A shareholder is entitled to inspect and/or obtain a copy of the relevant records of the company under sections 26, 90, 98, 114A, 120, 129G and 161BB of the Companies Ordinance (Cap. 32) of Hong Kong (the “Ordinance”). These provide for a shareholder to receive limited information with regard to a company’s affairs e.g. the right to receive copies of the annual audited accounts. However, it does not provide a shareholder with rights to inspect the company’s books and records or to participate in the management of the company.

“In most instances, a contributory has little control over the conduct of the day to day affairs of a company. His right to attend meetings and vote on resolutions, important though it is, gives a contributory little power within the company. The provisions protecting shareholders in respect of their interest in a company ultimately turn upon their right to present a petition for winding-up under s. 177(1) and their right to relief under s. 168A” (Yuk Wah Ho v. Gao Jiaren & Another [1999] 3 HKLRD 870).

The above citation reflects the fact that statutory protection for a minority shareholder may not be sufficient if he/she does not want to incur the legal costs in litigation to enforce his/her minority shareholder’s rights in court. Therefore, one of the reasons why a minority shareholder would usually require a shareholders’ agreement be entered into with the controlling shareholder(s) is to ensure that his/her interests can be contractually protected.

A shareholders agreement will provide much protection for both the minority and majority shareholders. It can specifically provide rights for the minority shareholder to have board representation. This will open the way to the minority having full access to the company’s books and records. A shareholders agreement is likely also to make provision as to the funding of the company and who should provide such funding. This may prevent the minority shareholder from being subsequently diluted or ensure that subsequent equity funding is on terms no less favourable than which the minority shareholder provided such funding.

A further area of protection that is provided by a shareholders agreement is in respect of the decision making process. The majority rule principle means that for most ordinary decisions making to the operation of the company’s business can be undertaken by majority vote. A shareholders agreement can require certain key decisions of the company to be undertaken unanimously. This can help protect a minority shareholder against dilution of its shares. Such provisions may also protect the minority shareholders by imposing restrictions upon the majority as to their ability to operate the business without approval of the other shareholders e.g. restrictions on asset disposals or acquisitions from connected parties, restrictions on employees or directors salaries without consent of the minority.

Commonly, a shareholders agreement provides for restrictions upon the transfer of shares. Typically a shareholders agreement will have pre emption clauses whereby a shareholder who wishes to sell shares must first offer those shares to one of the existing shareholders. This is a protection for both the majority and the minority shareholders who have chosen to do business with each other, but might not wish to conduct business with other parties whom they may consider to be undesirable for whatever reasons. The provisions relating to transfer of shares are also relevant as often shareholders agreement will have so called “tag along” or “drag along” rights. These rights mean respectively that if shares are to be sold (usually shares in excess of a certain percentage of the issued share capital) the selling shareholder must also procure the sale of a similar percentage of the minority shareholder’s stake. This obviously offers protection for the minority in that if the majority shareholder agrees to sell his stake he must also procure that the purchaser acquires the minority shareholder’s interest. Drag along rights provide that in the event that the majority shareholder wishes to sell his stake at a particular price he can compel the minority shareholder to sell their shares at that same price.

Thus, for both majority and minority a shareholders agreement offers important rights and remedies. Given the lack of statutory protection to a minority shareholder a minority shareholder in a private company will normally insist upon a shareholders agreement. As we have seen above these protections also work to the benefit of the majority shareholder in many instances and provide a framework which will make investment in such a business a much more attractive proposition than it otherwise might appear to a minority shareholder.

The question then arises as to the enforceability of shareholders agreements and in this respect so far as rights as between the shareholders are concerned, if the shareholders agreement is validly entered into and agreed upon by those shareholders they will be bound by the terms of the agreement as between themselves. Problems arise, however, in instances where the company is made a party to the shareholders agreement there are issues as to the extent to which the company is bound by that shareholders agreement such that the company may not necessarily be bound by those terms.

Let us review 2 of the leading cases on validity of a shareholders’ agreement to dispel this misconception.

