THE HONG KONG INSTITUTE OF CHARTERED SECRETARIES. Suggested Answers. Level : Professional Subject : Hong Kong Corporate Law Diet : June 2006

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1 THE HONG KONG INSTITUTE OF CHARTERED SECRETARIES Suggested Answers Level : Professional Subject : Hong Kong Corporate Law Diet : June 2006 The suggested answers are published for the purpose of assisting students in their understanding of what may be expected from a good candidate in the time allowed for each paper. They are in no way exhaustive nor model answer to the questions. They do not reflect the opinion of HKICS.

2 THE HONG KONG INSTITUTE OF CHARTERED SECRETARIES HONG KONG CORPORATE LAW JUNE 2006 Section A Suggested Answers 1. (a) According to section 29 of the Companies Ordinance, to be a private company in Hong Kong, a company has to include the following three restrictions in its articles of association: (i) (ii) (iii) the company restricts the right to transfer its shares; and the company limits the number of its members to 50, not including persons who are in the employment of the company and persons who, having been formerly in the employment of the company, were, while in that employment, and have continued after the determination of that employment to be, members of the company; and the company prohibits any invitation to the public to subscribe for any shares or debentures of the company. If the articles of association of a company fail to satisfy the requirement of section 29, the company is a public company. (b) A fixed charge fastens on ascertained and definite property or property capable of being ascertained and defined. On the other hand, a floating charge is usually created over an entire class of assets such as book debts or stock. The identity of individual items will change constantly and the charge attaches only when the charge crystalises; this is triggered by an event specified in the debenture document. The classic definition of the floating charge was given in Re Yorkshire Woolcombers Association (1903), in which the court decided that a floating charge must have the following characteristics: (i) (ii) (iii) is a charge over a class of assets, present or future; and the class of assets would be bought or sold or changed in the normal course of business; and the parties to the charge both imagine that the company's ordinary business will continue in the usual way and that the charge s assets will continue to be dealt with by the company. In deciding whether a charge is a fixed charge or floating charge, the court will construe the debenture to ascertain what the parties intended to grant each other. The court will regard a charge to be floating if the parties are free to deal with the charged assets. Agnew & Bearsley v Commissioners of Inland Revenue (2001) 2

3 Smith (Administrator of Cosslett (Contractors) Ltd.) v Bridgend Courty Borough Council [2002] 1 All ER 292 (c) From section 131 of the Companies Ordinance: (1) Every company shall at each annual general meeting of the company appoint an auditor or auditors to hold office from the conclusion of that meeting until the conclusion of the next annual general meeting of the company. (2) Where at an annual general meeting of a company no auditors are appointed or reappointed, the court may, on the application of any member of the company, appoint a person to fill the vacancy. (3) The first auditors of a company may be appointed by the directors at any time before the first annual general meeting of the company, and auditors so appointed shall hold office until the conclusion of that meeting. (4) If the directors fail to exercise their powers under subsection (3), those powers may be exercised by the company in general meeting. (5) The directors, or the company in general meeting, may fill any casual vacancy in the office of auditor, but while any such vacancy continues, the surviving or continuing auditor or auditors, if any, may act. (6) 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; and, 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 shall within 14 days give notice of that fact in the specified form to the Registrar of Companies. (d) Rights issues are dealt with in section 57B of the Companies Ordinance. A rights issue is an invitation to the company s existing shareholders to subscribe for further shares on a pro rata basis. The board of directors has the power to make such an issue without first obtaining the approval of the general meeting under section 57B(1), which reads as follows: (1) Notwithstanding anything in a company's memorandum or articles, the directors shall not without the prior approval of the company in general meeting exercise any power of the company to allot shares: 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, excluding for that purpose any member whose address is in a place where such offer is not permitted under the law of that place. A letter of right or a provision letter of allotment may be issued to existing shareholders. The letter may be renounceable, i.e. allowing shareholders to transfer the letter, or non-renounceable, i.e. only the person to whom it is addressed may exercise the right to subscribe for the shares. 3

