Tuesday, June 14, 2011

Hong Kong High Court Imposes Fiduciary Duty on Company Directors in Issuing New Shares

The Hong Kong High Court has ruled that company directors have a fiduciary duty, when deciding whether or not, and in what manner, to embark on an issue of new shares, to have regard to the interests of shareholders, and to exercise the power in a way that is fair to different groups of shareholders. Further, the directors, as fiduciaries, should take into account relevant factors and exclude from consideration irrelevant factors. While a court should not set itself up as a tribunal to which disgruntled litigants can appeal against the commercial decisions of the board of directors, noted Justice Barma, this does not exclude the possibility that the court can and should inquire into the manner in which the decision was reached. If it can be established that the decision was reached with no consideration at all for a clearly relevant factor, noted the court, it should be subject to challenge. In the Matter of Esun Holdings Limited, Action No. 2722, June 8, 2011.

Justice Barma said that this inquiry does not contravene the principle that the court should not substitute its own judgment for the business judgment of the directors. If it is shown that the directors have taken account of the relevant factors, and have not acted for improper purposes, noted the court, the weight that they choose to assign to the various factors which they properly take into account is a matter for them, and not something with which the court should concern itself. Justice Barma also noted that the consequences of this approach are not as drastic as might at first appear, provided that it is borne in mind that the consequences of a breach of this fiduciary duty are not that the exercise of the power is void, but that it is voidable.

Thus, the court held that the effect of the failure by the directors to comply with their fiduciary obligations in exercising the power to issue shares in the company was that the placement was voidable, and not void. To have voided and set aside the decision of the board and the placing agreement entered into in consequence of it would have interfered with the rights of the placees under the placement, said the court, when there is no basis for thinking that they were aware of any defect in the processes of the company when it decided to enter into the placement. The placees would not have known of the way in which the board meeting proceeded, so as to be aware that the directors had failed to give any real consideration to the economic impact of the placement on company’s shareholders.