1 THE HONG KONG INSTITUTE OF CHARTERED SECRETARIES THE INSTITUTE OF CHARTERED SECRETARIES AND ADMINISTRATORS International Qualifying Scheme Examination HONG KONG CORPORATE LAW DECEMBER 2014 Suggested Answer The suggested answers are published for the purpose of assisting students in their understanding of the possible principles, analysis or arguments that may be identified in each question
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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
DECEMBER 2014
Suggested Answer
The suggested answers are published for the purpose of assisting students in their
understanding of the possible principles, analysis or arguments that may be identified in each
question
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SECTION A
1.
Carmen is the managing director and controlling shareholder of Hong Kong
Development Ltd (HKDL). Albert and Benny are the other two non-executive
directors of HKDL. Albert seldom attends any board meetings while Benny is a
new university graduate. Although Carmen occasionally shows Benny some of
HKDL’s financial reports, Benny does not understand the reports and simply signs
whatever Carmen asks him to sign.
Although the objects clause of HKDL provides that the company’s main business
is to trade in merchantable goods, it does not have any real transactions. In fact,
HKDL was set up to mastermind a fraudulent scam on investors (the Scheme).
Under the Scheme, HKDL solicited and obtained funds from wealthy individuals
who are known as traders, under the promise of high returns from a factoring
business. Benjamin was one of these traders and he invested HK$50 million in the
Scheme under an investment agreement with HKDL.
HKDL advertised that the funds collected in the Scheme were to be used in
purchasing and selling merchantable goods, and when not being so used were to
be deposited with a bank. Under the Scheme, HKDL entered into a management
agreement with Property Management Ltd. (PML), a company wholly controlled by
Carmen, to manage and carry out its business and to maintain its bank accounts.
Funds advanced by traders to HKDL were passed to PML, but, instead of being
used to purchase goods, they were either used to pay the purported profits back to
traders or circulated around other companies controlled by Carmen in order to
inflate HKDL’s and PML’s apparent turnover and mask the absence of any real
business in either company.
Money advanced by Benjamin was also used in that process. As a result of this
Scheme, HKDL and PML reported ever growing turnover and profits and their
share price rose accordingly. Early this month, Carmen sold all her shares in
HKDL to Nancy, and then disappeared.
Mark, who holds 5 per cent of the shares in HKDL, found out about the scam and
would like to call a general meeting to discuss the issue with other members of
HKDL. Mark knows that one of his friends, Kelvin, who holds another 5 per cent of
the shares in HKDL, is also very unhappy about this problem. Benjamin has found
out that the Scheme is actually a scam and would like to claim back his HK$50
million from PML as he has found that HKDL has no assets at all. Nancy is worried
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that she may have liability for the criminal acts of HKDL and she would like to wind
up the company. Nancy also wonders whether Albert and Benny may have any
liability as they, as directors of HKDL, failed to monitor the company properly.
REQUIRED:
1. (a) Advise Mark as to the proper procedures to call a general meeting of HKDL.
(10 marks)
Ans (a) Candidates are expected to discuss sections 113(1) and 114A(1)(b) of the
Companies Ordinance (Cap 32).
Section 113(1) provides that the directors of a company, notwithstanding anything
in its articles shall, 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 extraordinary general meeting of the company.
Section 113(2) provides that the requisition must state the objects of the meeting,
and must be signed by the requisitionists and deposited at the registered office of
the company, and may consist of several documents in like form, each signed by
one or more requisitionists.
Section 113(3) provides that 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.
In our case, Mark holds 5 per cent of the issued shares of HKDL and may request
that the directors of the company hold a general meeting.
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Section 114A(1)(b) provides that two or more members holding not less than
one-tenth in nominal value of the issued share capital or, if the company has not a
share capital, not less than 5 per cent in number of the members of the company,
may call a meeting.
In our case, if Mark can find another shareholder who holds 5 per cent issued
shares in the company, they may call a general meeting.
Or candidates may refer to the new Companies Ordinance (Cap. 622)
Members of a company may request the directors to call a general meeting of the
company. The directors are required to call a general meeting if the company has
received requests to do so from members of the company representing at least 5
per cent of the total voting rights of all the members having a right to vote at
general meetings. The request must state the general nature of the business to be
dealt with at the meeting; and may include the text of a resolution that may
properly be moved and is intended to be moved at the meeting. The request may
be sent to the company in hard copy form or in electronic form; and must be
authenticated by the person or persons making it (section 566).
Once the above request to call a meeting is made, directors must call a meeting
within 21 days after the date on which they become subject to the requirement. A
meeting called must be held on a date not more than 28 days after the date of the
notice convening the meeting. If the requests received by the company identify a
resolution that may properly be moved and is intended to be moved at the
meeting, the notice of the meeting must include notice of the resolution. The
business that may be dealt with at the meeting includes a resolution notice of
which has been included in the notice of the meeting. If the resolution is to be
proposed as a special resolution, the directors are to be regarded as not having
duly called the meeting unless the notice of the meeting includes the text of the
resolution and it specifies the intention to propose the resolution as a special
resolution (section 567).
If the above request to call a meeting is made but the directors do not follow the
above procedures to call a meeting, the members who requested the meeting, or
any of them representing more than one half of the total voting rights of all of them,
may themselves call a general meeting (section 568(1)). The meeting must be
called for a date not more than three months after the date on which the directors
becomes subject to the requirement to call a meeting (section 568(3). Any
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reasonable expenses incurred by the members requesting the meeting by reason
of the failure of the directors duly to call a meeting must be reimbursed by the
company (section 568(6)). Any sum so reimbursed must be retained by the
company out of any sum due or to become due from the company by way of fees
or other remuneration in respect of the services of the directors who were in
default (section 568(7)).
