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Jordan, C --- "A Long and Winding Road: The Making of New Companies Law in Hong Kong" [2009] UMelbLRS 10

Last Updated: 7 December 2009

(Baker & McKenzie, “Comments on the Consultancy Report prepared by the

(L. Bebchuk and M. Roe, “A Theory of Path Dependence

A Long and Winding Road:

The Making of New Companies Law in Hong Kong

Cally Jordan1

“The Master said: ‘Put me in the company of any two people at random – they will inevitably have something to teach me. I can take their qualities as a model and their defects as a warning.’” (The

Analects of Confucius, 7.22)

“The corporate structure with which a country began will influence those that it will have down the road: if two countries start with contrasting corporate structures, then, even if they become similar in every other respect, those countries’ different corporate structures will tend to persist .... Interest group politics introduces further path dependence. A country’s initial pattern of corporate structures will create interest groups and determine the power of groups to influence which

corporate law will persist and which ones change.”

in Corporate Governance and Ownership”, unpublished, to appear in the Stanford Law Review)

“However old fashioned the legislation may be, lawyers and advisers in Hong Kong are familiar enough with it, and with the methods of improving company operation, to continue to recommend

Hong Kong incorporation ...”

Companies Ordinance Review Committee”, 30 March 1998)

INTRODUCTION

All has been very quiet on the company law front in Hong Kong of late. So, where is Hong Kong companies law on the long and winding road to renewal? Still in the thickets of the Standing Committee on Company Law Reform (SCCLR).

The Consultancy Report on the Review of the Hong Kong Companies Ordinance (the

1. B.A., M.A., LL.B., D.E.A., B.C.L. Cally Jordan is the author of The Consultancy Report on the Review of the Hong Kong Companies Ordinance (March 1997) commissioned by the Financial Services Branch of the Hong Kong Government in November 1994. At the time of undertaking the mandate, the author was an Associate Professor at the Faculty of Law, McGill University, Montréal. She is currently an Associate Professor at Melbourne Law School and a Visiting Professor at Duke School of Law. The views expressed in this paper are those of the author and do not represent the views of the Government of the Special Administrative Region of Hong Kong, China The full text of the Consultancy Report is available at: http://www.cr.gov.hk/en/stnading/docs/concmpny.pdf.

Consultancy Report) was made public by the Financial Services Branch of the Hong Kong

Government on May 1, 1997. The public consultation period, a very low key affair, formally

came to an end March 31, 1998 although submissions continued to trickle in until November

1998. In a speech made shortly afterwards in early December 1998, the Financial Secretary, Sir

Donald Tsang, announced that the SCCLR, a group of government, academic, professional and

private sector representatives, had just concluded its chapter by chapter consideration of the

Report. The SCCLR would be moving on to consider the submissions made on the Consultancy Report and would then formulate its own views on the way forward. The deliberations of the

SCCLR are continuing and a report will likely be made public in early 2000.

The SCCLR was constituted in 1984, as the final recommendation of the last major

review of Hong Kong companies law. It is an influential body and has been responsible for the updating, on a yearly basis, of the Hong Kong Companies Ordinance. The SCCLR does publish an annual report although its activities remain somewhat opaque and its sessions, an hour and a half once a month, are open by invitation only. The submissions to be considered by the SCCLR are not being made generally available. I have obtained a half dozen or so of the comments and spoken informally to several members of the SCCLR. The observations that follow are thus

subject to the caveat that they may suggest an incomplete impression of the reactions to the

Report and the future direction of Hong Kong company law.

At this point, company law reforms are still very much the captive of the SCCLR, which,

likely unbeknownst to it, is struggling with issues of path dependency. As one member of the

SCCLR put it:

The Committee worked through all the recommendations and there were extensive discussions. Hong Kong is not an easy place to introduce fundamental law changes. Diversity of background and our historical past probably had something to do with it. Structural amendments which may mean having to re-learn a new set of wheels may not find ready acceptance. Be that as it may, the review has given a good ventilation to a dated area of the law and [I] am sure some good will come out of it. It is probably a little early to speak in terms of developments.

The starting point of the Consultancy Report, that it is time to take a new path through the

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woods, appears to be the source of the most hesitation and reluctance on the part of the SCCLR and the commentators. According to one member of the SCCLR, the best bet at the moment is that there will be no brand new Companies Ordinance, but rather a lot of wholesale cutting and pasting. New companies law will follow the same path but hack away at the undergrowth.

The cutting and pasting has already begun. In fact, since many of the recommendations followed on directly from SCCLR discussions which themselves had taken place over a long period of time, some issues had already been fully “ventilated” and legislation contemplated. Provisions designed to eliminate the application of the ill-loved “ultra vires” doctrine in company law were implemented before the Consultancy Report itself was made public. Streamlined liquidation procedures for solvent companies may find a legislative time slot early this year. Provisions for the codification of directors duties have already made it to the Legislative Council on one occasion (where they were derailed) and may easily be resurrected.

A few factors, though, may still nudge Hong Kong companies law out of its path-dependent state. One is the “ventilation” factor referred to above. The Consultancy Report has been called “thorough and thought-provoking” by Baker & McKenzie and the SCCLR has reviewed it paragraph by paragraph. Repeated exposure and growing familiarity with new ideas and concepts can lead to gradual acceptance over time, even where the origin of the ideas and concepts is forgotten. A year ago, the Chair of the SCCLR, Mr Justice Rogers, was publicly expressing his incredulity at the prospect of companies with no par value shares. I suspect that such a prospect (floated last year by the U.K. government), is no longer quite so farfetched, irrespective of its merits.

To this extent, the Consultancy Report has already served a purpose in terms of outlining the dominant trends in modern companies law and establishing the benchmarks. And the Consultancy Report itself is only the tip of the iceberg. Under it are 600 pages of background papers and memoranda, prepared for the working party groups, which delve into the issues in greater detail. If nothing else the Report and its background papers served to heighten academic debate and interest in Hong Kong companies law, as evidenced by a spate of company law texts and services that have appeared (and continue to appear) since the inception of the Review. Not

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everyone agrees with the detail or the thrust of the Consultancy Report and that is as it should be (although I would add that undertaking company law reform in Hong Kong is not for the faint of heart nor for those of tender sensibilities). Debate foments change.

A second factor at play is the state of securities legislation in Hong Kong. In April 1996 a composite securities bill was released for consultation. Although the bill was not much more than a housekeeping measure, interest group pressures resulted in it missing the legislative window in March 1997. The change of sovereignty then delayed the legislative process; the Provisional Legislative Council decided that its mandate was restricted to dealing with laws essential for the functionning of the Special Administrative Region Government. Then came the shock of the Asian financial crisis. Now, the new Chairman of the Securities and Futures Commission went on record in October 1998 to say that the composite securities bill itself must be reviewed, and in the light of international standards.

I intend to cooperate not only with domestic regulators within Hong Kong but also with regional regulators and international regulators to bring Hong Kong’s regulatory framework to the best international standards of transparency and competition2.

The guidelines for a new Composite Securities and Futures Bill have already appeared and the Bill itself is expected shortly. Enhanced enforcement powers for the Securities and Futures Commission, increased disclosure, greater liability for directors, and the creation of a Market Misconduct Tribunal are among the proposals. Companies law and securities legislation are coterminous in certain respects. Changing the path of one will inevitably change the other.

It also appears that the Consultancy Report has created an intriguing feedback loop. The path taken by Hong Kong companies law for over 150 years has been the British one. The Consultancy Report, however, has itself served as the “catalyst” (in the words of the Department of Trade and Industry in London) for a major rethinking of the future direction of U.K. companies law. In March 1998, the U.K. Government launched a major three year review of companies law:

2. “Hong Kong Regulator Seeks International Input”, Asian Wall Street Journal, October 6, 1998, 11.
   
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The Government has decided that the time is now right to embark on a fundamental review of the framework of core company law. Many of the key features of our current arrangements were put in place in the middle of the last century; and although there have been numerous changes and additions through the years, it is nearly 40 years since the last broad review of company law. The current framework has as a result become seriously outdated in key respects, not least as the economy has become more globalised.3

To tangle a few metaphors, should the United Kingdom beat a new path in companies law, Hong

Kong may be left paddling its own canoe, or worse, up a creek without a paddle. On the other

hand, if the Consultancy Report has flapped a few wings in Hong Kong that change the future

course of U.K. companies law, this may in and of itself shake Hong Kong out of its path-

dependent state.

Then there is the China factor. China is bushwacking its way to a legal system. There are

faint traces of the old pre-1949 paths discernible (in the German influences in the 1994

Companies Law, for example) but apparently little investment in nor sentimentality about them.

