HKCL Suggested Answer + QP - Chartered Secretaries · company trouble should the transfer go ... the most fundamental fiduciary duty of a director ... fiduciary duties of a director

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

ADMINISTRATORS

International Qualifying Scheme Examination

HONG KONG CORPORATE LAW JUNE 2011

Suggested Answers

The suggested answers are published for the purpose of assisting students in their

understanding of the possible principles, analysis or arguments that may be identified

in each question

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Case list for candidates’ reference

1. Aktieselskabet Dansk Skibsfinansiering (body corporate) v Brothers [2000] 1 HKLRD

568

2. 2. A. L. Underwood Ltd. v Bank of Liverpool & Martins [1924] 1 KB 775

3. Charterbridge Corporation Ltd v Lloyds Bank Ltd [1970] Ch 62

4. Re Elgindata Ltd [1991] BCLC 959

5. Re Five Lakes Investment Co. Ltd [1985] HKLR 273

6. Gluckstein v Barnes [1900] AC 240

7. Hickman v Kent or Romney Marsh Sheepbreeders’ Association [1915] 1 Ch 881

8. Kelner v Baxter (1866) LR 2 CP 174

9. Kinsela v Russell Kinsela Pty Ltd (In Liq) [1986] 4 NSWLR 722

10. Re Macro (Ipswich) Ltd [1994] 2 BCLC 354

11. Newborne v Sensolid (Great Britain) Ltd. [1954] 1 QB 45

12. Phonogram v Lane Ltd. [1982] QB 938

13. Royal British Bank v Turquand (1856) 6 E & B 327

14. Securities and Futures Commission v Stock Exchange of Hong Kong Ltd [1992] 1 HKLR

135

15. Simon Fireman v Golden Rice Bowl Ltd [1987] HKLR 981

16. Southern Foundries (1926) Ltd v Shirlaw [1940] AC 701

17. Re Taiwa Land Investment Ltd [1981] HKLR 197

18. Tett Phoenix Property and Investment Company [1986] BCLC 149

19. Tradepower (Holdings) Ltd (in liquidation) v Tradepower (Hong Kong) Ltd [2010] 1

HKLRD 674

20. Twycross v Grant (1877) 2 CPD 469

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SECTION A

Q1. ABC Ltd is a Hong Kong private company incorporated by Tim’s mother, who

transferred a 70% shareholding to Tim and made him the only director before

she was forced to retire in 2010 due to health reasons. However, Tim was

neither a smart nor industrious person, and he did not have the necessary

competence to understand the company’s business. He effectively entrusted

the company’s business and affairs to Helen, who had been the general

manager of the company since its incorporation.

In one board meeting, Tim was asked to approve the transfer of Karl’s shares to

his son. (Karl held 10% shares in ABC Ltd.) Since Tim and Karl’s son had never

been on friendly terms, Tim worried that Karl’s son would give him and the

company trouble should the transfer go through, so he did not approve the

transfer. He also instructed Helen not to give reasons to Karl despite his asking

for the reasons for the refusal. When Helen proposed opening a flagship store

in

Central, Tim simply approved the idea without considering its details, as he

would do whenever Helen submitted business ideas to him.

The flagship store turned out to be a disaster. As a result, ABC Ltd had lost half

of its value in the subsequent year. Karl was so furious that he formally

submitted a request to Tim that he wanted to add an item to the next annual

general meeting to appoint a new director nominated by him to the board.

Thinking that Karl was intending to introduce his man to “spy” on him, Tim

ignored Karl’s written request. In extreme disappointment, Karl sold all his

shares to Tim and left the company. Soon after all other shareholders followed

suit by selling their shares to Tim. Tim saw the departure of Karl and other

shareholders as a victory for him. He also thought that he no longer needed to

convene an annual general meeting (AGM) because that would be a “meeting

with him and him only”. For the subsequent two years, ABC Ltd had done

nothing in relation to general meetings, though annual audit had been carried

out as before.