If at any time a company does not have any director or does not have sufficient
directors capable of acting to form a quorum, any director, or any two or more
members of the company representing at least 10% of the total voting rights of all
the members having a right to vote at general meetings, may call a general
meeting in the same manner, as nearly as possible, as that in which general
meetings may be called by the directors of the company (section 569).
1. (b) Advise Benjamin as to how and against whom he should consider taking action to claim back his $50 million.
(10 marks)
Ans (b) Candidates are expected to discuss the rule about separate legal entities and
lifting the corporate veil.
In law, registered companies are recognised as having their own legal personality
and can exist separate and distinct from their members and managers. This basic
legal idea was confirmed in Salomon v Salomon and Co. Ltd. [1897) AC 22.
The case concerned a man who ran a shoe-making business as a sole trader but
then sought to convert the business into the form of a limited company. As the
company was a separate legal entity to its owners, the company had to pay Mr.
Salomon for the value of the business transferred to it from Mr. Salomon. The
company paid him partly in shares in itself and partly by way of a secured loan
from Mr. Salomon to it, which it promised to repay at a later date. Before the
company had repaid its debt to Mr. Salomon, it went into insolvent liquidation. Mr.
Salomon claimed all the assets of the company to repay the loan but the other
creditors said it was all a fraud and that Mr. Salomon and the company were, in
reality, the same. Thus, they said Mr. Salomon should not have priority in getting
his loan back. However, the court did not agree and held that once a company is
legally incorporated, it must be treated like any other independent person with
rights and liabilities appropriate to itself.
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In our case, Carmen, as a shareholder of the HKDL, is not liable for the debt of the
company. Besides, Carmen and PML are, under the same rule, to be regarded as
separate legal entities. PML’s assets may not be used to repay Carmen’s debts,
although Carmen may be forced to sell her shares in PML in order to repay her
debts.
However, under some special situations, the court may ignore the separate legal
entity concept and regard the company and its shareholders as one entity, i.e.
lifting the corporate veil.
If the court lifts the corporate veil, a shareholder may be liable for the debts of a
company.
If a company is used as a means to commit fraud or to avoid legislation, the court
may lift the corporate veil.
In Gilford Motor Co. v Horne [1933] Ch.935, Mr. Horne had been employed as a
director of Gilford Motor and as part of his conditions of employment he agreed not
to seek the company's customers' business once he left their employment. After
Mr. Horne left the company he set up a new company, which employed him and
his wife. Mr. Horne, acting on behalf of the new company, then sought to get the
business of Gilford's customers. The court held that the new company was a sham
and ordered both the new company and Mr. Horne not to approach Gilford's
customers.
.
In our case, if it is proved that HKDL was used as a sham to commit fraud, the
court may lift the corporate veil and hold Carmen personally liable for the debts of
HKDL.
1. (c) Advise Nancy as to the grounds under which she may petition to wind up HKDL.
(10 marks)
Ans (c) Candidates are expected to discuss section 177(1) of the Companies Ordinance
(Cap. 32).
Section 177(1) provides that a company may be wound up by the court if:
(a) the company has by special resolution resolved that the company be wound up
by the court;
(b) the company does not commence its business within a year from its
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incorporation, or suspends its business for a whole year;
(c) the company has no members;
(d) the company is unable to pay its debts;
(e) the event, if any, occurs on the occurrence of which the memorandum or
articles provide that the company is to be dissolved;
(f) the court is of opinion that it is just and equitable that the company should be
wound up..
In our case, Nancy may pass a special resolution to wind up the company.
However, it is not clear whether she has sufficient votes to pass a special
resolution, i.e. not less than 75% of votes in a general meeting.
If Nancy does not have enough votes to pass a special resolution, she may wind
up the company on just and equitable grounds.
The Companies Ordinance does not define the meaning of ‘just and equitable
grounds’. However, if a company carries on illegal business, it may be just and
equitable to wind the company up.
In our case, Nancy can argue that the company is used to carry on illegal
business, i.e. the scam to cheat traders, and it is just and equitable to wind up the
company.
1. (d) Advise Albert and Benny as to whether they are in breach of their duties as directors of HKDL.
(10 marks) (Total: 40 marks)
Ans (d) Candidates are expected to discuss the rule about breach of directors’ duties.
Directors of companies always owe directors’ duties to their companies, but not to
individual shareholders.
Directors’ duties may be classified into two main categories: fiduciary duties, and
duties of skill and care.
Fiduciary duties include the following:
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
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A director’s duties of care and skill toward the company are not as onerous as
their fiduciary duties.
In Re City Equitable Fire Insurance Co Ltd. [1925] Ch 407, the court laid down
three propositions which summarise a director’s duty of care.
A director need not, in the performance of his duties, exhibit a greater degree of
skill than may be reasonably expected from a person of his knowledge and
experience. Thus, in an action where it is claimed that a director acted negligently,
his conduct is judged against that of the reasonable man with his (the director’s)
qualification and experience. If the director is qualified as an accountant, lawyer,
engineer, or otherwise, his conduct will be judged in comparison with that of the
relevant professional, but where the director is unqualified, the standard of
competence may be very low.
A director is not bound to give continuous attention to the affairs of the company.
His duties are of an intermittent nature to be performed at periodic board meetings
and at meetings of any committee of the board upon which he happens to be
placed. He is not, however, bound to attend all such meetings, though he ought to
attend whenever in the circumstances he is reasonably able to do so. This duty
may need to be reconsidered in the case of directors who are employed by the
company.
