The notorious “dissipation” cases
One of the common questions a desperate creditor would ask is whether he/ she can go after the ultimate owner/ the controller of the debtor company instead of the debtor itself. In most circumstances, the answer is No because:-
- Under the “privity of contract”, only the contracting party can be sued for breach of contract. Where there is a written contract, a party is in general bound by its terms after signing. A party is not allowed to claim that there are contracting parties other than those stated in the contract, especially when the application of The Contracts (Rights of Third Parties) Ordinance has been expressly excluded.
- A company is accepted in law as a separate “legal personality” which is able to act on its own, and is also able to be sued and become liable on its own. In the case of a limited liability company, a shareholder’s liability is limited to the extent of his investment in the company.
- Only in very exceptional circumstances (such as fraud) that the court would “lift the corporate veil”. But even in the case of fraud, the UK Supreme Court once pointed out in VTB Capital plc v. Nutritek International Corp  UKSC 5 that it is wrong to treat the persons behind as contracting parties to hold them contractually liable.
In view of the above cardinal principles, a cunning owner/ controller may nominate a limited liability entity as the borrower/ contracting party thus shielding oneself from personal liability. Such owners/ controllers may also willfully drain the company’s financials or in more radical cases, they may even try to siphon off assets from the company to their related parties. In the latter scenario, as it is not uncommon for such controllers to have lent money to the company by way of shareholders’ loans, such controllers may even actively pursue the winding-up of the company with the ultimate goal to appoint a liquidator over whom they may exert influence.
Creditors’ options in such an unfortunate circumstance are limited. The creditor may try to obtain a Mareva injunction against the debtor company, which is, however, preventive in nature and would have no use if dissipation has already occurred. In such a situation, what has been consistently underexplored, if not overlooked, is the tort as recognised in Lumley v. Gye  EWHC QB J73, or what is modernly called the tort of procuring a breach of contract. As will be seen below, this tort has been recently reinvigorated (in particular in the cases of Marex Financial Limited v. Carlos Sevilleja Garcia  EWHC 918 (Comm) and Palmer Birch v. Lloyd  EWHC 2316 (TCC)) to cover shareholders/ directors (and even ultimate beneficial owners and shadow directors) of a company who, through dissipation, have emptied the pocket of the company to deprive it of the means to make payments to its contractual counterpart. This may sound a bit ironic because while commercial lawyers have always tried to use the device of contract to avoid the need to establish a “duty of care” should a dispute later arise, it is tort law which comes to the rescue when no effective means is to be found in enforcing a contract. On the other hand, as will be analysed below, it cannot be overstated that a contract nonetheless plays a significant role here because the tort relies on the existence of a contract and a breach thereof (which in turn depends on the existence, breadth, legality and enforceability of a contractual clause). Viewed in this light, the existence of the Lumley v. Gye tort actually highlights the importance of the drafting technique of a commercial lawyer.
The Elements of the Lumley v. Gye Tort
The basic elements of the Lumley v. Gye tort are that:
- There at least has to be a contract.
- There at least has to be a breach of the contract.
- There has to be an element of participation (which has to be more than mere prevention) on the part of the shareholder/ director/ controller in causing the breach of the contract.
- The shareholder/ director/ controller must also have intended to procure the breach of the contract through its participation. Impliedly, they must also have known of the existence of the contract.
- The plaintiff has to have suffered a loss.
Having regard to the elements of the tort, it is then not difficult to understand why such a tort can be a useful weapon in a dissipation case against the controllers of the company where a breach of contract has already occurred. By definition, such controllers are in control of the company so that it is usually hard for them to insulate themselves from the dissipation. On the other hand, being close to the affairs of the company, they cannot really deny their knowledge of the contract. As for the fifth element, the non-payment under the contract is the loss suffered.
It can be immediately observed that while the Lumley v. Gye tort seems to have “sidestepped” the doctrine of separate legal personalities, it does not deny and is actually premised on the recognition of the separate legal personalities of a company and its controllers (so that they can be properly regarded as third parties). Therefore, there is no established policy reason to exclude a claim against the controllers once the elements of the tort are satisfied. The debtor in Palmer Birch tried to argue that the whole claim was an impermissible attempt to pierce the corporate veil but such argument failed.
As can be shown in the Supreme Court case of Sevilleja v. Marex Financial Ltd  UKSC 31, a claim based on the Lumley v. Gye tort is allowed even when the company is in the process of being wound up. The no reflective loss rule is no bar to such a claim. A general creditor may therefore be in a more advantageous position since he/ she could have a direct claim against the controllers circumventing the problems of ranking lower than secured creditors or ranking pari passu with claims of other general creditors.
Is there a tort of knowingly inducing or procuring the wrongful violation of a judgment debt?
