Introduction

S.168A of the Companies Ordinance (Cap. 32) (the “Old CO”) offers an alternative remedy to just and equitable winding-up in cases where the affairs of a company have been conducted in a manner unfairly prejudicial to its shareholders.  The provision has proved to be a useful remedy for minority shareholders, especially in private companies.

The Court of Appeal decision in Luck Continent Ltd v Cheng Chee Tock Theodore & Ors [2013] 5 HKC 442 introduces a new perspective to the application of s.168A, in which the unfair prejudice remedy was made available to the majority shareholder of a listed company.

Background

Under the Bye-laws of C Y Foundation (“CYF”), a Bermudan company listed on the Hong Kong Stock Exchange (“HKEx”), a director could only be removed by the passing of a special resolution of its shareholders in general meeting (the “Bye-law”).  The Bye-law was inconsistent with the requirements under the Listing Rules, which provided for the power to remove a director by ordinary resolution.  Since end of 2009, HKEx urged CYF to amend the Bye-law.  The Petitioner, the largest shareholder of CYF with 46.58% of the issued shares, had made several attempts to achieve the amendment of the Bye-law.  However, the motion for amendment was repeatedly defeated by the Respondents, who were shareholders holding 25.211% of CYF’s issued shares.

For reasons unconnected with the Bye-law issue, HKEx suspended the trading in CYF’s shares since August 2010.  It also became evident that HKEx would not lift the suspension of trading of CYF’s shares until the Bye-law was amended.

The Petitioner then brought an unfair prejudice petition under s.168A of the Old CO, which was opposed by the Respondents.

At first instance, the Court held that there was unfair prejudice in the Respondents’ voting to defeat the motions to amend the Bye-law and ordered the Bye-law to be amended, replacing the requirement of a special resolution with an ordinary resolution.

The Respondents appealed on three grounds:-

1.        The basis on which the Court found unfair prejudice was different from the case pleaded in the petition (“the Pleading Point”);

2.        The defeat of the motions to amend the Bye-law was not conduct of the affairs of CYF (“the Affairs Point”); and

3.        The defeat of the motions to amend the Bye-law could not be regarded as unfairly prejudicial conduct (“the Unfair Prejudice Point”).

The Pleadings Point

The Respondents argued that it was not enough to have the material facts pleaded in the petition; the Petitioner was required to plead the precise formulation of its case on unfair prejudice.  They further argued that although the petition included the relevant Listing Rule and the alleged breach; there was a lack of clarity in the petition as to how such alleged breach would be unfair to the shareholders.

The Court of Appeal rejected the Respondents’ arguments and held that the authorities did not decide that allegations in the petition must contain the precise legal formulation or characterization of the forensic analysis relied upon.  Once the factual allegations were pleaded and established, it was a question of law whether they were sufficient to support a case for relief under s.168A of the Old CO.  In the present case, all the material allegations had been included in, or fairly covered by, the petition, including the breach of the relevant Listing Rule and the jeopardy to the listing status of CYF caused by the blocking of the amendment to the Bye-law.  The Court of Appeal therefore rejected the Respondents’ first ground of appeal.

The Affairs Point

Under s.168A of the Old CO, the acts or conduct in question must be in respect of the affairs of a company.  The court would construe the words “affairs of a company” liberally and would not adopt a technical or legalistic approach but would look at the business realities.

The Respondents contended that the blocking of the amendment of the Bye-law could not be regarded as the company’s affairs.  Rather, it was the exercise of the voting rights by the shareholders.  The Bye-law was an article that governs a private matter between shareholders in respect of the power to remove directors.  For private matters between shareholders in the articles of association, the company was only a nominal party to the statutory contract.

The Court of Appeal disagreed and held that:-

1.        The company was not only a nominal party to the statutory contract embodied in the articles of association; it was bound by such provisions as much as the shareholders.  If there was a contravention of an article, the company was bound to take heed of it.

2.        In the present case, it was wrong to characterize the Bye-law as an article conferring only private rights between shareholders.  The Bye-law deals with the shareholders’ power to remove a director.  If it is not observed, the company could refuse to act on a resolution to remove a director.  If it is observed, the company has no right to continue to recognize a removed person as its director.  Whether a director had been validly removed was plainly part of the affairs of a company.

