Protecting minority shareholders - Different actions for different wrongs

Thursday | 5 September 2013

Corporate governance is based on majority rule, which although efficient, allows for possible abuse by the majority. The law has therefore provided various methods for the protection of minority shareholders. These methods are highly fact-sensitive and minority shareholders are reminded to choose the correct method for addressing the specific problems they face.

Like any collective organisation which makes decisions through its constituent members, corporate governance relies on majority rule heavily. While efficient, such reliance inevitably gives rise to the temptation of abuse, and it is therefore crucial that there are safeguards to protect shareholders who only hold a minority stake in a company. The law has therefore provided an array of remedies available through different procedures, to protect the rights of minority shareholders. Each procedure is appropriate for a different situation. Minority shareholders must therefore be aware of the problem they are facing, and seek recourse through the appropriate channel. Broadly speaking, under the existing legal framework, there are five main channels of recourse available to protect minority shareholders’ rights. These protect minority shareholders by ensuring accountability on the one hand and transparency on the other.

Protections available under the existing legal framework

1. Unfair prejudice petition

Where a minority shareholder's interest has suffered prejudice, one common method of redress is to make an unfair prejudice petition. This is provided for under Section 168(A)(1) of the Companies Ordinance (Cap 32). The minority shareholder provisions referred to in this article are those in the existing Companies Ordinance (Cap 32), but these have been carried over and in some cases extended in the new Companies Ordinance (Cap 622). See 'Changes brought by the new Companies Ordinance' on page 24 for information on the minority shareholder provisions of the new Companies Ordinance.

Under Section 168(A)(1), a member who complains that the affairs of the company are being, or have been conducted, in a manner unfairly prejudicial to the interests of the members generally, or of some part of the members (including himself), may make such a petition to the court for relief. The crucial requirements under Section 168A are that the relevant conduct must relate to the affairs of the company and the conduct must be both prejudicial and unfair. The test is of unfair prejudice, not of unlawfulness, and the relevant interests are the interests of members.

The situations where such a petition is commonly made include:

where a minority shareholder previously participating in the management of the company has been excluded from management
mismanagement of the company by the directors
where a majority shareholder takes steps to dilute or restrict the voting rights of a minority shareholder, and
alteration of articles beyond any bona fide purposes and so on.

Under such a petition, the court has wide remedial relief (although there is no jurisdiction to grant an order for winding up). The usual remedy is a buy-out orderfor one party to buy out the shares of the other. It must be borne in mind, however, that this petition is not meant to provide a means for a 'no-fault’ divorce: a minority shareholder cannot rely on this petition as a means of exiting the company, in the absence of any unfairly prejudicial conduct.

2. Just and equitable winding up

Where a buy-out offer is not feasible, or where there is such misfeasance by the directors warranting a full investigation by a liquidator, it is appropriate to petition for just and equitable winding up pursuant to Section 177(1)(f) of the Companies Ordinance. There are no fixed categories or headings as to what amounts to 'just and equitable' and the court will invoke the same whenever justice and equity demands. The situations as developed in case law whereby such a petition is justified are very similar to those for unfair prejudice. The commonly known examples where just and equitable winding up is applicable include:

a breakdown of trust and confidence in quasi-partnership
an exclusion from management
a management deadlock, and
the need for an investigation.

However, liquidation is a drastic remedy, so generally speaking where unfair prejudice is available to provide an alternative remedy, the courts will not grant a petition for just and equitable winding up. This is especially where the company is healthy and profitable as a going concern. Hence minority shareholders should be aware that they should not join Section 168A and Section 177(1) (f) in a petition as a matter of course without justification by pleading winding up as an alternative remedy in an unfair prejudicial petition. The courts generally speaking discourage such practice. In some cases, the majority shareholders may even succeed in striking out the winding-up prayer (and get a costs order against the minority shareholders as petitioner) by persuading the courts that, taking the complaints at their highest and given the fact that the company is profitable and healthy, the only appropriate remedy will be a buy-out instead of winding up the company: see

Wong To Yick Wood Lock Ointment Ltd [2003] 1 HKC 484.

