HK company law Directors_and_Directors_Duties

HK company law Directors_and_Directors_Duties Directors and Directors’ Duties Objectives a) To understand the qualification requirements for directors and the circumstances under which they will vacate office. b) Identify the types of directors and their duties and liabilities c) Understand the legal requirements for appointment and removal of directors d) Explain the rules governing prohibition of loans to directors and the exceptions e) Understand the fiduciary duties of directors and duty of care and skill f) Explain the remedies available to the company and the shareholders for breach of directors? duties. Introduction 1 Definition The Companies Ordinance defines a director as a person occupying the position of director regardless of his job title. It also provides that the term "officer" includes a director, manager or secretary. This means that the term “director” is taken to include any person occupying the position of a director regardless of title e.g. „manager?, „governor”, or “president? within the company. For some purposes, the question of whether or not a person is a director is a matter of law and fact and anyone carrying out the functions of a director is included, even a person not actually appointed to the board e.g. a de factor director (i.e. a director in fact), a shadow director. Thus, a majority shareholder cannot on one hand direct the board of directors how to manage the company and on the other hand avoid the liabilities imposed on directors by law. Manager means a person who, under the immediate authority of the board or directors, exercises managerial functions e.g. chief executive office; but exclude (a) a receiver or manager of the property of the company; or (b) a special manager of the estate or business of the company appointed under section 216 2 Number of Directors (Section 153A) Every public company must have at least two directors. However, a private company may have only one director. If a private company which has only one director subsequently ceased to have a director due to vacation of office (e.g. resignation, removal), the vacancy must be filled within 2 months. If the vacancy is caused by the death of the sole director, the vacancy must be filled within 4 months of the date of the grant of probate of the will/letter of administration of the deceased director. CL-1 Qualification and Disqualification of Directors 3 Qualification and Disqualification 3.1 Age Only persons who have attained the age of 18 years can be appointed as directors. 3.2 Corporate Director A body corporate cannot act as a director of a relevant company (i.e. a listed company or any of its group companies) or a public company. Consequently, only natural persons can be appointed directors of listed companies and their group companies and public companies. Non-relevant private companies (i.e. private companies which are not member companies of a listed company) can appoint both natural persons and body corporates as their directors. 3.3 Sections 156, 168E to 168H and 168L of the Companies Ordinance The Companies Ordinance provides that the following persons cannot be appointed as directors a) An undischarged bankrupt unless the permission of the court by which he was adjudged bankrupt was obtained; b) A person against whom a disqualification order is made. Section 168 provides that a disqualification order (The minimum and the maximum period of disqualification is two and 15 years respectively) may be made under any one of the following circumstances: i) a person is convicted of an indictable offence in connection with the promotion, formation, management or liquidation of a company, or with the receivership or management of a company's property; Re Holds Industrial Co Ltd [2003]3 HKLRD 744 Facts X was a director and a shareholder of C Limited which was put into compulsory liquidation due to inability to pay its debts. The Official Receiver applied for a disqualification order against X under section 168H(1)(b) of the Companies Ordinance based on the following reasons: (a) X was responsible for failure to keep proper accounting records pursuant to sections 121, 122 and 274 of the Companies Ordinance; (b) X has caused C Limited to issue cheques without due regard to the likelihood of the cheques being honoured; (c) X has misapplied the properties of C Ltd by transferring its assets and business to another company he controlled; (d) X was responsible for extending an unsecured loan from C Limited to another company of which he is a director. Judgment A disqualification order for 7 years was granted. CL-2 ii) a person has been persistently in default in relation to certain provisions of the Companies Ordinance e.g. failed to submit annual returns; failed to keep proper books of account iii) a person appears, in the course of a winding up of a company, to have been guilty of certain offences of fraud in relation to a company (section 276); iv) a person who is or has been a director of an insolvent company is unfit to be concerned in the management of a company - matters specified in the Fifteenth Schedule to the Companies Ordinance will be taken into consideration for determining unfitness of directors; Official Receiver v Mak Wing Hung [2004] 427 HKCU 1 - A director was disqualified for 7 years due to deception and failure to distinguish between the assets of the company and personal assets, hence falls below the standards of probity and competence to be expected of a company director. v) a person who has been involved in fraudulent trading under the Companies Ordinance. 3.4 Share Qualification The Companies Ordinance does not require a director to be at the same time a member of the company. However, if a share qualification is required by the company's articles of association, each director must take up his qualification shares (i.e. the required number of shares) within: , two months after his appointment; or , such shorter period as fixed by the articles of association. 3.5 Specific Qualification contained in the company's articles of association e.g. Only a director of the holding company can be appointed a director of the company, only professional accountants can be appointed as directors of a limited company which provides audit services. Types of Directors 4. Types of Directors The provisions of the Companies Ordinance governing directors apply equally to all types of directors: 4.1 Shadow Director A shadow director means a person in accordance with whose directions or instructions the directors of a company are accustomed to act e.g. controlling shareholders. Hence, controllers of companies cannot avoid liabilities imposed on directors by not taking up the position of directors. However, a person is not a shadow director by reasons only CL-3 that the directors act on advice given by him in a professional capacity e.g. solicitor, accountant. 4.2 Executive Director He/she is a full-time director employed for his/her expertise under a contract of service e.g. a finance director. 