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Shareholders’ Claim for Damages – Part 1, Jurisdictional limits under ss.728-730 of the Companies Ordinance

18 Aug 2020

In its recent landmark decision Ge Qingfu & Ors v L&A International Holdings Ltd & Ors [2020] HKCA 687 (11 August 2020), the Court of Appeal has clarified the scope and application of sections 728-730 of the Companies Ordinance (Cap. 622) (the “CO”). This decision is of importance in at least two aspects: (1) it has clarified the boundaries between the various remedies available to shareholders under Part 14 of the CO; and (2) it demonstrates the court’s approach in interpreting the new provisions in the CO which are worded differently from their antecedent provisions in the predecessor Companies Ordinance (Cap. 32) (the “Old CO”).

In this case, the Plaintiffs (who were shareholders of L&A International Holdings Ltd) relied on sections 728-729 of the CO to claim damages against the company’s directors (i.e. the Defendants), on the grounds that they had breached their fiduciary duties by causing the Company to grant share options and allot shares for improper purposes.

The wording of sections 728-729 on its face appears to be very wide. Section 728(1)(a) states that section 729 applies if a person “has engaged, is engaging or is proposing to engage in conduct that constituted, constitutes or would constitute” certain conduct, which includes, inter alia, “a breach of the person’s fiduciary or other duties as a director of the company owed to the company” (section 728(4))Section 729(1) provides that “The Court may, on application by a member or creditor of the company whose interests have been, are or would be affected by the conduct or by the refusal or failure, do any or all of the following – (a) grant an injunction… (b) order the person to pay damages to any other person; (c) declare any contract to be void or voidable to the extent specified in the order” (emphasis added). The Plaintiffs relied on such apparently wide wording and contended that the Court could order the Defendants to pay damages to them directly under these provisions.

Such a wide construction of sections 728-729 is problematic as a matter of legal principle. Firstly, under such a construction, section 729 (“New CO s.729”) would have a much wider scope than its predecessor, section 350B of the Old CO (“Old CO s.350B”), which provided that the court may grant an injunction to restrain wrongful conduct and may, “either in addition to or in substitution for the grant of the injunction”, order damages. Old CO s.350B had created only a limited statutory exception to the rule in Foss v Harbottle, giving locus to a shareholder/creditor to seek only injunctive relief or damages in lieu in respect of breaches of the CO or the law in respect of a company’s affairs. Its purpose being to facilitate the prevention of wrongdoing, Old CO s.350B did not allow a shareholder/creditor to, irrespective of whether there is any basis for injunctive relief, advance any free-standing damages claim for personal loss caused by any wrongful conduct / breach of duty owed by directors to the company.

Secondly, if New CO s.729 were to be construed as allowing shareholders and creditors to bring free-standing damages claims against directors for breach of duties (even though the duties are owed to the company), New CO s.729 would have the effect of recognising a duty owed in parallel by directors to shareholders and creditors generally. This is contrary to the well-established principle that directors do not, by virtue of office, owe duties to members/creditors.

Thirdly, such a wide application of New CO s.729 would result in incoherence/discordance within the New CO. If New CO s.729(1)(b) authorises the Court to award damages to “any other person” including the Company, then in principle an applicant may bring a derivative claim under New CO s.729(1)(b) for damages to be paid to the Company, without going through any of the requirements to obtain leave for a statutory derivative action. If such an approach were correct, there would be no incentive for members to seek leave from the Court to commence a statutory derivative action. They could simply proceed under New CO s.729. This would render the provisions on statutory derivative action entirely nugatory.

In light of the above, the consequence of such a wide construction of New CO s.729 is to introduce a fundamental sea change and drastic disruption to established company law principles. However, the legislative materials (including the consultation papers and the Bills Committee paper) in relation to sections 728-730 do not in any way indicate any major policy objectives or major changes from Old CO s.350B. Rather, the relevant provisions in the Bill were presented as representing “existing law” with improvements made to the drafting language and style.

The Defendants highlighted the above to the judge in the court below and argued that New CO s.729 should be interpreted in a manner similar to the Old CO s.350B and the equivalent Australian provision. In the present case, since the relevant shares were sold in the open market by the time the Plaintiffs commenced the proceedings, there was no basis for the Plaintiffs to have obtained any injunctive relief and therefore no damages should be awarded under the section.

