Short Summary: Directors, Boards and Corporate Governance in Hong Kong

The main recent reform proposal in Hong Kong

Reform in company law

The new Companies Ordinance (Chapter 622 of the Laws of Hong Kong) (CO) has now been in force for 22 months since it came into operation on 3 March 2014. The CO contains new initiatives to facilitate business and cater for the needs of small and medium enterprises (SMEs). It has simplified the procedures for starting a business by, for example, removing the memorandum of association and the par or nominal value for shares. More SMEs can now prepare simplified financial statements and directors’ reports.

According to the Companies Registry (CR), the transition to the new regime has been very smooth and it is encouraged that the business community has adopted the new measures under the CO, which aim to facilitate business and save costs, such as the alternative court-free procedure for reduction of capital and the new merger procedures.

The CO has strengthened Hong Kong’s competitiveness and reinforced Hong Kong’s position as an international financial and commercial centre through enhancing corporate governance, facilitating business and modernising Hong Kong’s company law.

Reform in risk management and internal control of listed companies

In December 2014, the Stock Exchange of Hong Kong Limited (SEHK) published the consultation conclusions on the proposed changes to the Corporate Governance Code (CG Code) and Corporate Governance Report (CG Report) relating to improving risk management and internal controls of listed companies. The CG Code has been amended accordingly and will become effective for listed companies for accounting periods beginning on or after 1 January 2016.

The consultation conclusions included the adoption of the following changes, among other things:

• Emphasise that internal controls are an integrated part of risk management by incorporating risk management into the CG Code where appropriate.
• Enhance accountability of the board, board committees and management by clearly defining their roles and responsibilities in risk management and internal controls.
• Improve transparency of the risk management and internal controls of listed companies, by upgrading to code provisions, the recommendation for listed companies to disclose their policies, processes and details of the annual review carried out in respect of the effectiveness of the risk management and internal control systems.
• Strengthen oversight of the risk management and internal control systems, by upgrading to a code provision the recommendation for listed companies to have an internal audit function.

Reform in the environmental, social and governance reporting guide

In July 2015, the SEHK published a consultation paper on the proposed changes to the environmental, social and governance (ESG) reporting guide for listed companies (Appendix 27 to the Main Board Listing Rules) (ESG Guide). The proposals aim to, among other things:

• Strengthen ESG disclosure requirements, encourage more widespread and standardised ESG reporting and help in meeting greater demand and expectations for non-financial information from investors and other stakeholders.
• Provide more guidance on ESG reporting in the ESG Guide and to be more in line with international standards.
• Upgrade the general disclosure under each of the aspects of the ESG Guide to “comply or explain”.
• Require a statement in the annual report or ESG report as to whether they have complied with the “comply or explain” provisions of the ESG Guide for the relevant financial year. Where there is deviation from the “comply or explain” provisions, considered reasons must be given in the ESG report.

Board composition and restrictions

Composition:

The Companies Ordinance (CO) adopts a unitary board structure for companies incorporated in Hong Kong.

A company is not legally required to have a minimum number of non-executive directors or independent non-executive directors. The Listing Rules require that every listed company must have at least three independent non-executive directors, one of whom must possess appropriate professional qualifications, or accounting or related financial management expertise, and must have independent non-executive directors representing at least one-third of its board.

A private company must have at least one director (whether listed on the Stock Exchange of Hong Kong Limited (SEHK) or not).

A company limited by guarantee must have at least two directors.

A company listed on the SEHK must have at least three independent non-executive directors.

There is no statutory limit on the maximum number of directors, but a company can, in its articles of association, place a limit on the maximum number of directors.

Restrictions:

• A director must be at least 18 years’ old. There is no upper limit on the age of a director.
• There is a code provision in the Corporate Governance Code that requires the nomination committee of a listed company to have a policy concerning diversity in the board. Listed companies are also required to disclose the policy or a summary of the policy in the Corporate Governance Report.
• An undischarged bankrupt cannot act as a director.
• Any person who has been disqualified from acting as a director must not act as a director.
• The company’s articles of association may stipulate additional eligibility requirements of being a director.

