Wang Pengying (王鵬英) v Ng Wing Fai
Kwan V-P, Cheung and Yuen JJA
9 September 2020, 28 January 2021

P, a shareholder of Convoy Global Holdings Ltd (CG), commenced two common law derivative actions. The claim in HCA 1479/2018 related to the fact that between February and October 2016, Forthwise International Ltd (FI), a wholly owned subsidiary of CG, advanced an aggregate loan of HK$90 million to one Forthwise Ltd. The claim in HCA 1619/2018 related to the fact that in January 2016, Convoy Finance Ltd (CF), another wholly owned subsidiary of CG, agreed to purchase the entire shareholding of Maxthree Ltd from another company (the Maxthree Share Transaction). N had been appointed as a director of CG in 2015. Following a joint operation by the Securities and Futures Commission and the Independent Commission Against Corruption, certain other directors of CG were arrested in 2017 and some new directors including Y were appointed to reconstitute the Board of Directors from December 2017. P alleged that N had breached his director’s fiduciary duties to the two subsidiaries by causing them to enter into the two impugned transactions which were not bona fide in the best interests of the companies, and that Y was a knowing recipient or dishonest assistor in the Maxthree Share Transaction. The Judge struck out the claims and dismissed both actions on the basis that P had failed to meet the locus standi requirements of establishing a prima facie case that: (i) N and Y were in control of the Board of Directors of CG or had control at the shareholder level (the Wrongdoer in Control Requirement); or (ii) there had been a fraud practised by them against FI and CF (the Fraud on the Minority Requirement). In respect of the latter, the Judge followed the line of English authorities affirmed by its Court of Appeal in Harris v Microfusion 2003-2 LLP [2017] 1 BCLC 305 (Microfusion) and held that mere negligence or even gross negligence without fraud or personal benefit to the alleged wrongdoer was not sufficient; and that there was no basis for suggesting any fraud, dishonesty or personal benefit. P appealed, arguing inter alia that: (i) in relation to control on the board level, the Judge had failed to consider the circumstances in which the directors of the reconstituted Board were appointed, and the directors had not explained how they had reached their independent judgment regarding the impugned transactions; (ii) in relation to control on the shareholder level, the Judge should not make it an additional requirement that the controlling shareholders would vote to insulate N from legal action, but in any case this was satisfied; and (iii) in relation to fraud on the minority, Microfusion was wrongly decided, but in any case P was able to show a prima facie case of deliberate and dishonest breach of duty.

Held, dismissing P’s appeals, that:

(Per Kwan V-P, Cheung and Yuen JJA agreeing on the Wrongdoer in Control Requirement)

Burden and threshold requirements

1) It was incumbent on P to show that the proposed claims in the derivative actions fell within an exception to the rule in Foss v Harbottle, here the “fraud on the minority” exception. To show locus standi, P had to establish a prima facie case that: (i) there was a viable cause of action or equitable claim vested in the company; (ii) the cause of action if made good would establish a fraud on the minority; and (iii) the wrongdoers were in control of the company such as to enable them to stifle any proposed action against themselves (Waddington Ltd v Chan Chun Hoo (2008) 11 HKCFAR 370 applied; Foss v Harbottle (1843) 2 Hare 461 referred to). (See paras.32–34.)

Wrongdoer in Control Requirement

2) The key issue concerning the Wrongdoer in Control requirement was whether CG was being improperly prevented from bringing proceedings, as prevention by “an appropriate independent organ” would not amount to improper prevention. P had to show that the wrongdoers were in “effective as opposed to legal control” of CG’s activities. P had failed to do so and accordingly her appeals would be dismissed (Ronald Li-kai Chu v Deacon Te-ken Chiu [1986] HKLR 1011, Smith v Croft (No 2) [1988] Ch 114 applied). (See paras.40, 50.)

3) In relation to control on the board level, there was no basis to interfere with the Judge’s assessment of the evidence. P’s forensic points about the circumstances of appointment of the new directors had not been raised previously and were unsupported by evidence. Further, the Judge appeared to have taken these circumstances into account and P had not adduced evidence to contradict N’s evidence that independent directors had been appointed to reconstitute the Board as part of CG’s efforts to strengthen its management and conduct investigations alongside the regulatory authorities. (See paras.43–47.)

