New Hong Kong Companies Ordinance: Directors' benefits - service contracts, loans and payment for loss of office

01 Dec 2013 | Newsletter/briefing

WHEN IN FORCE: 3 March 2014

1. DIRECTORS’ SERVICE CONTRACTS

COMPANIES AFFECTED: All Hong Kong incorporated companies

NEW PROVISIONS: Part 11, Division 4 of new CO: ss530-535

SUMMARY OF CHANGES

Prohibition

  • before a company agrees to grant a director a service contract which employs the director for longer than three years (the "extended service provision"), the company must receive prior written shareholder approval (in a prescribed manner)
  • if the company is a public company, disinterested shareholders’ approval is required

Prescribed manner for shareholder approval

  • in order for the shareholder approval to be valid:
    • the shareholder approval must be given before the company agrees to the extended service provision
      a memorandum setting out the proposed service contract (including the extended service provision) must be sent to every shareholder
  • if a director’s service contract with an extended service provision is entered into in contravention of the above, the extended service provision will be void and the company may terminate the service contract at any time by giving reasonable notice

Scope

  • the prohibition extends to service contract terms that a director of a company may agree to perform for a subsidiary, as well as for the company itself

2. LOANS TO, QUASI-LOANS TO, AND CREDIT TRANSACTIONS FOR DIRECTORS

COMPANIES AFFECTED: Principally Hong Kong incorporated companies

Non-Hong Kong incorporated companies may also be affected if they are controlled by the director for whom the prohibited transaction is entered into.

NEW PROVISIONS: Part 11, Division 2 of new CO: ss491-515

SUMMARY OF CHANGES

Prohibition

  • loans: as under the existing legislation, the new CO prohibits a Hong Kong company from making loans to its directors or to directors of its holding company (together, "Directors"), or to Hong Kong incorporated companies controlled by such Directors. The new CO also goes further than the existing legislation by extending these provisions to also apply to non-Hong Kong incorporated companies controlled by such Directors
  • quasi-loans, credit transactions: the new CO extends the prohibition on quasi-loans to (and the giving of guarantee or security for such quasi-loans), and credit transactions for, Directors to all Hong Kong public companies and their subsidiaries ("specified companies"). The prohibition is now broader than under the existing legislation - in particular, the existing legislation does not catch private companies (including those which are subsidiaries of public companies) that are not part of a group which has a listed company as a member (a "listed group")
  • the above provisions in the new CO on specified companies also prohibit quasi-loans to (and guarantees, security and credit transactions for) companies controlled by such Directors, and entities "connected with" such Directors (as defined in s486 of the new CO)
  • as under the existing legislation, the new CO prohibits a Hong Kong incorporated company from arranging an assignment to it, or the assumption by it, of any rights, obligations or liabilities under a "questionable transaction" (being a transaction that, if entered into by the company, would contravene the above prohibitions). Similarly, a Hong Kong incorporated company is prohibited from taking part in any arrangement under which a third party would benefit from the company or its associated company carrying out a questionable transaction

Exemptions

  • under the existing legislation, private companies which are not part of a listed group are exempt from the prohibition on loans (provided shareholder approval is obtained). Under the new CO, all companies (including public companies) will be exempt from the above prohibitions with prior shareholder approval. This exemption requires a new prescribed procedure, under which the company must send to its shareholders a memorandum containing information on the nature of the transaction, the amount of the loan, quasi-loan or credit transaction, its purpose and the extent of the company’s liability. In the case of public companies and their subsidiaries, disinterested shareholders’ approval is required
  • two new exceptions to the prohibitions on loans and similar transactions have been introduced under the new CO:
    • if the aggregate value of the transaction (and any other relevant transaction) does not exceed 5% of the value of the company’s net assets (as determined by the most recent annual financial statements) or 5% of the called-up share capital
    • where the transaction is to provide directors with funds to meet expenditure incurred in defending proceedings, investigations or regulatory actions in relation to the company or an associated company
  • the new CO retains numerous exceptions found under the existing legislation. However, conditions under certain exceptions have been revised, including intra-group transactions, expenditure on company business, transactions that are entered into in the company’s ordinary course of business, home loans and leasing or hiring of goods or land

Remedies

  • under the existing legislation, breach of the prohibitions attracts criminal and civil liability
  • criminal liability: under the new CO, criminal liability is abolished
  • civil liability: under the new CO, the above prohibited transactions are voidable at the company’s instance unless:
    • restitution is no longer possible
    • the company has been indemnified for loss
    • an innocent third party (other than the director, his controlled body corporates or connected entities) has acquired rights which would be affected by the avoidance
    • the transaction has been affirmed by the company
  • this is different from the existing position: the existing legislation provides that any prohibited guarantee or security provided by a company is unenforceable against the company (unless the person to whom the guarantee was given or the security was provided did not know the relevant circumstances). The transaction itself is not invalidated under the existing legislation
  • as under the existing legislation, the director of the company or of the holding company for whom the company has entered into the prohibited transaction (the "Relevant Director") and any other director who knowingly authorised such transaction will be liable to account to the company for any gain made and indemnify the company for any loss from the transaction
  • the new CO extends this liability to the following persons, subject to certain defences:
    • a body corporate controlled by the Relevant Director or an entity connected with the Relevant Director (unless such body corporate or connected entity was not aware of the circumstances constituting the contravention)
    • the director of the company concerned (or of the holding company of the company concerned) who controls such a body corporate or with whom such an entity is connected (unless such director has taken all reasonable steps to secure the company’s compliance)

3. PAYMENT FOR LOSS OF OFFICE

COMPANIES AFFECTED: All Hong Kong incorporated companies

NEW PROVISIONS: Part 11, Division 3 of new CO: ss516-529

SUMMARY OF CHANGES

Prohibition

  • under the existing legislation, a company is prohibited from making any payment to a director or former director by way of compensation for loss of office or as consideration for retirement from office unless the particulars of the payment are disclosed to and approved by the shareholders
  • the new CO goes further than the existing legislation by extending the prohibition to cover: (i) payment to an entity connected with the director; (ii) payment to a person made at the direction of, or for the benefit of, the director or an entity connected with the director; and (iii) payment by a company to a director of its holding company
  • the prohibition is subject to a number of exemptions, including prescribed approval by shareholders. The prescribed manner for shareholder approval is similar to the one described above for the approval of a director’s service contract (ie prior shareholder approval and the circulation of a memorandum setting out the particulars of payment). Disinterested shareholders’ approval is required for public companies
  • any payment for loss of office made in contravention of the new CO will be held on trust for the company by the recipient and any director who authorised the payment will be liable to indemnify the company for any loss resulting from the payment

De minimis exception

  • the new CO provides for a de minimis exception if the payment for loss of office does not exceed $100,000

Contacts

Peter Brien (partner), Lisa Chung (partner), Peter Lake (partner)


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