Shareholder Disputes in Family Companies · 5 10,000 A Shares 1,000 B Shares Sons + Wives Sons + Wives Profit Shares Father Voting Power Father + Mother 8,972 shares 1,028 shares

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Shareholder Disputes in Family Companies

Ludwig NgPartner, ONC Lawyers

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• All happy families resemble one another, each unhappy family is unhappy in its own way.

Leo Tolstoy

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The stories of 6 families

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10,000 A Shares

1,000 B Shares

Sons + Wives

Sons + Wives

Profit Shares

Father

Voting Power

Father + Mother

8,972 shares 1,028 shares

214 shares 786 shares

Re H.R. Harmer Limited [1958] 3 ALL ER 689

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Re H R Harmer Ltd (1959)

• Relationships and Background

• Mr. Harmer senior was founder of a stamp dealing business.

• In 1947, when he was 77, he formed a company and transferred the business to it.

• Shares were given to his wife, his two sons and their wives, resulting in the structure shown.

• He was appointed ‘governing director’ and his two sons ‘life directors’.

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• The Sons’ (Petitioners) complaints: • Father ran the business in an autocratic manner

and in total disregard of the company’s articles.

• Father committed the company to business decisions without proper authorization of the board, e.g., setting up branch in Australia which folded up soon, selling a profitable branch in New York.

• Father appointed ‘yes men’ to the board without sons’ consent.

• Father acted capriciously and changed his minds often.

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• The judge found the allegations proved and ordered the following:-

• The court ordered that Father was to be employed as a ‘senior stamp consultant’ with a salary of £2500 per annum;

• Father was not to interfere in any way with the running of the company;

• Father was appointed as ‘president for life’ but with no powers; and

• The company was to buy out Father’s shares

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• Harmer senior appealed to the Court of Appeal.

• The court considered the following arguments (and dismissed them).

• The sons got their shares as a gift

• Court: So long as the gift was a valid one, it conferred the same power as if the shares were acquired by good consideration.

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• The sons should have known, when they got the shares, that Father would retain absolute control by way of his majority shares.

• Court: That didn’t mean Father could ignore the proper procedures laid down in the articles.

• Father’s acts were not for personal gains.

• Court: This was irrelevant, so long as the conducts prejudiced the sons’ rights as shareholders.

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• Father would have gotten his way anyway and in a lawful manner by way of his majority voting power.

• Court: The sons were at least entitled to have the proper procedures followed.

• Note: special feature of the case – how old was the Father?

• Query: What if the Father had followed the proper procedures? Would the petition still be successful?

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• The law behind the story

• The Harmer case was based on s.210 of the Companies Act 1948, which provided that a shareholder may petition to the court for relief where the affairs of the company was conducted in a manner oppressive to the minority.

• s.210 of CA 1948 is the predecessor of s.168A of the Companies Ordinance

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• Another remedy available to the “oppressed minority” is the just and equitable winding-up of the company under s.177(1)(f) of the Companies Ordinance.

• In the Harmer case, the court accepted that the company could have been wound-up under the just and equitable ground, but the Petitioners asked for alternative remedies instead.

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• The court would not normally wind up a company on just and equitable ground if the company is solvent, has a viable business and there are other shareholders who would like to continue the business.

• See s.180(1A), CO.

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Wong To Yick Case

HCCW 668/2000 & CACV 867/2001

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Wong To Yick

(R1)

Tinly Wong

(P1)

Cathy Wong

(P2)

Wong Sou Kin

(P3)

45%

12%

4%

4%

35%

R1’s Wife – 11%

Child A – 4%

Child B – 4%

Child C – 4%

Child D – 4%

Child E – 4%

Family Member A – 2%

Family Member B – 2%

HCCW 668/2000 & CACV 867/2001

Wong To Yick Case

R2

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Wong To Yick Case

• Petitioners’ complaints

• Exclusion of Ps from participation and management of the Company;

• Oppression through the passing invalid board resolutions or acting without passing any board resolution; and

• Obstruction in the delivery of accounting papers and balance sheets to Ps.

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Wong To Yick Case

• Particulars

1. Following a family dispute in mid-1999, R1 asked three other children who resided overseas to return to Hong Kong and disclosed to them and to the spouse of one of them the production line and formula for the Oil, contrary to the longstanding policy and agreement of the company that these matters should not be disclosed to members who were not direct members of the family.

