Throughout this year’s regulatory newsletters, we have discussed numerous enforcement actions and we have often encountered the term “Carecraft Procedure”. In this article, we shall explain in detail what it means and how it operates with case illustrations.

Introduction

One of the vital enforcement powers vested in the Securities and Futures Commission (the “SFC”) includes their ability to seek disqualification orders from the Court under section 214 of the Securities and Futures Ordinance (Cap. 571) (the “SFO”) against the directors of a listed company who are found to have been involved in misfeasance or other misconduct towards the listed company.

To expedite the disqualification proceedings with a view to reducing the potential penalty, the subject director may offer to settle the proceedings with the SFC by adopting the Carecraft Procedure, in which the SFC’s application can be disposed of summarily. Agreeing to use the Carecraft Procedure has been recognised as a form of cooperation with the SFC. 

How does the Carecraft Procedure work?

By way of the Carecraft Procedure the SFC and the director reach an agreement on the factual basis upon which the disqualification application is made. It was originally sanctioned in an English case Re Carecraft Construction Co Ltd [1994] 1 WLR 172, where a disqualification order of a company’s director was sought and the Court was requested to decide the issue on the basis of agreed facts without conducting a full trial of the factual allegations. In Hong Kong, the Carecraft Procedure has been repeatedly adopted in disqualification proceedings to facilitate expeditious resolution of the matter, with the benefit of avoiding substantial costs that would otherwise be incurred if a full trial is conducted.

A Carecraft Schedule is produced and submitted to the Court that contains the material facts relied on by the SFC that are not disputed by the director, and where appropriate, an agreed period of disqualification. In addition, the specifics of the cooperation provided by the director can be included as well for the Court’s consideration. On that basis, the Court is invited to determinate the appropriate outcome, as to whether a disqualification order should be made and, if so, for how long.

The effect of the Carecraft Procedure

The Court, however, is not bound by the agreed facts and proposal as submitted in the Carecraft Schedule by the parties. It remains open for the Court to (i) make findings as to the directors’ conduct, (ii) assess whether the conduct fall under section 214 of the SFO, (iii) determine whether the agreed facts warrant the disqualification order sought, and (iv) decide on the appropriate period of disqualification and/or any other relief.

Despite that the Court is not bound by the agreement reached by the SFC and the director, the Court is likely to be guided by such agreement unless the proposed orders are inconsistent with or do not adequately reflect the agreed facts. In addition, in deciding the length of disqualification period, the Court takes into account the fact that the director has admitted certain material facts and promptly consented to the Carecraft Procedure and the orders proposed by the SFC. The cooperation provided by the director is considered a relevant mitigating factor and may lead to a more lenient sanction being imposed.

Recent disqualification cases adopting the Carecraft Procedure

SFC v Wong Kam Leong & Ors [2020] HKCU 791 (22 April 2020)

The directors of Long Success International (Holdings) Limited were found by the Court to have breached their fiduciary duties and common law duties to act in the interest of the company and/or to exercise due and reasonable skill, care and diligence in the course of acting as directors of the company. In particular, they had allowed the former chairman and executive director to exercise domination and control of the affairs of the company and the board for his personal advantage or other ulterior purposes. Each of them submitted the Carecraft Schedules agreed with the SFC respectively.

In relation to the length of disqualification period, the starting points identified in previous cases are (i) over 10 years for particularly serious cases, (ii) below 5 years for relatively less serious cases and (iii) between 6 and 10 years for cases in between. The factors taken into account by the Court include, among others, the directors’ agreement to dispose of these proceedings by the Carecraft Procedure with the consequent saving of time and costs. Whilst the Court found that there were serious breaches of director’s duties, the Court accepted the starting point of the disqualification period for each of the directors was 5 years or below, which was usually adopted for the less serious cases.

SFC v Tong Shek Lun & Ors [2020] HKCU 654 (2 April 2020)

The managing director of Starlight Culture Entertainment Group Limited was alleged to have caused or permitted the listed company to repeatedly breach the Listing Rules of SEHK, and have misappropriated various business opportunities in the amount of over US$1.5 million away from the group of the listed company. The Court found that the director had breached his duties to act in good faith and in the best interest of the listed company. A high degree of incompetence or negligence was also found by the Court on the part of other executive directors in discharging their duties as directors.

The Court recognised the fact that all of the executive directors had adopted a reasonable course by agreeing to conclude the proceedings by way of the Carecraft Procedure, and consequently disqualification orders were made in the proposed terms as set out in the Carecraft schedule. The managing director was disqualified for a period of 7 years and the other executive directors were disqualified for a period of 5 years.

SFC v Wong Wai Kwong David & Ors (No 2) [2020] HKCU 2227 (17 July 2020)

The directors of EganaGoldpfeil (Holdings) Ltd. were alleged to have approved the misapplication of funds belonging to the company and its subsidiaries, resulting in a loss of approximately HK$2.55 billion to the company that subsequently became insolvent. The Court found the directors, in contravention of section 214 of the SFO, had breached their duties of care and skill and failed to perform due diligence before approving the transactions.

In this case, the directors had made various offers to the SFC to settle the action during the course of the proceedings. However, since the SFC insisted on seeking compensation orders against the directors in addition to the disqualification orders, they were not able to reach an agreement and the disqualification orders were granted without adopting the Carecraft Procedure. When considering the matter of costs, the directors argued, among others, that the stance of the SFC was unreasonable and caused a significant increase in the length of and costs of the proceedings as the SFC rejected offers made by the directors. However, such argument was not accepted by the Court. The readers may refer to our June 2020 newsletter for details of this case.

Takeaway

It is apparent from the above examples that the adoption of the Carecraft Procedure is considered by the Court as a relevant mitigating factor. In considering the strategy when dealing with the SFC in disqualification proceedings, the subject director should always seek the advice from their lawyers as to whether the Carecraft Procedure should be adopted in order to reduce the cost exposure and achieve a more lenient sanction to be imposed.