How does the conflict of interest arise on the part of the directors after establishing a business in Hong Kong?

It is the duty of director to avoid the situation where there is the possibility of clash of his or her personal interests and the interest of the company. Past reports of the situation, there was no such imposition of duty on the director for conflict of interest, except of concealing him or her to act in such conflicting matter. However, now situation is different and in Hong Kong there is the imposition of the duty on the fiduciary and conflict of interest is counted as proscriptive fiduciary duty to sustain Hong Kong company establishment.

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Rule of No-conflict

On the role of fiduciary, directors are required not to place their self in the condition where there exists a clash between the interests of the directors and that of a director. The rule of no conflict does not restrict director to go into contracts, instead it stresses on the informed consent of the company. There is the perception which says that, even if the transaction is fair in nature, even then the duty of breach or the duty of conflict of interest can be imposed.

It must be noted that, the rule of no-conflict applies not only to the transactions between the director and the company but also applies to the transactions between the company and any partner to which director is a partner, transaction between the company and another company in which director holds shares. The duty for conflict of interest also imposes to the condition where the director is also the director of another company, with which former deems to transact.

Transvaal Lands Co’s case presents of the circumstances where Samuel was the director of both plaintiff and defendant company with about 5% shares in the defendant company. Another person, Harvey was also the director of both companies and had 1000 shares in the defendant company. Samuel didn’t vote for the transaction which proposed purchase of certain shares from the entity of the defendant company and the selling of forfeited shares of the plaintiff company to the defendant company while Harvey voted in favour but both of them concealed their identity of being the shareholders of both companies. English court of Appeal held this to be the case of Breach of their fiduciary duty on the grounds of conflict of interest and communicated that even though if stakes are of minute nature even then there is the need to disclose them properly thus there will be the existence of conflict of interest even if there is sufficient establishment of director’s personal interest in the transaction.

For the case of Belgian Bank, director was given express power to mortgage company’s property. The director mortgaged the properties to obtain loans in the favour of another company, in which director holds 50% percent of shares and he didn’t disclose of his stakes in the company. Thus, on these grounds court held that director was in breach of his fiduciary duties as he did not disclose about his stakes in the company for which properties was mortgaged.

There even be the existence of conflict of interest, where company went in transactions with the director’s close relative or any of his or her spouse. However, Justice David Richards communicated in Newgate Stud Co’s case that not every transaction with director’s spouse or any close relative of his or her would be considered as conflict of interest instead determination of risk associated with personal loyalties cannot be negated. Similar circumstances were reported in Breitenfeld UK Ltd where managing director of the plaintiff’s company assisted his son and daughter-in law in the business matters of the company which they incorporated to carry out the same business as does the plaintiff and once they did traded with plaintiff. Court held that, although Managing director didn’t held any position or designation in this company but he did assisted them on the business matters and on the grounds of conflict of interest, managing director is subjected to the breach of fiduciary duties owed to the plaintiff.

It is the matter of clear understanding that, where directors fail to disclose their conflicting interests, validity of the transactions cannot be evaluated merely on the fairness and unfairness of the transactions. High standards have been imposed on the fiduciary duties and thus the strictness of the matter should be understood and thus be exercised properly so as to ease out the operations of Hong Kong company establishment.

General view does not impose restriction on the directors to be directors of more than one companies but factuality prevails the concept of conflicting interests in case the two companies transact with each other. Additionally, legality does not prevents director to be even the director of rival companies, until and unless there is no proper disclosure of his or her conflicting interests in both companies or the company’s articles restricts to do so. But generally, it is seen that a person who is the director of both companies who are transacting with each other, is subjected to the breach of his or her fiduciary duties until and unless he or she reveals about their conflicting interests.

For the executives who are under an employment contract, are subjected to refrain from contracting with another company because of their fiduciary duties owed to the former.

Rules on disclosing the conflicting interests for better Hong Kong business formation

There will be no possibility of conflicting interests if director discloses about his or her conflicting interests in the general meeting and gets the approval of the company’s members. In the case of Man Leun Corp, company purchased some items from the partner firm and three of company’s directors were the partners in this firm. These three directors disclosed that they are to form the partnership with the buying firm. But, court held that as it was necessary to disclose and get the approval from the general meeting, which these directors failed to furnish. So, on this failure of disclosure and approval, directors are subjected to the breach of duty.

It is noted that adequate disclosure like the extent of gain which directors expects to get from this transaction as well as nature and scope of his or her conflicting interests is required to refrain from the imposition of breach of duty and to let the company decide, whether or not to enter into the transaction about which director disclosed his or her conflicting interests.

