BUSINESS
ASSOCIATIONS
(TUTORIAL)
PANGYUE CHENG
FACULTY OF LAW
THE UNIVERSITY OF HONG KONG
T3
CORPORATE LIABILITY,
CAPITAL, & CAPITAL
MAINTENANCE
QUESTION 1(A) CORPORATE LIABILITY
1. Company’s Defences
If you were counsel for the Company, what arguments would you advance to say that the sale
and purchase agreement is not binding?
The sale and purchase agreement does not bind the Company because Paul had no authority to enter
into the transaction for and on behalf of the company.
The articles of association provide that the directors only have the power to enter into transactions
not exceeding HK$5 million for the Company unless approved by members’ special resolution. No
such resolution has been passed in relation to the transaction.
Proper notice of meeting has not been given to all directors in accordance with the articles.
The Sellers were given a certified copy of the Company's articles of association and therefore had
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actual notice of the restriction on the directors’ power as stated in the articles.
QUESTION 1(A) CORPORATE LIABILITY
2. Sellers’ Counter-Attack
How would the Sellers respond? Even if Paul lacked actual authority, what kind of authority
might this be?
Apparent authority
Freeman and Lockyer v Buckhurst Park Properties (Mangal) Ltd [1964] 2 QB 480 (4 conditions)
Representation made to the seller
Representation must be made by a person or persons having actual authority
Counterparty induced by such representation to enter into the contract and in fact, relied upon it
Company is not deprived of capacity to enter into the contract (this condition is no longer relevant
as company does not lack capacity under s115 CO). 3
QUESTION 1(A) CORPORATE LIABILITY
2. Sellers’ Counter-Attack
If the articles limit the directors’ power, does that automatically defeat apparent authority?
The Turquand Rule (Indoor Management rule)
Sellers were outsiders
Sellers could assume that all procedural requirements (e.g. giving of written notice to all directors)
for convening board meeting have been complied with
Sellers were aware of the special resolution requirement in the articles but could assume special
resolution has been passed under the Turquand’s rule
Is the rule available in all circumstances?
Sellers were dealing in good faith and neither had notice nor was put on enquiry of irregularity (Re 4
Moulin Global)
QUESTION 1(A) CORPORATE LIABILITY
2. Sellers’ Counter-Attack
What statutory provision can the Sellers rely on?
Under s117 CO, in favour of a “person dealing with a company in good faith”, the power of the
company’s directors to bind the company, or authorise others to do so, is to be regarded as free of any
“limitation” under any “relevant document” of the company.
Sellers were only dealing with Paul and not directly with the directors as a board but s117 still applies as it
covers the situation where the directors authorised others to bind their company
The requirement of obtaining prior shareholders’ approval (by way of a special resolution) is a limitation on the
director’s power to enter into the transaction for and on behalf of the Company which is covered by s117
The limitation is contained in the articles of association which fall within the definition of “relevant document”
Does Seller act in good faith?
Knowledge that the act was beyond the director’s powers not bad faith (s117(2)(c) CO) 5
Sellers not required to inquire as to the limitation (s117(2)(d) CO)
QUESTION 1(B) CORPORATE LIABILITY
What would be different if Paul and his friend’s partnership held the property? What statutory
provision can the Company rely on?
The Company may avoid the agreement under s118(2) CO, as Paul, a director of the
Company, is a party to the transaction, unless one of the statutory exceptions in s118 applies.
Can the Company obtain a remedy in any event? On what statutory basis?
Under s118(4) CO, Paul is required:
to account to the Company for any gain he has directly or indirectly made from the
transaction; and
to indemnify the Company against any loss or damage resulting from the transaction,
Regardless of whether the transaction is avoided by the Company.
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QUESTION 2(A) CAPITAL
The current shareholding structure of the Company:
Bianca – 50%
Lucy – 25%
Sophie – 25%
If an outsider (Ken) wishes to acquire shares, what options are available?
1. Subscription for new shares (i.e. the Company issues new shares to Ken)
2. Purchase of existing shares from Bianca (assuming Lucy and Sophie wish to maintain
their respective shareholdings)
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QUESTION 2(A) CAPITAL: ALLOTMENT OF SHARES
Allotment of shares
What contractual protections might Ken seek as an outsider investor?
If the Company issues shares to Ken, will this be a pro rata or non-pro rata allotment? Why?
Under the Companies Ordinance, can the Board freely allot shares in this situation?
Since Ken is an outsider, it is likely that he will want certain warranties and undertakings
from the Company. This would necessitate a subscription agreement to be entered into.
Because the shares are not being offered to existing shareholders in proportion to their
existing shareholdings. Instead, new shares are being issued to an outsider (non-pro rata
allotment).
