HONG KONG COMMERCIAL LAW - University of Hong Kong · Kong and in England and Wales. She is the author of Hong Kong Busi-ness Law and also writes in the areas of trade union and employment

HONG KONGCOMMERCIALLAWCurrent Issues andDevelopments

The contributors to this book are:

Charles D. BoothAnne CarverClive Grossman QCCaroline HagueAndrew J. HalkyardI.A. TokleyJefferson P. VanderWolkHenry J.H. Wheare

HONG KONGCOMMERCIALLAWCurrent Issues andDevelopments

Edited by Charles D. Booth

Hong Kong University Press139 Pokfulam Road, Hong Kong

© Hong Kong University Press 1996

ISBN 962 209 426 0

All rights reserved. No portion of this publicationmay be reproduced or transmitted in any form orby any means, electronic or mechanical, includingphotocopy, recording, or any information storageor retrieval system, without permission in writingfrom the publisher.

Printed in Hong Kong by Condor Production Ltd.

ContentsAndrew J. Halkyard

. CHAPTER EIGHT .

Foreword vii

Preface ix

Contributors xi

Table of Cases xv

Table of Legislation xxiii

Introduction Charles D. Booth 1

CHAPTER ONE A Patent System for Hong Kong 5

Henry J.H. Wheare

CHAPTER TWO Credit Card Fraud 31

Clive Grossman QC

CHAPTER THREE Transnational Insolvency Law 55

Charles D. Booth

CHAPTER FOUR Oversubscription of Initial Public Offerings: 103Success or Failure? An Analysis of Directors’Duties When Issuing Shares

I.A. Tokley

CHAPTER FIVE Disqualification of Company Directors 125

Caroline Hague

CHAPTER SIX Legal Dysfunctionalism: Hong Kong Company 155Law in the 1990s

Anne Carver

CHAPTER SEVEN Tax Aspects of Cross-Border Trade and Investment 181

Jefferson P. VanderWolk

CHAPTER EIGHT Asset Protection? Estate Planning? (Unit) Trust Me 203

Andrew J. Halkyard

Index 223

vi Contents

ForewordAndrew J. Halkyard

. CHAPTER EIGHT .

It is with great pleasure that I write a foreword to this book. It is hopedthat this collection of essays will make an important contribution to theunderstanding of the commercial law of Hong Kong. The subtitle ‘Cur-rent Issues and Developments’ describes the objectives and the motivationthat lie behind the book. It is not intended to be a comprehensive cover-age of the whole of commercial law but rather addresses specific issues onwhich useful comment and contribution can be made. The themes ofpracticality, relevance, and topicality run throughout each chapter, andpractitioners will find much that is pertinent to their interests and profes-sional practice.

Most of the contributors are current or former members of the De-partment of Professional Legal Education at the University of Hong Kong,and the department is particularly pleased to welcome contributions fromdistinguished practitioners Clive Grossman QC and Henry Wheare. Eachchapter has been written by an expert in the field who has broughtacademic expertise and practical experience to the task.

I pay tribute to the editor of this book, Charles D. Booth, for his ex-cellent work in editing the contributions and launching the book sosuccessfully. Special thanks must also go to Hong Kong University Press fortheir support, and we look forward to further happy associations.

Christopher SherrinHead, Department of Professional Legal EducationThe University of Hong Kong

PrefaceAndrew J. Halkyard

. CHAPTER EIGHT .

In 1994 Professor Christopher Sherrin, the Head of the Department ofProfessional Legal Education at the University of Hong Kong, proposedthat members of the department contribute to a book discussing currentissues and developments in Hong Kong law that would be of specialinterest to Hong Kong practitioners. As the project developed, one bookgave way to two — Modern Trends in Litigation, edited by my colleagueGary N. Heilbronn, and this book dealing with commercial law.

I am grateful to Professor Sherrin for initiating this project and pro-viding comments on the authors’ initial submissions. I also benefited fromthe comments of our anonymous reviewer.

I am indebted to all the contributors for participating in this project. Iwant also to thank the secretarial staff of the Faculty of Law for assistingwith the typing of much of the manuscript. In particular, I want toexpress my gratitude to Mrs Cecilia Chan, the Senior Secretary of theDepartment of Professional Legal Education, who proceeded with herusual efficiency and good humour and enabled us to meet our manydeadlines. I would also like to thank Ms Magdalen Spooner for assistingwith the preparation of the tables and for making endless trips to thelibrary to check ‘just one more citation’. Special thanks are also due toMr Don Brech of Records Management International Ltd for compilingthe index. Finally, I am especially grateful to the staff of Hong KongUniversity Press for their assistance and encouragement.

The authors have tried to state the law as at the end of February1996. However, the proofs have been amended in a few places to incor-

porate more recent developments. Readers should be aware that both theBankruptcy (Amendment) Bill 1996, which was gazetted in March 1996,and the Companies (Amendment) Bill 1996, which was gazetted in April1996, propose amendments to Hong Kong law that are relevant to issuesdiscussed in this book. As of July 1996 neither bill had yet been enacted.

Charles D. BoothJuly 1996

x Preface

Charles D. Booth is a Lecturer in the Department of Professional LegalEducation and an Associate Dean of the Faculty of Law at the Universityof Hong Kong, where he teaches Comparative and Transnational Insol-vency Law in the LLM programme and lectures in Commercial Law andPractice in the PCLL. He received his BA in history from Yale Universityand his JD from Harvard Law School and is a member of the New Yorkand New Jersey Bars. Prior to joining the University of Hong Kong, hepractised law in New York City and taught at the William S. RichardsonSchool of Law at the University of Hawaii. He has published many arti-cles on a variety of insolvency topics, including comparative andtransnational insolvency law and Hong Kong bankruptcy law reform.

Anne Carver is a Senior Lecturer in the Department of Professional LegalEducation at the University of Hong Kong, where she lectures in BusinessLaw to BBA and MBA students in the School of Business. She receivedher BA and MA at Cambridge and is admitted as a solicitor in HongKong and in England and Wales. She is the author of Hong Kong Busi-ness Law and also writes in the areas of trade union and employmentlaw.

Clive Grossman QC is a barrister in Hong Kong and took silk in 1993.He received his BA and LLB from the University of Cape Town. Beforecoming to Hong Kong, he practised at the Bar in Rhodesia (later Zimba-bwe), where he also served as Chairman of the Bar Council and acted as a

ContributorsAndrew J. Halkyard

. CHAPTER EIGHT .

Deputy High Court Judge. He was a member of the Legal Department inHong Kong from 1983–94. When he left government, he was DeputyDirector of Public Prosecutions and head of the Commercial Crime Unit.His main areas of practice are criminal law, commercial law, and arbitra-tion.

Caroline Hague is a Lecturer in the Department of Professional LegalEducation at the University of Hong Kong, where she lectures in Com-mercial Law and Practice in the PCLL. She received her BA HonoursDegree from Manchester University and is admitted as a solicitor in HongKong and in England and Wales. Prior to joining the University of HongKong, she practised law in Hong Kong with Johnson Stokes & Master.Her main areas of research are company and commercial law, in particu-lar the role of company directors.

Andrew J. Halkyard is a Senior Lecturer in the Department of Profes-sional Legal Education at the University of Hong Kong, where he teachesTaxation and Tax Planning in the LLM programme and lectures in Rev-enue Law in the PCLL. He is also a consultant to Baker & McKenzie. Heobtained an LLB from the Australian National University and an LLMfrom the University of Virginia. He has published extensively on a varietyof tax issues and is the co-author (with Peter Willoughby) of the Encyclo-paedia of Hong Kong Taxation and the co-author (with Jefferson P.VanderWolk) of Hong Kong Tax Law: Cases and Materials.

I.A. Tokley is a consultant to an international firm of solicitors based inHong Kong. He formerly was a Lecturer in the Department of Profes-sional Legal Education at the University of Hong Kong, where he taughtSecurities Regulation to LLM students and Banking Law to LLB students.He received his LLB and LLM from the University of Adelaide and isadmitted as a solicitor in Hong Kong, England and Wales, New SouthWales, and South Australia. He is currently a Visiting Professor in Corpo-rate and Securities Law at Tsinghua University in Beijing and has writtenseveral books, including Company Securities: Disclosure of Interests andLaw of Finance.

Jefferson P. VanderWolk is a tax principal at Deloitte Touche Tohmatsuin Hong Kong. He formerly was a Lecturer in the Department of Profes-sional Legal Education at the University of Hong Kong, where he co-taughtTaxation and Tax Planning in the LLM programme and lectured in Rev-enue Law in the PCLL. He obtained his BA from Boston University, hisMA from the American University in Cairo, and his JD from Columbia

xii Contributors

Law School. He is a member of the New York and New Hampshire Barsand has practised law in New York and with Baker & McKenzie in HongKong. He has written widely on a variety of tax issues and is the authorof The Source of Income: Tax Law and Practice in Hong Kong andPractical China Tax Planning.

Henry J.H. Wheare is the partner in charge of the intellectual propertydepartment at Lovell White Durrant. He received his BA and MA atCambridge and is admitted as a solicitor in Hong Kong and in Englandand Wales. His practice covers all areas of intellectual property, withparticular emphasis on patent law. He taught an LLM course on intellec-tual property at the University of Hong Kong in 1993–94. He is currentlyPresident of the Asian Patent Attorneys Association in Hong Kong and isgeneral editor of IP ASIA.

Contributors xiii

Table of CasesAndrew J. Halkyard

. CHAPTER EIGHT .

Page

Allobrogia Steamship Corp, Re (1978) 80Altim Pty Ltd, Re (1968) 129American Express International Banking Corp v Johnson

(1984) 72, 96–98Anderson, Re (1911) 60, 62Andrew, Re (1937) 72Ansett v Butler Air Transport Ltd (No 1) (1958) 112Ashbury Railway Carriage and Iron Co Ltd v Riche (1875) 168Attorney General v Bouwens (1838) 210Attorney General v Yeung Shun-shum (1987) 46Austinsuite Furniture Ltd, Re (1992) 142Australia-wide Management Ltd v CSD (NSW) (1992) 210, 212, 213Axona International Credit and Commerce Ltd, In re (1988) 98, 99Axona International Credit and Commerce Ltd, In re (1990) 98Axona International Credit and Commerce Ltd, In re (1991) 98

Baker v Archer-Shee (1927) 209, 212, 213Banque des Marchands de Moscou v Kindersley (1951) 79Barnado’s Homes v Special Commissioners of Income Tax (1921) 213Bath Glass Ltd, Re (1988) 141, 142, 143–144, 149Benson v Heathorn (1842) 118Bicoastal Corp v Shinwa Co Ltd (1994) 74

xvi Table of Cases

Page

Blithman, Re (1866) 60, 62Board of Trade v Owen (1957) 44Briess v Woolley (1954) 107British Leyland Motor Corp v Armstrong Patents Co Ltd (1984) 13British Leyland Motor Corp v Armstrong Patents Co Ltd (1986) 13

Canny Gabriel Castle Jackson Advertising Pty Ltd v VolumeSales (Finance) Pty Ltd (1974) 211

Canon Kabushiki Kaisha v Green Cartridge Co (Hong Kong)Ltd (1995) 5, 13

Catnic Components Ltd v Hill & Smith Ltd (1982) 18Chan, In re (1993) 99Chan Yee Nam, Re (1918) 91Chan Yue Shan, Re (1908) 89, 91, 92, 95Charles v FCT (1954) 209, 210, 213Charterbridge Corp Ltd v Lloyds Bank Ltd (1970) 109Chartmore Ltd, Re (1990) 148China Tianjin International Economic and Technical

Co-operative Corp, Re (1994) 77, 82City Equitable Fire Insurance Co, Re (1925) 108, 110, 111, 126–127City Investment Centres Ltd, Re (1992) 137–138, 149Commissioner of Estate Duty v Ramchandani (1982) 218Commissioner of Inland Revenue v Euro Tech (Far East) Ltd

(1995) 189Commissioner of Inland Revenue v Far East Exchange Ltd

(1979) 182Commissioner of Inland Revenue v Hang Seng Bank Ltd

(1990) 185, 189Commissioner of Inland Revenue v Wardley Investment

Services (Hong Kong) Ltd (1992) 189Compania Merabello San Nicholas SA, Re (1973) 79–80Company (No 00359 of 1987), Re A (1988) 81, 82Company (No 003102 of 1991), ex parte Nyckeln Finance Co,

Re A (1991) 81Copecrest Ltd, Re (1993) 150Costa & Duppe Properties Pty Ltd v Duppe (1986) 210Cotman v Brougham (1918) 169Countess Fitzwilliam v IRC (1993) 216–217Crestjoy Products Ltd, Re (1990) 151Crumpton v Morrine Hall Pty Ltd (1965) 110–111

Table of Cases xvii

CS (Vic) v Yellowco Five Pty Ltd (1993) 219CSD (Qld) v Livingston (1965) 210Cuff Knox (1961) 212, 213

Dairen Kisen Kabushiki Kaisha v Shiang Kee (1941) 77Dallhold Estates (UK) Pty Ltd, Re (1992) 92Deak, R. Leslie v Deak Perera Far East Ltd (in liq) (1991) 85Deak Perera (Far East) Ltd (in liq) v R. Leslie Deak (1995) 85–86Denham & Co, Re (1883) 107D’Jan of London Ltd, Re (1994) 127Dovey v Cory (1901) 107DPP v Stonehouse (1977) 45

Eades Estate, Re (1917) 91Eloc Electro-Optieck & Communicatie BV, Re (1982) 80Elscint (Asia-Pacific) Ltd v The Commercial Bank of Korea Ltd

(1994) 186Espin v Pemberton (1859) 162Estate of Aw Hoe, Re (1957) 59–60, 66European Asian Bank v Reicar Investments Ltd (1988) 169–170

Federal Commissioner of Taxation v Everett (1980) 211Federal Commissioner of Taxation v St Helens Farm (ACT)

Pty Ltd (1981) 119, 120Felixstowe Dock and Railway Co v United States Lines Inc

(1989) 63, 71Firedart Ltd, Re (1994) 146Foss v Harbottle (1843) 122, 173Fraser v Whalley (1903) 112Furniss v Dawson (1984) 198, 216

Galbraith v Grimshaw (1910) 65–66, 70Gartside v IRC (1968) 210, 213–214Godwin Warren Control Systems plc, Re (1993) 148Guinness v Saunders (1990) 118

Harlowe’s Nominees Pty Ltd v Woodside (Lakes Entrance)Oil Co (1968) 112, 113

Hely-Hutchison v Brayhead (1968) 118Herbert, Elizabeth v Commissioner (1958) 195

Page

xviii Table of Cases

Hirsche v Simms (1894) 110Hogg v Cramphorn Ltd (1967) 111, 112, 113–114Howard Smith Ltd v Ampol Petroleum Ltd

(1974) 109, 111, 112, 114, 115Hutcheson v Taylor (1931) 91Hutton v West Cork Rlwy Co (1883) 110

Improver Corp v Raymond Industrial Ltd (1989) 11–12Improver Corp v Raymond Industrial Ltd (1991) 12, 18Improver Corp v Remington Consumer Products Ltd (1990) 18Insurance Co of Pa v Grand Union Insurance Co (1988) 72Introductions Ltd v National Provincial Bank Ltd (1970) 169IRC v McGuckian (1994) 216IRC v Reid’s Trustees (1949) 209Irish Shipping Ltd, Re (1985) 61, 76, 80–81 82–83, 86Irish Shipping Ltd, Order, Re (1985) 75, 83Irvine v Union Bank of Australia (1877) 164

Jon Beauforte (London) Ltd, Re (1953) 164, 167

Kan King Investment Ltd (in liq), Re (1995) 153Keypak Homecare Ltd, Re (1990) 142, 146Kleinwort Benson (Hong Kong) Trustees Ltd v Wong Foon

Hang (1993) 210Kooperman, Re (1928) 65, 87Kowloon Container Warehouse Co Ltd, Re (1981) 68Kwok Chi Leung, Karl v Commissioner of Estate Duty (1988) 216, 218