The new Securities Law of the People’s Republic of China, adopted 29 December 1998, strikes

out on its own (perhaps one of the reasons for its long gestation).

The following paper will look to the major considerations that determined the direction of

The Consultancy Report on the Review of the Hong Kong Companies Ordinance, its substantive

recommendations, the political influences at work, and the developments since the Report, in Hong

Kong and elsewhere.

1. HONG KONG COMPANIES LAW: AN ORPHAN IN ASIA

For decades, Hong Kong, like many other Commonwealth jurisdictions, looked exclusively

to the United Kingdom in structuring its public institutions and formulating its legislation, for a

3. Department of Trade and Industry, “Modern Company Law For a Competitive Economy”, March 1998,1.
   
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variety of obvious reasons. Other small jurisdictions as different as Singapore and New Zealand had done the same, essentially importing legislation developed elsewhere, and relying on the judicial and other resources of that jurisdiction to "maintain" the local legislation. Professor Walter Woon, formerly of the National University of Singapore, has spoken of "legislation by Xerox". In Hong Kong, the process was an even more natural and integral one, Hong Kong being an extension of British territory.

In companies law, however, it had become evident that the United Kingdom no longer provided a model that was easily emulated. As long ago as 1973, the last major review of Hong Kong companies law noted that it would no longer be possible to look as a matter of course to U.K. law as a model for Hong Kong companies law.4 Since then the difficulties of following a U.K. model were exacerbated by successive waves of complex and marginally successful companies legislation in the United Kingdom. Hong Kong companies law was orphaned.

In fact, Hong Kong companies law had been looking elsewhere for direction for quite some time, as had, to a greater or lesser degree, other common law jurisdictions including South Africa, Singapore, New Zealand, Australia and Canada. Initiatives to abolish the noisome doctrine of ultra vires in Hong Kong looked to the Business Corporations Act (Ontario)5. This initiative, however, also serves to illustrate the potential pitfalls of incorporating isolated provisions taken from foreign legislation which proceeds from different assumptions and underlying concepts. The Ontario legislation is specialized business corporations legislation, by its terms not applicable to the broad range of different entities, such as not-for-profit enterprises, which may be created under the current Hong Kong Companies Ordinance. The Ontario provisions, assuming as they did, applicability exclusively to commercial entities, could not be dropped, unaltered, into the Hong Kong legislation.

It is primarily for this reason that the Consultancy Report recommended following a new path, a shift to a new, coherent model rather than cobbling bits and pieces of foreign legislation together with the existing legislation. The piecemeal approach to legislative change in this area had

4

5

Hong Kong, Second Report of the Companies Law Revision Committee -- Company Law (12 April 1973).

Ontario Business Corporations Act, R.S.O. 1990, c. B.16, as amended.

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long been criticised both in the United Kingdom and in Hong Kong.6 A new model would provide a coherent legislative framework for commercial entities in Hong Kong, internally consistent, conceptually clear and well articulated. What was proposed was not the old "legislation by Xerox". The use of model legislation, as it has been developed, of necessity, in federal jurisdictions such as the United States and Canada, is much subtler and more flexible.

The model provides the basic principles and structure of the legislation which can then be adapted in detail to local circumstances. With its fifty state jurisdictions, the United States has been a consummate master in developing this technique. Model laws, such as the Model Business Corporation Act ("MBCA"),7 are developed by bodies like the American Bar Association, drawing on the vast resources available to them among practioners and academics. A detailed official commentary is provided section by section explaining the origins, purpose and intended operation of the model legislation. The legislation is then adopted voluntarily on a state by state basis, being tailored and adapted as each state wishes. Over time, the model itself is revised and updated.

In this way, the costs of developing and maintaining sophisticated and responsive legislation are spread across many states. Individual states are free to adapt the model legislation as they wish, but the basic principles of the model continue to inform local legislation. Reference can continue to be made to developments and evolution in both the model and judicial decisions in other jurisdictions using the model. This process has also been taking place, informally, among Commonwealth jurisdictions which share common legal traditions; legislators and the judiciary in Commonwealth countries have been looking increasingly to each other rather than back to the United Kingdom. Of course, given its wealth of sophisticated commercial legislation, everyone looks to the United States, if not to follow, then as a benchmark against which to act.

The question then became what new path to follow. Hong Kong had its own particular set

of constraints and considerations.

7. American Bar Association, Committee on Corporate Laws, Revised Model Business Corporations Act, 1984. The Revised Model Business Corporations Act replaced the 1969 Model Business Corporations Act; the “revised” was recently dropped.
   
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2. THE LANDSCAPE DETERMINES THE PATH

2.1 The Basic Law

First among the factors determining the direction of the path was the Basic Law, Hong Kong’s “mini constitution”. Article 8 of the Basic Law maintains, for the next 50 years, the existing common law legal system that has been operative in Hong Kong for over 150 years. This answered the often - asked question throughout the course of preparation of the Consultancy Report: to what degree should Hong Kong companies law be aligned with the new PRC companies legislation.

The Western legal tradition being gradually reintroduced on the mainland after a hiatus of several decades is strongly European civil law inspired (German law, by way of Japan and Taiwan). Although the PRC has been quite eclectic in its use of foreign models for its 1994 Companies Law, the predominant influence of the German model is quite discernible. Structural concepts, such as dual boards and worker participation in management, have been astutely turned to socialist market economy purposes but would appear quite alien to the Hong Kong business community.

Secondly, the primary purpose of the new PRC Companies Law is “corporatization” of state-owned enterprises in furtherance of the transition to a market economy. The mainland legislation is a first step, and a good one, towards creation of a more comprehensive companies law. It is essentially transitional in nature and somewhat incomplete pending the further development, among other things, of mature capital markets on the mainland. Hong Kong is a freewheeling market economy with developed capital markets. Over 98% of the companies in Hong Kong are private and virtually 100% are owned by the private sector.

2.2 Political Imperatives

• 2.2.1 Influences from the Northern Capital
  
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The last several years have been a time of high politics in Hong Kong. The reform of the Hong Kong Companies Ordinance was caught straddling the transition in political sovereignty.

The political events of the time in Hong Kong did influence the choices made in the process of the Review but perhaps not in the way many imagined. Initially, given the fact that the Review was commissioned by the outgoing administration with a deadline corresponding so closely with the resumption in sovereignty by the PRC, the assumption was sometimes made that the intention was to bring in new legislation before the transition, under the wire so to speak. This had never been contemplated since the Consultancy Report itself was merely a preliminary step in a process that would easily take five years or more.

Towards the end of the Review, in the weeks leading up to the handover, the question then became the influence which the mainland did or should have on the orientation of the recommendations. There again, the influences were not what might be imagined. During the course of the Review there had been no formal contacts or consultation with Beijing concerning to the Review process or its product, either on the part of the consultants, or the part of the Hong Kong administration. This was not particularly surprising or untoward.

However, in the process of preparing the Consultancy Report (and in particular the background report looking at companies law in a number of jurisdictions), there were several days of discussions with different senior members of the Standing Committee for Legislative Affairs of the National People's Congress. In July 1994, shortly before the Hong Kong Review began, the PRC had implemented a companies law. Obviously this new legislation was of great interest to all those engaged in China work out of Hong Kong.

The discussions with the members of the Beijing Standing Committee were of an academic nature and for the purpose of mutual exchanges of information. As with all the academics and agencies which assisted in the Review, the Consultancy Report and various background papers were sent to Beijing as a matter of courtesy. So, although there is no doubt as to the interest which Beijing took in the process and its product, it was primarily an academic, and not an overtly

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political, interest.

Having said this, the question which, again, was repeatedly asked was the extent to which Hong Kong companies law should be aligned with that of the mainland. The short answer, for some of the reasons given above, is that it shouldn't. Very different economies at a very different stage of development. Different legal traditions and a different role for companies legislation. That the two will converge over time is inevitable but it will not happen overnight; it will be a much slower process of growing familiarity and accommodation.

2.2.2 The Row over Legco

One unfortunate casualty of the political transition was a possible second volume to the Consultancy Report, which would have contained draft or model legislation to accompany the text of the Consultancy Report. This format was not new to Hong Kong, having been used in both the areas of insolvency and securities law. It was the format of the Dickerson Report, the Ghana Code, the Model Business Corporations Act and New Zealand Law Commission, Company Law-Reform and Restatement, Report No. 9 (1989).

The virtue of draft or model legislation is that it provides precision to the generality of the recommendations. In fact, many of the subsequent questions that have arisen in the public consultation period as to the mechanics and application of the recommendations would have been answered by reference to a form of draft legislation. The preparation of draft legislation, to this end, has been a specific request of the Hong Kong Institute of Company Secretaries.

