In the recent Hong Kong case of Passport Special Opportunities Master Fund, LP v eSun Holdings Ltd [2011] 4 HKC 62, the court examined the law of improper purpose in relation to fiduciary obligations on directors, when deciding whether or not, and in what manner, to embark on an issue of new shares. The judgment demonstrates the court’s reluctance to draw the conclusion of serious misconduct or impropriety except in the case of commensurately cogent evidence (whether direct or circumstantial) even though the test to be used for any finding of misconduct or impropriety should be on a balance of probabilities.
Background
eSun Holdings Limited (“eSun”), a Hong Kong listed company, entered into a placing agreement with Chung Nam Securities Limited (“Chung Nam”) on 10 December 2008 (“Placing Agreement”) under which eSun agreed to issue 120,000,000 new shares to placees to be identified by Chung Nam at par value and each placee would receive one non-listed warrant for every placing share taken up, entitling him to subscribe for one further new share in eSun at par value.
A representative of the major shareholders of eSun, Passport Special Opportunities Master Fund, LP and Passport Global Master Fund SPC Limited (collectively called “Passport”) commenced legal proceedings against eSun and its four executive directors and obtained an ex parte injunction to restrain eSun from proceeding with the placement. eSun applied to discharge the injunction but failed and the long-stop date of the Placing Agreement was then extended. Passport presented a petition under section 168A of the Companies Ordinance Cap.32 against eSun and its executive directors, seeking injunctive and declaratory relief to prevent the proposed placement from being completed and to declare it invalid. eSun terminated the Placing Agreement on 9 January 2009. Chung Nam and the placees who agreed to subscribe for the placing shares joined the proceedings as interveners.
Issues
Passport’s primary case was that the directors approved the placement with a predominant but improper purpose of protecting the controlling interest of its executive director Mr Lam Kin Ngok Peter (“Mr Lam”) in eSun by diluting Passport’s shareholding. Therefore, the Placing Agreement was not entered into in what the directors in good faith considered to be the best interests of eSun.
Passport’s alternative case was that even if the Placing Agreement was entered into in what the directors considered in good faith to be the best interests of eSun, the directors failed to have proper regard to the dilutive effect of the placement on eSun¡¦s shareholders generally and other possible ways of raising funds that could have avoided such dilutive effects. Therefore, the directors’ decision was void and of no effect as such decision was made in breach of their fiduciary duty and unlawful.
Reasons of Decision
In considering Passport’s primary case, the court held that the purpose or primary purpose for which the directors acted in deciding to enter into the Placing Agreement should be considered and the directors’ subjective intentions and perceptions were determinative in deciding this question. Objective considerations of matters such as eSun’s true financial position, the reality of its need for funds, and the effects of the allotment of new shares upon the shareholders were relevant only in that they may be taken into account when assessing the credibility of the directors’ evidence as to their professed purposes.
The decision as to whether or not the directors acted with a predominant improper purpose in mind was one that was to be reached on a balance of probabilities and in coming to such a decision the court would bear in mind the inherent improbability of allegations of serious misconduct or impropriety and would require commensurately cogent evidence before concluding that the allegations were made out.
The court after taking the evidence as a whole decided that an inference that the placement was motivated primarily by an improper purpose of seeking to protect Mr Lam’s control over eSun should not be drawn on the balance of probabilities.
As to Passport’s alternative case, the court determined that there was a fiduciary obligation imposed upon directors, when deciding whether or not, and in what manner, to embark on an issue of new shares, to have regard to the interests of shareholders, and to exercise the power (if it was decided to do so) in a way that was fair as between different group of shareholders. The court was not satisfied that there was any, or any sufficient, material placed before the board of eSun to enable them to make any meaningful assessment of the financial impact of the placement upon eSun or its shareholders. Therefore, the directors in this case fell short of their obligations and their decision in relation to the placement was susceptible to being challenged.
The consequence of such a holding was that the placement was voidable and not void, but in this case the placement should not be avoided or set aside as the rights of the placees who were third party purchasers without notice of impropriety of the Company’s decision should not be affected.
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