Introduction

Section 740 of the Companies Ordinance (Cap.622 of the Laws of Hong Kong) (“CO”) serves as a power weapon for minority shareholders to seek discovery and inspection of records and documents of companies.  Section 740 provides that either shareholders holding at least 2.5% of the voting rights, or at least 5 shareholders of the company may apply to the Court for an order requiring the company to disclose its records or documents. 

The recent Hong Kong case Artan Investments Ltd & Ors v The Bank of East Asia Ltd & Ors [2015] HKCU 1268 demonstrates how minority shareholders may use section 740 to require disclosure of the company’s documents and records.

Facts

On 5 September 2014, the 1^st Defendant, the Bank of East Asia Limited (“BEA”) by way of public announcement declared that it had entered into a non-binding memorandum of understanding (“MOU”) with Sumitomo Mitsui Banking Corporation (“SMBC”) in relation to the placement of 222 million new shares of BEA to SMBC, representing around 9.53% of BEA’s issued share capital (the “Proposed Placement”). As a result of the Proposed Placement, SMBC’s shareholding in BEA would increase to 17.43%.  The Plaintiffs, who were shareholders holding 2.5% of the issued share capital of the 1^st Defendant, made enquiries with BEA on the Proposed Placement, causing the Board of BEA to retain Goldman Sachs to assess whether raising more capital was justified and whether the Proposed Placement was an appropriate means to do so.  Goldman Sachs prepared a presentation for the Board on 14 January 2015.  Two days later, the Plaintiffs took out a Court application under section 740 of the CO for inspection of BEA’s records and documents relating to the Proposed Placement.  A board meeting subsequently took place on 12 February 2015, at which a resolution was passed approving the Proposed Placement and subscription was then completed on 27 March 2015.

The Plaintiffs’ application for an inspection order of BEA’s records and documents relating to the Proposed Placement under CO section 740 was premised on the following grounds:

1.        it was unnecessary for BEA to raise additional capital at the material time;

2.        the directors of the Board of BEA were not provided with adequate information when considering the MOU and had approved the Proposed Placement without scrutinising it and having regard to the interests of BEA shareholders as a whole; and

3.        the Proposed Placement had materially diluted existing shareholders’ voting rights and was intended to build alliances with strategic shareholders in order to entrench the Li’s family’s position. BEA had on three separate previous occasions issued large blocks of shares to strategic investors (CaixaBank and SMBC), which represented 37% of BEA’s total share capital at the end of 2007 if combined with the Proposed Placement.

BEA however argued that the Proposed Placement was in BEA’s best interest in that it:

1.        allowed BEA to increase its capital so as to meet the stringent capital requirements set by the Hong Kong Monetary Authority (the “HKMA”) and withstand any periods of stress caused by negative economic developments;

2.        strengthened BEA’s relationship with SMBC, which might provide funding support to BEA and allowed BEA to get access to SMBC’s customers seeking to do business in Hong Kong and the Mainland; and

3.        created opportunities for sharing know-how and expertise between SCMB and BEA.

Section 740 of the CO

Under CO section 740, on the application of 5 or more shareholders, or members representing 2.5% in value of the voting rights, the Court has discretion to order inspection of a company's records or documents if it is satisfied that:

1.        the application is made in good faith; and

2.        the inspection is for a proper purpose

The following points were noted by the CFI in relation to the application of CO section 740:

1.        the “good faith” and “proper purpose” requirements are separate and independent to each other. First, the applicant must first establish that he is acting in good faith. Second, the Court must believe the circumstances are such that the inspection sought is for a proper purpose;

2.        for the “proper purpose” requirement, the Court must be satisfied that a proper purpose has been established and also that in the exercise of the Court’s discretion it is a proper case for an inspection order to be made;

3.        a wish to inspect documents to investigate a genuine and credible belief that there has been corporate mismanagement is sufficient to constitute a proper purpose. It is unnecessary to show that an application for inspection order is made with a view to taking action to protect a particular right of the applicant;

4.        the Court should be more willing to grant inspection orders for public listed companies in order to advance the protection of shareholders’ rights and interest and the maintenance of appropriate standards of corporate governance; and

5.        the applicant must show that there is a sufficiently reasonable case for investigation as regards to past or future wrongful conduct.

CFI’s Judgment

The CFI, after considering the following matters, found that the Plaintiffs’ application was made in good faith and that the inspection was for a proper purpose.

The Board of BEA failed to
consider properly the Proposed Placement

The main factor for the CFI to find the Plaintiff’s application satisfying both the “good faith” and “proper purpose” requirements was that the Board of BEA failed in its duty to scrutinise the Proposed Placement in September 2014 before the MOU was signed.

There was no evidence of any board meeting or discussion taken place in September 2014. A board meeting was only held after the presentation of Goldman Sachs, which was only engaged by BEA after the Plaintiffs’ enquiries on the Proposed Placement. No consideration had been given by the Board of BEA to the consequences of the dilution effect caused by the Proposed Placement on shareholders’ interest in BEA before the MOU was signed.

The CFI held that BEA’s shareholders were entitled to investigate the process by which the Board approved the Proposed Placement with a view to taking actions against the directors, which constituted a proper purpose for the Plaintiffs’ application for an inspection order.

BEA was not in need for additional capital

As shown by annual report and interim report published by BEA within the period of 2013-2014, BEA’s capital adequacy ratios were well above the HKMA’s capital requirements. The CFI held that no information published by BEA or by the HKMA suggested that BEA required additional capital to satisfy any regulatory requirements.

The Proposed Subscription was not
an appropriate means of raising capital for BEA

BEA argued that a rights issue was more expensive and time-consuming and would cause unnecessary pressure on BEA’s share price when compared to a bilateral placing, which explained why BEA chose to raise capital by way of the Proposed Placement.

The Plaintiff however claimed that a right issue for a bank in Hong Kong was not time-consuming and that the benefit of right issue to existing BEA’s shareholders (i.e. to subscribe for new shares at a discount) should offset any loss caused to existing BEA shareholders by any downward pressure on BEA’s share price.

The CFI held that whether a placement or a rights issue was a better choice was very much a commercial decision. What was material was that the choice between a placement and a right issue had not been properly considered by the Board of BEA in September 2014.

The proposed collaboration did not
justify the Proposed Placement

The CFI rejected BEA’s argument that the Proposed Placement strengthened BEA’s relationship with SMBC and thus enhanced collaboration between BEA and SMBC. BEA had made 3 historical bilateral share issuances to CaixaBank and SMBC, which represented a dilution of approximately 23% to other BEA shareholders’ interest. However, there had been no evidence of any measurable benefit arising from their strategic relationship.

Confidentiality

The CFI rejected BEA’s argument that the confidential nature of the documents of which inspection was sought militated heavily against ordering inspection. While noting that confidentiality is an important factor to be considered, the CFI was of the view that BEA failed to show a sufficiently strong case on confidentiality to justify refusing the Plaintiffs’ application. BEA’s concerns over confidentiality could be adequately dealt with by requiring the Plaintiffs to provide appropriate undertakings about the use of the information covered by the inspection order.

Conclusion

This case demonstrates how section 740 may assist minority shareholders in seeking discovery and inspection of records and documents of companies.  The applicants would need to establish to the Court that the application is made in good faith and for proper purpose.  In addition, the Court will also take into account the confidential nature of the documents when deciding whether or not to make the order.  If the issue of confidentiality can be dealt with by applicants’ undertakings as to the use of the documents, the Court will be more readily to grant an inspection order.