Law Ip Po, Re (1994) 210Lee Behrens & Co Ltd, Re (1932) 113Levasseur v Mason & Barry Ltd (1891) 67Liangsiriprasert v Government of United States of America (1991) 46Linvale Ltd, Re (1993) 154Liwan District Construction Co v Euro-America China

Property Ltd (1990) 99–100Lo-Line Electric Motors Ltd, Re (1988) 142, 145, 149–150Looe Fish Ltd, Re (1993) 147Lyall v Jardine, Matheson, & Co (1870) 94

Macau-Mokes Group Ltd, Re (1994) 77

Page

Table of Cases xix

Manlon Trading Ltd, Re (1995) 151–152Marshall, Re (1914) 212, 213Marshall’s Valve Gear Co Ltd v Manning Wardle & Co (1909) 107Mattel Inc v Tonka Corp (1992) 24Metropolitan Police Commissioner v Charles (1976) 47–48Mobil Sales and Supply Corp v Owners of

‘Pacific Bear’ (1979) 63, 68–69, 70, 71Modern Terminals (Berth 5) Ltd v States SS

Co (1979) 60, 62–63, 66, 68, 69–71Mosely v Koffeefontein Mines (1911) 120

National Research Development Corp v The WellcomeFoundation Ltd (1991) 12–13

Neale v Cottingham (1770) 66Ngurli Ltd v McCann (1953) 113NLRB v Bildisco & Bildisco (1984) 63

Official Receiver of Hong Kong v Keith Thomas Philcox (1992) 99Ord Forrest Pty Ltd v Federal Commissioner of Taxation (1974) 120

Paradis (1934) 50Penrose, Re (1933) 220Percival v Wright (1902) 107Pfizer Inc and Toyama Chemical Co Ltd v Jiwa International

(HK) Co (1988) 11Piercy v Mills (1920) 111, 112Probe Data Systems Ltd (No 3) (Secretary of State

of Trade and Industry v Desai), Re (1992) 151Produce Marketing Consortium Ltd (No 2) (1989) 127

Quistclose Trust, Re (1970) 162

R v Ahern (1988) 50R v Allsop (1977) 51R v Aspinall (1876) 49R v Bradley (1961) 130R v Brisac (1803) 50R v Brockley (1994) 130R v Campbell (1984) 131R v Chan Suen Hay (1995) 132

Page

xx Table of Cases

R v El-Hakkaoui (1975) 45R v Ghosh (1982) 51R v Griffiths (1965) 49R v Hui Wai-bun (1986) 50R v Jones (1832) 49R v Lambie (1981) 47, 48–49R v Liu Po-sing (1986) 45–46R v Simmonds (1969) 49R v Sinclair (1958) 51R v Wai Yu-tsang (1991) 51–52R v Walters (1979) 50R v Williams (1942) 218Ramsay v IRC (1982) 216, 217, 218Rank Yam Investments Ltd (in liq), Re (1995) 153Real Estate Development Co, Re (1991) 81, 82Rex Williams Leisure plc, Re (1994) 139, 140–141, 152Rolled Steel Products (Holdings) Ltd v British Steel

Corp (1986) 113, 170–171Royal British Bank v Turquand (1856) 3, 156, 159, 162, 166–167,

170, 171, 175, 178Russo-Asiatic Bank, Re (1930) 61

Scientex Corp v Harry Kay (1986) 99Scott v Metropolitan Police Commissioner (1975) 51Sea Fire and Life Assurance Co (Greenwood’s case), Re

(1854) 161Securities and Futures Commission v MKI Corp Ltd (1995) 77, 78, 82Selangor United Estates Ltd v Craddock (No 3) (1968) 107Sennar, The (No 2) (1985) 86Sevenoaks Stationers (Retail) Ltd, Re (1991) 128, 142,

144–145, 150Sharp v Jackson (1899) 72Smith & Fawcett, Re (1942) 109Smith Kline & French Laboratories v Attorney General

(1966) 10, 11, 12–13Smith Kline & French Laboratories v Harbottle (1980) 24Smyth, Leach v Leach, Re (1898) 212Solomons v Ross (1764) 65–66Standard Chartered Bank v IRC (1978) 205Sudeley (Lord) v Attorney General (1897) 212, 213

Page

Table of Cases xxi

Tam Hing-yee v Wu Tai-wai (1991) 68Teck Corp Ltd v Millar (1972) 108, 112, 114, 115–116Transvaal Lands v New Belgium (1914) 118Travel Mondial (UK) Ltd, Re (1991) 146, 154Treacy v DPP (1971) 45Tripodi v R (1961) 50Turquand’s case, see Royal British Bank v Turquand

Vatcher v Paull (1915) 112

W & M Roith Ltd, Re (1967) 109Walk Fit Shoes Factory Ltd (in liq), Re (1995) 153Wallace Smith & Co, Re (1992) 81Weiner, Wyner v Braithwaite, Re (1956) 212Weir’s Settlement, Re (1971) 214Welham v DPP (1961) 51Whitehouse v Carlton Hotel Pty Ltd (1987) 114Wyllie v Pollen (1863) 163

Page

Table of LegislationAndrew J. Halkyard

. CHAPTER EIGHT .

PagePage

Hong Kong Legislation

Bankruptcy Ordinance 1891s 3 95s 4 89s 6 92s 7 91s 8 91

Bankruptcy (Amendment) Ordi-nance 1901 (Ordinance No 2 of1901)

s 4 92

Bankruptcy (Amendment) Ordi-nance 1902 (Ordinance No 6 of1902)

s 3 92

Bankruptcy Ordinance (cap 6)s 2 91, 95, 97s 3 88–90

s 4 89s 5 93s 6 90–91, 92s 7 76s 9 91, 94s 10 91, 94s 12 88, 93s 13 93s 14 88ss 20–21 93s 22 93s 23 93s 29 88s 30 94s 42 88, 95s 43 95s 45 88s 47 88s 49 72, 88s 55 96s 58 93, 95s 99 91

xxiv Table of Legislation

Page Page

s 100 94s 104 94s 109 76

Business Registration Ordinance(cap 310)

s 2 186

Companies Ordinance (cap 32)1932

s 313 77

Companies Ordinance (cap 32)s 1 133s 2 71, 72, 76, 130s 4 160s 5 171s 8 166, 169s 13 166s 22 166s 28A 159s 29 160s 48B 119s 57A 159s 80 164s 81 133, 137s 95 137s 96 137s 107 137s 108 137s 109 137s 116 166s 119A 137s 121 137s 122 137s 129B 137s 142 138s 146 138s 152A 138s 152B 138

s 154A 139s 156 129, 131, 139s 157B 127s 157C 125s 157E 127, 128–129, 131s 157F 127, 128–129, 131, 135s 158 137s 158A 137s 162 118s 168C 130, 137ss 168C-168T 130s 168D 130, 131s 168E 129, 130, 132, 134s 168F 129, 130, 132, 133–134s 168G 129, 130, 132, 134, 137s 168H 129, 130, 132,

135–136, 137, 152, 153s 168I 129, 130, 132,

135, 137, 140, 153s 168J 130, 132, 138, 147s 168K 136, 137s 168L 130, 134s 168M 131, 133s 168N 139s 168O 139s 168P 132s 168S 140s 168T 132, 134ss 169–227F 74s 176 71s 177 73s 178 73, 77s 179 75s 180 73s 180A 71s 181 73, 79s 182 72, 136s 186 73, 79s 190 136s 193 74

Table of Legislation xxv

Page Page

s 194 74s 206 74s 209 73–74s 211 136s 221 73s 222 73ss 228–233 75s 228A 136ss 234–239A 75ss 240–248 75s 241 136ss 249–257 75ss 263–296 74, 75s 265 83s 266 72, 136s 267 72s 269 72, 96–97s 275 73, 134, 135, 150s 276 150s 279 134s 300A 136–137s 300B 137s 302 134s 305 164s 306 134s 326 72, 76s 326–331A 71s 327 75, 76–77, 78,

79–80, 87, 100s 327A 77–78, 79, 86s 329 79s 330 79s 331 72, 75, 78, 87, 100s 332 72, 78, 186s 341 186s 351 133s 358 150Part IVA 127, 150Part X 71, 72, 76,

78, 86, 87, 100

Part XI 77, 185–186First Schedule 127Seventh Schedule 171Eighth Schedule 193Twelth Schedule 130, 133, 134Fifteenth Schedule 136–137,

147

Companies (Disqualification Or-ders) Regulation (cap 32)

Schedule 1 140Schedule 2 140Schedule 3 140

Companies (Winding-Up) Rules(cap 32)

r 58 150

Conveyancing and Property Ordi-nance (cap 219)

s 20 218

Crimes Ordinance (cap 200)s 69 52ss 71–76 52

District Court Ordinance (cap 336)s 52E 68

Estate Duty Ordinance (cap 111)s 3 208, 216–217, 219–220s 5 193, 204, 210, 214s 6 204, 205, 215,

217, 219, 220s 7 217s 10 181, 205, 216, 217, 218s 14 215ss 34–45 205s 35 214–215s 40 208

xxvi Table of Legislation

Page Page

s 43 215s 44 220Schedule 1, Part 22 204Schedule 2 205, 214

Hong Kong Bill of Rights Ordi-nance (cap 383)

s 8art 12 132–133

Inland Revenue Ordinance(cap 112)

s 2 186s 5 181, 192s 8 181, 193s 14 181, 182, 185–190s 15 191s 20A 191, 192s 20B 191s 21A 182, 191Schedule 1 182, 203Schedule 2 203

Inland Revenue Rules (cap 112)r 5 186–188

Partnership Ordinance (cap 38)s 22 210s 41 210

Registration of Patents Ordinance(cap 42)

s 6 9, 12s 7 9–10s 8 9

Registration of UK Patents (Amend-ment) Ordinance 1968 (OrdinanceNo 24 of 1968)

ss 7A-7D 10

Rules of the Supreme Court (cap 4)O 30 67O 44A 67, 68O 46 67O 47 67O 48 68O 49 67O 49B 68O 50 67

Securities and Futures CommissionOrdinance (cap 24)

s 29A 138–139

Securities Listing Ruless 1 125s 3.08 125–126

Stamp Duty Ordinance (cap 117)s 4 181, 192s 19 192First Schedule 181, 192

Supreme Court Ordinance (cap 4)s 20 72s 21A 68s 21B 68s 21L 67

Theft Ordinance (cap 210)s 27 53

United Kingdom Legislation

Bankruptcy Act 1861s 218 91–92

Bankruptcy Act 1914s 122 59–60, 65, 87, 92, 98

Table of Legislation xxvii

Page Page

Companies Act 1948s 5 169s 188 131s 399 79

Companies Act 1985s 24 160s 35 159, 169,172s 35A 159s 300 142s 416 165s 447 139s 711A 165Part XII 166Part XXIII 166

Companies Act 1989s 3A 172s 35 172–173, 179s 35A 172s 35B 172s 108 159, 169ss 108–112 172s 142 159, 165Part IV 155, 156, 160Schedule 15 156Schedule 16 156

Company Directors Disqualifica-tion Act 1986

s 6 128, 141s 7 135s 8 147Schedule 1 147

Co-operation of Insolvency Courts(Designation of Relevant Countriesand Territories) Order (1986) 99

Copyright Act 1956s 5 24

European Communities Act 1972s 9 165, 172

Finance Act 1959s 35 217

Firearms Act 1968s 16 45

Insolvency Act 1985s 213 60

Insolvency Act 1986s 8 92s 214 127s 220 87s 265 90s 426 60, 92, 98–99

Land Charges Act 1972s 3 166

Law of Property Act 1925s 198 165

Patents Act 1949s 21 10s 46 10

Patents Act 1977s 1 7s 4 12ss 39–43 23s 60 11s 61 11s 62 11, 13s 63 11, 13s 64 11s 67 11s 69 9, 24

xxviii Table of Legislation

Page Page

s 75 13s 130 24Schedule 1 12

Patents Etc (Hong Kong) (Conven-tion) Order (1977) 14

Theft Act 1968s 15 47s 21 45

Australian Legislation

Corporations Laws 117 174s 161 174s 162 175s 164 175–176s 229 127, 129s 230 127s 592 127s 599 127s 600 128

Canadian Legislation

Ontario Business Corporations Act1982

s 15 176–177s 17 176–178s 19 176–178

Chinese Legislation

Basic Law of the Hong Kong Spe-cial Administrative Region of thePRC 1990

art 139 8

International Conventions

European Patent ConventionArticle 69 12, 18

Singaporean Legislation

Companies Act 1990 (cap 50)s 25 176

United States Legislation

Bankruptcy Act 1898s 342 62Chapter XI 62, 68, 69, 70

Bankruptcy Code (Title 11, USC)s 101 64, 76s 303 76, 96, 98s 304 98s 1101 62Chapter 7 98Chapter 11 63, 84

Internal Revenue Code (Title 26,USC)

s 163 198s 482 197ss 861–863 194, 195s 864 194, 197s 871 197s 882 194, 196, 197s 884 196s 897 197s 1442 194s 1445 197s 2105 197s 6038A 197s 6038C 197

IntroductionCharles D. Booth

. CHAPTER EIGHT .

This is an exciting time to practise commercial law in Hong Kong. Withthe transfer of Hong Kong’s sovereignty to China fast approaching, prac-titioners are adjusting to many recent changes in commercial law and areawaiting the enactment of further legislative amendments.

This book focuses on current issues and developments in eight areasof commercial law: patents, credit card fraud, transnational insolvency,the oversubscription of securities offerings, the disqualification of com-pany directors, the protection of company creditors, cross-border taxation,and the use of trusts for estate planning. A primary theme of the book isthe effect of recent and ongoing law reform on Hong Kong commerciallaw. Many of the authors discuss proposals by the Law Reform Commis-sion or other bodies. The authors also make their own proposals forimproving Hong Kong’s legislation and case law.

The call for law reform is not surprising. Much of Hong Kong com-mercial law has its origins in late nineteenth and early twentieth centuryEnglish legislation and, until recently, little was done to update it. HongKong bankruptcy law is a prime example. Existing law still provides thata creditor must prove that a debtor has committed an ‘act of bankruptcy’before a bankruptcy case may be commenced against the debtor. Andonce debtors have been adjudicated bankrupt, they will normally spendthe rest of their lives languishing in bankruptcy, unable to emerge with afresh start and get on with their lives and new business opportunities. Oldprinciples such as these (which originally regulated the conduct of mer-chants) have outlived their usefulness. Yet, the Law Reform Commission

2 Introduction

has only recently recommended that Hong Kong’s bankruptcy legislationbe updated. The proposed bankruptcy amendments are but a part of thepre-1997 flurry of commercial law reform.

In the first chapter, Henry Wheare discusses the need to localize HongKong patent law, which currently is ‘wholly dependent’ on UK patentlaw. At present, only UK patents or European patents designating theUnited Kingdom are eligible for patent protection in Hong Kong. Whearehighlights this and other weaknesses in the current patent system and thenanalyses the draft Patents Bill, which incorporates most of the recommen-dations of the Patent Steering Committee and should be enacted later thisyear. The proposed legislation provides for the registration in Hong Kongof Chinese patents and, initially, of UK and European granted patents.Wheare notes that the resulting Hong Kong patents will be independentof the original patents and subject to a detailed local patent regime. In hisview, the most radical aspect of the draft bill is the proposal to introducea ‘petty patent’ system offering short-term protection that is easier toobtain.

In Chapter 2, Clive Grossman QC analyses various types of creditcard fraud, many of which are quite intricate. He discusses several practi-cal and legal matters that arise in the prosecution of credit card fraud andurges the reform of Hong Kong’s ‘cumbersome procedures’ regarding thesubmission of evidence from overseas. He also stresses the need for thecredit card industry, applicable law, and law enforcement authorities tocontinue adapting to the ever-changing nature of credit card fraud.

