A recent decision by the Court of First Instance confirms the ability of minority shareholders to obtain an order for inspection of documents under Section 740 of the Companies Ordinance (Cap 622) to investigate into potential corporate mismanagement.

The recent case Re Bank of East Asia Ltd HCMP 125/2015 (Court of First Instance, 5 June 2015, before Judge Harris) demonstrates how five minority shareholders (the plaintiffs) of Bank of East Asia Ltd (BEA) successfully obtained an order against BEA for inspection of documents under Section 740 of the Companies Ordinance (Cap 622) to investigate into suspicions of corporate mismanagement by BEA's board.

Background

BEA issued a public announcement on 5 September 2014 stating that it had entered into a non-binding memorandum of understanding with Sumitomo Mitsui Banking Corporation (SMBC) to subscribe for shares representing approximately 9.53% of BEA's issued share capital (the subscription). The plaintiffs corresponded with BEA to express their concern that the proposed subscription did not appear to have any genuine economic need and caused BEA's board to engage Goldman Sachs to evaluate the proposed subscription. BEA's board subsequently passed a resolution on 12 February 2015 approving the original decision to enter into the subscription and the subscription was completed on 27 March 2015. The plaintiffs remained sceptical as to whether the subscription was in the best interest of BEA. Thus, the plaintiffs proceeded with the originating summons, which was issued on 16 January 2015, for an order from the court for disclosure and inspection of documents relating to the subscription under Section 740 of the Companies Ordinance and Section 41 of the High Court Ordinance. That said, in practice the plaintiffs’ application was framed and presented to the court as an application under Section 740 of the Companies Ordinance only. The key issues considered were

• whether the plaintiffs’ application for inspection was for a 'proper purpose' pursuant to Section 740 of the Companies Ordinance, and
• the effect, if any, of the confidential nature of the documents sought.

Proper purpose

Under Section 740 of the Companies Ordinance, the court has the discretion on the application of five or more shareholders, or shareholders representing 2.5% in value of the voting rights, to order inspection of a company's records or documents if it satisfied that:

• the application is made in good faith, and
• the inspection is for a proper purpose.

The 'good faith’ and 'proper purpose' criteria are two separate and independent tests. The plaintiffs were required to first show that they were acting in good faith. The court must then believe the circumstances are such that the inspection sought was for a proper purpose. In order to establish that the inspection of BEA's documents was for a 'proper purpose', the plaintiffs were required to demonstrate:

• a 'purpose' relevant to a shareholder's economic interest in BEA, and
• a sufficiently reasonable case for investigation as regards past or future wrongful or undesirable conduct.

The subscription was a major decision involving the dilution of the voting rights of existing shareholders. The court held that BEA's board did not consider the subscription adequately, as BEA did not hold a board meeting to discuss the subscription until five months after its original decision and BEA's board did not consider the impact of the dilution effect on shareholders’ interests in BEA. The plaintiffs’ investigation into the potential breach of fiduciary duty by BEA's board was a 'proper purpose' for granting the inspection of BEA's documents.

Confidentiality

BEA argued that the confidential nature of the documents was a sufficiently strong consideration for rejecting the plaintiffs’ inspection of BEA's documents. Although the court accepted confidentiality was an important consideration, it did not accept BEA's argument in this case and explained that any concern about confidentiality could be addressed by the plaintiffs’ undertakings on the use of documents.

Obiter

Under Section 41 of the High Court Ordinance, the court has the discretion to order disclosure of documents against parties likely to be a party to subsequent proceedings before the commencement of those proceedings. In this case, the court commented that Section 740 of the Companies Ordinance had a broader scope than Section 41 of the High Court Ordinance and that most (if not all) applications under Section 41 of the High Court Ordinance, if successful, would satisfy the requirements under Section 740 of the Companies Ordinance. The reverse, however, was not true – applications within the ambit of Section 740 of the Companies Ordinance would not necessarily fall within the scope of Section 41 of the High Court Ordinance. The key difference between the two provisions is that minority shareholders can rely on Section 740 of the Companies Ordinance to require disclosure of a company's documents without having to demonstrate proceedings are likely to be commenced or commenced against the person whom inspection would be sought.

Implications

This case reveals Section 740 of the Companies Ordinance as a practical tool for minority shareholders to investigate into potential corporate mismanagement and safeguard their economic interests in the company without having to demonstrate the prospect of litigation being pursued. It is clear that the court takes a liberal view on determining what constitutes 'proper purpose' under Section 740 of the Companies Ordinance and is prepared to allow applications for inspection of documents in order to give effect to the Companies Ordinance's underlying legislative intent of protecting shareholder rights and maintaining appropriate standards of corporate governance. Nevertheless, the principles under Section 740 of the Companies Ordinance are limited to their own special sphere and do not alter the requirements or scope for general litigants in obtaining pre-action discovery under Section 41 of the High Court Ordinance. Mark West, Partner; Rudy Chung, Partner; Kevin Yam, Partner; and Bertha Ng, Solicitor Kennedys Copyright: Kennedys. All rights reserved.