In respect of all duties that may properly left to some other official, having regard
to the needs of the business and the articles of the company, a director, in the
absence of grounds for suspicion, is justified in trusting that official to perform such
duties honestly.
In our case, It is likely that Albert was in breach of his duties of skills and care as
Albert seldom attended any board of directors’ meetings.
It is arguable whether Benny is in breach of his duties of skills and care as he is
judged by his qualification and experience. It may arguably be reasonable for a
recent university graduate not to understand a company’s financial reports,
especially if he did not major in accounting or finance. As long as he exercises
reasonable skills and care as a reasonable university graduate, there is no breach
of director’s duties of skill and care.
However, this principle about the standard of directors’ duties of skill and care is
now in doubt after an Australian case, Australian Securities and Investments
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Commission v Healey [2011] FCA 717
Candidates may also refer to section 465 of the Companies Ordinance (Cap. 622)
A director of a company must exercise reasonable care, skill and diligence
(section 465(1)).
Reasonable care, skill and diligence mean the care, skill and diligence that would
be exercised by a reasonably diligent person with:
(a) the general knowledge, skill and experience that may reasonably be expected
of a person carrying out the functions carried out by the director in relation to
the company; and
(b) the general knowledge, skill and experience that the director has
(section 465(2)).
The duty specified in section 465(1) is owed by a director of a company to the
company (section 465(3)).
The duty specified in section 465(1) has effect in place of the common law rules
and equitable principles as regards the duty to exercise reasonable care, skill and
diligence, owed by a director of a company to the company (section 465(4)).
Section 465 applies to a shadow director as it applies to a director (section
465(5)).
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SECTION B
2.
A group of artists intended to perform under the name ‘Hong Kong Girls’ and to
form a company for the purpose to be called Hong Kong Girls Ltd. Daisy accepted
a cheque from Martin for $100,000 and acknowledged receipt by signing her name
“for and on behalf Hong Kong Girls Ltd.” The money was to be used to finance
production of an album and was repayable if this objective was not achieved. Hong
Kong Girls Ltd. was not formed as its name was rejected by the Companies
Registry. When the album was not produced, Martin sought to recover the money
from Daisy.
REQUIRED:
2. (a) Advise Daisy as to the grounds under which the Companies Registry may reject the proposed name of a company.
(10 marks)
Ans (a) Candidates are expected to discuss section 20 of the Companies Ordinance (Cap. 32).
Section 20(1) provides that a company is not allowed to be registered by a name:
(a) Which is the same as a name appearing in the Registrar’s index of company
names;
(b) Which is the same as that of a body corporate incorporated or established
under an Ordinance;
(c) The use of which by the company would, in the opinion of the Chief Executive,
constitute a criminal offence; or
(d) Which, in the opinion of the Chief Executive, is offensive or otherwise contrary
to the public interest.
Section 20(2) provides that, except with the consent of the Chief Executive, no
company is allowed to be registered by a name which:
(a) in the opinion of the Chief Executive, would be likely to give the impression that
the company is connected in any way with the Central People's Government or
the Government of Hong Kong or any department of either Government; or
(b) Includes any words or expression for the being time specified in an order which
approval of the Chief Executive is required.
In our case, it seems that the only ground which the Companies Registry may
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reject the name “Hong Kong Girls Ltd.” is that it is the same as a name appearing
in the Registrar’s index of company names.
Other grounds seem not too relevant.
If this is the case, Daisy has to change the name of the proposed company in order
for it not to be the same as any name appearing in the Registrar’s index of
company names.
Candidates may also refer to section 100 of the Companies Ordinance (Cap. 622).
A company must not be registered by:
(a) a name that is the same as a name appearing in the Index of Company
Names;
(b) a name that is the same as a name of a body corporate incorporated or
established under an Ordinance;
(c) a name the use of which by the company would, in the Registrar’s opinion,
constitute a criminal offence; or
(d) a name that, in the Registrar’s opinion, is offensive or otherwise contrary to the
public interest (section 622(1)).
Except with the Registrar’s prior approval, a company must not be registered by:
(a) a name that, in the Registrar’s opinion, would be likely to give the impression
that the company is connected in any way with:
(i) the Central People’s Government;
(ii) the Government; or
(iii) any department or agency of the Central People’s Government or the
Government;
(b) a name that contains any word or expression for the time being specified in an
order under section 101; or
(c) a name that is the same as a name for which a direction has been given under:
(i) section 108, 109 or 771; or
(ii) section 22 or 22A of the predecessor Ordinance on or after 10 December
2010 (section 100(2)).
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The Financial Secretary may, by order published in the Gazette, specify any word
or expression for the purposes of section 100(2)(b) (section 101).
2. (b) Advise Daisy as to whether she is liable to return the $100,000 to Martin.
(10 marks)
(Total: 20 marks)
Ans (b) Candidates are expected to discuss the rules about a pre-incorporation contract.
A promoter is ‘one who undertakes to form a company with reference to a given
project and to set it going, and who take the necessary steps to accomplish that
purpose’ (Twycross v Grant (1877) 2 CPD 469).
In this case, it is likely that Daisy is a promoter of the proposed company.
A promoter may enter into a contract on behalf of the proposed company before its
incorporation, i.e. a pre-incorporation contract (Kelner v Baxter (1866) LR 2 CP
174).
In our case, the contract between Daisy and Martin is a pre-incorporation contract.
The rule in Kelner is restated in section 32A(1)(a) of the Companies Ordinance,
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 company in other capacities.