In Chapter 3, I focus on transnational insolvency law and examinethe options available in Hong Kong to a foreign representative who seeksto protect the assets of a foreign debtor in Hong Kong and to obtaincross-border assistance from the Hong Kong courts. I discuss the recogni-tion of foreign insolvencies, non-insolvency options, the winding up offoreign companies, and the bankruptcy of foreign individuals and part-nerships. I also examine the ability of Hong Kong trustees and liquidatorsto seek assistance abroad. Although existing law enables Hong Kong tocooperate in transnational insolvencies, there are many weaknesses andomissions in the current statutory regime. I argue that many of the com-mon law tests are inadequate and suggest that the enactment of detailedstatutory guidelines would lead to greater cross-border cooperation andprovide more consistency and predictability in the law.

In Chapter 4, I.A. Tokley addresses issues involving the oversubscrip-tion of initial public offerings (‘IPOs’). He argues that from the perspectiveof the issuing company, any oversubscription should be viewed as a fail-ure, because an oversubscription of shares results in a notional loss to thecompany. He sets out the various approaches regarding the responsibility

Introduction 3

of directors when issuing some shares at a notional loss and concludesthat issuing shares at a notional loss is prima facie evidence of an im-proper use of the power to issue shares.

In Chapter 5, Caroline Hague discusses the recent amendments to theCompanies Ordinance regarding the disqualification of company direc-tors in Hong Kong. She notes that the Hong Kong reforms exemplify thetrend throughout common law jurisdictions to make directors more ac-countable for their actions. The Hong Kong enactments are based on theUK Company Directors Disqualification Act 1986, and Hague thus analy-ses the interpretations of UK courts of the equivalent UK disqualificationprovisions. Among the issues raised in these cases are what actions consti-tute ‘unfit’ behaviour that should lead to a director’s disqualification andwhat mitigating factors may be considered when deciding on a period ofdisqualification. Hague notes that differences between Hong Kong andthe United Kingdom could cause the new disqualification provisions tohave less impact in Hong Kong than the corresponding provisions havehad in the United Kingdom.

In Chapter 6, Anne Carver argues that existing company law inad-equately protects the interests of outsiders when dealing with Hong Kongcompanies and that there is a growing dysfunctionalism between the ob-jectives and the operation of Hong Kong company law. She notes thegrowing divergence between Hong Kong and UK company law and sug-gests that the English model for company law is no longer appropriate forHong Kong. She then focusses on the inadequacy of three areas of HongKong law in addressing the needs of the business community — thedoctrine of constructive notice, the rule in Turquand’s case, and the doc-trine of ultra vires. She concludes with a discussion of two other modelsfor reforming Hong Kong company law. She notes that the StandingCommittee on Company Law Reform supports the adoption of changesbased on Canadian law, but argues that Australian law would serve as abetter model for improving Hong Kong law.

The last two chapters focus on taxation matters. Chapter 7, by JeffersonVanderWolk, discusses the tax aspects of both inbound and outboundtrade and investment. In his discussion of inbound trade and investment,VanderWolk stresses that because of the risk of double taxation of in-come earned in Hong Kong, lawyers should carefully consider theapplication of the rules, both in Hong Kong and in a foreign entity’shome jurisdiction, for determining the source of income subject to taxa-tion by the respective jurisdictions. In his discussion of outbound tradeand investment by Hong Kong companies, he notes that tax rates aregenerally higher abroad than in Hong Kong and discusses why it can bedifficult for Hong Kong companies to minimize foreign taxes. VanderWolk

4 Introduction

concludes his discussion of tax planning by emphasizing several overrid-ing principles that lawyers should consider when advising on investmentschemes with cross-border tax implications.

The final chapter of the book by Andrew Halkyard discusses the legalimplications of using trusts for asset protection and estate planning inHong Kong. This chapter should be of special interest to tax lawyers orcommercial lawyers with some tax background. Halkyard explains whyan offshore trust is often the best way to mitigate Hong Kong estateduties and analyses the structure of a typical offshore trust in which theunits of a unit trust are held by a discretionary trust. He emphasizes thedistinctive nature of a beneficiary’s interest in a unit trust and suggestshow a Unit Trust Deed should be drafted to protect a beneficiary’s inter-est. He also explains why, as a rule, gifts should be avoided whenstructuring transfers of property to a trust and why the trustee of thediscretionary trust must be independent.

As an important commercial centre, Hong Kong has developed asophisticated body of commercial law, many areas of which are undergo-ing rapid reform. Of course, every jurisdiction should continually reviseits commercial law, if only to keep up with new technology and transac-tions. In Hong Kong, however, law reform has taken on new importance,as Hong Kong strives to make — as smoothly as possible — the enor-mous transition from British Colony to Special Administrative Region ofChina. We hope that these chapters will assist readers in better under-standing Hong Kong’s commercial law during this period of transition.

A Patent System for Hong KongHenry J.H. Wheare

. CHAPTER ONE .

Whereas the overall intent that patents should be registrable andenforceable in Hong Kong could be said to be clear, the wording of theOrdinance gives rise to difficulties when it comes to a more detailedexamination of how that is done. The matter is clearly ripe for detailedlegislation.1

INTRODUCTION

An important issue relating to Hong Kong’s future legal system is whetheran independent patent system is justified and, if so, whether it is practica-ble. The maintenance of effective intellectual property protection in HongKong is fundamental to its role as a sophisticated environment for inter-national business. More particularly, a patent system is required in HongKong if it is to retain its status as a free port and regional focus forindustrial development in Southern China.

This chapter first outlines the nature of patent protection and looks atthe existing patent system in Hong Kong. It then examines the interna-tional patent obligations relevant to Hong Kong and discusses proposalsfor reform of the patent system. At the time of writing, a draft Patents Bill

1 Rogers J in Canon Kabushiki Kaisha v Green Cartridge Co (Hong Kong) Ltd [1995] 1HKC 729, 740 [hereinafter Canon Kabushiki Kaisha].

6 Henry J.H. Wheare

is under consideration. This is planned to be introduced in the 1995/96session of the Legislative Council and is expected to follow most of theproposals here discussed. An agreement reached by the Sino-British JointLiaison Group (‘Joint Liaison Group’) in November 1995 provides for thenew patent system to continue after the setting up of the Hong KongSpecial Administrative Region (‘SAR’) on 1 July 1997.2

What is a patent?

A patent is the purest form of intellectual property. It is a species of legalproperty concerned with rights in inventions. In return for disclosing hisinvention, an inventor is granted a statutory monopoly for a limitedperiod during which he can prevent others from exploiting the invention.A patent encourages investment in innovation and the development ofnew machines, products and processes. It covers subject matter as diverseas agriculture, medicines, toys, electronics, and engineering.

Over thirty million patents have been published worldwide and eachyear a million more appear.3 Patents are filed internationally. Japan isacknowledged as receiving the greatest number of applications annually.In 1989 the Japanese Patent Office received 357,464 patent applicationsand the United States Patent Office received 161,660 applications; fol-lowed by West Germany with 102,427 and the United Kingdom with90,234. China’s applications for that year amounted to 9,659, half ofwhich came from non-residents. Hong Kong, by comparison, received 901applications, a mere fifteen of which came from Hong Kong residents.4

The limits of patent protection in Hong Kong

A recognized advantage of effective patent laws, particularly for develop-ing countries, is the consequential attraction of foreign investment. The

2 A meeting of the Sino-British Joint Liaison Group [hereinafter Joint Liaison Group] inBeijing from 31 October to 2 November 1995 reached agreement on localization ofHong Kong’s patent, copyright and designs laws. It confirmed that intellectual propertyrights applied for before 30 June 1997 would continue to be processed and recognizedby the future SAR Government.

3 United Kingdom Patent Office information booklet (Nov 1991).4 World Intellectual Property Organisation Industrial Property Statistics 1989 quoted in

the Hong Kong Patent Steering Committee, Report on Reform of the Hong Kong PatentSystem (May 1993) [hereinafter Patent Steering Committee Report]. The Report notes(para 7.3, at 53) that the local level of inventiveness is higher than might appear becausepatents are sometimes registered in the name of associated companies resident abroad.

A Patent System for Hong Kong 7

relatively small number of patents applied for each year in Hong Kong sug-gests a lack of both local and foreign interest in protecting inventions. Whyis there this apparent indifference to patent protection in Hong Kong?

First of all, Hong Kong companies have had no pressing need forpatent protection. A patent principally affords monopoly rights for inno-vative manufactured goods and manufacturing processes. Hong Kong isnot renowned as a manufacturing base, nor has innovation featured highlyin the development of Hong Kong’s industries. Trading companies, essen-tially dealing in other people’s products, and service industries, such asthose covering financial, real estate and legal fields, have no need forpatent protection.5

Second, although immensely valuable for the right invention in theright hands, obtaining patent protection is both expensive and time con-suming. Accordingly, only industries with heavily funded research facilities,such as pharmaceutical and engineering companies, fully benefit fromlong-term investment in patents. By contrast, the success of Hong Kongbusinesses has traditionally been attributed to short-term investment, effi-cient entrepreneurial skills and low cost manufacturing resources. Patentprotection has played no part in this development.

Third, foreign companies have not regarded Hong Kong as a necessaryterritory for patent protection. Intellectual property protection tends to besought in territories where competition is expected to be most keenly felt.Until recently, albeit a source of competitive products, Hong Kong has notbeen regarded as a competitive market in its own right. Patent protectionhas therefore only been considered necessary in markets such as Europe andthe United States, where Hong Kong goods have been exported.

Fourth, a major concern of intellectual property rights owners is coun-terfeiting — but in Hong Kong, this activity has been considerably reduced,at no cost to the owners, because the Customs and Excise Department wasempowered in 1975 to take criminal proceedings for copyright infringe-ment under the Copyright Ordinance6 and in 1980 for trade markinfringement under the Trade Descriptions Ordinance.7 However, no suchmeasures apply to patent infringement, which remains fully within the do-

5 Patent law in Hong Kong specifically excludes from the definition of invention anyscheme, rule or method for performing a mental act, playing a game or doing business.The presentation of information is also excluded (UK Patents Act 1977, s 1(2)(c), (d)).The above categories are only excluded to the extent that the invention relates to them‘as such’. So, for example, a technical device used in business, such as a calculator, isnot excluded from patent protection.

6 Cap 39, LHK. Copyright subsists automatically without registration.7 Cap 362, LHK. The provisions allow action to be taken based merely on a UK trade

mark registration. No separate registration in Hong Kong is therefore necessary.

8 Henry J.H. Wheare

main of civil law. The inevitable cost of civil infringement proceedingspresents a major disincentive to the maintenance of patent rights.

Finally, Hong Kong has no independent patent system. As will beseen, under the present system Hong Kong is wholly dependent upon theUnited Kingdom for patent protection. Anyone seeking patent protectionin Hong Kong must first obtain (not simply apply for) a UK patent or aEuropean patent designating the United Kingdom. This may take overfour years to achieve. The proprietor of such a patent then has a furtherfive years within which to apply for a corresponding Hong Kong patent.Given the lengthy timescale within which to obtain protection, and thefact that many patents applied for are not ultimately granted,8 or if granted,fail to result in marketable inventions, the impetus to apply for protectionin Hong Kong is considerably reduced.

Nevertheless, an attractive feature of the present Hong Kong patentsystem is that it is reasonably simple to obtain protection once the UK-based patent has been granted. No further technical examination of theinvention is required in Hong Kong. Moreover, as a result of the UnitedKingdom’s obligations under various treaties and conventions,9 Hong Kongresidents automatically benefit from international protection of patentand other intellectual property rights.

The present system is now under review, as part of a comprehensiveexamination of Hong Kong’s intellectual property (and other) laws beingundertaken by the government. The principal reason for this review is theneed to localize Hong Kong’s laws before the setting up of the SAR on1 July 1997 if they are to remain in force after that date.10 With this inmind, the government set up a Patent Steering Committee in 1977 toadvise on what patent system should be adopted in Hong Kong and todraw up detailed proposals for implementation. At the end of May 1993the Patent Steering Committee issued its Report on Reform of the HongKong Patent System.11 A modified version of the Patent Steering Commit-tee proposals is now in the process of being implemented under a draftPatents Bill.12

8 Hence the frequent packaging designation: ‘pat pending’.9 See text below accompanying notes 40–46.10 Under Article 139 of the Basic Law, which regulates the laws of the SAR after 30 June

1997, the SAR government ‘shall on its own formulate policies on science and technologyand protect by law achievements in scientific and technological research, patents,discoveries and inventions.’ The SAR will be a separate intellectual property entity fromChina, with its own independant legal framework for registration and protection ofintellectual property. A patent system dependent upon UK law clearly cannot survive.

11 Note 4 above.12 See text below accompanying notes 60–91.


THE PRESENT PATENT SYSTEM

There is no original grant of patents in Hong Kong. Patent protection isafforded through the mechanism of first registering a patent in the UnitedKingdom Patent Office or in the European Patent Office designating theUnited Kingdom (‘European (UK) patent’).

Under the Registration of Patents Ordinance,13 a UK patent may beregistered in Hong Kong within five years of the date of its grant. Anyoneentitled to the Hong Kong patent rights may apply to the Registrar ofPatents for a Hong Kong Certificate of Registration of Patent. This certifi-cate confers on the applicant ‘privileges and rights, subject to all conditionsestablished by the law of Hong Kong, as though the patent had beengranted in the United Kingdom with an extension to Hong Kong.’14 Theseprivileges and rights are not defined, but continue in force only for solong as the UK patent remains in force.15

Under the current UK patent law,16 there is a statutory code applica-ble to patents covering such matters as infringement, revocation andlicensing, as well as the right to restrain unjustified threats of litigation,restrictions on the recovery of damages for innocent infringement and theright to continue use begun before the priority date of a patent. Since theRegistration of Patents Ordinance only confers privileges and rights onthe applicant for registration, such provisions of the UK legislation arenot directly applicable in Hong Kong. For example, a UK patent can bedirectly attacked by revocation proceedings, but in the case of a HongKong patent the Hong Kong courts only have power to declare, on any ofthe grounds upon which the UK patent might be revoked, that the exclu-sive privileges and rights have not been acquired in Hong Kong.17 Likewise,as regards infringement, an important provision of the UK law18 allows apatentee to recover damages for infringement occurring from the date ofpublication of the application for the UK patent. Under Section 7 of the

13 Registration of Patents Ordinance (cap 42, LHK). This ordinance, which was enacted in1932 and revised in 1990, largely consolidates previous amendments of an earlierRegistration of UK Patents Ordinance 1925. It is not, as has been previously assumed(see Patent Steering Committee Report (note 4 above), para 6.4, at 48), the first enactmentof the present law.

14 Registration of Patents Ordinance, s 6.15 Ibid, s 7.16 UK Patents Act 1977.17 Registration of Patents Ordinance, s 8. Under s 8(2) this includes use in Hong Kong

prior to the date of the issue of the UK Patent. It is of course possible to apply directlyfor revocation in the United Kingdom.

18 UK Patents Act 1977, s 69.

10 Henry J.H. Wheare

Registration of Patents Ordinance, however, no action can be entertainedfor any act of infringement of a Hong Kong patent prior to the date of itsregistration in Hong Kong. Thus, although the Hong Kong patent datesfrom the grant of the UK patent, no action for any infringement prior tothe issue of the Hong Kong registration may be entertained.19

Is the patent system effective?

The courts have from time to time examined the structure of the Registra-tion of Patents Ordinance and found it wanting.

In Smith Kline & French Laboratories v Attorney General (‘SmithKline’),20 a Hong Kong government department purchased quantities of apatented drug for the treatment of schizophrenia and other mental disor-ders. The patentees, who had obtained registration of their patent underthe Registration of Patents Ordinance, claimed infringement by the gov-ernment. The government argued that it was entitled to use patents in theUnited Kingdom by reason of the Crown user provisions of Section 46 ofthe UK Patents Act 1949 and that these provisions extended to HongKong under the Registration of Patents Ordinance.