4 (e) As Fa Fa Ltd is a Hong Kong listed company, the following methods may be used to buy back its shares: (1) by making a general offer (2) by purchasing the shares through the Stock Exchange of Hong Kong or a recognised stock exchange (3) otherwise than any of the above A general offer is offer to all members of company or to all members holding shares of a particular class on terms which are the same in relation to all such shares or in relation to shares in each class. A general offer: must be authorised in general meeting by an ordinary resolution a copy of an offer containing such particulars as would enable a reasonable person to form a valid and justifiable opinion as to the merits of offer must be included in the general meeting notice A stock market purchase: must be authorised in general meeting by an ordinary resolution (typically at the company s AGM) the memorandum of terms of the proposed offer must be included with the notice of the meeting the authorisation is valid until the next AGM Any other purchases must be authorised by special resolution (e.g. if the company buys shares belonging to only one member). A statement signed by the directors, which contains such particulars as would enable a reasonable person to form a valid and justifiable opinion to such a purchase, must be prepared. (f) Every company in Hong Kong must have a company secretary (section 154 of the Companies Ordinance) and the company secretary is an officer of the company. Section 154 reads as follows: (1) Every company shall have a secretary. (1A) Subject to subsections (1B) and (4), a director of a company may be the secretary of the company. (1B) The director of a private company having only one director shall not also be the secretary of the company. (2) The secretary of a company shall:- (a) if an individual, ordinarily reside in Hong Kong; (b) if a body corporate, have its registered office or a place of business in Hong Kong. (3) Anything required or authorised to be done by or to the secretary may, if the office is vacant or there is for any other reason no secretary capable of acting, be done by or to any assistant or deputy secretary or, if there is no assistant or deputy secretary capable of acting, by or to any officer of the company authorised generally or specially in that behalf by the directors. 4

5 (4) No private company having only one director shall have as secretary of the company a body corporate the sole director of which is the sole director of the private company. The Listing Rules require that company secretary of a listed company must be must be: (i) an Ordinary member of The Hong Kong Institute of Chartered Secretaries (ii) lawyers or professional accountants; or (iii)otherwise have an appropriate level of experience. In our case, if Shirley does not have the above qualifications, she is not allowed to be the company secretary of Wonderful Ltd once it is listed on the Hong Kong Stock Exchange. (g) Under Table A Article 49, a company must hold an AGM at least once a year, and no more than 15 months may lapse between AGMs. However, so long as a company holds its first AGM within 18 months of incorporation, it need not hold an AGM in the year of incorporation or in the following year (section 111(1) of the Companies Ordinance) In practice most companies will hold their AGM at the same time every year business transacted may be ordinary or special. However, as from 1 July 2000, companies can dispense with holding a physical AGM if all the documents normally tabled at an AGM are circulated to all members and all the members sign a written resolution consenting to the proposals. Therefore, if 100% of members agree in writing not to hold an AGM, none need be called (section 111(6)). The length of notice required is 21 days for AGMs (section 114(1)(a)) Section 114(3) and Table A, Article 52 provide that an AGM of the company may be called by a shorter notice if all members entitled to attend and vote agree. (h) Preference shares: This type of share normally has a preferential right to a fixed dividend and/or to capital on a winding-up. Fixed rate of dividend. Preference shares usually do not carry voting rights. The right to dividend may be cumulative or non-cumulative. The description of the shares as cumulative means that if no dividend is declared in any year, the arrears must be carried forward and paid before the dividend paid on ordinary shares, Webb v Earle (1875). The articles of association, the terms of issue or the share certificate usually define the right of preference shares. If these documents are silent, it will be presumed that a preference shareholder has no right to participate in profit beyond his entitlement to a fixed percentage of dividends stated in the terms of issue; that he has the same right to vote as other shareholders; and in a winding-up there is no priority as to repayment of capital. 5