4.3 Non-executive Director Non-executive directors may be appointed not to work full time under a contract of service, but to give general advice and business skill and experience to the board of the directors or the goodwill attached to their names. In Dorchester Finance Co. Ltd. v Stebbing [1989] BCLC 498, Re Boldwin Construction Co Ltd [2003] 2 HKLRD 237, and Daniels v Andersen [1995] 13 ACLC 614 , it was held that the duties of a director, whether executive or not are the same. Re Boldwin Construction Co Ltd [2003] 2 HKLRD 237 Facts Y had been appointed as a director because of his technical expertise in relation to building construction. He regarded himself as responsible only for ensuring the company?s compliance with building regulations. He had nothing to do with the books and accounts, not even the financial transactions between the company and its subcontractors. Judgment Y, even though a non-executive director, was nevertheless a director, hence he could not absolve himself entirely from his duties as a director. 4.4 Independent Non-executive Director To protect the interest of the minority shareholders, the Listing Rules provide that every listed company must appoint at least three independent non-executive directors. In assessing the independence of a non-executive director, the Stock Exchange will take into consideration the following factors (i.e. the Independence Guidelines). Subject to exceptions, an independent non-executive director , should not, subject to exception, holds more than one per cent of the total issued shares of the listed company , should not has received an interest in any securities (e.g. shares, warrants) of the company as a gift or by means of other financial assistance (e.g. a loan), from a connected person (e.g. director) of the listed company itself. However, if a person receives shares or interest in securities from the listed company or its subsidiaries (but not from connected persons) as part of his director?s fees or share option schemes, he is still eligible to be appointed an independent director. CL-4 Example If Martin was granted a loan by the majority shareholder of Lucky Limited to finance the purchase of debentures in Lucky Limited, then Martin is not qualified to be appointed an independent director of Lucky Limited. , should not be a director, partner or principal of a professional adviser which currently provides or has within the preceding one year provided services. He should not be an employee of such professional adviser who is or has been involved in providing such services during the same period, to (a) the listed company, its holding company or any of their respective subsidiaries or connected persons, or (b) any person who was a controlling shareholder [or where there was no controlling shareholder, to any person who is the chief executive or a director (other than an independent non-executive director)] of the listed company within the preceding one year or to any of their associates Example 1 If Nancy is a partner of Wong Lam CPA Limited, the auditor of Apple Limited, he is not qualified to be appointed an independent director of Apple Limited. Example 2 If Terence is a manager of Leung & Co, Solicitors which provide legal services to Banana Limited ( the holding company of Orange Limited), he is not qualified to be appointed as an independent director of both Banana Limited and Orange Limited. , should not has a material interest in any principal business activity of the listed company or their respective subsidiaries or with any connected persons of the listed company Example If Alfred is the supplier of Irena Limited (the subsidiary of Cecilia Limited), he is not qualified to be appointed an independent director of both Irena Limited and Cecilia Limited. , should not be appointed specifically to protect the interests of an entity whose interests are not the same as those of the shareholders as a whole Example If Noble Limited issued both preference shares and ordinary shares and Sally is being appointed a director of Noble Limited by the preference shareholders, she is no qualified to be appointed an independent director of Noble Limited. , should not be or was connected with a director, the chief executive or a substantial shareholder (i.e. holding 10 per cent of the issued shares) of the listed company within the preceding 2 years. CL-5 Example If Francis is the brother of a director of Panarama Limited (a listed company), she is not qualified to be appointed an independent director of Panarama Limited. , should not be or has at any time during the preceding two years been, an executive or director (other than an independent non-executive director) of the listed company, of his holding company or of any of their respective subsidiaries or of any connected persons of the listed company. Note An executive includes any person who has any management function in the company and any person who acts as a company secretary of the company. Example If Anna is the company secretary of Evergain Limited (the subsidiary of CCC Limited, a listed company), he is not qualified to be appointed an independent director of both Evergain Limited and CCC Limited. , should not be financially dependent on the listed company, its holding company or any of their respective subsidiaries or connected persons of the listed company Example If Larry is the trustee of the MPF fund of Blue Limited (the holding company of Green Limited, a listed company) and the trustee fee is his sole source of income, he is not qualified to be appointed an independent director of both Blue Limited and Green Limited. 4.3 Managing Director Even if the company's articles of association make no provision for such an appointment, the shareholders can appoint a managing director in a general meeting. The powers of the managing director are provided by the articles of association of the company. Article 109 of Table A of the Companies Ordinance provides that the managing director need not retire in annual general meeting; but his appointment will automatically be terminated if he ceases for any reason to be a director. 4.4 Alternate/Substitute Directors The appointment of an alternate director to act in place of as director is useful where he/she has many outside commitments which may from time to time result in prolonged absences from the board of directors. Such an appointment can solve problems as to quorum, cheque signing etc. A director has no statutory authority to appoint an alternate director unless; (a) this is authorised by the articles of association, or (b) the power to do so is included in the terms of his appointment. CL-6 Unless the articles of association provide otherwise, an alternate director is the agent of the director who appoints him. The appointing director is vicariously liable for torts committed by his alternate. 4.5 Reserve Director For a company which has only one member who is also the sole director, a reserve director (who is at least 18 years old) can be nominated in general meeting and act in the place of the sole director in the event of his death. 