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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 2012

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.

Hong Kong Natural Rubber Ltd. (HKNRL) is a private company incorporated in Hong

Kong trading under the name Woolala Rubber. HKNRL adopted Table A as its articles

of association and had an objects clause “to import natural rubber from Brazil and

resell it in Hong Kong”. The articles of HKNRL also provided that the managing director

of HKNRL was only authorised to borrow up to $1 million on behalf of the company.

Any loan exceeding $1 million had to be approved by an ordinary resolution in a

general meeting.

Peter owned 25% of the issued share capital of HKNRL and Jody owned the remaining

issued shares. Peter and Jody were the only two directors of HKNRL while Jody was

also the managing director of HKNRL. In an attempt to protect HKNRL from the rising

exchange rate of the Brazilian real (R$, the official Brazilian currency), Jody, without

discussing the matter with Peter, entered into some derivative transactions under

which Hong Kong Investment Bank (HKIB) would make payments to HKNRL when the

R$ exchange rate was high and HKNRL would make payments to HKIB when the

R$ exchange rate fell below an agreed level.

From 2009-2011, the R$ exchange rate rose and HKNRL received a huge amount of

payments from HKIB. Most of these payments were paid to Jody as his bonus for his

“good performance” according to his employment contract with HKNRL. However, in

August 2012 the R$ exchange rate began to fall and eventually collapsed, meaning

that HKNRL was required to make payments to HKIB. As HKNRL was in financial

difficulty, Jody decided, on behalf of HKNRL, to borrow $5 million from Kowloon Bank

(KB) which was subsequently paid to HKIB, without passing any ordinary resolution.

HKNRL made the requisite payments up the November 2012 but failed to make any

further payments. HKIB then brought legal proceedings against HKNRL to recover the

sum due, but HKNRL alleged that the derivative transactions were not binding as it had

not had the capacity to enter into these derivative transactions according to its objects

clause, which stated that the main business of HKNRL is to import and resell natural

rubber.

As HKNRL’s financial position did not improve, Jody decided to wind the company up.

When HKNRL entered into creditors’ voluntary liquidation, Peter found that Jody had

permitted Jody Rubber Ltd. (JRL) to trade as Woolala Rubber at a time when HKNRL

had also been trading under that name without requiring any payment from JRL for its

use. It was found that Jody was the majority shareholder of JRL. Peter also found that

Jody had caused HKNRL to pay him an excessive bonus for his “good performance” as

the managing director of HKNRL since 2009. As a result, no dividend had been

declared since 2009. When Peter found out about the loan agreement between

HKNRL and KB, he wanted to challenge the agreement on the ground that Jody was

not authorised to sign any loan agreement exceeding $1 million without an ordinary

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resolution.

It was also found that just before HKNRL was wound up, Jody had caused HKNRL to

transfer its business and its goodwill in the name Woolala Rubber to JRL for only

$50,000, which was only enough to pay the liquidation fee.

REQUIRED:

1. (a) Advise HKIB as to whether the derivative transactions between HKIB

and HKNRL were valid.

Ans (a) Candidates are expected to discuss the ultra vires rule.

An objects clause is an optional clause in a company’s memorandum of

association, which states the purpose of setting up a company. Section

5(1A)(b)

If a company does not have an objects clause it has all the rights and

powers of a natural person. Section 5A

If a company acts outside its objects clause, the transaction is an ultra vires

transaction. The members of the company can then take out an injunction

to stop the company from acting ultra vires. Section 5B(2)

Any ultra vires transaction carried out by the company remains legally valid.

Section 5B(3)

Candidates may argue that the derivative transactions were not within the

objects clause and were ultra vires.

However, even though the derivative transactions were ultra vires, the

transactions were still valid.

1. (b) Advise HKNRL as to whether it may successfully sue Jody for any

breach of his duty as a director of HKNRL by transferring HKNRL’s

business and goodwill in the name Woolala Rubber to JRL.

Ans (b) Candidates are expected to discuss the rules about directors’ duties.

Directors of companies owe directors’ duties to their companies but not to

individual shareholders.

