carrying on of a mobile business is not explicitly prohibited by the object clause of the memorandum and articles of association of the company. 4

5 1. (c) Can Jill legally deny Ron access to the company s internal information and not give him notice of board meeting? Ans (c) In relation to Ron s request to inspect A Ltd s documents, Re Fook Lam Moon (Kowloon) Restaurant Ltd [2011] 1 HKLRD 964 is a relevant authority in which the court said that: (1) Common law confers a right upon a director to inspect documents belonging to the company, and, if necessary, to take copies of the documents, which is essential to the proper performance of a director s duties.(2) A director will not be called upon to furnish his reasons before being allowed to exercise his right of inspection since the right of inspection flows automatically from the director s duties, and in the absence of clear proof to the contrary, the court would assume that the director is exercising it for the benefit of the company.(3) It is only if it can be clearly and affirmatively proved that (i) a director intends to abuse the confidence in relation to the company s affairs so as to injure the company in a material way, or (ii) a director is wanting to inspect the books of a company for a collateral purpose other than in pursuit of his duties as a director and for the benefit of the company, that the director s right of inspection could be interfered with. (4) The onus of establishing any alleged abuse of confidence or improper purposes lies clearly and squarely on the person who asserts it, and the court will not restrict [a director s] right to inspect the books of accounts on the strength of flimsy assertions by a hostile camp in the board Therefore, the board chairman may want to argue that Ron, who is going to join a competitor as a director, may have an ulterior purpose underlying his request to read A Ltd s documents. On the other hand, a director has a common law right to receive notice of board meeting and attend such meetings (Harben v Philips (1883) 23 Ch D 14). In principle, the chairman may rely on Re Fook Lam Moon (Kowloon) Restaurant Ltd to support his decision not to serve board meeting notice with Ron. However, in the absence of direct authority on this point, the chairman should expect Ron s legal challenge to be based on Harben v Philips. 5

6 1. (d) Explain to Wendy whether she, as a shareholder, has any legal ground to challenge the proposed amendment to articles of association if it is approved at the extraordinary general meeting. Ans (d) Subject to the Companies Ordinance and to the conditions contained in its memorandum and articles of association, a company may by special resolution alter or add to its articles of association. (section 13(1)). Any alteration or addition so made in the articles shall be as valid as if originally contained therein, and be subject in like manner to alteration by special resolution (section 13(3)). This means that the chairman s proposed amendment, if approved at the extraordinary general meeting, can be used to remove Wendy from the board. Jill should advise the chairman that even if the proposed amendment is passed, a shareholder can at the court challenge the amendment on the ground that shareholders who approved it did not vote in good faith for the interests of the company as a whole (Allen v Gold Reefs of West Africa Ltd [1900] 1 Ch 656). It is stated in Citco Banking Corporation N.V. v Pusser's Ltd & Anor (British Virgin Islands) [2007] 2 BCLC 483 that the test is whether the alteration of the articles was in the opinion of the shareholders for the benefit of the company. By what criterion is the Court to ascertain the opinion of the shareholders upon this question? The alteration may be so oppressive as to cast suspicion on the honesty of the persons responsible for it, or so extravagant that no reasonable men could really consider it for the benefit of the company. In such cases the Court is, I think, entitled to treat the conduct of shareholders as it does the verdict of a jury, and to say that the alteration of a company's articles shall not stand if it is such that no reasonable men could consider it for the benefit of the company. Jill may advise the chairman that since the proposed amendment is one that a reasonable shareholder could have considered to be for the benefit of the A Ltd as it can be seen as a step to enhance the general quality of the board of directors, the chance of success of a challenge to the proposed amendment is not high. 6

7 SECTION B 2. The board of B Ltd has decided to convene its annual general meeting on a Monday morning at a conference centre in Shenzhen. This news has surprised most of the shareholders as most of them live and work in Hong Kong. However, the board of directors explained that a visit to the factories in Shenzhen after the meeting would enable shareholders to know more about the company s operations. Therefore, the date of meeting has to be a weekday. Another thing that has surprised the shareholders is the unexpectedly bad results as stated in the annual report. REQUIRED: 2. (a) Explain, as a general rule, whether there can be any legal grounds to questions the directors decision on the time and place of a general meeting. Ans (a) Under Table A, the board of directors decide the time and place of general meeting. When making this decision, every board member must act in good faith in the interests of the company. By nature this is a subjective duty. In other words, it will be the directors not the shareholders or even the court to decide the appropriate time and place of a general meeting. The validity of an exercise of power cannot be challenged merely because too little weight is given to some matters which properly fall for consideration and too much to others. As a general rule, the court will not substitute its discretion for the discretion exercised in good faith by the directors. However, if the decision is such that no reasonable board of directors could think the decision to be substantially for which the power was conferred, the court may infer that the directors did not make the decision in good faith and intervene on that ground (Wayde v New South Wales Rugby League Ltd (1985) 3 ACLC 799). 7

