Directors with no apparent personal gain are liable to compensate the company for improper payment

Introduction

In the recent case of Securities and Futures Commission v Yin Yingneng Richard & Others (HCMP 2502/2012), the Court held that three directors are liable to compensate the listed company for causing it to make a payment that it was not required to make, despite two of them did not have apparent personal gain in the matter. The case once again demonstrates that the Securities and Futures Commission (“SFC”) is determined to go after wrongdoing directors and the Court is ready to exercise its wide judicial discretion to remediate corporate losses pursuant to section 214 of the Securities and Futures Ordinance (“SFO”). 

Summary of the case

First China Financial Network Holdings Limited (“First China”), a company listed on the Growth Enterprise Market (“GEM”) of The Stock Exchange of Hong Kong Limited published a clarification announcement in December 2008 in relation to an acquisition completed in 2007 stating that there was before completion a mutual understanding and agreement with the seller (who was a third party at that time) that a dividend of RMB18.7 million would be distributed to the seller of the acquisition.

The SFC alleged that the purported prior understanding and agreement did not exist and as such, the directors were not entitled to distribute the sum. In November 2012, the SFC commenced civil proceedings under section 214 of the SFO against three current and former directors for breach of directors’ duties seeking court orders to disqualify them as company directors and orders that First China and/or its relevant subsidiaries bring court proceedings to recover the dividend distributed.  The three directors included the two executive directors of First China at the time of the acquisition (Mr. Yin and Mr. Lee), and the current chairman of First China (Mr. Wang) who was one of the shareholders of the seller and who became an executive director and the chairman of First China a few months after completion of the acquisition.

No personal gain?

Mr. Yin and Mr. Lee asked the Court to take into account that they had no personal gain in the matter in assessing their evidence.  However, the Court was not convinced that there was no reason for either of them to maintain a good relationship with Mr. Wang in view of their respective capacities as a substantial shareholder and the chief executive officer of First China.

Following a finding that there had never been any mutual understanding or arrangement as alleged, the Court ordered the three directors to repay the sum of the wrongful distribution with interest to First China. There was consensus that Mr. Wang should bear primary responsibility over this compensation because he is the only person who had benefited from the distribution. A further hearing will be rescheduled to determine whether disqualification orders should be made against the three directors.

Reminder of directors’ duties

The three directors were considered to have failed to exercise reasonable skill, care and diligence in the management of the business and affairs of First China, and/or failed to act in the best interests of First China, when they agreed to cause First China to make the distribution.

Directors of listed companies should always bear in mind their common law duty of care and fiduciary duty, as well as the requirements under Rule 3.08 of the Main Board Listing Rules or Rule 5.01 of the GEM Listing Rules that in the performance of the duties as a director, every director must:

(a)      act honestly and in good faith in the interests of the company as a whole;

(b)     act for proper purpose;

(c)      be answerable to the listed issuer for the application or misapplication of its assets;

(d)     avoid actual and potential conflicts of interest and duty;

(e)      disclose fully and fairly his interests in contracts with the listed issuers; and

(f)      apply such degree of skill, care and diligence as may reasonably be expected of a person of his knowledge and experience and holding his office within the listed issuer.

Poor corporate governance to provide indemnity to directors for the defence of the proceedings

During the trial, it was revealed that the non-executive directors of First China resolved to provide an indemnity to Wang and Lee for all professional and legal fees incurred by them concerning the defence of the SFC proceedings. The Court commented that the indemnity was “plainly inappropriate” and “a very poor reflection” on First China’s corporate governance. Consequently, Mr. Wang and Mr. Lee have fully repaid the legal costs to First China and have undertaken not to rely on the indemnity.

Conclusion

This case illustrates that directors who cause the company to make a payment that it is not required to make can be found to be liable to compensate the company even if they may not have apparent personal gain.  It is a timely reminder to listed company directors of their duty to safeguard the company‘s funds and not to use them for improper purposes.