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Wong To Yick Case

2. The three children who had newly returned to Hong Kong were asked by R1 to look into the accounts of the Company. R1 authorised them without the consent or authority of the board, to take away the books and accounting records of the Company.

3. Without the knowledge, consent or permission of the board, a general meeting of shareholders was held, at which Ps were replaced as directors by the three newly returned children.

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Wong To Yick Case

4. Thereafter, despite repeated requests, the Company not only refused to supply audited accounts to the Ps but withheld all financial and other relevant information pertaining to the Company.

5. R1 had the habit of drawing cheques on the company’s account as he pleased, i.e. helping himself to Company funds.

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Wong To Yick Case

6. Rs have failed to provide information to Ps without which they cannot assess the value of the company,

7. Rs have prevented the Ps from ascertaining how R1 and the new directors have been conducting the affairs of the Company

8. R1 and the new directors have shown lack of probity in the conduct of the Company’s affairs

It is unjust and inequitable to require the Ps either to continue as members or to leave on unjust terms.

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Wong To Yick Case

• Rs applied to strike out the Winding-Up relief.

• Court held:-

1) The company was solvent, financially sound and profitable. It followed that it was not in the interest of any of its members to wind up a solvent company.

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Wong To Yick Case

2) There are innocent shareholders (holding 35% of the issued capital) who would be adversely affected by a winding up order. Even if the shareholding of the new director (12%) were ignored, that would still leave 5 neutral members holding between them 23% of the shares.

3) There was no prejudice to the Ps by striking out the claim for winding up relief. Nor was there any substantive benefit to be gained from a winding up order which the Ps would not receive from a buy-out order.

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Wong To Yick Case

4) The absence of an offer from the R1 was immaterial since under section 168A of CO, the court has power to order the purchase of shares at a fair value.

5) Having regard to all those matters, the judge came to the conclusion that there was no real prospect of the court making a winding-up order in the particular circumstances of this case.

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Wong To Yick Case

• Result: Winding-up relief struck out.

Ps complained that information/books and records were withheld from them. What could they have done?

See s.152 FA of the CO

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Wong To Yick Case

• On the other hand, what should the father have done?

• A reasonable offer to buy out:-• To purchase share at a fair value

• To be determined by a competent expert (jointly appointed)

• Minority should be given access to company documents

• Both sides should have the opportunity to make representations to the expert

• Reasonable provision for costs

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• Apart from 168A and 177(1)(f), another remedy for the minority is to take a derivative action on behalf of the company against the majority and related wrong-doers.

• What is a derivative action?

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The Playmates Case

FACV 15/2007

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Waddington

(P)

Playmates Hldg

(D3)

Playmates Int’l

(D4)

Profit Point

(D5)

TGC Investment

(D2)

Thomas Chan

(D1)

6.5%

100%

Chairman & Executive Director

Indirect controlling interest in Playmates

100%

FACV 15/2007

Playmates Case

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The Playmates Case

• The actors • P = Waddington Ltd, a BVI co and minority

shareholder in Playmates Hldg (D3)

• D1 = Chan Chun Hoo Thomas, Chairman and Executive Director of Playmates Hldg (D3) and director of each of the companies of the Playmates Group

• D2 = TGC Investments Ltd, a holding company of Thomas Chan via which (and through a family trust) he holds an indirect controlling interest in Playmates (D3) and its subsidiaries and sub-subsidiaries

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The Playmates Case

• D3 = Playmates Holdings Ltd, a Bermuda co listed on HK stock exchange involved in design, manufacture, marketing and sale of toys

• D4 = Playmates International Ltd, a wholly owned subsidiary of Playmates (D3)

• D5 = Profit Point Limited, a wholly owned subsidiary of Playmates International (D4) and thus a wholly owned sub-subsidiary of Playmates (D3)

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The Playmates Case

Transaction impugned by Waddington

- Sale by Profit Point (D5) of its entire shareholding in a company called Prestige Properties Holding Ltd in 2000

• Sale alleged at undervalue thereby causing loss directly to Profit Point (D5) and indirectly to parent co Playmates International (D4) and ultimate holding co Playmates (D3).