3. Derivative action

When a company suffers a wrong, generally it is itself the proper plaintiff to take legal action for redress, rather than the individual shareholders of the company. This is known as the rule in Foss v Harbottle (1843) 2 Hare 461. Yet companies are legal entities separate from their members and they cannot make decisions on their own. Where the majority shareholders in control are those who perpetrated or tolerated the wrongdoing in the first place, a minority shareholder may be forced to stand by without being able to do anything. In such situations, where the minority shareholder has suffered no loss personally but where the company has suffered loss and there is a corresponding diminution in the value of the minority shareholder's shareholding, the appropriate route for remedy is to bring a derivative action. There are now two routes to begin a derivative action, the common law route as an exception to the Foss v Harbottle rule and the statutory route under Section 168BA-BK of the Companies Ordinance which first came into operation in 2005. Although the principles of the two routes are similar, there are some practical differences in terms of requirements and procedures, hence minority shareholders should consult legal advice beforehand since it is inappropriate to proceed a derivative action through the two routes at the same time. They must make a choice, either the common law derivative action or the statutory one.

4. Inspection of books and records

Besides accountability, the other main limb of protection provided to minority shareholders is access to information. Under Section 152FA of the Companies Ordinance which also came into effect in 2005, minority shareholders can seek an inspection order of the company's books and records. Note, however, that this provision does not apply to publicly listed shares held through CCASS. To be eligible to make such an application, the applicants must be:

any number of members representing not less than 1/40 of the total voting rights, or
any number of members holding shares in the specified corporation on which there has been paid up an aggregate sum of not less than HK$100,000, or
not less than five members.

Since, as a general rule, a shareholder has no right of access to books and records of a company, a minority shareholder must be able to show that the application is made in good faith and with proper purpose. These requirements are satisfied if there is a sufficiently reasonable case for investigation, and that the information is required to assist the minority shareholder in his capacity as member of the company. In seeking to understand the good faith and proper purpose test as required by this section, one can obtain some guidance from the case of Wong Kar Gee Mimi v Raymond Hung [2011] 5 HKLRD 241 which was probably the first case to discuss this particular section after it became effective in Hong Kong.

5. Requisition of meeting

Minority shareholders are not only entitled to information from the company if good grounds are shown: they are also entitled to receive information from and impart information to other shareholders. Section 113 of the Companies Ordinance allows members who own 5% of the company's paid up share capital to demand that the directors convene an EGM to discuss any matter notified to them in a written notice. If the directors refuse to call the EGM, the members can convene a meeting themselves after giving proper notice to pass special or ordinary resolutions as necessary. The directors may then have to pay personally the costs of such meeting.

Special challenges posed by foreign companies

A note must be made here as to the special considerations that apply to companies not incorporated in Hong Kong. For petitions for unfair prejudice, applications for inspection of books and records and derivative actions, it must be shown that the company has a 'place of business’ in Hong Kong. For petitions for just and equitable winding up, the court must be satisfied that the company has 'sufficient connection’ to Hong Kong. Technically speaking, it is a three-stage test, as laid down in Re Gottinghen Trading Ltd [2012] 3 HKLRD 453, but the overriding theme is to establish sufficient connection in the broad sense with Hong Kong. Factors such as location of the company's assets, location of its business operations and whether there are any creditors in Hong Kong will be considered. Failure to satisfy these requirements would mean that the court will find that it has no jurisdiction to determine the dispute. This was the main reason why the petitioner lost in the recent shareholder dispute litigation Re Yung Kee Holdings Ltd [2012] 6 HKC 246 (currently under appeal), where an unfair prejudice petition and a petition for just and equitable winding up of unregistered companies were brought.

Conclusion

The situations where a minority shareholder's rights and interests may be infringed are varied. This gives rise to the need for different remedies to cater for different situations. However, if an inappropriate route is adopted, remedy may not be granted at all, and the minority shareholder may even have to bear heavy legal costs. It is therefore advisable to seek professional legal advice at an early stage so as to determine which route is most suitable given a particular set of facts. Richard Leung FCIS FCS(PE), MA, LLB Barrister-at-Law, former HKICS President Kerby Lau BA, BCL Barrister-at-Law