The company’s business performance grew even worse but Tim was so

optimistic about the recovery of the local and global economy that he believed

that the business would soon come good. Unfortunately, this has not happened

and Tim started to believe that he did need some external counsel. He

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instructed a business consultant, to scrutinise the company’s records and see

whether he or the company had done anything in breach of company law. From

the board minutes the consultant found that Tim had not actually considered the

merits of the flagship proposal. Tim replied that the proposal was so well drafted

that any reasonable director would have approved it, and therefore he would

have approved it anyway. Further, the consultant put it to him that the flagship

store business should have ceased at an earlier time to avoid prejudice to the

company’s creditors. Tim frankly admitted that with hindsight he should have

made that decision.

REQUIRED:

Having considered the facts and Tim’s explanations, advise him in relation to

the following matters, including remedial actions that should be taken:

Q1 (a) His decisions regarding the proposed transfer of sh ares from Karl to

his son.

Ans (a) The director’s powers are fiduciary in nature, implying that a director must

consider in good faith whether the exercise of any of his powers is in the

interests of the company as a whole.

Regarding a request to approve the transfer of shares and make

corresponding changes to the shareholders’ request, the same principles

apply. Tim must actually consider the pros and cons of approving or

rejecting Karl’s request of transfer. The common law position is that a

director need not give reasons to shareholders in relation to any exercise

of his powers. The articles of association a private company may empower

the directors to refuse to register any transfer of shares in their absolute

discretion without the duty to give reasons (Art 3, Part II, Table A). If the

board of directors refuses to register a transfer of shares the company

must send to the transferor and the transferee a notice of refusal within

two months after the instrument of transfers was lodged (section 69(1)).

Any rejected transferee can apply to the court to have the shares

registered, and the court may make such an order if it is satisfied that the

application is well founded (section 69(1B)). But the court is, as a general

rule, reluctant to interfere with commercial decisions made by directors if

the articles give directors an absolute discretion as the court is not entitled

to interfere with a decision with which “it merely disagrees” (Simon

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Fireman v Golden Rice Bowl Ltd [1987] HKLR 981). In considering

whether the directors have acted bona fide in refusing a transfer of shares,

the court normally presumes that the directors have been acting bona fide

and the onus of proving the contrary rests on the transferee. The court in

Tett Phoenix Property and Investment Company [1986] BCLC 149

explained: “It is trite law that the court will not interfere with the exercise by

directors of a discretion to register a transfer if their decision was one

which a reasonable board of directors could bona fide believe to be in the

interests of the company. If the discretion is an unfettered one and is not

limited to specific grounds of refusal the court will not compel the directors

to give their reasons for their refusal… If their decision was one which a

reasonable board of directors could consider to be in the interests of the

company then the court presumes that they acted bona fide and had good

grounds for their decision. However, if the directors once give their

reasons the court can consider how far those reasons did justify their

decision.”

Q1 (b) His approval of the flagship-store proposal without proper

consideration, assuming that the proposal was reaso nable in its

content.

Ans (b) As mentioned above, the most fundamental fiduciary duty of a director is to

exercise his powers for the benefit of the company (Kinsela v Russell

Kinsela Pty Ltd (In Liq) [1986] 4 NSWLR 722). Where a case of breach of

fiduciary duties of a director is raised upon the ground that he has acted

otherwise than for the benefit of the company it will be necessary for the

court to determine as a factual issue whether the director in question did

exercise his powers for the benefit of the company (Charterbridge

Corporation Ltd v Lloyds Bank Ltd [1970] Ch 62). The Charterbridge case

lends support to an argument that in the context of corporate group, the

proper test of liability is “in the absence of actual separate consideration,

must be whether an intelligent and honest man in the position of a director

of the company concerned, could, in the whole of the existing

circumstances [ie, the group situation], have reasonably believed that the

transactions were for the benefit of the company.” However, Tim may not

be able to rely on this test as ABC is not a company in any corporate

group. Although the proposal may be one that an intelligent director might

have approved if he had considered it, the fact that Tim had not actually

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considered it shows that he had exercised his director’s powers without

considering the company’s interest. Therefore the advice is that Tim might

have breached his duty to consider the company’s interests in good faith.

Q1 (c) The company, being a one-member company, had not co nvened an

AGM for two consecutive years.