Including draft legislation had been discussed for many months during the course of the Review. It had not been envisaged in the original mandate and would possibly have required an extension to complete. Producing draft legislation in a law reform report can have untoward consequences to the extent that it can be seen as preempting role of other government departments.

Aggravating the situation in this case was the fact that early in 1997 a very conspicuous row broke out between the U.K. government and the PRC over the provisional legislature which the

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PRC announced it would put in place immediately upon taking over Hong Kong. The idea of producing a second volume of draft legislation to accompany the Consultancy Report died a quiet death in early January 1997.

2.2.3 The Prospect of Hanging

The prospect of hanging is said to concentrate the mind wonderfully. The original mandate required a final report to be produced by the end of December 1996, but allowed for some slippage into 1997. Because of the impending change in sovereignty, there was no room for extending the mandate beyond July 1, 1997. The imposition of an historic and immutable deadline resulted in speed and focus. There was little time to waste and little dillydallying.

Focus was the consequence of a rigid time frame and very limited staffing. This was not a broad consultative effort. Consultation within Hong Kong was limited to working party sessions. Working party members were handpicked, high level representatives of various constituencies. The orientation of discussions, although involving diverse and sometimes conflicting viewpoints, was very much determined by the briefing books and background papers.

The result is a report which bears little resemblance to similar efforts which are the product of committees. It is written by one person and demonstrates an internal coherence and consistent point of view, in the tradition Gower's 1962 Ghana Code8 and the 1972 Dickerson Report9. The objective was to provide a conceptually consistent and coherent starting point for any legislative action, irrespective of the ultimate direction such action might take.

Both a strength and a weakness, the Consultancy Report very much represents one person's view of the possible future direction of Hong Kong companies law. If it is the wrong direction, it is terribly wrong. The very tightly focused approach for both the process and the report itself may

8. L.C.B. Gower, Final Report of the Commission of Enquiry into the Working and Administration of the Present Company Law of Ghana, 1961.
   
9. R.W.V. Dickerson, J.L. Howard & L. Getz, Proposals for a New Business Corporations Law for Canada (Ottawa: Information Canada, 1971).
   
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preclude discoveries and innovations that might have surfaced in a more diffuse and less pressured investigation, although the counter argument here is simply that that is not the Hong Kong way.

2.2.4 The Through Train

The impending change in sovereignty also created a climate of uncertainty and insecurity that affected the choices made in proposing changes to the companies legislation. In some quarters there was great hesitation about any change whatsoever on the grounds that the legislative system was on a “through train” through the transition. The legal system should be cryogenically frozen as of June 30, 1997, warts and all, to survive the fifty year voyage into the future.

This concern resulted in proposals for new companies law which were very conservative. No innovations here. The exercise was one of bringing the legislation up to date. With one exception, every recommendation is based on existing legislation, operating in the real world. Tried and true.

In addition, at the time of initiation of the Review, the fate of the judicial system, particularly the Court of Final Appeal (which replaced recourse to the Privy Council in the United Kingdom) was still unsettled and the identity of the new Chief Justice was unknown. As well, Hong Kong had never been rich in case law. It is a small jurisdiction (6 million souls); legal fees are among the highest in the world; and culturally (or just plain sensibly), it is litigation averse. If the United Kingdom were no longer an appropriate legislative model, and recourse would no longer be had to the U.K. judiciary nor its case law, then the argument in favour of adoption of a model which provided a large body of ready-made judicial interpretation, was persuasive.

2.3 The Local Face of Hong Kong Business

Three features of the local business community were also highly significant; the domination of the private company in terms of incorporations; the prevalence of the family-controlled public company; and the widespread use of overseas incorporation by local business. These features were not unique to Hong Kong but the existing legislation was not responsive to these aspects of the

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commercial reality.

Nearly 99% of incorporations in Hong Kong are private companies. There is a strong securities regulator for public and listed companies, and a separate regulatory regime in place. For this reason, the proposals could focus on private company concerns.

Private companies are often, but not always, family-controlled. A most notable characteristic of Hong Kong business is the use of the family-controlled company by businesses both big and small10 and, particularly for public companies. The Second Corporate Governance Study of the Hong Kong Society of Accountants confirmed the "widespread view that the extent of control by one shareholder or one family group of shareholders in the shareholding of listed companies in Hong Kong is significant"11. Almost 90% of all Hong Kong listed companies have one shareholder or one family group of shareholders owning 25% or more of their entire issued capital; 77% show one shareholder or family group owning 35% or more of the entire issued capital, and more than half have one shareholder or family group owning 50% or more.

A curious anomaly in some respects, given that Hong Kong has rapidly risen to prominence as a major international business centre, is the equally rapid rise of foreign incorporation of Hong Kong business. In some respects, this is a phenomenon sparked by the conjuncture of political, fiscal and commercial forces unique to Hong Kong. Although there has been abundant speculation as to the implications of political risk for Hong Kong businesses, strictly financial and commercial factors emerged as primarily responsible for the wave of offshore private company incorporations.

The British Virgin Islands (BVI) appears to be the jurisdiction of choice for private foreign incorporations of Hong Kong businesses. Although 1121 BVI companies were registered under Part XI of the Ordinance as of December 31 199612, the vast majority are not registered and their

10

11

12

The Review of the Hong Kong Companies Ordinance, Family-Controlled Companies Background Memorandum, 1-3.

Hong Kong Society of Accountants, Second Report of the Corporate Governance Working Group, January 1997, 3.

According to statistics provided by the Companies Registry, the number of incorporations registered under Part XI of the Ordinance from the British Virgin Islands increased by almost 1% from 1121 at December 31, 1996 to 1131 at January 31, 1997.

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actual presence in Hong Kong is estimated to be over 100,000. Professional advisors appear to be the driving force behind the proliferation of these offshore incorporations. The speed and ease of incorporation and reduced costs of operation were cited. BVI incorporation has been found to be suitable for both small flat owning companies and as a building block in major commercial conglomerates. The enabling nature of BVI companies law, as well as the absence of stamp and capital duty, ongoing reporting formalities, and the mandatory audit ranked high in the decision to incorporate in the BVI.

As for listed company offshore incorporations, political considerations appear to have given way to competitive forces; Bermuda and the Cayman Islands, having been recognized as acceptable jurisdictions of incorporation for listing purposes in Hong Kong, compete in a variety of ways to attract such incorporations. This does not constitute a "race to the bottom" since both jurisdictions must remain reputable for listing purposes in Hong Kong. In this way, the SEHK and the SFC continue to monitor the standards of corporate governance of these companies by serving as the gatekeepers to their entry into the public markets in Hong Kong. Both Bermuda and the Cayman Islands promote their responsive legislation and fine professional and back office services as primary attractions.

The recommendations in the Consultancy Report are geared primarily to structural features either common to public and private companies or exclusively related to private companies. Public and listed companies will, by definition, be of a sufficient size and economic significance to engage sophisticated professional advisors to structure their affairs; such structuring may point to offshore incorporation. Given that oversight of their financial market activities in Hong Kong should be subject to the SFC and, in the case of listed companies, the SEHK as well, there are few compelling reasons to dictate local incorporation in Hong Kong.

With respect to private companies on the other hand, there are much stronger arguments for actively promoting local Hong Kong incorporations, shareholder protection and the maintenance of respectable standards of commercial dealing being among them. Small businesses should prefer Hong Kong incorporation; it should be in their best interest. The remarkably high incidence of foreign incorporation of private companies by Hong Kong businesses is very much at odds with the usual bias of such businesses in favour of the convenience and predictability of local incorporation.

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3. THE NEW PATH THROUGH THE WOODS

3.1 The Models

In light of the above considerations, the recommendations in the Consultancy Report were drawn primarily from four interrelated sources: the U.S. MBCA (1984) (revised annually since then), the ALI Principles of Corporate Governance (1994)13, the Canada Business Corporations Act ("CBCA")14 (and its provincial variants) and the New Zealand Companies Act 199315. The MBCA and the ALI Principles of Corporate Governance represent the expression of modern and sophisticated thinking in companies law. The MBCA provides the structural and conceptual framework upon which to build new legislation, as it did for the Canadian and New Zealand legislation. These U.S. sources also provide the ample annotation and rich body of commentary to inform the legislation and guide practitioners and the judiciary alike.