In our case Daisy, who signs the pre-incorporation contract on behalf of Hong
Kong Girls Ltd., is personally liable for the contract.
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.
However, since Hong Kong Girls Ltd. was not formed and there was no ratification
by the company, Daisy is personally liable for the contract and is liable to return the
$100,000 to Martin.
Candidates may also refer to section 122 of the Companies Ordinance (Cap. 622)
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Subject to any express agreement to the contrary:
(a) the contract has effect as a contract entered into by the person purporting to
act for the company or as an agent for the company; and
(b) the person is personally liable on the contract and is entitled to enforce the
contract (section 122(2)).
After incorporation, the company may ratify the contract to the same extent as if:
(a) the company had already been incorporated when the contract was entered
into; and
(b) the contract had been entered into on the company’s behalf by an agent acting
without the company’s authority (section 122(3)).
Despite section 122(2)(b), if the contract is ratified by the company, then on and
after the ratification, the liability of the person mentioned in that subsection is not
greater than the liability that the person would have incurred if the person had
entered into the contract after the company’s incorporation as an agent acting
without the company’s authority (section 122(4)).
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3.
Kowloon Shipping Ltd. (KSL) was formed to purchase a ship from Singapore
Shipping Ltd. (SSL) on the basis that the ship was to be chartered back to SSL for
a period of three years at a minimum hire of $1 million per month. Sunny, who is
SSL’s managing director, met KSL's representatives in Denmark and told them
that he had authority on behalf of SSL to sign such a contract. When the other
directors of SSL found out about this, they complained that, according to SSL’s
articles of association, such a contract has to be approved by the board of
directors. However, no such approval had been obtained.
REQUIRED:
3. (a) Advise KSL as to whether the contract is binding on SSL.
(10 marks)
Ans (a) Candidates were expected to discuss Turquand’s rule.
Outsiders are entitled to assume all internal regulations and procedures are
complied with and have no duty to check any internal irregularity of a company.
In Royal British Bank v Turquand (1856), the board was allowed by the company's
memorandum and articles of association to borrow money on behalf of the
company if authorised by an ordinary resolution. The board borrowed money from
the bank via a contract bearing the company's seal without obtaining an ordinary
resolution. The court held that the contract was valid even though the ordinary
resolution had not been obtained as the bank was not able to discover from the
public register whether the internal procedures had been followed and if it was
usual for a company to borrow in this way.
However, there are exceptions to Turquand’s rule.
1) Where the person seeking to rely upon it is not a true outsider
In Howard v Patent Ivory (1888), the articles of association allowed the
directors to borrow up to £1,000 on behalf of the company without the
general manager’s consent and more with the general manager’s consent.
The directors lent £3,500 to the company and the company borrowed the
money without the general manager’s consent. Could the directors get
their money back? It was held they could only reclaim up to the £1,000 limit
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and no more. They were insiders and knew or should have known of the
restriction.
Candidates may cite any relevant case to support. Marks should be given to any
relevant case cited.
2) Where the outsider has actual notice of some internal irregularity.
3) Where the outsider is on inquiry (due to suspicious circumstances).
In our case, KSL may rely on Turquand’s rule and assume all internal procedures
have been complied with, i.e. a board resolution has already been passed to
authorise the agreement.
As a result, the agreement is binding on SSL.
Candidates may also refer to sections 117-119 of the Companies Ordinance (Cap.
622)
Sections 117-119 set out a new statutory indoor management rule. Under
section 117(1), in favour of a person dealing with a company in good faith, the
power of the company’s directors to bind the company, or authorising others to do
so, is regarded as free of any limitation under any relevant documents of a
company. A relevant document means: (a) the company’s articles; (b) any
resolutions of the company or of any class of members of the company; or (c) any
agreements between the members, or members of any class of members, of the
company (section 117(6)).
A person is presumed to have acted in good faith unless the contrary is proved
(section 117(1)(b)). A person dealing with a company is not to be regarded as
acting in bad faith by reason only of the person’s knowing that an act is beyond the
directors’ powers under any relevant document of the company (section
117(1)(c)). A person dealing with a company is not required to inquire as to the
limitations on the power of the company’s directors to bind the company or
authorise others to do so (section 117(1)(d)).
Section 117 only applies only where the transaction is entered by the board of
directors or through an agent acting under the authority of the board, e.g. a lack of
quorum at a board meeting. Section 117 provides that only the directors’ powers
are to be regarded as free of constitutional limitations, but does not confer
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authority to a person who has no authority under agency law.
Section 119 restricts the application of section 117 in respect of charitable
companies (referred to in the section as ‘exempted companies’) (section 119(1). A
person dealing with a charitable company is entitled to rely on section 117 only if:
(a) the person did not know that the company was a charitable company, or (b)
gave full consideration and did not know that the transaction was beyond the
directors’ powers.
3. (b) Would your answer be different if Sunny was not the managing director of
SSL but simply a chartering manager of SSL? Explain your reasoning.
(10 marks)
(Total: 20 marks)
Ans (b) Candidates are expected to discuss the rules about apparent authority.
In our case, if Sunny were not the managing director but just a chartering
manager, Turquand’s rule would not apply. However, KSL may rely on the
apparent authority of Sunny.