4.6 Nominee Director Nominee directors are persons appointed to the position of directors. However, they only hold the position to protect the interest of those who appoint them. Kuwait Asia Bank v National Mutual Life [1990] BCLC 869 (PC) Facts The plaintiff owned 40 percent of the shares of AICS (a firm of money brokers) and nominated two of its employees to serve on the board of directors of AICS. AICS sued the two nominee directors on the basis of negligence and the plaintiff on vicarious liability. Judgment The plaintiff was not vicariously liable for the acts of the directors who were its employees since they had acted as individuals and not as employees. The plaintiff, as an employer and a shareholder, who nominated its employees to serve as directors of AICS, it did not owe a duty of care to AICS unless it interferes with the company?s affairs. Furthermore, the two directors appointed by the plaintiff were not agents of the plaintiff in carrying out duties to AICS. Appointment and Vacation of Office 5 Appointment of Directors The methods of appointment of directors are prescribed by the company's articles of association. For example, directors may be appointed by the board of directors in a board meeting or by the members in a general meeting. 5.1 First Directors First directors may be named in the articles of association. However, they must be named in the Incorporation Form (From NC1 or NCIG). On the date of incorporation of the company, the persons named therein would become the directors of the company. 5.2 Subsequent Appointment Any subsequent appointment must be made in accordance with the provisions of the articles of association e.g. to be appointed by the directors in a board meeting or by the members in a general meeting. CL-7 6. Removal of Directors Section 157B of the Companies Ordinance provides that members have a statutory power to remove a director before the expiration of his period of office, notwithstanding any provision in the company's memorandum or articles of association, or in any agreement between the company and the director. A director being removed will not lose the right to compensation or to damages in respect of loss of office in case there is a contract providing for such a payment. 6.1 Procedure To remove a director, a special notice (section 116C) must be sent to the company. A special notice means a notice of such a proposed resolution must be given to the company (usually by a member) at least 28 days before the relevant general meeting. The company must then give its members at least 21 days' notice of such a proposed resolution at the same time and in the same manner as the notice of the general meeting which will consider the proposed resolution. If it is not practicable (e.g. if the notice of the general meeting has already been despatched at the time the special notice is received), the notice must be given by newspaper advertisement or any mode allowed by the company's articles of association at least 21 days before the general meeting. However, if the general meeting is held within the 28-day period (e.g. by the convening of a meeting on short notice), the resolution can still be validly passed. The director concerned has the right to make his defence both by written representation circulated to members and by addressing the meeting before a vote is taken. If the proposed ordinary resolution is passed, the director will be removed and the Companies Registry should be informed of the removal. Section 116B of the Companies Ordinance provides that members of a company may (instead of attending an actual meeting) pass a resolution by a written resolution signed by all the members. However, if an actual meeting is not held to consider the resolution, the director concerned will be deprived of his right to make oral representation in the general meeting before a vote is taken. Hence, a general meeting must be held to approve an ordinary resolution to remove a director. 7. Vacation of Office by Other Means Besides resignation and removal by an ordinary resolution, the office of a director is also vacated if he: (a) ceases to hold his qualification shares, if a share qualification is provided by the company's articles of association; (b) becomes bankrupt or makes any arrangement or composition with his creditors generally; (c) is convicted of an indictable offence in connection with the promotion, formation, management, or liquidation of a company or with the receivership or management of the property of a company, or is found to be unfit to be concerned in the management of a company, and a court has made a disqualification order against him; (d) becomes of unsound mind; (e) dies; CL-8 (f) retires and does not seek re-election (or is not re-elected) at the annual general meeting if the articles of association require the directors to retire at an annual general meeting; (g) any other ways as provided in the articles of association, e.g. the director is absent from board meetings without the permission of the board for a specific period; (h) assigns his office - section 164 of the Companies Ordinance provides that a director may only assign his office provided such is either authorised by the articles of association or there is agreement to that effect between the company and the director concerned, and in either case is approved by a special resolution of the company; or (i) ceases to hold office on the expiration of the term fixed for the appointment. Loans to Directors 8 Loans to Directors - sections 157H and 157HA Prohibitions A company (excluding authorised financial institutions) cannot (directly or indirectly) grant loans, enter into guarantees or provide securities (in respect of loans granted by third parties) to , its directors; , directors of its holding company; , a company of which its directors have control Exceptions 1) Group Company Exception Intra group loans, guarantee or provision of security provided by a holding company to its subsidiary or vice versa is allowed even though the subsidiary is controlled by the directors of the holding company 2) Non-relevant Private Company Exception --non-relevant private company + approval in general meeting 3) Proper Expenditure Exception/Loans to assist in directors? duties --funds for business purpose + approval of general meeting + ? 