Validation of Improperly Issued Shares and an Introduction to the Transfer of Shares for a Hong Kong Open Company

There can be the situations where after Hong Kong incorporation of company shares could have been issued improperly, but as shares are the most important and fundamental part of company’s capital, there is the need to validate shares that were issued improperly so that due to any invalidity, company may not suffer.

As per Section 146 of Cap. 622 court has the power to validate any share that were issued in contravention to the provisions of Companies Ordinance, articles of association of the company or violation of any regulatory doctrine after Hong Kong incorporation of company. In addition to this, court also has the power to confirm any such terms of allotment which are found to be inconsistent with any legislative provision. To avail such validation, company itself, creditor of the company, shareholder of the subjected shares or mortgagee of the share could seek the help of the court. Court would then look into the prospects of the case and if it finds that it would be just and equitable to validate the improperly shares, then court would for sure issue an order where improperly issued shares would be validated and from then it shall be considered proper and legitimate.

If we see the script of the provisions, then one would notice that these provisions are derived from the similar Australian provisions. In order to decide that whether it would be legitimate to validate the shares or not, Australian court examines:

  • Whether the shareholder relied upon the purported shares or not?
  • What are the associated interests of the innocent parties with subjected shares?
  • If shares are validated then would it cause prejudice to any one or not?
  • What shall be the business and legal complications if shares are not validated?
  • Would there be any blatant disregard towards the obligations under Companies Ordinance?

In addition to this, public interest is the most relevant one. Hence, any improperly issued shares which are found to be abiding by the tax avoiding schemes, shall not be validated.

Introduction to the Transfer of Shares

Basically, after opening a business in Hong Kong division of company’s capital into the shares is done for three primary purposes namely; to measure the liability to contribute to the assets of the company, to determine the extent to which shareholder may participate in profit sharing of the company and to determine the measure upon which credential of the shareholders to transfer and the value of his/her shares is ascertained. Therefore, transferring of shares is a corporate reality after opening a business in Hong Kong must not be confuse with the issue of shares. Because issuance of shares is entirely a different process, as in the process of share issuance, company validates and ascertains the credentials of the person wanted to become the member of the company while on contrary transfer of shares is done through a mechanism where existing shareholder of the company dispose off his/her ownership on his/her shares in favour of the one to whom shares are being transferred. Shareholders are thus allowed to transfer their shares to the transferee, provided articles of association of the company does not impose any restriction on transfer of shares. As shares consist of bundle of associated rights but each right is not the separate one. Therefore, transferring of share would transfer whole of associated rights and it is not possible for the transferor to transfer part of rights such as the right to receive dividends only, to the transferee.

After create company HK, member of the company holds the right and power to transfer his/her possessed shares to anyone of his/her choice, but directors can invoke restriction to the transfer of shares in certain conditions, subjected to the compliance with the statutory requirements. This power is conferred to the directors on account of being the executives of the company and being responsible for the daily affairs of the company. But this restriction is subjected to the availability of any such clause in the articles of the company and wherever such provision exists then there should be ensured that director do so for the good reason and in the best interest of the company. Wherever directors think that subjected transfer of shares is fraudulent or fictious, then these would be good grounds to invoke restriction on the transfer process. However, one must not forget that with the perspective of the company, shares are the sort of partnerships in which member can retire anytime he/she wants to and upon retirement they shall be free from any liability or responsibility which was imposed on them for being the member of the company.

However, this argument is considered to be a major turning point in the judicial history and reverses the judgement of Lord Romilly MR. Lord Romilly MR thinks that director’s power to invoke restriction on the transfer of shares after create company Hong Kong should be more traditional as possibility exist that transferor may have been transferring the shares so as to escape the applicable liability specially the one where company would make a call to him/her to pay more out of his/her unpaid due, in the case where shares are partly paid. What Lord Romilly MR wrote in his judgement also puts the fine argument, his lordship said that:

It is quite obvious that if directors to put restriction on the transfer of shares then such restrictions would be put on the account of the aspirations of most of the shareholder rather than for the company. If this is not stopped then probability exist that there would be large number of people at the time of receiving dividends but when company makes the call to pay the due amount, they would consider that such escape occured because transferor was liable for such payments and not the transferee. Hence, I am of the opinion where shareholders can legitimately say that how can the person who enjoys perks of dividends but when it comes to pay the due amount in relation to the shares he/she possessed, he/she escapes the liability by getting it transferred to any other person.