Under the doctrine of merger, upon obtaining a judgment, the contractual debt has “merged” into the judgment and the claimant can no longer rely on the original contractual debt. The question then is, whether the creditor can still rely on the Lumley v. Gye tort where the non-payment is in respect of a judgment debt deriving from a contractual debt? This is the scenario encountered by the English Court in Marex Financial, where at first instance Knowles J decided in an interlocutory application hearing that there exists a tort of knowingly inducing or procuring the wrongful violation of a judgment debt, thereby extending the application of the Lumley v. Gye tort to cover such a judgment debt. Though this case was subsequently appealed to the Supreme Court on other points, ruling on this point remains undisturbed.
The decision of Marex Financial however leaves another problem unaddressed. Given that the original Lumley v Gye tort only recognizes contractual interests as a specific asset class worthy of its protection, it remains to be seen whether the tort of knowingly inducing or procuring the wrongful violation of a judgment debt can be extended to judgment debts based on other causes of action (e.g. a monetary judgment obtained solely based on a tortious claim).
Even if the tort of knowingly inducing or procuring the wrongful violation of a judgment debt is kept within its current bounds, it still represents an outlier in the common law world because a cause of action is generally considered as completed upon the grant of the judgment so that the failure of the debtor to satisfy a judgment debt would not give rise to another cause of action, and the creditor is left with traditional enforcement actions and winding-up proceedings. By this special tort, the creditor can now launch a new claim against the shareholder/ director/ controller of the debtor company where the judgment debt (which has to be derived from a contractual debt) remains unsatisfied.
Comparison to other economic torts
The Lumley v Gye tort also has the following advantages when compared with other economic torts:
- No fraud needs to be proved as in the case of tort of deceit. It has to be borne in mind that fraud is a serious allegation and it is hard to prove fraud in a commercial context.
- No unlawfulness needs to be proved as in the cases of unlawful means conspiracy and unlawful interference.
- Unlike conspiracy, only one wrongdoer (other than the contract breaker) is enough in the Lumley v. Gye tort.
The Lumley v. Gye tort also seems to be exceptionally useful against shadow directors who are acting outside of the constitution of the company. Ironically, this may deprive them of the defence of “acting bona fide within the scope of his authority” conferred on by the company whereas such a defence is generally available to a de jure director. It is therefore not a coincidence that the main defendant in both the cases of Marex Financial and Palmer Birch is a shadow director.
On the other hand, in dissipation cases, what the claimant requires is some initial evidence that there has been dissipation of assets from the company. Such financial information is not normally available to outsiders and as the claimant cannot fish for evidence, he may have to obtain such evidence through other legal routes. Such routes may include contractual clauses which allow access to financial information (which are commonly included in commercial agreements), as well as disclosure orders ancillary to a Mareva injunction.
Both the cases of Marex Financial and Palmer Birch have not been considered by the Hong Kong courts in the context of a Lumley v. Gye tort. It therefore remains to be seen whether the two cases will be followed by the Hong Kong courts, especially when the flexible use of the Lumley v. Gye tort has the effect of sidestepping many of the long-lasting common law principles as described above. However, as an experienced litigator can tell, there is often no better way to apply pressure on the other side than to sue the natural persons behind, and for this reason alone the possibility of launching a claim based on the Lumley v. Gye tort is worth exploring.
Our firm has extensive experience in debt recovery action in HK. If you have any question regarding the topic discussed above, please contact our partner Anna Chan at email@example.com or Martin Tse at firstname.lastname@example.org for further assistance.
We are frequently asked by our startup clients whether or not written contracts are strictly necessary, particularly during the early stages when their business may not be much more than a great idea about a product or a service. We are aware that founders frequently jump into building their businesses without any written contracts but doing so can prove to be a costly mistake.
Why bother with contracts at all?
Written contracts set out the rights and obligations of each party, thereby reducing uncertainties and helping to minimise the risk of disputes getting out of hand. Accordingly, embarking on a business arrangement without a signed written contract means that all of your rights and obligations are left uncertain, leaving your business in a weak position overall.
Regarding the kinds of business arrangements that startups and founders will find themselves in, there are few absolute rules but one is that you should use a written contract whenever you intend to enter into dealings with third parties (paid/unpaid workers, vendors, customers or investors) or with other founders. Employees are a special category because employment laws in Hong Kong actually require employers to provide written employment agreements.
So, what contracts does a startup really need and why?
The following is our Top Seven list of all contracts that founders are likely to need during the early phases of setting up and growing their businesses:
1. Employment contract
You will need at least one sturdy, reusable employment contract for your startup to be in compliance with Hong Kong employment laws but will also need to address confidentiality, non-solicitation, non-competition as well as several other key issues. If you intend to hire interns or other unpaid workers, you will also need a variation of an employment contract for them. For anyone who will be working for the business as a legitimate independent contractor you may also need a services agreement. You will also find that as a startup, these agreements and the business itself will probably need to incorporate a share incentive scheme of some sort to incentivise performance.