Ans (c) A company is under a duty to convene an annual general meeting (AGM)

every calendar year (section 111). The provision which provides that the

quorum shall be one if the number of shareholders falls to one implies that

even a one-member company has to convene an AGM each year.

Although Tim is ABC’s only shareholder after the departure of Karl and all

other shareholders, an AGM had to be convened as before. But the fact

that ABC has not called any AGM is not conclusive enough in finding the

company and Tim guilty of ignoring their legal obligations as there is an

exception to that obligation. It is stated under section 111(6) that the board

of directors may choose not to convene an AGM if all the necessary

resolutions (in particular those related to the ordinary business) can be

secured under the written resolution procedure under section 116B and

that the relevant directors’ report and auditors’ report are distributed to

shareholders. Tim must be asked whether his appointment as a director

should have been renewed in the AGMs (e.g., under the rotation system)

which had not been convened and whether the company had paid out any

dividends to him. Even if there was no need to pass such resolutions ABC

Ltd should appoint or reappoint auditors at each AGM. Since the company

has conducted annual audits, perhaps Tim has signed a written resolution

regarding auditors’ appointment at the company secretary’s request. If the

truth is the unlikely case that the auditors have worked for ABC Ltd without

a relevant resolution, then the company must apply to the court for a

permission to reconvene the missing AGMs. In this case, Tim and the

company will be liable to a fine.

Q1 (d) The possible legal implications in relation to the fact Tim did not

close down the loss-making flagship-store business “early enough”,

assuming that ABC Ltd will subsequently be liquidat ed on the ground

of serious insolvency.

Ans (d) Tim could be made personally liable for ABC Ltd’s debts and subjected to

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a disqualification order if he is found by the court to have knowingly

allowed the company to trade when it was seriously insolvent. Fraudulent

trading under section 275(1) is committed if the directors allow the

company to continue its business if they know that there was no

reasonable prospect of the company being able to repay the debts

incurred in the business (Aktieselskabet Dansk Skibsfinansiering (body

corporate) v Brothers [2000] 1 HKLRD 568). The court may make the

directors personally liable for the company debts incurred as a result of the

fraudulent trading. Further, the court is obligated to grant a disqualification

order against the directors responsible for fraudulent trading for a period

up to 15 years (section 168G(1)). The key legal issue under the fraudulent

trading provisions is whether a person should be found to be trading

fraudulently if he continues to carry on business and incur new liabilities,

while genuinely believing that things will improve and that he will be able to

repay his creditors even though, viewed objectively, his belief is wholly

unrealistic and unreasonable. As a general rule, the court “will naturally be

slow to impose personal liability on directors who understandably consider

themselves within the protection of the limited liability afforded to the

company through which they are trading and will do so only if personal

dishonesty on their part can be established” (Tradepower (Holdings) Ltd (in

liquidation) v Tradepower (Hong Kong) Ltd [2010] 1 HKLRD 674). The

court will ask when the directors’ decision to go on with business “ceases

to involve merely misguided optimism and becomes cheating one’s

creditors.” The common law position is that subjective dishonesty is the

basis of testing the directors’ intention, and the court has stressed that the

showing of objective unreasonableness in continuing with a doomed

business is insufficient to lead to an inference of fraudulent intent

(Tradepower (Holdings) Ltd (in liquidation) v Tradepower (Hong Kong) Ltd

[2010] 1 HKLRD 674). Therefore Tim’s business incompetence may not be

against him when facing a charge of fraudulent trading. But, depending on

the totality of evidence, the court may draw an inference that Tim actually

knew that ABC Ltd could not avoid liquidation when he allowed the

company to continue its business.

Q1 (e) Tim having turned down Karl’s request to add an ite m to the AGM

agenda.

Ans (e) Any number of shareholders holding 2.5% of the issued shares can, at

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their expense, request the inclusion of resolutions for consideration by

members at general meeting, or ask the company to circulate a statement

of not more than 1,000 words with respect to the resolution proposed this

section or the business to be dealt with at that meeting (section 115A(1)(a)

and (2)). The failure to cause the company to discharge its duty to circulate

such resolution and/or statement can make the officers of the company

liable to a fine. Generally a resolution of a nature suggested by Karl must

be deposited with the registered office not less than six weeks before the

meeting but, if the meeting is an AGM, the resolution could be lodged

within six weeks of the meeting because it would be treated as an ordinary

business (section 115A(6)). If Karl did not or had not deposited a sum of

money sufficient to meet the expenses of the company to circulate the

resolution, the company is not to discharge this duty.