5 per cent net asset 4) Residential Premises Exception/Housing Loans -- employee housing loans + legal mortgage + (80 per cent value -- limit or 5 per cent net asset limit, whichever is the lower); 5) Leasing Arrangement Exception --leasing or hiring goods or leasing of land + terms not more favourable than those offered to unconnected persons on the open market + 5 per cent net asset limit 6) Business Operation Exception/Moneylending Companies --company is a money lender + ($750,000 or 5 per cent net asset limit, whichever is the lower) Extension of Section 157H Prohibition CL-9 For relevant companies (i.e. listed companies and their group companies), the prohibitions extend to 1) quasi-loans and credit transactions as creditors e.g. hire purchase, conditional sale agreement ( except those entered in the ordinary course of business of the company) 2) connected persons of directors who should include a) spouse b) infant children (includes illegitimate children and step children) c) trustees of a trust (except those acting as trustees of employee share scheme or pension funds), the beneficiaries of which include a director, his/her spouse or infant children d) partners of a director, his/her spouse, infant children or trustees Consequences of breaches of section 157H - civil liability (repay loans, account for gains, indemnify loss) - criminal liability (imprisonment and fines) Disclosure in accounts: sections 161B-161BB Loans, quasi-loans, credit transactions, related guarantees and security need to be disclosed in the accounts to be laid before the annual general meeting. It applies to transactions with a person who is at any time during the financial year a director, manager or secretary of the company. Transactions with employees are exempted from disclosure, subject to certain conditions including a limit of HK$100,000. A register of quasi-loans and credit transactions is required to be kept for 10 years. Disposal of Fixed Assets by Relevant Company 9. Approval of Members required for disposal of Relevant Company's fixed assets--section 155A For non-relevant companies, only directors? approval is required for disposing the company?s fixed assets - Section 155A applies to relevant companies i.e. listed companies and their group companies in case of disposal of fixed assets - approval of the members is required if a relevant company wishes to dispose its fixed assets, the value of which exceeds 33 per cent of the company's fixed assets as shown in the latest audited accounts . The amount or value of consideration for any disposal of fixed assets during the 4-month period immediately prior to the proposed disposal should be added when calculating the said 33 per cent. Roles and Duties of Directors CL-10 10. Roles of Directors --Agent of the company acting on behalf of the company --Quasi-trustees of the company's money and property, and of the powers given to them e.g. the power to approve transfer of shares. --Professional Adviser who renders services for reward --Employee 11. Duties of Directors (a) Statutory Duties All Types of Company , Companies Ordinance e.g. duty to keep proper books and accounts, filing of annual return to the Companies Registry , Memorandum and Articles of Association -- A director must act in accordance with the company?s constitution. He must also comply with resolutions that are made in accordance with the memorandum and articles of association. Listed Public and Unlisted Public Companies , Codes on Takeovers and Mergers and Share Repurchases Listed Companies , Securities and Futures Ordinance—insider dealing + disclosure of interests in shares and debentures , Listing Rules—include Code of Corporate Governance (issued by the Hong Kong Stock Exchange) governing the manner in which listed companies are managed (b) Common Law Duties , Non-statutory Guidelines on Directors? Duties (issued by the Companies Registry) , Guidelines for Directors; and Guidelines for Independent Non-executive Directors (issued by the Hong Kong Institute of Directors) Fiduciary Duties of Directors 12. Introduction The word „fiduciary? refers to trust and confidence. A fiduciary is a person who agrees or undertakes, to act for, or on behalf of, or in the interests of, another person in the exercise of a power or discretion which will affect the interests of that other person in a legal or practical sense [ per Mason J in Hospital Products Ltd v United States Surgical Corporation (1984) 156 156 CLR 41, High Court of Australia, at pp 96-7] A fiduciary acts in a representative capacity. The best known examples of fiduciaries are the relationships of trustee to beneficiary, agent to principal, solicitor to client and director to company. Lord Potter said in Regal (Hastings) Ltd v Gulliver [1967] 2 AC CL-11 134 page 159 “ Directors, no doubt, are not trustees, but they occupy a fiduciary position towards the company whose board of directors they formed.” Equity imposes duties (called the fiduciary duties) on a fiduciary requiring him not to exercise his power or discretion in a manner detrimental to the person he represents and not to abuse the trust and confidence reposed in him. The general statement of directors? duty is that the directors must act bona fide in what they consider (not what a court may consider) is in the interests of the company, and not for any collateral purpose. Re Smith & Facett Ltd [1942] Ch 304 CA. Teck rdCorporation Ltd v Millar [1972] DLR (3) 288 British Columbia 12.1 To Whom the Directors Owe their Duties ? Directors owe to the company itself a fiduciary duty, hence only the company can enforce it. Members of the company may ratify a transaction whereby the directors had breached their duties owed to the company provided that there was no fraud on minority. Fiduciary duties are the duty : (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 Solvent Companies Subject to exceptions, directors owe their duties to the company itself and not to individual members, associated companies, creditors or employees. Consequently, only the company can sue the directors for breach of duty. Pervical v Wright {1902} 2 Ch 421 Facts Shareholders of the company approached the directors desiring to sell their shares. Two of the directors and the chairman agreed to buy, but they did not disclose to the sellers that the board of directors was negotiating a take-over bid by an outsider at well above the price they had agreed to pay for the shares. The seller claimed that the directors stood in a fiduciary relationship towards them as shareholders, hence the share transfers were voidable for non-disclosure. Judgment There was no fiduciary relationship between the directors and the shareholders individually. There was no question of unfair dealing, hence the share transfers were valid. However, in exceptional circumstances directors may place themselves in some other fiduciary relationship with members, e.g. as their agent, in which case they may be liable on that basis. CL-12 Allen v Hyatt [1914 ] 30 TLR 444 (PC). Facts The directors were negotiating to sell the business of the company to another firm and persuaded the members to give them an option to buy the members? shares at a fixed price, representing that this would assist their negotiations. When the terms of the amalgamation were agreed upon, the directors exercised their options and made a huge profit. Judgment The directors must hand over the profit they had made to the former shareholders. In Dawson International plc v Coats Patron plc [1898], BCLC 233, it was held that if directors took upon themselves to advise shareholders, they had to do so in good faith and not mislead the shareholders, whether deliberately or carelessly. Insolvent Companies Where a company is insolvent, or doubtful solvency, a director must treat the interests of the company?s creditors as paramount and bear in mind such interests may conflict with those of the company. West Mercia Safetywear Ltd [1988] BCLC 250 Facts Mr Dodd was a director of A. J. Dodd & Co Ltd and of its wholly owned subsidiary, West Mercia Safetywear Ltd. The parent company was owed 