Matters related to the Corporate Frauds and how they can be controlled after forming a company in Hong Kong


The general equitable doctrine of fraud on power is found to be the basis of the principles laid down for frauds on the company. It is the matter of understanding that any act of dishonesty and deceitful context must not be counted as fraud because notion “fraud” implies of any arrangement which involves abuse or any misuse of power, giving rise to the concept of “equitable fraud”. Breach of fiduciary duties on the part of director, breach of no profit rule, breach of conflict rule and breach of corporate opportunity, all these breaches extends the concept of equitable fraud. For the situation where directors have breached their fiduciary duties such as misappropriations in the company’s transactions, even though directors acted in good faith and for the best interest of the company still they would be liable for the imposition of duty of equitable fraud.

Although negligence on the part of the directors does not provides sound grounds for the constitution of claims as per equitable fraud however where director has benefited or made un-precedented profits through the alleged wrong doing or mis-conduct, then there is the proper evidence to take derivative action against the accuser. Referring to the situation presented in the case of Daniels where directors benefited from their negligent act, fraudulent actions or by any manner whether intentional or un-intentional, but their gained profits or benefits were staunchly established at the expense of the company and so they were held liable for it. It was later noted in this case and so was held by the court that, members could initiate proceedings as per Derivative Action against the directors on their mis-conduct which involved selling of company’s assets at the value much less than the market value, to one fellow director of the company’s board of director and which in turn enables that specific director to earn elevated profit on its resale.

It was held by the English Court of Appeal to grant exceptions to the circumstances which does not falls within the jurisdiction of the fraud and this exception would not be made available if:

  • Any such act or conduct of the directors caused loss to the company.
  • The person who is accused of any such mis-conduct or wrongdoing has benefited personally from such arrangement of fraud.

It was held later on that, not only the negligence entailed in Daniels be considered appropriate, instead negligence can also take other breach of duties under its shadow, with exception to the dishonest breach of duties after company registration Hong Kong. Hong Kong’s legal perspective reports of the situation in Liu Hsiao Cheng’s where an application was moved before the Hon’ble court to strike out the action it deemed to take, claiming that no such plea is found indicating of the situation where wrong doer has took personal benefit at the expense of the company. Court of Appeal rejected this request and held that requirements laid down in the case of Daniels regarding the personal gain of the wrongdoer stands valid in the Hong Kong also.

It normally conceived that where the majority of members ratified of the setting which involved any act or conduct which falls within the jurisdiction of equitable fraud such as misappropriation of company’s assets or capital, same liability as of the director(s), would be imposed upon them also.

Exception Frauds and the matter of control over the Company

For the application of the fraud exception, it is mandatory for the applicant, plaintiff or the pleader to establish the capacity of the wrongdoer as company’s controller. This control can be of any sort such as this control can be over the company’s board, control over the company’s general meeting. As the provision of fraud exception to the company, which is considered as proper plaintiff for any wrong doing, is to make sure the initiation of proceedings against the accuser of wrong doing. As any those wrongdoers may prevent themselves from the legal proceedings from the control they have over the company’s board or general meeting. To initiate any such proceeding after company registration Hong Kong it is mandatory to assess the extent of control i.e. was that control spread over the company’s board or general meeting or such corporate culprits had control over the both corporate organs?  And also, was that control so intense that it restrained company to initiate proceedings or any action to be taken against those corporate culprits.  This is a matter of immense importance and thus be noted that, where there is the existence of the fact that control was so minor or so negligible that it could not restrict corporate organs to put forward any legal proceedings, then in the presence of such evidences there would be restriction on continuation or exercise of derivative action pertaining to the fraud exception.

For the situation where control of the wrongdoer over any corporate organ or concurrently over the both is established and that control was of the intensity which could prevent company or any corporate organ to initiate proceedings against the wrongdoer then even if accusing personality was not a majority shareholder of the company, even then his or her control over the company would be established and thus proceedings could be initiated and where it has been initiated, can kept on continuing. This arrangement could better be understood while referring to Anglo- Eastern Ltd case, here company went into the situation of the deadlock as two of its beneficial members possessed 50% of company’s shares each. The Court of Appeal, in this situation of deadlock, held that out of these two shareholders who holds 50% of total shares each, one shareholder who possess 50% of company’s shares could take the derivative action on behalf of the company against second member who possessed other 50% shares of the company, for his or her breach of owed duties.