The Canadian and New Zealand legislation impart Commonwealth sensibilities to the U.S. model; they share the same U.K. roots as the Hong Kong legislation. In particular, the prevalence in both New Zealand and Canada of majority-held, publicly-traded companies and family-controlled businesses (characteristics shared with Hong Kong) argues for a different balancing of shareholder/management powers than in the United States. As well, unlike the United States, the Commonwealth jurisdictions tend to be considerably more litigation averse in commercial matters. Mediation and other alternative dispute resolution mechanisms should be highly appropriate to Hong Kong business and are now becoming firmly established in Canada in commercial matters16. The New Zealand and Canadian legislation also provide the additional benefit of working

13

14

15

16

American Law Institute, Principles of Corporate Governance: Analysis and Recommendations, vols. 1-2 (St. Paul, Minnesota, USA: American Law Institute Publishers, 1994).

Canada Business Corporations Act, R.S.C. 1985,c. C-44, as amended.

[cite]

See, e.g., J. McFarland, "Companies Move Away from Courtroom Battles" The [Toronto] Globe and Mail (22 November 1996) B-19.

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legislative models; this is legislation which is operating in the real world, in the case of the Canadian legislation for nearly 25 years. In addition to an established body of case law and practice which can be drawn upon by the judiciary and practitioners, recourse can be had to administrative practices that make the legislation work.

Finally, the use of internationally recognizable models for companies law serves to enhance Hong Kong's role as a centre for international and regional business. The form of legislation proposed meets modern international expectations and would promote the use of Hong Kong incorporated entities for international business in the region. In addition, by developing modern companies legislation adapted to the Asian environment, the Hong Kong legislation itself could become the model and the benchmark for the region.

3.2 The Guiding Principles

3.2.1 The Basic Building Block

The first objective of a modern companies law in a developed economy should be to provide a simple, efficient and cost effective method of incorporation and ongoing corporate maintenance. The pace and complexity of modern commercial dealings has far outstripped the nineteenth century company law forms and procedures, the vestiges of a more leisurely and localized business environment. The modern corporation has become a basic building block of commercial activity. It should be possible to incorporate quickly and cheaply. The costs and complexity of incorporation and maintenance of a Hong Kong company were cited frequently as the underlying cause for recourse to BVI incorporations. Hong Kong based businesses would have a local alternative which is competitive with foreign incorporations of convenience.

With the emergence of specialized regulatory regimes in other areas such as insolvency and securities regulation, companies law can be freed of a heavy regulatory burden. Companies law can become, as it has in other jurisdictions, permissive, facilitative and enabling.

Rather than relying upon externally imposed administrative and criminal sanctions, company law can be structured so as to be primarily self-enforcing. This is a corollary of a

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permissive, facilitative and enabling regime; there are few mandatory provisions and little to prohibit. The Hong Kong Companies Ordinance contains a multitude of offences17; compliance is spotty and enforcement necessarily ineffectual. In the proposed regime, greater reliance would be placed upon civil and contractual remedies. The burden of enforcement would be shifted to those most directly aggrieved and, to the extent possible, the participants themselves would be encouraged to fashion their own dispute resolution mechanisms in advance. Recourse to court order would be exceptional and the use of alternative dispute resolution such as commercial arbitration and mediation would be recommended.

3.2.2 Simplification and Rationalization

In terms of simplifying and rationalising legislation,18 form is as important as content. Much of Hong Kong legislation reflects 19th century drafting which tends to be prolix to no good end. Much of the language in older U.K.-style statutes is at odds with modern drafting techniques to say nothing of modern English usage. The language itself was often drawn straight from the 19th century case law. The clarity and economy of modern drafting techniques can be applied to commercial legislation to good effect.

In Hong Kong, a change in drafting style is imperative, the necessity arising out of the translation of all English legislation into Chinese. The Legal Department has considered "a systematic programme to rewrite laws in both languages to make them clearer"19. In the same article, Bar Association chairman Gladys Li Chi-hei is quoted as saying "Let us strive to do what we can to simplify and inform, rather than to transform what is impenetrable in English into impenetrable Chinese"20. The experience has been similar in other jurisdictions (such as Canada) in the move to a bilingual legislative system; the discipline of the translation process has instilled a

17

18

19

20

See Laws of Hong Kong, Cap.32, Companies Ordinance, Sch.12 which lists 25 pages of offences, section by section.

See Schedule A - Terms of Reference

"Plan to rewrite century-old laws in modern language", South China Morning Post (13 Nov 1996, 3.

Ibid.

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belief in the virtues of simplicity and clarity.

3.3.3 Core Company Law

The overall approach recommended by the Consultancy Report is one characteristic of North American corporate law regimes, a "core company law". It is the approach recently followed in New Zealand in its Companies Act 1993. Several substantive areas are identified as more appropriately dealt with in separate legislation: capital market activities of public and listed companies; charges; insolvency; regulation of financial institutions; and not-for-profit enterprises. With the increasing complexity of commercial dealings and the development of areas of specialized regulatory focus, company law would no longer serve as a general repository for all statutory commercial law.

3.3.4 Mainstream Models

Obscurity does little to promote continuity, stability and certainty in commercial dealing. The recommendations attempted to build on the company law institutions and concepts familiar to the common law world but place them in a more coherent and rational framework. Where older constructs no longer serve a purpose they were replaced with newer working formulations. There was very little in the recommendations that was cut from whole cloth; in the interests of continuity, stability and certainty, the recommendations were drawn from existing legislative models for which a body of judicial interpretation and commentary exists. Most importantly, in addition to clearing out the legislative accretions of decades, the recommendations strived to obviate the convolutions of the old case law which only add to the cost of doing business.

3.3.5 Ideological Stance

The recommendations do not purport to be ideologically neutral; they were made very much with the Hong Kong policy of minimum government intervention in the market in mind (as is

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expressly required by the Terms of Reference21). The goals were quite modest, the creation of a basic building block for commercial activity. Viewed as such, a company law regime can remain relatively stable for long periods of time. Other areas of the law are subject to much greater and more frequent shifts in underlying policy. Tax policy can be notoriously changeable, for example. It became evident at several points that the primary purpose served by some Hong Kong Companies Ordinance provisions was related to Inland Revenue considerations. Such a purpose was not viewed as a compelling reason to retain a provision which did not otherwise serve core company law ends.

3.3.6 International Outlook

Finally, as attuned to local circumstances as it may be, companies law in Hong Kong cannot afford to be parochial. Hong Kong is an international commercial and financial centre the importance of which is disproportionate to its size. Both international and Hong Kong businesses are nimble and well aware of the alternatives available to them. To continue to compete effectively, companies law in Hong Kong must take into account and meet international expectations with respect to the incorporation, operation and administration of modern companies.

CONCLUSION

The fate of Hong Kong companies law is finely balanced. The Consultancy Report was commissioned as one independent of government, leaving the administration free to take it up or distance itself as appropriate. The official government position, pending conclusion of the consultation period and the deliberations of the SCCLR, is one of neutrality.

Eighteen months ago, there were those of the view that the Consultancy Report would be left to gather dust. In a speech I gave at the University of Canterbury in December 1997, I commented that this would not be such a bad thing. Let the Consultancy Report age. Put the

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Report in the closet for a few years and shake it out at another time: it has a classic cut, like a good tuxedo and will still present well a few years down the line. Hong Kong has already waited 25 years for modern company law, it can wait a few more. Much of Hong Kong commercial law is like a vintage sports car; with enough tinkering and effort (and provided you are not concerned about reliability, speed and comfort), it can be made to work.

Now that the reactions to the Consultancy Report are trickling out, it is apparent that reforms there will be; they are already in the works. At this point, the underlying struggle with path dependency is evident throughout the comments. The longer the wait for implementation of the recommendations, however, the greater the likelihood of embarking on a new path rather than simply hacking at the old one.

There appears to be support for a remarkable number of individual recommendations, although different groups have different views on any particular recommendation. For example, the very active and influential Institute of Company Secretaries has difficulty with the recommendations (i) that the appointment of any particular corporate officer, such as a company secretary, not be mandatory; (ii) permitting one person incorporation (e.g. wholly-owned subsidiaries); (iii) prohibiting par value shares; and (iv) permitting the elimination of the board of directors where there is identity of ownership and management. The utility of unanimous shareholder agreements remains a mystery to them.

On the other hand, the former head of the Hong Kong Institute of Company Secretaries, John Brewer, is in favour of permitting directors to dispense with the appointment of company secretaries for non-public and non-listed companies. Baker & McKenzie supports one person incorporation, has no difficulty with statutory recognition of unanimous shareholders agreements, is still open-minded about prohibiting par value shares, but would retain the mandatory requirement for a company secretary and the formal distinction between directors and shareholders.

The Hong Kong Institute of Directors agrees that no par value and partly paid shares should be prohibited and that there should be a no mandatory requirement for a company secretary for private companies but that the board of directors should be retained in all

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circumstances.

