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