In this fourth and final update on the provisions of the new Companies Ordinance, we will discuss some of the important changes relating to directors. Banks and financial institutions often deal with their corporate customers' directors. Banks and financial institutions are not charged with supervision of their customers' directors. Nevertheless, they need to be aware, albeit as an outsider, of what the directors should be doing to properly discharge their duties. They would not be able to hold their customers to the contract if they are on notice that the directors are acting improperly.
We will also discuss the new procedures for proposing and passing shareholders' written resolutions. Written resolutions have been a convenient way to get shareholders' approval when needed.
Under the existing law, (a) all public companies and (b) private companies which are members of a group which includes a listed company cannot appoint a body corporate as a director. Other private companies are not so restricted, and may have corporate directors or a sole corporate director.
The new Ordinance will require Hong Kong private companies to have at least 1 director who is a natural person. The individual director need not be a Hong Kong resident. There will be a grace period of 6 months until 3 September 2014 for private companies to comply with this new requirement.
Disclosure of director's interest
Under the existing law, a director, who has a material interest, directly or indirectly, in a contract or proposed contract with the company which is of significance to the company's business, is required to disclose the nature of such interest at the earliest board meeting that is practicable.
The new Ordinance will widen the existing disclosure requirement – which the Government describes as being “relatively narrow” – to cover “transactions” and “arrangements”.
In the case of a public company (including a listed company incorporated in Hong Kong), disclosure will also be required of any material interest of entities connected with the director.
The disclosure requirement will extend to shadow directors.
Disclosure is required if the director ought reasonably to be aware of the interest. Failure to make disclosure is an offence.
Further, a director will be required to disclose the “nature and extent” of the interest, instead of just the “nature” of the interest under existing law.
The disclosure must be made in relation to a proposed transaction, arrangement or contract before the company enters into the transaction, arrangement or contract.
The fact that the other directors are already aware of the interest would not exempt from the requirement to make disclosure.
In a recent case, the Court of Final Appeal found a bank to be irrational in its belief when it relied on the apparent authority of the executive chairman and chief executive officer of a company. A comment made by the Court was that the minutes contained no disclosure of interests.
Directors' duty of care, skill and diligence
The old case law focuses on the knowledge and experience which the particular director has. This is generally called the subjective test. It is considered to be too low nowadays.
The new Ordinance provides that a director must exercise 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 director (an objective test); and
(b) the general knowledge, skill and experience that the director has (a subjective test).
The objective test sets out the minimum required standard, and will be applied with reference to the functions carried out by the director in the company.
The subjective test would raise the standard expected of directors who have special knowledge, skills or experience beyond what the objective test may require.
The new Ordinance would not introduce a higher standard of care for directors. In fact, the Government believed that nowadays the Hong Kong courts would likely adopt the combined objective and subjective test at common law, but nevertheless sought to clarify the point in the new Ordinance.
This is the only duty which is codified in the statute. All other duties of a director remain to be found in the voluminous court decisions.
Ratification of directors' breach of duty
The existing case law permits ratification by members' approval in a general meeting.
The new Ordinance will require ratification by disinterested shareholders, or by unanimous consent of all shareholders (in a case where there are no disinterested shareholders).
Ratification is only valid if the company is solvent at the time of passing the resolution. Further, certain breaches of duty (e.g., misappropriation of the company's assets, and fraud on minority shareholders) are not ratifiable.
Loans to directors, etc
Loans to directors (and directors of the holding company), and the giving of a guarantee or security for such a loan, are currently prohibited. The new Ordinance will expand the prohibitions to overseas companies controlled by a director.
Extended prohibitions on loans, quasi-loans and credit transactions currently apply to public and listed companies. The existing law subjects private companies which are members of a group which includes a listed company to the same extended prohibitions. The new Ordinance will apply tighter control only to private companies which are subsidiaries of a public or listed company. The reasoning is that the public investors of a listed company would have no interest in a private company which is not its subsidiary. However, private companies which are subsidiaries of a public company will be caught, even if there is no listed company within the group.
The extended prohibitions will extend to a wider range of persons connected with the director, e.g., a parent and a cohabite, and to Hong Kong and overseas companies associated with the director. A company is “associated” if the director (or certain related persons) controls more than 30% of its voting power.
The exemption for transactions approved by the members in a general meeting (i.e., by a majority) will be extended to all companies. The members' resolution must be passed before the transaction is entered into. The company must send to its shareholders a memorandum setting out the nature of the transaction, its amount, purpose and the extent of the company's liability. In the case of a public company and its subsidiaries, the transaction must be approved by disinterested members. Transactions may also be entered into with the unanimous consent of the members.
There will be a new exception for loans, quasi-loans and credit transactions of a value of not exceeding 5% of the company's net assets (as determined by the most recent annual financial statements) or called-up share capital.
The criminal sanction under the existing law will be abolished by the new Ordinance. The Government considers that civil sanction is sufficient. A prohibited transaction will be voidable, subject to some exceptions including where a third party (other than the director or persons connected with him) has acquired rights in good faith, for value, and without actual notice of the contravention, and those rights would be affected by the avoidance. However, this is without prejudice to the common law remedies by which the transaction may be called into question.
Shareholders' written resolutions
The new Ordinance lay down procedures for proposing and passing members' written resolutions. These include who may propose a written resolution, a duty to circulate the proposed resolution to every member, accompanied by specific guidance (including as to how to signify agreement), a 28 days' period (or another period specified in the articles) for agreeing to a written resolution, and a duty to notify the auditor (upon circulating the proposed resolution), and every member and the auditor (if the written resolution is passed). The new procedures will not replace the common law rule that if all members of the company agree, the decision is binding and effective without a meeting.
It may be recalled that the new Ordinance will come into effect on 3 March 2014.