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SECTION B (Answer THREE questions from this section)

Q2. Darren, Edith, Felix and Gill were equal shareholders of H Ltd. Darren was the

sole director of the company. The articles of association, which are not based

on Table A, provide that the board of directors may purchase equipment for the

purposes of the company up to a maximum value of $5 million and that any

purchase over this amount must first be sanctioned by ordinary resolution of the

company (the First Clause). Darren placed an order with M Ltd for $9 million.

Due to the regular business relationship with H Ltd, the directors of M Ltd were

aware of the existence of the First Clause but they did not ask Darren about the

necessary approval. The equipment was delivered to H Ltd but Edith, the

general manager, returned the equipment to M Ltd, with a note stating that H

Ltd had never approved of this transaction.

REQUIRED:

Q2 (a) Explain whether the transaction is binding on H Ltd .

Ans (a) On behalf of H Ltd, Darren made a contract with M Ltd. The value of the

subject matter of the contract is more than what Darren, as the sole

director of the company, could authorise. He would have the power to

make that contract if H Ltd had passed an ordinary resolution to authorise

him to do so. The directors of M Ltd did not ask Darren whether there was

such an approval even though its directors knew that the making of that

contract was restricted by the articles of association of H Ltd. Whether the

contract is binding H Ltd will depend on whether the indoor management

rule should apply to the facts.

The indoor management rule, which had its origin in Royal British Bank v

Turquand (1856) 6 E & B 327, states that an outsider who deals with a

company in good faith may assume that acts which appears to be

consistent with the company’s articles have been properly done by the

company. The court in Turquand said: “It is a rule designed for the

protection of those who are entitled to assume, just because they cannot

know, that the person with whom they deal has the authority which he

claims. This is clearly shown by the fact that the rule cannot be invoked if

the condition is no longer satisfied, that is, if he who would invoke it is put

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upon his inquiry. He cannot presume in his own favour that things are

rightly done if inquiry that he ought to make would tell him that they were

wrongly done."

Therefore a party without knowledge of the irregularities in the company’s

internal procedures is not bound to inquire whether those internal

procedures have been duly complied with. The good faith of directors is

irrelevant to the application of the rule. The rule does not apply if the

circumstances put the outsider to inquiry (A. L. Underwood Ltd. v Bank of

Liverpool & Martins [1924] 1 KB 775) or if the doctrine of constructive

notice applies (Irvine v Union Bank of Australia (1877) 2 App. Cas. 366). In

this case, it can be argued that nothing had put M Ltd to enquiry because

the purchase of the equipment was in the course of the company’s

ordinary business. In addition, H Ltd and M Ltd have maintained a regular

business relationship. More importantly, there is no way for M Ltd to check

if H Ltd has passed a resolution to authorise the contract. Under the

Companies Ordinance, only a special resolution has to be filed at the

Companies Registry (section 116). Therefore, the contract is binding on H

Ltd.

Q2 (b) Edith, Felix and Gill are fed up with Darren’s erratic behaviour and decide

not to reappoint him as a director at the next annual general meeting

(AGM). However, they know that there is a clause in the articles stating

that all of them may serve as executive directors for the first 15 years from

the incorporation of H Ltd and they can share equally half of the

company’s annual profit as remuneration (the Second Clause). Darren has

an employment contract with the company which incorporated the terms of

the Second Clause. Edith, Felix and Gill plan to pass a resolution at the

next AGM to amend the articles by removing the Second Clause. They

hope that the removal of that clause could cause Darren’s employment

contract to become void as a result.

Explain whether H Ltd has to compensate Darren for breach of

contract if he is removed from the position of exec utive director after

the proposed amendment is made to the articles of a ssociation.

Ans (b) The other directors of the company believe that the removal of the Second

Clause, which seems to give all four shareholders a right to serve as

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executive directors and take part of the company’s profit as remuneration,

can cause Darren’s employment to become void because of the loss of

the raison d'être.

