Shareholders Disputes

Basic Principles & the New Law

15 September 2006

� Mr. Ludwig Ng, LL.M.

Senior Partner, ONC Lawyers

� Mr. Sherman Yan, LL.M.Partner, Head of Commercial Litigation,

ONC Lawyers

Legal Rights of a Shareholder are governed by:-

� the law: Companies

Ordinance, case law

� the Memorandum and

Articles of Association

� Shareholders Agreement,

if any

Unless there is a Shareholders Agreement to the contrary, the

general law that normal M&A provide that:-

� Management of the company is in the hand of the Board

of Directors (A.82)

� The Board is elected by the Shareholders

� The Majority Shareholders can dictate the composition of

the Board (but beware of two-members companies)

� Minority has no automatic right to management

� Majority shareholder is not a fiduciary

� There is no mechanism for “no-fault divorce”

Management can be conducted in a way adversely affecting the value of the Shareholding, e.g.:-

� not declaring dividends but paying excessive remuneration to Directors

� selling assets of the Company at under-value to related parties

� (for quasi-partnership companies) excluding the Minority from

� participating in management

� mis-management/negligence

� diverting business away from the Company to related parties

� hiring relatives of Directors at excessive pay

� issuing new shares unnecessarily

� contravening the law (unlawful return of capital, unlawful loan

� to directors …)

� not providing information to Shareholders

What can the Minority do in such a situation?

� Sell his Shares?� Not always possible for private companies

� Problem of valuation

� Call for a General Meeting?� s.111(2) (court may order AGM to be held on default),

� s.113 (5% shareholder may requisition a general meeting),

� s.114B (court order general meeting when one cannot be called)

� no use if meeting controlled by Majority

� Fire the delinquent Director?� got to have 50% (s.157B) – note the cumbersome procedures

The Legal Armory Against the Abusive Majority

� Derivative Action

� s. 168A petition (unfair prejudice)

� s. 177(1)(f) petition (just and equitable winding up)

� s. 350B injunction - NEW

The Legal Armory Against the Abusive Majority

� Derivative Action

� The principle of majority rule provides that:-

� Only the company can sue the wrongdoer

� Only a majority of the board can decide whether to take

legal action

� Derivative Action is an exception to this principle

� A minority can take action on behalf of company

if two stringent requirements are met:-

� Fraud on minority

� Wrongdoer in control

The Legal Armory Against the Abusive Majority

� Derivative Action

� In a derivative action a Minority is suing the

wrongdoer on behalf of the Company (form of

action: XX suing on behalf of all shareholders of the

Company except YY)

� an action in the name of the Company

� all recoveries go to the Company

� but the Minority may bear the costs consequences

of losing

Derivative Action - The New Law (1)

� Sections 168BA – BK

� Problems with the Old Law

� principles and procedures to be deduced from cases, not always

clear and consistent

� not clear about the effect of ratification of the wrong by

majority shareholders

� not clear when the question of locus is to be determined

� not clear when and how the question of costs is to be

determined

Derivative Action - The New Law (2)

� a shareholder may apply to court for leave to commence the action (168BC(1))

� 14 days written notice has to be given to the Company (168BD(1)), could be dispensed with if urgency or secrecy justifies (168BD(4))

� The criteria for granting leave is now made clearer (168BC(3)):-

� prima facie in the interest of the Company

� there is a serious question to be tried (i.e., an apparent case that a wrong has been done to the Company)

Derivative Action - The New Law (3)

� as regards ratifications, the Court may consider

the following factors (168BF(2)):-

� the extent of the independence of the members

ratifying

� how well-informed about the matter were the

members ratifying

� whether they were acting for proper purpose when

ratifying

Derivative Action - The New Law (4)

� express provisions regarding the costs of proceedings (168BI)� court has power to order costs to be paid by the Company if the

member bringing the action acts in good faith and has reasonable grounds for making the application (168BI(3)) (note: Re F&S Express Ltd HCMP 2675/2005)

� more ancillary powers (168BG):-� interim orders (preservation of property, injunction)

� appointment of investigator and costs thereof [ job opportunities for accountants ! ]

Some further points about the new law:- (1)

� The above applies to commencement

of action as well as intervention

of action already begun, but

not diligently pursued, by the

Company

� The old common law derivative action is still retained.

� But it would be quite unwise to rely on it instead of making use of the new law.

Some further points about the new law:- (2)

� Derivative Action is to deal with a wrong done to a company. Some abuses by the Majority are only in relation to internal management and do not necessarily result in loss to the Company. E.g.:-

� Exclusion of Minority from Management

� Refusal to declare dividends

� Unnecessary issuance of shares

� Breakdown of trust / deadlock between the shareholders

� In such case, the proper remedy should be a Petition under s.168A (Unfair Prejudice) or s.177(1)(f) (Just and Equitable Winding Up) (See Re Chime Corp Ltd [2004] HKLRD 922)

s.168A –

� The basic premise� Any member who suffered “unfair prejudice” may petition to

court for reliefs to end the “unfair prejudice”.