The court in Freeman and Lockyer v Buckhurst Park Properties (Mangal) Ltd
[1964] All ER 630 stated the four conditions which must be fulfilled to entitle a
contractor to enforce against a company a contract entered into on behalf of the
company by an agent who had no actual authority to do so. To constitute apparent
authority, the following must be shown: (1) that a representation that the agent had
authority to enter on behalf of the company into a contract of the kind sought to be
endorsed was made to the contractor; (2) that such representation was made by a
person or persons who had ‘actual’ authority to manage the business of the
company either generally or in respect of those matters to which the contract
relates; (3) that he (the contractor) was induced by such representation to enter
into the contract, that is, that he in fact relied upon it; and (4) that under its
memorandum or articles of association the company was not deprived of the
capacity either to enter into a contract of the kind sought to be enforced or to
delegate authority to enter into a contract of that kind to the agent.
In our case, it is arguable whether it is within the usual authority of a chartering
manager to sign such a contract. Despite this, Sunny may tell KSL that he has
authority to sign the contract on behalf of SSL, i.e. make a representation to KSL
17
that Sunny had authority to enter into the contract on behalf of SSL, even though
Sunny was not the person who had actual authority to manage the business of the
company. Therefore, it is unlikely that Sunny has apparent authority to sign the
contract on behalf of SSL as the second condition in the Freeman case is not
fulfilled.
The answer will be different from part (a).
The contract is not binding on SSL.
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4. Ronald and Tom, who are brothers, carried on a family business through Good
Family Ltd. (GFL). GFL had two principal business lines: a road haulage business,
and a manufacture and distribution of drinks business. Early this year, the brothers
quarrelled and the resulting deadlock put the existence of the business in jeopardy.
After negotiation, an agreement was reached whereby GFL’s business would be
split so that Ronald would acquire the haulage business and Tom would acquire
the drinks business. The agreement provided for a scheme of corporate
reorganisation whereby the assets of the business were divided equally but GFL
was left in place. The proposed arrangements also required GFL to be the
guarantor of a loan from Taiwan Bank to Ronald in order to allow him to purchase
Tom’s shares in GFL. Tom later took the view that the assets had not been equally
divided and challenged the scheme.
REQUIRED:
4. (a) Advise Ronald as to the grounds under which the scheme may be
challenged under the Companies Ordinance.
(14 marks)
Ans (a) Candidates are expected to discuss the rules about financial assistance to buy a
company’s shares under section 47A of the Companies Ordinance (Cap. 32).
Section 47A(1) of the Companies Ordinance provides that where a person is
acquiring or is proposing to acquire shares in a company, it is not lawful for the
company or any of its subsidiaries to give financial assistance directly or indirectly
for the purpose of that acquisition before or at the same time as the acquisition
takes place.
If a company acts in contravention of this restriction, it is liable to a fine, and every
officer who is in default is liable to imprisonment or a fine.
Section 47B(1) provides that financial assistance means:
(a) financial assistance given by way of gift;
(b) financial assistance given by way of guarantee, security or indemnity, other
than an indemnity in respect of the indemnifier's own neglect or default, or by
way of release or waiver;
(c) financial assistance given by way of a loan or any other agreement under
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which any of the obligations of the person giving the assistance are to be
fulfilled at a time when in accordance with the agreement any obligation of
another party to the agreement remains unfulfilled, or by way of the novation
of, or the assignment of rights arising under, a loan or such other agreement; or
(d) any other financial assistance given by a company the net assets of which are
thereby reduced to a material extent or which as no net assets.
In our case, it may be argued that the scheme which provided finance to Ronald in
order to allow him to purchase Tom’s shares in GFL was prohibited under section
47A(1).
Section 47C(1) provides that the above restriction does not prohibit a company
from giving financial assistance for the purpose of an acquisition of shares in it or
its holding company if:
(a) the company's principal purpose in giving that assistance is not to give it for the
purpose of any such acquisition, or the giving of the assistance for that purpose
is but an incidental part of some larger purpose of the company; and
(b) the assistance is given in good faith in the interests of the company.
In our case, Ronald may argue that the financial assistance was given to him in
good faith in the interests of the company and was incidental to a larger purpose,
i.e. corporation reorganisation.
In Brady v Brady [1989] AC 1, it was held that a reorganisation scheme had clearly
been made in good faith in the interests of a company and therefore fell within
section 47C(1); but that the financial assistance had not been an incidental part of
some larger purpose of the company and therefore prima facie it did not fall within
the exception to the prohibition in section 47A(1) against a company giving
financial assistance for the acquisition of its own shares.
According to this case, it is unlikely that Ronald may rely on this exception.
However, Ronald may follow the procedures in section 47E.
Candidates may also refer to sections 274-278 of the Companies Ordinance (Cap.
622).
Section 275(1) provides if a person is acquiring or proposing to acquire shares in a
company, the company or any of its subsidiaries must not give financial assistance
directly or indirectly for the purpose of the acquisition before or at the same time as
20
the acquisition takes place, except as provided by this Division.
Section 274(1) provides that financial assistance means:
(a) financial assistance given by way of gift;
(b) financial assistance given:
(i) by way of guarantee, security or indemnity (other than an indemnity in
respect of the indemnifier’s own neglect or default); or
(ii) by way of release or waiver;
(c) financial assistance given:
(i) by way of a loan or any other agreement under which any of the obligations
of the person giving the assistance are to be fulfilled at a time when in
accordance with the agreement any obligation of another party to the
agreement remains unfulfilled; or
(ii) by way of the novation of, or the assignment of rights arising under, a loan
or other agreement referred to in subparagraph (i); or
(d) any other financial assistance given by a company if:
(i) the net assets of the company are reduced to a material extent by the
giving of the assistance; or
(ii) the company has no net assets.
Section 276 provides that if a company gives financial assistance in contravention
of the above restriction, the validity of the financial assistance and of any contract
or transaction connected with it is not affected only because of the contravention.
