The Civil Liabilities of Directors, Shareholders and Senior Management in Winding Up Proceedings in Hong Kong

By Keith Brandt and Grace Lee (Dentons Hong Kong LLP)

Introduction

The winding up of insolvent companies in Hong Kong is governed by the Companies (Winding Up and Miscellaneous Provisions) Ordinance (Chapter 32 of the Laws of Hong Kong) (“CWUMPO”), the Companies (Winding-up) Rules (Chapter 32H) (“CWUR”) and case laws. They provide the legal source of civil liabilities for directors, shareholders and senior management.

Directors

In Hong Kong, the Companies Ordinance (Chapter 622) (“CO”) does not provide for the concept of “legal representative” in Hong Kong. Instead, a director is responsible for the day-to-day management of a company and subject to the legal duties as a director in Hong Kong winding up proceedings.

A)    General Duties of Directors

The CO imposes a general duty on directors to exercise reasonable care, skill and diligence (section 465). According to the English cases of West Mercia Safetywear Ltd v Dodd (1988) 4 BCC 30 at p 33 and MacPherson v European Strategic Bureau Ltd [2002] BCC 398 at para 48, when a company is insolvent, its directors owe a duty to consider, inter alia, the interests of creditors and not to prejudice interests of creditors. These English cases were cited with approval by the Hong Kong court in Tradepower (Holdings) Ltd v Tradepower (HK) Ltd [2010] 1 HKLRD 674 at para 129. 

B)    Duties of Directors in Winding Up

After the court makes a winding up order and a provisional liquidator is appointed for an insolvent company, the Official Receiver’s Office requires its directors to:

•    Deliver to the provisional liquidator the company’s assets, books and records and the company’s seal (the accounting records must comply with sections 373(2) and (3) of the CO);

•    Attend the provisional liquidator’s office to provide information about the company’s assets and dealings;

•    Continue to cooperate with the (provisional) liquidator and perform their duties as a director properly until the liquidation is concluded; and

•    Notify the (provisional) liquidator immediately if they change their addresses.

Under the CWUMPO, directors must submit a sworn statement of affairs of the company to the provisional liquidator within 28 days of the appointment of the provisional liquidator or the date of the winding up order, as the case may be (section 190). Also, the CWUR requires directors to attend the meetings of creditors and contributories (rule 110). 

If directors fail to fulfil their duties above, the Official Receiver’s Office may take criminal prosecution and disqualification actions against them under the CWUMPO and the CO.

C)    Civil Liabilities of Directors

Breach of Fiduciary Duties

If a director fails to exercise reasonable care, skill and diligence, they can be subject to civil claims under the common law rules and equitable rules (section 466). For example, in Moulin Global Eyecare v Olivia Lee (2014) 17 HKCFAR 466, the liquidators of an insolvent company sued the directors for breach of fiduciary duty, and the duty of care and skill.

The above types of claim do not limit other civil liabilities under other parts of the CO or under the CWUMPO (section 466 of the CO), as we will see below.

Unfair Preference

Under the CWUMPO, a company would be deemed to have given unfair preference to a person if (sections 266, 266A and 266B):

• He is a creditor of the company, or stands as a surety or guarantor of the company’s debts or liabilities;
• He is, by reason of the company’s act, placed into a better position than he otherwise would be in if the company goes into insolvent liquidation; 
• The company has the desire of placing him into a better position (such desire is presumed if the unfair preference is given to an associate of the company); and
• The unfair preference takes place during the relevant statutory periods, i.e. two years (if an unfair preference is given to a person who is connected with the company (otherwise than by reason only of being its employee)) or six months (in any other case of an unfair preference) ending with the day on which the winding up of the company commences.

A director responsible for causing an unfair prejudice is liable for misfeasance.

Transactions at Undervalue

The CWUMPO defines the following as transactions at undervalue if they take place within the five years before the winding up, and they are conducted when the company is insolvent or they cause the company to become insolvent (sections 265D, 265E, 266B, 266C and 266D):

• Gifts given for no consideration in return; and
• Transactions entered into for significantly less than their value.

If a director is responsible for the transactions at undervalue, he may be liable for misfeasance unless he can show that (section 265D(4) of the CWUMPO):

• The company has entered into the transaction in good faith and for the carrying on of the company’s business; and
• There are reasonable grounds for believing that the transaction would benefit the company.

