Sherman Yan, Managing Partner and Head of Litigation and Dispute Resolution, ONC Lawyers, reviews a recent Court of First Instance ruling that sends a clear message about the fiduciary duties of non-executive directors and independent non-executive directors.

In the recent case of Miu Hon Kit & Others v The Stock Exchange of Hong Kong Ltd [2020] HKCFI 675, the non-executive directors (NEDs) and the independent non-executive directors (INEDs) of Kong Sun Holdings Ltd (Kong Sun), a company listed on the Main Board of The Stock Exchange of Hong Kong Ltd (the Exchange), applied for judicial review of the decision of the Listing Appeals Committee of the Exchange to impose the sanction of public censure on them. The applications were dismissed by the Court of First Instance (CFI).


The chief operating officer (COO) and the financial controller (FC) of Kong Sun authorised Kong Sun and its subsidiaries (together, the Group) to issue around RMB1.523 billion worth of loans to Zhongke Hengyuan Technology Co Ltd and its subsidiaries (together, the Zhongke Group), without the approval of the board of directors of Kong Sun (the Board), between 26 November 2014 and 15 March 2016 (the Pre-March Loans). The Pre-March Loans were interest free, not secured with collateral and without fixed terms of repayment. In a board meeting on 15 March 2016 (the March Board Meeting), the Board first became aware of the Pre-March Loans – which should have been subject to disclosure and shareholders’ approval requirements as a ‘major transaction’ and an ‘advance to an entity’ – and thereafter instructed the COO, FC and chief financial officer (CFO) of the Group to cease all loans to the Zhongke Group. No other action or disciplinary action was taken to prevent the COO and FC from authorising further loans. The COO and FC did continue to make further loans to the Zhongke Group, in the amount of around RMB84.72 million, again without the Board’s knowledge or approval, between 18 March 2016 and 11 May 2016 (the Post-March Loans). Kong Sun failed to publish either an announcement in respect of the loans, or their financial reports for 2015 and 2016 in a timely manner, and failed to seek shareholders’ approval of either the Pre-March Loans or the Post-March Loans (together, the Loans).

On 21 December 2017, the Listing (Disciplinary) Committee (LDC) of the Exchange found that the INEDs (who also formed the audit committee) and the NEDs of Kong Sun had breached Listing Rule 3.08(f) of the Exchange’s Rules Governing the Listing of Securities (Listing Rules), as well as the directors’ undertaking contained in Part 2 of Appendix 5 to the Listing Rules (Undertakings), by failing to perform their duties as directors with reasonable skill, care and diligence to:

  • use their best endeavours to procure Kong Sun to comply, and themselves comply, with the Listing Rules in relation to: (a) Kong Sun’s breaches with respect to the Loans, and (b) the publication of the financial reports within the specified time limits (Specific Breaches)
  • take sufficient or effective action to stop the COO and FC from authorising further loans to the Zhongke Group after the Board had become aware of the Pre-March Loans (Prevention Failure)
  • ensure that Kong Sun had established and maintained effective and appropriate internal control procedures and risk management systems (ICRM system), particularly when the COO and FC were given immense power over Kong Sun’s operations and funds (Internal Control and Risk Management Failure), and
  • ensure that Kong Sun’s staff had received adequate and appropriate training with respect to the Listing Rules (Training Failure).

As such, the LDC imposed the sanction of public censure on each of the NEDs and INEDs, who then requested a review of the LDC’s decision. On 6 June 2018, the Exchange’s Listing (Disciplinary Review) Committee (LRC) upheld the decision of the LDC. The NEDs and INEDs requested a further review of the LDC’s decision. On 23 January 2019, the Exchange’s Listing Appeals Committee (LAC) also upheld the decision of the LRC and conveyed the same by way of letter, together with a copy of a news release approved by the LAC, to the lawyers of the NEDs and INEDs. The NEDs and INEDs then applied for a judicial review of the LAC decision on the grounds that, among other things: (a) the LAC failed to give adequate reasons for their decision, (b) there was an error of law, and (c) the INEDs and NEDs suffered procedural unfairness.