A rather chary reaction to a new path on the part of the Institute of Company Secretaries is to be expected; they are the tenders of the existing path. But despite their reservations on proposals for a new path, they do urge reforms: “The Institute would be disappointed if some of the more straightforward changes to company law in Hong Kong were not implemented before the five to seven year period referred to in the Consultants Report.” Wholesale change, according to the Institute, would be too disruptive and perhaps too onerous and costly. However, there is a hint that the Institute is not completely dismissive of the possibility of following a new path: “We would support any initiatives which aim to develop, on a gradual basis, a legal system which is clear, consistent, is easy to ‘look-up’ and is capable of being enforced.”

Interestingly, the reluctance to embark upon a new path is generally attributed to the time it may take to beat the path. Comments indicate that both the Hong Kong General Chamber of Commerce and the law firm, Baker & McKenzie , are open to striking out on a new path but are concerned that the time and effort required to do so will impede immediate reforms.

We are by no means averse to an entirely new companies ordinance nor the long timeframe for implementation provided that the pursuit of what the committee sees as ideal does not result in further and perhaps intolerable, delay in relation to urgent legislative amendments in the securities and insolvency areas currently comprised in the Ordinance22.

The Hong Kong General Chamber of Commerce finds that the “academic ideal of adopting a completely new code of company law and conduct has obvious attractions, but its practical viability in any circumstances, let alone, during the serious economic situation which has prevailed in East Asia in recent months, is questioned. The expectation that a relevant part of the community, even a sophisticated sector such as the business community, will adequately focus on legislative proposals at a consultancy or bill stage is usually misplaced, and when representations are made they are not always taken sufficiently into consideration. The wholesale

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revision of the Companies Ordinance would be a massive undertaking which would, if it were to be done properly, demand enormous input and attention from the Administration, legislature and the business sector. We doubt whether, with the establishment of the new Legco and current statutory backlog, such legislation would receive the attention and care which will be essential to its success.”

It has now been eighteen months since these comments were submitted at the end of the formal public consultation period, March 31, 1998. Since that time, there have been several developments which may assuage the hesitations evident in the comments.

The shock of the financial crisis has moderated and the process of adjustment commenced in Hong Kong. The new Legislative Council is in place and much of the political uncertainty surrounding the return of Hong Kong to China has dissipated.

Elsewhere in the world, corporate law continues to develop. The New Zealand Companies Act 1993 has successfully negotiated its transitional period, as did the Canadian legislation twenty years before it. Anecdotal evidence from New Zealand practitioners is to the effect that they are well pleased with the new legislation and that they find it a measurable improvement on its Hong Kong-style predecessor. An indication of the satisfaction in New Zealand with the implantation of a North American-style corporate law is the recently announced draft legislation on personal property security interests. Recommended in 1989 by the New Zealand Law Commission in its Report No.8, this is companion legislation to the companies legislation recommended in Report No. 9 in the same year; the two snaplock together. The proposed personal property security legislation “will provide a simple solution to a complex problem”, according to New Zealand counsel, Chapman Tripp23.

Of historic significance, and with the assistance of and closely watched in Hong Kong, was the enactment of securities legislation in mainland China on December 29, 1998. This legislation was some eight years in the making. During the final stages of preparation of the

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legislation, a major concern of the legislative drafters was reconciliation of the proposed securities legislation with the existing 1994 companies legislation, which as noted above, shows very decided continental European influences. The 1994 companies legislation, always considered a transitional measure, is now itself scheduled for revision.24

Of perhaps greatest persuasive interest to the path dependent in Hong Kong, the United Kingdom announced its major and fundamental review of U.K. companies law, commencing in March 1998 and extending into the year 2001. The United Kingdom has picked up the banner of “core company law”. The U.K. Review has been a very different exercise from that of Hong Kong, a very broad consultative one directed by a significant contingent within the Department of Trade and Industry itself. Hong Kong’s Review, however, was the “catalyst” and like all exercises of its type, the U.K. Review will stand on the shoulders of the reviews that have preceded it.

To the extent the Consultancy Report reflects dominant trends in modern corporate law, the U.K Review will be looking at the same issues. With the cooperation of the Hong Kong government, one of the background reports prepared in the course of the Hong Kong Review

(The Comparative Survey of Companies Law in Selected Jurisdictions) was updated and published on the internet by the Department of Trade and Industry (www.dti.government.uk/cld/review.htm). In three years from now, the comforting familiarity of the old paths and byways of U.K. companies law may no longer be there for the Hong Kong practitioner.

Finally, a word about Singapore. Hong Kong is ever looking over its shoulder at Singapore as Hong Kong hurries down the path of its own economic destiny. On November 9, 1998 the Singapore Government responded to a report submitted in October by the Corporate

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Finance Committee of the Monetary Authority. Singapore announced “an important shift in the approach to regulation of capital markets in Singapore. When implemented, their recommendations will help achieve the broader objective of making Singapore a world-class financial centre”25. Recommendation 3 reads:

Laws and rules applicable to the securities market, as distinct to core company law, should be consolidated into a single legislation.

Singapore has jumped the track on securities law. Like the United Kingdom, Singapore has picked up the banner of “core company law”. Hong Kong knows.

The danger in hesitation for Hong Kong, of course, is that the centre of gravity in commercial matters, from a legal point of view, may shift elsewhere. Hong Kong will have missed the opportunity to become Asia’s leading, and much needed, commercial law jurisdiction. Hong Kong has thrived on its nimbleness and adaptability; it may still run true to form on companies law.

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Schedule A

REVIEW OF THE HONG KONG COMPANIES ORDINANCE

TERMS OF REFERENCE

Having regard to:-

(a) The Government's policy of minimum interference in the market;

(b) the economic and legal systems in Hong Kong;

(c) Hong Kong's status as an international financial and business centre;

(d) the particular and unique aspects of the corporate culture in Hong Kong;

(e) recent developments in companies law and regulation in other comparable jurisdictions; and

(f) the existing framework of securities-related law and regulation in Hong Kong,

consider and make recommendations on the following matters:-

and if the latter course of action is proposed, to make recommendations as to the nature of the respective regulatory regimes for private and public/listed companies.

2. The scope for and desirability of -
   
   • (a) rationalising and simplifying the Ordinance, including a greater use of subsidiary legislation and/or administrative arrangements;
     
   • (b) streamlining and simplifying the procedures prescribed under the Ordinance, including in relation to the incorporation of a company and the submission of returns;
     
   • (c) codifying duties and responsibilities and stipulating minimum qualifications and capacities for company directors;
     
   • (d) including more specific statutory assistance for minority shareholders, and other persons who deal with companies, who wish to forestall, or to seek redress against, misconduct or abuses by a company and/or its directors (including through easier access to the judicial process);
     
   • (e) extending financial and other disclosure requirements, having regard also to existing non-statutory rules in respect of listed companies;
     
   • (f) rationalising and making more effective the enforcement provisions and sanctions under the Ordinance;
     
   • (g) extending regulatory powers in relation to the investigation and inspection of a company's affairs; and
     
   • (h) providing alternative forms for the constitution of a company.
     

100. Whether Part XI of the Ordinance is sufficient to regulate the activities of companies incorporated overseas with a place of business in Hong Kong.
     

4. The relevance with respect to Hong Kong of the development of international business companies.
   
5. Such other related matters as the Secretary for Financial Services may from time to time specify.
   

November 23, 1994

Hong Kong

Schedule B

REVIEW OF THE HONG KONG COMPANIES ORDINANCE

HIGHLIGHTS OF THE RECOMMENDATIONS

Simplification of the Ordinance

• Streamlining and rationalisation of structure
  
• Simplification and modernisation of statutory language
  
• Adoption of a "core company law" approach
  
• Removal of provisions relating to securities regulation, charges, insolvency and not-for-profit organisations
  
• Facilitation of solvent corporate reorganisations and restructuring, especially among related companies
  
• Decriminalisation of companies law; greater reliance on self-enforcement
  

Incorporation

• Quick, single-step incorporation procedures
  
• One person, one director companies
  
• Facilitation of electronic filing and record keeping
  
• Import/export provisions to facilitate international operations
  

Private Companies

• Creation of an optional statutory regime for private companies
  
• Streamlining formalities
  
• Provisions permitting informal and consensual operation
  
• Permitting shareholders to eliminate the board of directors
  
• Non-litigious dispute resolution mechanisms

Accounts and Audits

• Elimination of the Tenth Schedule; reference instead to external generally accepted accounting principles
  