2. Co-Founders agreement / Collaboration Agreement / Founders’ Agreement
The function of this contract is to address the contributions of the respective founders, their entitlement to shares in the business (vested over what time period) as well as set out clear contingencies in case any of the founders withdraw. These are often put into place before the business has been incorporated so frequently, founders will ask to include simple administrative rules that will govern the founders’ conduct until a formal shareholders’ agreement is put in place which then replaces the Co-Founders Agreement.
3. IP assignment contract
This is the next most important contract on the list partly because it often is put in place before the business has been incorporated and before any employment contracts are needed. However, the main reason is that the technology developed by the founders is, more often than not, the lynchpin of the business but until the underlying IP has been legally assigned to the business, it consists of little more than ideas in the founders’ heads. Without that crucial step of assigning the IP, no investor will invest in the business for the simple reason that the business doesn’t own its IP. The founders own it. And unless that IP is assigned to the business, what will prevent the founders from leaving the business in 5 months to set up another business?
4. Non-disclosure agreement (NDA)
Everyone has heard of NDAs (aka confidentiality agreements) which primarily function as a means of protecting the business from unauthorised disclosure or use of confidential information. The general rule of thumb is that, as a business, you should not allow any individual or organisation to have access to any valuable confidential information until after they have signed a properly prepared NDA.
5. Investment agreement / Subscription agreement
This contract, often signed together with the shareholders’ agreement, governs the relationships between the company, the founders and new investors and can take many forms depending on the investors’ intended contribution. In Hong Kong, the investment will usually center around a subscription of either preference or ordinary shares in exchange for an agreed amount of cash (ie: an equity investment). Occasionally, investors will offer cash in exchange for a convertible note or other debt instrument. Regardless of how the investment is structured, at a bare minimum, the underlying contract must address details such as the amount, timing and conditions for the investment, and conditions that must be met before the investors can recover their investment. Regardless of who prepares the original agreement, the company and founders need to careful about the scope of representation and warranties as well as potential indemnity / liability provisions that investors will typically insist on inserting to protect their own interests.
7. Shareholders’ agreement
These are used to govern the relationship among shareholders once the business has been incorporated and, like the Investment Agreement, are usually quite detailed. Because they are so detailed and therefore costly to prepare, founders will normally wait until they start fundraising before paying to have a shareholders’ agreement prepared. The reason for that is because each investor will assert specific demands to protect their investment and these will need to be reflected in both the shareholders’ agreement and the Investment Agreement. Each new set of demands will entail changes being made to both agreements.
How can OLN help?
With the above list in mind, we hope you can appreciate why it is foolhardy to operate a startup without written contracts. So, how do you avoid that?
Although contracts are freely available online, the quality and suitability of these vary tremendously. Without substantial prior experience dealing with contracts, you will not know which ones to use and what changes need to be made. To avoid making a costly mistake, in most instances, you should seek advice from a lawyer before negotiating, preparing or signing any significant contract.
If you only require a few contracts at a time and some occasional legal advice, the most cost-effective option available in Hong Kong is to subscribe to OLN Online. OLN Online offers a huge library of contract templates for Hong Kong startups (including all of the ones listed above), as well as the basic advice you will need to get started, and is available through two subscription plans.
If you need more hands-on assistance with your contracts, we recommend that you contact one of us at OLN. We have decades of experience advising founders and investors about emerging businesses and can provide all of the advice you will need for your contracts and other arrangements.
If you have any questions regarding your contract needs or other legal issues, feel free to contact Cermain Cheung (email@example.com) for advice.
It is not at all surprising in Hong Kong for job applicants to back out of the already accepted job offer and accept a better job offer with a more competitive remuneration package. In practice, usually the innocent employer would save themselves the hassle of chasing after the defaulting recruits and simply find a substitute from the job market, especially for those junior or middle-level positions. However, this may not always be the case and the recent judgment handed down by the Court of Appeal in the Hong Kong case Law Ting Pong Secondary School v Chen Wai Wah  HKCA 873 demonstrated clearly that not honouring a signed employment contract may come with a price even before commencement of the employment.
Overview of the case facts
The case of Law Ting Pong Secondary School started off at the Hong Kong Labour Tribunal and was argued all the way up to the Court of Appeal.
In gist, this case concerned a teacher who was offered employment by a local secondary school. On 17 July 2017, this teacher was given (a) an Offer of Appointment; (b) the Conditions of Service for Teachers; and (c) a Letter of Acceptance in respect of his then potential employment with the school. The teacher signed and returned the Conditions of Service and the Letter of Acceptance to the school on the same day. The Letter of Acceptance stated that:-
“I accept the appointment offered in your letter dated 17th July 2017 in accordance with the attached Conditions of Service for Teachers in Law Ting Pong Secondary School.
I also understand that once I accept this contract, the conditions of the new contract will come to [sic] immediate effect e.g. I need to give three months’ notice to terminate my employment with the school.
I confirm that I have read and understood all the above conditions and hereby agree to abide by them.”