4) As for control on the shareholder level, there was similarly no basis to interfere with the Judge’s findings. It had not been alleged that N controlled the controlling shareholders, or that they were complicit in or had benefitted from N’s alleged breaches of duty. The purported status of N as an associate or nominee of the controlling shareholders was not sufficient. (See paras.48–49.)

Fraud on the Minority Requirement

5) (Obiter) While it was not strictly necessary to consider the Fraud on the Minority Requirement, the true test in Hong Kong for that requirement is that set out by Yuen JA in her judgment in this case. The essence of that test is that a dissenting minority of shareholders cannot pursue a derivative action in defiance of an effective and binding decision by a corporate organ. As to what constitutes an effective and binding corporate decision, three issues have to be considered: (i) whether the company has the capacity to make the decision; (ii) whether the relevant corporate organ (often the general meeting) has the authority to make the decision; and (iii) whether that authority has been properly exercised, which issue is a form of equitable restriction requiring discretionary powers to be exercised bona fide and for proper purposes (Daniels v Daniels [1978] Ch 406 considered; Abouraya v Sigmund [2014] EWHC 277 (Ch), Harris v Microfusion 2003-2 LLP [2017] 1 BCLC 305 not followed). (See paras.50–66.)

6) P’s alternative position that there was a prima facie case of deliberate and dishonest breach of duty was not made out. The subjective test of dishonesty was applicable as on the available evidence, it could not be said that N had failed to give any actual consideration to whether the impugned transactions were in the interests of the companies. Nor could it be irresistibly inferred that there was fraud or dishonesty. At most, there may be a prima facie case for negligence (Extrasure Travel Insurances Ltd v Scattergood [2003] 1 BCLC 598, Re ‍HLC ‍Environmental Projects Ltd (in liq) [2014] BCC 337, Kwok Hiu Kwan v Convoy Global Holdings Ltd (HCMP 900/2018, [2018] HKEC 2068) applied). (See paras.67–74.)

(Per Yuen JA, Kwan V-P agreeing on the obiter comments regarding the Fraud on the Minority Requirement)

Fraud on the Minority Requirement

7) (Obiter) Where a plaintiff does not allege actual fraud, but some other breach of duty, the true test for whether the Fraud on the Minority Requirement is met is whether there has been (or would likely be) a misuse of the majority’s voting power to release the directors from their breach (the Voting for Proper Purpose Test). A plaintiff has to establish a prima facie case that the shareholders’ vote was not or would not be a bona fide exercise of their voting power. It may reasonably be assumed that a director in breach would, when voting as a shareholder, vote to exonerate himself, and hence his power to vote would not be exercised bona fide for the proper purpose. Whether that could be ascribed to other shareholders forming the majority who are not themselves in breach of duty would depend on the facts, including whether there is evidence that they had voted or would vote simply as the directors directed (Allen v Gold Reefs of West Africa Ltd [1900] 1 Ch 656, Anglo-Eastern (1985) Ltd v Karl Knutz [1988] 1 HKLR 322 applied). (See paras.84–85, 87.2–88.)

8) (Obiter) The Voting for Proper Purpose Test, inter alia, preserves the principle that a company is entitled to make its own decisions, so long as its decision-making organ is acting lawfully under company law. By contrast, the “personal benefit to wrongdoers” requirement in Microfusion should not be adopted as it does not achieve the purpose of enabling a company to redress a wrong when it should be entitled under company law to choose to do so and is too restrictive in principle and in practice. Personal benefit was instead an important factor which informed the Voting for Proper Purpose Test (Pavlides v Jensen [1956] Ch 565, Estmanco (Kilner House) Ltd v Greater London Council [1982] 1 WLR 2 considered; Harris v Microfusion 2003-2 LLP [2017] 1 BCLC 305 not followed). (See paras.85–87.1, 89.1–90.)

Appeals

These were two appeals by the plaintiff in common law derivative actions against the orders of Coleman J in the Court of First Instance, striking out the plaintiff’s statement of claim in each action and dismissing the two actions (see [2019] HKEC 4107).

Jurisdictions: