The entirely new Companies Ordinance (Cap 622) (“New CO”) will come into force on 3 March 2014. In our November 2013 and January 2014 eNews, we highlighted the New CO’s major changes relating to registration of charges and private limited companies. In this eNews, we will review the important changes relating to directors’ duties of companies incorporated in Hong Kong.
Standard of Directors’ Duty of Care
The New CO sets out a new statutory standard by which directors must exercise reasonable care, skill and diligence in their work. It contains both objective and subjective elements. In carrying out their duties, a director must demonstrate :-
(1) the general knowledge, skill and experience that may be reasonably expected of a person who is carrying out the functions of the director in relation to the company (objective test); and
(2) the general knowledge, skill and experience that the director actually has (subjective test).
This statutory standard will replace the existing case law and equitable principles, except that the civil consequences for breach of duty of care under common law and equity are preserved. Any third party dealing with a company must be aware of whether the directors have exercised their powers for proper purposes. The consequence is that the third party cannot sue for breach if they knowingly assisted in the breach(es).
The new standard of care will also apply to shadow directors, meaning a person who is not officially a director of the company but gives instructions or directions to the existing directors.
The New CO does not address the fiduciary duties of directors which will still be governed by case law. Fiduciary duties include the obligation to exercise directors’ powers in good faith and in the company’s best interests.
Statutory Offences Apply to Responsible Person
Under the existing Companies Ordinance (Cap 32), there are various offences which officers of a company (typically company secretaries and directors) will face if they do not comply with certain administrative requirements, such as the filing of annual returns. However, an officer is only liable if he “knowingly and wilfully authorizes or permitted the default” and the burden of proving both knowledge and intent is high.
The New CO retains many of the existing offences but the threshold for liability will be lowered to where a responsible person “authorizes or permits, or participates in, the contravention or failure”. In effect, a responsible person may now become liable if he has actual knowledge, is wilfully blind or is reckless about the default.
The definition of a “responsible person” expands the reach of such offences to more than just company secretaries and directors of the company. It will also include shadow directors of the company as well as officers or shadow directors of a corporate officer of a company.
This part will apply equally to both Hong Kong and non-Hong Kong companies.
Declaration of Interest
The ambit of interest disclosure by directors will be widened. Under section 536 of the New CO, a director must disclose his interest in “transactions” or “arrangements” (as opposed to just “contracts”) which he has entered into or proposed to enter into with the company and which are significant to the company’s business. The director will also be required to disclose the “nature and extent” of his interest (as opposed to just the “nature”).
Shadow directors will be under the same obligations to disclose their interests.
Ratification of Conduct of Directors
Where the shareholders of a company ratify an act or omission of a director, the company is barred from bringing an action against the director for resulting damages. The New CO provides that conduct of directors amounting to negligence, default, breach of duty or breach of trust can be ratified, but only by disinterested shareholders. Where none of the shareholders are disinterested, ratification can be achieved by a unanimous approval of all shareholders.
Indemnification by the Company
To remove the common law uncertainty of whether directors can be indemnified by their company, the New CO now permits a company to indemnify a director against liability incurred by the director to a third party if certain specific conditions are met. The indemnity cannot cover criminal fines, penalties imposed by regulatory bodies, defence costs of criminal proceedings where the director is found guilty or where the civil proceedings were brought against the director by or on behalf of the company and where judgment is given against the director.
Where indemnity is given to the director, the company must disclose the indemnity provision in its directors’ report and make it available for shareholders’ inspection.
Companies with a Single Director-Shareholder
For companies with the same person acting as sole director and sole shareholder, the director-shareholder still owes the same fiduciary duties to the company and must still demonstrate the standard of care required by the New CO. He cannot use his position as the sole shareholder to ratify fraudulent acts committed in his capacity as the company’s sole director, especially where the interests of third-parties such as creditors are involved.
If you have any queries regarding the above eNews or any other questions relating to the New CO, experienced lawyers in our Corporate & Commercial department will be happy to assist you.