The directors may be surprised to know that the Second Clause is

unenforceable. This is because section 23 only confers binding rights on a

clause if it affords rights on a member as a member. Since the Second

Clause purports to give them a right to be appointed as directors, this is

regarded as an outsider’s right, which is not enforceable under section 23.

As the court said in Hickman v Kent or Romney Marsh Sheepbreeders’

Association [1915] 1 Ch 881: “An outsider to whom rights purport to be

given by the articles in his capacity as such outsider, whether he is or

subsequently becomes a member, cannot sue on those articles, treating

them as contracts between himself and the company, to enforce those

rights.”

However, the legal position will be different if the director and the company

have entered into a separate contract which has incorporated an article

which purports to give an outsider rights. In this case, Darren can insist on

his rights given to him by the employment contract, not by the articles of

association of H Ltd. “A company cannot be precluded from altering its

articles thereby giving itself power to act upon the provisions of the altered

articles – but so to do may nevertheless be a breach of the contract if it is

contrary to a stipulation in a contract validly made before the alteration”

(Southern Foundries (1926) Ltd v Shirlaw [1940] AC 701). The conclusion

is that Darren must be sufficiently compensated if he is removed from

office, regardless of whether the Second Clause is removed or not.

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Q3. Alongside his brothers Benny and Calvin, Aaron has served as a director of P

Ltd since its incorporation until recently. The three brothers and their mother are

equal shareholders of the company. Aaron has fallen out with his brothers and

as a result resigned from the board of directors. Since then Aaron has found

that the company’s business performance has deteriorated sharply due to his

brothers’ incompetence as directors. He is sure that a contract that the

company is going to enter into next month will turn out to be a disaster. Aaron

has convinced his mother to side with him not to re-elect Benny and Calvin

back to the board when they have to step down as required by the articles of

association at the next AGM. His mother also agrees to nominate and elect

Aaron as the sole director of the company. Benny and Calvin are angered by

Aaron’s move and have indicated that they will not vote for Aaron. Therefore, it

is highly likely that the company will have no director after the AGM.

REQUIRED:

Q3 (a) Advise Aaron whether he can seek a court order unde r the unfair

prejudice remedy to stop the company from entering into the

contract.

Ans

(a) Under section 168A, any member of a company who complains that the

affairs of the company are being or have been conducted in a manner

unfairly prejudicial to the interests of the members generally or of some

part of the members (including himself) or, in a case falling within section

177(1)(f), may make an winding-up application to the court. If the court is

satisfied that there is a case of unfair prejudice, in order to bring to an end

the matters complained of the court may make an order restraining the

commission of any such act or the continuance of such conduct (section

168A(2)(a)).

As a shareholder, Aaron may want to argue before the court that the

effects of the recent decisions of the board, which are affairs of the

company, were prejudicial to the shareholders’ interests, as evidenced by

the dismal business results. Aaron should be advised that the existence of

corporate affairs causing prejudice to shareholders’ interests, by

themselves, is not sufficient to activate the court’s jurisdiction under

section 168A because such affairs may not be unfair. In other words,

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prejudicial acts may not necessarily unfair. As the court in Re Taiwa Land

Investment Ltd [1981] HKLR 197 pointed out: “It seems clear that

elements of both unfairness and prejudice must co-exist for the section to

come into play. Conduct which is intrinsically prejudicial to the interests of

a shareholder, without also being unfair, will not be enough; conversely the

section cannot be relied upon if the conduct of which complaint is made is

merely unfair."

In an appropriate case it is open to the court to find that serious

mismanagement of a company's business constitutes conduct that is

unfairly prejudicial to the interests of minority shareholders (Re Macro

(Ipswich) Ltd [1994] 2 BCLC 354). But, as a general rule, the court will

normally be very reluctant to accept that managerial decisions can amount

to prejudicial conduct, for two reasons. First, there will be cases where

there is genuine disagreement between shareholders and directors as to

whether a particular decision is commercially viable or sound. The fact the

parties have taken different views is not of itself a proof of unfairness.

