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Shareholders in Hong Kong


Jan 08, 2014

Introduction

The decision by a company to bring a legal action is usually in the hands of those persons controlling the company. However, a derivative action - originally developed by the courts and now expanded under the Companies Ordinance - allows minority shareholders to force the company to take action against the will of the majority in certain cases where it can be shown that the interests of the shareholders of the company as a whole have been disregarded.
 
A recent Hong Kong decision in the Court of First Instance in World One Investments Ltd v Chow Cheuk Lap [2013] 3 HKLRD 701 acts as an illustration of the use of derivative action in a share placement context.


 

The Facts

The Plaintiff (“P”) was a company and a 16% shareholder of a listed company C. X1 and X2 were two related companies holding around 16% of C’s shares. About 55% of C’s shares were owned by the public. The first to the sixth defendants (“D1-D6”) and three others, including the owner of P, formed the board of directors of C.
P claimed that D1-D6 were closely associated with X1 and X2 so in essence D1-D6, X1 and X2 enjoyed control of C’s board. A board resolution was passed to issue 200 million new shares in C (approximately 10.65% of the existing issued share capital) to independent investors (the “Share Placement”). P brought a derivative action on C’s behalf seeking an interlocutory injunction to restrain the Share Placement. P alleged that D1-D6 failed to exercise reasonable care in approving the Share Placement with ulterior motive of having the shares acquired by their associates to increase their own voting power as shareholders.


 

The Burden of Proof

Since the interlocutory relief claimed would in effect give P final relief so P is required to satisfy a higher burden, the Court said that the P should demonstrate that their case is “at least likely to succeed” or has “overwhelming balance on the merits”.
On facts, the Court was of the view that P failed to establish ulterior motive and any failure to exercise reasonable care by D1-D6 as directors.

Interestingly, Anthony Chan J in particular noted that “the alleged ulterior motive…very difficult to understand in the context of a public company. Anyone who wants to have more shares in C to enhance his voting right can buy from the market. By the same token, P can easily counteract the increase in shareholding…by acquiring more shares from the market.

In other words, it may be very difficult to prove the existence of an ulterior motive where a listed company uses a share placement scheme to increase general voting power.


 

Derivative Action

Under the common law, a plaintiff who seeks to bring a derivative action must establish a prima facie case that the company is entitled to the relief claimed and that the action falls within an applicable exception to what is known as the rule in Foss v Harbottle (namely that the majority shareholders should be able to bind a company) where there is a fraud on the minority.

The Court also explained that in addition to fraud on minority, a plaintiff has to plead and show that the wrongdoers are themselves in control of the company such as to enable them to stifle any proposed action against themselves.

Counsel for D1-D6 argued that “control by the wrongdoer” must embrace control of the majority shareholding as well as the board of directors, on the basis that without the former, the control of the board could be changed. The Court disagreed stating that, for example, in the case of a public company, it is possible to control the outcome of a shareholder’s meeting without controlling the majority shareholding because of lack of attendance by some of the shareholders.

The Court did not agree that there was any fraud on the minority here, on the basis that the substance of P’s case was of negligence on the part of D1-D6. There was no evidence which suggested that the defendants has profited from the alleged negligent act particularly that C was in need of funds to continue its business operations. The Court accordingly dismissed the application as there was not sufficient evidence to suggest that a derivative action was appropriate in the circumstances.

 

Publication Date: 8th January 2014

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