8 2. (b) Explain in this case whether there would be any legal grounds for questioning the decision of the directors of B Ltd on the time and place of the proposed AGM if their true intention is to have a smaller audience for the meeting. Ans (b) In this case, it is arguable that the directors did not decide the time and place of the annual general meeting in good faith. Despite the subject nature of the duty, the court may wonder if the board could genuinely believe that the visit to the factory is so important to the company and its shareholders that it must be arranged even though it is expected that many shareholders would not be able to attend the annual general meeting, given that the visit is not even part of the annual general meeting, and that the purpose of the annual general meeting is to allow shareholders to make important decisions like appointing new directors and putting questions to directors on the company s performance and strategy. The court may come to the conclusion that no reasonable directors in the same circumstances would make the same decision. Another director s duty which is related to the duty to act in good faith is the duty to exercise powers for proper purposes. As stated in A Guide on Directors Duties published by the Companies Registry of Hong Kong, a director cannot exercise his powers for purposes that are different from the purposes for which they were conferred. The primary and substantial purpose of the exercise of a director s powers must be for the benefit of the company. If the primary motive is found to be for some other reasons (e.g. to benefit one or more directors and to gain control of the company), then the effects of his exercise of his power may be set aside. This duty can be breached even if he has acted in good faith. If there is evidence to show that the primary motive of the directors to call the annual general meeting in the Mainland is to make it difficult for shareholders to attend the meeting, then the directors of B Ltd will have breached their duty to exercise powers for proper purposes. 8

9 3. The board of directors of H Ltd, a private company formed under the Companies Ordinance only two weeks ago, had decided to issue 1.5 million new shares (the par value of one share is $1) to an important supplier (the investor) to strengthen the business relationship between them. It was agreed that the investor should hold a 20% shareholding after the allotment. One of the investor s concerns is that the total value of the proposed shareholding would exceed his budget for this investment. He has asked H Ltd to accept $1 million as full payment. REQUIRED: 3. (a) Explain what H Ltd should do before new shares can be issued to the investor. Ans (a) Notwithstanding anything in its memorandum or articles, the board of directors of H Ltd shall not without the prior approval of the company in general meeting exercise any power of the company to allot shares. This is provided that no such prior approval shall be required in relation to the allotment of shares in the company under an offer made pro rata by the company to the members of the company (section 57B(1)). Since H Ltd was only recently incorporated, we can reasonably assume that the shareholders of the company have not passed an ordinary resolution to authorise the board to issue shares to persons other than the shareholders themselves. Therefore, H Ltd should be advised to call an extraordinary general meeting for that purpose. 9

10 3. (b) Explain whether H Ltd can issue new shares to the investor for $1 million. Ans (b) Under section 50(1) of the Companies Ordinance, it is lawful for H Ltd to issue at a discount shares in the company of a class already issued if (a) the issue of the shares at a discount must be authorised by resolution passed in general meeting of the company, and must be sanctioned by the court; (b) the resolution must specify the maximum rate of discount at which the shares are to be issued; (c) not less than one year must at the date of the issue have elapsed since the date on which the company was entitled to commence business; (d) the shares to be issued at a discount must be issued within one month after the date on which the issue is sanctioned by the court or within such extended time as the court may allow. Since the company was just recently formed, its shares cannot be sold at a discount until one year has lapsed since it started its business. The procedure described here will apply in that case. Where a company has passed a resolution authorising the issue of shares at a discount, it may apply to the court for an order sanctioning the issue, and on any such application the court, if, having regard to all the circumstances of the case, it thinks proper so to do, may make an order sanctioning the issue on such terms and conditions as it thinks fit (section 50(2)). The court must be convinced that sufficient case be made for the court to exercise its discretion to sanction the issue of shares at a discount. A proper explanation should be given why it was proposed to raise capital in this way, how the discount was arrived at, and whether there would be proper protection for creditors. For example, to publish a notice of the order confirming the issue of shares at discount in a Chinese newspaper and an English newspaper circulating in Hong Kong (Re First Technology International (HK) Ltd, unrep., Miscellaneous Proceedings 1749 of 2005 (Court of First Instance, 18 November 2005)). 10