6 Ordinary shares: Ordinary shares only receive a dividend after the preference shares have been paid. They carry no fixed rate of dividend. The right to dividend is non-cumulative. Ordinary shares usually carry voting rights. (i) The duty of disclosure arises when, in the circumstances set out in section 313 of the Securities and Futures Ordinance (SFO), a person acquires or disposes of an interest in the relevant share capital of a listed corporation or there is a change in the nature of his existing interest (section 310(1), (2) and (3) provide for disclosure in respect of specific interests held at specified times). At present, a substantial shareholder must give a notification if he acquires an interest in shares or ceases to have an interest in shares and there is a change in the percentage level of his interest (section 4(5) (b) of Securities (Disclosure of Interests) Ordinance. However, there are situations where a person may enter into a transaction which dramatically changes the nature of his interest without changing the percentage level: for example, where a substantial shareholder exercises an option to buy or sell shares, or in the case of stock lending. The current percentage share holding for a substantial shareholder is 5%. In our case, Peter has acquired 10% shares in a listed company, so he is under a duty to disclose his interest under section 313(1)(a) of the SFO. He needs to make the disclosure within three business days after he acquires not less than 5% of the shares of the listed company. Under the SFO, he needs to notify both the Stock Exchange of Hong Kong and the relevant listed company, i.e. Song Ltd. (j) Section 2(4) of the Companies Ordinance provides that a company shall be deemed to be a subsidiary of another company, if: (a) that other company: (i) controls the composition of the board of directors of the first-mentioned company; or (ii) controls more than half of the voting power of the first-mentioned company; or (iii) holds more than half of the issued share capital of the first-mentioned company; or (b) the first-mentioned company is a subsidiary of any company which is that other company's subsidiary. Section 2(5) provides that the composition of a company's board of directors shall be deemed to be controlled by another company if that other company, by the exercise of some power exercisable by it, without the consent or concurrence of any other person, can appoint or remove all or a majority of the directors, and, for the purposes 6

7 of this provision, that other company shall be deemed to have power to make such an appointment if: (a) a person cannot be appointed as a director without the exercise in his favour by that other company of such a power; or (b) a person's appointment as a director follows necessarily from his being a director or other officer of that other company. Section 2(6) provides that in determining whether one company is a subsidiary of another company: (a) (b) (c) (d) any shares held or power exercisable by that other company in a fiduciary capacity shall be treated as not held or exercisable by it; subject to paragraphs (c) and (d), any shares held or power exercisable- (i) by any person as a nominee for that other company (except where that other company is concerned only in a fiduciary capacity); or (ii) by, or by a nominee for, a subsidiary of that other company, not being a subsidiary which is concerned only in a fiduciary capacity, shall be treated as held or exercisable by that other company; any shares held or power exercisable by any person by virtue of the provisions of any debentures of the first-mentioned company or of a trust deed for securing any issue of such debentures shall be disregarded; and any shares held or power exercisable by, or by a nominee for, that other company or its subsidiary (not being held or exercisable as mentioned in paragraph (c)) shall be treated as not held or exercisable by that other company if the ordinary business of that other company or its subsidiary, as the case may be, includes the lending of money and the shares are held or power is exercisable as aforesaid by way of security only for the purposes of a transaction entered into in the ordinary course of that business. 7

8 SECTION B 2.(a) A pre-incorporation contract is a contract purported to be made or on behalf of a company which has not yet been formed. At common law the following rules have been established: (1) Until a company is formed it has no legal existence. A company comes into being from the date in its certificate of incorporation. Prior to this a pre-incorporation contract cannot be enforced by or against the company, for it is not possible to contract with a non-existent person. (2) An attempt to ratify the contract by the company after it has been formed will not make such a contract valid. This is because ratification has retrospective effect and attempts to give authority to a person to act on behalf of the company at the time the contract was made. Since a company was not formed at this time it cannot give the necessary authority to the person who actually made the contract. (3) Since the company is not liable on the contract, the promoters may be personally liable. Personal liability of promoters In Kelner v Baxter (1866), K owned some wine which was to be sold to a new company which was promoted by A, B and C. The wine was delivered and drunk but not paid for. The new company went into liquidation. K sued A, B and C, who were found to be personally liable on the contract. In Phonogram Ltd. v Lane (1981), a new company was to be formed to manage a pop group. P agreed to provide a loan to the new company and the contact was signed by L for and on behalf of X Ltd. X Ltd never formed. L was personally liable. Novation. Where the promoters enter a contact on behalf of a new company before it is formed, the company may, after incorporation, enter into a new contact on exactly the same terms as the old one. The first contract is then discharged and the company will be liable, not the promoters. The other party to the new contract must agree with this scheme. (4) Ratification of pre-incorporation contracts. It is now possible for a company to ratify pre-incorporation contracts as the Companies Ordinance has changed the common-law position. Under section 32A(1) a company is given legal power to confirm a preincorporation contract notwithstanding that it did not exist at the time the contract was made. Also, unlike novation, a third party cannot refuse substitution of the company for the promoter if it was made clear in the original contract that the company would take over (ratify) the contract when it was legally formed. 8

