Filter
Back

Will a shareholder’s failure to serve adequate notice on the company result in dismissal of his application to commence statutory derivative action?

2019-02-01

Introduction

Section 732 of the Companies Ordinance (Cap. 622) (the “CO”) allows a member of a company, with leave of the Court, to bring proceedings on behalf of the company in respect of any misconduct committed against the company. Under s.733(3) of the CO, a member of a company must serve 14 days’ written notice on the company of his intention to apply for leave to commence a statutory derivative action under s.732, and under s.733(4)(b) must set out the “reasons for that intention” in the written notice. The rationale of this notice requirement is to give the directors of a company a chance to consider a response to the complaints set out in the notice. If the subject company is willing to pursue the complaints on its own, a leave application by the shareholder will become redundant, meaning that no further legal costs will be incurred or wasted in dealing with the issue of whether leave ought to be granted.

In a recent Court of First Instance case Chung Keng v Pearl Oriental Oil Ltd [2018] HKCFI 2564, a company argued that the leave application by a shareholder to commence a statutory derivative action should be dismissed because of the shareholder’s failure to set out his “reasons for that intention” required under s.733(4)(b), as only one of the complaints set out in his draft statement of claim was stated in the written notice served earlier.

Facts

In September 2018, the applicant, a registered shareholder of the subject company (the “Applicant”), sent a letter which was stated to be a formal written notice under s.733 of the CO (the “Written Notice”) to the subject company (the “Company”) that the Applicant intended to apply for leave to commence a statutory derivative action in the name of the Company against two of its directors (the “Two Directors”). The Company has not replied to the Written Notice.

Subsequently, the Applicant filed an Originating Summons exhibiting a draft statement of claim to apply for leave. The draft statement of claim mentioned five complaints in relation to the conducts or omissions of the Two Directors which are said to constitute breaches of fiduciary and statutory duties of the Two Directors owed to the Company. Four out of his five complaints, such as the Two Directors’ failure to settle the outstanding wages of the employees and refusal to convene a Special General Meeting in respect of resolutions to remove existing directors, were not set out in the Written Notice.

The Company argued that the leave application should be dismissed for non-compliance with the requirement under the CO. The requirement under s.733(4) is that the notice must state in full the reasons for the intention to apply for leave, but only one of the Applicant’s five complaints set out in the draft statement of claim was stated in the Written Notice.

On the other hand, the Applicant argued that the Written Notice was adequate, as he had stated in the Written Notice that the Two Directors had been acting in breach of their duties owed to the Company. The complaints, i.e. the various acts and/or omissions of the Two Directors, are merely particulars and do not constitute “reasons for that intention” under s.733(4) of the CO.

The Court considered two major issues:

1.          whether the Written Notice was adequate in respect of the four complaints not being set out therein; and

2.          if not, whether a dispensation with the service of a notice ought to be granted in this case for the four complaints.

The Court’s Decision

The adequacy of notice under s.733(4)

The Court held that the Written Notice was inadequate. The purpose of a notice under s.733(4) of the CO is to allow the Company to consider what to do with the complaints stated in the Written Notice. Therefore, the Written Notice must set out sufficient details and particulars of each of the complaints. Such details are part and parcel of the reasons required to be given in a notice under s.733. What constitutes sufficient details and particulars is a question of fact in each case. In considering the adequacy of a notice under s.733(4), one should apply the test of whether the directors of the Company, as reasonable commercial persons, with their knowledge of the Company’s affairs, would be in a position to make a proper and informed decision on how to respond when reading the Written Notice.

In the present case, only one out of the five complaints was set out in the Written Notice. The Company was simply not in a position to consider how to respond at all. The Applicant’s bare assertion of breach of fiduciary and statutory duties without reasons does not suffice as “reasons for that intention” required under s.733(4) of the CO. It was therefore held that the Written Notice was inadequate in so far as the Applicant is seeking leave to commence a statutory derivative action for the four complaints not mentioned in the Written Notice.

Discretion to dispense with the service of notice under s.733(5)

Although the Written Notice was held to be inadequate, the Court decided to exercise its discretion under s.733(5) of the CO to grant leave to dispense with the service of a notice for the four complaints not stated in the Written Notice for several reasons. Firstly, under s.733(3) of the CO, the Company was given 14 days to consider whatever complaints the Applicant had. It was not the Company’s case that had such an adequate notice setting out all five complaints of the Applicants been given to the Company, the Company would have agreed to take action against the Two Directors itself, thus rendering a leave application by the Applicant unnecessary.

Furthermore, the question that the Court should consider in exercising its discretion is whether, in all the circumstances, including in particular the intended purpose of the Written Notice and any likely prejudice or wastage of costs in granting or refusing dispensation, it was just to grant dispensation. Whilst the draft statement of claim containing details of all the complaints had been duly served on the Company 22 days before the present hearing for the leave application, there was no response from the Company. The Applicant’s failure to mention and to give full details of the other complaints in the Written Notice was thus immaterial in the present case.

In addition, it would be meaningless and a complete waste of time to dismiss the leave application for all complaints except for one and start the whole process afresh. In the meantime, no prejudice would be caused to the Company in granting the dispensation. It is still open to the Company to agree to take action on the complaints directly.

Conclusion

This case provides welcome guidance to a shareholder contemplating statutory derivative actions in the face of mismanagement of the company by its directors. A shareholder must serve an adequate written notice setting out details of all his complaints in the written notice of his intention to commence a statutory derivative action to the subject company, failing which his leave application may be dismissed by the Court. Nevertheless, the shareholder’s failure to provide adequate written notice will not be fatal to his leave application, as the Court will grant dispensation of such notice if it is just to do so. The nature of the tests in determining the adequacy of such notice and whether it is just to grant dispensation, as discussed above, means that the Court’s findings largely turn on the facts of the case.

  

For enquiries, please contact our Litigation & Dispute Resolution Department:

E: insolvency@onc.hk                                   T: (852) 2810 1212
W:
www.onc.hk                                             F: (852) 2804 6311

19th Floor, Three Exchange Square, 8 Connaught Place, Central, Hong Kong

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 © 2019

 

Our People

Ludwig Ng
Ludwig Ng
Senior Partner
Eric Woo
Eric Woo
Partner
Ludwig Ng
Ludwig Ng
Senior Partner
Eric Woo
Eric Woo
Partner
Back to top