City University of Hong Kong School of Law LW3902 The Law Relating to Companies Revision Tutorial

Lectures 5 & 6 Corporate Constitution & Contractual Effect and Alteration Mr. Lee was employed as an accountant and a director for 10 years under the companys Articles of Association and was not to be removed at any stage unless he was found to have acted with gross dishonesty. At the time of employment, Mr. Lee was not a shareholder. However, after 2 years, he then decided to purchase some shares of the company. In a general meeting, the existing members voted under an ordinary resolution to remove all the existing directors. The new appointed directors then also proceeded to dismiss Mr. Lee as an accountant of the company after only 5 years service owing him $1,000,000. Mr. Lee wants to sue the company for a breach of the Articles of Association and seek for damages and retaining his position. Advise Mr. Lee with reference to case law and legislation. Answer Guidelines Discuss the following issues: (a) capacity (employee or member?); (b) reliance (employment contract or companys Articles of Association?); and (c) any wrongful dismissal? Advise Mr. Lee on whether he can seek for damages and retaining his position; if yes, what legal action to be taken. Discussions include s.23 of Companies Ordinance (Cap. 32): (a) Articles of Association, which is a statutory contract under s.23 of Companies Ordinance, would generally bind a company with its member, but not outsiders (Eley v Positive Life Assurance). (b) Terms of articles may be incorporated into a contract between a company and an outsider (Re New British Iron Co. and Southern Foundries v Shirlaw). (c) A company can alter its articles under s.13(1) of Companies Ordinance, but so to act may nevertheless be a breach of contract if it is contrary to a stipulation in a contract validly made before the alteration (Southern Foundries v Shirlaw). Mr. Lee can sue the company:(a) in the capacity of a member relying on the Articles to seek for setting aside the decision in removing all existing directors (including him) and dismissing him (as an accountant of the company appointed under the Articles) in order to retain his position, and/or (b)in the capacity of an employee relying on the employment contract to sue the company for breach of contract (early removal without good reason) and seek for damages ($1,000,000 plus). Legal grounds for setting aside the directors decisions (a) s.13(1) of the CO to change the articles by special resolution (not ordinary resolution). Furthermore, at common law, any alteration of the articles must be bona fide for the benefit of the company as a whole. (Allen v. Gold Reefs of West Africa Ltd.) (b)Therefore, if the alteration is made to oppress Mr. Lee (properly a minority shareholder), or to dismiss him without reasonable grounds, Mr. Lee may apply to the court to set aside the directors decision. (c) Further discussion on the breach of directors fiduciary duty to exercise their powers for a proper purpose (Howard Smith Ltd. v. Ampol Petroleum Ltd.) Legal grounds for seeking compensation or damages:- breach of employment contract and according to provisions under s.157B(1) & (8) of the Companies Ordinance.

Lecture 7 Promoter and Pre-Incorporation Contract Richard was interested in setting up a new company, Master Kitchens Ltd., specialized in importing and exporting kitchen appliances. He was certain that with his expertise and connections, the company would be a huge success. He entered into a contract with Golden Ovens Ltd. to purchase 100 ovens from them at $1.1 million. In the purchase agreement, Richard signed his name. Above the signature, there was a phrase stating, on behalf of Master Kitchens Ltd., which had not been incorporated on the date of signing. Two months after Richard signed the contract, the company Master Kitchens Ltd. was incorporated. However, Master Kitchens Ltd. refuses to honour the contract as it has found a new supplier who will sell ovens to it at half of the price. Advise what legal action that Golden Ovens Ltd. can take.

Answer Guidelines Richard is a promoter of the new company (Master Kitchens Ltd.); Richard purports to make a pre-incorporation contract on behalf of the company (Master Kitchens Ltd.); Liability of promoter (Richard) personally; Company (Master Kitchens Ltd.) is not liable; Common law position and s.32A of Companies Ordinance; Remedies available specific performance or damages?

Lecture 8 Control of the Company Splendid Ltd was set up in 1997. It had adopted similar provisions under Table A, Art 82. There is an additional part, which reads that non-management decisions of the Company will be decided by the shareholders at the general meeting. Recently, the company has decided to renovate its reception area and decided to give the contract to Painters Ltd. The shareholders are not happy with this decision, as they do not feel that Painters Ltd has the expertise in such works. Therefore, they pass an ordinary resolution at the extraordinary meeting to stop the execution of the decision. Advise the directors of Splendid Ltd as to the validity of the resolution passed by the shareholders. Would your answer differ if the directors had acted beyond their powers given to them under the articles, but it was within the powers of the company? Answer Guidelines Significance of Table A, Article 82 before/after February 2004 (Slide no. 5-8); Discuss cases on powers of directors (Slide no. 9-14); Discuss the wordings (non-management decisions?) in the additional part; and Discuss position where directors act beyond their powers and seek approval by shareholders at the general meeting (Slide no. 19-23).

