Remedy for members via Common Law Derivative Action in Company Formation HK

This is not itself a dedication statutory provision nor is an implication of any legal proceeding. Instead the term “Derivative Action” defines of the action taken by any member or the company, on behalf of the company against any wrong doing of director or against any irregularity in following the daily business of the company. However, it has been established in prior discussion that, for the case of any irregularity or wrong-doing, company is the proper plaintiff to initiate the legal proceeding. But, if the company does not initiate legal proceeding for such inappropriacy then any individual can act on behalf of the company and the action this individual would take against the mis-conduct would be called as “Derivative Action”. Such provision extends not only to the company’s incorporated in Hong Kong, but also open to be exercised by any offshore company incorporation or foreign incorporate company having a place of business in Hong Kong, been registered under Part XI of Companies Ordinance, which makes offshore company incorporation or the Non-Hong Kong company’s its subject.

Legal Perspective of “Common Law Derivative Action”

Section 168BC says that any member of the company can:

  • Initiate any civil proceeding on behalf of the company, as stated in ss(1)(a) and (2).
  • If the company is the party to any purpose of discontinuation, defending or continuation on behalf of company, then proceeding of intervention can be furnished before court.

Legal commentator thinks that, such privilege and perks be awarded only, if court establishes that:

  • Such grant will be prima facie in the interest of the company.
  • For the case where intervention application is furnished before the court, court’s satisfaction that company has not diligently discontinued, continued or defended the proceedings.
  • The written notice as per Section 168D has been served on the company.
  • For the case where application to bring or initiate proceedings is sought, satisfaction that company itself hasn’t brought proceedings.

It the responsibility of the member, who sought for court’s help, to serve the notice to company’s registered office, 14 days prior to his or her application of grant of leave. For the case of Non-Hong Kong company, notice must be served at the address of company’s authorised representative. Once the court’s proceedings have been initiated, matter or dispute can only be settled with the leave of court.

Personal Remedies

Common Law provides personal remedies to the members, whose rights have been infringed by any mal-practice or wrong doing and is liable to:

  • If the shares of the subjected person have been forfeited, he or she can restrain both company and its director(s).
  • If the subjected was not allowed to vote or his or her vote was rejected, then the subjected person may restrain directors.
  • If the annual subscription fee is increased without the prior approval or notification to the general meeting, then the victim of such mal-practice can obtain declaration against both company and its directors.
  • As per the statutory rights, conferred to the member(s), the member is independent to take action against any director.

Basis of Common Law Derivative Action

Where the rights of company have been infringed, only company can seek for remedy and not any member, minority or anyone. Nor can any member complaint about the irregularity, if company does not seek for any remedy, in its separate legal entity.

Common Law Derivative Action can be brought up in the circumstances where:

  • Fraud on the part of company exists.
  • Any matter that ultra vires or can be counted as illegal conduct.

Case of Foss and Implementation of Common Law Derivative Action

For the Foss’s case, circumstances reported that Foss and other members of the company, which was incorporated on statutory grounds for the purpose of Property Development and was named Victoria Park Company. Foss claimed on behalf of the company, for the loss company incurred by the mal-intention of Harbottle and other four directors. Harbottle and four directors, let company enter into the arrangement which involved:

  • Purchasing of property from them on an elevated price, as compared to the market price.
  • Borrowing the funds, which is beyond its scope and financial standing.

Foss claimed that, three of these directors were already bankrupted and with the dismissal of company secretary Hong Kong it was impossible to call a general meeting and thus he and other members pursued the daily business of the company. Wigram VC was found to be much convinced with Foss’s arguments and acknowledged his credentials to govern company. However, as Foss already declared that three of directors became bankrupt and despite of their bankruptcy they still were governing the company’s matters for three years, since their bankruptcy. In these circumstances it seemed as if it was not member’s prerogative, instead director’s privilege to exercise their conferred powers pertaining to the oversee this matter and appoint new directors even when there was the absence of company secretary Hong Kong.

This case thus opened new avenues for the consideration of implementation grounds for Common Law Derivative Action and thus for members to seek for this remedy there is the need to have following reasons:

  • Where the director’s conduct made company enter in to the transaction(s) which ultra vires it, then member(s) on the behalf of company can seek for the remedy against the loss or damage incurred to the company. However, this does not mean that unanimous consent of members could let company to enter into transaction or any act, which it could not perform.
  • Where the person or director, who has been accused of misconduct, has been found involved in the transaction or act which clearly proves that it sabotages the minority members rights and infringed specific group of members, then members are allowed to seek for remedy such misconduct on behalf of the company.
  • If the matter, which is subject of any abuse is supposed to be approved via special resolution then member is entitled to obtain its invalidity through the declaration. Instead of this, company’s refusal to take action would itself be considered equivalent to the simple majority of 75% majority, as mentioned in the company’s articles or Companies Ordinance.