Yuk Wah Ho v. Gao Jiaren & Another [1999] 3 HKLRD 862
The corporate structure of this case was as follows: X and Y signed a joint venture agreement to govern their respect rights and entitlements as shareholders in M and C (the “Agreement”) which provided that matters for each relevant company (including M and C) which required the approval of both X and Y included ... (d) the winding up of the relevant company. X and Y were the directors of M.

There was a fall out between X and Y to the extent that Y refused to attend board meeting and shareholders meeting. M, as a contributory, petitioned the court to seek the compulsory winding-up of C. The petition was sanctioned by a resolution passed by X only (“the Resolution”). There were 2 main issues before the Court i.e. whether the Resolution was valid, and whether M was debarred from presenting such a petition by the Agreement.

Although both M and C were incorporated in British Virgin Islands, the Court of Appeal held for the purposes of these proceedings that the law of the British Virgin Islands was the same as the law of Hong Kong.

M succeeded in convincing the Court that the board of M was ineffective and the power of management had reverted to the members of M. As to the validity of the Resolution, Rogers JA of the Court of Appeal held that “In my view, in considering the question as to whether or not an act of the company is valid and effective, it is the regulations of the company to which the Court must have regard” (3 HKLRD page 867).

Article 1(b.1) of the articles of M stated that a resolution consented to in writing by an absolute majority of the votes of shares entitled to vote thereon was a valid member’s resolution. The Court held that the Resolution was valid and said “irrespective of how any other shares were voted, the Resolution would be passed if the absolute majority of the votes of shares of the company go in a particular way”.

Thus, readers acting for a minority shareholder and working with a BVI company having an article such as article 1(b.1) above should be careful to note whether a controlling shareholder may validly pass a written resolution on his/her own. (In Hong Kong, section 116B of the Ordinance requires a resolution in writing to be signed by or on behalf of all members.) Obviously, Y should not have refused to attend board meetings thereby causing the control of M to revert to the shareholders of M in the first place.

Regarding the second issue, the Court opined that the relevant provision of the Agreement was for voluntary winding up and not on compulsory winding up which Y had objected to. The Court refused to allow the Agreement be amended accordingly. It held that:

“The Companies Ordinance gives to a contributory the right to present a petition to wind-up the company. This right is an important right held by a contributory….; and…Article 2 of the Agreement provides that M must hold a controlling stake in C. In those circumstances, if X’s and Y’s approval was required for the presentation of M i.e. by the controlling shareholder, of a petition to wind-up C, this would be to fetter the statutory right of M as the controlling contributory of C. This, as it seems to me, would be just as much contrary to public policy when it is contained in the joint venture agreement as it would if there were contained in the articles of C a provision that the controlling shareholder might not present a winding-up petition without the consent of X and Y or whoever bought their shares in M” (3 HKLRD page 871).

In sum, M was not debarred by the Agreement from presenting the petition by the fact that the effect of the Agreement was to fetter the statutory rights of M which was contrary to public policy and was thus invalid.

The Court of Appeal applied the case of Russell v. Northern Bank Corp Ltd. & Others [1992] 1 WLR 588 in Yuk Wah Ho. In the Russell case, 1 shareholder owned 60 percent and other 4 each owned 10 percent of the entire issued shares. The 5 shareholders and the company were parties to the shareholders’ agreement; clause 3 of which provided, among other things, that “no further share capital shall be created or issued in the company or the rights attaching to the shares already in issue in any way altered without the written consent of each of the parties hereto”.

On hearing an application for granting an injunction to restrain 4 shareholders from considering and/or voting on an ordinary resolution to increase the share capital of the company, the House of Lords applied the precedent of Welton v. Saffery [1897] A.C. 299, 331 in which Lord Davey said:

“Of course, individual shareholders may deal with their own interest by contract in such a way as they may think fit. But such contracts, whether made by all or some only of the shareholders, would create personal obligations, and would not become a regulation of the company, or be binding on the transferees of the parties to it, or upon new or non-assenting shareholders. There is no suggestion here of any such private agreement outside the machinery of the Companies Act.”

