Hong Kong's New Companies Ordinance On Directors' Liabilities

Background

The new Hong Kong Companies’ Ordinance came into force on 3 March 2014 and is a major rewrite of Hong Kong's company law. It follows five rounds of public consultations over several years and is aimed at maintaining Hong Kong's position as an international finance centre. Several of the leading jurisdictions have done similar exercises – Hong Kong's new law is similar to the English Companies Act 2006 which fully came into force in late 2009 but (as is often the case in Hong Kong) there are some important differences.

 

This article looks at the new rules on corporate directors and natural directors; directors’ personal data; directors’ duties; the ratification of acts of directors; indemnities; and liabilities of “responsible persons”. It further considers the potential litigious areas which may arise out of the new rules.

 

The new law

The main change is the requirement to have at least one natural director of a private company whereas, previously, a private company could have a sole corporate director unless it was part of a group with a listed company in the group.

 

This will bring to an end the very common practice for Hong Kong companies, particularly trading companies, to have nominee directors and shareholders. The change would have happened anyway, as a result of the tax reforms taking place worldwide and requirements for substance – "postbox" companies are already ineffective for tax purposes. It should be said that some companies use nominee directors not for tax avoidance purposes, but for reasons of confidentiality, or to avoid personal liability falling on the nominee director. However, this will end.

 

The change only affects private companies, since the new ordinance maintains the previous restrictions on directorships (no corporate directors are allowed for public companies, companies limited by guarantee and private companies which are members of a group which includes a listed company). Public companies and companies limited by guarantee must continue to have at least two directors. Private companies can still have only one director and until the new law it could have been a corporate director. Directors do not need to be resident in or nationals of Hong Kong.

 

 

Actions to take

Private companies need to:

 

  • identify any subsidiaries which have corporate directors and find individual(s) to replace them; and
  • put in place Directors' and Officers' Insurance and consider indemnities if appropriate.

 

There is a grace period of six months to make the necessary changes to directorships, until 3 September 2014.

 

Potential disputes

It is clear that a heavier burden is now placed on natural directors. Perhaps there will be an increase in situations whereby beneficial owners appoint what are essentially nominee natural directors instead of corporate directors. We see a potential increase in litigation arising from such situations, especially where beneficial owners wish to remain anonymous and run businesses in the background and there is friction between the natural director and beneficial owner who appointed the director. There are known cases whereby beneficial owners engaged in criminal activities have appointed natural directors to front the business. The new laws are therefore likely to increase such situations in the future. We have already been made aware of various companies offering a personal director service, and we anticipate the need for these services to increase.

 

Directors’ personal data

In conjunction with the requirement to have at least one individual as a director, section 49 allows the withholding of the residential address and passport or Hong Kong Identity card number from the register. This will be kept in a confidential part of the register, access being restricted to members of the company, public officers, public bodies, liquidators and other specified persons. Directors will be able to provide a correspondence address as well as their residential address. The Companies (Residential Addresses and Identification Numbers) Regulation will include types of persons for whom disclosure may be made upon application. The New Ordinance will also allow creditors of the company and other persons having a sufficient interest to apply to the court for disclosure.

 

Confidentiality concerns

This provision is very similar to that in the English Companies Act. One of the concerns in England when this provision was granted, was radical action by groups who had access to the director's home address, (the notable example being attacks on the homes of directors of a medical research company carrying out vivisection.) So far, such physical risks have not materialised in Hong Kong but this did not prevent a campaign to radically alter the new law to obscure company directors' residential addresses and full identification numbers. The proposal was rebuffed by trade unions and small businesses who have used the database to track down runaway employers who owed wages and to carry out background checks on trading partners. The new law creates a confidential part of the register, however one can see that certain people (such as shareholders) will probably be able to obtain the details from the confidential part of the register so it will not take a lot of effort, especially with quoted companies, to obtain this information.

 

Directors’ duties

The new law now codifies various directors’ duties (http://www.cr.gov.hk/en/publications/docs/ec3-2014-e.pdf). Until now there have been no statutory rules in Hong Kong describing directors’ duties. In other comparable jurisdictions such as England, the law has already moved away from the "subjective" test (based only on the knowledge and experience which the particular director possesses), which is considered too lenient, towards a mixed standard of the "objective test" and a "subjective test" in deciding the standard of care expected of directors. This means: the standard of care which would be exercised by a reasonably diligent person with a) the general knowledge, skill and experience that may reasonably be expected of a person carrying out the director's functions; and b) the general knowledge, skill and experience which the particular director has.

 

The new law did not follow the English legislation in providing statutory codification of directors’ fiduciary duties – these will remain subject to the common law rules in Hong Kong so there is no change. (Fiduciary duties are for example the duty to act in good faith in the best interests of the company, to avoid conflicts of interest, and not to make any personal profit out of their directorship. (There are others, summarised by the English Act lists seven statutory duties).

 

Ratification by shareholders of directors’ acts

Under the old law there was no statutory rule and it was open to the members in general meeting to ratify directors' acts and release them from their fiduciary duties. Now there is a new section (473) which allows disinterested members to ratify, by passing an ordinary resolution, any act which would amount to negligence, a default, a breach of duty or a breach of trust – and if there are no disinterested members, the resolution must be unanimous. This provision is not a major reform but certainly clarifies on this area of law.

 

Indemnities

The new law (section 469) clarifies the common law rules on granting a director an indemnity against liability incurred by the director.  Specified conditions are included – the indemnity cannot cover certain liabilities and costs, such as criminal fines, penalties imposed by regulatory bodies, the defence costs of criminal proceedings or civil proceedings brought against the director where he is found guilty or where judgment is given against him. To enhance transparency, a company which provides a permitted indemnity to its directors of the company or of its associated companies must disclose the indemnity in its directors’ report and make it available for inspection by any shareholder on request.

 

Conclusion

The laws clearly place a heavier burden on natural directors and there will be much wider scope for directors to become embroiled in disputes. We anticipate that Directors’ and Officers’ liability insurance will also be in greater demand as a result of the new laws.

 

Geoffrey Lung of MI Insurance Brokers, an experienced insurance broker, commented as follows:

 

The new amended law will certainly increase the demand for D & O insurance in the private company sector. In the coming year, the tendency of claims and allegations are expected to increase due to the fact that the amended law will make claims easier to establish and potentially trigger policy coverage. Policies do usually indemnify defence costs and these can sometimes be very costly.

 

In terms of coverage in response to the amended law, most underwriters have improved their policy coverage in recent years and this tendency is still going on. If the claims experience turns out to be bad in the coming few years due to the amended law, rates will certainly increase but this also highly dependent on the capacity of the insurance market in this class of insurance. The present situation is that the D & O market in HK is still very soft. It will be interesting to see how the market reacts to the amended law.