As per the common law, those shareholders who are also the director of the company, would not be deprived of their voting right at the general meeting merely on the grounds of conflict of interest.

How articles can alter the duty of conflict of interest for better Hong Kong business formation

Company’s articles may provide for the way through which director can make disclosure to the board about their conflicting interests. It must be noted where there is such provision, if disclosure is made to any individual of the board outside the board meeting or in any capacity which deprives board to assess the extent of conflict as the board, would not be considered as sufficient evidence for the proper disclosure. Where the material facts before the board itself disclose the conflict interesting of the director and such matter is in the knowledge of board members, then court would not impose the breach of fiduciary duty on the grounds of conflicting interests.

For the companies adopting Predecessor Companies Ordinance Table A provides for the way where director has the conflicting interest in transaction of the company with other, then:

  • Director must disclose the extent of stake or interest in transacting company, before the board meeting.
  • Director with conflicting interest is not entitled to vote, or for any reason if he or she votes, then his or her vote must be disregarded.
  • While asserting requirement of quorum, such director must not be counted.

For the voting rights there is exception in Regulation 86(2)(d) which says that director may vote for the resolution regarding endorsement of contract or any transaction with the company where director holds the position of any officer or shareholder, however such exemption can still be subject to act in best interest of the company on the part of director. Section 78 of Cap.622 imposes the same regulatory duties on the director as what Predecessor Companies Ordinance Table A imposes.

Disclosure of interest as per Companies Ordinance

As per the Section 536 of Cap.622 director is bound to express his or her every direct and indirect material interests in the company, his or her employer thinking of transact with. Section 538(1) reports this disclosure to made in the board meeting or by written notice to every member of the board of directors. Section 538(4) gives leverage of furnishing general notice disclosing about the conflicting interest of the director, instead of presenting disclosure in every such matter.

Cap.622 modifies the disclosing requirements and now the amended one has following requirements:

  • The obligation to disclose does not applies to the contract instead it is needed in the matter involving transacting contract.
  • For the director of public companies, disclosure needs to furnish every material interest of the director with its connected entities.
  • Disclosure about the extent and nature of the conflicting interest must be made.
  • There is the exemption of disclosure if director does not know about the concerned contract or transaction.
  • Written notice about the disclosure of interest must be furnished at board meeting, to all the directors.
  • Shadow directors are also subjected to serve the disclosure.

Director who contravenes the Section 536 of Cap.622 is subjected to the fine of level 6 which is $100,000.

Issue of Compensation

Until and unless company’s articles allow, director is not allowed to demand compensation pertaining to the abidance of No-Conflict rule. However, Model Articles allows general meeting to determine the extent of compensation to the director(s).

Generally graceful compensations are provided to attract talented and competent persons in the company for better establishing business in Hong Kong, however such elevated compensatory packages might get company in trouble especially in the situation where company is going through poor financial situations. Cap.622 generally does not regulates any compensations except the Section 4 of Cap.622G which bounds company to provide the details of allotted compensations to the directors in the company’s financial statements but this does not addresses the individual compensations rather it provides with the summated allotted compensations.

For the listed companies, there is some sort of transparency as the result of amendments in 2004 in the Listing Rule, which retains and enhances the shareholders control over the compensation allotment to the directors because it requires the approval of shareholders in the general meeting to allocate certain compensations to the director.

Issue of providing Directors with Loan

On the account of abuse of providing loans to the director, amendments were introduced in 1984, which now restricts company to give director a loan or either non-commercial basis or on the basis of gifts as per which director is not liable to repay it to the company. Cap.622 now has somehow amended this restriction and now it allows company to give directors loan, if company’s members allows to do so. This provision is subjected to some requirements so as to balance out the Hong Kong company setup cost which are mentioned in Section 496 of Cap.622, as per which following conditions are to be met:

  • Requirement of notice and presentation of ordinary resolution.
  • For the public companies and companies limited by guarantee, there is the terminology of “disinteresting voting” as per which director who is subjected to receive loan, his or her votes may be disregarded.

Exceptions pertaining to the allocation of loan to the director

As per the Sub-division 2 Division 2 of Pt.11 of Cap.622 there are certain exceptions where loan can be given to the director without the approval of the general meeting, these exceptions are:

  • For the small loan which does not exceeds 5% of company’s net assets whether a quasi-loan, credit transaction or whatsoever.
  • To provide director with the expenditures of the company or to enable him or her to perform his or her entitled duties.
  • Expenditures to defend any civil, criminal or any legal proceedings or any regulatory act.
  •  Loan to facilitate the acquiring or renovation of the premises to be used as director’s main residence, which must not exceed 10% of company’s net assets.
  • Transaction for the company of same corporate group etc.