The full court held that the Registration of Patents Ordinance gavethe patent holder in Hong Kong the same rights and privileges as the UKpatent holder, as if the words ‘Hong Kong’ had been included in theoriginal letters patent. The Hong Kong patent holder therefore had thesame right of action against the Crown as the UK patent holder underSection 21 of the UK Patents Act 1949. However, the Crown user provi-sions of Section 46 of the UK Patents Act 1949 only applied to the UKCrown (and UK government departments). The Registration of PatentsOrdinance did not extend the provisions of Section 46 to Hong Kong, nordid Section 46 extend to Hong Kong government departments. Accord-ingly, the Hong Kong government had no defence to infringement underthe Crown user provisions.21

19 In effect, this limits the privileges and rights to priority over other inventors until issueof the Hong Kong registration.

20 [1966] HKLR 498.21 The Registration of UK Patents (Amendment) Ordinance 1968 introduced in ss 7A-7D

a complete code for Crown use of patented inventions. Further amendments are proposed(ss 7B-7G) under the Intellectual Property (World Trade Organisation Amendments)Bill 1995 (gazetted 6 October 1995). Under the amendments the Crown use provisionsare restricted to use during periods of extreme urgency for securing sufficient suppliesand services essential to the life of the community. Compensation is payable to thepatentee or exclusive licensee for such use.


Patent rights under the UK Patents Act 1949 were conferred partly bystatute and partly in exercise of the Royal prerogative (e.g., as regardsinfringement). Accordingly, there was no requirement to extend any sec-tions of the UK Patents Act 1949 to Hong Kong under the Registration ofPatents Ordinance. However, with the introduction of the UK Patents Act1977, a complete statutory code of patent law was introduced, includinga right of action for infringement in the United Kingdom. In a 1982paper,22 it was argued that the effect of Smith Kline was to cast doubt onwhether any of these statutory provisions, referring as they do to activitiesin the United Kingdom, were extended or otherwise applied to HongKong. To overcome these doubts, it was suggested that relevant provi-sions of the UK legislation be expressly enacted in Hong Kong.23 Onlynow is this suggestion being implemented.

Despite the doubts cast on the effectiveness of UK patents registeredin Hong Kong, the courts have continued to uphold such patents as if therelevant sections of the UK law on infringement applied in Hong Kong. InPfizer Inc and Toyama Chemical Co Ltd v Jiwa International (HK) Co,24

on an interlocutory application to dismiss a claim by an exclusive licen-see, Penlington J noted that ‘the position regarding patent protection inHong Kong is far from clear’ but that ‘even with the passing of the codecontained in the [UK] Patents Act 1977 a registered certificate holder inHong Kong of a UK patent has the same common law rights as he wouldhave had before the passing of that Act’.25 The question here was whetherthe exclusive licensee had a right to sue, since the relevant provision of theUK Patents Act 197726 did not apply. It was held that Pfizer was morethan an exclusive licensee and had the common law right to sue in its ownname if it also joined the proprietor.

In Improver Corp v Raymond Industrial Ltd27 the High Court consid-ered whether a patent should be interpreted in the light of guidelines laid

22 Peter Sinden, ‘Hong Kong’s Patent Law’ (1982) 9 European Intellectual Property Review247.

23 These included UK Patents Act 1977, s 60 on infringement, excluding provisions relatingto exhaustion of rights under the Community Patent Convention (not yet in force); ibid,s 61(1),(2),(3),(4), (6) on infringement proceedings; ibid, s 62 on restrictions on recoveryof damages for infringement; ibid, s 63 on relief for infringement of a partially validpatent; and ibid, s 64 on the right to continue use begun before the priority date.

24 [1988] 1 HKLR 76.25 Ibid, 78.26 UK Patents Act 1977, s 67, under which an exclusive licensee may sue for patent

infringement if he joins the proprietor as a party. At the ex parte stage, Pfizer had suedonly in its name; by the time of the application to dismiss, the proprietor had beenjoined as a second plaintiff.

27 [1989] 1 HKLR 356 [hereinafter Improver].


down under Article 69 of the European Patent Convention. On an appli-cation for an interlocutory injunction, Mayo J rejected the defendants’argument that only common law rights were conferred by Section 6 of theRegistration of Patents Ordinance and that the European Patent Conven-tion should therefore be ignored. He said that ‘the rights conferred are thesame as those conferred upon the holder of a UK patent’,28 meaning ineffect that current UK law (including the European Patent Convention)applies in Hong Kong.29 On appeal the Court of Appeal paraphrasedMayo’s decision on this as saying ‘that the UK Patents Act 1977 was inforce in Hong Kong . . . and we are satisfied that he was correct to sohold’.30 With respect, the logic of this statement is hard to follow, asclearly the UK Patents Act 1977 is not in force in Hong Kong.

The question was again reviewed by the UK Patents Court in Na-tional Research Development Corp v The Wellcome Foundation Ltd(‘NRDC’).31 In this case, the term of certain pre-1977 Act patents ownedby National Research Development Corporation (‘NRDC’) had been ex-tended by four years under the UK Patents Act 1977. Under the relevantprovisions of the 1977 Act,32 existing licences were to continue royalty-free as licences of right. NRDC submitted that these provisions of the UKPatents Act 1977 did not apply in Hong Kong. Aldous J agreed thatneither the UK Patents Act 1949 nor the UK Patents Act 1977 extendedto Hong Kong, but that the relevant UK Act could be ‘consulted toascertain the rights and privileges acquired under a certificate of registra-tion in Hong Kong’.33 He held that ‘Hong Kong patentees have the samerights and privileges as if the patent had been granted in the UnitedKingdom with an extension to Hong Kong’ and that these rights andprivileges might be ascertained from the 1977 UK Act. In the present case,the extended term of the UK patents was equally effective in Hong Kong,but was subject to the same limitations as under the 1977 Act in theUnited Kingdom. NRDC in Hong Kong obtained the same rights andprivileges as they obtained in the United Kingdom; no more, no less. Thelicence of right provisions were therefore applicable.

On this analysis, it is at first sight difficult to see why the right topursue the Crown for patent infringement in Smith Kline was not likewisecurtailed by the Crown user provisions of the UK Patents Act 1949.

28 Ibid, 360.29 He said as much in his decision at trial. Ibid.30 Improver Corp v Raymond Industrial Ltd [1991] 1 HKLR 251, 254 (per Penlington JA).31 [1991] FSR 663 [hereinafter NRDC].32 UK Patents Act 1977, Schedule 1, s 4(2)(b).33 NRDC (note 31 above), 667.


However, these provisions were limited to departments of state of theUnited Kingdom and did not provide any immunity for any Hong Konggovernment departments. Moreover, it was the rights of the Crown thatwere being considered in Smith Kline, not the rights of the patentee.Finally, in NRDC, there was no need to read any territorial restrictioninto the licence of right provisions of the UK Patents Act 1977.

The NRDC approach was recently approved by Rogers J in CanonKabushiki Kaisha v Green Cartridge Co (Hong Kong) Ltd.34 Part of thedefendants’ argument was that no relief could be given for a partiallyvalid patent because the relevant provisions of the UK Patents Act 197735

only applied to the court’s (meaning the UK court’s) powers and not thepatentee’s rights. Rogers J accepted that the Hong Kong court’s powerswere not the same as in the United Kingdom. For example, the HongKong court has no power to amend a patent under Section 75 of the 1977UK Act. However, even though a particular section of the 1977 Act isexpressed as a power of the court, this did not prevent it applying to therights and privileges of a patentee. On this basis, Rogers J saw ‘no reasonwhy relief for a partially valid patent should not be granted by interpret-ing the patentee’s rights as including such a right.’36 On the same basis, heheld that, as in the United Kingdom, a defendant who had no knowledgeof a patent could have a defence to payment of damages in Hong Kong.37

However, because the UK Patents Act 1977 refers to a UK Patent, mereinnocence of the Hong Kong Certificate of Registration would not besufficient.

In a similar vein, Rogers J held that the decision in British LeylandMotor Corp v Armstrong Patents Co Ltd38 extending to manufacturersthe right to make spare parts of copyright (but not patent) protectedarticles in the United Kingdom did not apply to patent protected articlesin Hong Kong. Otherwise, he held, ‘the holder of the rights would notenjoy the same rights in Hong Kong as he does in the United Kingdom’.39

34 Note 1 above. The decision of Rogers J was largely overturned in the court of appeal(Civil Appeal No. 152 of 1995), but not on the matters here discussed.

35 UK Patents Act 1977, s 63.36 Canon Kabushiki Kaisha (note 1 above), 746.37 Ibid (citing UK Patents Act 1977, s 62).38 [1984] FSR 591 (CA); [1986] AC 577 (HL).39 Canon Kabushiki Kaisha (note 1 above), 818.


INTERNATIONAL OBLIGATIONS RELEVANT TO HONGKONG

Since 1970, Hong Kong has benefitted from the United Kingdom’s mem-bership in the World Intellectual Property Organisation (‘WIPO’), a UnitedNations agency responsible for administering certain conventions relatingto the international protection of intellectual property. These include (a)two copyright conventions: the Berne Union and the Universal CopyrightConvention; (b) a general intellectual property convention: the Conven-tion for the Protection of Industrial Property (‘Paris Convention’); and (c)two specifically patent-related conventions: the Patent Cooperation Treatyand the European Patent Convention. Under its copyright laws, HongKong benefits from the Berne Union and the Universal Copyright Con-vention. By virtue of the United Kingdom’s membership, the ParisConvention and the Patent Cooperation Treaty have been applied toHong Kong since 16 November 197740 and 15 April 1981,41 respectively.Although the United Kingdom has been a member of the European PatentConvention since 1978 and the 1979 edition of the Registration of Pat-ents Ordinance amended the definition of patent to include UK patentsgranted under the European Patent Convention, none of the substantiveprovisions of the European Patent Convention have been applied or ex-tended to Hong Kong.

Under the agreement reached by the Joint Liaison Group in Novem-ber 1995, China will continue to apply all relevant conventions and treaties,the Paris Convention and Patent Cooperation Treaty, to Hong Kong after30 June 1997.42

Paris Convention

An important feature of the Paris Convention is the principle of conven-tion ‘priority’, under which an inventor can wait for up to twelve monthsafter filing a patent at home before deciding whether or not to file abroadin another convention country with the same effective filing date. In thisway, he can determine the value of the invention before committing to thecost of worldwide filing.

As has been seen, there is no provision for filing a patent at home inHong Kong until after registration of a UK patent and this registration

40 UK Patents Etc (Hong Kong) (Convention) Order 1977, SI No 1634 of 1977.41 By notification to the Director-General of WIPO.42 See note 2 above.


process takes more than three or four years to complete. It is thereforemany years before any patent protection can even be applied for in HongKong, by which time the decision under the Paris Convention to fileelsewhere must already have been taken.

Another important feature of the Paris Convention is the principle of‘national treatment’. Under this principle, member states must treat na-tionals of other member states in the same way as they treat their ownnationals.43 In this way, member states cannot set unacceptable proce-dural obstacles in the way of foreign applicants; at the same time, nationalsof member states can obtain the fullest available patent protection abroad.

China has been a member of the Paris Convention since 19 March1985. At present, UK nationals need only apply for a UK patent forprotection at home and in Hong Kong, whereas Chinese nationals mustapply separately for protection in the mainland and for a UK patent foreventual protection in Hong Kong. After 1997, it might be argued thatthe principle of national treatment (although only strictly applying toforeign nationals) requires the same patent procedure to apply to allChinese nationals and that Hong Kong would then have to allow the re-registration of Chinese patents.

European Patent Convention and Patent Cooperation Treaty

Under the European Patent Convention and Patent Cooperation Treaty, itis possible to apply for separate patents for a number of territories, in-cluding the United Kingdom and China, under a single application. Witheffect from 1 June 1978, the United Kingdom has been a member of boththe European Patent Convention and Patent Cooperation Treaty. Chinajoined the Patent Cooperation Treaty on 1 January 1994.

Under both systems, the applicant specifies the countries of interest.The European Patent Convention is a regional patent treaty covering anumber of European countries, including both EEC and non-EEC coun-tries.44 Application is through the national offices or the European PatentOffice in Munich. It provides for the grant of patents under a commonprocedure, evidenced by a single document, the European patent, which is

43 Equal treatment is also afforded to those domiciled or having a real and effective orcommercial establishment in a member state.

44 As at 1 March 1996, the members of the European Patent Convention were Austria,Belgium, Denmark, Finland, France, Germany, Greece, Ireland, Italy, Liechtenstein,Luxembourg, Monaco, the Netherlands, Portugal, Spain, Sweden, Switzerland and theUnited Kingdom.


45 As at 1 April 1995, there were 78 contracting states.46 Patent Cooperation Treaty Regulations, amended September 1993.

in fact a bundle of patent rights for the countries specified, subject to thejurisdiction of the national patent systems. Within nine months of thegrant of the patent, anyone may oppose the patent on the grounds thatthe invention comprises unpatentable subject matter; that the specifica-tion does not adequately disclose the invention; or that there has been anunallowable amendment. This can considerably add to the delay in ob-taining patent protection, although the courts can still determineinfringement (and validity) of a patent undergoing European Patent Of-fice opposition.

The Patent Cooperation Treaty system covers more countries world-wide.45 It likewise provides a single application, search and (optional)preliminary examination procedure; thereafter the application is inde-pendently handled by the national patent offices (or the European PatentOffice) as separate applications in accordance with domestic criteria.

The advantage of the Patent Cooperation Treaty route is that theapplicant has up to thirty months from first filing (or eighteen monthsafter the expiration of the Paris Convention priority period) to submit theapplication to each of the designated patent offices. The application isthen said to enter the ‘national phase’. It also provides a reasonablyreliable common search and preliminary examination procedure. This isvaluable to those patent offices that do not have an examination facility.

It is open to anyone, regardless of nationality or residence (and whetheror not a national of any member country), to apply under the EuropeanPatent Convention for a UK patent and for eventual registration of aHong Kong patent. It is merely necessary to specify the United Kingdomin the application and in due course to register the UK patent so grantedin Hong Kong.

Likewise, any national or resident of a Patent Cooperation Treatycontracting state can designate a UK patent (national or European) undera Patent Cooperation Treaty application for eventual registration as aHong Kong patent. National or regional patent offices are appointedreceiving offices for applications or, as from 1 January 1994, an applica-tion may be filed direct with the WIPO International Bureau in Geneva.46

At present, the appointed receiving office for Patent Cooperation Treatyapplications by Hong Kong residents is the United Kingdom Patent Of-fice; whilst the receiving office for China is, understandably, the ChinesePatent Office.


PROPOSALS FOR REFORM — THE NEED TO LOCALIZE

There are two major reasons for seeking to reform Hong Kong’s patentlaw. First, as has been seen, there are anomalies in the present law,casting doubt on the extent to which patent rights are protected. Second,there are fundamental constitutional difficulties in maintaining after 1997what is, in effect, an imported UK patent system.

Logically, if the present system of registering patents elsewhere ismaintained, this could be effected by registration in Hong Kong of Chi-nese-granted patents. However, this would bring about fundamental andconfusing changes of practice on the construction and enforcement ofpatent rights in Hong Kong. By analogy with the present system, theprivileges and rights of the patents registered in Hong Kong under such asystem would be determined by reference to provisions of the ChinesePatent Law, whereas existing patents would continue to be assessed underthe UK Patents Act 1977. It is therefore crucial to have domestic legisla-tion to cover at least basic questions of validity and infringement.

Continuity demands that the new patent system be as similar as possi-ble to the existing system. At the same time, steps must be taken tointroduce all appropriate measures not now expressly provided for. Theseinclude revocation procedures, compulsory licences, employee’s inventionrights, and unjustified threats actions. Apart from legislation, the patentright must itself be localized; this will avoid the present difficulties in-volved in seeking amendment or revocation of a patent in the UnitedKingdom or Europe.

