2 April, 2012

 

The statutory derivative action regime under Part IVAA of the Companies Ordinance (Cap. 32) enables a member to bring or intervene in legal proceedings on behalf of a company, with leave of the court, under section 168BC(3), provided that (i) the proceedings appear to be prima facie in the interests of the company; and (ii) there is a serious issue to be tried and the company has not itself brought proceedings. The regime came into force in July 2005, following concerns raised in relation to the limited scope for redress under the traditional common law derivative action regime, which strictly required the shareholder to prove fraud on the minority (at least to a degree of "equitable fraud" or abuse of power). By comparison, the statutory regime is wider and covers general misfeasance by directors of a company.
 
Locus Standi
 
If a wrong has been done to a company, the proper plaintiff would be the company itself. This is the rule in Foss v Harbottle1, a bedrock principle of corporate law under the common law. The constraints of the rule are obvious. A minority shareholder would not be able to raise a complaint, even though their interests (e.g. value of their shares) may be at stake. The concept of a derivative action (be it at common law or under statute) is an exception introduced to alleviate the harsh consequences of this rule on the minority shareholder.
 
In the context of the statutory derivative action regime, the right is extended to members of the company and since the further amendments to the Companies Ordinance in December 2010, to members of a related company as well2. A "related company" includes a holding company, a subsidiary or a subsidiary of a holding company of the subject company3, which means that multiple derivative actions are now permissible under the regime, provided the company is one which is incorporated in Hong Kong4.
 
However, it remains the case that only a member registered on the company's (or related company's) register of members would have standing to make an application under section 168BC. Standing is not conferred upon those who have beneficial ownership of the shares in the company (or related company) but are not, for whatever reason, registered as members. In Re Luen Fat Paint Co Ltd (unreported, HCMP 1791/2009, 11 February 2010), the administratrixes of a deceased member's estate under a limited grant who had yet to obtain the full grant of letters of administration (let alone be registered as members of the company in place of the deceased) were faced with a situation of having to make an application under section 168BC to stop an imminent sale of a property by the board of directors at a gross undervalue. The Court, at the initial hearing of the leave application under Part IVAA, ordered that the hearing be adjourned to enable an independent valuation to be conducted on the subject property, pursuant to section 168BG(1)(d). Fortunately for the applicants, by the time of the adjourned hearing, they were able to get themselves registered as members of the company in place of the deceased through a separate court application to rectify the register, by relying on the strength of the limited grant and on the court order made at the initial hearing and, therefore, to overcome the initial problem of their lack of standing.
 
Whilst the granting of the adjournment was a clear blessing for the applicants in that case, the principle distilled there from that an applicant need only be registered as a member of a company by the time that leave is granted (but not necessarily at the time of the application) is one that remains to be affirmed by higher authority.
 
In any event, the case does highlight a potential constraint in the statutory derivative regime, especially for beneficial owners of shares who are not registered as members (perhaps due to an error on the part of the company only) but are required to bring or intervene in proceedings on behalf of the company on an urgent basis.
 
Prima Facie Interests of the Company
 
The Hong Kong judiciary has been consistent all along, that the threshold that proceedings be prima facie in the interests of the company, is low5. At the stage when the member is applying for leave, the court will not attempt to resolve the underlying dispute. Instead, for the purpose of the leave application, the court will simply consider whether there is an arguable case before it and whether the company will suffer any prejudice from the bringing of the intended proceeding6.
 
The court may, in addition, enquire into whether the intended proceedings, even if successful, would positively serve the interests of the company, be it commercially or otherwise7. If the court has any hesitation in this regard, it could require the applicant to be responsible for the costs ordered against the company and to give an undertaking that he/she shall not seek contribution or indemnity from the company8.
 
Serious Question To be Tried
 
In a similar vein, the judiciary has emphasized that the threshold for a serious question to be tried is not difficult to meet and is in fact comparable to that required for an interlocutory injunction. The court would not look into the merits of the intended action to any great degree and would only consider whether there is enough to show a sufficient likelihood of success. In the recent case of Re Li Chung Shing Tong (Holdings) Ltd [2011] 5 HKC 531, the Court even went so far as to say that odds against success would not count against the plaintiff, unless the prospects of success were so dim that the plaintiff could not have no expectation but only a hope of success.
 
The Nexus Between the Two Criteria
 
The Court of First Instance raised an interesting point in the Li Chung Shing Tong case on how the two criteria of "the prima facie interests of the company" and "a serious question to be tried" interrelate. The Court was of the view that, in normal circumstances, where there is a serious issue to be tried, it is very likely that it would be in the prima facie interests of the company to bring the proposed legal action. However, such logic does not necessarily apply to every case. For instance, in situations where the company has a claim against a person with which it regularly does business, the proposed legal action is likely to damage the business relationship and maintenance of the relationship is more valuable to the company than any likely recovery in the contemplated proceedings. The Court was of the view that in such circumstances, one must first look to the decision of the directors who, having been given reasonable notice by a complainant in good faith, decide not to assert a corporate right of action. One must also be careful when looking at the directors' intention, as there would be cases in which the complaint relates to the misconduct of the directors and therefore their decision to bring a corporate action would inevitably not be impartial. Therefore, in cases in which a prospective claim is not against a director or directors, the board's view of what is in the interests of the company should generally be given considerable weight; in cases in which the prospective claim is against a director or directors, the board's view would be of less significance.
 