• Private companies would have the option of eliminating the mandatory audit
  

Capital Structure

• Facilitation of the creation of modern, flexible capital structures
  
• Prohibition of par value shares and partially paid shares
  
• Optional pre-emptive rights
  
• Replacement of the capital maintenance requirements by a solvency test
  
• Provisions for optional use of uncertificated or book-entry securities
  

Directors and Executive Officers

• Statutory formulation of directors' and executive officers' duties
  
• Provision for action being taken without the necessity of a meeting
  
• Facilitation of meetings using telecommunications
  
• Duty of fair dealing in interested transactions
  
• Safe harbour provisions for interested director transactions, based on disclosure, disinterested voting and fairness to the company
  

Shareholders

• Broadening of the current unfairly prejudicial and just and equitable winding up remedies
  
• Creation of new shareholder remedies:
  
  • - statutory derivative action
    
  • - an appraisal/buy-out remedy triggered by fundamental changes
    
    • - 2 -

- statutory compliance and restraining order

• Statutory unanimous shareholder agreement
  

International Implications

• Creation of modern legislation meeting international expectations which provides an alternative to offshore incorporation for Hong Kong businesses
  
• Avoidance of provisions having an extraterritorial effect
  
• Introduction of a simple "carrying on business" test for registration by foreign companies
  

Transitional Measures

• Three to five year transitional period for implementation
  
• Mandatory continuance by simple re-registration procedures for existing companies
  

Source:The Consultancy Report on the Review of the Hong Kong Companies Ordinance (March 1997).

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Schedule C

SUMMARY OF RECOMMENDATIONS

1.00

GENERAL RECOMMENDATIONS FOR A NEW BUSINESS CORPORATIONS ORDINANCE

1.01

Aims and Objectives. The proper aims and objectives of companies law in Hong Kong should be:

⋅

to provide a simple, efficient and cost effective method of incorporation and ongoing

corporate maintenance;

⋅

to be enabling and permissive rather than regulating and prohibitive;

⋅

to the extent possible, to be self-enforcing so as to avoid intervention of public authorities

and to limit the necessity of recourse to the judicial system;

⋅

to be written in clear, concise language so as to be accessible to business people as well as

lawyers and accountants;

⋅

to focus on "core company law", the birth, life and death of the enterprise;

⋅

to strike a balance between the interests of management or majority shareholders on the one

hand and shareholders or minority shareholders on the other hand, in keeping with modern

commercial practices;

⋅

to promote continuity, stability and certainty in commercial dealing;

⋅

to refrain from being a vehicle for implementation of industrial relations, tax, social or

monetary policy;

⋅

to take account of and to meet international expectations with respect to the incorporation,

operation and administration of modern companies.

1.2 Business Corporations Ordinance. Hong Kong should implement a modern, streamlined Business Corporations Ordinance drawing on the most appropriate aspects of existing North American and Commonwealth models. Continued primary reliance on the U.K. model of companies law is not advised.

1.3 Single Regime. With respect to core company law matters, the same regime should be applicable to both public and private companies. In addition, the new Ordinance should provide a basic optional regime for private companies that would facilitate their operation in an informal and consensual manner.

1.4 Securities Regulation. The new Ordinance should not regulate the capital markets activities of companies nor the protection, in the largest sense, of public investors; this should be left to the SFC and the SEHK. With the removal from companies legislation of securities regulation, the SFC should consider the need to re-enact existing, updated or comprehensive new provisions in securities legislation. In the process of extracting the securities law aspects from companies legislation, careful consideration needs to be given to the dangers of creating regulatory gaps as well as the need to address any inadequacies in existing statutory regulation.

1.5 Insolvency. The new Ordinance should not apply to insolvent winding up; matters pertaining to insolvency should be left to a comprehensive Insolvency Ordinance.

1.6 Charges. A study should be undertaken with a view to introducing a separate, comprehensive regime governing security interests in personal property (such as recommended by the U.K. Diamond Report). It

would permit the elimination of Part III of the Ordinance, Charges. Until such time, Part III would continue in effect in conjunction with the new Ordinance.

1.7 Financial Institutions. The new Ordinance would continue to serve as the basic legislation governing the "core company law" aspects of regulated financial institutions in Hong Kong, essentially incorporation and its incidents; the regulatory aspects would be determined by the Hong Kong Monetary Authority and the Insurance Authority, as appropriate, and would preferably appear in their related legislation.

1.8 Not-for-profit Enterprises. The new Ordinance would not be applicable to not-for-profit enterprises, currently formed as companies limited by guarantee; the current Ordinance would continue to apply to such entities until such time as consideration is given to their separate treatment.

1.09 A new Not-for-profit Corporations Ordinance. Serious consideration should be given to implementation of an Ordinance governing incorporated not-for-profit organisations.

1.10 Structure of a New Ordinance. The following structure is proposed for the organisation of a new Ordinance:

OUTLINE FOR A BUSINESS CORPORATIONS ORDINANCE

Part 1: Interpretation

Part 2: Administration of the Ordinance

Part 3: Incorporation; Capacity and Powers

Part 4: Capital Structure

Part 5: Management and Administration

Part 6: Directors and Executive Officers

Part 7: Shareholders' Rights and Remedies

Part 8: Fundamental Changes

Part 9: Solvent Dissolution and Liquidation

Part 10: Private Companies/Closely Held Corporations

Part 11: Foreign Corporations/Oversea Companies

Part 12: Transitional Provisions

Part 13: General

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2.00 ADMINISTRATION OF THE ORDINANCE

2.1 Consolidation and Updating Part VII. The provisions of Part VII of the existing Ordinance, General Provisions as to Registration, should be consolidated, and if necessary, updated in this Part. In particular, provision for the electronic keeping and filing of notices and other documents should be made.

2.2 Role of Registrar. The role of the Registrar should continue to be primarily an administrative and policy advisory one.

2.3 Charges. Pending reconsideration of the legislative treatment of "Charges", the Companies Registry would continue its administration of Part III of the current Ordinance.

2.4 Subsidiary legislation. Subsidiary legislation and standard forms should be used extensively to deal with technical filing requirements, fees, etc. in order to facilitate timely updating and amendment.

2.5 Offences. With respect to offences, the Twelfth Schedule should be eliminated; such offences which are to be retained or created should be regrouped in more generic categories in this Part of the Ordinance and accorded appropriate sanctions.

2.6 Enforcement. To the extent possible, companies legislation should be self-enforcing and self-executing; investigation and inspection by a government body should essentially be a residual remedy, available in the event that private civil recourses are inadequate or ineffective. Powers comparable to the existing investigation and inspection powers would be maintained.

2.7 Role of the Financial Secretary. The Financial Secretary should continue to have residual discretion to act in the public interest in certain circumstances (such as investigation).

3.00 INCORPORATION; CAPACITY AND POWERS

3.1 One-step incorporation. The new Ordinance would provide one-step incorporation by filing a simple application for incorporation.

3.02 One person companies. The new Ordinance would permit one person/one director incorporation.

3.03 Numbered companies. Provision should be made for numbered companies, and use of the company name.

3.4 Pre-incorporation contracts. Provisions for the adoption by the company of pre-incorporation contracts should be simplified.

3.5 Capacity, powers and privileges of natural person. A corporation should be given the capacity, powers and privileges of a natural person. Restrictions may be placed on the activities of a corporation in its constitution but the rights of third parties should be preserved in the event that a corporation acts in contravention of its articles or the Ordinance.

3.6 Constructive notice. The constructive notice doctrine should be eliminated except, temporarily, with respect to charges.

3.7 Indoor Management rule. A statutory formulation should be given to the indoor management rule (the so-called rule in Turquand's case).

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4.00 CAPITAL STRUCTURE

4.1 Modern capital structure. A new Business Corporations Ordinance should provide for a modern, flexible capital structure.

4.02 No par value shares. Par value shares should be prohibited.

4.3 Classes and rights of shares. The corporate constitution should prescribe the classes of shares (if more than one) and the number of shares of each class that the company is authorised to issue if there is a limit (which there need not be). If there is only one class of shares, that class must have three fundamental rights of share ownership: the right to vote, the right to receive dividends when declared and the right to receive the net assets of the company upon dissolution. Where there is more than one class of shares, the rights, preferences, etc. should be stated in the corporate constitution; the three fundamental rights of share ownership should be attached to at least one class of shares although not all rights need be attached to any one class. For statutory purposes, the traditional distinction between common or ordinary shares and preference shares should be eliminated.

4.04 Series. Statutory provisions with respect to the use of series within classes of shares are unnecessary. 4.05 Partly paid shares. Partly paid shares should be prohibited.

4.6 Optional pre-emptive rights. Pre-emptive rights for existing shareholders should be optional; they may be provided for in the corporate constitution.