The Conditions of Service stated that the period of employment would be “from 1st September 2017 to 31st August 2018”. Under the Conditions of Service, the teacher was required to give the school three months’ notice in writing, or payment in lieu of notice, or a combination of both in order to terminate the employment contract “in order to terminate my [i.e. his] employment with the school” [Emphasis Added] (the “Termination Provisions”). In August 2017 the teacher backed out of the contract. The school then claimed against the teacher for payment in lieu of notice pursuant to the Termination Provisions.
The school succeeded at the Labour Tribunal and was awarded damages in the sum of HK$139,593 (equivalent to 3 months’ payment in lieu of notice).
The teacher subsequently appealed against such decision and the same was overturned by the Court of First Instance. The Court of First Instance held that the Letter of Acceptance did not form part of the specified terms offered by the school to the teacher, as, inter alia, the Conditions of Service did not make any reference to the Letter of Acceptance. Accordingly, the employment should be read as only starting on 1 September 2017 in accordance with the terms of the Conditions of Service, and hence the teacher was not liable to make any payment in lieu as his employment had not commenced at the time when he back out of the employment contract.
Thereafter, the school further appealed against the decision of the Court of First Instance and the Court of Appeal restored the decision of the Labour Tribunal. The judgment of the Court of Appeal can be summarized as follows:-
- The Offer of Appointment, the Letter of Acceptance and the Conditions of Service were given to the teacher together when the school’s offer of employment was made, thus the terms of all the three documents were accepted as a “package deal”. Accordingly, it must be plain and reasonably understood by the teacher, that the school was offering (and only ready to offer) employment on the basis set out in all the three documents. It follows that the Letter of Acceptance formed part of the contract between the school and the teacher, thus should be taken into consideration for adjudication of the matter.
- A reasonable person shall take the Letter of Acceptance to mean that the terms of the employment contract would come into immediate effect such that the teacher would have to give 3 months’ notice to terminate the same. This shall be obvious as the notice requirement under the Termination Provision was specifically used as an example of the terms of the employment contract taking immediate effect.
- Further, the fact that the period of employment would start from 1 September 2017 only meant that the teacher’s performance of teaching duties was to commence on a future date. In general, a valid contract had legal effects, for example, as to repudiatory or anticipatory breach, and was enforceable immediately when it was made, irrespective of the time of performance. Hence, although performance of teaching duties would commence on a future date (i.e. 1 September 2017), as from 17 July 2017 (i.e. the date of signing the contract) both parties were both legally bound to perform their obligations under the contract.
- In response to the defendant teacher’s argument that the amount required to terminate the employment contract under the Termination Provision was wholly disproportionate to the monetary loss that the school might suffer and any legitimate interests of the school (thus is a penalty clause and unenforceable), the Court ruled that a clause could only be a penalty if it operated upon a breach of contract (i.e. a liquidated damages clause). The payment of a sum in lieu of notice under the Termination Provisions was a contractually agreed method of lawful termination of the employment contract; it was not in the nature of damages for breach of contract. It was therefore a primary obligation to pay rather than a secondary obligation arising upon the breach of a primary obligation of performance, thus not a penalty clause.
- The Court further completed the analysis by commenting that the Termination Provisions would still be enforceable even if the same was a liquidated damages clause. On this issue, the Court of Appeal clarified the test to determine whether a clause was a penalty clause was, whether the relevant clause was out of all proportion to the innocent party’s legitimate interest in enforcing the contract; and that the innocent party could have a legitimate interest in the performance of the contract or some appropriate alternative to performance that goes beyond compensation. In applying the test, the Court shall first identify the legitimate interest of the innocent party that is being protected by the clause, then move on to assess whether the clause is out of all proportion to such legitimate interest by considering the circumstances in which the contract was made.
- Accordingly, the teacher was ordered to, inter alia, pay to the school HK$139,593, being payment in lieu of 3 months’ notice.
The case of Law Ting Pong Secondary School suggests that once the employment contract is signed, the agreed notice under its termination provision has to be observed, even before the commencement of the employment.
However, it is arguable that Law Ting Pong Secondary School turns on its specific facts that the employer school has made it explicit on the Letter of Acceptance that the conditions of the employment contract came to immediate effect upon execution and the notice requirement under the Termination Provision was specifically used as an example for illustrating the same.
Further, it is also not certain as to what the Court’s decision would be if any probation period is provided for in respect of the relevant employment. It seems the Court did not pay any regard to Section 6(3A) of the Employment Ordinance (Cap.57) when reaching its decision in Law Ting Pong Secondary School, which provides that:-
“Where in any contract of employment, whether in writing or oral, it has been expressly agreed that the employment is on probation and the contract makes provision for the length of notice required for its termination such contract may be terminated —
(a) notwithstanding the length of notice provided for in the contract, by either party at any time during the first month of such employment without notice or payment in lieu;
(b) by either party at any time after the first month of such employment by giving to the other party notice of the agreed period, but not less than 7 days.”