Directors’ duties may be classified into two main duties: fiduciary duty and

duty of skill and care.

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The fiduciary duty of directors are:

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.

Directors must only use their legal powers under the AA for the purpose for

which they were given; they must not use their powers for their own

interests.

In Regal Hastings v Gulliver [1942] 1 All ER 378, R Ltd. owned a cinema.

The directors decided that to make the business more profitable they

needed to expand and the company should acquire two more cinemas. R

Ltd. could then be sold at a profit. A new company was formed to buy the

two cinemas, which was to be wholly owned by R Ltd. But a problem arose

as R Ltd. could not raise enough money itself to inject into the new

company. The new company needed £5,000 but could only raise £2,000.

One of the directors of R Ltd. bought some of the new shares himself so the

scheme could go ahead. Later, R Ltd. and its subsidiary were sold at a

profit to Mr. X. The new owner of R Ltd. then began a case on behalf of R

Ltd. to sue the director for breach of duty and for him to hand over the profit

that he had made. The court agreed, saying that even though the original

deal could not have gone ahead without the director buying some of the

shares in the subsidiary, he should have formally disclosed his interest and

obtained formal consent from all the members of R Ltd. He did not do so

and this was in breach of his duty, so he had to hand over his profit on the

transaction.

(Candidates may use any relevant cases to support.)

Candidates are expected to apply the above rules to our case study and

discuss.

Candidates may argue that, in transferring HKNRL’s business and goodwill

to JRL for only $50,000, Jody was in breach of his directors’ duty as there

was a conflict of interest between Jody’s personal interest and HKNRL’s

interest.

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1. (c) Advise KB as to the validity of the loan agreement between KB and

HKNRL.

Ans (c) Candidates are 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 MA to borrow money on behalf of the company if authorised by

an OR. The board borrowed money from the bank via a contract bearing

the company's seal without obtaining an OR. The court held that the

contract was valid even though the OR had not been obtained as the bank

was not able to discover from the public register whether the internal

procedures had been followed and 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 AA allowed the directors to borrow

up to £1000 on behalf of the company without GM consent and more

with GM consent. The directors lent £3,500 to the company and the

company borrowed the money without GM consent. Could the directors

get their money back? It was held they could only reclaim up to the

£1,000 limit and no more. They were insiders and knew or should have

known of the restriction.

Candidates may cite any relevant case to support.

(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, KB may rely on Turquand’s rule and assume all internal

procedures have been complied with, i.e. an ordinary resolution already

been passed to authorise the loan agreement.

As a result, the loan agreement between KB and HKNRL was valid.

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1. (d) Advise Peter as to whether he may take any legal action under section

168A of the Companies Ordinance if HKNRL has not been wound up.

Ans (d) Candidates are expected to discuss the rules about unfairly prejudicial acts

under section 168A of the Companies Ordinance.

Section 168A(1) provides that any member of a specified corporation who

complains that the affairs of the specified corporation 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 may make an

application to the court by petition for an order under this section.

Peter may apply to the court and complain that the affairs of HKNRL were

being conducted in a manner unfair and prejudicial to his interests.

The Companies Ordinance does not define an unfairly prejudicial act, while

some cases may be helpful in understanding the concept.

In Re Taiwa Land Investment Co. Ltd. [1981] HKLR 297, it was held that

unfairness and prejudice must co-exist with respect to the complained

conduct.

Unfair discrimination against a minority may be unfair prejudice. In

Donaldson Investment v Anglo Transvaal [1979] 3 SA 7`13, the court said

that the minority must show that the majority acted in such a way as to

prevent the minority exercising a fair participation in the running of the

company's affairs.

An example of unfairly prejudicial conduct can be shown in Re Tai Lap

Investments [1999] 3 HKC 660 (CA), in which the minority complained that

company money had been used to subsidise the majority shareholders’

family members’ businesses in Canada. It was held that this was clear

unfair prejudice.

Candidates may use any relevant cases to support.

If an unfairly prejudicial act is proved, the court may grant remedies under

section 168A(2).