30,000 pounds by the subsidiary. The parent company had a large overdraft at the bank which Mr Dodd had personally guaranteed. Both companies got into financial difficulties and Mr. Dodd was advised by an accountant that they were both insolvent and should go into creditors? voluntary liquidation. West Mercia Safetywear Ltd was then paid 4,000 pounds by one of its debtors. Mr Dodd transferred that money from West Mercia „s bank account to the overdrawn account of the parent company apparently for part payment of the 30,000 pound debts but really so as to reduce his liability under his personal guarantee. The transfer was obviously a preference of the parent (or, to be precise, a fraudulent preference ). Accordingly, the liquidator took misfeasuance proceedings against Mr. Dodd personally. Judgment Mr Dodd was ordered to pay 40,000 pounds to West Mercia Safetywear Ltd. Dillon LJ also approved the following statement made by Street CJ in Kinsela v Russel; Kinsela Pty Ltd at p 730 “ In a solvent company the proprietary interests of the shareholders entitle them as a general body to be regarded as the company when questions of the duty of directors arise. If, as a general body, they authorize or ratify a particular action of the directors, there can be no challenge to the validity of what the directors have done. But where a company is insolvent the interests of the creditors intrude. They become prospectively entitled, through the mechanism of liquidation, to displace the power of the shareholders and directors to deal with the company?s assets. It is in a CL-13 practical sense their assets and not the shareholders? assets that, through the medium of the company, are under the management of the directors pending either liquidation, return to solvency, or the imposition of some alternative administration.” Accordingly, if directors of a company, at a time when the company is insolvent, deal with its property in a way that is prejudicial to the interests of the creditors then they are in breach of their fiduciary duty to the company. This is especially so if the purpose of the transaction is to place the company?s assets beyond the reach of the creditors. 12.2 Common Law Duties Directors have the following fiduciary duties: (a) Duty to act bona fide for the benefit of the Company as a whole The law requires a director to act honestly and in good faith in the best interest of the company as a whole. That means that a director owe a duty to act in the interests of all its shareholders, present and future. In carrying out this duty, a director must (as far as practicable) have regard to the need to achieve outcomes that are fair as between its members. In discharging their duties, a director should not gain advantages from use of his position as a director. He should not make unauthorised use of the company?s property or information. Moreover, he should not accept personal benefit from third parties conferred because of his position as a director. CMS Dolphin Ltd v Simonet [2002] BCC 600 Facts Mr. Simonet, a former director took the company?s staff and solicited its principal clients to join a new company formed by him Judgment A company?s maturing business opportunity (e.g. contracts with clients) is regarded as its property. The exploitation of such business opportunity amounts to a misappropriation of the company?s property. Mr. Simonet was therefore held in breach of his fiduciary duty and therefore liable to account for profits attributable to the breach of the duty. Re Smith Fawcett Ltd [1942] Ch 304 Facts The articles of association of the company gave the directors absolute discretion to refuse to register any transfer of shares. The directors refused to register a transfer of 4001 shares from the appellant unless he was prepared to sell 2000 of the shares to a named director. Judgment It was held that the appellant failed to show that the refusal was not due to a bona fide consideration. The courts will only allow the decision of the directors to be challenged on strong evidence of bad faith or fraud. CL-14 Industrial Development Consultants Ltd v Cooley [1972] 1 WLR 443 Facts C was the managing director of IDC. The company was a consultant to the gas industry. A gas company made it clear that it had a big project and did not want to award it to IDC but they did want C to do the work for them personally. C claimed he was sick and resigned as managing director of IDC to begin work on the project. IDC sued him saying he had breached his duty as he came to know of the project as a result of his position in IDC. Judgment The court agreed and found that he had to hand over the profit on the project to IDC . Canadian Aero Services v O'Malley [1974] SCR 592 Facts O?Malley was a director of Canadian Aero Services. He took part in preparations for a project. He resigned and put in a bid for the project himself and won the contract. Canadian Aero Services sued him on the same basis as IDC v Cooley. Judgment O Malley had to hand over the profit to Canadian Aero Service. Peso Silver v Cropper (1966) 58 DLR (2d) 1 Facts Cropper was a director of a mining company. The board decided not to proceed with a project as they thought it was too risky. Cropper 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. Judgment The court refused saying that the company had rejected the project; Cropper had been honest and thus he could keep the profit. The duty to act bona fide in the interest of the company is a subjective duty. There is no breach where the directors act in what they honestly believe to be in the interest of the company. The courts are generally reluctant to override the business judgment of directors Fireman (Simon) v Golden Rice Bowl Ltd [1987] HKLR 981. Directors are presumed to have acted bona fide for the benefit of their company. Consequently, those persons alleging a breach of duty must prove that there was a breach: Bishopgate Investment Management Ltd v Maxwell [No.2] [1994] 1 All ER 261. (b) Duty to Exercise their Powers for Proper Purpose CL-15 Directors of a company have authority to exercise powers in their management of the company?s affairs. However, a director must exercise his power for “proper purpose „. This means that he must not exercise his powers for purposes that are different from 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. The duty can be breached if he has acted in good faith, In exercising their powers (e.g. power to buy and sell assets, power to allot shares, power to refuse share transfers, power to borrow and give security, power to call general meetings), directors may take into account many factors and their decisions may be influenced by mixed motives. But their decisions will be justified if the main purpose is a proper one. Example The power to issue shares is given to directors for the purpose of: , raising additional capital; or , acquiring assets which the company needs for its business. To issue shares for any other purposes e.g. to resist a takeover bid, to create a majority or to dilute control of a particular shareholder, is a breach of duty even if the directors honestly believe that to do so is