David Webb responds to the Legislative Council's invitation for comments on proposed amendments to the statutory derivative actions regime. In its current form it is unlikely to be useful to public shareowners of listed companies, but we suggest how to improve it. We also call on the Administration and Legislators to get behind class actions, litigation finance and contingent legal fees. Justice is the friend of fair societies, and litigation is the path to it.

Multiple statutory derivative actions
18 April 2010

Submission to the Legislative Council
Bills Committee on Companies (Amendment) Bill 2010

Honourable Members,

Thank you for your e-mail of 8-Apr-2010 inviting me to give views specifically on Clauses 14-20 of the Companies (Amendment) Bill 2010 (the Bill), to enable a member of a related company of a specified corporation to bring or intervene in proceedings against a specified corporation as defined in section 2 of the Companies Ordinance. This I now do, and apologise for it being 1 business day late. I hope that you can still incorporate my views into your deliberations on 20-Apr-2010.

Most importantly, the Bill will allow registered shareholders (members) of a holding company to bring a statutory derivative action on behalf of its direct or indirect subsidiary. As the Administration notes, this is already a common law right, as affirmed by the decision in Waddington Ltd v Thomas Chan Chun Hoo, Court of Final Appeal, 8-Sep-2008. Holding companies are just one category of related companies in the Bill, the others being subsidiaries or fellow subsidiaries of the specified corporation. The CFA did not deal with the question of minority shareholders in a subsidiary company bringing a derivative action on behalf of a holding company or on behalf of a fellow subsidiary.

Whilst the proposed amendments to the Ordinance will certainly be of use to registered shareholders in private holding companies and their subsidiaries, they are not, in their present form, of much use to the public shareowners of listed companies, for reasons which I will explain. You can rectify this by amending the Bill.

The Financial Services and Treasury Bureau (FSTB) in Annex D of its follow-up to issues raised at the first meeting on 23-Feb-2010 (pages 30-34 of the PDF), provides a helpful review of the legislation in Australia, New Zealand, Canada, the UK and Singapore. In three of those places (Australia, New Zealand and Canada), there is now a statutory right of derivative action for all related companies. Furthermore, in Canada and Singapore, any other person who, in the discretion of the court, is a "proper person", may seek to bring a derivative action. Presumably, in determining whether a person is a proper person, the issue to be considered is whether the person has suffered a loss from the wrong done to the specified corporation and will have a sufficient economic interest in the relief claimed in the proceedings.

Include all proper persons

Now this brings me to the key gap in the Administration's proposal. The vast majority of shares beneficially owned by the public in HK-listed corporations are not in fact held by them, but by a bare nominee. In most cases, the registered shareholder is HKSCC Nominees Ltd (HKSCCN), the de facto central depository of the Central Clearing and Automated Settlement System (CCASS) operated by Hong Kong Securities Clearing Co Ltd, a wholly-owned subsidiary of Hong Kong Exchanges and Clearing Ltd. In order to settle a transaction on the stock exchange, the shares must have been deposited into CCASS. HKSCCN in turn holds the shares for more nominees, owned by banks, brokers and custodians, who in turn hold shares for beneficial owners.

There is no realistic possibility of HKSCCN bringing derivative actions on behalf of beneficial owners, because it has no economic interest in the shares it holds, and because it is part of a bureaucratic public body which I doubt would entertain the idea of conducting the litigation on behalf of a beneficial owner even if it was remunerated and under a collateralised indemnity for costs. Even under scrip-less registration proposals (if we ever get them implemented), it is likely that most beneficial owners would still not be legal shareholders.

It might be possible for a prospective applicant to withdraw shares from CCASS and register them in its own name, but this would inevitably occur after the alleged wrongdoing to the specified corporation, and it could be open to the defendant to argue that the applicant was not a legal shareholder at the time of the alleged wrongdoing. Furthermore, if a holding company has put itself, or been put, into provisional liquidation, then under s182 the register of members is automatically frozen and transfers are prohibited without the consent of the court, so taking legal ownership of the holding would not be an option.

Incidentally, the freezing of the share register is another area of the Companies Ordinance that needs reform, since it makes it impossible for most public shareowners, not being registered holders, to oppose a petition by a company to put itself into provisional liquidation. That process is something which several apparently solvent companies used in the last 2 years to run away from minority shareholders.