Fraudulent Trading

If a company conducts its business with the intent to defraud its creditors or creditors of any other person (or otherwise for any other fraudulent purpose), all knowingly involved parties (including directors) may become personally liable for the debts and liabilities of the company without limitation pursuant to the CWUMPO (section 275). The application against the persons who were knowingly parties to the carrying on of the business in the above manner may be brought by the Official Receiver, or the liquidator or any creditor or contributory of the company (section 275). In Aktieselskabet Dansk Skibsfinasiering v. Robert Brothers [2000] 1 HKLRD 568, the directors of an insolvent company were sued for fraudulent trading and the court held that the test for fraudulent intention is subjective. This means that the persons involved must actually be dishonest. 

Share Redemption or Buy-back out of Capital before Winding Up

If the company has paid out of its capital to redeem or buy back shares within one year before the winding up, the directors (who have signed the solvency statement in support of the redemption or buy-back) would be under joint and several liabilities with the past shareholders for the amount paid out of capital by the company (section 170A of the CWUMPO).

D)    Assessment of Civil Damages

Section 276(1) of the CWUMPO applies where a “specified person” in the course of winding up:

• Has misapplied, retained, become liable or accountable for any money or property of the company; or
• Has been guilty of any misfeasance (such as 2.3.2 and 2.3.3 above), breach of duty or breach of fiduciary duty (such as 2.3.1 above) in relation to the insolvent company.

In such cases, the court may (on the application of the Official Receiver, the liquidator or any creditor or contributory) (section 276(1)):

• Examine the conduct of that “specified person”; and
• Compel that “specified person” to repay or restore the money or property with interest, or make compensation as the court thinks just.

A “specified person” is widely defined to include an officer of the company (section 276(1A)(a)). The CWUMPO expressly provides that a director is an “officer” (section 2(1)). Therefore, directors are subject to the court’s assessment of civil damages under section 276(1).

Senior Management

In the course of winding up, the civil liabilities of senior managers are similar to those of the directors because of the wide scope of liabilities provided under the CWUMPO.

Senior managers are also “specified persons” under section 276 of the CWUMPO because:

• The definition of “officer” in section 2(1) also includes managers; and
• In any event, section 276(1A)(d) extends section 276(1) to anyone “who is or has been concerned, or is taking or has taken part, in the promotion, formation or management of the company”.

Therefore, if senior managers are guilty of misfeasance due to their involvement in unfair preference (as in Unfair Preference above) and transactions at undervalue (see 2.3.3 above), the court can also examine their conducts and compel them to repay, restore and make compensation to the company under section 276 of the CWUMPO.

Further, if senior managers are knowingly involved in fraudulent trading, they can be personally liable for the debts and liabilities of the company without limitation under section 275 of the CWUMPO. In the case of Aktieselskabet Dansk Skibsfinasiering v. Robert Brothers [1989] 2 HKC 273, at the first instance, a creditor of the company took civil actions against not only the directors, but also the general manager and secretary of the company.

Shareholders

When an insolvent company is being wound up, shareholders (who are neither the directors nor the managers of the company) have a very passive role.

However, as mentioned in Share Redemption or Buy-back out of Capital before Winding Up above, in case of any share redemption or buy-back out of capital within one year before the winding up, the shareholders involved are primarily liable to contribute the amount paid out of capital by the company (section 170A of the CWUMPO).

If the shareholders receive benefits or property from their insolvency company (as part of a transaction at undervalue or fraudulent trading discussed above), then they may be liable to contribute that amount back to the company as those transactions are void and the court may order the shareholders to do so (section 266C(1) of the CWUMPO). Once a winding up petition is filed, any subsequent transfer of shares in the company or alteration in the status of the shareholders is also void, unless the court otherwise orders (section 182 of the CWUMPO).

Conclusion

In summary, the directors and senior management of an insolvent company are subject to similar civil liabilities in the winding up proceedings in Hong Kong under the CWUMPO and the CWUR. 

Shareholders should also be careful and refrain from entering certain transactions when they foresee or know that their company is insolvent and going to be wound up in Hong Kong.

(*) This article was first published by Dentons Hong Kong on 7 April 2022