The Court of First Instance has recently discussed the Court’s discretionary power in allowing private companies to be carved out from disqualification orders made against former directors of a listed company (“ListCo”) under s.214 of the Securities and Futures Ordinance (“SFO“).1 The Court retains discretion in deciding whether exemptions to disqualification orders should be granted in the circumstances. We discuss the principles and key factors considered by the Court in dealing with such carve-out applications below.
This recent decision sets out the Court’s approach in determining the scope and duration of disqualification orders in s.214 proceedings. We recommend that directors and senior management of listed companies take note of the following:
- The objections against the resolutions to publish the announcement in question are not sufficient to absolve the directors from being held liable for misconducting the listed company’s business or affairs.
- Disqualification orders may be made against independent non-executive directors regardless of their limited role and involvement in the day-to-day management.
- Directors may apply for the Court’s permission to exempt certain companies from the disqualification orders to be made against them. The directors bear the onus of establishing that certain companies should be exempted from the disqualification order.
- In exercising its discretionary power, the Court will consider a wide range of factors such as the nature of the misconduct concerned, the structure and nature of business of the company to be exempted, and the risks posed to the general public by permitting the carve-out application. Hardship to the subject director alone is not a persuasive ground for the granting of carve-out applications, but it is not entirely irrelevant.
In more detail
This recent case concerned misstatements and misrepresentations in financial statements and announcements published by the ListCo between 2011 and 2013. The SFC’s investigation revealed that figures in the ListCo’s financial statements were grossly overstated, and the ListCo misrepresented in its disclosures that the published financial statements had been agreed with the auditors when they in fact had not.
In July 2019, the SFC commenced the s.214 proceedings against eight individuals for orders including disqualification orders against (1) an executive director (also the CFO and Company Secretary) (“ED”) and (2) an independent non-executive director (“INED”) of the ListCo.
Both the ED and INED agreed with the SFC to dispose of the s.214 proceedings by way of the Carecraft procedure.2 The agreed facts reveal that both the ED and INED had in fact voted against resolutions to publish the financial statements in question. However, their objections were not considered sufficient to absolve them from liabilities. The Court ordered the ED and the INED be disqualified for six years and 1.5 years respectively.
The ED and INED each took out an application for a private company to be exempted from the disqualification order. The Court discussed the principles in exercising its discretion in determining the scope of a disqualification order and the relevant factors include:-
- the nature of the misconduct concerned and the director’s involvement;
- the director’s general character, including conduct after leaving the subject listed company;
- the ownership and structure of the company to be carved out from the disqualification order, the nature of its business, and the interests of its shareholders, creditors and employees;
- the risks to the public in allowing the director to assume such positions;
- whether the SFC has consented to such application;
- the need for general deterrence;
- the hardship to the director.
As regards the types of companies to be exempted from disqualification orders, the Court had in the past allowed private companies, companies limited by guarantee/non-profit organizations and a statutory body to be carved out.3
In this case, the ED sought exemption for a private company for which he is responsible for the day-to-day running with the title “Financial Controller“. The SFC considered that there was a question of risk posed to the general public in allowing the exemption as the private company was responsible for managing at least 11 other companies that operate a fleet of ships and containers. Nonetheless, having taken into account other factors, the SFC did not object to the ED’s exemption application.
In allowing the exemption, the Court had regard to the SFC’s considerations (including the absence of fraudulent intent or motivation for personal gain, the cooperation with the SFC and the hardship to the ED as he was the sole breadwinner) and took into account the fact that the private company to be exempted was owned by a sophisticated investor.
As for the INED, the Court granted him an exemption to be the director and/or take part in the management of a small/medium-sized accounting firm with limited clientele and no connection with the listed company concerned or its associate companies.
This recent decision offers an insight into the SFC’s and the Court’s considerations when a carve-out application is considered a borderline case. The ED’s liability was considered relatively serious given his gross incompetence or negligence in overseeing the ListCo’s affairs.
Nevertheless, directors falling short of the standard of competence does not necessarily render them unfit to be concerned in the management of all companies. Whether a carve-out application is allowed is subject to the Court’s discretion, and as the case law under s.214 develops, it remains to be seen how the aforementioned factors will be applied. We recommend that directors and senior officers facing s.214 proceedings should seek legal advice as early as possible in order to formulate the most appropriate strategy in the circumstances.
1  HKCFI 653
2 The Carecraft procedure is a summary procedure allowing the limiting of facts (by way of a statement of agreed facts) on which the Court will be asked to base its judgment as to whether the disqualification sought should be made, and if so, the duration and scope of the disqualification order.
3  HKCFI 606;  HKCFI 302