9 Section 32A(1) reads: Where a contract purports to have been made in the name or on behalf of a company at a time when the company has not been incorporated: (a) subject to subsection (2) and any express agreement to the contrary, the contract shall have effect as a contract entered into by the person purporting to act for the company or as agent for it, and he shall be personally liable on and entitled to enforce the contract accordingly; (b) the company may, after incorporation, ratify the contract to the same extent as if it had already been incorporated at that time and as if the contract had been entered into on its behalf by an agent acting without its authority. (5) Breach of warranty of authority. If the company refuses to ratify a pre-incorporation contract, the other party may then sue the promoter for any losses it has sustained (section 32A of the Companies Ordinance). Section 32A(2) reads: Where a contract is ratified by virtue of this section, the person who purported to act for or on behalf of the company in making the contract shall not thereafter be under any greater liability than he would have been if he had entered into the contract on behalf of the company as an agent acting without its authority and after its incorporation. In this case, if Sandy and Cindy sign a pre-incorporation contract, they will be personally liable for the contract unless they can successfully seek ratification of the contract after incorporation. Ratification is made by passing an ordinary resolution in a general meeting of the company, i.e. more than 50% vote, by members present and who vote in the meeting. In this case, it seems that Sandy and Cindy will become shareholders of the company and they may subsequently exercise their voting right to pass an ordinary resolution to ratify the contract. Therefore, it seems that there is no risk of being personally liable in signing a pre-incorporation contract provided that they own more than 50% of the voting rights of the company. 9

10 2 (b) (a) Promoter Sandy may be regarded as a promoter of the company. A promoter is a person who sets up a company by arranging its incorporation and/or sales of shares in the company. In Emma Silver Mining v Grant (1879), the court decided that anyone who arranges for some one to be a director, places shares, negotiates contracts or even prepares a prospectus is a promoter. In Tracy v Mandalay (1953) " the term "promoter" involves the idea of exertion for the purpose of getting up and starting a company and also the idea of some duty towards the company imposed by or arising from the position which the so-called promoter assumed towards it. " And also in Twycross v Grant (1877) Cockburn J defined a promoter as "... one who undertakes to form a company with reference to a given project, and to set it going, and who undertakes the necessary steps to accomplish that purpose." A promoter is a person who brings the company into existence other than by merely carrying out professional duties as a lawyer, accountant, etc., section 40(5)(a) of the Companies Ordinance. Whether a person is a "promoter" is a question of fact depending on the circumstances of the case. In this case, it seems that Sandy and Cindy are the persons who are responsible for setting up the company and may be regarded as promoters. However, whether they are promoters or not is a question of fact. If the court decides that Sandy is not a promoter, she does not owe any duty to the company and she may keep the profits. However, if she is regarded as a promoter of the company, she owes a fiduciary duty to the company and may not be able to keep the profits. (b) Fiduciary duties A fiduciary is a person who stands in a position of trust and confidence with respect to someone else and who is therefore obliged to act for that person's benefit (i.e. a trustee is a fiduciary re a beneficiary, a partner re another partner, etc.) Anyone regarded as a "promoter" is in a fiduciary position to the company with all the duties of disclosure and accounting. A promoter must not make any profit out of the promotion without disclosing it to the company (Schedule 3, Para. 6 of the Companies Ordinance). (c) Disclosure of profits The promoter must disclose the amount of his profit to an independent board of directors. In Erlanger v New Sombrero (1878) 3 App Cas 1218, E purchased an island with the right to mine for minerals. E then formed a company whose directors took their instructions from E. The directors then signed a contract on behalf of the company to buy the island from E for a large sum. E made a profit. The minerals were not a profitable business for the company and the company later 10