� The most usual remedy granted by court is buy-out at a fair valuation.

� Problems with the Old Law� Only applied to HK incorporated companies

� Past member could not invoke this section

� Not sure whether court can order monetary compensation to petitioner or other members against the wrongdoer, or just injunction and buy-out

s.168A – The New Law

� Applies to all “specified corporation”� S.2(1) – “specified corporation” means a company [HK

incorporated] or a non-Hong Kong company

� Applies to past member in relation to acts committed whilst he was a member (new (2A))

� Expressly allows court to order monetary compensation to petitioners (and other shareholders) against the wrongdoer (new (2)(b))

� But such award cannot be made in relation to “reflective loss” (new 2(C))Note that “Just and Equitable Winding Up” has always been applicable to oversea company by virtue of s.327(3)(c), whilst s.177(1)(f) makes it applicable to HK companies.

Other amendments to the Companies

Ordinance to enhance protection of Minority:

� Inspection Order (s.152FA

– s.152FE)

� Injunction Order (s.350B)

Inspection Order (1)The Old Law:

� Shareholders’ rights to inspect company documents are limited:-� register of debenture holders (s.74A), register of charges (s.83),

register of directors and secretaries (s.158(7)), minute books of general meetings (s.120), register of members (s.95),

management contracts at general meetings (s.162A),

� p/l statement, balance sheet and auditor’s report sent before

AGM (s.129G)

� A.126 – other accounts, books or papers can be inspected only if authorized by directors or company in general meeting

� Directors can always inspect – s.121

Inspection Order (2)The New Law – s.152FA – FE – Inspection Order

� Threshold for application (s.152FA(2)):-

� 2.5% of total voting rights

� paid up capital of not less than $100,000

� not less than 5 members

Inspection Order (3)The New Law – s.152FA – FE – Inspection Order

� Conditions for application (s.152FA(3)):-

� Good faith

� Proper purpose

� Note: no requirement for unfair prejudice or even

breach of law or duties

� Why? Because it’s primarily for evidence gathering

Inspection Order (4)The New Law – s.152FA – FE – Inspection Order

� Use of Information obtained from Inspection

� Not to be disclosed without permission of court

except for criminal proceedings (s.152FC(1))

� It seems specific court order would be needed for use

of the documents/information in civil action against

delinquent directors or other persons

The General Power to Injunct – s.350BThe Old Law:

� Interlocutory injunction or appointment of

receivers/provisional liquidators is available in limited

circumstances;

� Generally need to show breach of duties, unfair

prejudice or that the conditions for derivative action are

satisfied (fraud on minority and

wrongdoer control);

� Generally not available to creditors

The General Power to Injunct – s.350BThe New Law:

� Who can apply (s.350B(1)):-

� the Financial Secretary

� a member

� a creditor

The General Power to Injunct – s.350BThe New Law:

� When can they apply (s.350B(1)):-� contravention of CO (e.g., illegal loan to directors,

unlawful return of assets, financial assistance to

purchase own shares)

� breach of fiduciary duties of any officers (not just for directors, maybe CEO or others)

� breach of fiduciary or other duties by directors

� attempt or conspiracy to do the above

The General Power to Injunct – s.350BThe New Law:

� Conditions for granting injunction:-� none of the Old Law requirements apply

� can be granted whether or not (s.350B(2)):-

� the act will be repeated

� there was such previous conduct

� there is imminent danger of damage

� obviously the purpose is to make it as easy to the applicant as possible

The General Power to Injunct – s.350BThe New Law:

� What can be ordered:-� negative as well as positive injunctions (s.350B(1))

� damages against the offender, whether to the

company or to the applicant (s.350B(7))

� No recovery of “reflective loss” (s.350B(8))

� Note: Leung Afred Cheuk Wah v Unity

Investment Holdings Ltd, HCMP 1885/2005

The Position of the Majority

� Beware of Two-Members Companies

� Compulsory Buy-out of Minority – possible?(see Re Nuneaton Borough AFC Ltd [1991] BCLC 267)

The Position of the Majority

� The basic elements of a reasonable offer (to preempt an unfair prejudice petition):-� To purchase share at a fair value

� To be determined by a competent expert (jointly appointed)

� Minority should be given access to company documents

� Both sides should have the opportunity to make representation the expert

� Reasonable provision for costs

IMPORTANT

The law and procedure on this subject

are very specialized and complicated. This

article is just a very general outline for

reference and cannot be relied upon as

legal advice in any individual case. If any

advice or assistance is needed, please

contact our solicitors.

The End