In Lehman & Co. Management Limited v Effiscient Limited CACV 272/2011 (Unreported), the Court of Appeal has found that a member may not recover reflective loss suffered by the company for acts of unfair prejudice done by another member under section 168A of the Companies Ordinance (the “CO”).

Background
The subject company, LehmanBrown Limited (the “Company”), is a company incorporated in Hong Kong in the business of an accounting firm in China. The Company is owned by Lehman & Co Management Limited (“Lehman Management”) and Effiscient Limited (“Effiscient”) in equal shares. Lehman Management is controlled and owned by Mr. Lehman and his wife, while Effiscient is controlled by Mr. Brown and his wife.

When the Company was established in 2001, Mr. Brown and Mr. Lehman agreed that each should be equal shareholders in the Company and each was to nominate a director where Mr. Brown would manage the Company on a day to day basis and that Mr. Lehman would have right to information and involvement only as a director. Mr. Brown nominated himself as a director while Mr. Lehman nominated Million Strong, a company owned by himself and his wife as the director.

As the Company became increasingly successful, Mr. Lehman repeatedly demanded to have a greater role in the management and control of the Company which has been refused by Mr. Brown. Since 2005, Mr. Lehman had been operating a competing accounting business in China which had names and domain names very similar to the Company’s business which diverted business from the Company to Mr. Lehman’s competing business.

Mr. Brown and Mr. Lehman also had an agreement for the Company to apply for registration of its trademark LehmanBrown. However, in breach of this agreement, Mr. Lehman applied for registration of the trademark in his own name and gave an undertaking to the Company that when the registration was granted, he would transfer the trademark to the Company. However, Mr. Lehman eventually misappropriated the trademark for the benefit of a company controlled by his wife.

When Mr. Brown discovered the wrongdoings of Mr. Lehman in 2008, the relationship between the parties gradually worsened and Mr. Lehman adopted an increasing hostile attitude towards Mr. Brown which made it impossible for the parties to work together. Between 2008 and 2009, Mr. Lehman caused the Company’s Shanghai, Shenzhen, Guangzhou and Beijing office be raided by local Administration of Industry and Commerce for the alleged infringement of trademark by the Company.

Mr. Brown found that Mr. Lehman’s behaviour was so inconsistent with the best interests of the Company and when Million Strong was deregistered in 2010, he took the opportunity to appoint his wife as a director in breach of the agreement between him and Mr. Lehman on the appointment of directors.

It was upon this background that Lehman Management and Effiscient each filed a section 168A petition to wind-up the Company and for the alternative remedy for the other party to sell its one-half of the Company to oneself.

Trial
At trial, the trial judge found that Lehman Management has failed to establish any unfairly prejudicial conduct on the part of Effiscient and dismissed the petition by Lehman Management. He also found that Effiscient has established that it has suffered from unfairly prejudicial conduct on the part of Lehman Management and ordered Lehman Management to sell its share in the Company to Effiscient. Further, the judge also made a novel order that Effiscient should be awarded damages for the loss suffered as a result of two aspects of unfairly prejudicial behaviour:

1.          the operation of the competing business by Mr. Lehman through his nominee or nominees; and
2.          misappropriation and infringement of the trademark of the Company’s business name.

Appeal
Lehman Management appealed against the trial judge’s finding that it failed to establish unfairly prejudicial conduct on the part of Effiscient. Further, it also contended that the court has no jurisdiction to award damages for unfairly prejudicial conduct as a result of section 168A(2C) of the CO.

The law
While the court may order payment by any person of damages caused by unfairly prejudicial conduct to any members of the company whose interests have been unfairly prejudiced under section 168A(2)(b) of the CO, section 168A(2C) of the CO prohibits the recovery of “any loss that is solely reflective” of the loss suffered by the company which only the company is entitled to recover under the common law by the members and former members of the company.

The Court of Appeal has endorsed the principles at common law on the prohibition for shareholders to recover reflective losses of the company laid down in the case of Johnson v Gore Wood & Co [2002] 2 AC 1:

1.          where the company suffers loss caused by a breach of duty owed to it, only the company itself may sue in respect of that loss and a shareholder may not sue on the diminution in share value if that merely reflects the loss suffered by the company.

2.          where the company suffers a loss but has no cause of action, the shareholder may sue even if the loss is only a diminution in share value.

3.          where a company suffers a loss by a breach of duty while the shareholder suffers a loss separate and distinct from that suffered by the company arising from a breach of duty independently owed to the shareholder, then the shareholder and the company may each sue for its own loss but not for the loss of each other.

The Outcome
Applying the principle set out above, the Court of Appeal found that, as regards the misappropriation of trademark claim, as the Company has instituted proceedings against Mr. Lehman and his associates and the Company may sue on an undertaking signed by Mr. Lehman for the Company, the award of damages under this head contravenes section 168A(2C) of the CO and shall be set aside for the lack of jurisdiction.

Regarding the award of damages for the operation of the competing business, although the Company has not instituted any action, the Court of Appeal has found that the Company may have a breach of fiduciary duty claim as a de facto director against Mr. Lehman and there may also be claims for passing off by the Company against Mr. Lehman and his associates. Thus the Court of Appeal also set aside the award of damages under this head for lack of jurisdiction.

The Court upheld the finding that there has been no unfairly prejudicial conduct done by Effiscient or Mr. Brown. The court held that if a person has by his own poor behaviour caused the conduct of which he complains, it is unlikely to be unfair to him even if the conduct is prejudicial. As Mr. Lehman’s conduct had become manifestly inconsistent with the best interests of the Company, the appointment of Mrs. Brown to the board to the exclusion of Mr. Lehman was justified.

Conclusion

The Court of Appeal has taken a much more restrictive approach to the damages available to a shareholder under an unfair prejudice claim. The shareholder being subject to unfairly prejudicial conduct is now generally debarred from any damages when the company has the right to claim unless he is able to bring the action in the name of the company or establish a cause of action independent of the rights owed to the company, which may prove to be a high threshold to cross.

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IMPORTANT: The law and procedure on this subject are very specialized 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.