11 4. All the properties and undertakings of M Ltd had been pledged to Money Bank (the bank) under a debenture which could effectively entitle the bank to appoint a receiver and manager (receiver) to take over the charged assets and sell them in order to repay the bank. In early November the bank appointed a receiver when M Ltd s failure to make repayment had triggered the relevant clause. The directors of M Ltd understood that the receiver was going to close the company down in mid December, whilst the directors believed that the possible business volume over the coming Christmas period could be high enough to earn enough to repay a large part of the debt owed to the bank. REQUIRED: Discuss whether the receiver would be in breach of any duty to M Ltd if he decided to close down its business before Christmas. Advise whether M Ltd can ask the court to give direction to the receiver in relation to his decision to close down the business before Christmas. Ans The duties of a receiver towards the mortgagor are to act fairly and equitably. These equitable duties are imposed in order to ensure that a receiver, while discharging his duties to manage the property with a view to repayment of the secured debt, nonetheless in doing so takes account of the interests of the mortgagor and others interested in the mortgaged property. The court in Medforth v Blake [2000] Ch 86 stated that, in managing and carrying on the mortgaged business, the receiver owed the mortgagor no duty other than that of good faith: The receiver is not obliged to carry on the business. He can decide not to do so. He can decide to close it down. In taking these decisions he is entitled, and perhaps bound, to have regard to the interests of the mortgagee in obtaining repayment of the secured debt. Provided he acts in good faith, he is entitled to sacrifice the interests of the mortgagor [ie, the borrower] in pursuit of that end. The court laid down the following principles: (1) A receiver managing mortgaged property owes duties to the mortgagor and anyone else with an interest in the equity of redemption. (2) The duties include, but are not necessarily confined to, a duty of good faith. (3) The extent and scope of any duty additional to that of good faith will depend on the facts and circumstances of the particular case. 11

12 (4) In exercising his powers of management the primary duty of the receiver is to try and bring about a situation in which interest on the secured debt can be paid and the debt itself re-paid. (5) Subject to that primary duty, the receiver owes a duty to manage the property with due diligence. (6) Due diligence does not oblige the receiver to continue to carry on a business on the mortgaged premises previously carried on by the mortgagor. (7) If the receiver does carry on a business on the mortgaged premises, due diligence requires reasonable steps to be taken in order to try to do so profitably. The directors of M Ltd may not be happy to know that the receivers of its assets are under no obligation to carry on the business with a view to maximising its value, though if they choose to do so, they must take reasonable steps to do it profitably. Another disappointment for the directors of M Ltd is that only a receiver of the property of a company or a holder of debentures of the company may apply to the court for directions in relation to any particular matter arising in connection with the performance of his functions (section 298A). 12

13 5. (a) Sam has been trying to negotiate with G Ltd for compensation having alleged that it had supplied him with defective goods. The subject matter of the dispute was a second-hand racing car valued at $1 million which broke down in the first week after it was delivered to Sam. Sam is certain that there was a latent defect in the car as he had been driving the car responsibly. But G Ltd has insisted that this is not the company s problem. Sam has been thinking of submitting an application to the court to liquidate G Ltd in order to force the company to pay. REQUIRED: Advise Sam whether his plan is workable under company law. Ans (a) A creditor of a company can submit an application to the court to wind up a company based on its insolvency (section 177(1)). A company is deemed to be unable to pay its debts (section 178) if (i) the company fails to pay off a debt exceeding $10,000 within three weeks of receipt of a written demand served by a creditor; (ii) an execution of judgement issued is returned unsatisfied in whole or in part; or (iii) the court, taking into account any contingent and prospective liabilities of the company, is satisfied that the company is unable to pay its debts. Although the value of the car is many times more than $10,000, whether G Ltd had sold a defective car to Sam is arguable. In other words, the existence of the liability is in dispute. The court in Re Par Excellence Co. Ltd. [1990] 2 HKLR 277 stressed that the presentation of a winding up petition is not a convenient, and often not a proper method of trying a disputed debt. In other words, if there is any reasonable ground for disputing the existence of the debt, a petition should not be presented. Sam should be advised that he should first go to the District Court or the Court of First Instance, depending on the amount of his claim. Should the court rule in his favour and G Ltd ignore his claim after being served a three-week written demand for repayment, then he can proceed to petition the court for a winding up order against G Ltd. 13