Powers of the Court
 
Under section 168BG, the Court is empowered to make a wide range of orders at any stage of the application, including:
 
  1. Interim orders (section 168BG(1)(a));
  2. Directions concerning the conduct of the proceedings or application (section 168BG(1)(b));
  3. An order directing the company, or an officer of the company, to do, or not to do, any act (including the provision of information or assistance) (section 168BG(1)(c)); and
  4. An order appointing an independent person to investigate and report to the court on the financial position of the company or the facts or circumstances that gave rise to the proceedings or the costs incurred by the parties (section 168BG(1)(d)).
 
The power under section 168BG(1)(c) requiring the company or an officer of the company to do or not to do any act is an interesting one but one that is yet to be tested by the Hong Kong courts. The wording of the legislation is extremely wide and on the face of the legislation alone, it could arguably enable an applicant to obtain an order requiring the offending board of directors or any one of them to take positive steps to remedy or rectify the precise wrong done to the company which gave rise to the application in the first place.
 
As an order under section 168BG could be made at any stage of the proceedings or application, the applicant could arguably even rely on section 168BG(1)(c) to obtain interlocutory relief which is in effect akin to a mandatory or prohibitory injunction pending determination of the action.
 
The power to order an independent person to investigate under section 168BG(1)(d) is a useful tool for a minority shareholder, especially considering their limited rights to obtain information on the company to conduct an investigation on their own. Note the wording of section 168BG(1)(d) enables the independent person to investigate into not only the financial position of the company, but also the facts or circumstances that gave rise to the proceedings. Arguably, it follows that the independent person must also have the ancillary right to inspect the company's books and records for the purpose of conducting the investigation.
 
However, section 168BG(1)(d) is certainly not a remedy or tool as of right and to the contrary, the courts have been quite cautious in considering whether to make an order under this section, commenting to the effect that an order under section 168BG(1)(d) should not be made unless the applicant would not be able to successfully bring the intended action on behalf of the company without such assistance. It has been held that the existence of conflicting evidence alone would not justify the appointment of an independent person under this section9.
 
Whilst there is plenty of room for judicial activism in the wording of the legislation, the question is whether and how far the Hong Kong courts would be prepared to use its powers under the regime to actively assist an applicant to put together his/her case (whether under section 168BG(1)(c) or (d)) or even to intervene in the management of the affairs of the company under section 168BG(1)(c).
 
Rights of Access to Company's records
 
There would appear to be considerable overlap between section 168BG(1)(c), section 168BG(1)(d) and section 152FA, which entitles a certain class of members10 to inspect the company's records, provided the application is made in good faith and for a proper purpose. An order under section 152FA would be allowed if the inspection was sought as a means to investigate into the affairs of the company for the purpose of contemplated proceedings on behalf of the company11 This leads to the question of whether a member who has made an application under section 168BC to bring proceedings on behalf of the company, but has been denied access to information under section 168BG(1)(c) and/or section 168BG(1)(d), could seek to bypass the court's decision therein by way of a separate application under section 152FA. Could the application be considered as one which is lacking in "good faith", in view of the previously unsuccessful attempt under the statutory derivative regime?
 
By contrast, directors' rights (as opposed to a member's rights) to inspect the company's books and records under section 121 is read quite liberally. In the recent case of Re Fook Lam Moon Restaurant (unreported, HCMP 270 and 271/2010, 3 January 2011), the Court did not regard the introduction of certain rules by the board, which required the director seeking to inspect the company's records to state his purpose and to give a written undertaking to maintain confidentiality, as necessarily inconsistent with the director's right to inspect under the law. Since the rules were introduced by the directors, the same were binding on them as a matter of contract, but their right of inspection under the law was quite a separate matter.
 
It further appears that the director's right of inspection under section 121 would not be disturbed even if it would result in inconsistency with the company's articles of association. In Tsai Shao Chung v Asia Television Ltd [2011] 6 HKC 71, the Court held that the right under section 121 extended to each individual director of the company and not to the board as a whole even though such an interpretation would result in inconsistency with the company's articles of association. The director was not required to demonstrate that the inspection was appropriate in order to bring or intervene in proceedings (unlike section 168BG(1)(c)) or that the application was made in good faith and for a proper purpose (unlike section 152FA).
 
Therefore, in circumstances where a member merely has suspicion that a wrong has been done against the company, but does not yet have any solid evidential basis for either an application under section 168BC or even section 152FA, he/she may well have to resort to relying on the allegiance of a trusted director on the board to conduct investigations on his/her behalf.
 
On the other hand, the question may be wholly academic in the context of family companies, where the members are often the directors of the company as well, such that inspection of the company's books and records could simply be sought in the person's capacity as a director under section 121.
 
Conclusion
 
There have only been a handful of cases in Hong Kong so far to test the ambit of the statutory derivative action regime, but what is pleasing for investors, is that the general attitude of the courts at the moment, is one that would appear to be open and willing to explore the possibilities under the statutory derivative action regime to give further protection to the rights and interests of minority shareholders. Whilst there may be potential constraints in relation to the locus standi requirement or in the court's slight conservatism in exercising their powers under section 168BG(1)(d) as discussed above, the introduction of the statutory derivative action regime and the development in case law on members' and individual director's rights to inspect the company's records does herald another step forward for minority shareholders of Hong Kong companies, in line with similar developments taking place in the rest of the common law world.
 
 
 
 

For further information, please contact:

 

Paul Kwan, Partner, Deacons

paul.kwan@deacons.com.hk
 
Vivien Leung, Deacons
vivien.leung@deacons.com.hk
 

 

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