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Key changes under the Companies Ordinance (Cap. 622)

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Key changes under the Companies Ordinance (Cap. 622)

1.5. LOANS TO DIRECTORS AND SIMILAR TRANSACTIONS

New CO references: sections 484 to 490, 491 to 515

Section 500 of the New CO prohibits a Hong Kong company from making a loan to, or giving a guarantee or providing security in connection with a loan made by any person to:

  1. its directors;
  2. directors of its holding company (“holdco directors”); or
  3. companies (whether incorporated in Hong Kong or not) controlled by the company’s directors or holdco directors.

The New Ordinance is more stringent than the Old Ordinance in that the prohibitions under the Old Ordinance did not extend to non-Hong Kong incorporated companies controlled by directors.

Specified Companies

More stringent provisions apply to “specified companies” which are Hong Kong public companies and their subsidiaries (including private companies and companies limited by guarantee). Specified companies are additionally prohibited from:

  • making quasi-loans to, and entering into credit transactions as creditors for, directors of the company or its holding company (or providing security for or guaranteeing such quasi-loans or credit transactions); and
  • making loans or quasi-loans to, and entering into credit transactions as creditors for, certain categories of persons connected with directors of the company or its holding company (or providing security for or guaranteeing such quasi-loans or credit transactions).

The prohibitions under the New Ordinance are wider than under the Old Ordinance in that:

  • Under the Old Ordinance, the prohibitions on quasi-loans and credit transactions only applied to private companies and companies limited by guarantee that are members of a listed group. Under the New Ordinance, the prohibitions apply to subsidiaries of all Hong Kong public companies; and
  • The New Ordinance extends the categories of persons connected with company or holdco directors which are covered by the prohibitions.

Prohibition on Quasi-loans

Specified companies are prohibited from:

  • making a quasi-loan to a director of the company or its holding company, or giving a guarantee or providing security in connection with a quasi-loan made by any person to such a director (ss.501(1) and (2)); or
  • making a loan or quasi-loan to an entity connected with a director of the company or its holding company (a “connected entity”), or giving a guarantee or providing security in connection with a loan or quasi-loan made by any person to a connected entity (s.502(1) and (2)).

A company makes a “quasi-loan” to a director or a connected entity if it:

  1. pays or agrees to pay a sum for the director or connected entity:
    1. on terms that the director or connected entity (or another person on their behalf) will reimburse the company;
    2. in circumstances giving rise to a liability on the director or connected entity to reimburse the company; or
  2. reimburses or agrees to reimburse expenditure incurred by another person for the director or connected entity:
    1. on terms that the director or connected entity (or another person on their behalf) will reimburse the company; or
    2. in circumstances giving rise to a liability on the director or connected entity to reimburse the company (section 493(1)).

Connected entity” is defined in section 486 of the New CO as:

  • a spouse;
  • a child, step-child, illegitimate child or adopted child of any age;
  • a parent;
  • a cohabitee;
  • a minor child, minor step-child, minor illegitimate child or minor adopted child of the cohabitee who lives with the director;
  • a trustee of a trust the beneficiaries of which include the director, his spouse, his minor children (other than employee share schemes or pension schemes)(“connected trustee”);
  • an associated company, meaning a company in which the director and/or his spouse, minor children or connected trustee control more than 30% of the voting power of the company; and
  • a business partner of the director or his spouse, minor children or connected trustee.

Prohibition on Credit transactions

Specified companies are prohibited by section 503 from:

  1. entering into a credit transaction as creditor for:
    1. a director of the company or its holding company; or
    2. a connected entity of a director of the company or its holding company; or
  2. giving a guarantee or providing security in connection with a credit transaction entered into by the company as creditor for:
    1. a director of the company or its holding company; or
    2. a connected entity of a director of the company or its holding company.

Credit transaction” is defined under section 494 of the New CO as:

  • the supply of goods under a hire-purchase agreement;
  • the sale of goods or land under a conditional sale agreement;
  • the lease or hire of goods or lease of land to a director or his connected entity in return for periodical payments; and
  • the supply of goods or services or disposal of land to a director or his connected entity on the understanding that payment is to be deferred.

