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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

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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.


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.


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).






(ii) giving the assistance is in the best interests of the company; and


and reasonable to the company;




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).






(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


and reasonable to the company and to those members not receiving 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.


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.


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.


END

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