• Sale alleged to have been entered into pursuant to an overall agreement for Thomas Chan’s personal benefit and procured by him in breach of his fiduciary duty.

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The Playmates CaseThe form of the action

• WADDINGTON LIMITED(Suing on behalf of itself and all other shareholders in PLAYMATES HOLDINGS LIMITED (except D1 and D2), PLAYMATES INTERNATIONAL LIMITED and PROFIT POINT LIMITED)

Vs

• CHAN CHUN HOO THOMAS D1

• TGC INVESTMENTS LIMITED D2

• PLAYMATES HOLDINGS LIMITED D3

• PLAYMATES INTERNATIONAL LIMITED D4

• PROFIT POINT LIMITED D5

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The Playmates Case

The Central Issue of the Case

• Thomas Chan (D1/Appellant) appeals to CFA to dismiss Waddington’s action contending that a derivative action may be brought only by a member of the company in which the cause of action is vested and not by a member of its parent or ultimate holding company.

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The Playmates Case• D1/Appellant’s reasons for disallowing the action:

1. The action contravenes fundamental principles of company law, in particular, that a co is a separate legal person from its shareholders and that directors owe fiduciary duties to the company alone and not to its shareholders, let alone to shareholders of its parent company

2. It is untrue that without the multiple derivative action a wrong would be without redress. Minority shareholders have a statutory means (under s.168A Companies Ordinance) of obtaining redress if the affairs of the company are being conducted in a manner prejudicial to their interests. (Affairs of subsidiaries have been held to constitute affairs of the company.)

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The Playmates Case

3. Legislation expressly authorizing multiple derivative actions has been introduced in recent years in Australia, New Zealand, Canada and Singapore –its introduction in Hong Kong should be left to legislature and not created by the Courts.

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The Playmates Case• The CFA found:

• the very same reasons to justify the single derivative action also justify the multiple derivative action (in other words, if wrongdoers must not be allowed to defraud a parent company with impunity, they must not be allowed to defraud its subsidiary with impunity)

• proceedings under s.168A CO may be brought by shareholders if the affairs of a subsidiary are being conducted in a manner which is unfairly prejudicial to their interests because the affairs of the subsidiary can also be regarded as the affairs of the parent company. However, unfair prejudice proceedings are concerned to bring mismanagement to an end while derivative actions are concerned to provide a remedy for misconduct .

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The Playmates Case

• the derivative action is the proper vehicle for obtaining such relief for complaint of misconduct rather than mismanagement

• other commonwealth countries have all legislated to introduce multiple derivative actions without finding it necessary to make any significant changes to company law to accommodate them. Such legislation merely confirmed the Common Law position without altering fundamental principles of company law.

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The Playmates Case

• Results: appeal dismissed. P could proceed with the multiple derivative action.

• Note: The claim was allowed to proceed as a derivative action (multiple) on behalf of Profit Point, not its immediate and ultimate holding cos. The action was struck out in so far as it claimed losses on behalf of the holding companies. This is known as the “no reflective loss principle.”

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The Playmates Case

• The law was subsequently changed to confirm the CFA decision. Now, derivative actions and multiple derivative actions are all governed by ss.168BC – 168BK of CO.

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The Playmates Case

• The distinction between MISMANAGEMENT and MISCONDUCT (and hence what kind of action the aggrieved minority should take) is not always an easy one.

• See The Shun Tak Case

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Shun Tak Case

HCMP 1377/2007

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4,250 shares

Interdragon

Winnie Ho

(P1)Minority shareholder, dismissed as director

in Mar 2002

Mutual Stand Ltd.

(P2)

Ambrose So

(R3)

Pansy Ho

(R2)

Stanley Ho

(R1)

STDM

100%

Minority shareholder, dismissed as director

in Mar 2002

Minority

shareholderMinority

shareholder

Managing Director

Largest shareholder, Chairman of the Board

Director

ManagerExecutive Director

Major shareholder, chairman of the executive committee of the board

Shun TakHldgs Ltd.