Restrictions on a director’s term of appointment

Under the Companies Ordinance, any directors’ service contract with a term which is stated to exceed three years must be approved by the shareholders of the company. In relation to listed companies, the Corporate Governance Code requires each director to be subject to retirement by rotation at least once every three years. The Listing Rules also require a listed company to obtain prior shareholders’ approval for any director’s service contract that either:

• Is for a term of more than three years.
• Can only be terminated on notice of more than one year or on payment of compensation of more than one year’s pay.

Appointment and removal of directors

Appointment:

The appointment of directors is governed by the Companies Ordinance (CO) and the company’s articles of association. Directors are appointed by the shareholders at a general meeting. The board may appoint a director to fill a casual vacancy or as an additional director to the board. However, usually that director will only hold office until the next annual general meeting where he can stand for re-election.

In relation to listed companies, the Corporate Governance Code stipulates that any director appointed by the board to fill a casual vacancy must retire, and that director can stand for re-election, at the first general meeting after his appointment.

Removal:

The CO provides that a company can by an ordinary resolution remove a director from his office before the end of his term of office. This resolution must be passed by the shareholders at a general meeting at which the director concerned has the right to attend and speak. A shareholder proposing a resolution to remove a director must give a special notice of at least 28 days to the company, which it must then give the shareholders at least 14 days’ notice of such resolution before the meeting at which that resolution is to be considered and passed.

Director’s duties

According to Guide on Directors’ Duties, that was published by Companies Registry there are 11 general duties for a director in the performance of his functions and exercise of his powers:

• Duty to act in good faith for the benefit of the company as a whole.
• Duty to use powers for a proper purpose for the benefit of members as a whole.
• Duty not to delegate powers except with proper authorisation and duty to exercise independent judgement.
• Duty to exercise care, skill and diligence.
• Duty to avoid conflicts between personal interests and interests of the company
• Duty not to enter into transactions in which the directors have an interest except in compliance with the requirements of the law.
• Duty not to gain advantage from use of position as a director.
• Duty not to make unauthorised use of company’s property or information.
• Duty not to accept personal benefit from third parties conferred because of position as a director.
• Duty to observe the company’s constitution and resolutions.
• Duty to keep accounting records.

The scope of a director’s duties and liability under insolvency laws

A director will be criminally liable if he is found to have:

• Failed to comply with the obligations imposed on him in the liquidation of the company.
• Given or concealed property of the company in liquidation with intent to defraud creditors.
• Failed to keep books for the two years before the winding-up of the company.
• Engaged in fraudulent trading.

The liability for directors under environment and health and safety laws

Environmental legislation covers a wide number of regulatory controls. These include:

• Air pollution control.
• Water pollution control.
• Waste disposal.
• Noise control.
• Ozone layer protection.
• Dumping at sea.
• Environmental impact assessment.

A company is liable for health and safety of its employees under common law as well as under various statutes. In particular:

• The Occupational Safety and Health Ordinance (Chapter 509 of the Laws of Hong Kong) imposes certain obligations on employers or occupiers of premises in relation to the health and safety of those working at a workspace.
• The Factories and Industrial Undertakings Ordinance (Chapter 59 of the Laws of Hong Kong) also imposes a general statutory duty on employers to ensure the health and safety at work of those persons employed by them at industrial undertakings.

Other liability that directors can incur under other specific laws

• The Stamp Duty Ordinance (Chapter 117 of the Laws of Hong Kong) regulates stamp duty in Hong Kong. Any person (including a company) who intends to defraud the Hong Kong Government of any stamp duty commits an offence.
• The Employment Ordinance (Chapter 57 of the Laws of Hong Kong) criminalises certain actions of an employer such as making illegal deductions from wages of his employees and late payment of wages of employees.
• The Telecommunications Ordinance (Chapter 106 of the Laws of Hong Kong) prohibits any person who, by telecommunications, knowingly causes a computer to perform any function to obtain unauthorised access to any program or data held in a computer.
• The offence of false accounting under the Theft Ordinance (Chapter 210 of the Laws of Hong Kong) also covers falsifying computer records.

Generally, a director’s liability cannot be restricted or limited if the director’s liability arises from any negligence, default, breach of duty or breach of trust, and a company cannot indemnify a director against that liability.