At the end of May 1993, the government-appointed Patents SteeringCommittee released its Report on Reform of the Hong Kong Patent System(the ‘Patent Steering Committee Report’).47 This report considered the pos-sibility of an original patent grant and examination system, or contractingout the search and examination processes to other patent offices, includingexamination under the Patent Cooperation Treaty. Nevertheless, the neces-sary resources required for the pro-active role of the domestic patent officein considering ultimate patentability was considered too great to justify.48 Onbalance, the Patent Steering Committee Report favoured retaining someform of a registration system.49 The main disadvantage of such a system wasseen to be the requirement to apply for a patent elsewhere. The other prob-lem was choosing the most appropriate patent on which to base the system.50

47 Note 4 above.48 Ibid, paras 9.22–9.28, at 87–88.49 Ibid, para 9.30, at 89.50 Ibid, para 5.9, at 38.


The Patent Steering Committee Report concluded that the EuropeanPatent Office was the most appropriate source for the new system.51 It iswell established, widely used and issues patents in conformity with HongKong’s existing system. Under the European Patent Convention, suchpatents should, theoretically at least, be treated the same way as regardsthe fundamental issues of term, validity and scope of protection.52

However, in view of the special relationship between Hong Kong andChina, consideration was also given to a system which allowed registra-tion of patents granted by the Chinese Patent Office.53 Following the JointLiaison Group agreement,54 the government’s current proposal55 is toprovide for registration of patents granted by the UK Patent Office andthe European Patent Office designating the United Kingdom (as at present),as well as patents granted by the Chinese Patent Office. After a period oftime (as yet undetermined) registrations based on UK and European Pat-ent Office granted patents will be phased out.56

Whichever patent is registered in Hong Kong, it is a further feature ofthe proposed system that the resulting Hong Kong patent will be inde-pendent of the original patent and subject to a local comprehensive patentlaw. The basic procedure will require the filing of an initial applicationfor protection within six months after the publication of the UK, Euro-pean (UK) or Chinese patent application; and a further application withinsix months of grant. Transitional arrangements will require those patentsqualifying under the present system to be filed under the new systemwithin one year of its introduction.

A novel recommendation of the Patent Steering Committee Report,which the government now wishes to adopt, is to introduce some form of

51 Ibid, para 9.36, at 90.52 The Hong Kong Court of Appeal in Improver (note 30 above) had to reconcile conflicting

decisions of the UK and German courts under the same European patent: the Germancourt had found infringement, whilst the UK court (Improver Corp v RemingtonConsumer Products Ltd [1990] FSR 181) had concluded that there was no infringement.The Court of Appeal held that the UK approach to the construction of the patentshould be followed, as laid down by the House of Lords in Catnic Components Ltd vHill & Smith Ltd [1982] RPC 183, 243 and that this was in accordance with theprinciples laid down in the Protocol on the Interpretation of Article 69 of the EuropeanPatent Convention.

53 Patent Steering Committee Report (note 4 above), paras 9.37–9.40, at 90–91.54 See note 2 above.55 The proposals were set out in a paper (Hong Kong Intellectual Property Law: Proposals

for Change) delivered to the Asian Patent Attorneys Association on 12 November 1995by Averil C. Waters, Deputy Director, Intellectual Property Department, Hong KongGovernment.

56 The timing and manner of phasing out UK and European Patent Office patents will befor the future SAR Government to decide based on need.


petty patent system in Hong Kong.57 A ‘petty patent’ is a form of short-term patent protection, possibly having a lower standard of novelty andinventiveness and, due to limited search and examination formalities, isrelatively easy to obtain. A number of Hong Kong’s trading partners haveadopted such a system. Only Australia and France extend protection tothe same subject matter as a full patent. The majority protect a lowerlevel of technical achievement, such as a new functional construction for aproduct. This would more accurately be termed a ‘utility model’, as it isin China and many other countries.58 The government proposes to intro-duce a full petty patent system, to be called a ‘short term patent’ system.59

The Patents Bill

The Patent Steering Committee Report included detailed proposals for anew Patents Bill.60 These proposals have now been modified and incorpo-rated in a draft Patents Bill expected to be introduced and passed in 1996.It covers application and registration procedures; employee’s inventions;compulsory licences; government use; infringement; groundless threats;revocation; international applications; language of proceedings; and othermiscellaneous matters.

Certain fundamental features are noted. First, although the PatentSteering Committee Report recommended English as the principal lan-guage of the new patent system, the government proposes61 a bilingualsystem with applications made either in English or Chinese. Translationsinto the other language will however be required for the title of the inven-tion, the abstract and certain bibliographic data . This is thought to strikea fair balance between applicants and users of the system. Nevertheless,the technical terminology inherent in patent documents and the existingprecedents favour the continued use of English for the patent system.

Second, all questions concerning post-grant matters, such as infringe-ment, revocation and amendment of patents will be dealt with by thecourts. There is no proposal to allow any such questions to be determinedby the patent office or other tribunal, unlike in the United Kingdom.

Third, although the Patent Steering Committee Report proposed tofollow the wording of the European Patent Convention for pre-grant

57 Patent Steering Committee Report (note 4 above), ch 13.58 See examples quoted in ibid, table, at 157–160.59 See further at text below accompanying notes 92–109.60 Patent Steering Committee Report (note 4 above), ch 10, at 104–148.61 Hong Kong Intellectual Property Law: Proposals for Change (note 55 above).


issues and the wording of the UK Patents Act 1977 for post-grant mat-ters,62 the proposals agreed by the Joint Liaison Group only provide forregistration of Chinese, UK and European (UK) patents. The need tofollow the European Patent Convention for pre-grant issues is thereforenot so clear. Nevertheless, the wording of the UK Patents Act 1977 is notwithout its difficulties. Thus, although the wording of the 1977 Act issupposed to follow the provisions of the Community Patent Conven-tion,63 which will govern post-grant issues under the proposed singleCommunity-wide patent, it differs in some material respects that havecaused difficulties of interpretation by the courts.64

Applications

There will in effect be a three-stage process:1. File and process a UK, European (UK) or Chinese patent applica-

tion.65

2. Within six months of publication of the patent application, file arequest to record (and publish) a copy of the published application inHong Kong (the ‘request to record’).66

3. Within six months of grant of the designated patent application, filean application for the grant (and publication) of a Hong Kong patent(the ‘request for registration and grant’).67

Time limits

Compliance with time limits is one of the more troublesome aspects ofpatent practice. Features of the proposed system are the need to file anearly request to record and a greatly reduced time for filing the requestfor registration. Certain minimum requirements must be met on filing therequest to record and the time limit for these cannot be extended. Otherrequirements are extendable, but the procedure is to apply for reinstate-

62 Patent Steering Committee Report (note 4 above), para 10.2, at 92.63 The Community Patent Convention, although signed in December 1995, is not yet in

force. If has as its object the establishment of a single community patent granted andeffective for the whole of the EC.

64 See Robin Jacob QC, ‘The Herchel Smith Lecture 1993’ (1993) 9 European IntellectualProperty Review 312 (‘no-one has ever explained why our Act did not just copy theEuropean Patent Convention or Community Patent Convention wherever we weremeant to be following those conventions.’).

65 Referred to as a ‘designated patent application.’ Draft Patents Bill, clause 10.66 Ibid, clauses 15–22.67 Ibid, clauses 23–27.


ment of the application within one month after refusal68 or to apply forrestoration of rights within a maximum period of one year, or two monthsafter the cause of non-compliance is removed.69

Right to apply

It is envisaged, as under the present system, that the applicant for a patentin Hong Kong may perhaps not be the same as the applicant for theoriginal patent. There may be an intervening assignment of the patent, orthe right to apply in Hong Kong itself may be assigned. In the latter case,the request to record will have to be accompanied by a statement indicat-ing the derivation of the applicant’s right to apply and prescribed documents(such as an assignment) in support. Questions of entitlement to record orgrant may be determined by the Registrar, or on referral by the court.70

Formal requirements 71

The request to record will have to be accompanied by the following (the‘formal requirements’):1. a verified copy of the designated patent application (including the

name of the inventor) and the search report, if any;2. a statement and prescribed documents in support of the applicant’s

right to apply;3. a statement indicating whether convention priority is claimed;4. a translation (into English or Chinese as the case may be) of certain

required documents; and5. the prescribed fees.

A filing date will be obtainable upon submission of a basic applica-tion including information as to the identity of the applicant, and thenumber and date of publication of the designated patent application. Anydeficiencies in these minimum requirements must be made good withinsix months after publication of the corresponding designated patent appli-cation.72

Any deficiency in the formal requirements will have to be made goodwithin a prescribed time limit, failing which the request will be deemed

68 Ibid, clause 28.69 Ibid, clause 29.70 Ibid, clauses 12–14.71 Ibid, clause 15.72 Ibid, clause 17.


withdrawn. There is a right to reinstate the application, but no right torestore.

Upon satisfying the formalities, the request will be recorded and pub-lished in the Gazette.73 The applicant will be required to pay annual feesto maintain the request to record for more than five years.74

The request for registration and grant 75

The application must be in prescribed form and accompanied by:1. a certified verified copy of the corresponding original designated pat-

ent;2. a statement and prescribed documents in support of the applicant’s

right to apply;3. verified copies of all documents in support of any convention priority

claim;4. an English or Chinese translation of certain required documents; and5. the prescribed fees.

A filing date will be obtainable upon filing an application includinginformation identifying the applicant, the publication number and publi-cation date of the corresponding designated patent, and the publicationnumber of the request to record.76

The Registrar will require deficiencies to be made good in the sameway as for a request to record, with a right to reinstate or restore. Uponcompliance, the applicant will be issued with a certificate of grant and thegrant will be gazetted.77

Maintenance, surrender and amendment of patents78

It is proposed that the granted patent will subsist for twenty years fromthe original filing of the designated patent application, upon payment ofrenewal fees three years after the grant in Hong Kong and thereafter an-nually. There will be a six-month grace period for renewals and a powerto restore lapsed patents within twelve months thereafter (i.e., eighteenmonths from expiry). There will also be a right to surrender patents.

73 Ibid, clause 20.74 Ibid, clause 33.75 Ibid, clauses 23–27.76 Ibid, clause 24.77 Ibid, clause 27.78 Ibid, clauses 38–49.


The aim of the new legislation is to establish an independent HongKong patent. However, no patent will be granted in Hong Kong until thecorresponding original patent application (UK, European (UK) or Chi-nese) is granted in its home country. Any successful immediate post-grantopposition to the original patent application will invalidate the HongKong patent. Likewise, any amendment of the original patent applicationbefore it is granted, or following opposition proceedings must be recordedon the Hong Kong patent. Any amendment of the original patent after itis granted may, upon the application of the Hong Kong proprietor, berecorded on the Hong Kong patent. There will also be a general power toamend the Hong Kong patent at any time on application to the court.

Employee’s inventions 79

A feature of the UK Patents Act 1977 was the introduction of a codegoverning the rights of employees in inventions and to obtain compensa-tion.80 Under common law, in the absence of an express agreement, anemployee generally holds an invention for his employer either where theemployee is, in effect, employed to invent or where the employee is in afiduciary relationship with his employer, for example, as a director. Un-der the UK Patents Act 1977, this common law position was codified, butwhere the invention belongs to the employer, the employee may be enti-tled to compensation if the patent is of outstanding benefit to the employerand it is just that compensation should be awarded, taking all relevantcircumstances into account.81

The Patent Steering Committee Report considered that employees inHong Kong should likewise be compensated and the equivalent provi-sions of the UK Patents Act 1977 are embodied in the draft Patents Bill.

Infringement 82

The Patent Steering Committee Report proposed adopting the provisionsof the UK Patents Act 1977.83 The UK courts have on more than oneoccasion had to consult the equivalent provisions of the Community Pat-

79 Ibid, clauses 57–61.80 UK Patents Act 1977, ss 39–43.81 Ibid, s 40.82 Draft Patents Bill, clause 73–90.83 Patent Steering Committee Report (note 4 above), para 10.29, at 97.


ent Convention.84 Section 130(7) of the UK Patents Act 1977 declaresthat the relevant parts of the Act are to have as nearly as practicable thesame effects as the corresponding provisions of the European Patent Con-vention, Community Patent Convention and Patent Cooperation Treaty.In the absence of such a provision in the new Hong Kong law, the extentto which the Community Patent Convention wording is adopted mayneed to be re-considered.

A notable proposal of the Patent Steering Committee Report embod-ied in the draft Patents Bill85 is to define and, in effect, to limit the meaningof the word ‘import’ to exclude goods in transit, namely, goods which arebrought into Hong Kong solely for the purpose of taking them out andwhich do not leave the vessel, vehicle or aircraft. Although the Patent Steer-ing Committee Report states that this continues the current legal position,no authorities are given. Indeed, in Mattel Inc v Tonka Corp,86 the equiva-lent position on infringement of copyright in Hong Kong, both for goodsin transhipment and in transit, has been held to apply. Further, the UKPatents Act 1977 specifically exempts use of a product or process in thebody or operation of a foreign ship or aircraft, which has temporarily en-tered territorial waters or air space. By implication, all other imports shouldinfringe.

The rights of the Hong Kong patentee will have effect from the dateof the publication of the request to record, as if the patent had beengranted on that date.87 As with the equivalent UK Patents Act 1977provision,88 no proceedings can be commenced until after the grant of theHong Kong patent. This is therefore, in effect, a right to claim backdamages.

84 See for example Smith Kline & French Laboratories v Harbottle [1980] RPC 363,comparing the word ‘keep’ in the UK Patents Act 1977 with ‘stock’ in the CommunityPatent Convention.

85 Draft Patents Bill, clause 73(2); Patent Steering Committee Report (note 4 above), para10.36, at 98–99.

86 [1992] FSR 28, 40 (per Deputy Judge Andrew Li QC) (‘In my judgement, the word“import” in section 5(2) [of the UK Copyright Act 1956] should be given its ordinarymeaning. It means simply bringing into Hong Kong’).

87 Draft Patents Bill, clause 88.88 UK Patents Act 1977, s 69, where the right stems from the date of publication of the

application.


Threats 89

A right of action for groundless threats has long been incorporated in UKlaw. The principle is that the patentee is allowed to draw attention to theexistence of the patent, but may not threaten proceedings, even in asolicitor’s normal letter before action. The patentee must justify the threatby showing that the person threatened infringes; normally this is done bycommencing actual patent infringement proceedings. Nevertheless, anyperson aggrieved by a threat of proceedings can obtain an injunction anddamages for loss, e.g., of customers. These so-called ‘threats actions’,being a right of someone other than the patentee, clearly do not apply inHong Kong under the Registration of Patents Ordinance and have nottherefore formed part of the litigious culture. The UK Patents Act 1977provision excludes threats relating to the making or importing of a prod-uct or using a process. The draft Patents Bill does not exclude importsfrom the ambit of the proposed law. Accordingly, only threats againstprimary users will be allowed to continue.

Validity and revocation 90

Validity will be judged in the same way as a patent under the UK PatentsAct 1977 and the European Patent Convention. After grant (and anyimmediate post-grant opposition proceedings), revocation of the originaldesignated patent will be irrelevant.

Validity may be put in issue in revocation proceedings, or as a defenceto infringement proceedings, and in proceedings for groundless threats.Such proceedings will be brought exclusively by application to the court.

Transitional provisions 91

Continuity with the existing system is proposed, with patents registeredunder the Registration of Patents Ordinance automatically being trans-ferred to the new register and becoming subject to the new law. Suchpatents will no longer be liable to be revoked in the United Kingdom, butwill be subject to renewal in the same way as patents registered under thenew system.

Existing granted or published UK or European (UK) patents will re-main eligible for registration under the new system for a transitional

89 Draft Patents Bill, clause 89.90 Ibid, clauses 91–101.91 Patent Steering Committee Report (note 4 above), Schedules 1–3, at 140–145.


period of one year after the introduction of the new system. PotentialHong Kong patentees will be advised to conduct thorough audits of theirpatent portfolios to ensure that they do not miss the cut-off date.

