SFC obtains Compensation orders against former directors of listed companies

In 2012, the SFC, for the first time, obtained from the Court compensation orders against former directors of listed companies, pursuant to Section 214 of the Securities and Futures Ordinance (Cap 571) (“SFO”). Under Section 214, where it appears to it that a listed company's business or affairs are being misconducted, the Court can make an order (amongst others), disqualifying a person from being a company director or involved (directly or indirectly) in the management of a company for up to 15 years. The Court can also order a company to bring proceedings in its own name against any person specified in the order and/or make any other order it considers appropriate. The type of misconduct under section 214 is wide, and includes defalcation, fraud or misconduct or acting in a manner unfairly prejudicial or oppressive to its members. Conduct resulting in its members not having been given all the information about its business or affairs that they might reasonably expect, may also bring the matter within the ambit of section 214.

On 26 September 2012, the Court of First Instance ordered Mr Li Wo Hing, the former CEO of Medical China Ltd (now known as China Asean Resources Ltd (“China Asean Resources”) to pay HK$10.7 million in compensation to the company. The Court also disqualified Li Wo Hing and Mr James Li Nga Kuk (“James Li”), former chairman of China Asean Resources, from being a director or taking part in the management of any corporation, without leave of the Court, for seven and four years respectively. The orders against Li Wo Hing and James Li were obtained under section 214 of the SFO.

The Court found that Li Wo Hing and James Li had issued two cheques of China Asean Resources (totalling HK$10.7 million), recorded as being payments to settle trade debts owed by US suppliers. The money was in fact transferred to Li Wo Hing and various persons connected with him and not made for any legitimate corporate purpose. The Court accepted that the payments were a misappropriation of corporate funds, which caused unfair prejudice to the company and its shareholders. The Court also found that Li Wo Hing and James Li had authorised the making of a misleading announcement.

This was the second such compensation order obtained by the SFC under section 214 of the SFO this year. On 7 March 2012, the Court of First Instance ordered the founder and former Chairman of Styland Holdings Ltd (“Styland”), Mr Kenneth Cheung Chi Shing (“Cheung”) and his wife, Yvonne Yeung Han Yi (“Yeung”), a former executive director of Styland, to pay almost HK$86 million in compensation to the company for losses caused by transactions entered into by Styland. This was the first time that the Court had made such compensation order under section 214 of the SFO. The Court also disqualified Cheung and Yeung from being directors or being directly or indirectly involved in the management of a company for 12 years, the longest disqualification orders ever made in such proceedings. Disqualification orders were also imposed on two other former directors of Styland, for six and seven years respectively.

In the Styland case the Court found that Styland had entered into a number of transactions, which were not in its best interests and which directly or indirectly benefited Cheung and Yeung, to the tune of HK$79 million and HK$6.95 million respectively. The Court held that:

1. Cheung and Yeung's receipt of personal benefits from the transactions in question was conduct amounting to defalcation towards Styland and its shareholders under section 214 (1)(b) of the SFO.
2. Cheung and Yeung's failure to exercise due skill and care in connection with the transactions, whether by failing to obtain proper independent valuations or advice, or by entering into such transactions at overvalues, having regard to the fact that large portions of the consideration paid found their way into the pockets of Cheung and Yeung, constituted misconduct or misfeasance towards Styland and its shareholders under section 214 (1)(b) of the SFO. Their mismanagement of the company in those respects amounted to unfairly prejudicial conduct under section 214(d) of the SFO.
3. Having regard to the repeated failures to observe the provisions of the Listing Rules relating to the need to make disclosure, and where appropriate to obtain shareholders' approval for the transactions, Styland's shareholders were not provided with all the information in respect of its business or affairs that they might reasonably expect under section 214(1)(c) of the SFO.
4. Had the complaints against Cheung and Yeung been limited to those involving mismanagement and failures to comply with the Listing Rules, this would have amounted to “serious misconduct” (the usual penalty for which is a disqualification order of 6 to 10 years). However, the fact that they had received substantial sums from Styland Group's funds (HK$79million in the case of Cheung and HK$6.95 million in the case of Yeung), took this case up to the top bracket of “particularly serious” cases (the usual penalty for which is a disqualification order of more than 10 years). The obtaining of personal benefits by directors of company funds, without disclosure and informed consent from the shareholders is a serious matter and justifies a lengthy disqualification order. Accordingly, Cheung and Yeung would each be disqualified from being a director, liquidator, receiver or manager or from being any way directly or indirectly concerned or taking part in the management of any listed or unlisted company in Hong Kong, including Styland, for 12 years, without leave of the Court.
5. The receipt of funds by Cheung and Yeung constituted defalcations and breaches of duty and the amount involved was readily ascertainable. Cheung was to repay Styland HK$79million plus interest and Yeung HK$6.95 plus interest. Interest was to run from the time of each receipt on the amount received at a commercial rate of 1% over the prime lending rate published by HSBC.

Comments

These cases are further examples of the SFC successfully persuading the Court to give a wide interpretation to the provisions of the SFO, to enable compensation orders to be made in favour of the victim of the misconduct. Under section 214, there is no express provision giving the SFC the power to apply directly for a compensation order in favour of the listed company in question. There is only an express provision under section 214(2)(b), for the Court to order the listed company to bring an action in its name against the persons who have violated the provisions under section 214(1). In this case, the SFC was able to persuade the Court to invoke section 214(2)(e) which provides that the Court may:

“… make any other order it considers appropriate, whether for regulating the conduct of the business or affairs of the corporation in future, or for the purchase of the shares of any members of the corporation by other members of the corporation or by the corporation (and, in the case of a purchase by the corporation, for the reduction accordingly of the corporation's capital) or otherwise.”

As the wording “other order [the court] considers appropriate” and “or otherwise” are very similar to the comparable provisions in section 168A of the Companies Ordinance, this provides the court with a high degree of flexibility in terms of the remedies which it might provide.
In the Styland case, the Court refused to make a compensation order in relation to certain claims which were not readily ascertainable. Instead, the Court ordered that the listed company should bring proceedings for those claims and should make inquiry as to the loss and damage. Nevertheless, these two cases set a precedent upon which the SFC can seek compensation orders against former directors of listed companies who are found to have committed, for example, fraud, defalcation, misfeasance or conduct which was unfairly prejudicial to the shareholders. This new type of action seems to be quicker than relying on the company to bring an action or the minority shareholders bringing a derivative action. In the China Asean Resources case, the SFC's action was filed in June 2011 and the compensation orders made in September 2012, in only about 15 months!

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