Section 277 provides that the following transactions are not prohibited:
(a) the distribution of a company’s assets:
(i) by way of dividend lawfully made; or
(ii) in the course of winding up the company;
(b) the allotment of bonus shares;
(c) the reduction of a company’s share capital in accordance with Division 3;
(d) the redemption or buy-back of a company’s own shares in accordance with
Division 4;
(e) anything done in accordance with a court order under Division 2 of Part 13
(arrangements and compromises);
(f) anything done under an arrangement made under section 237 of the
Companies (Winding Up and Miscellaneous Provisions) Ordinance (Cap 32)
(power of liquidator to accept shares, etc., as consideration for sale of property of
company);
(g) anything done under an arrangement made between a company and its
21
creditors that is binding on the creditors because of section 254 of the Companies
(Winding Up and Miscellaneous Provisions) Ordinance (Cap 32) (arrangement,
when binding on creditors).
Section 278 provides that the restriction does not prohibit a company from giving
financial assistance for the purpose of the acquisition of a share in the company or
its holding company or for the purpose of reducing or discharging a liability
incurred for such an acquisition if
(a) either:
(i) the company’s principal purpose in giving the assistance is not to give it for
the purpose of the acquisition of a share in the company or its holding
company or for the purpose of reducing or discharging a liability incurred
for such an acquisition; or
(ii) the giving of the assistance for the purpose of the acquisition of a share in
the company or its holding company or for the purpose of reducing or
discharging a liability incurred for such an acquisition is only an incidental
part of some larger purpose of the company; and
(b) the assistance is given in good faith in the interests of the company.
4. (b) Advise Ronald as to the proper procedures under the Companies Ordinance
he may follow in order to avoid the scheme being challenged.
(6 marks)
(Total: 20 marks)
Ans (b) Section 47E of the Companies Ordinance (Cap. 32) provides that an unlisted
company may give financial assistance for the acquisition of its shares if:
(a) The assistance does not reduce the company’s net assets, or if it does, the
assistance is provided out of distributable profits;
(b) A majority of the directors make a statement explaining:
(i) The form of the assistance;
(ii) The names, addresses, and occupations of the persons given the
assistance;
(iii) The intended purpose of the assistance;
(iv) That in their opinion, immediately following the giving of the assistance,
there will be no ground on which the company could then be found to be
unable to pay its debts.
(c) The financial assistance is approved by special resolution passed at a general
meeting within 30 days of a majority of directors making their statement.
22
In our case, Ronald may follow the above procedures to approve the financial
assistance. However, as Tom would like to challenge the scheme it is unlikely that
Tom would support the scheme. Accordingly, it is unlikely that a special resolution
can be passed.
Candidates may also refer to sections 283-285 of the Companies Ordinance (Cap.
622).
Section 283(1) provides that a company may give financial assistance for the
purpose of the acquisition of a share in the company or its holding company or for
the purpose of reducing or discharging a liability incurred for such an acquisition if:
(a) the directors resolve, before the assistance is given, that:
(i) the company should give the assistance;
(ii) giving the assistance is in the best interests of the company; and
(iii) the terms and conditions under which the assistance is to be given are fair
and reasonable to the company;
(b) on the same day that the directors pass the resolution, the directors who vote
in favour of it make a solvency statement that complies with Division 2 in
relation to the giving of the assistance;
(c) the aggregate amount of the assistance and any other financial assistance
given under this section that has not been repaid does not exceed 5 per cent of
the paid up share capital and reserves of the company (as disclosed in the
most recent audited financial statements of the company); and
(d) the assistance is given not more than 12 months after the day on which the
solvency statement is made under paragraph (b).
Section 284(1) provides that a company may give financial assistance for the
purpose of the acquisition of a share in the company or its holding company or for
the purpose of reducing or discharging a liability incurred for such an acquisition if:
(a) the directors resolve, before the assistance is given, that:
(i) the company should give the assistance;
(ii) giving the assistance is in the best interests of the company; and
(iii) the terms and conditions under which the assistance is to be given are fair
and reasonable to the company;
(b) on the same day that the directors pass the resolution, the directors who vote
in favour of it make a solvency statement that complies with Division 2 in
relation to the giving of the assistance;
23
(c) the giving of the assistance is approved by written resolution of all members of
the company before the assistance is given; and
(d) the assistance is given not more than 12 months after the day on which the
solvency statement is made under paragraph (b).
Section 285(1) provides that a company may give financial assistance for the
purpose of the acquisition of a share in the company or its holding company or for
the purpose of reducing or discharging a liability incurred for such an acquisition if:
(a) the directors resolve, before the assistance is given, that:
(i) the company should give the assistance;
(ii) giving the assistance is in the best interests of the company and is of
benefit to those members of the company not receiving the assistance; and
(iii) the terms and conditions under which the assistance is to be given are fair
and reasonable to the company and to those members not receiving the
assistance;
(b) on the same day that the directors pass the resolution, the directors who vote
in favour of it make a solvency statement that complies with Division 2 in
relation to the giving of the assistance;
(c) the company sends to each member of the company a copy of the solvency
statement made under paragraph (b) and a notice containing the following
information:
(i) the nature and terms of the assistance and the name of the person to
whom it will be given;
(ii) if it will be given to a nominee for another person, the name of that other
person;
(iii) the text of the resolution of the directors;
(iv) any further information and explanation that would be necessary for a
reasonable member to understand the nature of the assistance and the
implications of giving it for the company and the members;
(d) the giving of the assistance is approved by resolution of the company before
the assistance is given; and
(e) the assistance is given:
(i) not less than 28 days after the day on which the resolution is passed under
paragraph (d); and
(ii) not more than 12 months after the day on which the solvency statement is
24
made under paragraph (b).