Under ss140–141 CO, the Board would only have the power to allot the shares if they have
first obtained approval from the shareholders by way of an ordinary resolution (assuming no 8
general mandate is already in place).
QUESTION 2(A) CAPITAL: ALLOTMENT OF SHARES
Allotment of shares
What are the key procedural steps for the allotment?
1. Application by Ken for shares at completion of the subscription agreement.
2. The Board to obtain shareholders’ approval.
3. The Board to consider the application and approve the subscription price.
4. The Company to issue the shares upon payment of the subscription price, enter the
name of the allottee into the register of members, issue a new share certificate, and
file a return of allotment.
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QUESTION 2(A) CAPITAL: ALLOTMENT OF SHARES
At what point does Ken become the legal owner of the shares?
Is stamp duty payable on this share allotment?
Ken only becomes the legal owner of the shares allotted to him upon his
name being entered in the register of members of the Company.
No stamp duty is payable on a share allotment.
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QUESTION 2(A) CAPITAL: ALLOTMENT OF SHARES
What potential obstacles might Ken face in obtaining a 20% shareholding?
1. Shareholder-level obstacle
If shareholder approval is required for the share allotment, can Bianca pass an ordinary resolution on her own?
What effect would allotting 20% of shares to Ken have on the existing shareholders?
No. Bianca holds 50% of the shares, which is insufficient on its own to pass an ordinary resolution (which
requires a simple majority).
Allotting 20% to Ken would result in the dilution of the respective shareholdings of all the existing
shareholders.
2. Board-level obstacle
Even if shareholder approval is obtained, can Bianca control the decision at Board level?
Bianca is only one of three directors but decision making on the Board is by majority vote so it depends on
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whether Sophie would vote for the resolution even if Lucy does not.
QUESTION 2(A) CAPITAL: TRANSFER OF SHARES
Alternatively, Ken can purchase 20% of the shares from Bianca
If Ken is purchasing shares from Bianca, what documents might he require in order to protect himself?
What statutory formality is required for a valid share transfer?
Is stamp duty payable on a share transfer? When must it be paid?
Ken might want certain warranties and undertakings from Bianca on title to the shares and
other matters relating to the Company. This would necessitate a share sale and purchase
agreement to be entered into.
A proper instrument of transfer is required under s150 CO.
Stamp duty must be paid on the share transfer before the Company will register the transfer.
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QUESTION 2(A) CAPITAL: TRANSFER OF SHARES
At what point does Ken become the legal owner of the transferred shares?
Does the Company need to do anything after the transfer?
In a share transfer, who receives the purchase price?
How does this transfer affect the shareholding structure of the Company?
Ken only becomes the legal owner of the shares transferred upon his name being entered in
the register of members of the Company (legal ownership passes).
The Company must issue new share certificates (prima facie evidence of title) to both Bianca
and Ken upon tender of the old share certificate by Bianca.
The purchase price is paid to Bianca, not to the Company.
Shareholdings of the other shareholders will remain the same whereas Bianca’ shareholding
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will get diluted from 50% to 30%.
QUESTION 2(A) CAPITAL: TRANSFER OF SHARES
What potential obstacles might Ken face in obtaining a 20% shareholding?
1. Shareholder-level obstacle
Before Bianca transfers her shares to Ken, what other potential restriction should be considered?
There may be pre-emption provisions in effect which give the other shareholders a right
of first refusal over Bianca’s shares.
2. Board-level obstacle
Even if Bianca wishes to transfer her shares to Ken, can she control the decision at Board level?
Does the Board have any power to refuse to register a share transfer? Under which Model article?
Bianca is only one of three directors but decision making on the Board is by majority vote
so it again depends on whether Sophie would vote for the resolution even if Lucy does
not.
Under Model Article 2(2), the Board has discretion to refuse to approve a transfer of 14
shares.
QUESTION 2(A) CAPITAL: TRANSFER OF SHARES
If the Board refuses to register the transfer, are there any statutory requirements that must be followed?
Can Ken request the reason for the refusal?
If the Board refuses to register the transfer, does Ken have any legal recourse?
Will the court automatically overturn the Board’s refusal?
Under s151(2) CO, notice of refusal must be given to both the transferor and the transferee.
Under s151(3) CO, Ken may request the reasons for the refusal.
Under s152 CO, Ken may apply to the court for an order that the share transfer be
registered.
Courts are generally reluctant to interfere with Board decisions to refuse registration of
share transfers unless the refusal is not well-founded, for example if it is prompted by
personal reasons and not exercised bona fide (Cheng Chien Kuo v New Resources Holdings Ltd).15
QUESTION 2(A) CAPITAL
If the purpose of introducing a new investor is to raise additional funds for the Company’s
expansion, what would be the most appropriate way to structure the acquisition?
by way of share allotment.