In light of the Court of Appeal’s decisions in Law Ting Pong Secondary School, it seems the legal position in such scenario could possibly be, albeit awkward, (a) the employee will be required to give notice equals to such length as stated in the employment contract if he chooses to back out of the contract; and (b) no notice is required if he chooses to terminate his employment in the first month of his probation by operation of Section 6(3A) of the Employment Ordinance (which kicks in following the commencement of the employment).
How can OLN help?
As can be seen, it would be advisable for employers to clearly and expressly document in its employment contract the notice period and/or the termination mechanism if the employee fails to show up on the commencement date of employment as agreed. The degree of clarity required in this regard can be very demanding.
We have practical experience in helping employers with the drafting and review of employment-related documentation to ensure the same complies with the employment law regime in Hong Kong and latest development on the same, so as to protect employers’ interest.
On the other hand, we also assist, from time to time, employees on the review of employment-related documentation and advise employees on any potential legal consequences arising from their employment contracts.
If you have any question regarding the topic discussed or other employment issues, please contact our Partner Mr. Victor Ng at firstname.lastname@example.org or our associate Ms. Barbara Kwong at email@example.com for further assistance.
Disclaimer: This article is for reference only. Nothing herein shall be construed as Hong Kong legal advice or any legal advice for that matter to any person. Oldham, Li & Nie shall not be held liable for any loss and/or damage incurred by any person acting as a result of the materials contained in this article.
- 不論閣下與員工的僱傭合約對薪金、 法定 假期、通知及遣散安排的描述，作為僱主，閣下須遵守各項香港僱傭法例所規定的法定最低要求。
請注意，作為僱主，如果有薪實習生年滿 18 歲並連續受雇 60 個日曆日或以上，閣下將需要向其繳納強積金。如有疑問，請在聘用此類候選人之前向有經驗的律師尋求意見清，因為倘證明其中任何人不符合所有標準，則閣下可能需要為已開始工作的欠薪、未支付的強積金供款以及一些嚴重的法律處罰負責。
Distinction, that was the key. The day Louboutin took his assistant’s nail polish in 1993 and painted the sole of the shoe he was making, he was telling the entire world, or at least the European Union, that shoes with red soles must be Louboutin’s.
In 2021, the French shoe designer is suing Amazon for trademark infringement… again.
The worldwide well-known online marketplace is offering High Heeled shoes with red soles, similar to those protected by Louboutin’s trade mark.
The case has been referred by the Luxembourg Court to the Court of Justice of the European Union.
The Red Sole Monopoly recognised in 2018
Louboutin’s red is well protected: on 12th June 2018, the Court of Justice of the European Union ruled in Case C-163/16 Christian Louboutin and Christian Louboutin SAS v Van Haren Schoenen BV that a trade mark consisting of a colour applied to the sole of a shoe may be registered in the EU.
The Court held that a sign, such as that at issue, cannot, in any event, be regarded as consisting ‘exclusively’ of a shape, where the main element of that sign is a specific colour designated by an internationally recognised identification code.
Previously, the Paris Court of Appeal had also considered that the application of a colour to a specific location on a product constituted a distinct and protectable trademark.
Therefore, in the European Union, only Louboutin is allowed to paint the sole of its shoes with the bright red number 18.1663TP in the Pantone colour chart.
Louboutin vs Amazon – Chapter 1, Belgium
Marketplaces like Amazon are online sales platforms connecting buyers and sellers.
Let’s say that a seller other than Louboutin wishes to offer Red Sole Shoes through Amazon. Should Amazon be liable for trademark infringement by a seller on the platform?
Is the storage of counterfeit goods for sale considered an infringement of trade mark rights in the European Union?
Amazon was sued by Louboutin in Belgium in order to engage its liability.
In August 2019, Amazon was found directly liable for the counterfeiting of the red Louboutin sole by a Brussels Court even though Amazon was only in charge of the storage and shipping of the products.
However, in April 2020, in Coty vs Amazon case, the Court of Justice of the European Union excluded any liability of Amazon judging that only the seller and not the platform has the purpose of offering those goods for sale.
National Courts within the European Union are bound by the Court of Justice of the European Union decisions. Based on the recent Coty Vs Amazon C 567/18 decision, the Brussels Court of Appeal partially overturned Louboutin’s decision in June 2020. Therefore, Louboutin lost its case.
Louboutin vs Amazon – chapter 2, Luxembourg
Amazon is evolving, mainly through new services launched during the pandemic. Nowadays, Amazon not only stores and ships the products, but also promotes and advertises counterfeit products through its “Fulfilment by Amazon” offer. This new era of online services could be considered as the platform’s active involvement in the sale of infringing products.
Louboutin has sued Amazon before the Court of Luxembourg. The novelty of the case compared to the 2020 Belgian lawsuit is the “Fulfilment by Amazon” offer.
Is the use of a sign identical with a trade mark in an advertisement displayed on a website attributable to its operator if, in the perception of a reasonably well informed and reasonably observant internet user, that operator has played an active part in the preparation of that advertisement or if that advertisement may be perceived by such an internet user as forming part of that operator’s own commercial communication?