in the interests of the company. When a power is exercised for an improper purpose, the court may intervene. Piercy v Mills [1920] 1 Ch 77 Facts P owned the majority of the shares in a company. He wanted to appoint himself and his two brothers to be directors at the next AGM. The existing directors did not want this to happen and so issued new shares to reduce P?s control over the company and prevent him appointing himself and his brothers to the board of directors. Judgment The court held that the new issue of shares was invalid as the directors were not acting in the interests of the company and had not used their powers for a proper purpose. Hogg v Cramphorn [1967] Ch 254 Facts The company's share capital consists of both preference shares and ordinary shares which carry one vote each. The company's articles of association gave the directors the power to issue new shares. The directors learned of an intended takeover bid which they believe would not be in the best interest of the company. To forestall the bid, they allotted new CL-16 shares carrying 10 votes per share to a trust which was controlled by them. The subscription monies were financed by an interest-free loan advanced by the company. Judgment The directors were in breach of their duty to the company by creating a new majority. Their belief that the issue of shares was for the benefit of the company was irrelevant. Howard Smith v Ampol Petroleum Ltd [1974] All ER 1126 (PC) Facts Two members held 55% of the shares of a company and declared that they would not even consider any offer to them to buy their shares. The directors thought that the company could be sold for a very good price and so issued new shares to another company which could then make a bid for all the company?s shares. As a result of the new issue of shares the original two members? control over the company was reduced and they could not prevent the takeover. They went to court to seek a declaration that the new issue of shares was invalid. Judgment The court declared that the issue of the new shares was invalid. The purpose of the issue was to reduce the percentage control of the two shareholders; this was not a legitimate use of their directors? powers. Harlowe's Nominees Pty Ltd v Woodside (Lakes Entrance) Oil Co NL [1968] 121 CLR 483 Facts The directors approved an issue of shares with the prime purpose of securing the financial stability of the company. The issue of shares also had the effect of defeating an imminent takeover of the company. Judgment The issue of shares was valid as the main purpose of the share issue was to improve the financial position of the company. (c) Duty to Avoid Conflict of between Personal Interests and Interests of the Company A director must not allow personal interests to conflict with the interests of the company. The courts adopt a severe method of ensuring that a fiduciary such as a director does not abuse the trust and confidence reposed in him. The fundamental principle was stated by Lord herschell in Bray v Ford [1896] AC 44 at pages 51-2: “ It is an inflexible rule of a court of equity that a person in a fiduciary position is not, unless otherwise expressed provided, entitled to make a profit: he is not allowed to put himself in a position where his interest and duty conflict. CL-17 It does not appear to me that this rule is, as has been said, founded upon principles of morality. I regard it rather as based on the consideration that, human nature being what it is, there is danger, in such circumstances, of the person holding a fiduciary position being swayed by interest rather than by duty, and thus prejudicing those whom he was bound to protect. It has, therefore, been deemed expedient to lay down this positive rule.” A director must not allow his duty to the company and personal interests conflict. A contract in which he has a personal interest adverse to that of the company is voidable by the company (i.e. may be set aside by the company), and any profits made by the director may be recovered by the company unless: , such contract is authorised by the company?s articles e.g. article 86(3) of Table A; or , the conflict is disclosed to the shareholders and the resulting contract is sanctioned by them. Aberdeen Railway Co v Blaikie Bros [1854] (1843-60) All ER249 Facts The defendant company entered into a contract with the plaintiff partnership, a partner of which is a director of the defendant company. Judgment It was held that a director who acts as an agent has duties to discharge of a fiduciary character towards his principal (i.e. the company). Moreover, directors are not allowed to enter into engagements in which he has or can have a personal interest conflicting or which possibly may conflict with the interests of the company. The director was interested in both sides of the bargain. Therefore, he could not make the best bargain for the company. The company was entitled to avoid the contract. Persons who are in a fiduciary position are liable to account for any profit made from that position and their liability does not depend on fraud or lack of good faith. Furthermore, the directors are liable even if they have caused no loss to the company. Regal (Hastings) Ltd v Gulliver (1942) 1 All ER 378 Facts The plaintiff owned a cinema and its directors decided to buy 2 more cinemas in the same area before selling all the three cinemas as a going concern. The formed a subsidiary to lease the other 2 cinemas and the landlord insisted that the subsidiary must had a paid-up share capital of 5,000 pounds. The plaintiff, its directors and its solicitors took up additional shares to meet the requirements of the landlord. Afterwards, the plaintiff and its subsidiary were being taken over and the directors made huge profit. The new owner (acting on behalf of the plaintiff ) sued the directors for the profits made. Judgment CL-18 The directors were liable to account for the profits. Porter LJ said “Directors? liability does not depend upon a breach of duty but upon the proposition that a director must not make a profit out of property acquired by reason of his relationship to the company of which he is a director. It matters not that he could not have acquired the contract for the company itself …the profit which he makes is the company?s even though the property by means of which he made it was not and could not have been acquired on its behalf.” A director can enter into a contract with the company if the articles of association of the company permit it or if full and material disclosure of the interest is disclosed and it is approved by the company in general meeting. Otherwise the contract can be avoided by the company. Disclosure of Directors' Interests under Section 162 Section 162(1) provides that a director who is (directly or indirectly) interested in a contract or a proposed contract of the company must disclose the nature of their interests in the company's contracts a) at the earliest board meeting at which it is practicable for him to do so; or b) by giving the company a general notice of his interest before the date on which the question of entering into the contract