Section 168A(2) provides that if the court is of opinion that the specified

corporation’s affairs are being or have been conducted in a manner unfairly

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

member:

(a) the court may, with a view to bringing to an end the matters

complained of—

(i) make an order restraining the commission of any such act or the

continuance of such conduct;

(ii) order that such proceedings as the court may think fit shall be

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brought in the name of the specified corporation against such person

and on such terms as the court may so order;

(iii) appoint a receiver or manager of the whole or a part of a specified

corporation’s property or business and may specify the powers and

duties of the receiver or manager and fix his remuneration; and

(iv) make such other order as it thinks fit, whether for regulating the

conduct of the specified corporation’s affairs in future, or for the

purchase of the shares of any members of the specified corporation by

other members of the specified corporation or by the specified

corporation and, in the case of a purchase by the specified

corporation, for the reduction accordingly of the specified corporation’s

capital, or otherwise; and

(b) the court may order payment by any person of such damages and

interest on those damages as the court may think fit to any members

(including the member who presented the petition) of the specified

corporation, whose interests have been unfairly prejudiced by the act or

conduct.

Candidates may argue that entering into the derivatives transactions and

paying most of the payments from it to Jody as his bonus might not be in

the company’s interest, and that allowing Jody Rubber Ltd. (JRL) to trade

as Wahaha Rubber without any payment and transferring HKNRL’s

business and goodwill to JRL for only $50,000 were unfairly prejudicial

acts; as a result and Peter should be entitled to the remedies under section

168A(2).

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SECTION B

2.

Danny was an executive director of Fastest Internet Ltd. (FIL), a private

company incorporated in Hong Kong which provided IT services. Andy had

been engaged as FIL’s auditor for many years. Recently, Danny found that

Andy had failed to report alleged accounting irregularities to him and failed

to advise him of any financial uncertainty at the company. Danny also

suspected that Andy had removed some adverse comments from his final

audit report without giving reasons. As a result of these omissions, FIL got

into serious financial difficulty and Danny lost his job as an executive

director of the company.

REQUIRED:

2. (a) Advice Danny as to whether he may take any legal action against

Andy for his breach of duty as an auditor of FIL.

Ans (a) Candidates are expected to discuss the duty of care that an auditor owes to

a party, other than the company appointing him.

In the absence of contractual relationship, a party may assert only action in

the tort of negligence against the defaulting auditor if they suffer any loss as

a result of an auditors’ breach of duty.

Hedley Byrne and Co Ltd v Heller and Partners Ltd [1963] 3 WLR 101.

Caparo Industries plc v Dickman [1990] 2 AC 605.

Candidates may cite any relevant case to support.

Negligent mis-statement under special relationship, leading to economic

loss was established as compensatable. This duty was expanded further

from the special relationship to the two-stage test in Anns v Merton London

Borough Council [1978] AC 728.

In a recent Hong Kong case, Guang Xin Enterprises Ltd. (In liquidation) v

Kwan Wong Tan & Fong (A firm) [2002] 2 HKC 613, the Court of First

Instance held (at 622D-625B):

“An auditor was not a business advisor. His position in relation to the

shareholders of a limited company arose from the relevant provisions of the

Companies Ordinance (Cap 32). His duty was to investigate and form an

independent opinion on the adequacy of the company's accounts and to

report to the company's members whether in his opinion the company's

accounts gave a true and fair view of its financial position. He was not

employed by the company to advise on how the company should be run.

Still less was it the auditor's duty to advise on whether or not the company

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should carry on its business.

In Yue Xiu Finance Co. v Dermot Agnew (1996) (HK), the court held that

the relationship of proximity could be established by showing that the

defendants knew that the plaintiffs would rely on the audited reports for a

particular purpose and intended that the plaintiffs should rely on the reports

for that purpose.

By applying the above special relationship test to this case study, it seems

that there was no special relationship between Danny and Andy.

As a result, Danny has no right to sue Andy for his breach of duty as an

auditor of the company.

2. (b) Advice FIL as to the proper procedures to remove Andy as the auditor

of the company.

Ans (b) Candidates are expected to explain the procedures to remove an auditor

under section 131(6) of the CO.

