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Can a director, who is also an employee of the company, vote in favour of a board resolution to pay bonus to himself?

2022-09-29

Introduction

Directors are office-holders. If a director is employed by the company, he is an office-holder as well as an employee.

At board of directors’ meetings, directors make important decisions by passing board resolutions, which may include resolution that approve discretionary bonuses to themselves. Whilst it is common for a company’s articles of association to prohibit a director from voting in resolutions where he has a material interest, but if there is no such restriction in the articles, can a director vote in favour of himself? Directors are bound by their fiduciary duties to act in the best interest of the company, and they are also bound by the “no-conflict” rule. So even if the articles permit the directors to vote in such resolution, would a director be in breach of his fiduciary duties to vote in favour of such a resolution?

In a recent judgment, Li Jian Chao v TC Orient Lighting Holdings Ltd [2022] HKCFI 2324, the Court of First Instance (“CFI”) held, on the facts and circumstances of the case, that the director, by taking part in passing the purported resolutions to pay bonuses to himself, failed to act in the best interest of the company and was in breach of his fiduciary duties.

Background

The plaintiff, Li Jian Chao (“Li”), was employed as an executive director and chief executive officer by the defendant, TC Orient Lighting Holdings Ltd (“Company”), on 1 September 2014. The contract of employment provided that the executive may be entitled to a discretionary bonus in respect of each financial year of the Company in an amount to be determined by the board in its absolute discretion.

The Company passed four resolutions to pay bonuses or special bonuses to Li (among others) at four board meetings on 30 December 2014, 26 January 2015, 14 April 2015 and 4 June 2015 respectively (the “1st resolution”, 2nd resolution”, “3rd resolution” and “4th resolution” respectively). In May 2016, Li commenced an action against the Company for an outstanding sum of $1,640,000, representing the outstanding amount of the special bonus payable to him under the 4th resolution.

Among other defences, the Company contended that Li was in breach of his fiduciary duties in procuring and taking part in the passing of the 1st to 3rd resolutions. The Company counterclaimed for damages caused by Li’s breach of fiduciary duties.

The Company’s argument

The Company contended that once it is shown that there is a transaction which calls for an explanation, it is for the director to explain the transaction in question. A fiduciary is obliged to account for his dealings with a trust estate.

The Company highlighted the following features to show that the bonus payments under the 1st to 3rd resolutions called for an explanation:

1.       The 1st to 3rd resolutions were passed successively in a short time span of less than four months. Such frequent payment of bonuses was prima facie unusual, to say the least.

 

2.       The total amount of the bonuses under these resolutions was $33,200,000, of which a total of $6,880,000 (being the highest amount) was payable to Li. This was 34.4 times his monthly salary of $200,000. Such an amount was extravagant and extraordinary on any reasonable view.

 

3.       At the time of the resolutions, the Company’s financial performance was poor. The Company reported a loss of $116,419,000 in 2014, despite significant “improvement” from the previous year. Shareholders were not paid any dividend because of the loss.

 

4.       The Company’s liquidity was likewise doubtful at that time. After deducting the trade and bills payable in January and February 2015 from the cash and bank balance as at 31 December 2014, the Company only had liquid assets of about $50,000,000. The total amount of bonuses given under the 1st and 2nd resolutions on 30 December 2014 and 26 January 2015 constituted 15.2% of its liquid assets.

 

5.       With respect to the 3rd resolution, Wang, also a director and an intended recipient under that resolution, sent an email to other directors 2 days after the resolution to express his disagreement over the bonus payment because of the Company’s poor financial health and the lack of contribution from the existing Company’s directors. He further stated that it would be difficult to resolve the doubt of the shareholders over the bonus payment.

Li’s explanations

Li denied that he was acting in breach of his fiduciary duties. He claimed the payments were not in conflict with the Company’s interests. They were approved and paid to him because of his significant contributions to the Company.

In respect of the 1st resolution, Li explained in his oral testimony that he had already worked for the Company for 4 months to “save” the Company before he was formally employed. The special bonus of $800,000 was awarded to him as compensation for his hard work in that period, using his monthly salary of $200,000 as the benchmark.

In respect of the 2nd and the 3rd resolutions, Li explained that the bonuses were awarded to recognize his work to significantly reduce the Company’s loss from about $300 million for 2013 to about $110 million for 2014. Li claimed that his contribution was the greatest and he should be given proper recognition for that.

CFI’s findings and decision

The CFI found that the Company’s argument could be verified from contemporaneous documents and objective facts. Therefore, the CFI held that the bonus payments under the 1st to 3rd resolutions called for an explanation on the basis of the following factors:

1.       The poor financial condition of the Company at the time.

2.       The succession of a series of bonus payments within a very short space of time.

3.       The large size of the bonuses comparing to the monthly salary of Li.

As a fiduciary, Li was obliged to give explanation to these bonus payments to justify that they were in the best interest of the Company. The CFI was doubtful towards Li’s oral testimony because he had never revealed those justifications throughout the proceedings until he was in the witness box at trial. Li also failed to offer any satisfactory explanation for the omission of these material matters in an earlier stage of the proceedings.

For the above reasons, the CFI did not believe Li’s explanations given in his oral testimony. Li was unable to give any other explanation save for a general assertion that the payments were not in conflict with the interests of the Company.

The CFI concluded that by taking part in passing the resolutions, Li failed to act in the Company’s best interest and was in breach of his fiduciary duties.

Takeaway

In Li Jian Chao, the CFI ruled against Li based on facts and circumstances of the case. The CFI did not lay down a general rule that a director would always be in breach of his fiduciary duties by voting in favour of a resolution to pay bonus to himself. That said, a director should always be cautious about his fiduciary duties to act in the best interest of his employer company when voting in such resolution, especially where the employer company was in poor financial condition at the time when such resolution was passed, the bonus payments were made in succession within a very short space of time, or the size of the bonuses are large when compared with the employee directors’ monthly salary.

Apart from fiduciary duties, a director must also beware of other restraints when taking part in passing resolution to pay bonus to him/herself. Examples include the rules in relation to conflict of interest in the Companies Ordinance (Cap.622) and the company’s articles of associations. When in doubt, it is always prudent to obtain legal advice.

 


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Important: The law and procedure on this subject are very specialised and complicated. This article is just a very general outline for reference and cannot be relied upon as legal advice in any individual case. If any advice or assistance is needed, please contact our solicitors.

Published by ONC Lawyers © 2022


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