Prohibition on Arrangements seeking to circumvent sections 500 to 503 (s.504)

The New CO retains the previous prohibitions on a company seeking to circumvent the prohibitions under sections 500 to 503.

Section 504 prohibits a Hong Kong incorporated company from:

  1. taking part in any arrangement under which a third party enters into a transaction with a director of the company or its holding company, a company controlled by such a director or a connected entity of such a director which, if entered into by the company, would be prohibited under sections 500 to 503 (a “questionable transaction”) where the third party will obtain a benefit from the company or its associated company; or
  2. arranging for an assignment to it, or the assumption by it, of any rights, obligations or liabilities under a questionable transaction entered into by a third party with a director of the company or its holding company, a company controlled by such a director or a connected entity of such a director.

Exemptions

Shareholder approval

The Old CO exempted private companies which are not part of a listed group from the prohibition on loans provided that shareholder approval was obtained. The New CO has extended the exemption so that all companies, including public companies, are exempt from the prohibitions on loans, quasi-loans and credit transactions if prior shareholder approval is obtained in accordance with section 496 of the New Ordinance. Arrangements and assignments in respect of questionable transactions are also exempt from the prohibitions under Section 504 if prior shareholder approval is obtained.

Section 496 requires that:

  1. the approval must be obtained before the transaction is entered into;
  2. a memorandum setting out the following matters must be sent to all shareholders together with the notice of general meeting, or if the resolution is to be passed as a written resolution, before or at the same time as the resolution is sent to them:
    1. in the case of a loan or quasi-loan:
      • the nature of the transaction to be approved by the resolution;
      • the amount of the loan or quasi-loan;
      • the purpose for which the loan or quasi-loan is required; and
      • the extent of the company’s liability under any transaction connected with the loan or quasi-loan;
    2. in the case of a credit transaction:
      • the nature of the transaction to be approved by the resolution;
      • the amount and value of the credit transaction
      • the purpose for which the goods, land or services supplied, sold, leased, hired or disposed of under the credit transaction are required; and
      • the extent of the company’s liability under any transaction connected with credit transaction; and
    3. in the case of a resolution for the purposes of section 504:
      • the matters that would have to be disclosed if the company were seeking approval of the transaction to which the arrangement relates;
      • the nature of the arrangement to be approved by the resolution; and
      • the extent of the company’s liability under the arrangement.
  3. in the case of specified companies (i.e. public companies and their subsidiaries) disinterested shareholder approval is required.

    Accordingly, the vote of the following members in favour of the transaction will be disregarded:

    1. the director of the company or its holding company to whom the loan or quasi-loan is made;
    2. a company controlled by a director of the company or its holding company to whom the loan or quasi-loan is made;
    3. a person holding shares in the company on trust for a director or controlled company referred to in (i) or (ii) above;
    4. a connected entity to whom the loan or quasi-loan is made;
    5. a director connected with a connected entity in (iv) above;
    6. a person holding shares in the company on trust for a connected entity or director in (v) above;
    7. the director or connected entity for whom a credit transaction is entered into;
    8. the director connected with the connected entity in (vii) above;
    9. a person holding shares in the company on trust for a connected entity or director in (vii) or (viii) above;
    10. a company controlled by, or a connected entity of, a director of the company or its holding company for whom the arrangement is entered into;
    11. a director:
      • who controls the controlled company or is connected with the connected entity referred to in (x) above ;or
      • for whom the arrangement is entered into; and
    12. a person holding shares in the company on trust for a controlled company in (x) above or a director in (xi) above.

Other exemptions

There are certain other exemptions (“other exemptions”) from the prohibition on loans and similar transactions described above which are set out in sections 505 to 512 of the New CO. These include two new exemptions for: (i) transactions with a value below 5% of the net assets of the company or 5% of the called-up share capital; and (ii) expenditure in connection with defending proceedings, investigations or regulatory actions for misconduct (provided the director repays the company if he is found guilty or to have committed the misconduct).

Exemptions are available for the following:

  1. Loans, quasi-loans and credit transactions with a value not exceeding 5% of net assets or called-up share capital (s.505)(New)

    A loan, quasi-loan or credit transaction, or the provision of a guarantee or security for any of the foregoing is exempt if the aggregate of the value of the transaction in question, and the value of any other relevant transaction or arrangement, does not exceed 5% of the company’s net assets or called-up share capital.

  2. Expenditure on company business (s.506)

    A transaction is exempt from the prohibitions under sections 500 to 503 if it is entered into for the purposes of providing the director, a company controlled by the director or a connected entity with funds to meet expenditure (or avoid expenditure) incurred for the purposes of the company or to enable the director, controlled company or connected entity to perform duties as an officer of the company.

  3. Expenditure on defending proceedings (s.507)(New)

    A transaction is exempt from the prohibitions under sections 500 to 503 if it provides a director with funds to meet expenditure incurred in defending any criminal or civil proceedings in connection with any alleged negligence, default, breach of duty or breach of trust by the director in relation to the company or an associated company of the company or to avoid incurring such expenditure.

    The exemption applies subject to the condition that the funds must be repaid (or any liability to the company must be discharged) if the director is convicted or judgment is given against him.

  4. Expenditure in connection with investigation or regulatory action (s.508)(New)

    A transaction is exempt if it provides a director with funds to put up a defence in an investigation, or against any action taken or proposed to be taken, by a regulatory authority in connection with any alleged misconduct by the director in relation to the company or an associated company. The exemption is subject to the condition that the funds must be repaid (or any liability to the company must be discharged) if the director is found to have committed the misconduct.

  5. Home loan (s.509)

    A transaction is exempt if it is entered into for the purposes of:

    1. the purchase of any residential premises for use as the only or main residence of a director of the company; an employee of the company who is a holdco director or an employee of the company who is a connected entity of a company or holdco director;
    2. improving any residential premises so used; or
    3. substituting any transaction entered into by any other person for a purpose in (i) or (ii) above.

    The following conditions apply:

    1. at the time the transaction is entered into, it must not exceed 10% of the value of the company’s net assets as determined by reference to the company’s relevant financial statements or, if no relevant financial statements have been prepared, 10% of the amount of the company’s called-up share capital;
    2. the company must ordinarily enter into transactions for the above purposes on terms no less favourable than those on which the transaction in question is entered into;
    3. a valuation report on the residential premises must be made and signed by a professionally qualified valuation surveyor within 3 months before the date of the transaction; and
    4. the transaction in question must be secured by a legal mortgage on the residential premises.
  6. Leasing goods and land (s.510)

    Leasing or hiring goods or leasing land to a director, a company controlled by a director or a connected entity of a director is exempt if:

    1. the transaction does not exceed 10% of the company’s net assets as determined by reference to the company’s relevant financial statements or, if no relevant financial statements have been prepared, 10% of the amount of the company’s called-up share capital; and
    2. the terms of the transaction are not more favourable than what is reasonable to expect the company to have offered on the open market to a person unconnected with the company.
  7. Transaction entered into in ordinary course of business (s.511)

    A loan or quasi-loan, or giving a guarantee or providing security for a loan or quasi-loan, is exempt if:

    1. it is made, given or provided by the company in the ordinary course of its business; and
    2. its amount is not greater than, and its terms are not more favourable, than what it is reasonable to expect the company to have offered to a person of the same financial standing but unconnected with the company (s.511(1).
      A credit transaction loan, or giving a guarantee or providing security for a credit transaction, is exempt if:
    3. it is entered into in the ordinary course of the company’s business; and

      its amount is not greater than, and its terms are not more favourable, than what it is reasonable to expect the company to have offered to a person of the same financial standing but unconnected with the company (s.511(2).

  8. Intra-group transaction (s.512)

    Transactions between members of a group of companies are exempt from the prohibitions under sections 500 to 503.

Civil consequences of contravention (s.513)

Under the New CO, criminal sanctions no longer apply to breaches of the prohibitions in sections 500 to 504.

If a company enters into a transaction in contravention of these prohibitions, the transaction is voidable at the company’s instance unless:

  1. restitution is no longer possible;
  2. the company has been indemnified for loss resulting from the transaction or arrangement;
  3. a third party (other than the director, his controlled body corporates or connected entities) has in good faith acquired rights for value and without actual notice of the contravention, and those rights would be affected by the avoidance; or
  4. the transaction is affirmed by the shareholders of the company and / or the holding company (as applicable) within a reasonable period after it is entered into in accordance with section 514 of the New Ordinance.

Whether or not the transaction has been avoided, the following persons will be liable to account to the company for any gain made and to indemnify the company for any loss resulting from the transaction or arrangement:

  • a director of the company, or of a holding company of the company, for whom the company entered into the transaction or arrangement;
  • a body corporate controlled by such a director, or a connected entity of such a director, for whom the company entered into the transaction or arrangement;
  • the director of the company who controls such a body corporate or with whom such an entity is connected;
  • the director of a holding company of the company who controls such a body corporate or with whom such an entity is connected; and
  • any other director of the company who authorised the transaction or arrangement.

Defences

The New Ordinance creates the following defences:

  1. For a controlled body corporate or connected entity of a director

    It is a defence if it establishes that, at the time the transaction or arrangement was entered into, it was not aware of the circumstances constituting the contravention (s513(4)(a)).

  2. For the director of the company (and its holding company) who controls the body corporate or with whom the entity is connected

    It is a defence if the director establishes that he took all reasonable steps to secure the company’s compliance with the relevant provisions (s513(4)(b)).

  3. For any other director of the company who authorised the transaction or arrangement

    It is a defence if the director establishes that, at the time the transaction or arrangement was entered into, he was not aware of the circumstances constituting the contravention (s513(4)(c)).

Summary table

The table below summarises the prohibitions on loans and similar transactions to directors and other parties under the New CO.

TRANSACTION (INCLUDES SECURITY OR GUARANTEE IN CONNECTION WITH TRANSACTION): PRIVATE COMPANIES PUBLIC COMPANIES AND SUBSIDIARIES OF PUBLIC COMPANIES (INCLUDING PRIVATE COMPANIES AND COMPANIES LIMITED BY GUARANTEE)
Loans to directors of Hong Kong company or body corporates controlled by those directors Prohibited unless approved by shareholders, or other exemption applies Prohibited unless approved by disinterested shareholders, or other exemption applies
Loans to holdco directors or body corporates controlled by those holdco directors

Prohibited unless approved by shareholders and holdco’s shareholders (if holdco is a Hong Kong company)*, or other exemption applies

Prohibited unless approved by disinterested shareholders and holdco’s disinterested shareholders (if holdco is a Hong Kong company)*, or other exemption applies
Loans to connected entities of directors Not prohibited Prohibited unless approved by disinterested shareholders, or other exemption applies
Loans to connected entities of holdco directors Not prohibited Prohibited unless approved by disinterested shareholders and holdco’s disinterested shareholders (if holdco is a Hong Kong company)*, or other exemption applies
Quasi-loans to directors Not prohibited Prohibited unless approved by disinterested shareholders, or other exemption applies
Quasi-loans to holdco directors Not prohibited Prohibited unless approved by disinterested shareholders and the holdco’s disinterested shareholders (if holdco is a Hong Kong company)*, or other exemption applies
Quasi-loans to connected entities of directors Not prohibited Prohibited unless approved by disinterested shareholders, or other exemption applies
Quasi-loans to connected entities of holdco directors Not prohibited Prohibited unless approved by disinterested shareholders and holdco’s disinterested shareholders (if holdco is a Hong Kong company)*, or other exemption applies
Credit transactions for directors Not prohibited Prohibited unless approved by disinterested shareholders, or other exemption applies
Credit transactions for holdco directors Not prohibited Prohibited unless approved by disinterested shareholders and holdco’s disinterested shareholders (if holdco is a Hong Kong company)*, or other exemption applies
Credit transactions for connected entities of directors Not prohibited Prohibited unless approved by disinterested shareholders, or other exemption applies
Credit transactions for connected entities of holdco directors Not prohibited Prohibited unless approved by disinterested shareholders and holdco’s disinterested shareholders (if holdco is a Hong Kong company)*, or other exemption applies

* Note: Only holdco disinterested shareholder approval required if company is a wholly-owned subsidiary and holdco is a Hong Kong company

Practical considerations and recommended steps

Companies should amend their existing policies and internal controls in respect of loans and similar transactions with directors to ensure that they cover the additional categories of entities (such as non-Hong Kong incorporated controlled entities, and new types of connected entities) that fall within the scope of the prohibitions.