Section 131(6) provides that a company may by ordinary resolution remove

an auditor before the expiration of his term of office, notwithstanding

anything in any agreement between it and him.

An ordinary resolution is one passed by majority of members who are

entitled to, and do, vote in person, or by proxy in a general meeting.

Except in the case of a private company, where a resolution removing an

auditor is passed at a general meeting of a company, the company has to

give notice of that fact in the specified form to the Registrar within 14 days.

Section 132(1)(d) provides that special notice is needed for removing an

auditor before the expiration of his term of office.

Section 116C provides that where special notice is required of a resolution,

the resolution is not 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 the company gives its members notice of any such

resolution at the same time and in the same manner as it gives notice of the

meeting or, if that is not practicable, gives them notice thereof, either by

advertisement in a newspaper having an appropriate circulation or in any

other mode allowed by the articles, not less than 21 days before the

meeting.

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3.

Catherine has recently been appointed as a company secretary of High

Tech Computers Ltd. which adopted Table A as its articles of association.

She was told that there were three classes of shares in the company: Class

A, Class B & Class C. Class A shares and Class B shares are ordinary

shares while Class

C shares are 10% cumulative preference shares. Catherine was also told

that Class A shares have five votes per share while Class B shares have

only one vote per share. Class C shares have no voting rights. One of the

Class B shareholders felt that this was unfair to all Class B shareholders

and proposed reducing the voting power of Class A shareholders.

However, Catherine does not understand the distinctions between the three

classes of shares and the procedures to reduce the voting right of Class A

shareholders.

REQUIRED:

3. (a) Advise Catherine as to the distinctions between ordinary shares and

preference shares.

Ans (a) Candidates are expected to discuss the distinctions between preference

shares and ordinary shares.

Ordinary shareholders are not guaranteed a fixed level of dividend.

They generally carry unrestricted voting rights so that ordinary

shareholders normally control the company.

Dividends are not cumulative; if no ordinary dividend is declared in a

particular year, the shareholders’ rights to dividends in subsequent years

are not increased.

Preference shares are shares which carry rights in preference to other

shares. The usual preferences given are:

Payment of dividends

Return of capital on winding up of the company

A preference share generally confers the right to receive a dividend up to a

specified amount, before any dividend is paid on the ordinary shares.

The preferential dividend is deemed to be cumulative, unless expressly

described as non-cumulative. Cumulative means that the preference

shareholder will be entitled to arrears of any dividend not paid out in one

year before any dividend can be paid to the ordinary shareholders.

Preference shares do not generally have voting powers unless the dividend

is in arrears or if a resolution may affect the preference shareholders’ class

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rights.

Preference shareholders usually have their capital returned in priority to

ordinary shareholders when the company is wound up. However, they

cannot share any surplus assets.

Any dividends in arrears when the company is wound up are paid out of

capital, but only after all the debts of the company have been settled.

3. (b) Advise Catherine as to the proper procedures to reduce the voting

right of Class A shareholders from five votes per share to one vote

per share.

Ans (b) Candidates are expected to discuss the rules dealing with the variation of

class rights under s.63A, 64 of the Companies Ordinance.

(1) Section 63A provides that: (1) Where, in the case of a company the

share capital of which is divided into different classes of shares, special

rights are attached to any such class of shares otherwise than by the

memorandum and the articles do not provide for the variation of those

rights, the articles shall be deemed to contain provision that such rights

shall not be varied except with the consent in writing of the holders of

three-fourths in nominal value of the issued shares of the class in question

or with the sanction of a special resolution passed at a separate general

meeting of the holders of that class.

(2) Where, in the case of a company the share capital of which is divided

into different classes of shares, special rights are attached to any such

class of shares by the memorandum and provision for the variation of those

rights is, at the time of the company's incorporation, contained in the

articles, those rights shall be capable of variation in accordance with the

articles as for the time being in force, even if no reference is made in the

memorandum to their variation in that manner.

(3) Where, in the case of a company the share capital of which is divided

into different classes of shares, special rights are attached to any such

class of shares by the memorandum and the memorandum and articles do

not contain provision with respect to the variation of the rights, those rights

may be varied if all the members of the company agree to the variation.