14 5. (b) Sam found out that a manager of G Ltd was actually a long-lost friend. The manager frankly told Sam that another creditor had filed a winding-up petition against G Ltd and that the company would very likely be wound up soon. Out of friendship, the manager suggested that G Ltd could pay half of the compensation that Sam was asking for to settle the dispute. Sam did not see any other better option so he accepted the offer and took the money. REQUIRED: Advise Sam on the legality of the manager s proposal if G Ltd subsequently goes into liquidation. Ans (b) Sam should note that the proposed payment to him can subsequently be challenged by the liquidator of G Ltd as an unfair preference. A company is said to have given an unfair preference to a creditor if it does anything which has the effect of putting the creditor into a position which, in the event of the company going into insolvent winding up, would be better than the position he would have been in if that thing had not been done, and the company in doing that was influenced by a desire to produce that effect. The nature of a desire to prefer was explained in Re MC Bacon Ltd. [1990] BCLC 324: A transaction will not be set aside as a voidable preference unless the company positively wished to improve the creditors position in the event of its own insolvent liquidation. [The desire to prefer] may be inferred from the circumstances of the case. That requirement is satisfied if it was one of the factors which operated on the minds of those who made the decision. It need not have been the only factor or even the decisive one. Therefore, if a payment is made under pressure such as when a creditor threatens to sue for payment, the payment may not be treated as an unfair preference (Re Hoi Sing Construction Co. Ltd. [2001] 2 HKLRD 833). A company who has given an unfair preference to a person who, at the time the unfair preference was given, was an associate of the company is presumed to have been influenced in deciding to give it by such a desire to prefer (section 50(5) of the Bankruptcy Ordinance). In relation to the company in question (section 51B of the Bankruptcy Ordinance): The preference must be given at a relevant time. For a time to be relevant, (i) the company must have been insolvent at the time of giving the preference, or have become insolvent as a result thereof (section 50(2) of 14

15 the Bankruptcy Ordinance); and (ii) the alleged preference must have been given within six months of the commencement of the winding up; or two years where the parties are associates (section 266B of the Companies Ordinance). If a case of unfair preference is proved, the court can make such orders it thinks fit to restore the position to it would have been if the company had not given the unfair preference. Based on the facts, the liquidator of G Ltd should be able to prove the desire of G Ltd to prefer Sam at the expense of other creditors even though the presumption of such desire will not apply to Sam s case as he is not an associate of G Ltd. 15

16 6. (a) Eric, the company secretary of D Ltd, a company incorporated under the Companies Ordinance with Table A as its articles of association, intended to post the notice of meeting to its members on 1 April 2012 to convene the annual general meeting (AGM) within the month. One agenda item at the AGM is the proposal to authorise the board chairman to sell his valuable property to the company. REQUIRED: Which date would be the earliest time that the AGM can be convened? What information should the notice of meeting contain? Ans (a) In relation to a notice of an annual general meeting, the notice period must not be shorter than 21 calendar days. Every day within the notice period must be a clear day. Therefore the day of posting or serving the notice and the day of meeting will not count towards the notice period. And, under Table A, a member of a company is deemed to have received the notice of meeting 48 hours after the day of posting or serving the notice. Given that Eric should take 4 April as the first day of the notice period, the earliest day for the annual general meeting will be 25 April. Table A requires a notice of annual general meeting to contain the time, place and a description of the special business of the meeting. Since the proposal to authorise the transaction between the director and the company is not one of the four ordinary businesses of the annual general meeting, it is taken as a special business. And the notice shall contain an accurate description of the ordinary resolution proposed to authorise the transaction between the chairman and the company. The notice shall also include a statement containing such information and explanation as is reasonably necessary to indicate the purpose of the resolution; and disclosing any material interests of any director in the matter dealt with by the resolution so far as the resolution affects those interests differently from the interests of other members of the company. Eric should make sure that the notice should notify the shareholders that the chairman as the seller will have an interest different from that of the company. 16

17 6. (b) Five days before the date of the proposed AGM, it was found that the notice of meeting failed to reach a shareholder of D Ltd, who was a long-time critic of the chairman of the board of directors. This shareholder refused to take the short notice and threatened to take legal action if the AGM was convened on the date stated on the notice of meeting. REQUIRED: Advise Eric whether D Ltd could still convene the meeting as scheduled in spite of the threatened legal challenge. Ans (b) Notice of the meeting of a company must be served on every member of the company in the manner in which notices are required to be served by Table A (section 114A(1)(a)). A failure to discharge this obligation will cause the meeting and the resolutions passed therein to be invalidated as a result. Eric can advise the board of directors that the meeting can proceed if they can prove that it is an accidental omission that the notice failed to reach that shareholder. 6. (c) On the morning of the day of AGM, the chairman was hospitalised with an emergency condition. The board members suggested that Eric should chair the meeting. REQUIRED: Explain whether Eric can chair the AGM. Ans (c) Table A provides that the chairman of the board of directors shall be the chairman at general meetings, or if he/she fails to attend or is unwilling to act, the directors present can elect one of them as the chairman. If no director is willing to preside as chairman, the members present can choose one of them to be chairman (Table A, arts 57 and 58). END 17