25
5. Four Brothers Ltd. is a private company incorporated in Hong Kong. Ivan and Gary
are the two directors of the company. On 1 October 2013, a debenture was issued
by the company to Vanessa to secure a loan of $1 million, with a floating charge
over the company’s assets and undertakings. At that date, the company was
insolvent and its debts included $200,000 each to Ivan and Gary in respect of their
directors' remuneration, and $600,000 to Mary, who had made a loan to the
company earlier in the year.
On 12 April 2014, $1 million in cash, which purported to be by way of subscription
for the debenture and which had been provided by Vanessa, was paid into the
company's bank account. On the same date, there were several payments made
out of the bank account, including $200,000 to Ivan, $200,000 to Gary and
$600,000 to Mary. On 3 May 2014, a petition was presented for the winding up of
the company and on 27 May 2014 the court ordered that the company be wound
up. Michael was appointed as the liquidator of the company.
REQUIRED:
5. (a) Advise Michael as to the validity of the floating charge created in favour of
Vanessa.
(10 marks)
Ans (a) Candidates are expected to discuss the rules about validity of a floating charge.
Section 267 of the Companies Ordinance (Cap. 32) provides that where a
company is being wound up, a charge which, when created, was a floating
charge on the undertaking or property of the company and which was also created
within 12 months of the commencement of the winding up shall, unless it is proved
that the company immediately after the creation of the charge was solvent, be
invalid, except to the amount of any cash paid to the company at the time of or
subsequently to the creation of, and in consideration for, the charge.
In our case, as the floating charge was created within 12 months before the
commencement of the winding up of the company, it was invalid unless one of the
two exceptions applies.
26
In our case, at the time of creation of the floating charge, the company was
insolvent. Therefore, the first exception did not apply.
Vanessa may argue that the second exception applies as $1 million was paid into
the company’s bank account on 12 April 2014 and could not be regarded as cash
paid to the company subsequent to the creation of, and in consideration for, the
charge.
However, in Re Destone Fabrics Ltd. [1941] 1 Ch 319, the court held that the
object and effect of the transaction was not to benefit the company, but merely to
provide money for the benefit of certain creditors of the company to the prejudice
of other creditors; that there was no cash bona fide ‘paid to the company at the
time of or subsequently to the creation of, and in consideration for; the charge’
within the exception in section 267; and that, therefore, the charge was invalid.
5. (b) Advise Michael as to the validity of the payments made to Ivan, Gary and
Mary.
(10 marks)
(Total: 20 marks)
Ans (b) Candidates are expected to discuss the rules about unfair preference.
The payments made may be challenged as unfair preference.
Unfair preference is defined under section 49 of the Bankruptcy Ordinance which
provides that a person gives an unfair preference to another person if:
(a) that person is one of the debtor's creditors or a surety or guarantor for any of
his debts or other liabilities; and
(b) the debtor does anything or suffers anything to be done which (in either case)
has the effect of putting that person into a position which, in the event of the
debtor's bankruptcy, will be better than the position he would have been in if
that thing had not been done.
The court shall not make an order in respect of an unfair preference given to any
person unless the debtor who gave the unfair preference was influenced in
deciding to give it by a desire to produce in relation to that person the effect
mentioned.
In our case, it is quite clear that the payments were influenced by a desire to prefer
27
Ian, Gary and Mary.
If any unfair preference is given to a non-associate of a company, the relevant
period is six months.
If any unfair preference is given to an associate of a company, the relevant period
is two years.
Section 51(2) provides that the relevant period is not regarded as relevant unless
the debtor:
(a) is insolvent at that time; or
(b) becomes insolvent in consequence of the transaction or preference.
In our case, the company was insolvent at the time when the payments were
made.
In our case, the payments clearly improved the position of Ian, Gary and Mary who
were creditors of the company, and the payments were made within six months.
As a result, the payments may be challenged as unfair preferences and declared
invalid.
28
6. A comprehensive exercise to rewrite the Companies Ordinance (Cap. 32) was
launched in mid-2006 with the aim of modernising Hong Kong's company law and
further enhancing Hong Kong's status as a major international business and
financial centre. The new Companies Ordinance (Cap. 622) (the new CO)
commenced operation on 3 March 2014. It was suggested that the new
Companies Ordinance aims to achieve four main objectives.
REQUIRED:
Explain the four main objectives of the new Companies Ordinance (Cap.
622). Give two examples of new features/ concepts in the new Companies
Ordinance (Cap. 622) which aim to achieve each of the four objectives.
(Total: 20 marks)
Ans The new Companies Ordinance aims to achieve four main objectives:
i) to enhance corporate governance,
ii) to ensure better regulation,
iii) to facilitate business, and
iv) to modernise the law.
Enhancing corporate governance
i) Strengthening the accountability of directors
- Restricting the appointment of corporate directors by requiring every
private company to have at least one natural person to act as director, to
enhance transparency and accountability.
- Clarifying in the statute the directors’ duty of care, skill and diligence with
a view to providing clear guidance to directors.
ii) Enhancing shareholder engagement in the decision-making process
- Introducing a comprehensive set of rules for proposing and passing a
written resolution.
- Requiring a company to bear the expenses of circulating members’
statements relating to the business of, and proposed resolutions for,
annual general meetings, if they are received in time to be sent with the
notice of the meeting.