(4) Where the articles of a company contain, or by virtue of this section are

deemed to contain, a provision for the variation of the rights attached to any

class of shares, those rights shall not be capable of variation otherwise

than in accordance with that provision.

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Section 64 provides that:

(1) If in the case of a company, the share capital of which is divided into

different classes of shares, provision is made by the memorandum or

articles for authorising the variation of the rights attached to any class of

shares in the company, subject to the consent of any specified proportion of

the holders of the issued shares of that class or the sanction of a resolution

passed at a separate meeting of the holders of those shares, and in

pursuance of the said provision the rights attached to any such class of

shares are at any time varied, the holders of not less in the aggregate than

10% in nominal value of the issued shares of that class may apply to the

court to have the variation cancelled, and, where any such application is

made, the variation shall not have effect unless and until it is confirmed by

the court.

In our case, the company adopted Table A as its articles of association and

Article 4 of Table A provides that, if at any time the share capital is divided

into different classes of shares, the rights attached to any class may,

whether or not the company is being wound up, be varied with the consent

in writing of the holders of three-fourths in nominal value of the issued

shares of that class, or with the sanction of a special resolution passed at a

separate general meeting of the holders of the shares of the class.

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4. Daisy and Edwin are the two directors of Wonderful Life Ltd. On

incorporation of the company in March 2012, Daisy, on behalf of the

company, borrowed $2 million from Kowloon Bank. Clause 10 of the

debenture provided that the company created a fixed charge over all

existing and future book debts owed to the company and all monies paid to

the company in respect of those debts.

In October 2012, the company was in serious financial difficulty and had to

pay its suppliers immediately. The company’s accountant advised that the

company should cease trading. However, Daisy and Edwin ignored the

accountant’s advice and borrowed a further $2 million from Hung Hom Bank

at an extremely high interest rate, creating a floating charge over the

company’s book debts in favour of Hung Hom Bank. By December 2012,

the company was unable to continue business and a petition was presented

to wind up the company.

REQUIRED:

4. (a) Advise Daisy and Edwin as to whether they may be liable for the debts

of the company.

Ans (a) 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 is 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 get priority to get 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, Daisy and Edwin are directors of the company and the

company is regarded as a separate legal entity. As a result, Daisy and

Edwin are not liable for the debts of the company.

However, under some special situations, the court may ignore the separate

legal entity concept and regard the company and its directors as one entity,

i.e. lifting the corporate veil.

As a result, if the court lifts the corporate veil, a director may be liable for the

debts of a company.

In our case, one relevant ground which may lift the corporate veil is

fraudulent trading (under section 275 of the CO).

Section 275(1) provides that, if in the course of the winding up of a company

it appears that any business of the company has been carried on with intent

to defraud creditors of the company or creditors of any other person or for

any fraudulent purpose, the court, on the application of the Official

Receiver, or the liquidator or any creditor or contributory of the company,

may, if it thinks proper so to do, declare that any persons who were

knowingly parties to the carrying on of the business in manner aforesaid

shall be personally responsible, without any limitation of liability, for all or

any of the debts or other liabilities of the company as the court may direct.

In our case, if the court holds that Daisy and Edwin commits fraudulent

trading, they may be liable for the debts of the company.

4. (b) Advise the liquidator of the company as to the validity of the charges

created.

Ans (b) Candidates are expected to discuss section 80, section 266B and section

267 of the CO. Candidates are also expected to discuss the rules about

creating a fixed charge over book debts.

The court held that if a borrower could collect the debt due without specific

consent and use the proceeds in the ordinary course of trade, the charge

thus created was a floating not a fixed charge. Therefore, to create a valid

fixed charge the lender (bank) must exercise real control over the charged

asset and the borrower (company) must not be able to use the asset freely

in its business or dispose of it without the lenders consent.

The House of Lords in the English case of Smith (Administrator of Cosslett

(Contractors) Ltd.) v Bridgend Courty Borough Council [2002] 1 All ER 292

agreed with the decision in Agnew.

Therefore, in our case, unless the bank can exercise control over the book

debts, the charges created are, most likely, floating charges.

