In this first of a series of articles by the Companies Registry looking at the reforms introduced by the new Companies Ordinance, Ada Chung, Registrar of Companies, and Karen Ho, Deputy Principal Solicitor, Companies Registry, highlight the major changes introduced to enhance corporate governance and modernise the law.

T he commencement of the new Companies Ordinance (NCO) on 3 March 2014 marks a new chapter in the company law of Hong Kong. The NCO, which was passed in July 2012, aims to achieve four main objectives, namely, enhancing corporate governance, facilitating business, ensuring better regulation and modernising Hong Kong's company law. The NCO (Cap 622) replaces those provisions in the old Companies Ordinance (Cap 32) governing the formation and operation of companies, which are repealed upon the commencement of the NCO. The provisions of Cap 32 which are not repealed relate mainly to prospectuses and insolvency. These remain in Cap 32 which has been renamed the Companies (Winding up and Miscellaneous Provisions) Ordinance. This article aims to set out some of the major changes introduced by the NCO to enhance corporate governance and modernise the law. The next article in this series will look at the major changes introduced to facilitate business and ensure better regulation.

1. Enhancing corporate governance

With the aim of enhancing corporate governance, the NCO introduces the major initiatives outlined below.

Strengthening the accountability of directors

There were provisions in Cap 32 prohibiting all public companies, as well as private companies which are members of a group of companies of which a listed company is a member, from appointing a body corporate as their director. There was no restriction for other private companies. The NCO requires, on top of these restrictions, that private companies must have at least one director who is a natural person. There were no provisions on directors’ duty of care, skill and diligence in Cap 32 and the common law position in Hong Kong in this respect is not entirely clear. The standard of the duty in old case law, which focuses on the knowledge and experience which a particular director possesses (the subjective test), is considered too lenient nowadays. In the light of overseas developments, the NCO introduces a statutory statement to provide clear guidance to directors. The new provision stipulates that a director must exercise reasonable care, skill and diligence, and sets out a mixed objective and subjective test in the determination of the standard. The objective test looks at the general knowledge, skill and experience that may reasonably be expected of a person carrying out the functions of the director in question.

Enhancing shareholder engagement in the decision-making process

To enhance the rights of shareholders, the expenses of circulating members’ proposed resolutions for annual general meetings (AGMs), and members’ statements relating to the proposed resolution or other business to be dealt with at AGMs, will be borne by the company if the required threshold for requests are met and the requests to circulate such documents are received in time for sending with the notice of the relevant meeting. Cap 32 provided that anything which might be done by a company by resolution in a general meeting might be done by a written resolution signed by all members without convening a meeting. However there were no statutory rules on proposing or passing a written resolution. The NCO provides the procedures for proposing, passing and recording written resolutions. A company's articles may set out alternative procedures for passing a resolution without convening a meeting, provided that the resolution is agreed to by the members unanimously. Under Cap 32, a poll would be called for if the demand is made by not less than five members, members representing not less than10 percent of the total voting rights, or members holding not less than 10% of the total paid-up share capital of the company carrying the right to vote at the meeting. The threshold for demanding a poll is lowered from 10 percent to 5 percent of the total voting rights under the NCO. The threshold of five members is retained but the threshold based on the total paid-up capital is removed.

Improving the disclosure of corporate information

The NCO requires public companies and companies not qualified for simplified reporting (details of the simplified reporting provisions will be covered in the next article in this series) to prepare a more comprehensive directors’ report which includes an analytical and forward-looking 'business review’, whilst allowing private companies to opt out from the requirement by a special resolution. The review should contain, for example, information relating to environmental and employee matters that have a significant impact on the company. The new requirement is in line with the international trend on integrated reporting.

Modifying the headcount test

The 'headcount test’, pursuant to which a majority in number of the members present and voting is required to pass a resolution to approve a scheme involving a takeover offer or general offer to buy back shares (including a privatisation scheme), is replaced under the NCO by a new requirement that the number of votes cast against a resolution to approve such a scheme must not be more than 10 percent of the votes attached to all disinterested shares. 'Disinterested shares’ basically means shares held by non-interested parties. For other members’ schemes, the headcount test is retained, with a new provision giving the court a discretion to dispense with the test where appropriate. To address the concern that minority shareholders are reluctant to challenge a scheme in court because of the potentially substantial legal costs, it is provided that a dissenting member might be ordered to pay legal costs only if his or her opposition to the scheme is frivolous or vexatious.