- Reducing the threshold requirement for members to demand a poll from
10 per cent to 5 per cent of the total voting rights.
29
iii) Improving the disclosure of company information
- Requiring public companies and the larger (i.e. companies that do not
qualify for simplified reporting) private companies and guarantee
companies to prepare a more comprehensive directors’ report which
includes an analytical and forward-looking ‘business review’, whilst
allowing private companies to opt out by special resolution. The
business review will provide useful information for shareholders. In
particular, the requirement to include information relating to
environmental and employee matters that have a significant effect on the
company is in line with international trends to promote corporate social
responsibility.
- Widening the ambit of disclosure of material interests of directors in
contracts of significance with the company to cover transactions and
arrangements and to expand the coverage to include the material
interests of entities connected with a director in the case of public
companies.
iv) Fostering shareholder protection
Introducing more effective rules to deal with directors’ conflicts of
interests, including expanding the requirement for seeking shareholders’
approval to cover directors’ employment contracts which exceed three
years.
- Requiring disinterested shareholders’ approval in cases where
shareholders’ approval is required for transactions of public companies
and their subsidiaries.
v) Strengthening auditors’ rights
- Empowering an auditor to require a wider range of persons, including the
officers of a company’s Hong Kong subsidiary undertakings and any
person holding or accountable for the company or its subsidiary
undertakings’ accounting records, to provide information or an
explanation reasonably required for the performance of the auditor’s
duties. The offence for failure to provide the information or explanation is
extended to cover officers of the company and the wider range of
persons.
Candidates are expected to give any two of the above examples.
30
Ensuring better regulation
i) Ensuring the accuracy of information on the public register
- Clarifying the powers of the Registrar of Companies (the Registrar) in
relation to the registration of documents, such as specifying the
requirements for the authentication of documents to be delivered to the
Companies Registry (the Registry) and the manner of delivery, and
withholding the registration of unsatisfactory documents pending further
particulars.
ii) Improving the registration of charges
- Revising the list of registrable charges, such as expressly providing that
a charge on an aircraft or any share in an aircraft is registrable, and
removing the requirement to register a charge for the purpose of
securing an issue of debentures.
iii) Refining the scheme for deregistration of companies
- Imposing three additional conditions for the deregistration of defunct
companies, namely that the applicant must confirm that the company is
not a party to any legal proceedings and that neither the company nor its
subsidiary has any immovable property in Hong Kong, to minimise any
potential abuse of the deregistration procedure.
iv) Improving the enforcement regime
- Enhancing the investigatory powers of an inspector, for example, by
requiring a person under investigation to preserve records or documents
and to verify statements made by statutory declaration.
Candidates are expected to give any two of the above examples.
Facilitating business
i) Streamlining procedures
- Allowing companies to dispense with annual general meetings by
unanimous shareholders’ consent.
- Introducing an alternative court-free procedure for reducing capital
based on a solvency test.
- Allowing all types of companies (rather than just private companies, as in
the current Companies Ordinance (Cap.32)) to purchase their own
31
shares out of capital, subject to a solvency test.
ii) Facilitating simplified reporting
- Facilitating SMEs to prepare simplified financial and directors’ reports
along the following lines:
- a private company (with the exception of a bank/deposit-taking
company, an insurance company or a stockbroker) will automatically
qualify for simplified reporting if it qualifies as a ‘small private company’.
- the holding company of a group of companies that qualifies as a ‘group
of small private companies’ will also qualify for simplified reporting.
- a private company that is not a member of a corporate group may adopt
simplified reporting with the agreement of all the members.
Allowing small guarantee companies and groups of small guarantee
companies, which have a total annual revenue of not more than $25
million, to qualify for simplified reporting.
A private company or a group of private companies which does not qualify
as a ‘small private company or a “group of small private companies”
respectively may prepare simplified reports if it meets a higher size criteria
and if the members holding 75% of the voting rights so resolve and no
member objects.
Making the summary financial reporting provisions more user-friendly and
extending their application to companies in general (rather than confining
them to listed companies, as in the current Companies Ordinance).
iii) Facilitating business operations
- Making the use of a common seal optional and relaxing the requirements
for a company to have an official seal for use abroad.
- Permitting a general meeting to be held at more than one location using
electronic technology.
- Setting out the rules governing communications to and by companies in
electronic form.
Candidates are expected to give any two of the above examples.
32
Modernising the law
i) Rewriting the law in simple and plain language
- Modernising the language and re-arranging the sequence of some of the
provisions in a more logical and user-friendly order so as to make the
new CO more readable and comprehensible.
ii) Abolishing par value for shares
- Adopting a mandatory system of no-par for all companies with a share
capital as par value is an antiquated concept that may give rise to
practical problems, such as inhibiting the raising of new capital and
unnecessarily complicating the accounting regime.
iii) Abolishing the memorandum of association
- Abolishing the requirement for companies to have a memorandum of
association and only articles of association are required. Conditions
contained in the memorandum of existing companies will be deemed to
be provisions of their articles, except those relating to authorised share
capital and par value, which are regarded as deleted under the new CO.
iv) Removing the power to issue share warrants
- Removing the power of companies to issue share warrants to bearers.
Share warrants are rarely issued by companies nowadays and are
undesirable from the perspective of anti-money laundering because of
the lack of transparency in the recording of their ownership and the
manner by which they are transferred.
v) Clarifying the rules on indemnification of directors against liabilities to third
parties
- Clarifying the rules on the indemnification of directors against liabilities to
third parties in order to remove the uncertainties at common law.
Candidates are expected to give any two of the above examples.