Lectures 9 & 10 Directors Duties and Protection of Minority Shareholders Ada, Brenda and Christina are the three directors of the company ABC Ltd. (ABC) holding 30%, 25% and 25% of the shares of ABC respectively. The remaining shares are held by Diana who is not a director of ABC. The Board of Directors in its meeting unanimously decides to increase the remuneration of the directors by 200%, and purchase three residential flats for the directors quarters for HK$40 million from Centaline Ltd. The purchase of the flats and the increase in directors remuneration are approved and ratified by the shareholders in the general meeting, despite Dianas objection. Recently, Diana discovers that Centaline Ltd. is owned by Adas husband, Brendas mother and Christinas sister who bought the residential flats for HK$20 million one month ago. Advise Diana and discuss the remedies available to her. Answer Guidelines A director owes fiduciary duties to the company, not individual shareholders; Re Smith and Fawcett Ltd [1942] burden of proof on the plaintiff Directors fiduciary duty to act in good faith, to exercise powers for proper purpose, not to conflict duty and personal interests; stringent standard of directors duty of care and skill [Daniel v. Anderson (1995), Re Boldwin Construction Co. Ltd. (2001)] Directors statutory duty to disclose interest under s.162 failing to disclose the material interest in a contract shall be liable to a fine under s.162(3). The Rule in Foss v Harbottle (the company is the only proper plaintiff) and the common law exceptions to this rule (fraud on the minority an abuse of power whereby the majority secure an unfair gain at the expense of the minority); Minority shareholders rights can be protected by a personal rights action (Pender v Lushington), a derivative action (Anglo Eastern v Karl Knutz, Cook v Deekes fraud on minority), representative action and petition for unfair prejudice under s.168A of Companies Ordinance; 3

In this case, Diana is the only minority shareholder other than the wrongdoers personal action; Statutory regime new statutory derivative action ss.168BA-BK of Companies Ordinance; The option would be for Diana to petition for unfair prejudice under s.168A what court order? Flagrant breaches of fiduciary duty may amount to unfair prejudice Re Texgar Ltd [2002]; Tseng Tueh Lee v Metrobilt Enterprise Ltd.; Courts may order restraining the doing or continuation of the increase in directors remuneration and/or purchase of properties if it is feasible [s.168A(2)(a)(i)], or, appoint a receiver or manager s.168A(2)(a)(iii), or other orders upon successful application under s.168A see Re Bondwood Development Ltd.

Lecture 11 Protection of Outsiders X was one of the four directors of ABC Ltd. He entered into an agreement with a developer Y to purchase off-the-plan properties of HK$12 million for and on behalf of the company in December 2011. Y had dealt with ABC Ltd in similar ways for many years. ABCs articles stated: any purchases over HK$10 million needed to be agreed to by the shareholders in a general meeting and passed by an absolute resolution. A special resolution was passed and ABC had purchased the property. It is now March 2012 and the company is in liquidation. The liquidator is refusing to honour the contract stating that X had no authority. Y is claiming that he relied on Xs representation. Advise both parties. Answer Guidelines Under the law of agency, where the existence of the principal (ABC) is disclosed to the third party (Y), the agents (Xs) acts have the same legal consequences as if the acts were made by the principal (the company ABC). In this case, Y had dealt with ABC Ltd in similar ways for many years. However, problem may arise if it is not clear whether a person has made a contract for himself or as an agent for the principal. In general, a company (ABC) will not be bound by the acts of its director (X) if the director: (a) makes a contract by deed in his own name (e.g. without on behalf of the company); (b) makes a contract which expressly imposes liability on the director; (c) signs a bill of exchange in his own name (ss.26 & 26A, Bills of Exchange Ordinance); & (d) acts in excess of or without the authority, but represents to third party that he has authority (e.g. a bank manager, in excess of or without any authority, guarantees payment of overdrafts.). The issue in this case is on point (d). The rule in Turquands case (indoor management rule) to protect an outsider (Y) dealing with a company in good faith and without notice of the fact that the companys internal management requirements (absolute resolution) have not been followed. Exceptions to the rule deemed notice (Irvine v Union Bank of Australia), has been abolished under s.5C of CO (Refer to slide no. 10). A company will be bound by the acts of its director under the doctrine of apparent authority Freeman & Lockyer v. Buckhurst Park Properties (Mangal) Ltd. [1964]. Advise Y on how to establish that X had the apparent authority in signing the contract. (Refer to Slide nos. 22-23)

Lecture 12 Share and Loan Capital and Winding Up Billy and Lilly are owners of two cafes in Central. Their business has been very successful over the last five years and therefore they plan to expand their business by opening more cafes. In order to raise sufficient money to expand their business and limit their future liabilities, they would like to form a private limited liability company. Advise Billy and Lilly on the following:(a) The methods to fund a private company and their characteristics; and (b) The ways of winding up the company if they plan to stop running the company or the company is unable to pay its debt.

Answer Guidelines (a) Discuss both shares (slide no. 5-8) and loan capital (slide no. 9-15, shareholder loan, third party, or bank loan, issuing debentures) and also their advantages and disadvantages: the basic distinction between share capital and loan capital is that a shareholder is a member of the company, whereas a lender is an external creditor; advantage of financing a company by way of issuing loan capital is that it avoids any dilution in the shareholding of the original shareholders, and has no impact on the control of the company; disadvantage of financing a company by way of issuing loan capital is that the company has to pay high interest and usually security for loan is required; nonetheless, the interest payable on the loan can be deducted from gross income for tax purpose. Issuing shares and debentures long term financing, raising large amount of capital (as time and cost in preparing and issuing prospectus is generally long and high) Loan short term financing, raising small amount of capital (simple, easy, immediate available and low cost), interest rate may be low or high as it is volatile. Discuss briefly the two forms of winding up voluntary winding up (if they plan to stop running the company) and compulsory winding up (if the company is unable to pay its debt) priority of claims (slide no. 21-24).

(b)

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