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Obligations on financial intermediaries to give effect to share lock-ups: placing agents v. custodians

5 Apr 2024  |  Authors: Clifford Smith, SC, Kerby Lau, Joshua Yeung

Introduction and Background

Introduction and Background

Rich Place Investment Limited & Wise Win Enterprises Limited v. Oriental Patron Securities Limited & Ors. [2024] HKCFI 576 is a recent judgment in the securities brokerage context that sheds new light on (i) the scope of duties imposed on introductory or canvassing agents such as placing agents; (ii) the legal principles governing implied terms; and (iii) the requirements of the tort of inducing breach of contract.

The Plaintiffs in the case had previously placed certain shares in Railsmedia Corporation Ltd (“Railsmedia Shares”) with a number of placees (“Placees”) who were procured by the 1st Defendant as placing agent of the Plaintiffs (“Placed Shares”). The Placed Shares were to be issued and kept by the Placees in their accounts held with the 1st Defendant. The agreement between the Plantiffs and the Placees contained a lockup arrangement that subjected the sale of the Placed Shares to certain conditions (“Lockup”). Subsequently, after the share price of the Placed Shares began to drop, the Placees sold the Placed Shares in breach of the Lockup. The Plaintiffs alleged that this unauthorized disposal of the Placed Shares caused the share price of the Railsmedia Shares to fall drastically. The Plaintiffs, which held a substantial number of Railsmedia Shares, therefore suffered loss and damage.

The Plaintiffs therefore brought the present claim against the 1st Defendant for their losses. The Plaintiffs alleged that the 1st Defendant (i) had breached an oral agreement that the 1st Defendant would ensure the custody of the Placed Shares after they were placed (“Collateral Agreement”); (ii) had acted in breach of its implied contractual duties and/or fiduciary duties to enforce the Lockup; and (iii) was liable for the tort of inducing breach of contract.

The Decision

The Court in its Judgment found in favour of the 1st Defendant and dismissed the Plaintiffs’ claims.

As a matter of fact, the Court held that the alleged Collateral Agreement was wholly incredible and not supported by contemporaneous evidence. The Plaintiffs had failed to prove the existence of the Collateral Agreement on the balance of probabilities.

As to the alleged breach of implied and/or fiduciary duties, the Court held that as a matter of law, a placing agent is in general not liable for the defaults of the parties it introduced, even if the placing agent was also the custodian of the placed shares. Further, the Court emphasized that the Plaintiffs had failed to meet the threshold for implying terms. The agreement between the Plaintiffs and the 1st Defendant (“Placing Agreement”) did not impose any duty on the 1st Defendant to ensure the compliance of the Lockup. This was squarely placed on the Placees alone. There was also no suggestion that the 1st Defendant would be renumerated for such additional duties. Importantly, the Court emphasized that in determining necessity for implying a term, the Court cannot look at necessity from the perspective of one party alone. The imposition of duties regarding the Lockup could not have been necessary from the point of view of the 1st Defendant. The Court therefore rejected the Plaintiffs’ claims based on implied terms and breach of fiduciary duties.

As for the claim in tort of inducing breach of contract, the Court held that this was not made out as (i) the conduct of the 1st Defendant did not “operate on the will” of the Placees, who had decided to sell the Placed Shares because of the fall in share price and had already given instructions to the 1st Defendant to sell the Placed Shares before the 1st Defendant had “procured” the breach of contract in carrying out such instructions; (ii) the 1st Defendant did not have the requisite intention for the tort of inducing breach of contract, which required the breach of contract to be an end in itself or a means to an end that was desired by the 1st Defendant. As the 1st Defendant did not desire that the Placees breach their contract, the requisite intention was not established; and (iii) the tortious act had not caused any loss to the Plaintiffs. There was no causation between the conduct of the Placees in selling the Placed Shares and the drop in share price. Further, the Plaintiffs could not claim for negotiating damages, which required a proprietary interest that the Plaintiffs did not have in the Placed Shares. The Plaintiffs’ claims were wholly rejected for the above reasons.

Key Takeaways

Rich Place Investment Limited provides useful insight for practitioners and industry professionals, especially in the securities and brokerage sectors. It helpfully clarifies the scope of duties to be generally imposed on brokerage and securities firm, who often wears two hats: as the middle-man responsible for bringing parties together (i.e an introductory agent), and also custodian of shares which are traded pursuant to the parties’ dealings. The case also highlights the high threshold required to imply a term, and why parties should expressly spell out all the legal consequences of their agreement whenever possible. Finally, the decision also provides useful clarification on the tort of inducing breach of contract, in particular on how the “operate on the will” requirement is applied as a matter of practice.

Mr Clifford Smith SC, Mr Kerby Lau and Mr Joshua Yeung, instructed by M/s Michael Li & Co, for the 1st Defendant. Full judgment is available here.