(R4)

60% 9,204 share

HCMP 1377/2007

Shun Tak Case

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Shun Tak Case

• the actors:

• P1 = Winnie Ho

• P2 = Mutual Stand Limited – a company owned entirely by P1

• R1 = Stanley Ho

• R2 = Pansy Ho

• R3 = Ambrose So

• R4 = Shun Tak Holdings Limited (the Co)

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Shun Tak Case

• The Co = HK listed co with main businesses in property development, transportation, hospitality• the Co is a shareholder of STDM (holding 4,250

ordinary shares) and of Interdragon

• STDM = Sociedade de Turismo e Diversoes de Macau SARL, a private Macau company previously (prior to 2001) owning monopoly franchise in Macau to operate casino businesses and since 2001 indirectly owns 1 of 3 licenses granted by Macau government to operate casino businesses

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Shun Tak Case

S/h--R4 = Shun TakHoldings Ltd

ManagerExecutive DirectorR3 = Ambrose So

DirectorMajor s/h, chairman of the executive committee of the board of directors

R2 = Pansy Ho

Managing directorLargest s/h, chairman of the board of directors

R1 = Stanley Ho

Minority s/hMinority s/hP2 = Mutual Stand Limited

Minority s/h, dismissed as director in Mar 2002

Minority s/h, dismissed as director in Mar 2002

P1 = Winnie Ho

STDMR4 = Shun TakHoldings Ltd

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Shun Tak Case

• Complaints raised in the s.168A petition

• In essence, complaint in petition is failure of the Co by its directors R1-3 to recognize and assert its rights and entitlement to proper payments of dividends from STDM:

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Shun Tak Case

1. The Interdragon issue

• Non-payment of preferential dividends by STDM to Interdragon in respect of 9,204 shares acquired by Interdragon in STDM in 2002.

2. The Sleeping Dividends issue

• Underpayment of dividends by STDM to the Co in respect of 4,250 ordinary shares held by the Co in STDM

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Shun Tak Case

3. The Article 46 issue

• Failure of STDM to distribute its entire annual net profits to it shareholders (including the Co and Interdragon) by way of dividends as required under Article 46 of its articles of association

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Shun Tak Case

4. inaction of the Co

• to inquire into the complaints 1 – 3,

• to enforce its rights and entitlement as holder of preferential and ordinary shares in STMD, and

• to take action against R1-3 for breaches of duties in failing to pursue the complaints 1 - 3 against STDM

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Shun Tak Case

• Substantive relief sought in the prayer

1) An order that the Co bring proceedings against STDM for recovery of all dividends the Co was entitled to be paid but has not been paid by STDM (ie. the Sleeping Dividends issue and the Article 46 issue [complaint 2 - 3])

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Shun Tak Case

2) An order that the Co cause proceedings to be brought in the name of Interdragonagainst STDM for recovery of all dividends which it was entitled to be paid but has not been paid by STDM (ie. the Interdragon issue [complaint 1])

3) An order that proceedings be brought by the Co against R1-3 for damages for breaches of duties in not causing the Co to bring the proceedings sought in relief 1 - 2 [complaint 4]

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Shun Tak Case

• Rs applied to strike out the petition on the grounds that:-

• the complaints in the petition are of misconduct alleged against R1-3 rather than allegations of mismanagement of the Co

• the relief sought in the petition is an order directing the Co to commence litigation (or cause Interdragon to commence litigation) so as to obtain redress for the Co for misconduct against it rather than to end any mismanagement

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Shun Tak Case

• Ps should have brought proceedings by way of a derivative action or sued STDM directly as shareholders of STDM and the use of a s.168A petition is an abuse of the process of the court

• The filtering safeguards for derivative actions should not be by-passed (see. S. 168 BC (3), CO)

• Petition dismissed.

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Shun Tak Case

• So, what could amount to “mismanagement”. The Ip’s family case illustrates.

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Ip Ching Ping, deceased

Wong MiuShim

Henry Cecilia

(P1)

Sammy, deceased

Regina

(R3)

Loretta

(R4)

Roseanna

(R8)

Maimie

(R5)

Marion

(R6)

Henrietta

(R7)

Arnold

(P2)

Desmond

(R9)

executrices of the estate of Ip Ching Ping, deceased (R1)

administratrix of the estate of Ip Man Kong, deceased (R2)

executrix of the estate of Sammy, deceased

Ip Man Kong, deceased

nephew

The Family Tree

HCCW 889/1999

The Ip’s Family Case

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Ching HingConstruction Co.

