A Quick Guide on Directors' Duties in Hong Kong
It's said that being a director is as difficult as it is prestigious. Let's look at directors' duties in Hong Kong and try to evaluate how much risk comes with this respectable job title.
Being a director is as prestigious as it is cumbersome, or so they say. There are certain rules and responsibilities to adhere and fulfil when it comes to the directors’ duties. However, if a person does not comply with his or her duties as a director, he or she may be liable to civil or criminal proceedings, which may result in him or her disqualified from acting as a director. Directors’ duties may seem mind-boggling to many who are planning to start a business in Hong Kong. The good news is, the Companies Registry has published the revised ‘A Guide on Directors’ Duties’ as a general guideline to help entrepreneurs understand the responsibilities of a director.
This article will be particularly useful if you are looking to set up a company in Hong Kong and appoint a director.
Who Is a Director?
A company is a combination of assets, property, employees and legal obligations. Someone needs to run this “machine”. A director is a statutory officer who manages a company, represents its interests and works hard to make it succeed. Directors are appointed by shareholders.
Company Law in Hong Kong states that a private limited company must have at least one director. This rule doesn’t apply to public companies and companies limited by guarantee that are required to have at least two directors. The minimum age required for a director is 18 years and above. He or she must be a natural person who can be of any nationality but not necessarily be a Hong Kong resident. Likewise, he or she must not be declared bankrupt or convicted of any malpractice.
Instead of one or two directors, a company may have a board of directors consisting of several persons. All executive and non-executive directors are subject to the same duties and are collectively and individually responsible for the management and operations of the company.
The director ensures that he or she is fulfilling the directors’ duties as outlined in the guide. Although the director does not oversee the day-to-day operations, he or she will need to check if the employees are achieving their company’s long-term strategic objectives by reviewing their work performance.
So-called “shadow directors” control a company behind the scenes. Any person who does not appear in the register of directors, but who, in fact, significantly influences the decision-making in the company may be recognized as a shadow director and is liable for their actions. An example of a shadow director would be an executive of a parent company giving direct orders to the management of a subsidiary.
What Are the General Directors’ Duties?
Did you know?
When you set up your company in Hong Kong, at least one share must be issued and allotted to the company’s founder.
All directors bear certain responsibilities. In general, these responsibilities are regulated by various sources, like:
- the Companies Ordinance;
- the common law;
- the case law;
- the articles of association (constitution) of a company,
- the shareholders’ (members’) resolutions.
If a director does not comply with their duties, they are liable to civil or criminal proceedings and may be disqualified from acting as a director.
Let’s take a closer look at the list of the directors’ duties:
1. Act in good faith
A director must act in the best interest of the company as a whole. It means showing good faith to all the shareholders equally and not putting the interests of one shareholder over the interests of the others.
There are cases, though, when the company’s best interests are hard to define.
Kevin is a director of subsidiary A. He was nominated by a parent company B. Now, Kevin is searching for a new CRM provider to improve the services of the company and to streamline its processes. The parent company, B, offers its services. But Kevin knows that B is not the best choice: its software doesn’t suit the needs of the company and is overpriced.
Kevin faces a dilemma (1) to decide in favour of company B that helped him get the job or (2) to act in the interest of his company and to find another provider. Kevin decides to act in good faith and chooses his company’s interests over the parent company’s demands. He justifiably declines company B’s offer and finds another provider. Kevin knows that he has to act in the best interest of his company and his company only. Other companies' interests must not be taken into consideration even if they have the same owners.
2. Use power for a proper purpose
A director must use their power only for the purpose for which they were intended. Their primary goal is to benefit the company. It is a breach of duty if they aim to benefit themself or to get control of the company.
A director’s good intentions and reasonable belief that their actions will benefit the company do not exclude them from liability for a breach of power.
A director issues shares to forestall a takeover bid. He believes that he is acting in the company’s best interests. But he was granted the power to issue shares only to raise capital for the company. This means that as a director he exercised his authority improperly and breached his duty.
3. Do not delegate powers except with proper authorisation and exercise independent judgement
A director has almost absolute power in a company.of a Only the shareholders have more power and can restrict the director’s authority in the articles of association or resolutions. Members of the board of directors can divide the responsibilities or form committees to make the correct decisions on certain matters. They can also appoint a managing director or a CEO who will ensure the day-to-day management of the company.
No one except a director can execute their powers without authorization from a direсtor, a board of directors or shareholders. Terms of proper authorization are usually stated in the company’s articles or in a resolution of the shareholders. If permitted a director may, for example, delegate some of his minor functions to the company's senior management.
While making a decision, a director can rely on professional advice from hired experts. Nevertheless, they are not bound by the experts’ instructions and must exercise independent judgment. It’s only the director who makes the final decision and they will be held responsible for any of the resulting damage.
4. Exercise care, skill and due diligence
A director is supposed to run the company with reasonable care. In other words, they must possess and use:
- the general knowledge, skill and experience that may reasonably be expected of a person in a director’s position;
- the general knowledge, skill and experience of that particular director taking into account their actual education and professional background.
Being under- qualified for their position as a director is not an excuse. He is still expected to demonstrate reasonable care and can be held liable for a breach of duty. On the other hand, a director having special expertise in, for example, both the law and finance, is expected to perform better in comparison to a director without this kind of knowledge.