11 sought to sue E, saying that since he was a promoter he should have fully disclosed his interest. The court held that the directors were not independent of the promoter (E). E was in breach of fiduciary duty and the contract for sale of the island could be rescinded. Explicit disclosure to subscribers in the prospectus: In Gluckstein v Barnes (1900), the promoter disclosed some of profit he made on selling an asset to the company in the prospectus, but not all of it. The court held he had to disclose the whole profit or he would be in breach of duty. In this case, assuming Sandy is a promoter of the company, she needs to disclose her profits to an independent board of directors. If there is no independent board of directors, she should make her disclosure to the initial shareholders. If she fails to disclose, she will be in breach of her fiduciary duty as a promoter. Recovery of secret profits is the normal remedy for breach of fiduciary duty. If a promoter sells property to the company at a profit and does not disclose the profit made, the company can rescind the contract but the right to rescind is only available if: (1) the company rescinds reasonably promptly after becoming aware of the misrepresentation; (2) the company does nothing that indicates that it has affirmed the contract after becoming aware of the misrepresentation; (3) restitutio in integrum is possible, i.e. it is possible to substantially restore the parties to their original position; (4) no innocent third party acquires an interest in the property prior to the rescission of the contract. Termination of a promoter's duties occurs when an independent board of directors takes over the management of the new company s affairs. In this case, if Sandy fails to disclose her profits, it seems that recovery of secret profits is an appropriate remedy. She needs to return the $100,000 to the company. 11

12 3(a) Charge created over book debts fixed charge or floating charge In the case of Illingsworth v Houldsworth (1904) the court described a fixed charge as one that fastens to ascertained and definite property or property capable of being ascertained and defined. Thus, a particular, identified, company-owned asset is fixed with payment of the charged sum. The company may not sell the asset without the consent of the debenture holder. The charge may be an equitable one over assets yet to exist or a legal one over assets that do exist at the time the charge is created. Legal fixed charges are usually created by a deed; if over land, they must be created. The classic definition of the floating charge was given in Re Yorkshire Woolcombers Association (1903) in which the court decided that a floating charge must have the following characteristics: charge over a class of assets, present or future the class of assets would be bought or sold or changed in the normal course of business the parties to the charge both imagine that the company's ordinary business will continue in the usual way and that the charge s assets will continue to be dealt with by the company Sometimes it can be difficult to distinguish between a fixed and a floating charge. In Re New Bullas Trading (1994) NBT gave a charge over its book debts. The debenture expressed the charge created as a fixed charge over all present and future book debts of NBT and that future book debts would be paid into a separate bank account and the money that arose from them could only be dealt with if the charge owner consented. The question arose as to whether a fixed or a floating charge was created. The Court of Appeal finally decided that the charge was a fixed one because that was the intention of the parties. However, the decision is controversial and is not accepted by many academics or lawyers. However, there has recently been an important new case on the issue Agnew & Bearsley v Commissioners of Inland Revenue ( Brumark ) 5 June This is a case on appeal from the New Zealand Court of Appeal to the Privy Council (PC) in London. It is an important decision but is not necessarily binding case law in Hong Kong. Brumark had granted a charge over book debts. The charge allowed the company to collect the debts and to use them in its ordinary course of business. The legal issue arose on the liquidation of the company as to whether the charge was fixed or floating. The outstanding book debts were the only asset of the company. The distinction was important because if the charge was fixed, the value of the debts in question would belong to the charge owner, the bank. If it was a floating charge at the date of its creation, the proceeds would belong to the employees and the government as they were preferential creditors, and so get paid before floating charge holders. The PC decided that the New Bullas Trading case had been wrongly decided. The PC held that if the 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 12