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Section 80(1) provides that every charge created after the fixed date by a

company and being a charge to which this section applies shall, so far as

any security on the company's property or undertaking is conferred thereby,

be void against the liquidator and any creditor of the company, unless the

particulars of the charge, together with the instrument, if any, by which the

charge is created or evidenced, are delivered to or received by the

Registrar for registration in manner required by this Ordinance within five

weeks after the date of its creation.

If a charge fails to be registered, it is void against the liquidator and other

creditors.

According to section 267 of the CO, all charges created within 12 months

before the winding up of the company are invalid unless the company was

solvent at the time of creation of the charges, or any cash paid to the

company at the time of creation of the charges, to that extent the charge is

valid.

According to section 266B, a fixed charge or a floating charge created

within six months before winding up may be challenged as an unfair

preference.

In our case, the charge created in favour of Kowloon Bank may be

challenged under section 267 if it is regarded as a floating charge and the

charge created in favour of Hung Hom Bank may be challenged under

section 266B and section 267 as it was created within six months before

winding up.

If a charge is invalid, the bank will become an unsecured creditor.

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5. Mandy is the secretary to the managing director of Sino Golf Ltd. (SGL), a

company listed on the Hong Kong and Shanghai Stock Exchanges. In

October 2012, when Mandy read one of her boss’s emails, she found that a

major debtor of SGL, Pluto Corporation (PC), had filed for Chapter 11

bankruptcy protection in the United States. The email also revealed PC’s

inability to pay its debt ($50 million) to SGL and that this would affect SGL’s

financial position and share price.

Mandy immediately called her boy friend, Michael, and asked him to sell all

his shares in SGL. Mandy also sold all her shares in SGL on the Hong

Kong Stock Exchange and Shanghai Stock Exchange, before the market

was made aware of the impact of PC’s bankruptcy on SGL’s financial

position.

In November 2012, SGL announced to the market a decline in net profit of

55%, attributing it partly to the bad debt provision of $50 million as a result

of PC’s bankruptcy.

REQUIRED:

5. (a) Advise Mandy and Michael as to whether they may be liable for insider

dealing under the Securities and Futures Ordinance. (No need to

discuss Chinese securities laws.)

Ans (a) Candidates are expected to discuss the rules relating to insider dealing

defined under the Securities and Futures Ordinance.

Section 270(1)(a) defines the fundamental act of insider dealing, which

shall consist of the following elements:

(a) a person is connected with a listed corporation;

(b) he is in possession of certain information;

(c) he knows the information is relevant information; and

(d) he deals in the listed securities of the corporation; or

(e) he counsels or procures another person to deal in such listed securities.

A person who is connected with a corporation for insider dealing purposes

is defined in section 247:

(a) one who is a director or employee of the corporation or a related

corporation;

In this case, Mandy, being the secretary to the managing director of the

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company, is a connected person of the company.

Relevant information is defined in section 245 of the Securities and Futures

Ordinance as specific information in respect of:

(a) the corporation;

(b) a shareholder or officer of the corporation; or

(c) the listed securities of the corporation or their derivatives,

which is not generally known to other potential investors, but if it were

known to them, it would materially affect the price of the listed securities in

question.

Candidates are expected to point out that Mandy is liable under section

270(1)(a) by

i) selling all her shares in the company; and

ii) procuring Michael to sell all his shares in the company.

Candidates are expected to point out that, even though Mandy sold all her

shares on the Shanghai Stock Exchange, she is still liable under section

270(2) of the Securities and Futures Ordinance.

Candidates may point out that Michael may be liable under section

270(1)(e), which provides that:

A person may be liable for insider dealing if he:

(a) receives the information whether directly or indirectly from;

(b) a person whom he knows is connected with the corporation,

(c) which information is known to be relevant information; and

(d) he deals in the listed securities of the corporation or counsels or

procures another person to do so. (section 270(1)(e))

Candidates may point out that Michael may not be liable in this case as he

did not receive any relevant information from Mandy.

However, if Mandy has told him about the relevant information, then

Michael may be liable as a tippee under section 270(1)(e).