It must be noted that legal title of shareholder shall not be transferred to the transferee until and unless transferee is not registered as the member of the company in company’s register of member(s). Henceforth, it can be said that transferee shall be called the member of the company upon registration of him/her in company member’s register.

While situation is different for bearer shares where transfer of legal title of company’s shareholder is transferred to the transferor upon the delivery of share warrant because share warrant is a negotiable document.

Let’s refer to the judicial case so that situation can be clearer. Smith and Fawcett Limited was formed in the year 1937 to take over the partnership. But upon the death of one of two owners of the company, son of the one who died, requested as the executor to register him as the member of the company in place of his father, but his request was refused. Now you may be thinking that situation seems to be quite obvious that if father dies then son automatically inherits the property or assets of the father as per the principles of Inheritance Laws. May be this is what solicitors of the son suggested to him and thus this matter was then taken to the court where Lord Greene MR communicated that:

Directors should exercise their power to refuse the request of transfer in the bona fide interest of the company and not on account of what court may consider and thus such exercise should never be for any collateral purpose. Private companies although enjoys status of separate entity as much as public companies enjoys. But from the commercial and personal perspective, private companies are more analogous to partnerships than public companies. Therefore, constitution of the company must define the role and powers of the directors, very strictly.

There is a very clear-cut guiding principle laid down in above mentioned judgement that; if refusal is to be made then it should be made within reasonable time. Refusal must be accompanied with the communication to the transferor about refusal of his/her shares to the transferee. If directors fail to exercise their power within the stipulated statutory time frame, then director would be considered to losing the right to refuse the transfer. If refusal is to be brought up in compliance with some harsh clause of the legislation, then exercise of such harsh clause should be done in due time otherwise there shall no argument be entertained in favour of exercise of refusing power, by the directors of the company.

Once transfer of shares has been refused, then matter would considered to be of personal capacity between the transferor and the transferee. However, transferor can enjoy sort of immunity in this condition if he/she promised to secure the registration. then upon refusal of transfer by the directors of the company, would not impose liability on the transferor except the one where transferor would now be the trustee of the transferee and from now on, transferor would now be the nominee shareholder of the transferee. But for the situation where transferee already owns the shares, then upon the refusal of transfer to his/her name in future would let transferee be in the position where he/she could argue that; mutual trust between the owners has been broken so now it would be legitimate to wind up the company on just and equitable grounds.

Transfer of Share as the Assignment or Novation

The general concept of share transfer communicates the setting where shares are assigned to the new shareholder by the existing shareholder of the company. But matter is not as simple as it seems and that is why legal commentators communicate that, transfer of shares is basically the novation rather than the assignment. Novation basically refers to the agreement involving three parties i.e. company, transferor and the transferee. Under this novation, company’s agreement with the transferor will be terminated and this agreement will be replaced by the new agreement between the company and the transferee upon registration. It must be noted that this replacement contract would not include any fresh terms and conditions, hence this agreement would be transacted on the same terms as included in the terminated agreement. Through this agreement, transferee would now be eligible to enjoy the same rights and powers as had been possessed by the transferor, in the capacity of the company’s shareholder. There is a little debate going on this technical matter but prima facie it seems legitimate to call this transfer, a novation rather than assignment. However, this argument seems to be valid where there is the situation of conflict of law, therefore in such situations this distinction can be argued.

It must be noted that as per the provisions of Cap. 622 transfer document shall not be considered valid and legitimate until and unless it is in proper form and properly stamped. The reason for such legitimacy and validity is quite obvious because corporate sector can easily be prone to the irregularities and discrepancies. Hence, to negate any such probability, requirement for the transfer document to be properly stamped and being in the proper form, was enacted.