13 floating and 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 this case, unless the banks can exercise control over the book debts, the charges created are most likely floating charges. (b) Registration Both charges must be duly registered under section 80 of the Companies Ordinance, i.e. within five weeks after creation of the charge. In Mini s case, both charges are duly registered, i.e. within five weeks. (c) Negative pledge clause The negative pledge clause is a clause that prohibits the company from creating a subsequent charge which takes priority over the prior charge holder. However, this clause is only a contract term between the company and charge holder and will not affect the priority of the two charges, unless the subject charge holder has knowledge of the clause. If the subsequent charge holder has knowledge of the clause but still, in contravention of the clause, creates a subsequent charge over the same charged property, he may lose priority to the prior charge holder, even though his charge is a fixed charge while the prior charge is a floating charge. (d) Section 267 of the Companies Ordinance According to section 267 of the Companies Ordinance, 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. Section 267 reads as follows: Where a company is being wound up, a charge which, when created, was a floating charge on the undertaking or property of the company and which was also created within 12 months of the commencement of the winding up shall, unless it is proved that the company immediately after the creation of the charge was solvent, be invalid, except to the amount of any cash paid to the company at the time of or subsequently to the creation of, and in consideration for, the charge, together with interest on that amount at the rate specified in the charge or at the rate 12 per cent per annum whichever is the less. In our case, the two charges were created within 12 months before the winding up of the company, therefore, they might be challenged under section 267 unless the directors can prove that the company was solvent at the time of creation or any cash paid to the company. 13

14 (e) Priority distribution of assets Assuming both charges are floating charges, the priority depends on the date of crystallisation, not on the date of creation, nor on the date of registration. In Mini s case, the charges were not crystallised until the winding-up. Therefore, they should have same priority and their priority is subject to those preferential creditors, i.e. government tax and employees unpaid wages. Therefore, $500,000 will be distributed to the company s unpaid employees first, and the remaining $3.5 million will be distributed to Shatin Bank and Ma On Shan Bank in proportion to the debts owed to them (4:3). Shatin Bank will receive $3.5 million x 4/7 = $2 million while Ma On Shan will receive $3.5 million x 3/7 = $1.5 million. If any one of the two charges is a fixed charge, then it may have priority over the other charge and over the preferential creditors. If any one of the two charges is void under section 267, the charge holder will become an unsecured creditor and rank after the other charge holder and the preferential creditors. 4.(a) Section 63A of the Companies Ordinance reads as follow: (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. 14

15 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. 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. According to the above sections and article, the company has to call a class meeting and pass a special resolution in the class meeting to vary the class right. Section 64 of the Companies Ordinance 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 authorizing 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 per cent 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. According to section 64, even if the company can successfully pass a special resolution in a class meeting, 10% of shareholders in that class may apply to the court. Apart from the class meeting, as the class rights are included in articles of association of the company, the company needs to call a general meeting to alter articles of association of the company by passing a special resolution in the general meeting under section (b) Section 157B reads as follows: (1) A company may by ordinary resolution remove a director before the expiration of his period of office, notwithstanding anything in its memorandum or articles or in any agreement between it and him: (1A) Special notice is required of a resolution to remove a director or to appoint somebody in place of a director so removed at the meeting at which he is removed. (2) On receipt of notice of an intended resolution to remove a director under this section the company shall forthwith send a copy thereof to the director concerned, and the director (whether or not he is a member of the company) shall be entitled to be heard on the resolution at the meeting. (3) Where notice is given of an intended resolution to remove a director under this section and the director concerned makes with respect thereto representations 15

16 in writing to the company (not exceeding a reasonable length) and requests their notification to members of the company, the company shall, unless the representations are received by it too late for it to do so- (a) in any notice of the resolution given to members of the company state (b) the fact of the representations having been made; and send a copy of the representations to every member of the company to whom notice of the meeting is sent (whether before or after receipt of the representations by the company), and if a copy of the representations is not sent as aforesaid because received too late or because of the company's default, the director may (without prejudice to his right to be heard orally) require that the representations shall be read out at the meeting. (4) Copies of the representations need not be sent out and the representations need not be read out at the meeting if, on the application either of the company or of any other person who claims to be aggrieved, the court is satisfied that the rights conferred by this section are being abused to secure needless publicity for defamatory matter; and the court may order the company's costs on an application under this section to be paid in whole or in part by the director, notwithstanding that he is not a party to the application. (5) On a resolution to remove a director before the expiration of his period of office no share shall, on a poll, carry a greater number of votes than it would carry in relation to the generality of matters to be voted on at a general meeting; and where a share carries special voting rights (that is to say, rights different from those carried by other shares of the same nominal value) in relation to some matters but not others, the reference in this subsection to the generality of matters to be voted on at a general meeting of the company shall be construed as a reference to the matters in relation to which the share carries no special voting rights. (6) A vacancy created by the removal of a director under this section, if not filled at the meeting at which he is removed, may be filled as a casual vacancy. (7) A person appointed director in place of a person removed under this section shall be treated, for the purpose of determining the time at which he or any other director is to retire, as if he had become director on the day on which the person in whose place he is appointed was last appointed a director. (8) Nothing in this section shall be taken as depriving a person removed thereunder of compensation or damages payable to him in respect of the termination of his appointment as director or of any appointment terminating with that as director or as derogating from any power to remove a director which may exist apart from this section. According to section 157B, a company may remove a director by passing an ordinary resolution. Special notice needs to be given to the directors when the company proposes removing one of them. Weighted voting rights are not allowed under section 157B(5). If there is an employment contract, the removal without properly terminating the employment contract may amount to breach of the employment contract and the 16