Proposed short term patent system 92

As discussed above, the proposal to introduce a short term patent sys-tem93 is the most radical departure from existing patent practice in HongKong. Although some forty countries have such a system, among Com-monwealth countries only Australia has adopted short term patents. Inthe United Kingdom, a Green Paper proposal in 198394 recommended theadoption of a second tier of patent protection with simplified proceduresand registration without examination. In the UK government’s WhitePaper,95 the proposal was rejected mainly due to concerns of uncertaintysurrounding an unexamined patent right. It was also felt that the sup-posed savings in cost would soon be outweighed by the cost of determiningthe validity of untested rights.

The Patent Steering Committee Report regarded the introduction of ashort term patent system as an appropriate solution to the inevitabledelays96 and cost of obtaining full protection from the registration ofEuropean patents. The Patent Steering Committee Report has alreadyrejected the adoption of a non-examination system for full patents andlogically rejected the possibility of a domestic examined patent grantsystem. The solution proposed for short term patents, however, is a sys-tem without any prior examination as to validity, but with an obligatorysearch report to be obtained from an authorized searching authority andfiled with the application.97 Additional safeguards include provision for a‘speedy trial’ and fortification of the cross-undertaking in damages in anyproceedings for an interim injunction, restrictions on allowable amend-ments, and shifting the burden of proof from the alleged infringer to the

92 Ibid, chs 11–13. The proposals are set out in Part XV of the draft Patents Bill, clauses108–128.

93 The expression ‘short term patent’ is thought to describe most accurately the nature ofthe new right. It will be a simplified (and shorter term) patent protection, but cover thesame scope of inventions as a full patent. The same expression is used for a similarsystem in the Republic of Ireland and has been proposed for Australian petty patents.

94 UK Intellectual Property Rights and Innovation (Cmnd 9117) (Dec 1983).95 UK Intellectual Property and Innovation (Cmnd 9712) (Apr 1986).96 Patent Steering Committee Report (note 4 above), paras 11.46–11.47, at 156. It normally

takes at least four years from the priority date to obtain a European patent.97 Ibid, para 13.9, at 170.


patentee.98 In effect, these safeguards would transfer the obligation ofpolicing potential abuse from the Registry to the courts, and to thoseprofessionals in the private sector (e.g., solicitors and patent agents) re-sponsible for advising potential short term patent holders.

Other proposed features include the following:1. The scope of protection and the substantive and formal requirements

of a short term patent will be the same as for a Hong Kong patent,except that the claims will be limited to one independent claim andfour subsidiary claims.99

2. Twelve-month Paris Convention priority may be claimed.100

3. A short term patent should be granted as soon as practicable afterfiling the application, but with a right for the applicant to defer grantfor up to six months if wished. The Registrar shall publish the namesof the proprietor, the inventor (if different) and the specification, andshall advertise the fact of grant by notice in the Gazette.101

4. Applications may be filed in English or Chinese.102

5. Minimum requirements103 will be necessary to obtain a filing date.6. The short term patent rights will arise after publication of the fact of

grant in the Gazette.104

7. There will be no opposition procedure.105

8. The term of a short term patent will be six years, comprising an initialperiod of three years from the date of filing of the application andrenewal for a further three years.106 In this connection, it is notewor-thy that a recent report on the Australian petty patent system has

98 Ibid, para 13.10, at 170–171.99 Ibid, para 13.10(d), (f), at 170 & para 13.27, at 174–175.100 Ibid, para 13.10(g), at 171 & para 13.26, at 174. China’s cooperation will be required

after 1 July 1997 to acquire convention priority. At present the United Kingdom’sinternational treaty obligations are extended to Hong Kong by Orders in Council ornotification to WIPO (see notes 40 and 41 above). In principle, there is no reason whypriority should not be afforded in the same way as it is already recognized for trademarkapplications.

101 Patent Steering Committee Report (note 4 above), para 13.10(h), at 171 & para 13.34,at 176; Draft Patents Bill, clause 118.

102 Patent Steering Committee Report (note 4 above), para 13.31 at 175; Draft Patents Bill,clauses 104(1), 113(3).

103 Draft Patents Bill, clause 114. The minimum requirements are:(a) an indication that short term patent protection is sought;(b) identity of applicant; and(c) informal description and one or more claims.

104 Patent Steering Committee Report (note 4 above), para 13.10(h), at 171 & para 13.33,at 176.

105 Ibid, para 13.10(i), at 171.106 Draft Patents Bill, clause 125.


recommended extending the term of petty patents to ten years.107

Current indicators are that Hong Kong short term patents will beextended to eight years.

It seems that there will be no constraint against filing simultaneouslyor within the priority period for a short term patent and a full HongKong patent. In this way, applicants can ‘hedge their bets’ on the poten-tial success of their inventions, and obtain much earlier protection, duringthe maximum period of short term patents. For this reason, advisers maywell counsel their clients to apply for double protection.

A major concern is the extent to which the granting of short termpatent protection without any form of substantive examination will leadto abuse. Recently, the Australian Advisory Council on Industrial Prop-erty, considering an equivalent petty patent system in Australia,recommended the retention of substantive examination, notwithstandingthe possible delays. It felt that this would provide certainty both forapplicants and the public, as there would then be a reasonable degree ofpresumption that petty patents were valid.108 The lack of resources inHong Kong prohibit the substantive examination of short term patents.Even with the requirement to file an overseas search report, there is noproposal to disallow short term patents shown to be invalid by suchreports, which will still be a matter for litigation. This will undoubtedlycause many defendants to settle on adverse terms rather than risk thecosts and hazards of litigation.109 As against this, the cost associated withthe requirement to file a search report with the application may discour-age less well off inventors from using the system at all. An alternativemight be to require the filing of a search report before threatening orinstituting proceedings.

CONCLUSION

Hong Kong has had its own patent system for seventy years. The depend-ence on UK and European granted patents has been a historical andpractical necessity. The emergence of an internationally recognized patent

107 Advisory Council on Industrial Property, Draft Report of the Review of the PettyPatent System (Mar 1995).

108 Ibid, at 28.109 A view recently expressed by Rogers J in a paper to the Asian Patent Attorneys Association

(Enforcement: the Role of the Courts beyond 1997) on 12 November 1995.


system in China in the last ten years has provided an appropriate founda-tion for patent protection in Hong Kong after 1997. To what extent thenew system will be used remains to be seen. In this respect, the proposedshort term patent system will no doubt be regarded as a convenientalternative. However, the viability of the system will very much dependupon the extent to which it is used and not abused.

Experience in Hong Kong shows that intellectual property rights arelargely treated as a means to an end, namely, the prevention of unfaircompetition. This is an effective approach wherever such rights can beenforced. However, as a matter of policy, intellectual property rights areoften considered to be an end in themselves, namely, to provide a stimu-lus to innovation. In China, intellectual property laws have been introducedspecifically to encourage technological investment. The problem of en-forcement in China remains. This contrast in approach between Chinaand Hong Kong is, of course, a reflection of the ‘one country, two sys-tems’ principle, under which Hong Kong is to retain a high degree ofautonomy and which the proposed patent system will have to reflect.

Credit Card FraudClive Grossman QC

. CHAPTER TWO .

INTRODUCTION

The use of credit cards has perhaps been the most spectacular lubricant ofthe wheels of commerce in the latter part of the twentieth century. Theease of acquisition of goods and services has fuelled the growth of theglobal economy, particularly in Asia. An inevitable spin-off of this phe-nomenon has been the abuse of the system to an extent hitherto unrivalledin terms of monstrous profits to those with the technological expertise tocheat the system.

This chapter does not purport to canvass exhaustively all facets ofcredit card fraud, but deals with some of the more important mechanical,jurisdictional and other legal problems encountered by those who dealdaily with this menace. This chapter first discusses the history of thecredit card and the parallel growth of fraud in this area. It then deals withthe law that covers this area of commerce and the lacunae therein.

A BRIEF HISTORY AND DESCRIPTION OF CREDIT CARDS

Bank cards, as they were first known, originated in the United States in1914 when Western Union issued the first consumer charge cards to itspreferred customers. The cards provided a variety of special services in-cluding interest-free, deferred payment.

32 Clive Grossman QC

During the first half of this century, businesses such as hotels, depart-ment stores and petrol companies regularly issued charge cards to theircustomers. But it was not until 1950, when the Diners Club Card wasintroduced, that a single card came to be accepted by a variety of mer-chants. Diners Club paid the merchants for transactions made with thecard, deducting a small percentage ‘discount’ as compensation for thecard’s role in the sale. Cardholders were billed monthly for their charges,and were required to pay in full upon receipt. In 1951 Franklin NationalBank on Long Island, New York, issued a card that was accepted by localmerchants. No fees or interest were charged to cardholders who had topay their complete bill upon receipt. Merchants were charged a fee ontransactions made with the cards.

This was the beginning of the deluge. Over 100 banks began bankcard programmes during the 1950s. But because these early bank cardsystems applied only to a bank’s local area, few generated sufficient vol-ume to provide a profit for the banks, and were discontinued. Bank ofAmerica, however, had the entire state of California as a potential mar-ket, and the BankAmericard, first issued in 1958, met with immediatesuccess. And, like a number of the other bank cards available at that time,the BankAmericard offered cardholders a new feature — credit. Ratherthan demanding full payment upon receipt of each monthly statement,these cards gave cardholders the option of paying the account balance ininstalments, with a monthly finance charge applied to the unpaid balance.The cardholder could also choose to pay the full balance each month,with no finance charge. By 1965 Bank of America had licensing agree-ments with a number of banks outside California, allowing them to issueBankAmericard. At the same time, a number of banks in Illinois, the EastCoast and California joined together to form MasterCharge.

With the growing success of these two large bank card associations,most regional banks soon dropped their independent programmes andconverted to MasterCharge or BankAmericard. By 1970 more than 1,400banks offered either BankAmericard or MasterCharge cards, and the totaloutstanding balance on the cards had reached US$3.8 billion. In 1970Bank of America relinquished control of the BankAmericard programmewithin the United States. The banks that issued BankAmericard tookcontrol of the programme, forming National BankAmericard Inc, an inde-pendent, non-stock membership corporation that would administer,promote and further develop the system within the United States.

Outside the United States, Bank of America continued to license banksto issue BankAmericard, and by 1972 there were licensees in fifteen coun-tries. In 1974 a multinational, non-stock membership corporation calledIBANCO was formed to administer the international BankAmericard pro-

Credit Card Fraud 33

gramme. However, in other countries outside the United States there wasresistance to issuing a card associated with the Bank of America, even ifthe association was in name only. So in 1977 BankAmericard became theVisa card, retaining its distinctive blue, white and gold bands, and IBANCObecame Visa International.

Visa is a typical example of a services association, which has memberbanking institutions. Visa members are permitted to offer customers creditcards bearing the Visa mark. A member banking institution can be eitherthe issuer of credit cards or the acquirer of merchant sales slips or bothissuer and acquirer. When a member issues a credit card bearing the Visamark it is required to emboss the card with the cardholder’s name, theexpiry date of the card, and the unique account number assigned to thatcardholder. The first six digits in the account number are known as thebank identification number (‘BIN’) and from this number it is possible todetermine which member issued the card. The first four digits of the BINnumber are printed on the face of the card. The full set of particulars isalso encoded in the magnetic recording stripe on the reverse side of thecard.

How a transaction is executed

A credit card holder may purchase goods or services using his card as apayment instrument. In many parts of the world, in a typical transactionthe cardholder presents his card to the sales clerk who will place it in thebed of a mechanical device called an imprinter. The bed of the imprinterhas a raised lettered block giving the name and unique identificationnumber of the merchant. Most types of imprinter in use today have arotating date stamp, which, through raised numbers protruding from thebed of the imprinter, will cause the date to appear on the sales draft. Theclerk will then place a sales slip over both the card and the merchants’name and number. The sales slip comprises three sheets, usually but notnecessarily, self-carbon printing. The raised lettering on the card and theimprinter act as dies creating like images of the data on the three copies ofthe sales draft when the clerk rolls a mechanical device on the imprinterover the slips, the card and the merchant identification block. Thecardholder will then be asked to sign the slip after the correct amount forthe purchase has been entered in the appropriate box. The clerk will thenreturn the card and one copy of the slip to the cardholder. A second copyof the slip is retained by the merchant for his records while a third is sentto the merchant’s ‘acquiring’ bank, which will credit the merchant’s ac-count with the face value of the slip less a service charge. The bank’s copy


is passed to the data entry clerks who key punch the data into the bank’shost computer, which, at an allotted time of each business day, willconnect to the credit card company’s electronic network for settlementwith the issuer.

The imprinter method of recording is not widely accepted in HongKong where merchants tend to use on-line verification. These systemsallow account details encoded on a credit card’s magnetic stripe to betransmitted to the acquiring bank, which verifies that the account is validand has sufficient funds and, if so, authorizes the sale.

CREDIT CARD FRAUD IN HONG KONG

Credit card fraud has the dubious distinction of being a modern crime. Asa product of high technology, it has many of the same characteristics, in-cluding expanding growth. Within the last decade, credit card fraud hasbecome a complex, worldwide law-enforcement problem. It is estimatedthat there are over one billion credit cards in circulation worldwide today.Taken as a percentage of legitimate business volume, the losses from creditcard fraud are small. However, the growth rate of this kind of fraud andthe dollar amounts involved are increasing exponentially.1 The Achilles’heel of the bank card is the account number. Initially, it was the embossednumber; now it is also the number encoded on the magnetic stripe.

The following sections trace the evolution of the problem and discussvarious types of credit card fraud.

Lost or stolen cards

A major problem is that of cards being stolen prior to receipt by thelegitimate cardholder, particularly in those circumstances where the cardsare mailed to the cardholder. Organized groups working in post officeshave sometimes stolen large numbers of cards prior to delivery to therespective cardholders. The first time the issuer or a cardholder is awareof the theft and fraudulent use is when the cardholder receives the firstbilling statement and realizes that there have been unauthorized chargesmade on his account. This tends not to be much of a problem in HongKong where most issuing banks require cardholders to collect their cards

1 See chart on pages 41–42 below.


from the bank in person. However, it is a major concern in places like theUnited States where most cards are mailed for customers’ convenience.

Worldwide, lost/stolen cards are the predominant fraud problem forthe credit card industry, accounting for about 46 percent of all fraudlosses. However, in Hong Kong they are relatively less significant ac-counting for less than 7 percent of the territory’s card fraud losses.

‘Shave and paste’

The first attempted manual alteration of credit cards was the ‘shave andpaste’ scheme. This scheme involves the removal of account informationembossed on the face of lost or stolen cards using a razor knife. Newnumbers removed from other credit cards (which are known to be valid)are then glued onto the cards using epoxy cement. As criminals began tolearn more about credit cards, they circumvented the system by calling abank authorization centre purporting to be a merchant and, by this means,finding valid account numbers. This number would then be used on a lostor stolen card using the ‘shave and paste’ scheme. In 1977 and 1978 it isunderstood that one group in the United States used this method todefraud the industry of more than US$1,500,000.

Merchant collusion

As noted above, most merchants in Hong Kong are now equipped withon-line card verification systems. If the merchant is in collusion with thefraudster, any card with a magnetic stripe encoded with genuine accountdetails will be sufficient to defeat the system. There have been incidents oftelephone, Mass Transit Railway, club membership and other similarcards being abused in this manner.

‘White plastic’

During 1979 and 1980, other schemes such as ‘white plastic’ schemesbegan. This form of fraud involves the participation of collusive mer-chants who are willing to accept blank ‘white plastic’ cards embossedwith valid account numbers for the purchase of merchandise at the mer-chant’s location. The merchant then calls the authorization centre usingthe good account number and, when he receives approval, creates a salesdraft for merchandise. Very often, no goods are actually sold and the


merchant merely splits the proceeds of sale with the thief when the mer-chant receives payment for the alleged sale from his bank. This form offraud used to be a particular problem in Hong Kong when imprinterswere the normal means of recording a transaction, but is less of a prob-lem today. Electronic data capture has added a new dimension to thisscheme and is discussed below.