A director gets a large report to sign off on. The CFO and an internal auditor prepared the document, so a director might well rely on their expertise and sign it right on the spot. Instead, the director shows reasonable care and studies the report before signing it. He doesn’t have a degree in finance but he consults the CFO when something seems unclear. When he does sign the document, he understands where every figure comes from.
This duty also applies to shadow directors.
5. Avoid conflict of interest
A director must avoid situations where they have to choose between personal gain and the company's interests.
A director can’t set up a rival business and work against the company where they are employed. Neither can he secretly hold a directorship in two companies in the same industry or have relatives working for a direct competitor.
If a conflict of interest arises, a director must disclose the issue to the shareholders and fellow directors.
6. Do not make transactions involving personal financial gain if it doesn’t comply with the law
If a director has a material interest in any transaction, arrangement, or contract with a company, they must not enter into it without going through specific procedures. In most cases, it means a director must declare the nature and the extent of his interest to the other directors or shareholders and get their approval.
Mr. Lee serves as a director in Raging Waters LTD. His wife, Mrs. Lee, owns a cleaning service, Cinderella LTD. When Mr. Lee’s company needs a cleaner, he considers hiring his wife’s company as they do clean well. However, there’s a clear conflict of interest in this situation. So Mr. Lee asks his wife for a discount and gets one. He then reaches out to the owner of Raging Waters LTD. and asks for her permission. She doesn’t mind, so Mr. Lee goes ahead with the deal.
The articles of association may outline a particular procedure to make sure that the decision-makers are impartial. For the same reason, a director who is seen as having a conflict of interest is usually excluded from voting.
7. Do not abuse power
A director of a company must not use his position as a director to his advantage when it damages the company.
Mr. Chang, the chairman of the board, notes that the new head of legal, Mrs. Hua, is quickly making a name for herself and feels threatened by it. She is young, friendly and highly qualified for her age and she also has a good reputation in the eyes of the shareholders. Mr. Chang sees a competitor in her. He keeps track of all her tiny missteps and uses his power to build alliances with several board members to fire her. Mr. Chang abuses his power, which costs the company an efficient employee.
The board members use their position to create new benefits schemes that are very favourable to them, but which are disadvantageous to other employees.
This duty seems quite logical: by breaching it a director would normally neglect their duty to act in the company’s best interest, too.
8. Do not use the company’s property or information if not authorized
A director ensures that the company’s assets are safe and are used properly. Assets include not only tangible ones, like computers, furniture or cash, but also intangible items of special value like know-how and trade secrets.
Any transfer of property which is forbidden by the articles of association or by law is a breach of this duty.
Ms Jeong, a director, talks to her friend privately about a new product that her company is launching in a few months and reveals some important details. Soon after, this information falls indirectly into the hands of a competitor. The rival company steals the idea and launches the same product before Ms Jeong’s company can. Ms. Jeong failed in her duty as director and cost the company a lot of money.
Insider dealing is also a breach of this duty. A director must not use confidential information to trade in securities of the company he works for.
9. Do not accept any personal benefit from third parties
A director or a former director must not accept benefits, gifts, and bribes that someone offers them because they are a director. Cufflinks from your spouse or a mug from your colleague are okay, a gold bar from your potential contractor isn't. It also isn’t okay if a potential contractor offers you a share in their company or invites you to spend a weekend at their villa in the Canary Islands in exchange for something.
However, a director can accept these benefits if the shareholders let them.
10. Obey the company’s law
A director must comply with the internal rules of the company, for example the company’s articles of association and resolutions.
These bylaws are not only a legal framework, but also the will of the shareholders who designed their business to work in a certain way.
11. Keep accounting records
A director of a company must ensure that the company keeps accounting books timely and properly. These records must truly reflect the financial situation of the company and its transaction history.
A director must not take out a loan if they know the company is close to insolvency. Otherwise, they may be charged with fraud.
What Are the Fiduciary Directors’ Duties?
Fiduciary duties is a legal term for the responsibilities of a director to act honestly and loyally on behalf of the company. These are based on case law and include:
- acting in good faith in the interest of the company,
- exercising power for the benefit of the company,
- avoiding conflicts of interest.
We have already covered all three of them above.
However, there has been an increase in numbers on breach of fiduciary duties of directors in recent years. This means the company’s shareholders are filing court proceedings against the directors for breaching some of the directors’ duties. Usually, these cases are conflict in interest or misappropriation of funds in nature.
In 2014, a company shareholder brought a case against one of the directors for a breach of fiduciary duties by diverting the business from Company A to another related company in the same line of business and for misusing the company's property. Pam was a shareholder of Company A but after a few years, she transferred her shares to her daughter, Gwen. Gwen became a director of Company B while she was still employed by Company A. Immediately, the shareholder filed a claim against Gwen for lack of integrity and assisting Pam to breach her fiduciary duties as a director of Company A.
These recent developments show that people are aware of the fiduciary duties of directors and the rights that the company’s shareholders have against the director. As such, it is important for the directors to know their duties before someone can file claims against them.
Summing It All up
It is not easy to be a director. Apart from making serious decisions every day, they must always keep in mind the legal implications they may face if something goes wrong.
On the other hand, it seems easy to comply with the requirements if you just stay loyal to the company.
In any case, make sure to get prepared before assuming the duties of a director.
And don’t forget that any director needs a Company Secretary to help him manage the business. Just let us know if you need one.