A number of significant legal issues arise out of the recent Court of Appeal decision in Ge Qingfu & Ors v L&A International Holdings Ltd and Others [2020] HKCA 687 (11 August 2020) (some of which have been discussed in another article as part of the present series, which is certainly recommended for readers interested in this area of the law).
In this article, we will look at only one of those, namely the standing of minority shareholders to directly seek redress for any wrongful allotment of shares. We will also consider the recent decision of Mr Justice Segal in Tianrui (International) Holdings Company Limited v China Shanshui Cement Group Limited FSD 161 of 2018 (6 April 2020, Grand Court of the Cayman Islands), which departed from an earlier decision of the same Court (Mr Justice Kawaley) in Gao v China Biologic Products Holdings, Inc. FSD 157 of 2018 (10 December 2018, Grand Court of the Cayman Islands).
The scope and limits of one of the most well-established principles of company law, the irrevocability of reflective loss, was recently the subject of a comprehensive review by the UK Supreme Court in Sevilleja v Marex Financial Ltd [2020] UKSC 31. However, while an extensive examination of that principle will be the subject of discussion for another day, a particularly interesting aspect, which is spotlighted in this article, is whether minority shareholders can seek direct relief for wrongful allotment.
As things presently stand, as a matter of Hong Kong law, the answer appears to be in the affirmative.
In Re L&A International Holdings Limited, after a thorough examination of the Court’s power to grant damages in addition to or in substitution for injunctive relief under the Companies Ordinance (Cap. 622), it considered this specific scenario.
At paragraphs 104-106, it was emphasised that where there are complaints about wrongful allotment of shares, the loss caused is not necessarily suffered solely by the company in question. As Hoffmann J (as he then was) said in Re Sherborne Park Residents Co Ltd (1986) 2 BCC 99, 528, “[T]he company is not particularly concerned with who its shareholders are. The true basis of the action is an alleged infringement of the petitioner’s individual rights as a shareholder. The allotment is alleged to be an improper and unlawful exercise of the powers granted to the board by the articles of association, which constitute a contract between the company and its members. … An abuse of these powers is an infringement of a member’s contractual rights under the articles.”
This is also borne out by a number of common law authorities, including a string of Hong Kong decisions[1] which have enabled members (in their own right) to restrain a wrongful allotment. The recognition of the member’s standing in such applications demonstrates that a member is entitled to seek some form of direct remedy in the face of a threatened or actual wrongful allotment, without having to pursue (for instance) a derivative action.
As a matter of reality, the Court went on, at paragraph 108, to illustrate the point by reference to the possibility of “a real loss suffered by a member as a result of a wrongful allotment of shares separate from and independent of any damage that is suffered by the company”, with such compensation being capable of being “rationalised in terms of an infringement by the company of his contractual rights under the articles which was procured by the improper actions of the directors who managed its affairs.”
Thus, at paragraph 109, the Court of Appeal affirmed the first instance decision that, as a matter of Hong Kong law, under section 729 of the Companies Ordinance (Cap. 622), Hong Kong, damages may be awarded to a member in lieu of a prohibitory injunction at his behest restraining the wrongful conduct.
At this juncture, it is also of interest to refer to the decision of Mr. Justice Segal in Tianrui (International) Holdings Company Limited FSD 161 of 2018 (6 April 2020, Grand Court of the Cayman Islands).
It was held that relief can be granted, on the basis that the company is regarded as being in breach of the articles and liable to be sued once powers have been improperly exercised by its directors (as the improper action necessarily remains attributable to the company, until and unless it is set aside).
In arriving at this view, Segal J specifically departed from a decision of the same Court in Gao in which Kawaley J held that to grant relief to the aggrieved member in such circumstances would be inconsistent with the rule that (absent a special relationship which, according to Kawaley J, did not arise) directors owe their duties to the company and not individual shareholders.
Viewing the matter differently, Segal J reiterated that the key question is not whether and when directors owe duties directly to shareholders, but whether and when a shareholder can bring proceedings against the company for the company’s breach of the statutory contract and the corporate constitution (paragraph 103(c)).
Further, as a matter of principle, Segal J considered that the shareholder’s cause of action (arising out of an improper allotment of shares) is premised on the statutory contract and is to be treated as a personal right. This recognizes the true nature of the dispute, i.e. being one between the shareholders themselves, and it is their rights (and technically not the company’s rights) which have been affected.
Following from the above, Segal J (at paragraph 108) concluded that the most appropriate remedy in such a scenario would be a declaration or injunction against the company. The learned Judge specifically left open the question as to whether “a claim for financial compensation for breach of the articles might be possible”. Noting that this was not argued before him, Segal J observed that this “would face a number of difficulties including the effect of the rule against recovery of merely reflective loss”.
Postscript
As Tianrui was decided several months earlier, Segal J did not have the advantage of being referred to it. It would be interesting to see whether the Cayman Court would likewise come to a similar view. As a matter of Hong Kong law, however, it seems clear that the reflective loss principle is no bar to the award of damages at least where it is considered on the facts to be appropriate as a relief in lieu of an injunction.
[1] See for example Fountain II LTD v. Ping An securities & Anon [2020] 1 HKLRD 429, Re Bank of East Asia [2015] 4 HKC 137, Tsang Wai v. Chu King [2009] 5 HKLRD 105
José-Antonio Maurellet SC and Michael Lok co-authored this article.