4.7 Solvency test. The concept of impairment of capital should be replaced by a solvency test to be used to determine the ability of the company to engage in a variety of activities: repurchase of its own shares (by way of redemptive provisions in the corporate constitution or otherwise), payment of dividends and other activities in the nature of a transfer of corporate assets to the possible detriment of creditors.

No "distribution" (widely defined) of company assets should be permitted if, after giving effect to it:

(1) the company would not be able to pay its debts as they become due in the usual course of business; or

(2) the company's total assets would be less than the sum of its total liabilities plus (unless the constitution provides otherwise) the amount that would be needed, if the company were to be dissolved at the time of the distribution, to satisfy the preferential rights upon dissolution of shareholders whose preferential rights are superior to those receiving the distribution.

4.8 Financial assistance. Provisions with respect to "financial assistance" for the purchase of company shares should be eliminated.

5.00 MANAGEMENT AND ADMINISTRATION

5.1 Companies' accounts. Companies should be required to prepare accounts that give a true and fair view of the state of affairs of the company. Details as to the form and content of accounts, to the extent required to be specified, should appear in subsidiary legislation; the Tenth Schedule of the Companies Ordinance (Accounts) should be eliminated.

5.2 Generally accepted accounting principles. Rather than detailing line item by line item the information to be contained in accounts, reference should be made to preparation of accounts in accordance with generally accepted accounting principles (GAAP). GAAP would be embodied in standards set by an independent accounting standards body or by a Hong Kong Society of Accountants process that would involve a wider

• - 4 -

representation of interested parties.

5.3 Waiver of generally accepted accounting principles. All companies should prepare their accounts in accordance with generally accepted accounting standards; consideration should be given as to whether private companies should be able to dispense with this requirement by means of unanimous shareholder agreement (unless required for other purposes).

5.4 Minimum financial information. As an aid to small companies in particular, the minimum financial information to be delivered to shareholders, unless they agree otherwise, should be stipulated in the legislation, or subsidiary legislation.

5.5 Filing of accounts. Unless required by other legislation (as should be the case for public and listed companies), companies would not be required to file accounts.

5.6 No mandatory audit. Company accounts should continue to be audited but shareholders should be able to dispense with an audit by unanimous agreement.

5.7 Formalities associated with directors' meetings. The formalities associated with routine directors' meetings such as notice, quorum, attendance, dissent, etc. should be set out in Part V, Management and Administration of the new Ordinance.

5.8 Formalities associated with shareholders' meetings. The formalities associated with routine shareholders' meetings such as notice, quorum, attendance, proxies, record date, etc. should be set out in Part V, Management and Administration of the new Ordinance.

5.9 Negotiable instruments. Securities certificates should be statutorily recognised as negotiable instruments.

5.10 Modernised security certificates system. Provisions with respect to security certificates, their form, content, registration and transfer should be modernised to provide for the optional use of "scripless" (book entry or "uncertificated") securities and, to the extent not dealt with under other legislation, the mechanics of their transfer (including the use of clearing agencies).

5.11 Part III retained. Pending consideration of the creation of a separate regime for the granting of security interests in personal property, Part III of the current Ordinance, Registration of Charges would continue to apply.

5.12 Modern record keeping. Provision should be made for modern record keeping, including electronic data processing. An obligation should be imposed to ensure the accurate preservation of data and its accessibility in written form to those entitled to it within a reasonable period of time.

5.13 Company records. The new Ordinance should contain a clear and concise statement of the records which must be kept by the company, their location and who has access to them (and in what circumstances and to what purposes.)

5.14 Corporate seal. Use of a corporate seal should be voluntary and no agreement should be invalid merely because a corporate seal is not affixed to it.

6.00 DIRECTORS AND EXECUTIVE OFFICERS

6.01 Unitary board structure retained. The traditional unitary board structure should be retained.

6.2 Board of directors. In private companies/closely-held corporations, a single decision making body should be an option; the responsibilities of the directors would be assumed by the shareholders.

• - 5 -

6.3 Statutory power of directors. The board of directors should be given a direct grant of statutory power to manage, or supervise the management of, the company. This power should be made subject to any unanimous shareholder agreement.

6.4 Delegation of powers. The board of directors should be permitted to delegate all those powers which it is not required to exercise itself.

6.5 Functions not subject to delegation. Certain functions of the board of directors should not be subject to delegation, for example:

6.8 Shadow and alternate directors. The troublesome concepts of shadow and alternate directors should be eliminated.

6.9 Company officers. There should be no requirement for the appointment of any particular company officer such as a company secretary.

6.10 Removal of directors by shareholders. Shareholders should be able to remove directors by ordinary resolution, subject to class voting rights and the company constitution.

6.11 Meetings of directors. Meetings of directors should be permitted by means of electronic communications, unless otherwise specified in the company constitution.

6.12 Unanimous action. Directors should be able to act unanimously by written resolution without a meeting.

6.13 Statutory statement of directors' duties. There should be a statutory statement of directors' duties to act honestly and in the best interests of the company and to exercise the care, diligence and skill that a reasonably prudent person would. These duties should also be made applicable to those corporate officers appointed by the board.

6.14 Reliance on reports. Directors and officers should be able to rely in good faith on financial statements and other reports prepared by officers and employees as well as the professional advice of lawyers, accountants, etc.

• - 6 -

6.15 Business judgment rule. There should be no need of a statutory formulation of the `business judgment rule'.

6.16 Indemnifying directors. Companies should be permitted to indemnify directors and officers in specific circumstances; companies should be required to indemnify directors and officers in specific circumstances.

6.17 Insuring directors. Companies should be permitted to insure directors and officers except for a failure to act honestly and in good faith with a view to the best interests of the company.

6.18 Disqualification of directors. Disqualification of directors provisions should be eliminated for company law purposes. Those existing provisions relating to securities, insolvency or criminal activity should be reenacted in appropriate legislation.

6.19 Conflicts of interest. Consideration should be given to placing directors and executive officers (i.e. those appointed directly by the board) under a duty of fair dealing with respect to transactions they enter into with the company.

6.20 Qualification of interested transactions. Interested transactions should be upheld if (i) directors disclose to the board their material interest in the transaction; (ii) do not vote as a director on any resolution to approve the transaction; and (iii) the transaction was reasonable and fair to the corporation at the time it was approved. In the alternative, such transactions could also be approved by unanimous shareholder consent.

6.21 Shareholder approval of interested transactions. Shareholders should be able to vote to uphold a transaction by special resolution in certain circumstances.

6.22 Loans to directors. Transactions involving loans to directors should continue to be prohibited subject to certain exceptions.

6.23 Use of Corporate Information and Opportunity. Directors and officers should not disclose or use for their benefit a corporate opportunity or information that they obtain by reason of their position or employment except (i) with consent of disinterested board members, (ii) where disclosure is required by law or otherwise or (iii) where it is reasonable to assume that the disclosure or use of the information or opportunity will not be likely to prejudice the corporation.

7.00 SHAREHOLDERS' RIGHTS AND REMEDIES

7.1 Shareholders' rights and remedies. A separate part of the new Ordinance should be dedicated to matters dealing with shareholders, their rights and remedies.

7.2 Proposal at annual meeting. Any shareholder entitled to vote at an annual meeting should be able to submit a proposal to the company to be raised at the annual meeting and circulated prior to the meeting. The board of directors could refuse to circulate proposals in certain circumstances such as proposals designed to redress personal grievances or espousing political or other causes. In addition, or in the alternative, a proposal put forward by a minimum number or percentage of shareholders (e.g. the lesser of 25 shareholders or those holding 2½% of the voting shares) could not be refused by the board of directors.

7.3 Requisition to call meeting. Shareholders holding 5% of the voting shares should be able to requisition the directors to call a meeting of shareholders or, if the directors fail to act, a shareholder should be able to call a meeting itself. The time delay in which the directors may act should be fairly short, 21 days for example. The requisitioners should be reimbursed their expenses unless the meeting otherwise resolves.

7.4 Shareholders' rights to dispense with meeting. A resolution in writing signed by all shareholders entitled to vote should be sufficient to preclude the necessity of a meeting. A meeting should be required,

- 7 -

however, in the event of the resignation or removal of a director or auditor who wishes to explain or contest the action. Shareholders should be able to dispense with the requirement for an annual general meeting (or other meetings) by unanimous shareholder agreement.

7.5 One share entitled to one vote. Unless otherwise provided by the company constitution, one share should be entitled to one vote. "Circular holdings" should be prohibited from voting.

7.6 Unanimous shareholder agreement. All companies should be able to make use of unanimous shareholder agreements to regulate (1) the exercise of corporate powers and management and (2) the relationship among shareholders.