Fostering shareholder protection

To avoid potential conflict of interests, Cap 32 prohibited a company from entering into loans or other similar transactions with a director. For a listed company or a private company that is within the same group as a listed company, the reference to 'director’ was extended to cover persons or corporations closely associated with a director. The NCO expands the prohibition to cover a wider category of entities connected with a director. In the case of a 'specified company’, that is, a public company or a private company or company limited by guarantee that is a subsidiary of a public company, the prohibition also covers, among others, an adult child, a parent, a cohabitee, a minor child of the cohabitee who lives with the director and an associated body corporate. The NCO also introduces a requirement for members’ approval of any longterm employment of a director, so as to minimise the risk that a director may entrench himself in office. It provides that the approval of members must be obtained for any contracts under which the guaranteed term of employment of a director with the company exceeds or may exceed three years. Except for some specified transactions (most of which relate to the purchase or redemption of a company's own shares), there was no provision in Cap 32 restricting members’ rights to vote or requiring members to abstain from voting on transactions in which they have an interest. In the NCO, there is a new requirement for disinterested members’ voting for connected transactions, namely, in considering if the relevant resolution is passed, every vote in favour of the resolution cast by interested members would be disregarded. The requirement is applicable to a 'specified company’ for various prohibited transactions. Lastly, the scope of the 'unfair prejudice' remedy is extended to cover proposed acts and omissions, so as to remove the uncertainty as to whether a member can bring an action for unfair prejudice where a course of action is only at the proposal stage, or where there is only a threat to do or not to do something. The remedies that may be granted by the court are also extended to cover an order restraining the proposed act or requiring the doing of an act that the company has proposed not to do.

2. Modernising the law

To modernise the law, the NCO introduces the major initiatives outlined below.

Rewriting the law in simple and plain language

The Companies Ordinance rewrite exercise has modernised the language and rearranged the sequence of some of the provisions in a more logical and user-friendly order, so as to make the NCO more readable and comprehensible. Under the current drafting convention, the NCO is written in simple and plain language.

Abolishing the memorandum of association

The memorandum of association has been abolished for all companies. For existing companies, the conditions in the memorandum are deemed to be contained in the articles of association, except for conditions relating to authorised share capital and par value, which are regarded to be deleted for all purposes. For companies which apply to be incorporated under the NCO, they need to submit their incorporation form and articles of association only. In addition to the mandatory articles required for every company, companies may choose to adopt all or any of the provisions of the model articles prepared for the type of companies to which they belong. These model articles are set out in the Companies (Model Articles) Notice (Cap 622H).

Abolishing par value

In line with international trends, the opportunity has been taken to migrate to a mandatory no-par regime for all companies. As a result, relevant concepts such as 'authorised share capital’, 'share premium’ and 'nominal value' no longer exist. Retiring the concept of par value creates an environment of greater certainty, simplifies accounting entries and gives companies greater flexibility in structuring their share capital.

Streamlining the types of companies

The types of companies that can be formed under the NCO have been streamlined:

• unlimited companies without share capital are abolished
• companies limited by guarantee, whether private or non-private, are categorised as a separate type of company, and
• a definition for 'public company’, that is a company other than a private company or a company limited by guarantee, has been introduced.

The five types of companies that can be formed under the NCO are:

1. public company limited by shares
2. private company limited by shares
3. company limited by guarantee without share capital
4. public unlimited company with share capital, and
5. private unlimited company with share capital.

Clarifying the rules on indemnification of directors

There were no provisions in Cap 32 regulating a director's right to be indemnified against liabilities to third parties. The case law in this area is rather difficult for directors to understand. In particular, the scope of the right of directors to be indemnified against liabilities to third parties is not clear. The rules on indemnification of directors against third parties are clarified under the NCO. With the exception of certain liabilities and costs (such as fines and penalties), a company is permitted to indemnify a director against liabilities to a third party if the specified conditions are met.

3. Looking forward

The NCO brings the legal framework for the incorporation and operation of companies in Hong Kong in line with modern international standards, and ensures that the infrastructure of Hong Kong's company law will continue to best serve the needs of Hong Kong as an international commercial and financial centre. It also reinforces Hong Kong's competitiveness as a place to do business. To prepare all parties for the change, the Companies Registry has sent circular letters to over one million companies on the register to announce the commencement of the NCO, highlighting the major changes. From January 2014, a dedicated hotline has been set up to answer enquiries relating to the NCO. Comprehensive information about the NCO is available at the 'New Companies Ordinance' section on the Companies Registry's website at www.cr.gov.hk. We aim to achieve a smooth transition to the new regime for all concerned. Ada Chung, Registrar of Companies, and Karen Ho, Deputy Principal Solicitor, Companies Registry Ada Chung is a Fellow of ICSA/ HKICS. Next month the Companies Registry will look at the changes introduced under the new Companies Ordinance to facilitate business and ensure better regulation. For enquiries, email: cr.nco@cr.gov. hk, or call the Companies Registry new Companies Ordinance hotline: 3142 2822 (available Monday to Saturday 9:00 a.m. to 8:00 p.m. excluding public holidays). Copyright: Companies Registry