A company can indemnify a director against liability incurred by him to a third party:

• In defending any proceedings, whether civil or criminal, if judgment is given in his favour or in which he is acquitted.
• In connection with any application for relief from his liability in respect of any negligence, default, breach of duty or breach of trust, provided that relief is granted to him by the court.

The company must disclose the permitted indemnity provision made for the benefit of its directors in the directors’ report and allow inspection by members on request.

Disclosure of information

All companies must make available certain statutory registers and minutes of general meetings for inspection by shareholders. Subject to rules relating to protection of personal data and legal professional privilege, the court may grant orders allowing access to books and records by shareholders. Shareholders are also entitled to receive the financial statements, directors’ report and auditor’s report from the company each year. When offering securities to the public, companies must disclose various information as required by the Companies Ordinance and the Listing Rules.

Listed companies are subject to further disclosure obligations under the Listing Rules and the Securities and Futures Ordinance, for example, disclosing inside information, large transactions with third parties and connected transactions, half-yearly results and quarterly reports (for companies listed on the Growth Enterprise Market (GEM)).

Company meetings

A company must convene an annual shareholders’ meeting for each financial year. Situations where a company is not required to hold an annual shareholders’ meeting are:

• If everything that is required to be done at the meeting is done by a written resolution and copies of documents required to be laid at the meeting are provided to each shareholder on or before the date of circulation of the written resolution.
• A single-member company is not required to hold an annual shareholders’ meeting.
• A written resolution or a resolution at a general meeting is passed by all members to dispense with the holding of annual general meetings.
• A dormant company does not have to hold an annual shareholders’ meeting.

An annual general meeting must be convened with at least 21 days’ written notice. Any other general meetings must be convened with at least 14 days’ written notice. This is reduced to seven days’ written notice for an unlimited liability company.

The directors of a company must convene a general meeting if they receive requests to do so from members of the company representing at least 5% of the total voting rights of all the members having a right to vote at general meetings. Failing this, the members who requested the meeting can themselves convene a general meeting at the company’s expense. In addition, subject to the company’s articles of association, if the company does not have any director or sufficient directors to form a quorum, any two or more members of the company representing at least 10% of the total voting rights of all the members having a right to vote at general meetings can convene a general meeting.

Internal controls, accounts and audit

There are no specific statutory provisions relating to internal control of business risks other than those in respect of directors’ specific duties.

The responsibilities and potential liabilities of directors in relation to the company’s accounts:

The company is primarily liable for the preparation of its financial statements. Directors must prepare and attach to the balance sheet of a company a report on the profit or loss of the company for the financial year and the state of the company’s affairs as at the end of that year. Public companies and companies that do not qualify for simplified reporting must prepare a “business review” within the directors’ report. Private companies can opt out by special resolution.

Directors must cause the company to lay the profit and loss account at the annual general meeting of the company. Directors must take all reasonable steps to ensure that a company’s balance sheet and profit and loss account are audited to give a true and fair view of the state of affairs of the company and the profit and loss of the company.

The Listing Rules require listed companies to send copies of the annual report and accounts to its shareholders within four months of the company’s financial year-end.

The role of company secretary in corporate governance

The company secretary plays an important role in the administration of the company. The main duties of a company secretary are to ensure that the company complies with relevant regulations and procedural matters, including:

• Maintaining the company’s registers.
• Organising meetings.
• Sending out notices of meetings.
• Attending, recording and keeping minutes of meetings.
• Filing forms and documents with the Companies Registry.

The Corporate Governance Code also lays down guidelines for directors to seek the advice of the company secretary with a view to ensuring that board procedures and all applicable rules and regulations are followed.

Endnotes

1. “Corporate Governance in Hong Kong, China Rising to the Challenge of Globalization”, Stephen Y. L. Cheung, 2014;
2. Hong Kong Exchange and Clearing Limited: “Consultation Pater on Risk Management and Internal Control”, 2015, <https://www. hkex.com.hk/eng/ newsconsul/mktconsul/Documents/cp201406.pdf>;
3. Practical Law: “Corporate governance and directors’ duties in Hong Kong: overview”, 2015, <http:// us.practicallaw.com/7-506-89 2o>.