Is the shipment, in the course of trade and without the consent of the proprietor of a trade mark, to the final consumer of goods bearing a sign identical with the mark constitutes a use attributable to the shipper only if the shipper has actual knowledge that that sign has been affixed to those goods?
Is such a shipper the user of the sign concerned if the shipper itself or an economically linked entity has previously made an active contribution to the display, in the course of trade, of an advertisement for the goods bearing that sign or has taken the final consumer’s order on the basis of that advertisement?
The Court of Justice of the European Union was seized on those terms by the Luxembourg Court on 8th March 2021.
Given the reasoning of the previous ruling by the Court of Justice of the European Union, we foresee a different issue for Amazon this time. Since Amazon is now actively promoting the goods, the Court of Justice of the European Union might consider that the platform The expected judgement will be crucial for Amazon services in the entire European Union.
Are you considering exporting your products to the European Union? OLN’s French Practice and IP Department can assist you to make sure you are not infringing EU trademark law.
By Patricia Bodalo
French Practice, Oldham, Li & Nie
Written: June 2021
Congratulations to Benjamin Choi and Vera Sung and the rest of the OLN IP team on being listed as a tier 1 firm for Trademarks/Copyright and as a tier 2 firm for Patents in the Asian Legal Business ‘Asia IP Rankings 2021’ for Hong Kong. For more details, please click here.
We are especially proud of this news given OLN IP is new venture. Established by OLN Oldham, Li & Nie on the 1st January 2021, OLN IP is a consultancy led by Benjamin Choi and Vera Sung. It offers tailored, commercially-driven advice to intellectual property owners, across the different IP asset classes, including IP portfolio management. For more details, please click here.
2020 was a year of turmoil, with the outbreak of COVID-19 in late 2019 and early 2020, global economy experienced the biggest slowdown in recent decades. Despite the economic downturn and the poor market sentiment, the Hong Kong IPO market saw an increase in the total IPO funds raised in 2020 by more than 26% when compared with 2019 totalling HKD397 billion and if compared with 2018, total IPO funds raised rose by 38%, while the total number of new listings dropped by approximately 15% compared with 2019 and by approximately 29% compared with 2018.
Consultation of the Stock Exchange
The Stock Exchange of Hong Kong Limited (“Stock Exchange”) published a number of consultation papers in 2020, out of which the consultation on Corporate WVR Beneficiaries and Main Board Profit Requirement are likely to have bigger impact on the IPO market performance in 2021.
In January 2020, the Stock Exchange published the Consultation Paper on Corporate WVR Beneficiaries (“WVR Beneficiaries Consultation Paper”) proposing to extend the WVR regime to permit corporates to benefit from WVR, subject to appropriate safeguards.
In November 2020, the Stock Exchange published the Consultation Paper on the Main Board Profit Requirement (“Profit Requirement Consultation Paper”) proposing to increase the profit requirement for Main Board listing applicants.
The current requirement for a Main Board listing applicant is that the minimum profit attributable to shareholders shall be HKD50 million for the 3 years preceding the application, with HKD20 million for the most recent financial year and an aggregate of HKD30 million for the 2 preceding financial years. In the Profit Requirement Consultation Paper, the Stock Exchange proposed 2 options for the increase:
Option 1: raises the overall profit requirement by 150%, with a minimum profit attributable to shareholders of HKD50 million for the most recent financial year and HKD75 million for the preceding 2 financial years
Option 2: raises the overall profit requirement by 200%, with a minimum profit attributable to shareholders of HKD60 million for the most recent financial year and HKD90 million for the 2 preceding financial years
Reasons for the change
The main reason for this proposed change is that since the increase in the market capitalisation requirement from HKD200 million to HKD500 million in 2018, the implied historical P/E ratio based on the market capitalisation requirement jumped from 10 times to 25 times. The new profit requirement will bring the implied historical P/E ratio of companies only marginally meeting the profit and market capitalisation requirements down to 8-10 times, a level similar to that prior to the market capitalisation increase in 2018. The Stock Exchange has indicated that the proposed increase in profit requirement is aimed at:
- Deterring creation of shells for subsequent disposal at a profit.
- Further distinguishing Main Board from GEM, attracting only sizeable companies that can meet high market standards to list on Main Board.
- Improving the overall quality of Main board issuers.
Who would be affected most by this proposed increase in profit requirement? Obviously, companies that originally planned to list on GEM, pre-revenue biotech companies and those companies that can meet the new profit requirement will not be affected by this proposal. This proposed increase will surely drive some of the intended applicants who just marginally met the current profit requirement out of the game, unless they turn to list on GEM instead, or wait a few more years until their profits meet the new requirement. The new profit requirement does not only apply to potential Main Board listing applicants, but it also applies to listed issuers who intend to transfer their listing from GEM to the Main Board.