7.7 Statutory remedies. There should be made available to shareholders a variety of statutory remedies designed to induce accountability of management and achieve the desired balance between flexibility in management powers and protection of shareholders, especially minority shareholders' interests. These statutory remedies should include the following:

7.9 Unfairly prejudicial remedy. The current unfairly prejudicial or oppression remedy should be broadened. The remedy should be available to a broader class of persons, to include

⋅ any registered holder or beneficial owner, and any former registered holder or beneficial

owner, of a security of the company or any of its affiliates;

⋅ any director or officer or former director or officer; and

⋅ the Financial Secretary.

The scope of the conduct that may be complained of would also be broadened to include conduct that is oppressive, unfairly prejudicial to or that unfairly disregards the interests of any security holder, director or officer.

7.10 Statutory compliance and restraining order. A shareholder or director should have the standing to apply to court for a statutory compliance and restraining order.

7.11 Just and equitable winding-up. The traditional "just and equitable" winding-up remedy should be retained, but the court should be given the option of making any other order it sees fit. The remedy should be dissociated from the more undesirable consequences of winding-up procedures in insolvency (such as the freezing of bank accounts).

7.12 Appraisal or "buy-out" remedy. A form of appraisal or "buy-out" remedy which does not necessitate judicial intervention should be adopted; the statutory buy-out remedy gives shareholders the right to have the company buy their shares upon the occurrence of a limited number of fundamental changes while permitting the company to proceed unimpeded with its proposed action. In the alternative, consideration should be given to introducing such a procedure but excluding its application to listed companies.

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8.00 FUNDAMENTAL CHANGES

8.1 Amendments by special resolution. There should be regrouped in one section, all amendments to the company constitution that may be effected by special resolution of the shareholders. A special resolution should require a "super-majority" vote, i.e. 75%.

8.2 Dissenting shareholder entitled to be "bought-out". Where an amendment to the constitution would

• (1) affect substantially the nature of a shareholder's investment (e.g. remove or change any restriction on the nature of the business of the company or change the characteristics of its shares) or (2) where the company proposes a fundamental change such as an amalgamation, continuance in another jurisdiction (see
  

recommendation with respect to continuance), or sale of substantially all of its property, a dissenting shareholder should be entitled to be bought out of the company at a "fair" price.

8.3 Class vote. In certain circumstances, a class vote should be held where a proposed amendment to the constitution would affect, directly or indirectly, the rights of that class of shares.

8.4 Corporate restructuring procedures. Simple procedures should be made available to provide for corporate restructuring such as by way of amalgamation without the necessity for court intervention or liquidation.

8.5 Restructuring of related companies. Restructuring of related companies and wholly-owned subsidiaries should be facilitated.

8.6 "Import" and "export" of companies. "Import" and "export" of companies into and out of Hong Kong should be permitted. Foreign companies should be able to re-incorporate in Hong Kong under the new Ordinance without the necessity of liquidation and the resulting disruption and interruption of corporate existence; Hong Kong incorporated companies should be able to continue under the laws of incorporation of another jurisdiction in the same manner.

8.7 Court ordered arrangements. Provision should be made for court ordered arrangements for solvent companies where it is impracticable to restructure under other provisions of the legislation.

9.00 SOLVENT DISSOLUTION AND LIQUIDATION

9.1 Solvent dissolution and liquidation. Only solvent dissolution and liquidation should be dealt with in the new Ordinance.

9.2 Voluntary dissolution by simple filing. Voluntary dissolution should be effected by a simple filing (depending on the nature of the dissolution sought) and should take effect upon filing; the corporate existence would then be continued only for the purpose of winding up and liquidating the business and affairs of the entity.

9.3 Circumstances for simple filing. Voluntary dissolution by way of simple filing should be available in two instances; (1) before the company has commenced business and (2) where initiated by directors and shareholders.

9.4 Revocation of dissolution. Within a limited period of time a company should be able to revoke dissolution essentially in the same manner as it has been initiated.

9.05 Claims of creditors. Provision should be made for the claims of known and unknown creditors.

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9.6 Administrative dissolution. The Registrar should be able to commence an administrative dissolution in limited circumstances, primarily where a company has failed to comply with its filing obligations under the new Ordinance.

9.7 Dissolution by the court. A court should be given broad discretion, both in terms of the grounds and the procedures adopted, to dissolve a company upon the application of the Financial Secretary or a delegated authority, a shareholder or a creditor.

10.00 PRIVATE COMPANIES/CLOSELY HELD CORPORATIONS

10.1 No separate ordinance. There should not be a separate specialized ordinance pertaining only to private companies/closely held corporations.

10.2 Purpose of legislative provisions. The purpose of legislative provisions specifically applicable to private companies/closely-held corporations should be to facilitate the creation of incorporated entities that, for internal purposes, function like partnerships or sole proprietorships.

10.3 Statutory definition. There should be a statutory definition of or conditions to be met for private companies/closely held corporations.

10.4 Definition of "private company". The traditional definition of "private company" should be retained. A private company has restricted the right to transfer its shares, has limited the number of shareholders to 50 and prohibits any invitation to the public to subscribe for its securities. In addition, a company which by means of a unanimous shareholder agreement abolishes the distinction between ownership and management, irrespective of number of shareholders, should also fall within the definition.

10.5 Optional regime. A separate part of the new Ordinance should contain an optional regime applicable to private companies/closely held corporations. The regime could be varied in the corporate constitution or by unanimous shareholder agreement. It should contain the following provisions:

⋅ Standard share transfer restrictions and exceptions (e.g. transfer to trustee in bankruptcy, by operation

of law);

⋅ Preservation of limited liability despite failure to observe corporate formalities;

⋅ No mandatory audit;

⋅ Standard form buy-sell and buy back provisions to permit shareholders to leave;

⋅ Recourse to mediation or arbitration to resolve shareholder disputes;

⋅ Possibility of applying to court for the appointment of a rehabilitative receiver in the event of

deadlock, etc.

10.6 Possibility of Eliminating Corporate Formalities. Private companies/closely held corporations should be able, by unanimous shareholders agreement or in their constitution, to eliminate certain corporate formalities and otherwise derogate from standard statutory provisions:

⋅ no need to have an annual meeting of shareholders unless requested by a shareholder;

⋅ no need to have separate bylaws/articles of association if constitution and statute sufficient;

⋅ ability to choose limited corporate life if desired;

⋅ possibility of dissolution at the request of a shareholder (or certain % of shareholders) or upon the

occurrence of a specified event;

⋅ elimination of board of directors;

⋅ restriction of discretion or powers of the board or weighted voting rights;

⋅ operation of enterprise as if a partnership among shareholders;

⋅ creation of relationship among shareholders that would otherwise be only appropriate among partners.

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11.00 FOREIGN CORPORATIONS/OVERSEA COMPANIES

11.1 Conflict of laws rule. For purposes of the new Ordinance, the traditional common law conflict of laws rule applicable to companies, i.e. that their creation, internal affairs, and termination are governed by the law of their place of incorporation, should be respected.

11.2 No extraterritorial effect. As a general principle, the new Ordinance should not contain provisions having an extraterritorial effect.

11.3 Threshold of registration. Registration of foreign incorporated companies should be required in Hong Kong but the threshold test should be changed.

11.4 Threshold test. The threshold test of carrying on business in the jurisdiction, including both an inclusionary and exclusionary list of what is or is not considered carrying on business, should be adopted for purposes of the new Ordinance.

11.5 Filing requirements simplified. The filing requirements for registration as a foreign company should be simplified. It should not be necessary to file the company constitution or accounts.

11.6 Service of process. An agent for service of process within Hong Kong should be required; alternative methods of service of process should be stipulated in default of an agent.

11.7 Disclosure of foreign status retained. Current requirements with respect to the obligation to disclose the foreign status of the company (on letterhead, at the place of business, etc.) should be retained.

11.8 Filing requirements. The filing requirements applicable to foreign companies under the new Ordinance should be coordinated with those of the Business Registration Ordinance; registration under the new Ordinance should be deemed to satisfy requirements of the Business Registration Ordinance.

11.9 International business companies. There appears to be no need to address the use of international business companies in a new Ordinance or otherwise.

12.00 TRANSITIONAL PROVISIONS

12.1 Mandatory continuance for companies. A new Ordinance should include a requirement of mandatory continuance for companies created under the old legislation over a transitional period of three to five years.

12.2 Simple reregistration procedure. Continuation under the new Ordinance should be effected through a simple reregistration procedure which should involve only minimally more effort and expense than the current annual filing and audit requirements.

Source: The Consultancy Report on the Review of the Hong Kong Companies Ordinance (March 1997).

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