What Can The Aggrieved Shareholders Of A Hong Kong Company Do Against Breaches Or Misconducts Done To The Company’s PRC Subsidiary?

As a city strategically located at the south gate to China’s most prosperous Greater Bay area, and with its inherent advantage of relatively low tax rates and status as an independent tariff zone, Hong Kong has in recent decades become a popular destination for asset management. One of the most common business arrangements is to put a PRC company with substantive business under a Hong Kong holding company.

Where there are various parties jointly investing in the business, a shareholders’ agreement may be signed to provide for the mechanism of profit distribution, board composition and the general conduct of company affairs, including that of the subsidiaries. While the ultimate shareholders may enjoy the benefits of such arrangement when they go along, things may turn into a mess when they fall apart given the cross-border culture / jurisdiction elements interacting. This article aims to provide an overview of the possible actions that the aggrieved ultimate shareholders may take when there are breaches or misconduct done to the PRC subsidiary.

Contractual Remedies

If the relevant misconduct involves breaches of the shareholders’ agreement, the simple and straightforward answer is to seek redress under the agreement.

Hong Kong contract law provides for the remedy of specific performance of an agreement. Where the contract entails something to be done by the party(s), and such has not been done despite the maturity of certain conditions, the innocent party may apply to the court for an order that a specific act be performed or refrained by the defaulting / breaching party. As it involves an injunctive relief ordering a person to do something or refrain from doing something, it will only be granted in exceptional circumstances where damages are not adequate. To put this into context, it may be relevant where the parties have contracted for the sale of certain shares of the PRC subsidiary at an agreed price, and this has not been done despite certain conditions being met, due to a defaulting party’s failure to cooperate. A successful specific performance application will compel the defaulting party to buy or sell the shares as agreed.

In most situations, damages are the relief granted in lieu of specific performance. It may be the proper remedy where no dividends have been declared despite parties’ agreement to the contrary due to the defaulting party’s breach of contract.

Shareholder’s Derivative Action

Alternatively, the aggrieved shareholder may consider bringing a double derivative action against the wrongdoer in the name of the company. The action is “double” in the sense that one derivative action would be brought by the Hong Kong holding company in the name of the PRC subsidiary, and another by the ultimate shareholders in the name of the Hong Kong holding company.

This is possible under section 732 of the Companies Ordinance, if the PRC subsidiary is considered a non-Hong Kong company with a place of business established in Hong Kong. Otherwise the shareholders can only bring a double derivative action under common law[1]. This may pose certain difficulties, as in common law whether a shareholder can commence a double derivative action in the name and on behalf of the company is governed by the law of the place of incorporation, and common law does not apply in the PRC.

Unfair Prejudice Petition

If the above does not work for the aggrieved shareholders, or if what the shareholders are looking for are not simple damages to be paid, but entails certain acts to be done, the shareholders may consider whether an unfair prejudice application is a viable option.

Under section 724 of the Companies Ordinance (Cap.622) (“the Ordinance”), aggrieved shareholders can petition to the court for reliefs if the affairs of the company are being or have been conducted in a manner unfairly prejudicial to the interests of the shareholders generally or one or more shareholders, including the petitioner.

Although the Companies Ordinance only applies to Hong Kong company and a non-Hong Kong company that establishes a place of business in Hong Kong, case law[2] indicates that the way in which the affairs of a subsidiary (including a foreign subsidiary) are conducted can constitute unfairly prejudicial conduct under section 724 to the Hong Kong parent company’s affairs, provided that the affairs of the two companies are closely administered. Presence of certain provisions in the shareholders’ agreement relating to the management of the subsidiary (eg. the appointment of management personnel, distribution of dividends etc.) may be cogent evidence so indicating.

As its name suggests, to succeed in the application, the relevant conduct or omission complained of must be both unfair and prejudicial. An example of such conduct is dissipation of the PRC subsidiary’s assets with a view to diminishing the economic value of the innocent party’s shareholding in the company.

Provided that unfair prejudice can be established, under section 725 of the Companies Ordinance, the Court has a wide discretion to grant such orders as it deems fit, including but not limited to the following:

Requiring the company to do, or refrain from doing certain acts
Authorising civil proceedings to be brought on behalf of the company
Appointment of receiver or manager
Regulating the conduct of company’s affairs
Ordering purchase of shares either from a member or by reduction of the company capital
Awarding damages and interest against the wrongdoer.

Conclusion

In view of the aforesaid, it is not difficult to see that a well drafted shareholders’ agreement could save the shareholders the trouble to go through complex litigations, as simple enforcement of contract can be sought. If the relevant PRC subsidiary is a non-Hong Kong company establishing a place of business in Hong Kong, a double derivation action may be brought. Where the aggrieved shareholders are seeking reliefs other than simple damages or where the PRC subsidiary does not have a place of business in Hong Kong, unfair prejudice action may be considered given the variety of orders that can be sought.

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