Ltd.

(R10)

Cecila

(P1)

Arnold

(P2)

Marion

(R6)Administratrix of the estate of Ip Man Kong, deceased

(R2)

Regina

(R3)

Loretta

(R4)

Maimie

(R5)

Executrices of the estate of Ip Ching Ping, deceased

(R1)

Henrietta

(R7)

Roseanna

(R8)

Desmond

(R9)

14.3%

19.2%

0.13%

10% 10.65%

10.65%

10.65%

10.65%

10.65%1.43%

R4-R8 jointly hold 0.26%

1.43%

HCCW 889/1999

The Ip’s Family Case

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The Ip ’s Family Case

1. The Company used to be in construction business, now mainly derives its income from leasing of properties (8 properties + 42 car park spaces, at estimated value of about $200m)

2. Petitioner petition for a buy out order under s. 168A or alternatively for an order to wind up on the just and equitable ground

3. The protagonists to these proceedings are on the one hand Cecilia and Arnold and on the other, the five daughters/sisters of the Ip family, in particular, Henrietta

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The complaints:-

1. Petitioners contended there was a common understanding and/or implied agreement amongst all shareholders that each of the shareholders would be

1) appointed and be allowed to remain as a director so as to take part in the management of the Company’s affairs (right to participate in management);

2) entitled to share the profits of the Company in proportion to their respective shareholding in the Company (right to share profits)

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2. Petitioners said it is part and parcel of the Common Understanding that the Company’s profits and assets were to be distributed by way of directors’ emoluments in proportion to shareholding since 1992

3. Petitioners alleged that the 5 daughters, in breach of this Common Understanding, had wrongfully expelled Arnold from the board in the 1996 annual general meeting, thereby depriving the petitioners’ right to manage the Company’s affairs and to share its profits

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4. Petitioner further alleged that irrespective of the Common Understanding, the petitioners are unfairly prejudiced because the wrongful expulsion of Arnold from the board had deprived the petitioners of their right to participate in the Company’s distribution of profits and assets, which had since around 1986 taken the form of director’s emoluments and allowances

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• The Court found:-

• The Company being a family company is by itself not an adequate basis for the allegation of an implied agreement or understanding

• The personal relationships among the members were not such that equitable restraints would be imposed on the exercise of their rights under the articles of association

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• While the five sisters no doubt enjoy harmonious relationships among themselves, that does not extend to other members

• Any suggestion that the relationships among the family members (with the exception of the five sisters as a camp) involved a mutual trust, understanding and confidence is unfounded

• Desmond may have a better relationship with his aunts. But that is not sufficient to ground the Common Understanding with Arnold.

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• Hence, there was no Common Understanding that Arnold should remain a director and participate in the management of the company and drew director’s emolument.

• The emoluments of the directors are not excessive in the circumstances of the case, hence there was no unfair prejudice in this regard.

• Result: Case dismissed.

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Excessive remuneration

• Directors drawing excessive remuneration could be an act of unfair prejudice. In deciding on this issue, the court adopted the “objective commercial criteria” test.

• The mere fact that the co was trading at a loss or low profitability would not in itself enable an inference of excessive remuneration to be drawn, unless it is proved that such payment was motivated by pure self interest.

• Expert evidence on proper level of remuneration could be adduced.

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• Common Understanding is important because if proved to exist, it could override the rights of the majority under the company’s articles.

• See the Silver Bell Uniform Case

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Silver Bell Uniform Ltd (R1)

Mrs. Lee

(P) 40%Silver Bell

Fashion Ltd

(R2)

Shen’s family

Ms. Chen

(on trust for R2)

50%

100%

10%

HCCW 478/2008

Silver Bell Uniform Case

David Shen Ginam Shen

5% 5%

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• The Parties and the Background

• The Company:Silver Bell Uniform Limited

• Petitioner (“P”): Mrs. Lee, Ng Louise

• 1st Respondent (“R1”): Silver Bell Uniform Limited

• 2nd Respondent (“R2”): Silver Bell Fashion Limited (the Shen Family)

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• P and a Mrs. Shen Lian Yien Hwa (“Shen ”) came to know each other when they both worked in a company which specialized in the business of the production and sales of uniforms.