No failure to give reasons

The INEDs argued that the LAC’s letter had only set out its considerations and its conclusion – there had been no reasoning whatsoever, including the reasoning behind the legal approach to assessing director responsibilities. The CFI concluded that the reasons given by the LAC were proper and adequate, and it considered that the letter and news release sent to the lawyers of the NEDs and INEDs should be treated and read together as constituting the entirety of the reasons for the LAC’s decision. In the news release, it was expressly stated that the LRC upheld the decision of the LDC, and the LAC upheld the decision of the LRC, and thus the CFI considered it to be clear that the LAC must, in the circumstances, have upheld and endorsed the decision of the LDC, including both the findings of breach and the reasons for those findings.

The INEDs argued that the LAC had not engaged the core issues raised by the INEDs, including but not limited to: (1) the INEDs’ duties may be materially different from other members of the Board, and (2) nothing indicated that the Board’s order for the loans to cease would not be carried out or would be ineffective. The NEDs argued that the LAC failed to show it had considered the appropriateness of the sanction, given their different individual knowledge and involvement.

The CFI considered that none of these issues would have affected the LAC’s conclusion and made the following remarks:

  • the INEDs constituted the audit committee, which was specifically responsible for, among other things, reviewing and monitoring the risk management and internal control principles, supervising the ICRM system, and reporting and making suggestions to the Board in relation to any material issues. The degree of care, skill and diligence reasonably to be expected of the INEDs to see that Kong Sun had established and maintained a proper ICRM system was at least as high as, if not higher than, that of the NEDs and executive directors
  • when the Board first learned of the unauthorised Pre-March Loans, any reasonable director should have immediately been concerned with: (i) the recovery of the loans, (ii) prevention of further unauthorised loans, and (iii) investigation of how the unauthorised loans came to be made, along with a review of any deficiencies in the ICRM system, and
  • although the NEDs were not members of the audit committee, their duties as directors must at least include a duty to see that proper ICRM systems were established and maintained. The LDC’s findings that Kong Sun did not have adequate ICRM systems, and that the Board failed to ensure that Kong Sun had established and maintained effective and appropriate ICRM systems, are justified and cannot be faulted.

No error of law

The INEDs argued that the LAC erred in applying hindsight and failing to ask the right questions when assessing whether there was a breach of duty. The NEDs argued that the LAC erred in adopting a collective responsibility approach and in imposing sanctions without considering the individual circumstances of each director.

The CFI did not see that the particular knowledge, skill or experience of the INEDs and NEDs required separate consideration. The Internal Control and Risk Management Failure and the Training Failure were systemic failures, for which all directors were individually responsible, and the Specific Breaches were consequences of those systemic failures. Regarding the Prevention Failure, all directors had the same relevant knowledge at the March Board Meeting. The measures taken by them to prevent the recurrence of further unauthorised loans was so obviously inadequate that no reasonable director could have considered it was sufficient in the circumstances.

The CFI also considered that the absence of written internal control procedures was itself a significant deficiency of Kong Sun’s ICRM systems. The public censure sanction – which serves to punish wrongdoers – alerts investors and communicates to the market that the required standards of conduct imposed on the NEDs by the Exchange cannot be considered as severe.

No procedural unfairness

It was argued that the INEDs and NEDs were never fairly and properly informed of the true allegations against them. The basis of the case against the INEDs and NEDs, as revealed in the Listing Department’s Report (LD Report), were different from the basis of the findings made by the LDC/LRC/LAC.

The CFI analysed the content of the LD Report and considered that there was no procedural unfairness as alleged. In any event, the INEDs and NEDs had full notice of the allegations made by the Listing Committee, and they had challenged the same at the hearings before the LRC and LAC. Each tier involved a new hearing on the merits of their case. Further, the patently inadequate measures adopted by the INEDs and NEDs inevitably led to the LDC/LRC/LAC’s conclusion that they had failed to take sufficient or effective action, or to take any proactive action with heightened awareness, to ensure there would be no further breaches.

Lessons for directors

While it is understandable that (independent) non-executive directors might be uncertain about their duties in a company, the Court has once again reminded them of their role in establishing and maintaining a proper system of internal controls and risk management within the company. As this case demonstrates, delegation of responsibility to senior management does not absolve directors from their responsibilities. Directors should not be a passive or ‘rubber stamp’ board, but should take an active approach to overseeing or rectifying the company’s internal compliance procedures and deficiencies.

Sherman Yan

Managing Partner and Head of Litigation and Dispute Resolution ONC Lawyers

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