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5. (b) Explain to them, if they are liable for market misconduct under the

Securities and Futures Ordinance, the penalties/ orders that may be

imposed on them under the criminal and civil provisions of the

Securities and Futures Ordinance.

Ans (b) Candidates are expected to point out that there are both criminal and civil

liabilities under the Securities and Future Ordinance.

A market misconduct case may go to the court for criminal penalties, while

it may go to the Market Misconduct Tribunal for civil orders.

Section 303(1) of the SFO provides that a person who commits market

misconduct is liable:

(a) on conviction on indictment to a fine of $10,000,000 and to

imprisonment for 10 years; or

(b) on summary conviction to a fine of $1,000,000 and to imprisonment for

three years.

Section 303(2) provides that where a person is convicted of market

misconduct, the court before which the person is so convicted may, in

addition to any penalty specified in subsection (1), make one or more of the

following orders in respect of the person:

(a) an order that the person shall not, without the leave of the court, be or

continue to be a director, liquidator, or receiver or manager of the property

or business, of a listed corporation or any other specified corporation or in

any way, whether directly or indirectly, be concerned or take part in the

management of a listed corporation or any other specified corporation for

the period (not exceeding five years) specified in the order;

(b) an order that the person shall not, without the leave of the court, in Hong

Kong, directly or indirectly, in any way acquire, dispose of or otherwise deal

in any securities, futures contract or leveraged foreign exchange contract,

or an interest in any securities, futures contract, leveraged foreign

exchange contract or collective investment scheme for the period (not

exceeding five years) specified in the order;

(c) an order that any body which may take disciplinary action against the

person as one of its members be recommended to take disciplinary action

against him.

Section 257(1) provides that the Market Misconduct

Tribunal may make one of the following orders in respect of a person

identified as having engaged in market misconduct:

(a) an order that the person shall not, without the leave of the Court of First

Instance, be or continue to be a director, liquidator, or receiver or manager

of the property or business, of a listed corporation or any other specified

19

corporation or in any way, whether directly or indirectly, be concerned or

take part in the management of a listed corporation or any other specified

corporation for the period (not exceeding five years) specified in the order;

(b) an order that the person shall not, without the leave of the Court of First

Instance, in Hong Kong, directly or indirectly, in any way acquire, dispose of

or otherwise deal in any securities, futures contract or leveraged foreign

exchange contract, or an interest in any securities, futures contract,

leveraged foreign exchange contract or collective investment scheme for

the period (not exceeding five years) specified in the order;

(c) an order that the person shall not again perpetrate any conduct which

constitutes such market misconduct as is specified in the order (whether

the same as the market misconduct in question or not);

(d) an order that the person pay to the Government an amount not

exceeding the amount of any profit gained or loss avoided by the person as

a result of the market misconduct in question;

(e) without prejudice to any power of the Tribunal under section 260, an

order that the person pay to the Government the sum the Tribunal

considers appropriate for the costs and expenses reasonably incurred by

the Government in relation or incidental to the proceedings;

(f) without prejudice to any power of the Tribunal under section 260, an

order that the person pay to the Commission the sum the Tribunal

considers appropriate for the costs and expenses reasonably incurred by

the Commission, whether in relation or incidental to-

(i) the proceedings;

(ii) any investigation of the person’s conduct or affairs carried out

before the proceedings were instituted; or

(iii) any investigation of the person’s conduct or affairs carried out for

the purposes of the proceedings;

(fa) where the proceedings were instituted as a result of an investigation

under the Financial Reporting Council Ordinance (Cap 588), an order that

the person pay to the Financial Reporting Council established by section

6(1) of that Ordinance the sum the Tribunal considers appropriate for the

costs and expenses in relation or incidental to the investigation reasonably

incurred by the Council;

(g) an order that any body which may take disciplinary action against the

person as one of its members be recommended to take disciplinary action

against him.

20

6.

