Will a Shareholder’s Failure to Serve Adequate Notice on the Company Result in Dismissal of His Application to Commence Statutory Derivative Action?

Chung Keng v Pearl Oriental Oil Ltd [2018] HKCFI 2564

In a Court of First Instance case Chung Keng v Pearl Oriental Oil Ltd [2018] HKCFI 2564, it was argued that the leave application by a shareholder to commence statutory derivative action should be dismissed because of the shareholder’s failure to set out his “reasons for that intention” required under s. 733(4)(b) of the Companies Ordinance (Cap. 622) (“CO”), as only one out of the five complaints set out in the draft statement of claim (“SOC”) was stated in a written notice served earlier.

In September 2018, a registered shareholder (the “Applicant”) sent a letter stated to be a formal written notice under s. 733 CO (“Notice”) to the subject company (the “Company”) that the Applicant intended to apply for leave to commence statutory derivative action in the name of the Company against two of its directors (“Two Directors”).

The draft SOC subsequently filed by the Applicant mentioned five complaints in relation to the conducts or omissions of the Two Directors said to constitute breaches of their duties owed to the Company. The Company argued that the leave application should be dismissed for non-compliance with the requirement under s. 733(4) that the Notice must state in full the reasons for the intention to apply for leave because only one of the five complaints was stated in the Notice.  The Applicant argued that the Notice was adequate, as he had stated in the Notice that the Two Directors were acting in breach of their duties owed to the Company. The complaints, i.e. the various acts and/or omissions of the Two Directors, are merely particulars and do not constitute “reasons for that intention” under s. 733(4).

At issue were:

  1. whether the Notice was adequate in respect of the four complaints that had not been set out; and
  2. if not, whether dispensation with service of a notice should be granted for the four complaints.

It was held that:

  1. Notice was inadequate

The purpose of a notice under s. 733(4) is to allow the Company to consider what to do with the complaints stated therein. The Notice must set out sufficient details and particulars of each of the complaints. Such details are part and parcel of the reasons required to be given in a notice under s. 733. What constitutes sufficient details and particulars is a question of fact in each case. In considering the adequacy of a notice under s. 733(4), one should apply the test of whether the directors of the Company, as reasonable commercial persons with their knowledge of the Company’s affairs, would be in a position to make a proper and informed decision on how to respond when reading the Notice.

In the present case, only one out of the five complaints was set out in the Notice. The Company was not in a position to consider how to respond at all. The Applicant’s bare assertion of breach of duties without reasons does not suffice as “reasons for that intention” required under s. 733(4). Therefore, the Notice was inadequate for leave sought to commence statutory derivative action for the four complaints not mentioned in the Notice.

  1. Service of notice dispensed with

The Court decided to exercise its discretion under s. 733(5) to grant leave to dispense with the service of a notice for the four complaints not stated in the Notice. Firstly, under s. 733(3), the Company was given 14 days to consider whatever complaints the Applicant had. It was not the Company’s case that had such an adequate notice setting out all five complaints been given, the Company would have agreed to take action against the Two Directors itself, thus rendering a leave application by the Applicant unnecessary.

Furthermore, the question that the Court should consider in exercising its discretion is whether, in all the circumstances, including the intended purpose of the Notice and any likely prejudice or wastage of costs in granting or refusing dispensation, it was just to grant dispensation. Although the draft SOC containing details of all the complaints had been duly served on the Company 22 days before the present hearing, there was no response from the Company. The Applicant’s failure to give full details of the four complaints in the Notice was thus immaterial.

It would also be a waste of time to dismiss the leave application for all complaints except for one and start the whole process afresh. No prejudice would be caused to the Company in granting the dispensation as it was still open to the Company to agree to take action directly.

 Senior Partner, ONC Lawyers