is first taken into consideration. „Contract? in this context refers to a contract that has significance in relation to the business of the company A declaration of interest under section 162 does not in itself relieve the directors from the operation of the rule against profiting and against conflict of interest i.e. a director may still be accused of profiting and have conflict of interest despite of the disclosure. Only the members of the company can exempt the directors from the rule, either by a) a general provision in the company's articles [e.g. Article 86(3) of Table A];or b) ratifying a particular transaction: Hely-Hutchinson v Brayhead Limited [1968]QB 549. Any director who fails to comply with the provisions of section 162 shall be liable to a fine unless he can prove that he had no knowledge of the contract and that he could not reasonably have been expected to have had such knowledge. Duty of Care, Diligence and Skill CL-19 13 Duties of Care, Diligence and Skill In addition to fiduciary duties, a director also owes a duty to care to the company not act negligently in managing its affairs. Directors must take proper care in the discharge and exercise of their duties. However, mere errors of judgement or imprudence on the part of directors may not constitute a breach of duty or negligence. To be guilty of negligence, the acts by the directors in question must amount to gross negligence. Overend Gurney & Co V Gibb [1872], Re New Mashonaland Exploration Co [1892] 3 Ch. 577. A director must exercise the care, skill and diligence that would be exercised by a reasonable person with the knowledge, skill and experience reasonably expected of a director in his position. In determining whether he has fulfilled this duty, the court will also consider whether he has exercised the care, skill and diligence that would be exercised by a reasonable person with any additional knowledge, skill and experience which he has i.e. an objective test Re City Equitable Fire Insurance Co. Ltd [1925] Ch 407 Facts The company lost over one million pounds, due partly to the failure of certain investments but mainly due to the frauds of the chairman of the board of directors. The liquidator sought to make the other directors liable for the losses on the ground of negligence. Judgment The directors were not liable for the losses as the company?s articles of association provides that directors are exempt from liability unless caused by “their own willful neglect or default”.(Please note that this kind of articles are invalid pursuant to section 165). Romer Justice laid down three propositions which summarise a director?s duty of care (a) A director need not in the performance of his duties, exhibit a greater degree of skill than may reasonably be expected from a person of his knowledge and experience.[A subjective test since the reasonable man in the court’s mind is one which has that kind of knowledge and experience being possessed by the director in question.] (b) A director is not bound to give continuous attention to the affairs of his company. (c) In the absence of grounds for suspicion, a director is justified in trusting officials of the company to perform their duties honestly. In modern times when the directors of companies are often experts in certain fields e.g. accounting and law, a good standard of competence is expected of them. Directors employed by companies in a professional capacity have to comply with an objective standard of care. Thus they can be held liable even if they do their best if that does not equate to a proper professional standard. In recent court cases, higher standard of duty and care was imposed on directors. The Australian Court of Appeal has held in Daniels CL-20 v Anderson [1995] 16 ACSR 607 that the directors are under a duty to familiarize themselves with the company's business and how it is run. They must ensure that the board has available means to audit the management of the company in order to satisfy themselves that the company is being properly run. They must make enquiries where these are warranted by the circumstances. In Permanent Building Society v Wheeler [1994] 12 ACLC 674, a managing director was held to have breached his duty of care and skill when he failed to make inquiries into a transaction which was unusual for the company and was capable of causing harm to the company. A director must exercise his discretion independently and must not blindly follow instructions or opinions of other people (including the shareholder who nominates him to the board). He should ensure that he has not be influenced by considerations irrelevant to the company?s interests and he has obtained and understood all necessary information and advice on which to base his decisions. Colin Gwyer & Associates Ltd and another and London Wharf (Limehouse) Ltd [2002] All ER (D) 226 The board of directors must be diligent and careful in its selection of the persons to whom it delegates any functions and those persons must not only be honest but be competent to carry out the function in question. Further, the board should review the delegation and the delegates on a regular basis. Relief for Breach of Duties 14. Relief of Breach of Duty Provided a director complies with the fiduciary duties and the requisite duties of care, diligence and skill, the fact that his decision turns out to be wrong or causes loss, does not necessarily means that he will be personally liable. Section 165 provides that a company cannot (by provisions in its articles of association or by contract) exempt its officers or auditors, or indemnify them from liability to the company or a related company for negligence, default, breach of duty and breach of trust. Any provision to this effect is void. Exceptions The breach of duty is ratified by the members in a general meeting provided that , There is no fraud on minority: Clemens v Clemens Brothers Ltd (1976) 2 All E. R. 268. , Proviso of Section 165 , A company may indemnify its officers or auditors against liability incurred in successfully defending any civil or criminal proceedings; or in connection with an application under section 358 in which relief is granted. , The company's articles of association may provide that directors may be CL-21 interested in the company's contracts provided that there are prior disclosures. , By the court under section 358 in case the court was satisfied that the officers or auditors have acted honestly and reasonably and ought fairly to be excused: In Dorchester Finance Co Ltd v Stebbing [1989] BCLC 498, Foster J explainted that there are 3 requirements for relieving a director under section 358: , That he acted honestly; , That he acted reasonsably; and , That he ought fairly to be excused Ching Tung Futures Ltd (in liquidation) v Lai Cheuk Kwan, Arthur (1994)1 HKLR 95 Facts The defendant was found liable for negligence and he claimed relief under section 358. Judgment Bokhary J explained that there was no allegation or evidence of dishonesty but that the defendant had failed to act reasonably. It was his failure to act reasonably which resulted in the loss giving rise to his liability for negligence, hence relief was not granted. , Sections 165(3)(a) and (b) provides that a company may buy or maintain insurance for its officers and auditors against any liability to the company and its related companies or any other parties in respect of negligence, default, breach of duties, breach of trust (except fraud); and in defending any civil or criminal proceedings for negligence etc Remedies for Breach of Directors’ Duties 15 Remedies for Breach of Duties of Directors Remedies are available to both the company and the members. 