Reform of minority shareholders rights in Hong Kong

25 August 2005

Edward Alder, Rosamund Cresswell

The Companies (Amendment) Ordinance 2004 (the “Amendment Ordinance”) passed by the Legislative Council in July 2004 contains provisions that significantly enhance minority shareholders’ rights. The provisions in schedule 3 of the Amendment Ordinance, took effect on 15 July 2005.

What is the current position?

The “rule in Foss v Harbottle” encapsulates two distinct common law principles: (a) the normal course of events is for internal company matters to be determined by majority vote; and (b) if a wrong is done to a company then only the company itself, and not individual members, may sue for redress.

The rationale for this rule is that it would serve no purpose to involve the courts in internal disputes in relation to irregularities when these can be ratified easily by the majority.

This can result in unfairness to minority shareholders and certain exceptions to the rule have therefore arisen.

Minority shareholders are offered some protection at common law through their right to commence a derivative action and by statute, in respect of unfairly prejudicial conduct (section 168A of the Companies Ordinance (Cap 32)). Further, the minority may apply to have the company wound up on “just and equitable grounds”.

Common law right to commence a derivative action

In certain circumstances, a minority shareholder may bring a common law derivative action against third parties, the directors or majority shareholders themselves. This is an action on behalf of the company to redress a wrong done to the company. The action does not require the support of the directors, in which the power to initiate proceedings on behalf of the company is generally vested, nor the support of the majority of the shareholders who control the composition of the board. The fruits of a derivative action belong to the company.

In order to succeed with a derivative action at common law, the minority shareholders must persuade the court that the company’s (that is the majority’s) decision not to pursue a remedy for the wrong done to the company constitutes a ‘fraud on the minority’, i.e. the court must conclude that the decision was not made independently, in good faith and for the benefit of the members as a whole.

Statutory remedy in respect of unfairly prejudicial conduct under section 168A of the Companies Ordinance

Currently, section 168A(1) of the Companies Ordinance provides that ‘any member of a company who complains that the affairs of the company are being or have been conducted in a manner unfairly prejudicial to the interest of the members generally or some part of the members (including himself)……may make an application to the court by petition for an order under this section’.

If the court determines that the company’s affairs are being or have been conducted in a manner unfairly prejudicial to the interests of the members it may:

(a) make an order to restrain the commission of any such act or the continuance of such conduct

(b) make an order that proceedings be brought in the name of the company

(c) appoint a receiver or manager of the whole or part of a company’s property or business

(d) make orders for regulating the conduct of the company’s affairs in the future, or for the purchase of the shares of any members of the company by other members of the company or by the company itself

The first three remedies existed, in a broad sense, at common law before section 168A came into force. The novel element is (d) which provides the court with the power to order the majority to purchase the shares of the complaining minority. This provides the minority with a remedy in respect of the prejudicial conduct, yet preserves the company as a going concern.

What is the effect of the Amendment Ordinance?

The Amendment Ordinance expands the types of company and members who will be able to obtain a remedy under section 168A.

Most importantly, the term ‘company’ is replaced by the words ‘specific corporation’ which covers both Hong Kong and non Hong Kong companies. Much business in Hong Kong is done through the use of offshore vehicles but to date, section 168A has not been applicable to non Hong Kong companies.

The court is empowered to grant damages and interest where it finds that the member has been unfairly prejudiced. For the first time, the injured party will be able to receive monetary compensation as opposed to only procuring restraining orders or buy out orders or the appointment of receivers. This is likely to prove an attractive remedy in many cases and may lead to an increase in minority shareholders’ litigation.

However, the scope of damages which may be awarded is limited to any loss suffered by the member personally in line with the common law position that a member may not recover compensation for economic loss to the value of his shareholding which is merely “reflective” of the company loss in respect of a wrong done to the company.

The Amendment Ordinance also introduces a new statutory right for a member of a Hong Kong or non Hong Kong company to commence a derivative action for ‘misfeasance’ committed against the company. 'Misfeasance' is defined as fraud, negligence, default in complying with any statutory provision or rule of law or breach of duty. Although the new statutory right echoes the common law position, it provides greater clarity as the right to bring a derivative action is more clearly defined.

In tandem with this, is the new right to apply for an injunction against an individual or a director for any breach of the Companies Ordinance. This wide-ranging new right does not just apply to minority shareholders’ grievances but extends to any breach of the Companies Ordinance. Further, in contrast to the common law position (where an injunction is only available when damages would not be an adequate remedy), the remedy of damages is available in addition to or instead of an injunction. This is likely to prove a valuable new weapon in the movement towards better corporate governance in Hong Kong.