Civil Liability of Directors, Shareholders and Senior Management in Hong Kong Liquidation Proceedings

1. Introduction

The winding up of insolvent companies in Hong Kong is governed by the Companies (Winding Up and Miscellaneous Provisions) Ordinance (Chapter 32 of the Laws of Hong Kong) (“CWUMPO”), the Companies (Liquidation) Rules (Chapter 32H) (“CWUR”) and case law. They constitute the legal source of the civil responsibilities of directors, shareholders and senior management.

2. Directors

In Hong Kong, the Companies Ordinance (Cap 622) (“CO”) does not provide for the notion of “legal representative” in Hong Kong. Instead, a director is responsible for the day-to-day management of a company and subject to legal obligations as a director in Hong Kong’s liquidation proceedings.

2.1. General duties of directors

The CO imposes a general duty on directors to exercise reasonable care, skill and diligence.1 According to the English cases of West Mercia Safetywear Ltd v Dodd2 and MacPherson v European Strategic Bureau Ltd3, when a company is insolvent, its directors are required to take into consideration, in particular, the interests of creditors and not to prejudice the interests of creditors. These English cases were cited with approval by the Hong Kong court in Tradepower (Holdings) Ltd v Tradepower (HK) Ltd.4

2.2. Duties of directors in the event of liquidation

After the court issues a winding-up order and a provisional liquidator is appointed for an insolvent company, the Office of the Official Receiver requires its directors to:

  • Deliver to the provisional liquidator the assets, books and registers of the company and the seal of the company;5
  • Present at the office of the provisional liquidator to provide information on the assets and transactions of the company;
  • Continue to co-operate with the (provisional) liquidator and properly exercise its functions as administrator until the conclusion of the liquidation; and
  • Inform the (provisional) liquidator immediately if he changes his address.6

Under the CWUMPO, directors must submit a sworn statement of affairs of the company to the provisional liquidator within 28 days of the appointment of the provisional liquidator or the date of the winding-up order, as the case may be.7 In addition, the CWUR requires directors to attend meetings of creditors and contributors.8

If the directors fail to fulfill their obligations above, the Office of the Official Receiver may bring criminal charges and disqualification actions against them under the CWUMPO and CO.

2.3. Directors’ Civil Liability

If a director fails to exercise reasonable care, skill and diligence, he may be subject to civil action under common law rules and rules of equity.9 For example, in Moulin Global Eyecare vs. Olivia Lee,ten the liquidators of an insolvent company sued the directors for breach of fiduciary duty and the duty of care and skill.

The above types of claims do not limit other civil liabilities under other parts of the OC or under the CWUMPO,11 as we will see below.

Under the CWUMPO, a company would be deemed to have given an unfair preference to a person if:

  • He is a creditor of the company, or stands surety or guarantor of the debts or commitments of the company;
  • He is, by reason of the company’s act, placed in a better position than he would otherwise be if the company goes into insolvent liquidation;
  • The business has a desire to place him in a better position (this desire is presumed if the unfair preference is given to an associate of the business); and
  • The unfair preference takes place during the relevant legal periods, i.e. two years (if an unfair preference is given to a person connected with the company (other than solely by reason of being its employee)) or six months (in all other cases of an unfair preference) ending on the day the liquidation of the company begins.12

The director responsible for causing unjust prejudice is responsible for the fault.

The CWUMPO defines the following transactions as undervalued if they occur within five years of liquidation, and are made when the company is insolvent or result in the insolvency of the company:

  • Gifts offered without consideration in return; and
  • Transactions concluded for an amount significantly lower than their value.13

If a director is responsible for the undervalued trades, they may be held liable for fault unless they can demonstrate that:

  • The Company entered into the transaction in good faith and for the continuation of the Company’s business; and
  • There are reasonable grounds to believe that the transaction would benefit the company.14

If a business conducts business with the intent to defraud its creditors or the creditors of any other person (or otherwise for any other fraudulent purpose), all parties knowingly involved (including directors) may become personally liable for debts and Company’s commitments without limitation under the CWUMPO.15 Claim against persons who were knowingly parties to the operation of the business in the above manner may be brought by the official receiver, or the liquidator or any creditor or contributor to the company.16 In Aktieselskabet Dansk Skibsfinasiering against Robert Brothers,17 the directors of an insolvent company were prosecuted for fraudulent transactions and the court held that the test of fraudulent intent was subjective. This means that the people involved must indeed be dishonest.

If the company drew on its capital to repurchase or repurchase shares in the year preceding liquidation, the directors (who signed the declaration of solvency in support of the repurchase or repurchase) would be jointly and severally liable with the former shareholders for the amount deducted from the company’s capital.18

2.4. Civil damage assessment

Section 276(1) of the CWUMPO applies where a “specified person” in the process of being wound up:

  • Misapplied, withheld, became responsible or liable for any money or company property; or
  • Has been guilty of any wrongdoing (such as 2.3.2 and 2.3.3 above), breach of duty or breach of fiduciary duty (such as 2.3.1 above) in relation to the insolvent company.

In such cases, the court may (at the request of the receiver, the liquidator or any creditor or contributor):

  • Examine the conduct of this “specified person”; and
  • Compel that “specified person” to repay or return the money or property with interest, or pay compensation as the judge deems just.19

A “specified person” is broadly defined to include an officer of the company.20 The CWUMPO expressly provides that a director is an “officer”.21 Therefore, the directors are subject to the court’s assessment of civil damages under section 276(1).

3. Senior management

Under liquidation, the liability of officers is similar to that of directors due to the scope of liability under the CWUMPO.

Executives are also “specified persons” under section 276 of the CWUMPO because:

  • The definition of “director” in Article 2(1) also includes managers; and
  • In any event, section 276(1A)(d) extends section 276(1) to any person “who is or has been concerned with, or takes or has taken part in, the promotion, training or to the management of the company”.

Therefore, if senior executives have been found guilty of misconduct due to their involvement in unfair preferences (as in 2.3.2 above) and undervalued transactions (see 2.3.3 above) , the court may also review their conduct and order them to reimburse, restore and indemnify the company under section 276 of the CWUMPO.

In addition, if senior executives are knowingly involved in fraudulent transactions, they may be personally liable for the company’s debts and liabilities without limitation under Section 275 of the CWUMPO. In the case of Aktieselskabet Dansk Skibsfinasiering against Robert Brothers,22 in the first instance, a creditor of the company brought civil actions not only against the directors, but also against the managing director and the secretary of the company.

4. Shareholders

During the liquidation of an insolvent company, the shareholders (who are neither the directors nor the managers of the company) have a very passive role.

However, as mentioned in 2.3.5 above, in the event of redemption of shares or redemption of capital in the year preceding the dissolution, the shareholders concerned are mainly required to contribute the amount deducted from the capital by the company .23

If shareholders receive benefits or property from their bankrupt company (as part of an undervalued transaction or fraudulent trade discussed above), they may be required to pay that amount back to the company because these transactions are void and the court can order the shareholders to do so.24 Once the petition for liquidation is filed, any subsequent transfer of company shares or change in shareholder status is also void, unless the court orders otherwise.25

5. Closing

In summary, the directors and senior management of an insolvent company are subject to similar civil liabilities in connection with the liquidation proceedings in Hong Kong under the CWUMPO and the CWUR. Shareholders should also exercise caution and refrain from entering into certain transactions when they anticipate or know that their company is insolvent and is going to be liquidated in Hong Kong.

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