Hong Kong court grants leave under new Companies Ordinance to bring unfair prejudice proceedings by way of derivative action

In Yu Yuchuan & Ors v China Shanshui Investment Company Limited (HCMP) 360/2015, Hong Kong's Court of First Instance granted leave to minority shareholders of Shanshui Investment Company Limited (Shanshui) to bring unfair prejudice proceedings in the name of the company, by way of statutory derivative action pursuant to sections 732 and 733 of the Companies Ordinance (Cap 622).

This is one of the first decided cases under the new regime in the Companies Ordinance. In addressing its application and scope, the case provides welcome clarity to minority shareholders contemplating unfair prejudice actions in the face of mismanagement.

Background

Section 732 allows a member of a company, with leave of the court, to bring proceedings on behalf of the company in respect of any 'misconduct' committed against the company. Section 733 sets out the circumstances in which the court may grant leave for the purposes of section 732.

The applicants in this case, who together held approximately 17.44% of the issued share capital in Shanshui, sought leave to bring proceedings against China Shanshui Cement Group Ltd (Cement) (in which Shanshui holds shares), Zhang Sr and his son Zhang Jr (directors of both Shanshui and Cement) and a recent corporate investor in Cement. The applicants made three broad claims to demonstrate the necessary 'misconduct', each relating primarily to the conduct of Zhang Sr and Zhang Jr and their dealings with Cement's shareholdings. These dealings were allegedly not in Shanshui's best interests, particularly due to the consequential dilution of its shareholding. Shanshui, acting under the 'control' of Zhang Sr and Zhang Jr, opposed the application.

Procedures available and threshold tests

The case contains a helpful overview of the procedures available to shareholders under the new Companies Ordinance when confronted by instances of mismanagement. In particular, it provides a clear commentary and guide to the appropriate process and necessary threshold tests to be met in an application for leave of the court to bring proceedings under sections 732 and 733. These are:

1.  An application for leave to pursue proceedings will be successful if the applicant shows that: (1) there is a serious question to be tried; and (2) it is in the company's interests to bring the proceedings. Usually, if a 'serious question to be tried' has been demonstrated then the proceedings are also likely to appear to be in the company's interests. There is no need to resolve conflicts of evidence or difficult questions of law at this stage.

The court considered that these criteria were satisfied in this application on the basis that the company directors' involvement in instigating a share issue and share options scheme may have been for improper purposes and not in the interests of the company, given the dilution of the company's strategic shareholdings and suggestion of personal motives.

2.  The 'proceedings' available under section 733 to deal with the 'misconduct' contemplated under section 732, including for breach of directors' duties, can include unfair prejudice proceedings, although it depends on the circumstances of each case whether an unfair prejudice petition is the appropriate redress for a breach of fiduciary duty.

3.  It is preferable that a draft petition fully sets out the case that an applicant is seeking leave to pursue. However, further amendment to that petition will not necessarily undermine the application or mean that a 'serious question to be tried' has not been established.

4.  Whilst it is also possible for shareholders to bring a derivative action at common law, a statutory derivative action is the preferable avenue for redress given that it is subject to the court's leave and with the wide discretion afforded to the court under the Companies Ordinance (Cap 622) to make orders to cure unfair prejudice and mismanagement. This is reinforced by section 733(2)(a) which provides that a court may refuse an application if a shareholder has also brought proceedings at common law in respect of the same cause or matter.

The minority shareholders in this application brought parallel proceedings at common law and, as such, the court's leave was granted on the condition that their common law action was withdrawn.

The above guidance should assist minority shareholders in assessing their legal options. That said, due to the nature of the threshold tests, such cases will continue to largely turn on their own facts.