On 7 May 2020, after a trial in the Court of First Instance before Mr Justice Coleman1, the Securities & Futures Commission (SFC) obtained disqualification orders against three former directors of EganaGoldpfiel (Holdings) Ltd (the Company) including Wong Wai Kwong David (Wong) (collectively the Directors) under section 214(2)(d) of the Securities and Futures Ordinance (Cap. 571) (SFO). Wong was disqualified for nine years and the two other directors were disqualified for six years each. However, the SFC failed to persuade the Court to order that the Directors compensate the Company for the significant losses it suffered as a result of their misfeasance.

Background

The SFC's case was that the Directors misapplied funds belonging to the Company and its subsidiaries which resulted in approximately HK$2.55 billion of receivables due to the Company which were irrecoverable. Subsequently, the Company became insolvent and liquidators were appointed.

The Court found that (1) the Directors had approved transactions and signed cheques including payments to at least seven debtors which were under the control of Wong and (2) the underlying transactions for the payments were not genuine commercial transactions in the first place.

As a result the Court held that the Directors had breached their duties of care and skill by not carrying out proper inquiries and not performing due diligence before allowing the Company to enter into the transactions and make the payments. The Court also held that each Director had committed defalcation, misfeasance or other misconduct and in a manner unfairly prejudicial to the members of the company, in contravention of section 214(1)(b) and 214(1)(d) of the SFO.

Disqualification Orders

The misfeasance by the Directors in this case was serious, particularly on the part of Wong. However, the Court took into account a number of mitigating factors in arriving at a nine year disqualification for Wong.

Applications for disqualification of directors have become one of the SFC's most frequently employed enforcement remedies since the SFO came into effect in 2003. To date, it has obtained disqualification orders against 58 individuals prohibiting them from being a director or taking part in the management of listed and unlisted companies in Hong Kong for periods of between two and 12 years. The statutory maximum period of disqualification is 15 years.

While this case went to trial, the majority of the SFC's disqualification applications have been resolved by way of the Carecraft procedure in which a schedule of the agreed facts in relation to the SFC's allegations against the directors is submitted to the Court. Where appropriate, an agreed period of disqualification is included as well. Then the Court determines the appropriate sanction on the basis of the facts in the schedule alone.

Compensation Orders

Section 214(2)(e) empowers the Court to "make any other order it considers appropriate .....". In previous cases this has been interpreted by the Courts to cover orders for payment of compensation or restitution by directors. For example, in Re Styland Holdings Ltd (No.2)2, the Court ordered that two directors who misappropriated funds for their own use should repay the company HK$79 million and HK$6.95 million respectively. In Securities and Futures Commission v Yeung Chung Lung and others3, the former Chairman of a Hong Kong listed company was ordered to repay HK$85 million he had embezzled from the company.

In this case, the SFC sought compensation from the Directors under section 214(2)(e), SFO for payment to the Company of HK$622 million. This was an amount equivalent to the Company's earlier payment of HK$622 million via various conduits to an entity owned by the family of the Company's then chairman. The money was then used to fund the purchase of some of the Company's shares.

However, the Court declined to make a compensation order against the Directors for a number of reasons. First, the Court was concerned that the compensation sought was not "readily ascertainable" as it had been in the Styland and Yeung Chung Lung cases. For example, there was not an underlying agreement between the parties which could form the basis on which compensation could be determined. Further, issues relating to time bar, remoteness, causation and mitigation raised by the Directors had not been addressed sufficiently in the proceedings for the Court to resolve them.

Second, the Court said the SFC brings proceedings under section 214 "primarily for public benefit"4, which may not always be the appropriate proceedings to resolve matters relating to "damages" and "compensation"5. In doing so, the SFC "does not act merely as a cipher for a company or the liquidators of the company"6.

Finally, as the SFC did not suffer any loss, "it may not be a necessary exercise of the widest powers to do justice" under section 214 for it to claim compensation, "where the person actually suffering the loss could have brought, or could still bring, an action of the more typical sort in which such forms of compensation are claimed and entitlement proved".7 The Court considered that it was for the Company (or specifically its liquidators, in this case) to assess the benefits of bringing proceedings in the Company's name against any party.8

Comment

In cases involving flagrant misappropriation of company funds for personal use, the Courts have not hesitated to order delinquent directors to repay the victim company under section 214(2)(e), SFO. However, while not ruling out orders for compensation or damages from directors under this section, to date the Courts have declined to entertain compensation claims by the SFC against directors for trading or transaction losses which are difficult to quantify and prove. In doing so, the Courts have expressed reservations about the SFC pursuing these types of claims under section 214 when the company is likely to be in a better position to assess whether it would be in the interests of shareholders to pursue the directors. There is also a sense that the Courts regard the petition procedure under section 214 as a less satisfactory means of determining issues such as quantum, causation and remoteness than proceedings begun by writ in the High Court.

Under section 214(2)(b) of the SFO, the Courts also have the power to order companies that have suffered loss to bring proceedings in their names against persons who have acted contrary to section 214(1). Despite the Courts' preference for the victim companies themselves to bring proceedings, an order under this section has only been granted once: Securities and Futures Commission v Cheung Keng Ching and others9. In that case, the Court ordered that the company commence a High Court action in its own name and at its own expense against three former directors for the recovery of compensation. However, since the section 214(2)(b) order was made in 2010, the action has not proceeded to trial nor does it appear to have been settled. While it is unclear why this action has not been concluded, the fact that 10 years have passed since the Company was ordered to take action casts doubt on the effectiveness of this particular remedy.

As the case law under section 214, SFO develops, it remains to be seen whether the SFC will continue to pursue more complex claims for compensation or whether it will focus on straightforward repayment claims against directors which have proved more successful.

Footnotes

1 Securities and Futures Commission v Wong Wai Kwong David and others [2020] HKCFI 727

2 [2012] 2 HKLRD 325

3 [2017] HKEC 313

4 Securities and Futures Commission v Wong Wai Kwong David and others [2020] HKCFI 727, §25

5 ibid, §215

6 ibid, §25

7 ibid, §25

8 ibid, §216

9 [2011] HKEC 657

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