The House of Lords held unanimously in the Russell case that:

“As such an undertaking (i.e. no further share capital shall be created or issued) it is, in my view, as obnoxious as if it had been contained in the articles of association and therefore is unenforceable as being contrary to the provisions of article 131 of the Companies (Northern Ireland) Order 1986. The company’s undertaking is, however, independent of and severable from that of the shareholders and there is no reason why the latter should not be enforceable by the shareholders inter se as a personal agreement which in no way fetters the company in the exercise of its statutory powers.” ([1992] 1 WLR 594)

In sum, provisions in the shareholders’ agreement binding on the company were severed and the case was remitted back to the Court of Appeal for a declaration as to the validity of clause 3 of the shareholders’ agreement as between the shareholders.

Conclusion:

The principles on validity of shareholders’ agreements are clear that a shareholders’ agreement cannot fetter the statutory rights of a shareholder / contributory, nor can it bind the company because a shareholders’ agreement constitutes personal contractual obligations only and shall not become regulations of the company.

One interesting point to note is that a standard clause in a shareholders’ agreement to the effect that it shall be a condition precedent to the transfer of shares that the transferee must agree to be bound by and shall be entitled to the benefit of the agreement as if he is an original party had been held invalid. In the Yuk Wah Ho case, Cheung J said that:
“The agreement clearly intends to bind future shareholders, not merely in their capacity as individuals, but as shareholders. In my view, this agreement is being elevated to the status of a regulation of a company. This goes beyond merely creating a personal obligation between individuals. On the authority of Lord Davey in Welton v Saffery [1897] AC 299, the agreement should not be upheld.” ([1999] 3 HKLRD 876)

It is not being suggested that a shareholders’ agreement is not useful. On the contrary a shareholders’ agreement is useful in binding the shareholders signing it even if the company is not bound by it based on the principles set down by the courts. For the reasons that were set out at the start of this article a shareholders agreement offers much protection to a minority shareholder and also often benefits the majority shareholder. However, the limitations upon the enforceability of such shareholders agreements should be borne in mind.

Companies (Amendment) Ordinance 2003
Companies (Amendment) Ordinance 2003 (except section 67) came into operation on 13 February 2004. Among many other amendments, section 23 of the Ordinance now reads as follows:

“(1) Subject to the provisions of this Ordinance, the memorandum and articles shall, when registered, have effect as a contract under seal –
(a) between the company and each member; and
(b) between a member and each other member,
and shall be deemed to contain covenants on the part of the company and of each member to observe all the provisions of the memorandum and articles.

(1A) Without limiting the generality of subsection (1), the memorandum and articles shall, when registered, be enforceable by the company against each member and by a member against the company and against each other member.”

In a scenario where provisions of a shareholders’ agreement are incorporated into the articles of association of the company, and registered, will the Courts interpret the law differently than before? It remains to be seen. Previous case law has held to the contrary, readers should take a prudent approach that a shareholders’ agreement cannot fetter the statutory rights of a shareholder / contributory for the fear that it will be held as against public policy; nor can it bind the company as shareholders’ agreement only constitutes personal contractual obligations and shall not become regulations of the company.

The new section 23 of the Ordinance has made it clear that “the Articles have effect as a contract under seal between the company and each member” which suggests that a shareholder may be able to sue the company if the articles are not complied with. In this respect, the principles of Foss v. Harbottle that a shareholder may not sue the company as the proper plaintiff in an action in respect of a wrong done to a company is prima facie the company itself may no longer apply in respect of an act undertaken by the Company contrary to its Articles of Association.

Yet, the court may still apply the case law discussed above as new section 23 begins with the proviso that “subject to the provisions of this Ordinance”. It is therefore likely that the legal principles laid down by Lord Davey in the Welton case in 1897 that “There is no suggestion here of any such private agreement outside the machinery of the Companies Act” is still good law, after all.