Secondly, it is a fact that the company’s value will depend on the

competence of management. Therefore, “short of a breach by a director of

his duty of skill and care there is prima facie no unfairness to a

shareholder in the quality of the management turning out to be poor” (Re

Elgindata Ltd [1991] BCLC 959). Aaron will find it very difficult to base his

claim only on the bad business result without alleging breach of duty of

care by his brothers. Even if the court is convinced by Aaron, there is

another technical difficulty that may deny him the injunction he wants to

seek. As it is now, it is arguable that section 168A only applies to acts of

the company but not its proposed acts. On this Aaron may want to argue

that the contract is within the company’s ordinary course of business so

that the making of that contract should be seen as part of the existing

corporate affairs.

Q3 (b) Advise Aaron whether he has a case for winding up t he company

compulsorily if it really turns out that no directo r is appointed at the

next AGM.

Ans (b) The common law position is that the managerial power of the board should

be reverted back to the shareholders should the board not be able to

perform its functions. However, in this case no camp is able to secure any

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ordinary resolution as neither have more than half of the issued shares.

There is a clear management deadlock in both the board of directors and

general meeting. Aaron may present a winding up petition under section

177(1)(f) on the grounds that it is just and equitable to wind up the

company. Management deadlock is a good ground for the court to

exercise its jurisdiction. If the company is left with no directors, Aaron may

also make an application to the court for the appointment of a provisional

liquidator to take care of the company before the court grants a winding up

order. It is necessary for Aaron to show first that there is a good prima

facie case for the making of a winding up order at the hearing of the

petition, and secondly that it is appropriate for a provisional liquidator to be

appointed, having regard to the commercial realities, the degree of

urgency and need established by the applicant and the balance of

convenience in all the circumstances of the case (Re Five Lakes

Investment Co. Ltd [1985] HKLR 273). Candidates can reasonably

conclude that the court should agree to appoint a provisional liquidator to a

company without directors to maintain the status quo of the business and

protect its assets before the court can make a decision.

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Q4. Avis is the auditor of S Ltd, a locally listed company which was incorporated

under the Companies Ordinance. In the course of her work Avis has found that

S Ltd’s account books are seriously incomplete and that the integrity of some

business documents is in question. As a result, Avis has decided to resign as S

Ltd’s auditor and to disclose the circumstances leading to her resignation to the

shareholders of S Ltd and to the Securities and Futures Commission (SFC).

REQUIRED

Q4 (a) What steps should Avis take in order to resign as S Ltd’s auditor?

Ans (a) Under the Companies Ordinance, Avis may resign her office by depositing

a notice in writing to that effect at the registered office of S Ltd; and any

such notice shall operate to bring her term of office to an end on the date

on which the notice is deposited or on such later date as may be specified

in the notice (section 140A(1)). To make her notice of resignation effective,

Avis must sign the notice and include in the notice a statement of any

circumstances connected with her resignation which she considers should

be brought to the attention of the shareholders or creditors or S Ltd, or a

statement that there are no such circumstances (section 140A(2)).

Q4 (b) How can Avis express her concerns to the shareholde rs of S Ltd and

to the SFC without breaching her duty of confidenti ality to S Ltd?

Ans (b) Should Avis include a statement of the circumstances leading to her

resignation in the notice, she may call on the directors of S Ltd to convene

an extraordinary general meeting for the purpose of receiving and

considering those circumstances they may wish to place before the

meeting (section 140B(1)). In such a case, the directors must proceed to

convene the meeting within 21 days from the receipt of Avis’s written

request and the meeting must be convened for a day not later than 28

days after giving notice of it (section 140B).

Avis can request that the company circulates a statement of reasonable

length in relation to the circumstances connected with her resignation to its

members, either before the general meeting at which her term of office

would otherwise have expired; or before any general meeting at which it is

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proposed to appoint a new auditor (section 140B(2)). However, S Ltd or

any person aggrieved by the statement and/or notice may apply to the

court for an order directing that copies of the statement and/or notice need

not be sent out. If the court is satisfied that the auditor is using the

statement and/or notice to secure needless publicity for a defamatory

matter, it may by order direct that copies of the statement and/or notice

need not be sent out; and the court may further order the company's costs

on the application to be paid in whole or in part by the auditor (section

140A(5)).

