Disqualification order obtained by SFC for breach of directors’ duties

A recent case has underlined the need for directors to be properly involved in decision making and not to abdicate responsibility to one of their number. Allowing one director to dominate and control the affairs of the company is a breach of fiduciary duties including the duty to exercise reasonable skill, care and diligence. The case also highlights the powers of the Securities and Futures Commission (SFC) to impose sanctions where directors of listed companies breach their duties.

On 22 April 2020, the Court of First Instance issued disqualification orders against several former directors of Long Success International (Holdings) Limited (Long Success) for periods ranging from 2 to 5 years. Long Success was delisted in October 2016 from the Growth Enterprise Market (GEM) of The Stock Exchange of Hong Kong Limited (SEHK). The disqualified directors admitted breaching their directors’ duties including fiduciary duties, common law duties and duty to ensure full compliance with the GEM Listing Rules.

Long Success was engaged in a gaming and entertainment business in Macau. The directors approved an acquisition agreement with profit guarantees for a paper manufacturing business in which Long Success had no experience or expertise. The acquired business did not meet the profit targets and the guarantee became payable. However, Long Success did not claim the compensation due under the acquisition agreement and deferred, and then effectively waived, the payment by agreeing in certain confirmation letters that a force majeure term applied (despite having legal advice to the contrary).

The Court accepted that there was no objective, rational or commercial reason for the company not to enforce the payment. The agreement to the confirmation letters was plainly to the financial detriment of Long Success and the prejudice was compounded by the adverse financial position of the company. Long Success had additionally guaranteed the personal liabilities of the Chairman of the board, again without any objective, rational or commercial reason.

The Court determined that the Chairman of the board was able to, and did, dominate and control the affairs of Long Success. There was no effective system of internal controls in the company and the directors had neglected or omitted to exercise their duties. It is clear that directors may not abdicate responsibility in favour of one of their number as this constitutes a breach of the duty to exercise reasonable care, skill and diligence.

The relevant directors included both executive directors and non-executive directors. The Court confirmed the well understood position that all directors have the same responsibility in law, whether they are in executive or non-executive roles. The Court stated that, whilst non-executives may, to some extent, reasonably rely on the executive directors to perform their duties, companies may look to non-executive directors to exercise independent judgement and supervise executive management. Non-executives cannot place unquestioning reliance on others to do their job.

The Court confirmed that section 214(1) of the Securities and Futures Ordinance (SFO) is wide in scope and the SFC, therefore, has broad powers to punish directors of listed companies. The Court agreed that the reference to ‘other misconduct’ in s214(1)(b) would include a breach of duty, including culpable neglect of duties, and the reference to conduct ‘unfairly prejudicial to…members’ in s214(1)(d) could include conduct in the form of neglect or inaction. The case is a timely reminder for directors of Hong Kong listed companies, particularly those with strong controlling shareholders or chairman, that they must take an active part in the management and decision making processes of the company and ensure suitable internal controls and governance systems.

In the COVID-19 pandemic, where companies are faced with unprecedented challenges, directors will need to take extra care when making major decisions, particularly where decisions could negatively affect the financial position of the company or prejudice its members. The provisions of the SFO give the SFC a very broad power to punish directors, even where their activities do not involve intentional misconduct or impropriety.