New Companies Ordinance - Prohibition of Loans, etc to Directors
Introduction
As discussed in our newsletter issued in November 2013, the new Companies Ordinance (“New CO”) is going to take effect from 3 March 2014. This issue aims to focus on part 11 of the New CO and highlight various major changes brought by the New CO in relation to fair dealing by directors. Part 11 of the New CO strived to enhance corporate governance and modernize the law to deal with situations in which conflict of interest may arise between a company and its director.
Prohibition of loans, etc. to directors
Pursuant to the s.157H of the existing Companies Ordinance (Cap. 32) (“CO”) and ss.500 – 503 New CO, a company is prohibited to enter into certain transactions such as loans, quasi-loans and credit transactions with its directors, unless the “prescribed approval of members” (discussed below) is obtained.
Widening the scope under the prohibition of loans, etc. to directors
The main change brought by the New CO on this part is to widen the coverage of persons affected by the prohibition. Below is a table comparing the scope of connected entities (other than the director himself) covered by s.157H CO and that covered by ss.486 to 488 of the New CO (for the purpose of interpretation of ss.500 – 503 New CO):-
| Scope under s.157H(8) CO | Scope under ss. 486 – 488 of the New CO |
| i. Spouse of a director | a. Spouse or cohabitee (whether of the same sex or of the opposite sex) of the director (s.484, New CO) |
| ii. Child (including illegitimate child) or step-child under the age of 18 of a director | b. Child (including illegitimate child), step-child or adopted child of any age of the directorc. Child (including illegitimate child), step-child or adopted child of the cohabitee under the age of 18 who lives with the director |
| iii. Does not include members of the director’s or former director’s family | d. A member of the director’s family |
| iv. A person acting as the trustee of any trust the beneficiaries of which include the director, his spouse or any of his children or step-children under the age of 18 | e. A person acting as the trustee (including the partner of the trustee) of any trust the beneficiaries of which include the director, his spouse or any of his children, step-children or adopted children under the age of 18, and that the director knows that he, or his spouse or child, is an object of that trust |
| v. A person acting as partner of a director or of his spouse, child or step-child under the age of 18 | f. A person acting as partner of a director, his spouse, child, step-child or adopted child under the age of 18 |
| vi. Does not include a body corporate associated with a director | g. A body corporate associated with a director |
“Prescribed Approval”
Under the CO, the prohibited transactions could only be made with the prior approval of its members. However, there is no provision requiring that a member of a company cannot vote in a general meeting for a resolution that he is interested in (except for those related to purchase or redemption of a company’s own shares). This would undermine the minority shareholders’ interest in a way that the majority shareholder may be able to pass resolution approving the company to use its capital to make loans to themselves and the minority shareholder would have no right to object.
The New CO not only preserved the requirement that a company must get prior approval from its members before entering into the prohibited transactions with its own directors, but also restricted the ways in which “prescribed approval” can be obtained. Under the New CO prescribed approval from members can be obtained in two ways, either by a written resolution with a memorandum setting out the details of the loan or quasi loan; or by a general meeting in which any interested members’ vote would be disregarded for that particular resolution. The memorandum shall contain the following details regarding the proposed transaction:-
1. the nature of the transaction to be approved by the resolution;
2. the amount of the loan, quasi-loan or credit transaction;
3. the purpose for which the loan or quasi-loan is required, or the purpose for which the goods, land or services supplied, sold, leased, hired or otherwise disposed of under the credit transaction are required; and
4. the extent of the company’s liability under any transaction connected with the loan, quasi-loan or credit transaction.
Exceptions to the restriction
That said, the CO did provide for exceptions to the above restrictions (s.157HA CO), including loans or quasi-loans to members within the same group of companies (s.157HA(1) CO), or funds to meet expenditure incurred or to be incurred by directors for the purposes of the company (s.157HA(3)(a) CO) etc.. These exceptions are kept in ss.505 to 512 of the New CO, such as any transaction entered or provision of funds to meet expenditure incurred for the purposes of the company or enabling such director, controlled body corporate or connected entity (as the case may be) to properly perform duties as an officer of the company, home loans, leasing goods and land, transaction entered into in ordinary course of business and intra-group transactions.
The New CO also comes with the new exceptions to the restrictions, in particular, for loan, quasi-loan or credit transaction value not exceeding 5% of net assets or called-up share capital, expenditure in connection with an investigation, regulatory action, or expenditure spent on defending proceedings.
Consequences of non-compliance
Under s.157J CO, criminal sanction may be imposed on those who breached the prohibitions in s.157H CO. However, the criminal sanction will be replaced by only civil consequences upon the New CO taking effect. Pursuant to s.513 New CO, the transaction or arrangement in breach of ss.500 – 503 New CO will be voidable at the company’s choice unless:
1. restitution is no longer possible;
2. the company has been indemnified of loss; or
3. the other person (not being a connected entity) who entered into such transaction did so in good faith.
Subject to s.513(4) New CO, parties benefited from such prohibited transactions may be liable to account to the company for any gain that he or she has made, directly or indirectly, by transaction or arrangement and indemnify the company for any loss or damage resulting from the transaction or arrangement.
Conclusion
The abovementioned prohibitions are what directors should pay attention to lest they should get themselves into trouble. This is especially important as some of the prohibitions apply not only to listed companies but also to private companies. While directors of public companies may be well advised by professional legal advisers or company secretaries, those of private companies may not be aware of the change of law in this area. You are always advised to seek professional advice in case of doubt.
For enquiries, please contact our Corporate & Commercial Department:
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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.