Gordon Oldham, and
Richard M. Healy,
Partners
Oldham, Li & Nie, Solicitors
www.oln-law.com

If globalization should bring about chaos and confusion, they are probably much closer to home than you used to think. Changes in nationality, country of abode or location of assets – all may sound comfortably familiar to you, are equally familiar to a Family Lawyer in his recipe for a knotty divorce suit. An average law student should be able to tell you the majority of the leading cases in the legal subject entitled “Conflict of Laws” arose not from international trade but divorce suits. A marriage (and, by the same token, a divorce) can transcend its intended jurisdictional boundaries overnight. Hence we feel the need to re-examine the functions of prenuptial agreements (“Prenups” for short, also known as Premarital Agreements) from different perspectives, both local and international.

It is almost common knowledge that prenuptial agreements are well-recognized by the legislature and the judiciary in the United States, Canada, Australia and many parts of Europe (with the notable exception of the U.K.). The U.S. federal Uniform Premarital Agreement Act of 1983 has also received adoption by most Statehouses. The States that declined the federal Act simply have their own legislation and case law to suit their distinctive social needs.

Generally speaking, a prenuptial agreement is an agreement made in contemplation of a marriage and to take effect on the day of marriage. Its primary function is to make financial pre-arrangements for the unwelcome event of separation, divorce or death. Although some jurisdictions permit the prenuptial agreement to contain provisions for personal rights and obligations like distribution of household chores and child-care, as a matter of practice most courts of law would consider these issues trivial (your disagreement is noted) and unenforceable.

So far as Hong Kong is concerned, a researcher of this topic would find himself wandering into no man’s land. The traditional and yet prevalent view here is that the court in making financial provision will look into the “need” and “reasonable requirement” of the parties having regard to a non-exhaustive list of circumstances contained in section 7 of Matrimonial Proceedings and Property Ordinance (“MPPO”) including:

(a) income, earning capacity, property and other financial resources of the parties;
(b) financial needs and obligations of the parties;
(c) standard of living during the marriage;
(d) age of the parties and duration of marriage;
(e) any physical or mental disability of the parties;
(f) contributions made by the parties, financial or otherwise, towards the welfare of the family; and
(g) tangible loss of chance to acquire property or benefit as a result of dissolution of marriage.

Apparently, the premarital common intention of the parties (if there was one) is not on the list of things the court has to take into account.

Further, section 14(1)(a) of MPPO says “if a maintenance agreement includes a provision purporting to restrict any right to apply to a court for an order containing financial arrangements, then that provision shall be void”. As it is not unusual for a prenuptial agreement to restrict or limit spousal maintenance or alimony, the ultimate question is whether a prenuptial agreement falls within the definition of a maintenance agreement. If the answer is “yes”, then the prenuptial agreement must be void.

We disagree that section 14 of MPPO would operate against a prenuptial agreement with restrictions on spousal support. The answer can be found in section 14 itself. Under section 14(2), maintenance agreement is defined as “any agreement in writing made … between the parties to a marriage … containing financial arrangements, whether made during the continuance or after the dissolution … of the marriage”. Clearly, an agreement made before the marriage does not fall within the bracket of maintenance agreement.

Most Hong Kong lawyers would say that as the court has the general discretionary power under section 6 of MPPO to grant an order for the transfer of property (including property held under trust), this alone overrides all pre-existing agreements of whichever nature. However, one also must not overlook the fact that as that is only a discretionary power, the court is not under any duty to exercise it, let alone in whose favour.

This view is reinforced by the Court of First Instance decision in the “big money” divorce suit of F v. F [HCMC No. 4 of 2001] where the husband purported to invoke a verbal prenuptial agreement. In his judgment Mr. Justice Hartmann took the view that there was insufficient evidence to proof that a prenuptial agreement really existed. However, nowhere in his judgment did the learned judge comment that a prenuptial agreement is void or unenforceable in this part of the world - a remark which he could easily have made had he taken that view.

The traditional views have probably cost prenuptial agreement its proper recognition by the legislature of Hong Kong. Be that as it may, and to echo the beginning of this article, we have to look at it from an international perspective. After all, it is nearly impossible for any couple to rule out the possibility of settling in a foreign country and, I beg your pardon, getting divorced in that country. If the contents and the manner of execution meet international standards, there is no reason why a prenuptial agreement signed in Hong Kong should not be upheld by the court of law of a foreign country.