• When the company ceased business in 1992, Shen and P decided to set up the Company to do the same kind of business

• Shen acted as the managing director and P acted as its general manager.

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• Shen became ill in 2006 and left P with the running of the Company until she died in April 2008.

• The Shen Family discussed appointing David Shen as Managing Director of the Company, to which P objected on the grounds that he did not have any experience of the business.

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• Alleged unfair prejudice / unjust or inequitable conduct

• The Shen Family circulated an announcement to staff and customers on 10 June informing them that David Shen would be managing director with effect from 16 June 2008, notwithstanding P’s objection.

• P then proposed that either the Shen Family buy her shares or the Company be wound up.

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• David and Ginam made it clear that they wished P to stay with the Company. P explained that she did not wish to remain, and said that she wished to leave and set up a competing business.

• P resigned on 12 September 2008 effective from 16 October 2008. She began to approach the Company’s customers and staff.

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• As a result the Shen Family purported to terminate P’s employment on 23 September 2008.

• P then wrote multiple letters repeating her offer to sell her shares, but the Shen Family maintained their refusal to buy them.

• This eventually led to presentation of the Petition on 13 October 2008.

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• P claimed that at the time the Company was established, both P and Shen discussed the management of the Company and agreed that if either R2 of P wished to withdraw from the Company either the remaining shareholder should buy the departing shareholder’s shares or the Company should be wound up.

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• Findings:-

• The court found that P and Shen did agree at the time of the Company was established that if one of them wished to leave the Company the other shareholder would buy the departing Party’s shares.

• The Court was concerned with whether or not the way in which the Company had been operated for 16 years and the understandings, implicit perhaps rather than express, underlying the way in which its affairs were conducted make it unjust to require the P to remain a shareholder.

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• Regard was had to the fact that between 2006 and 2008 the Shen Family did not take any steps to replace Shen or assist the P in the management of the Company.

• This suggests that the Company was generally understood by the P, Shen and the other members of her Family to be a venture between the P and Shen.

• In those circumstances the Court considered it unjust to require the P to have to work with a new partner in whom she does not have confidence.

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• The court concluded that the way in which the affairs of the Company were conducted prior to Shen’s death gave rise to equitable considerations, which made it unfair for the Shen Family to insist on their de facto right to replace Shen with their preferred David Shen without offering to buy P’s shares.

• P was found to be entitled to relief, and the Shen Family has to buy out P’s shares.

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Order made by the court:-

1) R do purchase within 14 days of the date of valuation all shares held by P at a price to be fixed by such valuer (“the Valuer”) as may be agreed, or failing such agreement, as may be appointed by the President for the time being of the HKICPA;

2) The valuer be directed to value the P’s shares on the following basis:a) the price shall be the value of the shares

determined by reference to the assets, profitability and future prospects of the company as at the date of the petition;

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b) P and R do provide to the valuer all books, accounts and documents of the company relevant to the valuation of the Petitioner’s shares within 14 days from the date of the appointment of the valuer and any other documents the valuersubsequently requests;

c) P and R shall have the right to make submissions to the valuer in such form as may be determined by the valuer.

3) The cost of the valuer’s valuation shall be borne equally by P and R.

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4) In the event R failing to complete the purchase within the time above specified, the company shall be wound up.

5) R shall pay the costs of the Petitioner and of the 1st Respondent, including all costs reserved, such costs to be taxed if not agreed on a party-to-party basis.

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Shareholder disputes in family companies

• Some lessons from the above cases:-

1. Even in a family company, company law and the articles of association have to be complied with.

2. It doesn’t matter that some family members got their shares freely, so long as the gift is a valid one.

3. Common understanding (e.g., on right to participate in management) amongst shareholders could override the provisions of articles, if proved to exist.

82

Shareholder disputes in family companies

4. Mere family relationship is not adequate ground to prove the existence of such common understanding.

5. Common understanding may exist amongst some family members but not others.

Documents

Shareholder Disputes in Family Companies · 5 10,000 A Shares 1,000 B Shares Sons + Wives Sons + Wives Profit Shares Father Voting Power Father + Mother 8,972 shares 1,028 shares