After addressing the question of how to incorporate in Hong Kong the company than as the fiduciary of the company, director is supposed to exercise his or her entitled powers for the proper purpose of the company. Privy council in Howard Smith Ltd emphasised that to determine that whether there was the breach of duty or not, it is compulsory to establish first, the nature of the power, the purpose for which the power was granted and exercised, eventually and does this exercise was in jurisdiction of what is permissible or not?

They way through which exercise of power would be considered for proper purpose

It is the company’s articles which confers dedicated powers for the directors, to the director. So, in this context there is the need to understand the scope and nature of the provision, which is conferring powers to the director after establishing the company’s plan for how to incorporate in Hong Kong. There are some of the basic powers conferred to the director.

Power to transact company’s assets

The power to use company’s assets for the transactions that are deemed to be beneficial for the company, is the conferred power to the director. However, in case such transaction is for the personal benefit rather than for company’s benefits, then such exercise of power would not be for proper purpose.

Power to transact company’s shares

Directors are allotted with powers to allot shares to anyone, they think would raise the company’s capital. Instead of this, director can issue shares to anyone for the reason falling in the benefit of the company. However, if shares are issued with the intention to disturb majority shareholders or to form new majority class, which was not existed earlier, then for such actions, directors are not allowed to use their power of shares allotment because it is not the prerogative of the director to encourage one group and discourage the other.

The circumstances reported in Kam San’s case presented of the situation where few directors acted to allot 9900 shares of the company to disturb the 100% stakes of existing majority shares to restrain to the 1% of company’s total share and thus converted majority into minority in the perspective of shareholding. Court of First instance declared this to be the breach of duty on the part of directors, as shares were issued at the nominal value of $1 and the capital of $9,900 is not as worthy as the company’s assets of RMB938 Millions, thus on the argument that it was done to raise capital, court rejected this narrative of director and declared it to be the breach of fiduciary duty on the part of the director.

The proceedings in eSun Holdings presented the different narrative where it was the allegation that despite of having considerable funds and no urgency for the funds, directors allotted shares following the private placement and it seems as it was done to protect and favour one director. Court after hearing the circumstances rejected the allegation on the part of directors to favour one director and held that: director profited from the handsome opportunity to overcome the lack of profits in the company and to compensate the elevated funds company incurred while acquiring the business, which costed them unexpectedly high cost.

Australian High Court considers that, not every time mal-intention on the part of directors exist, sometimes it may be necessary to dilute the majority of existing shareholders and to constitute the new voting power may be considered as the legitimate initiative. New South Wales Court of Appeal communicated that, where the company is at edge of liquidation then if director acquires shares of the company with the intention that they will get the control of company then such intention of director would not be counted as breach of their duties as they saved the company from liquidation and kept the control of company in their hands instead of giving it to anyone else.

Apart from alteration of voting rights director can act to defeat the takeover offer by any way. For example, directors may get company to enter into the contract which would make so unattractive and expensive for the offering person to fulfil his or her intention to take over the company. But where directors defeated takeover just to retain their position in the company formation HK then this would be counted as breach of his or her fiduciary duties.

There is the takeover code for both private and public companies. For the public company, as per the General Principle 9, any director of the concerned company cannot involve in the transaction on behalf of company which would mistreat the offer or effects shareholders rights to decide for any transaction on merit, without the prior approval from General Meeting. For the private companies, company’s articles must contain the provision which restricts transfer of shares. Thus, for the directors of the private company, there is more liverage to look for the identity of the certain shareholders to ascertain the eligibility of the shareholder to be company’s controller or member of the company.

Director’s power to appoint more directors in the board of directors might also amounts to the breach of duty. In the case of Chu King Fai, circumstances reported that company’s constitution fixed maximum limit for the inclusion of directors in the company formation HK. The company’s directors appointed additional directors to the maximum limit, as in the company’s article to seize the control of opponent over the managerial affairs of the company. Though it seems that directors did it in the good faith and for the interest of the company but on the grounds that there was a breach of fiduciary duties of the director, appointments were held to be invalid.