15.1 Remedies Available to the Company a) Damages or Compensation All directors who are found to have acted in a breach of duty are jointly and severally liable to pay damages to the company. This is the appropriate remedy where the directors breached their common law duty of care. If the breach of duty is fraudulent, the company has a common law action under the tort of deceit and may recover damages. If the breach of duty arises from a failure to exercise reasonable care, the company has an action for negligence and can recover damages for any loss CL-22 which results. All directors who participated in the breach of duty are jointly and severally liable to pay the damages or compensation. b) Account for Profit Though directors are not strictly trustees, the misapplication of the company?s property renders the directors liable to account to the company in equity on the same basis as governs a misapplication of trust funds by trustees. Directors should repay the company the secret profit earned. In CMS Dolphin Ltd v Simonet and another [2002] BCC 600, a director who diverted a maturing business opportunity to a new entity he established after resignation from the company, constituted a breach of his director?s fiduciary duties and was accountable to the company for the profits attributable to such breaches. This remedy is given without any need to prove that the director acted dishonestly but it is confined to recovery of profits that the director has himself made: Regal (Hastings) Ltd v Gulliver(1967)2 AC 134. Directors should not make undisclosed profits which arise from a conflict of duty situation. In some cases, this remedy may be a more satisfactory remedy to the company. c) Rescission of Contract The effect of rescission is to put both parties to the contract in the position they would have been in had no contract been made; hence, any money paid or property transferred is returned. This remedy enables the company to get out of an unfavourable contract. However, this remedy will be lost if: * it is no longer possible to restore the parties to their original position e.g. the subject matter of the contract has been destroyed; or * bona fide outsiders have acquired rights in the subject matter of the contract; or * the company fails to rescind within a reasonable time. d) Return of Property Where a director misappropriates property or misapplies money belonging to the company for his own purpose, the company may seek a declaration from the court to declare that the director holds the property on trust for the company. The effect of this remedy is to return the property to the company. e) Injunction A court order may be obtained to prevent the improper exercise of a power being put into effect. For example, if the directors propose to use their powers for an improper purpose, an injunction may be obtained to prevent them from so acting. CL-23 15.2 Remedies Available to Members under the Companies Ordinance a) Section 168A This section provides that a petition may be brought by any member where the affairs of a specified corporation (i.e. Hong Kong and Non-Hong Kong companies) are being conducted in a manner that is unfairly prejudicial to one or more of the members including the petitioning member. - The term "unfairly prejudicial" is not defined in the Companies Ordinance. However, courts have held that the following conduct are unfairly prejudicial conduct: * the diverting of business and corporate opportunities away from the specified corporation Re London School of Economics Limited [1986] Ch211, Cooks v Deeks [1916] 1 AC 554, Industrial Development Consultants Ltd v Cooley [1972] 1 WLR 443. * negligent or inefficient management or mismanagement. * the misapplication of specified corporation's assets by the controlling shareholders for their own benefit or for the benefit of their family and friends Re Tai Lap Investment Co. Ltd [1999] 1 HKLRD 384 Under section 168A, the court has the powers to: , regulate the conduct of the specified corporation in future; , require the specified corporation to refrain from doing or continuing an act complained of by the petitioner; or to do an act which the petitioner has complained the company has omitted to do i.e. an injunction; , authorise civil proceedings to be brought in the name and on behalf of the specified corporation by such person and such terms as the court may direct; , grant a court order to authorise the purchase of shares of any members by the other members or by the corporation itself Chuan Wen Sze v Usine Co. Ltd & Another (1990), CWU Nos 104 and 5, 1990; and , alter the memorandum of association and/or articles of association of the specified corporation. , award damages and interest b) Statutory Derivative Action—Sections 168BA to 168BK Sections 168BA to 168BK of the Companies Ordinance provides that a member of a specified corporation has a statutory right to bring civil proceedings on behalf of the specified corporation (or to intervene in its proceedings) if the certain conditions are met. c) Section 177(1)(f) Section 177(1)(f) may enable members to get their capital out of the company to invest elsewhere or start their own business. Section 177(1)(f) gives members the right to apply for a winding up of the company CL-24 even if the company is solvent and able to pay its debts. The court may order the winding up of a company if it is of the opinion that this would be just and equitable. However, winding up a solvent company is a drastic step, the court will not make such an order if it is of the opinion that there are some other remedies available; or where the applicant is acting unreasonably in seeking a winding up instead of pursuing other remedies e.g. remedies under section 168A or common law remedies. The courts have made a winding up order on the just and equitable ground in the following circumstances: * profits are taken out by way of directors' remuneration and no dividends are paid Re a Company (No. 0047 of 1986)[1986] BCLC 376; * rights issue to dilute shareholding in circumstances in which it is known that a particular shareholder is unable to take up new shares Re Cumana Ltd [1986] BCLC 430 (CA), Tseng Yueh Lee Irene v Metrobilt Enterprises Ltd [1994] 2 HKC 684; * where there is fraud, misconduct or oppression in the conduct and management of the company's affairs The plaintiff's conduct is one of the factors to be taken into consideration by the court in deciding whether it is just and equitable to wind up the company. In Ebrahimi v Westbourne Galleries Ltd [1973] AC 360 and Ng Yat Chi and Max Share Ltd [2001] 1 HKL CL-25