At the same time, some of the new changes are likely to facilitate business for Hong Kong companies, in particular the introduction of new exemptions, and the extension of the shareholder approval exemption to all companies (albeit requiring approval of disinterested shareholders in the case of “specified companies”).

Where a company is seeking shareholder approval for a particular transaction, it must send shareholders a memorandum containing information on the nature of the transaction, the amount of the loan, quasi-loan or credit transaction, its purpose and the extent of the company’s liability.

1.6. DIRECTORS’ SERVICE CONTRACTS

New CO references: sections 530 to 535

The New CO requires a company to obtain shareholder approval before entering into any contract under which the guaranteed term of employment of a director (including a shadow director) with the company exceeds or may exceed three years (whether under the original contract or under a new contract entered into pursuant to it). Where a company enters into a further service contract (not pursuant to a term of the original contract) more than 6 months before the end of the guaranteed term of a director’s contract, the guaranteed term of employment under the further contract is taken to include the unexpired period of the guaranteed term under the original contract.

If the company is a public company, approval of the company’s disinterested shareholders is required. Accordingly, votes in favour of approving a relevant contract of the following categories of shareholders are to be disregarded:

  1. the director with whom the service contract is proposed to be entered into; and
  2. any person holding shares in the company on trust for that director.

In order for the shareholders’ approval to be valid:

  1. it must be given before the company agrees to the relevant provision; and
  2. a memorandum setting out the proposed service contract (including the provision in question) must be sent to shareholders with the notice convening the general meeting, or if the resolution is to be passed as a written resolution, either at or before the time at which the proposed resolution is sent to shareholders.

Consequences of Breach (s. 535)

If a service contract is entered into in breach of these requirements, the provision granting long-term employment will be void and the contract is regarded as containing a term entitling the company to terminate it at any time on reasonable notice. The restrictions also apply to service contracts which relate to services to be provided by a director to a company’s subsidiary.

1.7. PAYMENT FOR LOSS OF OFFICE

New CO references: sections 516 to 529

Section 521(1) of the New CO prohibits a Hong Kong company from making any payment by way of compensation for loss of office or as consideration for retirement from office to a director or former director of the company unless the payment has been approved by the company’s shareholders in the manner prescribed in section 518.

Section 521(2) of the New CO additionally prohibits a Hong Kong company from making any payment by way of compensation for loss of office or as consideration for retirement from office to a director or former director of its holding company unless the payment has been approved by the company’s shareholders and the holding company’s shareholders in the manner prescribed in section 518. However, if a company’s holding company is incorporated outside Hong Kong, the payment need only be approved by the company’s shareholders (s.521(3)(a)).

The New CO extends the prohibition on payments for loss of office to include:

  • a payment to a connected entity (as defined in s486) of a director or former director; and
  • a payment to a person made at the direction, or for the benefit, of a director or former director or a connected entity of such a director (s.516(3))
  • payments made in connection with a transfer of the undertaking or property of the company or of its subsidiary (s.522); and
  • payments made in connection with a transfer of shares in the company, or in a subsidiary of the company, resulting from a takeover offer (s.523).

Shareholder Approval

Where shareholder approval is to be obtained, it must be obtained before the payment for loss of office is made and a memorandum setting out particulars of the payment must be sent to shareholders either:

  1. together with the notice of general meeting at which the resolution will be passed; or
  2. if the resolution is to be passed as a written resolution, before or at the same time as the resolution is sent to shareholders.

Where the payment is made by a public company, disinterested shareholder approval is required.

Exemptions

The prohibitions are subject to the following exemptions:

  1. Exemption for payments in discharge of a legal obligation

    The following payments are exempt:

    1. payments in discharge of an existing legal obligation;
    2. payments by way of damages for breach of an existing legal obligation;
    3. payments by way of settlement or compromise of any claim arising in connection with the termination of a person’s office or employment; and
    4. payments by way of pension for past services; and
  2. Exemption for small payment

    Payments not exceeding $100,000 when aggregated with all other payments for loss of office made by the company or a subsidiary to the director or former director in connection with the same event are exempt.

