Hong Kong Breach Of Fiduciary Duties Of Company Directors: Unfair Prejudice Petition And Just And Equitable Winding-Up?

19 July, 2017

 

When a company director breaches his/her fiduciary duties to the company, primarily it is for the company itself to commence civil proceedings against the directors. The company can bring a claim against the wrongdoing director if it can demonstrate that it has suffered some losses. For example, if the director has obtained some personal profits, he/she can be required to account for the profits to the company. 

 

Unfair Prejudice 

 

While civil claims could be brought against the wrongdoing director by the company, the scope of remedies may not be as wide as those offered by the unfair prejudice petition, by virtue of sections 724 and 725 of the Companies Ordinance (Cap 622) (CO), which are available to a member/members of a company, namely the shareholder(s). 

 

Section 724(1)(a) of the CO allows a member/members of a company to present  a petition to the Court if the company’s affairs have been conducted in a manner unfairly prejudicial to the interests of the members generally or of one or more members, including the member(s) making the petition. 

 

Section 725(1)(a) further provides that the Court may make any order it thinks fit for giving relief under a petition presented under  section 724(1)(a). According to Section 725(2) and Section 726, the specific remedies which the Court may impose include:- 

 

• an order restraining the continuance of the conduct of the company’s affairs mentioned in the petition;
• an order that proceedings that the Court thinks fit be brought in the company’s name;
• an order appointing a receiver or manager;
• any other order the Court thinks fit, whether for regulating the conduct of the company’s affairs in future, for the purchase of shares of any member of the company by another member of the same company, for the purchase of shares of any member by the company and the reduction accordingly of the company’s capital, or for any other purpose;
• an order for the company or any other person to pay any damages that the court thinks fit to a member of the company whose interests have been unfairly prejudiced by the conduct of the company’s affairs or by the act or omission; and
• an order for alteration of a company’s articles. 

 

Not all breaches of fiduciary duties will suffice 

 

Whilst a petition under section 724 usually arises out of a complaint by minority shareholders against the majority shareholders who are in control of the company, given its wide wording, section 724 can be invoked in many other cases, as long as the company’s affairs were conducted in a manner unfairly prejudicial to the interests of one or more members, not necessarily the minority shareholders.  It is settled law that a breach of fiduciary duty can be a ground for invoking the unfair prejudice petition.

 

Common examples are the making of secret profits, diverting company opportunities, misappropriating company assets and exercising power for improper purposes. However, not all breaches of fiduciary duties will suffice; the member presenting the petition has to demonstrate that he/she has suffered some form of prejudice. 

 

An example is Rock (Nominees) Ltd v RCO Holdings plc (in liq.) & Ors [2003] EWHC 936 (Ch), which involved breach of fiduciary duty of the directors in relation to a sale of shares by a company. The petitioner commenced unfair prejudice proceedings against the directors, alleging that the directors of the subject company were also directors of the company which acquired the shares, and the sale of the shares of the subject company was at an undervalue, which unfairly prejudiced the interests of the petitioner.

 

The Court held that the directors were in breach of fiduciary duty since they were in a position of “hopeless conflict and they would have been well advised to obtain an independent valuation” in relation to the sale of shares. However, no actual harm was done, as the sale price was the best price available. Therefore, there was no damage or prejudice caused, nor was there any question of the directors being personally accountable in any way. As such, whether the breach of fiduciary duty is sufficient to invoke unfair prejudice proceedings must be assessed on a case by case basis.  

 

Prayer for just and equitable winding-up in the alternative? 

 

It used to be common practice to seek unfair prejudice relief first and a winding-up order on the just and equitable ground in the alternative under section 177(1)(f) of Companies (Winding Up and Miscellaneous Provisions) Ordinance. However, when pleading such alternative relief, the petitioner must think carefully whether it can be substantiated. The Court has repeatedly emphasized that it is undesirable to include as a matter of course a prayer for winding-up as an alternative to, for example, an order for a buyout under the unfair prejudice petition (Re Sun Light Elastic Ltd [2013] 5 HKLRD 1 and David Golan v Janek Davitashvili BSD (HK) Ltd [2017] HKCU 542). 

 

As Harris J mentioned in Re Sun Light Elastic, the petitioner must be able to point to the particular matters which might make a winding-up order the appropriate or the only practical relief. It is not enough simply to say “well one never knows what will transpire”. In that case, the petitioner sought a buyout order by way of unfair prejudice petition and in the alternative a winding-up order. However, the Court considered there was no explanation in the petition for the inclusion of a prayer for a winding-up order.

 

Also, there was no evidence showing that the respondent may not be able to buy out the petitioner’s shares if a buyout order was made. As a result, the Court struck out the prayer for a winding-up order. 

 

Conclusion 

 

To conclude, there are various remedies available in the case of breach of fiduciary duties of directors, including remedies under an unfair prejudice petition and/or a prayer for winding-up. It is therefore important to ascertain precisely what the aggrieved members wish to do beforehand in order to decide which options to pursue. Also, parties will have to be cautious not to include a prayer for winding-up as a matter of course as an alternative to an unfair prejudice petition. This is not only for the sake of saving unnecessary legal costs but also for minimising the risk of the prayer for winding-up being struck out.