Effect of the new Profit Requirement
With the increase in the profit requirement for new listing applicants, the Stock Exchange expects the number of eligible companies to drop drastically. Based on the number of applications received by the Stock Exchange between 2016 and 2019, about 60% of the applicants would have become ineligible for listing upon adoption of either Option 1 or Option 2 of the new profit requirement.
Companies in early stage of development or small to medium-sized companies which have lower profits will be affected by the new profit requirement. But this does not mean they will be refused access to the capital market at all. These companies can still apply to list on GEM and raise funds for their future development. They still can transfer their listing to Main Board once they are able to meet the new Main Board profit requirement.
The Stock Exchange acknowledges that there are companies who may have already commenced their listing project on the basis of the current profit requirement. As the new profit requirement is expected to come into effect not earlier than 1 July 2021, the Stock Exchange believes that there should be sufficient time for these potential applicants to prepare and submit their listing applications prior to the new profit requirement coming into effect.
As indicated in the Profit Requirement Consultation Paper, applications submitted prior to the new profit requirement becoming effective will be assessed under the current profit requirement, provided that such applications have not lapsed for more than 3 months, been withdrawn, rejected or returned by the Stock Exchange. All applications submitted prior to the new profit requirement effective date will be allowed to be renewed ONCE after the new profit requirement effective date if the renewal is submitted within 3 calendar months after the original application is lapsed such that the application will continue to be assessed under the current profit requirement. But any further renewal of applications after the first renewal will be subject to assessment under the new profit requirement.
It should be noted that any applicant who has submitted their listing application prior to the new profit requirement coming into effect will not be permitted to withdraw their application and re-submit again just shortly before the new rules’ effective date such that the application will have a longer period of assessment and vetting under the current profit requirement.
This may even apply to companies which might otherwise have fulfilled the new profit requirement but for the economic downturn in 2020 which caused its final year of profit attributable to shareholders to drop below the proposed new threshold. In the Profit Requirement Consultation Paper, Stock Exchange raised a point on whether temporary relief shall be granted to good quality companies with strong historical financial performance whose financial results were adversely affected by COVID-19 if certain conditions were met. If such temporary relief is adopted by the Stock Exchange, any potential company seeking such relief shall submit an application to the Stock Exchange for consideration on a case-by-case basis. As it is unclear whether this temporary relief will eventually be adopted after the consultation, it would seem unwise for companies to wait for the consultation conclusion rather than submitting their listing application prior to the effective date of the new profit requirement. If it turns out the temporary relief is not adopted, these companies may lose the chance of submitting their application before the new rule comes into effect, and will have to wait until they meet the new profit requirement.
Conditions for granting temporary relief:
1. Aggregate profit during Track Record Period (TRP) meets the aggregate proposed profit requirement;
2. Positive cash flow from operating activities from ordinary course of business;
3. Circumstances affecting the financial performance is only temporary;
4. At least 6 months of TRP falls in 2020;
5. Sufficient disclosure on the likelihood of recurrence of circumstances affecting its financial performance plus mitigation measures undertaken plus profit forecast covering 1 full financial year after listing
GEM transfer of listing
Since the publication of the Profit Requirement Consultation Paper, sponsors have been actively pursuing potential cases trying to persuade and convince interested companies considering listing on the Main Board or a transfer to the Main Board from GEM to kick start the process in order to meet the last day for submission prior to the new rules becoming effective such that their applications will still be considered and assessed under the current profit requirement.
Outlook for 2021
Since the proposed change in the profit requirement, if eventually adopted, will only come into effect not earlier than 1 July 2021 together with the proposed transitional arrangements which apply to applications filed before the effective date of the new rules, we can most certainly expect a surge in the number of new listing applications and transfer of listing applications to be submitted prior to the effective date of the new profit requirement. Applicants who have commenced their IPO or transfer of listing projects will definitely speed up their process with a view to submit the application before the new rule comes into effect. Even the Stock Exchange indicated in the Profit Requirement Consultation Paper that it is expected the number of applications will increase before the new rules come into effect. In fact, the Stock Exchange has accepted 102 Main Board listing applications since 1 January 2021 which is more than the combined applications for July to December 2020. Just in April 2021 the Stock Exchange has accepted 33 Main Board listing applications. It is very likely that the expected increase in number of both Main Board listing applications and GEM transfer applications will inevitably delay the process and vetting time of applications, whether these applications can proceed to listing within the original 6 months plus the additional 6 months of a renewed application under these circumstances in order to rely on the current profit requirement remain to be seen.
Holding Foreign Companies Accountable Act
In addition to the proposed new profit requirement, the passing of the Holding Foreign Companies Accountable Act (HFCAA) by the US government in December 2020 will also be a driving force for more US-listed Chinese companies to apply for secondary listing on the Stock Exchange pursuant to Chapter 19C of the Listing Rules. The Act requires auditors of US listed foreign companies to allow the Public Company Accounting Oversight Board (PCAOB) to inspect their audit work papers as a means to protect investors and further public interests in the preparation of informative, accurate and independent audit report. If a company fails to comply with this for 3 consecutive years, the Act requires that the SEC prohibit the securities of such company from being traded on a national securities exchange, including OTC trading. will render the company liable to be delisted from the US stock exchange.