Nancy had been the company secretary of King Development Ltd. (KDL),

a private company incorporated in Hong Kong, for many years. Alex, the

chairman of the board of directors of KDL, wanted Nancy to become a

director and shareholder of the company. Alex told Nancy that the

company could offer a loan to help her subscribe for shares in the

company, but the company would only offer that loan if Nancy were

successfully appointed as a director of the company. However, the articles

of association of the company provide that all directors of the company

have to be Hong Kong permanent residents: Nancy is currently not a Hong

Kong permanent resident.

REQUIRED:

6. (a) Advise Nancy as to how she may be appointed as a director of the

company.

Ans (a) Candidates are expected to explain the procedures for altering the articles

of association of a company.

Candidates are expected to point out that Nancy may be appointed as a

director of the company by passing an ordinary resolution in a general

meeting. However, according to the articles of association of the company,

a director of the company has to be a Hong Kong permanent resident, so

the company has to alter its articles of association first.

Section 13(1) of the CO provides that a special resolution is needed to

alter the articles of association of a company.

The general principle that a company can alter its AA was confirmed in

Allen v Gold Reefs of West Africa Ltd (1900).

The court held that a company must exercise the power to change the

articles in accordance with the ordinance but also “bona fide in the interest

of the company as a whole” and not only purely for the purpose of the

majority who can ignore minority shareholders.

In Greenhalgh v Arderne Cinemas (1951), the court explained that bona

fide for the benefit of the company as a whole meant that a member

should vote honestly in what the thinks is for the good for he company.

This might be the same as his own self interest.

In Brown v British Abrasive Wheel Company (1919) the owners of 98% of

the shares in the company were willing to subscribe for additional shares

in the company if the AA were changed so that a member had to sell his

shares to the company or the other shareholders if 90% of the

membership agreed. The company was in urgent need of new funds and

21

was not able to borrow. The court held the change was not in the interests

of the company as a whole as the change was aimed at removing the 2%

minority owner, so could not be in the interests of the “whole” company.

In Sidebottom v Kershaw (1920), the company altered its articles to allow

the directors to force a member to sell his shares if he was involved in a

competing business at the market value of the shares. A shareholder

challenged the alteration. The court held that the alteration was made

bona fide in the interest of the company as a whole.

6. (b) Assuming that Nancy is successfully appointed as a director of the

company, advise KDL as to the proper procedures which should be

followed in providing the loan to Nancy.

Ans (b) Candidates are expected to discuss the rules about loans to directors

under section 157H of the CO and financial assistance to buy the

company’s shares under section 47A of the CO.

Section 157H(2) provides that, subject to exceptions under section 157H,

a a company is not allowed to make any loan to its directors.

Section 157HA(2) provides that section 157H does not prohibit a private

company from doing anything that has been approved by the company in

a general meeting.

As KDL is a private company, any loan to a director may be approved in a

general meeting.

Section 47A(1) provides that it is not lawful for a company or any of its

subsidiaries to give financial assistance directly or indirectly for the

purpose of any acquisition of shares of that company before or at the

same time as the acquisition takes place.

Section 47B 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 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

22

which are thereby reduced to a material extent or which has no net assets.

Section 47E provides that section 47A does not prohibit an unlisted

company from giving financial assistance if the following provisions are

complied with.

The financial assistance may only be given if the company has net assets

which are not thereby reduced or, to the extent that they are reduced, if the

assistance is provided out of distributable profits.

The financial assistance is approved by special resolution of the company

in a general meeting.

A majority of the directors of the company proposing to give the financial

assistance shall before the financial assistance is given make a statement

complying with section 47F.

Section 47F(1) provides that the statement shall be in the specified form

and shall be signed by the directors and shall state:

(a) the form which such assistance is to take;

(b) the names and addresses of the persons to whom such assistance is

to be given;

(c) the purpose for which the company intends those persons to use such

assistance;

(d) that the directors making the statement have formed the opinion, as

regards the company's initial situation immediately following the date on

which the assistance is proposed to be given, that there will be no ground

on which it could then be found to be unable to pay its debts; and either-

(i) if it is intended to commence the winding up of the company within

12 months of that date, that the company will be able to pay its debts

in full within 12 months of the commencement of the winding up; or

(ii) in any other case, that the company will be able to pay its debts as

they fall due during the year immediately following that date.

END