Consequences of Breach

The recipient of a payment for loss of office that breaches section 521 will hold the relevant amount on trust for the company, and any director who authorised the payment will be liable to indemnify the company for any loss resulting from the payment.

1.8. DISCLOSURE OF INTERESTS

New CO references: sections 536 to 542

Interests to be disclosed

The New CO, like the Old CO, requires a director who has a material interest in a contract or proposed contract with the company that is of significance to the company’s business, to disclose to the board of directors the nature of such interest at the earliest meeting of directors that is practicable.

The scope of disclosure under the New CO is widened to cover “transactions” and “arrangements” as well as “contracts”, and directors must disclose the “extent” as well as the “nature” of the interest (s536(1)).

Directors of public companies are additionally required to disclose material interests of their connected entities (but only if they are aware, or ought reasonably to be aware, of the interest or the relevant transaction, arrangement or contract). Section 540 of the New CO also extends the disclosure requirements to shadow directors and sets out the procedures for a shadow director to provide general notice of his interests.

Directors are not however required to declare their interest in the terms of their service contracts which are to be considered by the board.

If a declaration proves subsequently to be, or becomes, inaccurate or incomplete, the director must make a further declaration.

Procedure for declaration of directors’ interests

Timing

Where a director has an interest in a transaction, arrangement or contract that has already been entered into, his declaration of interest must be made as soon as reasonably practicable. A director’s interest in a proposed transaction, arrangement or contract must be declared before the company enters into the relevant transaction, arrangement or contract.

Method

A declaration of interest must be made:

  1. at a directors’ meeting;
  2. by notice in writing sent to the other directors; or
  3. by general notice.

Where a declaration of interest is to be made by notice in writing to the directors:

  1. it must be sent:
    1. in hard copy form by hand or post; or
    2. in electronic form if the recipient has agreed to receive it by electronic means; and
  2. the making of the declaration will be regarded as forming part of the proceedings at the next directors’ meeting after the notice is given.

A general notice is a notice to the effect that the director:

  1. has an interest in a body corporate or firm specified in the notice and is to be regarded as interested in any transaction, arrangement or contract that is entered into with that body corporate or firm; or
  2. is connected with an individual specified in the notice and is to be regarded as interested in any transaction, arrangement or contract that is entered into with that individual.

A general notice must state:

  1. the nature and extent of the director’s interest in the specified body corporate or firm; or
  2. the nature of the director’s connection with the specified individual.

A general notice given at a directors’ meeting takes effect on the date of the meeting. A general notice may also be given in writing sent to the company in which case it will take effect 21 days after it is sent to the company. The company must send a copy of a director’s written general notice to the other directors of the company within 15 days after it receives the notice (s.541).

Consequences of Contravention

A director or shadow director who fails to disclose a material interest commits an offence and may be liable to a fine of $100,000.

Practical considerations and recommended steps

Directors and shadow directors should be made aware of the new disclosure requirements. In many cases, directors disclose their interests in particular businesses by way of general notice (to avoid the need for repeated declarations). Directors should consider updating any general disclosures in order to ensure that their disclosures comply with the wider disclosure obligations under the New CO.

1.9. RESTRICTING CORPORATE DIRECTORSHIPS IN PRIVATE COMPANIES

References: sections 456 and 457

Position under the Old CO

Under the Old CO, public companies and private companies within the same group as a listed company were prohibited from appointing a body corporate as their director. However, the prohibition did not apply to other private companies.

Key changes under the New CO

Section 456 of the New CO restates the prohibition on corporate directorships for public companies, private companies within the same group as a listed company and companies limited by guarantee. Section 457 now also requires other private companies (other than those within the same group as a listed company) to have at least one director who is a natural person.

Practical considerations and recommended steps

Hong Kong private companies that are engaging corporate secretarial service providers to provide nominee corporate directors need to ensure that at least one natural person is appointed as a director.
 

Skills

Posted on

2014-06-16