Counterfeiting

Credit card operations

The counterfeit credit card system starts with the production of the coun-terfeit card. As a rule this is not done in one place. The base cards areusually supplied with the hologram affixed, and account details (i.e., theembossing and encoding) will be added at a secondary factory. To dateno base card or hologram manufacturing factories have been discoveredin Hong Kong, and it appears that the territory is not a major area for theproduction of base cards. Major base card plants were neutralized inMacau in 1993, and since then it appears that they have moved princi-pally to China and Taiwan.

The main ingredient needed to produce the card is the account infor-mation. This comes from what are known as ‘points of compromise’ andwas traditionally provided by the manufacturers of the fake cards whoprovided a complete product. In the early 1990s the main points of com-promise in Hong Kong were small retail establishments such as tailors,hi-fi shops and the like in Tsim Sha Tsui that provided tourists’ creditcard information. The criminals soon moved up into bulk acquisition bygaining credit card information from hotel employees. In many hotels,credit card information of guests was easily accessible to hotel employees.Arrests and education have been effective in solving this problem, and inrecent years hotels have put in a considerable number of checks andbalances to ensure that account data is on a ‘need to know’ basis.2 Inaddition, many hotels installed sophisticated computer programmes tolimit access. Thereafter the syndicates moved on to the banks in HongKong, but immediate enforcement action by the ICAC and the police havesuccessfully limited that area of operation.

2 For example, years ago the ICAC discovered that in one hotel up to sixty persons couldhave access to credit card data, including the boy who removed the laundry! Thatnumber has now been reduced to three.


Recently, the Hong Kong syndicates have moved many of their pointsof compromise away from the territory. It has been reported of late thatmost compromised cards emanate from the United States or Canada andare used in Japan. This appears to indicate that the syndicates have indi-viduals planted in North American banks or in the credit card centres.However, the volume of fake cards produced now probably exceeds thesupply of information.

From the factory, finished cards pass through one or more levels ofbrokers to the users. Sometimes the users are individuals who buy fakecards for their personal use. More often, however, they are members oforganized groups who will be provided with counterfeit cards, told spe-cifically what goods to buy, and paid a commission based on the value ofgoods that they obtain.

Finally, the goods will be realized through handlers. This may bedone in Hong Kong by selling them through merchants prepared to ac-cept such goods, or by smuggling them to China. High-value jewellery,particularly Rolex watches, are especially popular as they can be pawnedto obtain ready cash. Recently one person pawned Rolex watches to avalue of HK$5 million in a matter of three months.

Pure counterfeiting

In 1981 and 1982, a more sophisticated scheme was developed whereby aplastic card is counterfeited using silk screen printing to replicate a validcard and then is embossed with a valid account number. These counterfeitcards can then be used at innocent merchant locations, because they canpass for legitimate cards. As a result of this type of counterfeiting, thebank card industry took measures to regain control of fraud losses relatedto counterfeiting. Credit cards were redesigned with new security devices,such as holograms to make counterfeiting more difficult. Similarly, litho-graphic printing was used to make the counterfeiting of the plastic moredifficult. These actions, in conjunction with the institution of new laws inthe United States, e.g., the Credit Card Fraud Act of 1984, helped toreduce, at least for a short period, fraud losses related to counterfeiting.

The use of counterfeit credit cards is the most common means ofcredit card fraud in Hong Kong, accounting for almost 90 percent of thefraudulent losses in the territory. Hong Kong syndicates, based eitherlocally or overseas, are thought to be responsible for many of the lossesfrom the worldwide use of counterfeit credit cards.

Essentially, counterfeit credit cards are clones of genuine credit cards.Their physical appearance is similar to that of a genuine card, and theyare embossed and encoded with account details copied from a genuine


card. The quality of many of the counterfeits produced today is extremelyhigh and would deceive most merchants. The production of counterfeitcards is dealt with in more detail later.

Fraudulent and inaccurate credit card applications

As the industry expanded, other types of credit card fraud developed,such as that associated with submitting fraudulent credit card applica-tions. Although applications should be carefully checked, well-organizedgroups of individuals have in some cases been able to obtain banks’internal card-issuing procedures, enabling them to circumvent the screen-ing process and to obtain valid credit cards in the process. Issuing banksthat mail cards are particularly susceptible to this type of fraud as thecards can be directed to a derelict address and the criminal need nevershow himself to collect the card. The intense competition between banksoften results in undue haste in the issuing of cards. This is clearly detri-mental to security and a more careful approach to screening potentialcustomers assists in eliminating fraudulent applications. At present, fraudu-lent applications are on the increase and vetting procedures are clearlyinadequate.

In Hong Kong a related problem is that of persons making bona fideapplications (or at least applications using their own details) that containinaccurate employment, salary or debt details. Having obtained the cardor cards, the holder often indulges in a spending spree, usually in China,and then reneges on the liability.

‘Lending’ of cards

Another scheme is the ‘lending’ of genuine cards by holders to criminalgroups that use the cards in a foreign country. The genuine holder doesnot leave Hong Kong and blames the usage on a ‘counterfeit’ card. Detec-tion of such a scam is possible by careful questioning of the card holder,but bank investigators often fail to identify this practice. It is cheaper andless trouble in the long run for the banks to bear the loss. Recently,however, there have been a significant number of cases where bank inves-tigators have been suspected of having been corruptly involved with thesyndicates. The ‘lending’ is often done under duress by victims of loansharksand the like.


Telemarketing and communications fraud

The fraudulent use of account numbers includes a wide variety of schemes,such as telemarketing and telecommunications fraud. Because an actualcard is not required in mail order and telephone order transactions — justan account number is required — the variations of such schemes areinfinite and are increasing at an alarmingly rate.

Telemarketing fraud relates to the entering of unauthorized chargesby fraudulent telemarketers, as well as to the placing of orders withtargeted legitimate telemarketers and mail order merchants by criminalswho have stolen credit card account numbers. In the latter scenario, theordered goods are usually delivered to vacant or temporarily occupiedaddresses, where the offender receives the goods and then disappears.These schemes frequently involve high-value items, such as computer orelectronic equipment. This is generally referred to as ‘inbound’telemarketing fraud. Account numbers are obtained from associates invarious commercial outlets where credit cards are used. ‘Outbound’telemarketing fraud involves fraudulent telemarketers. These criminalsobtain genuine account numbers through various schemes and use themto make fraudulent sales drafts that are credited to the telemarketer’sbank account on a daily basis. Because most banks treat the sales draftsas cash, the telemarketer can immediately transfer these funds to anotheraccount or simply withdraw the funds on a daily basis. Before theseschemes are discovered, the fraudulent telemarketer will generally disap-pear with the funds. Telemarketing frauds are most common in the UnitedStates, where this kind of retailing is very popular. It is relatively new inHong Kong and the problem has not yet arisen here.

Recent activities

In recent years, because of technological changes and lower communica-tions costs, electronic data capture terminals for credit card transactionsare becoming more widespread. This development has been of great ben-efit to the credit card industry by speeding up the authorization andtransaction process. No longer is it necessary for the merchant to depositthe paper drafts with a bank in order to be paid for the transaction. Thisis now done electronically.

However, this process has also enabled criminals to increase theirability to defraud the industry. The magnetic stripe on the cards containsmagnetically encoded account information and criminals have been quickto determine the vulnerability of this information and its susceptibility to


being re-encoded, in the case of lost and stolen cards, as well as thebenefits to be gained from encoding valid account numbers on counterfeitcards. And, of course, the fraudulent merchant is able to obtain his ill-gotten gains that much faster.

In an effort to counter this, the industry has data verification fieldsfor the magnetically encoded data (in the case of Visa it is called ‘CardVerification Value’ or ‘CVV’). The CVV will protect the magnetic stripeagainst counterfeiting unless the data from a legitimate card has been‘skimmed’. Such skimming does not pose any major technical difficultiesto criminals. The industry is constantly developing and examining newtechnologies to prevent the magnetic stripe from being ‘skimmed’.

Holograms have been used by the industry for over six years as asecurity feature of the card, but are now being replicated by criminalgroups who counterfeit credit cards. These counterfeit holograms are be-ing used on counterfeit cards that are fabricated in Asia. As a result,Asian organized criminal groups, in particular, have expanded their coun-terfeit credit card activities to every region of the world. These groupsobtain valid account numbers from collusive merchants or from associ-ates working in retail businesses in one geographical location and thenuse these numbers to make purchases with counterfeit cards in anothergeographical location. Thus, banks in one country are susceptible to beingvictimized in another country. These organized criminal groups are verymobile and are able to exploit the system particularly when there areinadequate laws to counter their criminal activity. The rewards are greatand the risks are low.

Trends

Though we continue to have a serious problem with counterfeiting inHong Kong, contrary to world trends our local losses are decreasing. In1990 Hong Kong accounted for over 23 percent of the world’s counterfeitlosses; by 1991 this figure had fallen to 10 percent, and in 1992, to 7.5percent. For example, Citicorp Hong Kong’s counterfeit losses in 1992were just 38 percent of its 1991 losses. There are a number of reasons forthis turnaround, perhaps most importantly, the many successes of locallaw enforcement. Improved card security and retailer awareness have alsohelped to reduce losses, as has a universal use of card verification codes(‘CVCs’) in the Territory.

In contrast to the decreases in Hong Kong, worldwide fraud involvingVisa cards has steadily increased since 1990. The figures below, whichwere supplied by Visa International, are in US$.


Worldwide Asia PacificWorldwide Asia Pacific counterfeiting counterfeitinglosses losses losses losses

1990 $240 million $15 million $ 27.7 million $12.4 million1991 $416 million $28 million $ 53.5 million $23.3 million1992 $565 million $40 million $ 96.0 million $31.7 million1993 $696 million $44 million $149.5 million $23.3 million

In contrast to the continuing worldwide increase in losses from counter-feiting from 1992 to 1993, Asia Pacific issuers experienced a 26.5 percentreduction in counterfeiting activity during that same period.

As noted below, Asia Pacific acquirers suffered US$53.4 million worthof fraud losses from March 1992–93 compared to US$39.8 million fromMarch 1991–92, an increase of 34.2 percent. Of these amounts, US$25.5million was caused by counterfeiting in 1992–93, down from US$25.9million in 1991–92, representing a decrease of 1.5 percent.

Acquirer Fraud

Worldwide Asia Pacificall credit Worldwide all credit Asia Pacificcard fraud counterfeiting card fraud counterfeiting

March $565 million $96 million $39.8 million $25.9 million1991–1992March $696 million $149 million $53.4 million $25.5 million1992–1993

Hong Kong Acquirer Fraud

All credit card fraud Counterfeiting

March 1991–1992 $10.5 million $7.9 millionMarch 1992–1993 $ 8.9 million $5.4 million

Although losses from counterfeiting in Hong Kong decreased from1992 to 1993, many other types of credit card fraud in the territoryincreased, as illustrated below:


% Change1991–92 to

1992–1993 1991–1992 1992–93 1990–1991

Lost cards $9.4 million $3 million + 213.3% $1.3 million

Stolen cards $9 million $3.9 million + 130.8% $2.8 million

Non-receivedcards $0.9 million $0.4 million + 125.0% $0.3 million

Fraudulentapplications $0.24 million $0.21 million + 14.3% $0.06 million

Counterfeiting $23.3 million $31.7 million - 26.5% $23.3 million

Miscellaneous $0.6 million $0.3 million + 100.0% $0.2 million

Fraudulentuse of account $0.3 million $0.2 million + 50.0% $0.08 million

These figures do not show the largely disproportionate influence playedby Hong Kong crime on the overall phenomenon of credit fraud growth.There is no accurate and auditable way to arrive at an exact figure forcredit card losses attributable to the Hong Kong criminal community, butthe police estimate that it may well account for more than 60 percent ofcounterfeit credit card losses. It has been estimated that these illicit earn-ings make up a significant portion of the income of organized crime andprovide seed money for the manufacture and sale of drugs, weapons, andother illegal or questionable commodities.

The figures shown above far from represent the true cost of creditcard fraud for they do not, for example, include administrative costs orthe costs incurred in the development of fraud prevention.

THE LAW

In the prosecution of credit card fraud, the potential legal problems in-volved are infinite. This chapter concentrates on some of the morefundamental aspects of the problem:• Problems in investigation and prosecution• The nature of the presentation of the fake card• Conspiracy• Mens rea — intent to defraud


Problems in investigation and prosecution

Overseas evidence

Counterfeit credit cards are commonly uttered in a country other than thecountry to which the account name and number relate. This has led to asituation where counterfeit credit cards bearing Hong Kong account de-tails are misused, for example, in Japan, and counterfeit cards bearingJapanese details are misused in Hong Kong. In one recent case a counter-feit credit card was uttered by a Hong Kong resident on twenty-nineoccasions over a five-day period in Hong Kong, purchasing US$20 mil-lion worth of high quality goods. The card bore a Japanese name andaccount number. Japanese credit cards are particularly favoured in HongKong due to their high credit limit.

A recent police operation illustrates how counterfeit Hong Kong creditcards are destined for use overseas. A Hong Kong resident was inter-cepted at Kai Tak Airport as he attempted to leave for Korea and Japan.He was found to be in possession of thirteen counterfeit credit cards all ofwhich bore Hong Kong account details. In a similar case, anotherJapan-bound Hong Kong male was found in possession of eighteen coun-terfeit Hong Kong credit cards.

Cases in which counterfeit credit cards are seized can generally beproved without needing the evidence of the genuine overseas cardholder.Evidence from the government chemist, coupled with evidence from eitherthe local credit card issuing banks or credit card companies suffices inproving that a card is counterfeit. In contrast, cases involving the modusoperandi of ‘white plastic’ primarily require overseas evidence to provecharges. Thus, in the vast majority of cases involving ‘white plastic’,the participating fraudsters favour overseas account details, at least partlybecause this makes subsequent investigation and prosecution difficult.The problems raised by this misuse of overseas accounts relate to thedifficulties encountered in obtaining and then adducing evidence froman overseas cardholder in the Hong Kong courts, including the follow-ing:1. the account holder not having been in Hong Kong at the time the

fraudulent transaction took place;2. the genuine credit card either having been lost, stolen or never having

left the account holder’s possession;3. the account holder never having purchased the goods or services from

the sales establishment in question; and4. the account holder not being in Hong Kong to state that the signature

appearing on the card sales slip is not genuine.


The cost of bringing evidence from overseas is prohibitive and may simplynot be worth the effort if the provable loss is relatively small.

Jurisdiction

Typically, a credit card belonging to a citizen of country A may be stolenin country B; a co-criminal takes possession of it in country C and iscaught in country D en route to country E where he planned to use it.This raises problems of jurisdiction which, although of great interest tothe academic, may be a nightmare for the law enforcement and prosecut-ing authorities.

Where a person obtains property in another country by means of aforged credit card that purports to be issued by a Hong Kong bank andthe card details relate to a Hong Kong credit card account, a charge ofconspiracy to defraud is triable in Hong Kong because the object of theconspiracy, even though carried out by overt acts abroad, is to defraudsome person or institution within the territory. In these circumstances, thecommon intention of the conspirators is to defraud banks, credit cardcompanies, or account holders in Hong Kong. Consequently, if the con-spiracy contemplates as an object some harm within the jurisdiction thenit is triable in the jurisdiction.

This development in the law of conspiracy may be traced through anumber of recent cases. In Board of Trade v Owen3 the respondents hadconspired in England to make false representations in Germany to obtainlicences to export strategic metals from Germany. The English court held,as per head note:

A conspiracy to commit a crime abroad is not indictable in Englandunless the contemplated crime is one for which an indictment would liein England; the conspiracy in the present case was to obtain by unlawfulmeans something that could lawfully be obtained and, since the unlawfulmeans and the object to be obtained were both outside the jurisdiction,the conspiracy was not indictable in England.