3.        The blocking of the amendment of the Bye-law was conduct of the affairs of CYF.

The Unfair Prejudice Point

In order to establish unfairness in respect of the exercise of rights under the articles of association (including the exercise of the Respondents’ voting right to block the motion to amend the Bye-law), the Petitioner needs to pinpoint some equitable constraints on such exercise of strict legal right. 

The Respondents contended that an agreement which gave rise to equitable constraint over the exercise of power under the articles had to be an agreement stemming from a private personal relationship or understanding between the shareholders (as opposed to an agreement between the company and the shareholders).

The Respondents’ argument was rejected by the Court of Appeal.  The authorities did not foreclose any equitable consideration stemming from understanding or agreement between shareholders and the company provided that such understanding or agreement could properly be characterized as a tripartite one (i.e. involving the shareholders inter se as well as the shareholders and the company).  This would be akin to the statutory contract in the form of the articles of association.  There was no reason why such a tripartite understanding or agreement cannot give rise to equitable consideration solely because the company was also a party to it.  So long as all shareholders were privy to the understanding or agreement, they were bound by it irrespective of the lack of direct personal relationship between one shareholder and another.  Equity would operate to hold them to their bargain and restrain them from exercising their strict legal rights in breach of it.

In the present case, the Court of Appeal found that there was a tripartite agreement that CYF would maintain its listing status.  Such agreement was a fundamental premise on which all the shareholders of CYF acquired its shares. 

Further, according to Re Astec (BSR) plc [1998] 2 BCLC 556, a mere breach of the Listing Rules by a public company could not automatically give rise to unfair prejudice.  However, such a breach was a relevant circumstance to be taken into account, especially when it led to the suspension of trading of shares and the real complaint was about the failure to take remedial steps to procure the resumption of trading.

In the present case, it was found that the blocking of the amendment of the Bye-law would prevent the resumption of trading of the shares of CYF and jeopardize CYF’s listing status.  This would constitute a breach of the common understanding of all the shareholders that CYF should maintain its listing status, which should give rise to equitable intervention by the court.  The Court of Appeal agreed with the first instance decision that there was unfair prejudice in the present case.

Unfair Prejudice Remedy under the New Companies Ordinance

The provisions in relation to the unfair prejudice remedy under the Old CO are largely restated in Part 14 Division 2 of the New Companies Ordinance (Cap. 622) (the “New CO”), which has become operative in March 2014.  Some new initiatives are also introduced, including:-

1.        Extending the scope of the unfair prejudice remedy to cover proposed acts and omissions; and

2.        Enhancing the court’s discretion in granting relief in cases of unfair prejudice.

Extending the scope of the unfair prejudice remedy

S.168A of the Old CO is applicable when the affairs of the company “are being or have been conducted” in an unfairly prejudicial manner.  It was therefore uncertain whether a member can bring an action for unfair prejudice where a course of action is only at the proposal stage, or where there is only a threat to do or not to do something. 

S.724(1)(b) of the New CO provides that the court may exercise the power to grant remedies under the unfair prejudice provisions if there is any actual or proposed act or omission of the company (including one done or made on behalf of the company) which is or would be prejudicial to the interests of the members.

The remedies that may be granted by the court under s.725 of the New CO are therefore extended to cover an order restraining the proposed act or requiring the doing of an act that the company has proposed to omit to do.

Enhancing the court’s discretion in granting relief

S.168A(2) of the Old CO provides that orders made by the court must be “with a view to bringing an end the matters complained of”.  This prevents the court from granting a remedy which is unable to meet that requirement.  To enhance the court’s discretion in granting relief in cases of unfair prejudice, s.725 of the New CO provides that the court may make any order that it thinks fit for giving relief in respect of the matter complained of.

Conclusion

As the provisions in relation to the unfair prejudice remedy under the Old CO are largely restated in the New CO, it appears that the Court of Appeal decision in the Luck Continent case will be applicable under the New CO regime.  However, as the case is now on appeal to the Court of Final Appeal, we shall await and see whether the Court of Final Appeal will provide further insights as to the application of the unfair prejudice provisions in the context of a petition by a majority shareholder of a listed company.