17 director removed will be entitled to the damages under the employment contract under section 157B(8). Section 116B, which allows written resolution, is not applicable to removal of a director (section 116B(11)). 4(c) The common law rule in Trevor v Whitworth is confirmed by section 47A of the Companies Ordinance which states that financial assistance is not allowed except in the following procedures stated in the ordinance. Section 47B(1) defines financial assistance as anything given by way of gift; guarantee, security or indemnity; or loan, novation, account or such other agreement. Section 47B(1) 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 which are thereby reduced to a material extent or which has no net assets. Financial assistance includes guarantees. Therefore, in this case, the guarantee given to Tai Po Bank is defined as financial assistance and Miranda is not allowed to use the money to purchase the company s shares from Niki unless she follows the procedures under sections 47C-G. However, section 47C allows listed, public and private companies to give financial assistance in the following situations: (1) The company's principal purpose in giving financial assistance is not for the purpose of acquisition or the giving of such assistance is incidental to a larger purpose of company. (2) The assistance is given in good faith and in the company's interest. (3) Section 47C(3) and (4) give examples of assistance that are not caught by the rules against financial assistance: a payment of dividend, distribution of assets on winding up, allotment of bonus shares, reduction of capital with court approval, redemption or purchase as authorised by the Ordinance; also where the company is a money lending company, employee benefit schemes, loans to employees to buy shares from the company. Additionally, unlisted companies are treated more favourably than listed companies and may give financial assistance for any purpose if: net assets are not reduced 17

18 directors make a statutory declaration, stating the nature of the financial assistance, the persons assisted, the purpose of the assistance, and confirming the solvency of the company a special resolution is passed within 30 days of the declaration copies of the declaration are available at the general meetings and sent to the Registrar of Companies 10% of non-assenting members can go to court to block the financial assistance In Jungle s case, if Miranda can satisfy any of the above exceptions, she may be allowed to receive financial assistance from the company. Otherwise, the guarantee is illegal under the Companies Ordinance. Consequences of a breach of section 47A section 47A (3) - liability of officers the transaction is illegal and hence void In Dressy Frocks Pty Limited v Bock (1951) the Court enforced the principle that if a company has provided unlawful financial assistance in form of a loan for the purpose of enabling a person to purchase company shares, it would be prevented from recovering the loan. 18

19 5. Proposed alteration of articles of associations Articles of association can be altered by passing a special resolution in a general meeting under section 13 of the Companies Ordinance. The general principle that a company can alter its articles of association 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 the 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 articles of association were changed so that a member must 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 was not able to borrow them. The Court held that as the change was aimed at removing the 2% minority owner, it could not be in the interests of the whole company. But, 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 bone fide in the interest of the company as a whole. In the Cable Radio case, if the alteration is not bona fide for the best interest of the company, Ming Yee may oppose the proposed alteration of the articles of association. (a) Dividends Normally, the directors will decide whether and to what extent such profits should be distributed to shareholders. Table A, Article 117, provides that dividends must be paid only out of profits. The rule ensures that the capital of the company is not returned to members but is maintained for the benefit of both creditors and members. Article 117 also provides that dividends must be paid in accordance with the provisions of Part IIA of the Companies Ordinance, i.e. sections 79A-79P. Although the directors of a company have absolute discretion in deciding whether and to what extent dividends should be declared, if the directors do not declare dividends but unreasonably increase their salaries, this may amount to an unfair prejudicial act under section 168A. Any member of the company can apply to the court for an order under section 168A on the grounds that the affairs of the company are being or have been conducted in a manner which is unfairly prejudicial to the interests of the members generally or of some part of the members. 19

