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Fair Dealing by Directors under Hong Kong’s New Companies Ordinance
1 May 2014

The new Companies Ordinance (Cap 622) (“CO”) which replaces the old Companies Ordinance in all areas (except the prospectus regime and the winding-up and insolvency provisions) came into force on 3 March 2014. Part 11 of the CO introduces modified and new provisions relating to fair dealing by directors which essentially tightens the making of loans, quasi-loans and the provision of guarantees and security for loans/quasi-loans made to directors.

Loans to Directors

The predecessor ordinance prohibited a company from entering into loans or similar transactions with its directors or persons connected with the directors unless certain exceptions apply. The CO preserves this prohibition and widens the coverage of persons affected by the prohibition by including a director’s cohabitee (whether of the same sex or of the opposite sex), adopted child, parent and family members. The prohibition also covers a body corporate associated with a director and a person acting as the trustee of any trust if the beneficiaries include the director, his spouse or any of his children.

Previously, a loan to director in private companies would be allowed if it has been approved by a members’ resolution. The exception allowing members by resolution to approve loans to directors remains and is now available not only to private companies but to all companies, including listed companies. The CO also introduces 2 new exceptions to the prohibition : (i) loans and credit transactions of value not exceeding 5% of net assets or called-up share capital of the company; and (ii) funds to meet expenditure, incurred or to be incurred by a director, in defending proceedings or in connection with an investigation or regulatory action for misconduct. In these 2 cases, loans to directors will be allowed but in the latter case, a director would have to repay the company if he is found guilty or to have committed the misconduct.

The CO removes the criminal sanction for breach of the provisions on prohibition of loans and similar transactions in favour of directors and replaced it with civil penalties. The rationale behind is the danger of over-deterrence if criminal sanctions are attached to general directors’ duties of loyalty rather than closely defined wrongdoing, and that enforcement of such duties should be a civil matter for companies. Pursuant to the CO, the prohibited transactions will be voidable at the company’s option unless (i) restitution is no longer possible; (ii) the company has been indemnified of loss suffered; or (iii) a third party (other than the director or persons connected with him) has acquired rights in good faith, for value, and without actual notice of the contravention, and those rights would be affected by the avoidance. Parties who benefited from the prohibited transactions may be liable to account to the company for any gain and indemnify the company for any loss or damage resulting from the transaction or arrangement.

Payments for Loss of Office

Under the predecessor ordinance, payments to directors or former directors of a company as compensations for loss of office or as consideration for retirement from office are prohibited unless disclosed to members and the company’s prior approval is obtained. In order to prevent the loophole of making payments indirectly via third parties, the CO extended the prohibition to include (i) payment to any entity connected with the director or former director; and (ii) payment to a person made at the direction of, or for the benefit of the director or an entity connected with the director.

Long-Term Service Contracts

The CO now requires the approval of members of a company for any contracts under which the guaranteed term of employment of a director with the company exceeds or may exceed 3 years. This prevents a director from arranging for himself long-term employment with the company which entrenches him in office or makes it too expensive for the company to remove him from office before his contract expires due to damages arising from early termination.

Declaration of Interest

The scope of interest which a director must declare to the company under the CO has also been widened. In addition to only “contracts” under the predecessor ordinance, directors are now required to disclose under Section 536 any “transaction” or “arrangement” which he has entered into or proposed to enter into with the company which is of significance to the company’s business.

Conclusion

Whilst the restriction on companies making loans, quasi-loans and the provisions of guarantee and security for loans/quasi-loans made to directors has been tightened but the new de minimis exception would allow companies to make loans or provide security of not exceeding 5% of the net assets or called-up share capital of the company to their directors even without members’ resolution.

If you have any queries regarding the above eNews or any other questions relating to the new Companies Ordinance, experienced lawyers in our Corporate and Commercial department would be happy to assist you.

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