It was reported in Eclairs Group Ltd that; company’s articles gave directors power to issue restriction notice to those members of company who had been issued “Disclosure Notice” but either they didn’t submit the required or the information they submitted was false. Having received such irresponsible response from the addressee of the notice, directors are entitled to issue “Restriction Notice” against the subjected member to restrict him or her to attend the meeting and seizure of their voting rights. Apart from this attendance and voting restriction, such member would not be able to transfer his or shares nor he or she be entitled to receive dividends on the issued shares. UK Supreme Court accepted director’s discretion to issue such notices and held this exercise of power to be legitimate. Moreover, court elaborated the reason for such expression of power from the directors as:

  • To let shareholders, act upon Disclosure Notice and justify what is being asked.
  • It is invoked to protect the rights of company and shareholders to take decisions for the company.
  • On account of failure to comply with the requirement of “Disclosure Notice”, application of the concealment on the respective person is so to ensure rule of law in the company and if the said person does not takes company’s interests seriously, then he or she must not be allowed to get benefit from the company as the dividend on the issued share on his or her part or through any other way.

It was noted that directors issued restriction notice pursuant to the false information given by the addressee in response to the issued disclosure notice. The notice was served immediately before the general meeting, where the resolution to allow market purchase of the shares was to be presented. Forestall. Supreme Court after hearing arguments of both sides held that directors action to issue restriction notices was the act for improper purpose even though the directors thought of acting in the best interest of the company.

Reason for the exercising of power

The question of the reason to find the objective for the exercise of particular power on the part of the director(s) is still a matter of consideration. As to assess the state of mind of the director, while exercising particular power, there is the need for the court to look into all presented evidences and the reported circumstances. Consider the case where matter of allotment of shares on the part of directors is the matter of question. To determine and evaluate the credibility of the director it is important to take into account the financial position of the company, extent to which funds are needed- whether really needed or not? And what would be the impact on the company or the shareholder’s voting rights, if shares would have been allotted?

If the act of director amounts to the proper purposes, even though such act had benefited the director, even then it would not make the act or exercise of power by the director, an invalid. For the situation after company incorporation HK where directors have more than one purposes for the exercise of their power and if such exercise of power amounts to the improper purpose then the director would be held to the breach of his or her duty. Australian High Court suggested it to be more descriptive and said that if the dominant act was impermissible and so does causative too, so it would amount to the imposed duty on the director for his or her breach of duty.

Legal Commentators emphasised on introduction of differentiation for the matters where more than one purposes are subject. Such multi purposes could be of two types, where in the 1st case they are linearly connected while in 2nd these are separate and independent. For instance, in the case where director’s intention to modify the voting rights is for some legitimate process then here these purposes are linearly connected. For the situation of independent and separate purposes, the legitimacy of one purpose can validate the action. Now the establishment to determine the substantiality of the purpose is upon court.

In the case of Howard Smith Ltd, directors claimed that they allotted shares to raise the capital and this narrative was accepted by the Trial Judge. But, judge held that substantial purpose of the director was not to raise the capital but rather to minimise the interests of their company to facilitate the procurement of it by the plaintiff’s takeover of the company. Court noted that there is enough evidence that indicates loss of interest in the defendant’s company by the director as they want to make the takeover of the plaintiff, a safe and feasible venture. Privy council also accepted these observations of the trial court.

Court believes that there could have been separate and independent purposes to amount the exercise of power. As evident in Harlowe’s Nominee pty Ltd’s case where the substantial purpose of allotment of shares to the business partner was accepted on the grounds that this allotment amounts to the betterment in the financial standing of the company and let it to spend more on the exploration of mines. Though this allotment has restricted the shareholder’s intention to take over the control of the company but even then such substantial purposes are for legitimate transactions.

Legal commentator’s comments that, timing factor along with other factors can prove to be deterministic to assess that whether the substantial purpose was for the legitimate or the illegitimate one? but, timing alone, cannot determine the true intention of the directors. There is the rule of thumb that, if the substantial purpose exists then there is no question of imposing breach of duty on the director and it was impermissible than proper examination of the facts and observation can help court to either impose breach of fiduciary duty or not?

Act of the directors favouring good faith on their part

 Legal experts suggest the imposition of “Objective Test” to determine that whether directors acted in good faith after company incorporation HK because even though directors acted in good faith but the probability of breach of duty still exists. There is distinction between the duty to exercise power and the duty to act in the good faith of the company, while there can be breach of former if there is no breach of latter.