So, for the current proposals to have any real benefit to public shareholders of listed companies, it is important that you amend the Bill to broaden the class of applicants to include not just related companies but all beneficial shareowners. I suggest you include "proper persons", preferably to be defined as:

 "any person who, to the satisfaction of the court, has an interest in the relief claimed in the proceedings, whether legal or equitable".

This would still be subject to the safeguard requirement in s168BC(3) that the court is satisfied that it appears to be prima facie in the interest of the specified corporation that leave be granted to the applicant and that there is a "serious question to be tried". As a second-best alternative, the law should state that a person who is a member of a company (or its related company) has the same rights to apply to bring the derivative action regardless of whether he was a member at the time of the alleged wrongdoing to the company.

Parallel regimes

While writing, I note that the CFA in Waddington urged the Administration and the Legislature to remove the duplication of common law rights and statutory rights. This has not been done, and the Administration has not explained why not. Ribeiro PJ wrote (para. 32):

"The co-existence of both the statutory and common law regimes is unusual in an international context and is a source of confusion and complication. It would appear to be appropriate for the statutory regime to replace the common law derivative action altogether. This question deserves to be addressed by the Administration and the Legislature as soon as possible."

While Lord Millett NPJ wrote (para. 80):

"We have no power to extend the provisions of s.168BC to multiple derivative actions by analogy. We must leave such actions to continue to be governed by the common law, while expressing the hope that the legislature may in due course extend the section to cover them, and perhaps at the same time take the opportunity to consider whether it is really sensible to maintain two parallel regimes with different threshold tests, one requiring leave and the other not."

The statutory regime requires that there is a "serious question to be tried", while the common law regime sets the higher hurdle of requiring that a prima facie case be shown. However, the statutory regime requires leave of the court to bring the action, while the common law does not. In my view, the statutory regime is more efficient, as it is less likely to require a "trial before a trial".

Access to Justice

I cannot conclude without mentioning the economic reality. While such statutory rights as are proposed are important to have, they are of little value if they are prohibitively expensive to enforce. While the court has discretion under s168BI at any time during the case to make an order for costs to be paid by the specified corporation, there is no certainty for a potential applicant as to whether and when this order will be forthcoming, and if it is, then whether the specified corporation, having been the subject of the alleged abuse by the defendants, will have the means to pay any costs if ordered to do so. A court will only make an award for costs if it is satisfied that the member was acting in good faith and had reasonable grounds for making the application for the derivative action.

Furthermore, even if a derivative action is successful, the award will be made to the specified corporation, not its members (or its parent's members), and the abused company will likely still be controlled by the defendants, since otherwise, it could have sued them on its own. So the money may promptly be siphoned off again, and the value of the recovery may never be realised by the shareholders.

So these are significant deterrents to bringing a derivative action, which is why so few have been brought since 2004. It is not as if HK is such a bastion of good governance that few cases warranted the action. There have also been very few shareholder legal actions of any other kind, including s168A (unfair prejudice), because the potential costs for any one shareholder on its own far outweigh the size of its claim.

To address this issue:

  1. the Administration and Legislators should give full support to the proposals of the Law Reform Commission to introduce class action rights;
  2. lawyers must be allowed to work for contingent legal fees;
  3. litigation finance companies must be permitted to finance litigation; and
  4. to make points (2) and (3) possible, the laws against champerty and maintenance must be abolished.

I wrote extensively about all these issues on Webb-site.com in the article "Class actions for HK" (17-Mar-10) which I attach. The 4 points above were also the subject of an opinion poll which indicated strong public support. I attach the results. The Administration has no excuse for inaction, if it wishes to enhance and protect HK's position as an international financial centre.

Finally, I note that a Legislator has expressed concerns that increasing shareholder rights will increase the amount of litigation "thereby subjecting the operation of listed companies to higher risks of legal challenges" (Panel on Financial Affairs, 11-Jun-2009). Of course it would. The point of these proposals is to increase the risk that abuse of a company will be challenged, and thereby to deter it. That is the whole point - you cannot have a fair society if people do not have laws to ensure fair play and the means to enforce them through litigation when all else fails. Honest management should have nothing to fear. Justice is the friend of fair societies, not its enemy. Our loser-pays costs system will ensure that frivolous or vexatious actions will be kept to a minimum and will remain the domain of those for whom money is no object.

Yours sincerely

David M. Webb
Editor, Webb-site.com

© Webb-site.com, 2010

Topics in this story

Sign up for our free newsletter

Recommend Webb-site to a friend

Copyright & disclaimer, Privacy policy

Back to top