However, the judge considered that as New CO s.729 is worded differently from Old CO s.350B “the change of legislative framework and the removal of these words unmistakably show that section 729 is a new piece of legislation not to be shackled by its predecessor or forerunners”. He concluded that damages can be awarded to any person who has suffered a pecuniary loss as a result of the conduct in question, whenever the court finds it “just and proper” to do so.

On appeal, the Court of Appeal overturned the judge’s interpretation of New CO s.729 and accepted the Defendants’ interpretation. First, applying the modern approach of statutory interpretation (§§61-63), the Court of Appeal considered that New CO s.729 should be construed in its proper context, which includes the “whole corpus of company law including both statute law and common law” (§64). The Court of Appeal also undertook a detailed review of the legislative history and purpose as set out in the consultation papers and Bills Committee paper, holding that they were admissible in order to identify the purpose of the legislation.

Having considered the difficulties and problems in terms of legal principle as identified above, the Court of Appeal agreed with the Defendants that the judge’s construction would represent a fundamental change in the law (§§65-67). By New CO s.729, the legislature could not have intended to create a free-standing, independent cause of action which would have the effect of recognising a duty owed by directors in parallel to shareholders and creditors generally (which is contrary to the well-established company law principle); and in addition, would abolish the rule in Foss v Harbottle and render the derivative action wholly otiose (§67).

With such broader context in mind, the Court of Appeal took the view that while “may” and “any or all” in New CO s.729 are on their face words of wide import, the scope of the power to order damages is “highly unclear” (§69). Such uncertainties are further heightened when one has regard to the legislative history, which did not identify any mischief that caused the legislature to make the relevant change (except that the language of Old CO s.350B was thought not “modern” enough) (§70).

Given such obscurities, the Court of Appeal agreed with the Defendants and found it legitimate to find guidance in the predecessor provision which New CO s.729 was merely intended to restate in different language and style. In this respect, the Court of Appeal referred to the UKSC’s decision on interpretation of consolidation statutes, R (Derry) v Revenue and Customers Commissioners [2019] UKSC 19, where Lady Arden said at §86 that consolidation statutes receive less Parliamentary scrutiny than other primary legislation, and there is a presumption, in relation to consolidating statutes, that Parliament did not intend to change the law. The Court of Appeal held that this applies a fortiori here, where it was represented to the Legislative Council that the provisions merely restated existing law in different language and drafting style without a change in substance (§75).

In the event, the Court of Appeal accepted the Defendants’ submissions that sections 728-730 of the CO should be interpreted in a similar manner to Old CO s.350B, and there should be jurisdiction limitations in the Court’s exercise of its power under New CO s.729 as to when an applicant (being a shareholder or a creditor of the company) would be entitled to relief by way of damages payable to himself personally. Injunction remains the primary remedy, to which damages is “an adjunct which may be granted in addition to or in substitution for an injunction” (§79). The Court of Appeal stressed that this did not involve reading words into a statute (§76) or denying the entitlement of the legislature to abrogate or reduce any fundamental principle of common law. Rather, this was to assume that the legislature would not alter fundamental principles except on a considered basis (of which there was none in the present case) (§78).

Key Takeaways

Following the re-write of the Companies Ordinance, many provisions have been revised and re-drafted, which has often resulted in different wording. This Judgment has demonstrated that in interpreting such provisions, the Court is ready and willing to consider the “whole corpus” of company law including both statute law and common law, and in appropriate cases, the Court will have regard to the legislative history, and give effect to a presumption that in rewriting the Ordinance the legislature did not intend to change the law. It also shows that in the absence of a clear indication, the Court would be slow to ascribe an intention to the legislature to make fundamental changes to law in one fell swoop, even if the wordings are on their face apparently of wide import.

Specifically in relation to sections 728-730 of the CO, the Court of Appeal has clarified that under these provisions an injunction is the primary remedy, to which damages is “an adjunct which may be granted in addition to or in substitution for an injunction”. These provisions therefore provide for different remedies as distinct from sections 731-738 of the CO which govern the statutory derivative action. Legal practitioners should pay attention to these different provisions when advising clients as to what remedies are available and which course should be taken.

Justin Lam and Jonathan Chan acted for the Defendants and co-authored this article