Avis, having resigned, is entitled to attend the general meeting at which

her term of office would otherwise have expired and the meeting convened

at her request. She is also entitled to receive all notices and other

communications relating to such meetings on any part of the business of

the meeting which concerns her as a former auditor of S Ltd (section

140B(5)).

Avis may report the case of S Ltd to the Securities and Futures

Commission (SFC) under the whistle-blowing protection of section 381 of

the Securities and Futures Ordinance which provides that auditors of a

listed company will not be made liable for any civil liability by reason only

of their communicating in good faith to the SFC any information which

suggests that, among other things, directors have engaged in defalcation,

fraud, misfeasance or other misconduct towards the company or its

members; or that shareholders have not been given all the information

with respect to its affairs that they might reasonably expect.

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Q5. A number of shareholders of G Ltd, together holding 10% of the issued shares,

have fallen out with the board of directors over the company’s recent business

performance. They want to call an extraordinary general meeting (EGM) to

discuss the matters and remove the managing director.

REQUIRED:

Q5 (a) Advise the shareholders how the Companies Ordinance can enable

them to make the board of directors convene the pro posed EGM.

Ans (a) The directors of a company, notwithstanding anything in the company’s

articles must, on the requisition of members of the company holding at the

date of the deposit of the requisition not less than one-twentieth of such of

the paid-up capital of the company as at the date of the deposit carries the

right of voting at general meetings of the company, or, in the case of a

company not having a share capital, members of the company

representing not less than one-twentieth of the total voting rights of all the

members having at the said date a right to vote at general meetings of the

company, forthwith proceed duly to convene an EGM of the company

(section 113(1)). (The requisition must state the objects of the meeting,

and must be signed by the requisitionists.)

If the directors do not within 21 days from the date of the deposit of the

requisition proceed duly to convene a meeting for a day not more than 28

days after the date on which the notice convening the meeting is given,

the requisitionists, or any of them representing more than one-half of the

total voting rights of all of them, may themselves convene a meeting, but

any meeting so convened shall not be held after the expiration of three

months from the said date (section 113(3)).

Reasonable expenses incurred by the requisitionists by reason of the

failure of the directors duly to convene a meeting shall be repaid to the

requisitionists by the company, and any sum so repaid shall be retained by

the company out of any sums due or to become due from the company by

way of fees or other remuneration in respect of their services to such of

the directors as were in default (section 113(5)).

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Q5 (b) The board of directors has informed the shareholders that it will not

answer their request to convene what they see as a “meaningless”

general meeting. The board also said that should the shareholders

exercise their statutory right to convene the meeting, the directors would

not provide any assistance and would not show up at the meeting.

Advise the shareholders of the procedures they shou ld follow to

convene the proposed EGM, and the legal requirement s regarding

the conduct of the meeting.

Ans (b) A meeting convened under this section by the requisitionists shall be

convened in the same manner, as nearly as possible, as that in which

meetings are to be convened by directors.

Notice of general meeting must be given to every member of the company

(section 114A(1)). Shareholders’ addresses can be found in the register of

members, which is open to the inspection of any member during business

hours without charge (section 98). Generally, an EGM must be called by at

least 14 days' written notice (section 114(1)(a) and reg.52, Table A). Since

the major purpose of the proposed EGM is to remove the managing

director by the passing of an ordinary resolution (section 157B(1)), the

requisitioning shareholders must note that special notice is required of a

resolution to remove a director (section 157B(1A)). Such a resolution will

not be effective unless notice of the intention to move it has been given to

the company not less than 28 days before the meeting at which it is

moved, and that its members are given notice of any such resolution at the

same time and in the same manner as they are given notice of the

meeting (section 116C).

For the purposes of serving notice of meeting, a day means a clear day.

Therefore, '14 days' means 14 clear days without taking into account the

day of posting the notice, the day of deemed receipt (reg.132, Table A)

and the day of the meeting (Securities and Futures Commission v Stock

Exchange of Hong Kong Ltd [1992] 1 HKLR 135). The notice must specify

the place, day and the hour of the meeting and, in case of special

business (section 114C(7)), and the general nature of that business

(art.52, Table A). There should be an accurate description of the proposed

ordinary resolution on the notice of meeting.