With the HFCAA becoming law in the US, and the successful homecoming listings of US-listed Chinese companies in Hong Kong in 2020, we can expect the number of homecoming listings of US-listed Chinese companies to continue to grow in 2021. Amongst the top 10 largest IPOs in terms of funds raised in 2020, three of which are secondary listing of NASDAQ primary listed Chinese companies, ranking first, third and sixth. All three of these secondary listing companies are in the TMT sector, their total funds raised comprised 18.5% of the total IPO funds raised in 2020. TMT continues to be the hottest sector ranking first in terms of total funds raised in the Hong Kong IPO market in 2019 and 2020.
Consultation Conclusion on Corporate WVR Beneficiaries
The Consultation Conclusion on Corporate WVR Beneficiaries published in October 2020 further opened the gate for Greater China Issuers (having centre of gravity in Greater China) that are:
1. controlled by one corporate WVR beneficiary (or a group of corporate beneficiaries acting in concert) which is the largest shareholder in terms of shareholders’ votes and such votes controlled by the WVR beneficiary is not less than 30% of the total shareholders’ votes (at or before 30 Oct 2020); and
2. primary listed on a Qualifying Exchange (being NYSE, NASDAQ and London Stock Exchange Main Market and belonging to the Premium Listing segment) on or before 30 October 2020,
to apply for secondary listing in Hong Kong.
These issuers, known as Qualifying Corporate WVR Issuers, will be treated in the same way as the Grandfathered Greater China Issuers under Chapter 19C of the Listing Rules. Qualifying Corporate WVR Issuers seeking to secondary list on the Stock Exchange shall be an innovative company and shall satisfy the qualifications for listing set out in Chapter 19C of the Listing Rules.
The total number of new listings in 2020 under the new listing regime, i.e. biotech companies, innovative companies with weighted voting rights structures and concessionary secondary listings, was 27, compared with 11 in 2019 and 7 in 2018, showing an increase by 145% and 286% respectively.
The consultation period for the change in Main Board profit requirement ended on 1 February, the consultation conclusion is not yet available when this article is published. We will find out when the consultation conclusion is published which option the Stock Exchange will adopt.
In the 3 months since the Stock Exchange published the Profit Requirement Consultation Paper, the Stock Exchange has accepted a total of 44 new listing applications (including transfer of listing applications and Reverse Takeover) in November, December 2020 and January 2021. As rightly predicted by the Stock Exchange, the number of new listing applications (including transfer of listing applications and Reverse Takeover) accepted by the Stock Exchange in the three months between February and April 2021 almost doubled, totalling 85 applications. We shall see whether the number of applications accepted in the coming months prior to the new profit requirement coming into effect will continue to increase.
If you wish to learn more about listing in Hong Kong, please feel free to speak to our Simon Wong.
+852 2186 1848 / +852 9460 9816
Partner, Corporate & Commercial
Oldham, Li & Nie
隨着世界全球化，跨境經濟活動近幾十年來已成常態。從前，跨國公司（MNC）會採取較進取的稅務策略，將其公司利潤大部分藏於避稅天堂內。由於這些避稅天堂過往很少與外國稅務機關分享資料，因此世界各國的稅務部門往往難以搜集納稅人的離岸資產和交易資料及在其國家管轄範圍內針對有關納稅人進行稅收評估。為堵塞這些漏洞，經合組織開始率領國際實施自動信息交換(Automatic Exchange of Information (AEOI))和採用通用報告標準(Common Reporting System (CRS))。
縱使新法律已經出台，我們了解到香港的一些企業並未得悉他們可能須符合三層架構的轉讓定價文件要求。事實上，自2018年4月起，香港稅務局會要求任何從事關聯交易的香港實體準備一個總體檔案(Master File)和一個分部檔案(Local File)。它們必須在提交報稅表時披露他們是否需要準備任何轉讓定價相關的文件。然而，如果某實體在一個指定的會計期間至少符合以下兩個豁免標準，則可獲豁免擬備有關文件。
• 物業轉讓（無論是動產還是不動產，但不包括金融資產和無形資產） – 2.2億港元。
• 金融資產的交易 – 1.1億港元。
• 無形資產的轉讓 – 1.1億港元；以及
• 其他交易 – 4400萬港元。
對香港稅務局而言，確定哪些公司有義務提交轉讓定價文件並不困難。 很多時候，由於香港稅務局並未向納稅人提出要求，企業並沒有意識到新法規對他們的直接影響。 因此，除非法定豁免範圍適用，跨國公司可能會因不遵守有關規定而誤墮法網。 因此，我們建議他們在進行有關關聯交易前儘早作出準備。鑑於上述涉及技術性問題，公司應徵詢會計和法律專家的意見以減低轉讓定價潛在的風險。