The Securities and Futures Ordinance (Cap. 517) (SFO) specifically empowers the Hong Kong Securities and Futures Commission (SFC) to apply to Hong Kong courts a disqualification orders against directors of companies whose shares are listed on The Stock Exchange of Hong Kong Limited.
The period of disqualification in Hong Kong can be up to fifteen years, depending on the severity of the misconduct. The disqualified person is prohibited from participating in the management, promotion, or formation of any company during the disqualification period. If a disqualified director breaches the order, it may result in a fine, imprisonment, or both. In Hong Kong, Director Disqualification Orders play a crucial role in regulating corporate governance and protecting the interests of investors, stakeholders, and creditors.
Section 214 of the SFO provides that:
(1) Where, in relation to a corporation which is or was listed, it appears to the Commission that at any relevant time the business or affairs of the corporation have been conducted in a manner:-
(a) oppressive to its members or any part of its members;
(b) involving defalcation, fraud, misfeasance or other misconduct towards it or its members or any part of its members;
(c) resulting in its members or any part of its members not having been given all the information with respect to its business or affairs that they might reasonably expect; or
(d) unfairly prejudicial to its members or any part of its members,
the Securities and Futures Commission may, subject to subsection (3), by petition apply to the Court of First Instance for an order under this section.
(2) If, on an application under this section, the Court of First Instance is of the opinion that the business or affairs of a corporation have been conducted in a manner described in subsection (1)(a), (b), (c) or (d), whether through conduct consisting of an isolated act or a series of acts or any failure to act, the Court may—
(d) order that a person wholly or partly responsible for the business or affairs of the corporation having been so conducted shall not, without the leave of the Court—
- be, or continue to be, a director, liquidator, or receiver or manager of the property or business, of the corporation or any other corporation; or
- in any way, whether directly or indirectly, be concerned, or take part, in the management of the corporation or any other corporation,
for such period (not exceeding 15 years) as may be specified in the order;
Reference can be made to the Schedule to the SFO and the common law, which provide further clarifications to a number of the terms used in section 214 of the SFO. For instances:
Section 214(1)(b): “Defalcation”, is defined under s.214(1)(b) in SFO Schedule 1 Part 1 to mean “misapplication, including misappropriation, of any property”.
Section 214(1)(b): “Misapplication” in this sense includes any disposition of the company’s property which by virtue of (inter alia) any rule of general law the company or the board is forbidden or incompetent or unauthorised to make, or which is carried out by the directors otherwise than in accordance with their duties in good faith to promote the success of the company and for proper purposes.
Section 214(1)(b): “Misfeasance”, which is defined under SFO Schedule 1 Part 1 to mean “the performance of an otherwise lawful act in a wrongful manner”.
Section 214(1)(c): “Other misconduct” covers a wide range of misconduct and is likely to be a “belt and braces” catch-all.
Section 214(1)(c): This may include failure to disclose a personal interest in a material transaction involving the company or causing the company to issue an announcement which is false or misleading in one or more material particulars.
Section 214(1)(d): “Unfairly prejudicial” conduct which refers to conduct which results in harm to the members of the company which could either have been avoided or ameliorated without harming the legitimate interests of others who were parties to the particular transaction.
On 22 May 2023, the Hong Kong Court of First Instance ordered that (i) Mr. Joseph Lau (a former executive director of Luxey International (Holdings) Limited (Luxey)), for a period of 8 years; and (ii) Mr. Eric Chung (a former executive director of Luxey) that for the period of 5 years, each shall not without the leave of the court, be or continue to be, a director, liquidator, receiver or manager of the property or business, of any listed or unlisted company in Hong Kong; and (b) in any event, whether directly or indirectly, be concerned, or take part, in the management of any listed or unlisted company in Hong Kong
Luxey was listed on GEM on 7 July 2000. The petition concerned Luxey’s attempt to acquire Ratio Knitting Factory Limited (Ratio), which initially did not proceed in 2010 as it was originally intended, and subsequently proceeded a few months later in 2011 in the form of Luxey acquiring the entire shareholding of Ratio through owning another entity.
The SFC’s complaints:
- Mr. Lau utilised nominees who acted on his instructions, to first acquire the entire share capital of Ratio at the price of HK$50.1 million.
- He then caused the Big Good Management Limited (Big Good) (company controlled by his nominees) to resell its interest in Ratio to Luxey at a substantially higher price of HK$390 million to sell Ratio to Luxey at a drastically increased price.
- The profit which Big Good made from the two transactions, namely the difference between the price for which Big Good acquired Ratio and the price paid by Luxey when it is sold to Luxey, or at last part of such profits, were held by Big Good on behalf of Mr. Joseph Lau. Joseph Lau thus obtained a profit and/or benefit from the Scheme.
- In using nominees to carry out the scheme, Mr. Joseph Lau sough to conceal his secret profit and/or material interest in the two transactions.
The SFC’s case is based on the fact that Messrs. Joseph Lau and Eric Chung owed fiduciary duties to Luxey, including –
- a duty to act honestly and in good faith in the interests of Luxey;
- a duty to exercise powers only for proper purposes;
- a duty not to place themselves in a position where their interests may conflict with those of Luxey;
- a duty not to obtain undisclosed profit through their position as directors; and
- a duty to disclose any misconduct on their part to Luxey.
The SFC also contended that they both owe a duty of care at common law to exercise the level of reasonable care, skill and diligence which would be exercised by a reasonably diligent person with –
- The general knowledge, skill and experience that may reasonably be expected of a person carrying out the functions carried out by the director in relation to the company; and
- The general knowledge, skill and experience that the director has, by reference to Mr. Lau’s position as Chairman of Luxey, and Mr. Chung’s position as Chief Executive Officer and Compliance Officer of Luxey at the material time.
The SFC submitted an alternative pleaded case – whereby if the court were to find that there was no scheme in the acquisition and onward sale of Ratio, and that no nominees were engaged, the SFC contended that both Messrs. Lau and Chung breached section 214 of the SFO on the basis that, among others, Mr. Lau placed himself in a position of conflict; and both Messrs. Lau and Chung for failure to disclose the conflict of duties and the relevant circumstances of Big Good’s acquisition of Ratio to Luxey shareholders.
The court found on a balance of probabilities, based on the aspects of the facts examined, Mr. Joseph Lau engaged nominees in the Scheme. It was considered that the remarkable aspects of the facts and circumstances raised an overwhelming case to answer, whereas on the basis of the facts proven or found, the inference of the existence of the Scheme is more probable than not.
Indeed, the Court went further and found that when the facts are viewed as a whole, the only reasonable inference to be drawn was that Joseph Lau had directed and controlled Big Good’s acquisition of Ratio, had financed the transaction or a significant part of it, with the intention that Ratio be resold to Luxey in a short span of time, with Big Good netting a very substantial profit, over at least part of which Joseph Lau had effective control.
The case highlights the severe consequences of a disqualification order. The draconian consequences of a disqualification order serve not only as a deterrent, but also a good reminder to directors and senior management staff of the serious consequences of breaching their fiduciary duties to their companies. Directors and members of senior management should not commit any misconduct or carry out any scheme for purpose of deceiving the company and its shareholders, they should also be cautious of any suspicious misconduct of other senior management staff and/or directors, whereby failure to enquire proactively, report to the board of directors, and/or failure to disclose or cause the company to publish false statements, may also result in disqualification orders against them.
YTL LLP is a law firm headquartered in Hong Kong, China. This article is general in nature is not intended to constitute legal advice.