19

Since all the directors are going to the meeting, therefore no director is

going to chair the general meeting, as is generally required by the articles

of association (reg.57, Table A). The members who attend the meeting

must elect one of them as the chairman of the general meeting (reg.58,

Table A).

The chairman of the general meeting must also make sure the

proceedings of meeting are accurately recorded so that minutes can be

prepared for the record as required by the Companies Ordinance.

20

Q6. In October, Jill and Nora agreed to form a new company which they intended to

call J & N Ltd, to carry out their business plan. Jill was asked to source new

suppliers for their proposed company. Jill decided to award the most valuable

contracts to Peter, her best friend, without telling Nora her close relationship

with Peter. Jill indicated on those contracts that she signed “for and on behalf of

J & N Ltd” despite the fact that the company had not been registered yet. Before

the company’s first board meeting Nora found out that the terms of the

contracts with Peter were more favourable to him than to the company. Nora

was very angry and she wanted to get the company out of those contracts. She

also wondered whether Jill, who was also a director, was liable to the company.

REQUIRED:

Advise Nora.

Ans A promoter is “one who undertakes to form a company with reference to a given

project and to set it going, and who takes the necessary steps to accomplish

that purpose” (Twycross v Grant (1877) 2 CPD 469). In other words, a promoter

is a person who handles the necessary incorporation procedures and related

works before a company comes into its independent existence upon the issue

of the certificate of incorporation. Nora should note that Jill was a promoter of

their company.

The promoter’s activities may involve making contracts with third parties before

the incorporation of the proposed company. It is an interesting question whether

a promoter can enter into contracts as an agent for an ‘unborn’ company. The

common law position is that, as stated in Kelner v Baxter (1866) LR 2 CP 174, a

company cannot ratify pre-incorporation contracts as principal because at the

time of contract the company did not exist. Therefore, the contracts concluded

before incorporation of the company will be regarded as the promoter’s own

contracts. Although common law provides a solution to this problem called

novation, this method is commercially inconvenient especially if the number of

the pre-incorporation contracts is large.

The rule in Kelner is restated in section 32A(1)(a), which provides that a

promoter is personally liable for any pre-incorporation contracts if he signs as

an agent or in those contracts he has purported to act for the proposed

21

company in other capacities. Therefore a promoter cannot avoid his personal

liability, for example, by arguing that he simply signed the contract not as an

agent but for the purpose of authenticating the signature of the proposed

company (Newborne v Sensolid (Great Britain) Ltd. [1954] 1 QB 45). The same

provision provides that the promoter can be absolved of liability if there is an

express agreement in the contract that the person signing for the proposed

company is not to be liable (Phonogram v Lane Ltd. [1982] QB 938). It is

important to note that section 32A(1)(b) modifies the rule in Kelner by allowing a

duly incorporated company to ratify pre-incorporation contracts. Since the

company is yet to have its first board meeting, we can reasonably assume that

J & N Ltd has not ratified any pre-incorporation contracts yet. Jill will be

personally liable for the contracts with Peter if the board refuses to render such

ratification.

Jill may argue that, at the material time, she did not owe any fiduciary duties to

J & N Ltd as a director because the company did not exist yet. Although that is a

correct legal position, Jill must also note that a promoter as such owes fiduciary

duties to the proposed company. One consequence of this fiduciary relationship

is that a promoter must not make profit in the course of and out of the

incorporation activities. If a promoter intends to do so, he must seek the

consent of the company just as a director should do if he has made an

unauthorised profit out of his position as a director, putting him into a conflict of

interest with the company. As a general rule, the company’s consent is only

effective if the promoter has first made a full and frank disclosure of all the

relevant information to an independent board of directors or if the board is not

truly independent, to the existing and prospective shareholders of the company,

for example, by making the disclosure in the prospectus. In this case, the

company can sue Jill for her breach of the fiduciary duty to avoid conflicts of

interest with J & N Ltd as a promoter (Gluckstein v Barnes [1900] AC 240).

END