As the above said matter, where wrongdoer would still be held liable for his or her wrongdoing to the company incorporation HK even if said person is not the majority shareholder. Legal commentators believe that this matter requires more elaboration so as to assess what circumstances and control to what extent would be sufficient to put forward any legal proceeding. So, the said sufficient control would be the one where wrongdoer controls company’s board and majority votes in the general meeting in a way, where he or she (the wrongdoer) can ratify any resolution which deems to bring any unlawful act or act of wrongdoing- even though such controller is not even the majority shareholder of the company.

The case of Chan Chun Hoo could better make this concept understand. In this case, The Court of Appeal completely rejected perception which entails for the need to have sufficient control only if accuser holds the 50% of voting rights in the general meeting, with the argument that control is solely the practical matter and thus circumstances could vary. So, proper examination is needed to assess the amount of control as it would vary case to case and for each company. Sufficient control would be the one which is enough to let wrongdoer exercise his or her mal-intention. Example of one such control could be the setting where wrongdoer can offer inducements to the controlling shareholders so that their vote would enable him or her to carry on wrong-doing. Enough control would also be established where mal-intention of wrongdoer can be made to incept by use of proxy votes or by the manipulation of his or her fiduciary or any position in the company.

Derivative Action in the “Interest of Justice”

In the case of Foss, it was established that where there is any sort of difficulty in finding proper grounds to sue the company or company incorporation HK because of some technical issues, superiority would be conferred to the “claims of justice”. This provision can be best interpreted for the situations where there is no evidence of ultra vires or any probability of fraud exceptions to the proper plaintiff principle but subjected to the interest of justice derivative action must be applied and taken appropriately. English Court of Appeal however found much confused upon the uncertainties and need to serve the interest of justice because they brainstormed the certainty that will there be enough grounds and exceptions for the application of “Derivative Action” just because of the facts that there were technical barriers in its application. English Court of Appeal thinks that the past circumstances report of the situation where such exceptional technical difficulty was found, was merely on the sufficient justification for the application of derivative action just for the sake of interest of justice and previous practices were not carried out on the grounds of separate residual exception. So, today’s application must assess for some other veil.

Australian Legal System however does not think the way The English Court of Appeal thinks and so Australian Court believes that such exception exists. For the case of Mallina Holdings Ltd, Justice Ipp allowed for the derivative action for the claim of justice because he found that:

  • Serious breaches of Fiduciary duties which were decided to be done at the time of start up company Hong Kong were found.
  • If derivative action could have been taken, company may benefit from recovery of significant compensation through incurred damages.
  • Here the wrongdoer disposed of its shares through some unusual transactions, after writ was issued.
  • Such disposal of shares by the wrongdoer itself was the sole reason to leave the liability for such fraudulency on the part of the director.
  • Action could also be legitimated as no explanation was given on the argument that why the buyer bought such shares, upon which there is pending litigation.
  • And also for the situation where the company’s prospect itself became remote upon commencement of proceeding.

Judicial Powers for Corporate Fraud and Infringed Rights

Court has the prerogative to discard or deny granting relief for any application of the plaintiff which pleads for the compensations for such matters, as per provisions of Common Law. But as per the Section 168BC (5) and (6), court cannot deny keeping the proceedings continue for any matter where plaintiff sought court’s help on behalf of the company, for his or her infringed personal rights after start up company Hong Kong. As per the Section 168BE, it is court’s privilege to either dismiss or continue the proceedings which the applicant lodged on behalf of company while exercising his or her rights as per common law for any proceedings, then court reserves the right to amend or strike out the plea - for the situation where court has granted leave to either initiate the proceedings or intervene in the proceedings.

If neither is the case, as discussed above, then court has the open choice to either issue a order or any direction for the proceedings being carried out as per Part IVAA. For such situation court may choose for either of following setting:

  • Issuance of Interim Order(s).
  • Directions about the mechanism of proceedings.
  • Direction to any officer or company itself.
  • Appointment orders of an independent person to oversee and carry out investigation and subsequently report to the court about:
  • Financial Condition of the company.
  • Cost incurred by the member who brought proceedings.
  • Facts upon which grounds for the initiation of proceedings was set.

It must be noted that, where court ordered appointment of such independent person, then the total incurred cost shall have to be bear by either company, proceeding party(s) or the member who intervened or brought the proceedings, says Section 168BG. There is another important aspect in framing court’s power for such matters is, court cannot authorise the collection or use of any personal data in contradiction to the Section 168BH of Cap486 (Privacy Ordinance) and as per the Section 168BI court has the power and jurisdiction to issue orders about the costs.