15 May, 2016
In Yifung Developments Limited v Ricky Liu Chi Keung & others (HCA 1341/2014), the Court of First Instance held that where a company fails to comply with relevant provisions in its articles of association regarding the commencement of litigation, the courts have inherent jurisdiction to strike out such a claim. Interestingly, Hon Au Yeung J also made comments on two related issues that may widen the scope for a defendant to pursue a strike-out application for want of a plaintiff's authority. First, the judgment highlighted that compliance with the articles of association was relevant beyond cases between company and shareholders, suggesting that any third party defendant may raise issue with the authority of a company to pursue litigation. Second, applying the well-established legal principles on contractual construction and implied terms to articles of association, Hon Au Yeung J was clear that the courts will not lightly imply terms into articles of association to correct a purported drafting error.
Facts
The Plaintiff, a BVI company, sought injunctions against the Defendants, its ex-directors, to restrain them from holding themselves out as directors and require the delivery of certain records and assets. In 2010, the shareholders of the Plaintiff pledged their shares in the Plaintiff to a third party ("MSC") as security for a loan. The loan defaulted and MSC enforced its security by resigning the Defendants as directors of the Plaintiff and appointing two other individuals as receivers (the "Receivers"). However, MSC did not enforce the share pledge, so the shareholders of the Plaintiff remained unchanged. In 2014, the Receivers purported to commence proceedings against the Defendants in the name of the Plaintiff, in mainland China and also in Hong Kong.
The First Defendant subsequently applied to strike out the Hong Kong claim on the ground of want of authority. This application alleged that the writ of summons was in contravention of the Plaintiff's articles of association, and that subsequent purported ratifications were also not in accordance with the articles. Four main issues were brought before the Court:
- Does the First Defendant have locus to raise the issue of authority?
- Can an implied term or the principles of construction be used to aid the interpretation of the articles of association?
- Can the commencement of litigation in breach of the articles of association be subsequently ratified?
- Was the authority summons an abuse of process?
Findings
The Court found in favour of the Plaintiff on the basis that, as a question of BVI law, the Plaintiff had successfully ratified the commencement of the legal action. However, the analysis of Hon Au-Yeung J in respect of the other issues raises important principles in terms of (i) who can challenge the authority of a Plaintiff; and (ii) the application of contractual interpretation principles to articles of association.
Who can challenge the authority of a Plaintiff?
In respect of the first issue concerning the locus of the First Defendant, the Court found that, despite not being a shareholder, the First Defendant had standing to raise the issue. Hon Au-Yeung J explained that the consequence of an action being carried out without proper authorisation in accordance with the articles of association is that the transaction is void, not merely voidable. If there is a want of authority in issuing a writ then it follows that the issue of the writ is equally void. On this basis, "it is thus open to a third party to challenge the lack of authority of the company to issue the writ".
In connection with the first issue, it is also of note that the fourth issue before the Court, namely the question of whether the summons was an abuse of process, was found in the negative. The Court was satisfied that the First Defendant was entitled to raise the question and that the complexities of the issues justified the bringing of the issue to a hearing.
Interpretation of articles of association and implied terms
In addition to the civil procedure points explored above, the Court also provided a useful outline of the legal principles to be applied in interpreting articles of association. Hon Au-Yeung J explained (following the approach of Lord Neuberger in Marks and Spencer plc v BNP Paribas Securities Services Trust Company (Jersey) Limited and another [2015] UKSC 72 ("Marks and Spencer") summarised here) that a two-step process should be followed in interpreting articles of association, where there is debate around the meaning:
- What would the relevant provision of the articles of association convey to a reasonable person with all the background knowledge?
- Following the above question, should a term be implied into the articles of association?
In respect of the second question, the judgment notably suggests that articles of association cannot be supplemented by implied terms. In spite of this, Hon Au-Yeung J went on to apply the 5 requirements test (outlined in Kensland Realty Ltd v Whale View Investment Ltd & anor (2001) 4 HKCFAR 381 ("Kensland")) for assessing whether a term should be implied into a contract. In doing so, it would appear that Hon Au-Yeung J does not completely discount the idea that a term may be implied into articles of association. Nevertheless, it is clear from her analysis that the courts will take a very restrictive approach when asked to do so.
Implications
The case is significant in two respects. Firstly, the Court's findings in respect of who can challenge the authority of a corporate plaintiff supports the idea that any third party, not just a shareholder of the plaintiff, may raise issue with a plaintiff's authority. Whilst it may be open to a company to ratify litigation started in breach of a plaintiff's articles of association, the best practice is to check for compliance with the articles of association before commencing any claim.
The consequences for failure to prove authority of strike out and the wide findings of the present case as to who may challenge authority will likely increase the scrutiny relating to the corporate authority behind claims.
Secondly, the Court's application of Kensland Realty and Marks & Spencer to articles of association confirms that the well-established principles of contractual interpretation have equal application to company constitutional documents.
Moreover, the Court's unwillingness to imply a term into the articles of association of the Plaintiff in the present case
should also be noted. Parties claiming drafting errors in articles of association should therefore be aware, following on from Lord Neuberger's comments in Marks & Spencer, that the courts will only very reluctantly imply terms to correct such errors.
For further information, please contact:
Gareth Thomas, Partner, Herbert Smith Freehills
gareth.thomas@hsf.com