Matters who Ultra vires the company

For the matters which involves the probability of any such conduct which ultra vires the company and is defined as:

Any act or conduct which may be considered unlawful on the part of the company such as unprecedented or illegal capital return to the shareholders, counted as the act which ultra vires the company. For any such act or conduct, members reserve the right to seek for the legal help on behalf of the company. Any action of the members which aims to restrain any unlawful conduct, such act of the member would be regarded as personal action rather than the act through derivative action. However, the act of the member would be called as Derivative action, if such act is supposed to bring remedy such as recovery of property or damages against the incurred loss and would ultimately benefit the company. For any such wrongdoing leading to the Derivative Action, the plaintiff is not supposed to bring evidence that the defendant controls the company, but if majority members are found to be opposed to such proceeding against the accuser, then court may strike out such action.

Matters related to the Fraud

Where there is the establishment of the fact that, accuser in the capacity of being the controller of the company has brought fraud on the company, then the member is entitled to initiate legal proceedings against the accuser. But where there is no such requisition for legal proceeding, then no legal proceeding could be initiated against wrongdoers as they reserve the right to prevent them from suing them, in capacity of being the controllers of the company.

It is said that the type of frauds which comes out of the jurisdiction entailed in the Foss case, such frauds would be called as “fraud on minority”. But as per the “Proper Plaintiff Principle”, company is the proper plaintiff for any mis-conduct, fraud or any wrongdoing hence it is mandatory to call such frauds as “fraud on company” rather than fraud on minority. For the case of fraud on minority, this terminology should be reserved for the cases where personal rights of the minority have been infringed.

For the case of Alexander, circumstances report of the situation where all the subscribers of the memorandum of “Automatic Telephone Company UK” were entitled to pay 6d per share on the subscription. Except the three out of five directors, denied paying further 2s 6d on each share and those three directors were found to be in possession of 75 % of company’s shares. The other two directors who voted in favour of such resolution, initiated an action against those three denying directors. Lindley MR communicated that:

“Directors whose act was meant for personal gain on the expense of the company and so its shareholders with prior notification or any sort of informing them, shall be considered as breach of duty hence they are not entitled to retain these benefits and thus must be held accountable in front of company for their such mis-conduct. Such act could only be ratified and thus not be considered as breach of their duties, if shareholders knew of this arrangement.”

It is noted that, individual shareholder cannot make director accountable or liable for the damages, if only accuse he or she carries was of “negligence” only. Such statement could be well elaborated by referring to the Pavlides case where minority shareholder sued the director of the company on the grounds that they had allegedly sold the asbestos mine to the associated company of the enterprise in Hong Kong holding company formation on the gross value which was quite less than its actual value. Justice Dankwerts said that: there is no clear evidence in determination of any fraud to the company on the part of the directors as it was under the conferred powers of the directors to sale mine and thus it does not amount to the ultra vires the company even if such sale was made to the associated company in Hong Kong holding company formation. For the argument that mine was sell at the under-rated value, then as per the defined mechanism in company’s articles, it was the company’s prerogative to decide the selling price of its assets through the consent of majority via resolution and hence for such cases, proceedings cannot be initiated against the directors by the company.

There is the exception in considering negligence as the fraud on the company, particularly for the cases where accuser or wrongdoer has gained personal benefit by breaching his or her duty, at company’s expense. Such situation can be best understood with reference to Daniels case, where three minority shareholders sued two directors of the company named Mr and Mrs Daniel on the account of selling company’s assets at the fraction of their true market value. Justice Templeman held this action to be legitimate and said that: for the situation where subjected person of negligence or any offence, is prone to the allegations that he or she has breached their duties owed to the company and through such breaches paved ways for their personal gain while depriving members, whether majority or minority, from their due rights upon company’s shares and profits and such circumstances not only harm the company and its directors but this harm of one party amount to the benefit of other that is director(s). Thus, minority shareholders reserve the legitimate privilege to sue the wrong doers, where their wrong doing or mis conduct results in personal gain for them and on the other hand harm or loss to the other side, members and company.

Legal Commentators says that: for the situation where company is to be put in liquidation or has been put to the liquidation, it would not be appropriate for the minority shareholders to proceed the action for “fraud on minority”. Rather it will now be the prerogative of the liquidator to take proceedings on the behalf of the company.