20 Unfairness and prejudice must co-exist with respect to the complained conduct: Re Taiwa Land (1981). Unfair discrimination against the minority may be unfair prejudice. In Donaldson Investment v Anglo Transvarticles of Associational (1979) the court said that the minority must show that the majority acted in such a way as to prevent the minority having 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] in which the minority complained that company money had been used to subsidise the majority shareholders family members businesses in Canada. The Court held that this was clear unfair prejudice. In O Neill v Phillips [1999] O owned 25% of the shares and was the managing director. P, who held 75% of the shares, allowed O to take 50% of the company's profits as salary. They discussed transferring 25% of P's shares to O but that never happened. Several years later P took back control of the company due to O s poor performance. O claimed unfair prejudice. It was held by the House of Lords that not transferring 25% of the shares and resuming control in the circumstances was not unfair prejudice. In Re Carrington Vivella Vinelott J said: "to succeed in a petition, the petitioners have to show conduct which is unfairly prejudicial to part of the shareholders." While section 168A appears to allow a single member to take the requisite action, a better interpretation would be for the court first to examine the interests of members and debenture-holders as a whole. The key test is whether commercial fairness as between two parties has been attained. The court has wide discretion to determine the appropriate order. Remedies include court ordered meetings, orders to force the company to buy out a minority shareholder, orders regulating the conduct of company business, and even dissolution of the company. Fraud here means abuse of power whereby the majority secures an unfair gain at the minority's expense. The injured party need not be the minority shareholders: it can be the company. In Daniels v Daniels (1978) a minority shareholder sued Mr and Mrs D, who were the directors and majority shareholders of the company, saying that they had authorised the sale of company property to Mrs D at a great undervalue and so caused a great loss to the company. The court held that the minority could sue on behalf of the company as this was a fraud on the minority. Directors owe a fiduciary duty to the company. These are special legal obligations of trust and confidence imposed by the law. Directors always owe these duties to their companies and, in rare cases, (see above) to individual members too: (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 20

21 In Cable Radio s case, Ming Yee may complain to the court that the directors are in breach of their duty as they are not acting in good faith and fail to exercise their powers for a proper purpose. 21

22 6. A company has perpetual succession. The company continues to exist until its registration is cancelled and it is dissolved, which usually occurs after the process of liquidation or winding-up is completed. The winding-up of a company is the process by which its assets are collected, its debts paid and the surplus, if any, distributed among its members. The company is a separate legal entity until this process is completed. The most common reason for winding up is that the company is insolvent, i.e. unable to pay its debts. Winding-up is the process undertaken to realise the company's assets and distribute them to its creditors. A solvent company can also be wound up, for example, if the members wish to realise their investment or when the court orders a just and equitable winding up under section 177(1)(f) of the Companies Ordinance. There are two modes of winding-up under section 169: voluntary (by the members) and compulsory (by the court) Members' voluntary winding-up Section 228: Circumstances in which the company may be wound up voluntarily: initiated by a special resolution and can only proceed if the company is solvent. Section 235: Power of the company to appoint and fix remuneration of liquidators Section 233: Certificate of solvency in case of proposal to wind up voluntarily Sections 235 and 235A: Power to remove directors Section 252: Court may appoint and remove the liquidator in voluntary winding-up Section 253: Notice by the liquidator of his appointment Creditors' voluntary winding-up (sections ) Section 237A: Duty of liquidator to call creditors meeting in case of insolvency Section 242: Appointment of liquidator Section 243: Appointment of committee of inspection If the members have taken steps to wind up the company voluntarily, but the directors do not make and lodge a declaration of solvency pursuant to section 233, the liquidation proceeds as a creditors' voluntary winding-up. In practice, the meetings of members and creditors usually occur on the same day at the same place. Notice for the meeting of the creditors is sent out at the same time as the notice to the shareholders for the proposed resolution to wind up the company (section 241). 22