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QUESTION 2(B) REDUCTION OF CAPITAL
Under common law, can a company freely return capital to its members?
How can a company ever reduce its share capital?
Return of capital to members is unlawful and, therefore, void under common law.
However, CO allows reduction of share capital provided that certain prescribed
procedures are complied with.
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QUESTION 2(B) REDUCTION OF CAPITAL
(1) Statutory procedure without court involvement (s211 CO)
What should the members and directors do?
Members must pass a special resolution within 15 days after the date of the solvency
statement (s215(1) CO). In this scenario, Bianca and Sophie together hold 75% of the
shares. They would therefore be able to pass the special resolution even if Lucy votes
against it.
All directors must sign a solvency statement (s216 CO).
publishing a notice in the Gazette (s218(1) CO) and making the special resolution
and solvency statement available for inspection by members and creditors (s219 CO)
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QUESTION 2(B) REDUCTION OF CAPITAL
(1) Statutory procedure without court involvement (s211 CO)
What should the solvency statement state?
The solvency statement must state that the directors have formed the opinion that the Company
satisfies the solvency test in relation to the transaction, after having considered (s206 CO):
the company’s state of affairs;
its prospects; and
its liabilities (including contingent and prospective liabilities)
What is the solvency test?
The solvency test is essentially a cash flow test (s205 CO). The directors must be satisfied that:
Immediately after the transaction, there is no ground on which the company is unable to pay its debts;
and
Within 12 months after the transaction, the company will be able to pay its debts as they fall due. 19
This would be a problem as Lucy also needs to sign the solvency statement
QUESTION 2(B) REDUCTION OF CAPITAL
(1) Statutory procedure without court involvement (s211 CO)
If Lucy or a creditor is unhappy with the shareholders’ resolution approving the capital reduction, what
can he or she do?
Dissenting members (i.e. members who voted against the resolution or abstained from voting) and
creditors may apply to the court for an order to cancel the resolution (s220(1) & (2) CO).
In principle, if Lucy did not consent to or vote in favour of the resolution, she would be entitled to
apply to the court to cancel it.
What is the primary concern underlying the statutory provisions on capital reduction? (See the
judgment in Fok Lai Lor Nora v Fok Ying Tung Ming Yuan Development Co Ltd [2020] 3 HKC 221)
The statutory provisions are primarily designed to protect creditors.
“In the case of a shareholder, the most likely legitimate concern is to have enough information to
conclude that the amount of the proposed distribution is viable in light of the company’s financial 20
position..” (para 34.2)
QUESTION 2(B) REDUCTION OF CAPITAL
(1) Statutory procedure without court involvement (s211 CO)
If Lucy or a creditor challenges the special resolution, is the challenge likely to succeed?
In Lucy’s case, if there is no procedural irregularity or failure of disclosure in relation
to the special resolution, she is unlikely to succeed in challenging the capital
reduction.
As for creditors, it seems from the facts that their interests are not jeopardised so it
is unlikely that any creditor will challenge or successfully challenge the reduction in
court
When does the special resolution and the related capital reduction become effective?
The reduction becomes effective upon registration (s215(2), notes to s224, s225 CO)21
QUESTION 2(B) REDUCTION OF CAPITAL
(2) Court approved reduction of capital
What should the members do?
The members pass a special resolution and apply to the court for an order confirming the
reduction (s226(1) CO).
In this scenario, the resolution is likely to be passed, as Bianca and Sophie together hold 75%
of the shares.
What can creditors do in this circumstance?
Creditors are entitled to object as the reduction involves payment to shareholders of paid-
up share capital (s226(2) CO).
The court needs to settle a list of creditors entitled to object (s227(2) CO). 22
QUESTION 2(B) REDUCTION OF CAPITAL
(2) Court approved reduction of capital
When deciding whether to make a confirmation order, what factors will the court take into account?
The court will take into account, among other things, the following factors before deciding
whether to confirm the reduction:
Whether creditors’ consents have been obtained, or their debts or claims have been
discharged, determined, or secured (s229(2) CO);
whether all members have been treated equitably;
whether members have passed the special resolution as an informed choice (i.e. reasons
for the reduction properly put to the members, and must be supported by evidence).
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QUESTION 2(B) REDUCTION OF CAPITAL
(2) Court approved reduction of capital
What should the company do after the court makes a confirmation order?
If the court makes a confirmation order, the company must, within 15 days after the date of
the order, deliver to the Registrar(s230(1) – (3) CO):
An office copy of the order;
A minute stating the particulars of the company’s share capital as altered by the reduction;
and
A return in the specified form
When does the capital reduction take effect?
The reduction takes effect upon registration of the above documents by the Registrar(s230(4)
CO) 24