We are sometimes asked questions from individuals who are about to be appointed as directors of a Hong Kong company, or from those who are currently in that position. These questions include: is there a specific procedure to approve a director’s package? Are there circumstances where a director is liable to pay the company’s debts? What are a director’s responsibilities? How can a director protect their risks? Similarly, shareholders may ask questions such as: what information am I entitled to about the company’s business?
This article addresses such questions by sharing a framework for understanding these highly relevant issues with reference to both old and recent common law cases, as well as hard and soft laws in Hong Kong.
The law in this respect is complex. Please note that this article does not, and is not intended to, constitute legal advice, and should not be relied upon as such. Slotine can assist with your corporate governance projects, such as an internal assessment of your Hong Kong holding and affiliates’ compliance processes, and sale-side or buy-side due diligence for M&A. Contact us if you wish to learn more about this.
Role of directors
Requirements:
In Hong Kong, a private company may have a sole director or a group of directors – also known as a board of directors. Directors may be individuals or corporate entities of any nationality or place of incorporation, without the need to be residing in Hong Kong. The only requirement is that the sole director, or at least one director if there are multiple directors, must be an individual.
Activities and responsibilities:
Directors, whether as a board or sole director, are officers of the company – both individually and collectively responsible for governance. This includes setting strategic goals, providing the leadership necessary to put these goals into effect, supervising the day-to-day management of the business and reporting to shareholders on their stewardship.
Powers and restrictions:
Directors are empowered to act on a company’s behalf by:
- the company’s articles of association
- the Companies Ordinance (Cap. 622) (CO)
- common law
- certain resolutions of its members, shareholders agreements or board policies.
The same documents may contain restrictions of the directors’ powers.
Indoor management rule and the requirement for adequate and updated delegations
Individuals transacting with companies are entitled to assume that internal company rules are complied with, even if they are not in actuality. This rule has been incorporated in section 117 of the CO, with restrictions in sections 118 and 119. However, directors acting on behalf of the company who disregard internal company limitations may be held responsible by the company. Hence, it is essential to have a delegation policy and review of its implementation, especially regarding bank authorisations or contract signing arrangements.
Compliance milestones:
The CO also governs directors’ actions in making important decisions, handling the company’s day-to-day management and annual financial statements. Failure to comply with the required milestones below are offences in the CO, incurring fines and imprisonment in extreme cases. They are also likely to result in noncompliance with a company’s obligations in relation to the Inland Revenue Department regarding the filing of profits tax returns supported by annual financial statements.
Annual obligations of a director
On an annual basis, directors are required to fulfil several obligations, including but not limited to:
- ensuring the company maintains its accounting records;
- preparing the directors’ report and providing the information required within the financial statements; and
- presenting the financial statements to the company at the annual general meeting within nine months of the end of the financial year.
Record decisions made by directors
- sole directors and boards of directors shall keep records of their decisions in the appropriate format, which is by minutes of a meeting or written resolutions for decisions circulated for signatures. The company secretary may assist with the drafting of minutes for sensitive subject matters (see below for some examples of pitfalls);
- minutes of meetings or written resolutions should be kept for ten years.
Compass
Fiduciary duties of a company’s director:
Directors have a fiduciary relationship with the company, holding a unique position of trust and confidence. Their fiduciary duties can be summarised in three points:
- Act in good faith for the benefit of the company.
- Exercise power for a proper purpose.
- Avoid conflicts between their interests and their duties.
Statutory duty of care, skill and diligence:
The responsibilities of a director are not limited to their role as a fiduciary – they must also exercise reasonable care, skill and diligence. These duties were established by common law and codified in section 465 of the CO.
Pitfalls
Directors should have a good understanding of the principles presented above as their compass. They should also be aware of specific provisions that require formal compliance. We have selected two of the most frequently encountered pitfalls as an example. Please note that the following list is not exhaustive.
Director’s remuneration:
There are two pitfalls to be aware of regarding directors’ remuneration: the determination and the disclosure requirements in financial statements.
Determination: Except when a director’s term of employment is guaranteed for three years or more, the CO does not require members’ approval for the director’s term of employment. However, the model articles for private company limited by shares in schedule 2 of the CO states that directors’ remuneration must be determined by the company at a general meeting. As such, any company incorporated with the model articles in force since 3 March 2014 will be subject to this rule. Typically, the board obtains a mandate from the shareholders to authorise the board to fix the directors’ remuneration.
Depending on a company’s specific situation, other approvals may be necessary. For example, it is market practice that key employees’ packages are reviewed by the remuneration committee of the board before their approval, possibly with a specific majority requirement (i.e. including the favourable vote of certain board members nominated by investors).
Disclosure: Directors’ emoluments and any other payments in cash or kind to directors or a service company for their services, as well as any director’s material interests in their company’s dealings, must be disclosed in the notes to the financial statements.
Directors conflicted on matters to be decided by the board of directors:
There are three pitfalls to be aware of regarding directors’ conflicts of interest: declaration, decision and disclosure.
Declaration: The CO strictly regulates the obligations of a director to declare any material interest in contemplated operations of the company to the other board members. However, the CO does not regulate how the decision must be made. The rules for the decision are left to the company’s articles of association.
Decision: According to the model articles for private companies limited by shares in Schedule 2 of the CO, a director who has declared an interest to the other directors under section 536 of the CO is neither counted for quorum nor vote on the said matter.
Disclosure: the nature and extent of a director’s interest in a transaction, arrangement or contract shall be disclosed to members of a company and included in the financial statements, to reflect a true and fair view of the company’s financial position.
Consequences of failure to comply with duties
Hong Kong law has a strong arsenal of potential actions against directors who fail to comply with their duties. For directors to protect their liability, corrective measures should be implemented as soon as possible to mitigate the consequences for both the company and themselves.
The list comprises actions:
- at the initiative of shareholders;
- at the initiative of other board members;
- at the initiative of the Department of Justice, subject to prosecution by the relevant authorities (e.g., the Companies Registry, the Labour Department, the Official Receiver’s Office).
Prosecution of offences in the CO is neither systematic nor exceptional in Hong Kong. The Companies Registry website shares examples of cases where directors have been convicted and fined for:
- failure to comply with their duties when requested to register a new member (HK$25,000);
- failure to file annual returns and have a registered office in Hong Kong (HK$60,000);
- failure to comply with a direction given by the register of companies requiring the company to appoint at least one director and at least one director who is a natural person, or failure to notify the resignation of the sole director within the required 15 days (HK$60,000);
- failure to convene annual general meetings of companies. In this example, four directors were prosecuted and convicted for failing to take all reasonable steps to lay before the companies at respective annual general meetings, profit and loss accounts and balance sheets for the period since incorporation or since the preceding accounts made up to date failing more than nine months before the relevant date of the annual general meeting (HK$4,000 to HK$6,000 for each charge failure to hold the annual general meetings and HK$10,000 to HK$12,000 for each charge of failure to lay accounts at the annual general meetings, amounting to a total fine of HK$576,000 on the four directors).
Understanding the role and responsibilities as a company director in Hong Kong ensures that your company can maintain compliant with local laws and regulations, protect the interests of your company, and fulfil your duties effectively. Knowing the potential pitfalls and prosecutions under the CO can help mitigate risks and uphold good governance practices.
If you need help or advice regarding your responsibilities as a company director, get in touch with us today.
