Challenging Capital Reductions by Hong Kong Companies

Until recently, a Hong Kong incorporated company was allowed to reduce its share capital only with the approval of the court.  In 2014, the new Companies Ordinance (Cap. 622) introduced a new court-free procedure to allow a company to reduce its capital by passing a special resolution supported by a solvency statement made by all the directors.  However, shareholders can still challenge the capital reduction.

Edmond Leung from the Corporate and Commercial practice group of Tanner De Witt reviews a recent High Court decision[1] which provides guidelines on shareholder challenges.

Fok Ying Tung Ming Yuan Development Co Ltd (the “Company”) is owned by family members of the late Henry Fok.  The Company was formed primarily to provide capital to support developments in Guangdong, China.  The Company suffered substantial losses.  Most shareholders believed the Company no longer needed all its share capital, and it should be distributed amongst them.  The Plaintiff Nora Fok, daughter of Henry Fok, disagreed.

A special resolution of the Company (“Special Resolution”) was passed at an extraordinary general meeting (“EGM”) which approved a reduction of the Company’s share capital in the amount of HK$861 million.  Nora Fok sought an order from the Court to cancel the Special Resolution.  

In reviewing the issues in the case, Justice Harris set out key principles that apply in capital reductions:

1. The court-free procedure is intended to be quicker, cheaper and less technical than the court-sanction procedure.
    
2. Ideally, the capital reduction process should be started as soon as audited financial statements are available.  This limits the variation between accumulated losses stated in the audited financial statements, and the accumulated losses at the date of the general meeting approving the capital reduction.  Also, auditors can be requested to provide supplementary evidence for the purpose of the general meeting.  If there is a significant delay, then the company should explain the reason for the delay and demonstrate that losses have not been increasing materially. 
    
3. There is no requirement for a shareholder circular in the court-free process to identify permanent losses, and explain why the losses are considered permanent.  Rather the circular needed to contain the information needed for an intelligent and interested shareholder to determine how to cast his vote.  The amount of detail could be less than would be required for a public company or for the court-sanction procedure.
    
4. Any challenge based on the information provided to shareholders would need to establish that the information was unsatisfactory to an extent that it prevented shareholders making an adequately informed decision or called into question the integrity of the process.
    
5. Normally, a capital reduction would only be permitted in respect of permanent losses.  Courts have developed a discretionary practice under which impairment losses (that theoretically could be recovered) could also be reckoned in a capital reduction.  This practice required that an undertaking be given that if any recovery occurred in respect of an impairment loss, it would be treated as a non-distributable reserve as long as any actual or contingent liabilities as on the date of the capital reduction remained outstanding.

Taking these principles into account, Justice Harris dismissed Ms. Fok’s application and upheld the Special Resolution.  It was common ground that creditors’ interests would not be adversely affected, and there was no evidence that called into question the integrity of the process or decision reached by a large majority of shareholders.

Here are some take away points for companies who wish to reduce capital via the court-free route:

1. The relatively new court-free procedure is faster and cheaper than the court-sanction procedure.
    
2. A capital reduction must not prejudice creditors’ interests.
    
3. Ideally, convene the general meeting to approve the capital reduction within one month from the availability of the audited financial statements of the company, and have supplementary evidence from the auditors included in the shareholder circular.
    
4. Provide sufficient financial information for shareholders to understand the issues, and to decide whether and how to vote.
    
5. If some of the losses are not strictly permanent, the company should consider offering an undertaking that any recovery would be treated as non-distributable reserve as long as any actual or contingent liabilities remain outstanding.
    
6. The grounds for shareholder challenge to a properly conducted capital reduction exercise are limited.  A shareholder wishing to bring a challenge must establish that the lack of information prevented shareholders from making an informed decision or called into question the integrity of the process.  A shareholder should think long and hard before initiating an expensive court action seeking to prove that high standard.

Edmond Leung

If you would like to discuss any of the matters raised in this article, please contact:

Eddie Look Partner | E-mail

Tim Drew Partner | E-mail

Edmond Leung Partner | E-mail

River Stone Partner | E-mail

Pádraig Walsh Partner | E-mail

Disclaimer: This publication is general in nature and is not intended to constitute legal advice. You should seek professional advice before taking any action in relation to the matters dealt with in this publication.

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[1] Fok Lai Lor Nora v Fok Ying Tung Ming Yuan Development Co Ltd [2020] HKCFI 354