This dictum has not always been understood. It has sometimes beenassumed that it echoes the requirement of double criminality in extradi-tion law — that is, is the contemplated crime of the type which could beprosecuted in England? However, plainly, what it means is — would anindictment lie in England for this crime which is contemplated?

3 [1957] 1 All ER 411.


In Treacy v DPP4 the appellant wrote and posted in England a letteraddressed to a Mrs X in Germany in which he demanded that she shouldsend £175 to him at an address in England under the threat that if she didnot he would inform her husband of some allegedly discreditable conducton her part. Mrs X received the letter in Germany. The question fordecision was whether, when a person makes an unwarranted demandwith menaces by letter posted in England and received abroad, can he betried in England on a charge of blackmail under Section 21 of the UKTheft Act 1968. It was held that the appellant could be tried in Englandin such circumstances because the demand was made, and thus the of-fence was committed, when the appellant posted the letter in England.

In R v El-Hakkaoui5 the court dealt with a somewhat different situa-tion under the UK Firearms Act 1968. The court held that it is an offenceunder Section 16 of the Firearms Act for a person in England to have in hispossession a firearm or ammunition with intent by means thereof to endan-ger the life of persons outside the United Kingdom. It was not necessary forthe Crown to establish that it was the accused’s intent to endanger the lifeof a person in the United Kingdom. The House of Lords took this a stepfurther in DPP v Stonehouse,6 where it held, as per head note:

The basis of the English courts’ jurisdiction to try the complete offenceof obtaining property by deception was that the physical acts of theaccused, wherever they were done, had caused the intended consequencein England that property belonging to another had been obtained bydeception, and was not that the accused had done some physical act inEngland. It followed that where the offence of attempting to obtainproperty by deception would, if successful, have resulted in the intendedconsequence that property belonging to another was obtained in England,the attempted offence also was triable in England notwithstanding thatthe acts intended to produce the prescribed consequence in England hadall been done abroad and no further act needed to be done in England bythe accused himself or on his behalf to complete the offence.

In Hong Kong there have been two recent decisions dealing with thisdifficult problem of jurisdiction. In R v Liu Po-sing7 the court was con-cerned with a situation where the defendants had conspired and had actedin Hong Kong to defraud a company based in the United States. RobertsCJ held:

4 [1971] 1 All ER 110.5 [1975] 2 All ER 146.6 [1977] 2 All ER 909.7 [1986] HKLR 198.


There could be no doubt that the main acts in furtherance of theconspiracy were carried out in Hong Kong. The object was to obtainmoney within Hong Kong from Ely & Walker (the American company)by fraud. This object was achieved when Liu negotiated the letters ofcredit. At this point, Ely & Walker and the Commerce Union Bankbecame immediately or ultimately liable to indemnify the negotiatingbanks. Thus it was in Hong Kong that loss was inflicted on Ely &Walker and the Commerce Union Bank. The fact that the mechanicsof the transaction meant that ultimately book entries debiting Ely &Walker’s accounts with Commerce Union Bank were made in the USAdoes not detract from the fact the victims were defrauded in HongKong. Indeed, the only foreign elements in the case were the nationalityand residence of the victims. The charge was therefore properly triablein Hong Kong.

In Attorney General v Yeung Shun-shum8 the Court of Appeal held:

In our view, the Hong Kong courts have . . . jurisdiction to try thosewho are charged with a conspiracy formed out of the jurisdiction if anyact has been committed within the jurisdiction in furtherance of theagreement. Such jurisdiction is not affected if:(a) the act was performed by an agent, innocent or guilty;(b) no conspirator had carried out any such act within Hong Kong;(c) no conspirator had entered the jurisdiction until the conspiracy was

discharged.9

The most authoritative (and comforting) pronouncement on jurisdic-tion is a recent Privy Council case dealing with an appeal from HongKong concerning a drug trafficking case, Liangsiriprasert v Governmentof United States of America.10 The accused had conspired in Thailand toimport heroin into the United States and had come to Hong Kong tocollect his share of the proceeds. The US courts sought their extradition.The Privy Council held that the appellant and another person came toHong Kong of their own free will to collect what they thought were theillicit profits of their heroin trade; in other words, they were present inHong Kong not because of any unlawful conduct of the authorities butbecause of their own criminality and greed. The proper extradition proce-dures had been observed and it was neither oppressive nor an abuse of thejudicial process for the US government to seek their extradition.

8 [1987] 2 HKLR 987.9 Ibid, 997 (per Roberts CJ).10 (1991) 92 Cr App R 77, [1991] 1 AC 225.


Thus, the current situation now appears to be that if any part, orconsequence, of the illegal act takes place within Hong Kong, the HongKong courts have jurisdiction, notwithstanding that the plan was hatched,and/or that the victim resides, outside the territory. However, where theconspirators have agreed in Hong Kong to use fake credit cards abroad,an even stronger argument in favour of jurisdiction may exist. A creditcard by its nature, form and purpose is not the same as a bottle ofwhisky. It is not a saleable product that is bought and sold. It is anegotiable instrument. It provides a person with a credit facility to trans-act in goods or services and on some occasions obtain cash, and guaranteespayment of it. Whenever credit is obtained through the use of the creditcard, the account holder, the bank that issued the credit card, and thecredit card company, are held responsible and liable.

It makes no difference if the object of the conspiracy is to obtainmoney and goods from merchants abroad. That is the means by whichthe object is achieved — to defraud the genuine credit card accountholders, their banks and credit companies. Hence, the object in thesecircumstances is to obtain money and goods from merchants in a foreigncountry by defrauding the genuine credit card account holders, their banksand credit card companies all of whom are in Hong Kong. It is thecommon intention of the conspirators to use the credit facility of a HongKong credit card account holder provided in Hong Kong by the issuingbank and credit card company, and to make them liable for the goods,services and cash obtained.

The nature of the presentation of the fake card

In R v Lambie11 (which was concerned with a prosecution under Section15(i) of the UK Theft Act 1968), the House of Lords dealt with thejuridical nature of the presentation of a credit card. Lord Roskill consid-ered the presentation as analogous to that of a cheque backed by a chequecard, the nature of which had been dealt with in Metropolitan PoliceCommissioner v Charles12 where Lord Diplock stated:

When a cheque card is brought into the transaction, it still remains the factthat all the payee is concerned with is that the cheque should be honouredby the bank. I do not think that the fact that a cheque card is usednecessarily displaces the representation to be implied from the act of

11 [1981] 2 All ER 776.12 [1976] 3 All ER 112.


drawing the cheque which has just been mentioned. It is, however, likelyto displace that representation at any rate as the main inducement to thepayee to take the cheque, since the use of the cheque card in connectionwith the transaction gives to the payee a direct contractual right againstthe bank itself to payment on presentment, provided that the use of thecard by the drawer to bind the bank to pay the cheque was within theactual or ostensible authority conferred upon him by the bank.

By exhibiting to the payee a cheque card containing the undertakingby the bank to honour cheques drawn in compliance with the conditionsendorsed on the back, and drawing the cheque accordingly, the drawerrepresents to the payee that he has actual authority from the bank tomake a contract with the payee on the bank’s behalf that it will honourthe cheque on presentment for payment.

It was submitted on behalf of the accused that there is no need toimply a representation that the drawer’s authority to bind the bank wasactual and not merely ostensible, since ostensible authority alone wouldsuffice to create a contract with the payee that was binding on the bank;and the drawer’s possession of the cheque card and the cheque bookwith the bank’s consent would be enough to constitute his ostensibleauthority. So, the submission goes, the only representation needed togive business efficacy to the transaction would be true. This argumentstands the doctrine of ostensible authority on its head. What createsostensible authority in a person who purports to enter into a contract asagent for a principal is a representation made to the other party that hehas the actual authority of the principal for whom he claims to be actingto enter into the contract on that person’s behalf. If (1) the other partyhas believed the representation and on the faith of that belief has actedupon it, and (2) the person represented to be his principal has so conductedhimself towards that other party as to be estopped from denying thetruth of the representation, then, and only then, is he bound by thecontract purportedly made on his behalf. The whole foundation of liabilityunder the doctrine of ostensible authority is a representation, believed bythe person to whom it is made, that the person claiming to contract asagent for a principal has the actual authority of the principal to enterinto the contract on his behalf.13

Lord Roskill said, in reference to this passage:

If one substitutes in the passage the words ‘to honour the voucher’ forthe words ‘to pay the cheque’ it is not easy to see why mutatis mutandisthe entire passages are not equally applicable to the dishonest misuse ofcredit cards as to the dishonest misuse of cheque cards.14

13 Ibid, 114.14 R v Lambie (note 11 above), 780.


The House of Lords thus removed the mystique of the innovativecommercial technology of the credit card and reduced it to merely an-other tool of legitimate business practice. The proffering of a credit cardto which the profferer has no right is a simple fraudulent misrepresenta-tion, no more and no less.

Conspiracy

Credit card fraud often tends to be organized and committed by syndi-cates. It is appropriate therefore to consider the nature of conspiracy,which is a feature of so many prosecutions in this field.

Conspiracy consists of an agreement between two or more persons todo an unlawful act or a lawful act by unlawful means.15 The crime hasbeen committed once the agreement has been made:

[T]he crime of conspiracy is completely committed . . . the moment twoor more have agreed that they will do, at once or at some future time,certain things. It is not necessary in order to complete the offence thatany one thing should be done beyond the agreement . . . . [T]he crime. . . was completed when they agreed.16

It is not necessary that it should be proved that the defendants met toconcoct the scheme, nor is it necessary that they should have originated it.If a conspiracy is formed and a person joins it afterwards, he is equallyguilty with the original conspirators. Some conspirators may drop outand others may join in during the course of the conspiracy but it maynevertheless remain a single conspiracy.17 Moreover:

All must join in the one agreement, each with the others, in order toconstitute one conspiracy. They may join in at various times, eachattaching himself to that agreement; any one of them may not know allthe other parties, but only that there are other parties; any one of themmay not know the full extent of the scheme to which he attacheshimself . . . .18

To establish a conspiracy, the prosecution must prove that an agree-ment had been entered into by the conspirators to carry out an unlawful

15 R v Jones [1832] 4B and Ad 345, 349, 110 ER 485, 487 (per Parke J).16 R v Aspinall [1876] 2 QBD 48, 58-59 (per Brett J).17 R v Simmonds [1969] 1 QB 685, 696 (per Fenton-Atkinson J).18 R v Griffiths (1965) 49 Cr App R 279, 290.


purpose (as signified by their acts and declarations) and that they in-tended to carry out the unlawful purpose. Proof of a conspiracy is generallya ‘matter of inference deduced from certain criminal acts of the partiesaccused, done in pursuance of an apparent criminal purpose in commonbetween them’.19

The crime of conspiracy does not consist in any of the overt acts thatmay be done by the conspirators pursuant to it. However, as most con-spiracies have been transacted, in part or in whole, the prosecution willgenerally seek to demonstrate their content and the parties to them byreference to the overt acts to infer a preconceived plan and continuingconsensus between the defendants.

In the prosecution of credit card fraudsters it is important to note thatthe acts and declarations of a party to a conspiracy or joint enterprise infurtherance of that conspiracy or joint enterprise are admissible againstthe person who made it and the other members of the joint enterprise.20

However, the court must be satisfied that the evidence was in furtheranceof the conspiracy or joint enterprise.21 The courts have observed:

For upon a charge of conspiracy the proof of the crime may well consistin evidence of the separate acts of the individuals charged, which, althoughseparate acts, yet point to a common design and when considered incombination justify the conclusion that there must have been acombination such as that alleged in the indictment. When that is so,evidence may readily be let in of what each party to the conspiracyalleged may do or say in furtherance of the common purpose.22

and

No doubt the agreement is the gist of the conspiracy offence, but onlyin very rare cases will it be possible to prove it by direct evidence.Ordinarily the evidence must proceed by steps. The actual agreementmust be gathered from several isolated doings having possibly little or novalue taken by themselves, but the bearing of which one upon the othermust be interpreted; and their cumulative effect, properly estimated inthe light of all surrounding circumstances, may raise a presumption ofconsented purpose entitling the jury to find the existence of the unlawfulagreement.23

19 R v Brisac (1803) 4 East 164, 171.20 R v Walters (1979) 69 Cr App R 115.21 See Tripodi v R (1961) 104 CLR 1; R v Ahern (1988) 34 A Crim R 178; R v Hui

Wai-bun Cr App 403/86.22 High Court of Australia in Tripodi (note 21 above).23 Canadian Supreme Court in Paradis (1934) 61 CCC 184.


24 [1975] AC 819.25 Ibid, 840.26 (1968) 52 Cr App R 618.27 (1977) 64 Cr App R 29.28 [1961] AC 103.29 [1982] 2 All ER 689.30 [1991] 4 All ER 664 (PC HK).

The leading authority for Hong Kong on conspiracy to defraud is theHouse of Lord’s decision in Scott v Metropolitan Police Commissioner24

where Viscount Dilhorne said:

It is clearly the law that an agreement by two or more by dishonesty todeprive a person of something which is his or to which he is or would beor might be entitled and an agreement to injure some proprietary right ofhis, suffices to constitute the offence of conspiracy to defraud.25

Mens rea — intent to defraud

An intent to risk prejudice to another’s right is sufficient to constitute anintent to defraud. See R v Sinclair,26 R v Allsop,27 and Welham v DPP.28

So, in the field of credit card fraud, an intention to repay is not a defence.In Allsop the English Court of Appeal stated that the primary objective offraudsters is to advantage themselves; the detriment that results to theirvictims is secondary to that purpose and incidental — it is ‘intended’ onlyin the sense that it is a contemplated outcome of the fraud that isperpetrated. The issue then arises if the fraudster is dishonest. The acceptedtest of ‘dishonesty’ is found in R v Ghosh.29 The questions to be answeredare:

(i) Was that which was done dishonest according to the ordinarystandards of reasonable and honest people? If no, the accused is notguilty. If yes —

(ii) Did the defendant realize that reasonable and honest people regardwhat he did as dishonest? If yes, he is guilty; if no, he is not.

More recently, the Privy Council in R v Wai Yu-tsang30 in an appealfrom Hong Kong, upheld the correctness of Allsop and took the conceptone step further. This case involved cheque-kiting where the victim bankerlost US$124 million. It was accepted that the accused had no real inten-tion that the banker should lose, and that he kept the kite going in thegenuine belief that the losses could be recouped. However, the Board heldthat ‘intention to defraud’ was not narrowly confined but meant an inten-


tion to practise a fraud on another, or an intention to act to the prejudiceof another’s right. It was sufficient, in cases such as this, that the con-spirators had dishonestly agreed to bring about a state of affairs whichthey realized might deceive the victim into so acting (or failing to act) sothat the victim would suffer economic loss or that the victim’s economicinterests would be put at risk.

Where a person uses a forged credit card he is falsely representinghimself to be a genuine credit card account holder. The forged credit cardis read and imprinted and the forged signature on the credit card sales slipis falsely represented as being that of the genuine credit card accountholder, that is, as the authorized signatory of the credit card account. As aresult this sets in motion a series of transactions falsely representing thatthe genuine credit card account holder had transacted his own credit cardaccount. It results in the credit card account holder being made liable forthe transaction. In addition, the issuing bank of the credit card and thecredit card company to which the credit card relates are also liable or atrisk for the transaction. Whatever the ultimate intention of the user of thefake card, once the economic rights of the genuine cardholder and/or theissuing bank is put at risk, the user has committed an offence.

The prosecution of offenders

Where counterfeit credit cards are found in the possession of an arrestedperson, difficulties have arisen in proving that he knew that the creditcards were forged. Mens rea is often established by a statement madeunder caution by the arrested person.

The Crimes (Amendment) Ordinance 1992,31 which is now incorpo-rated in the Crimes Ordinance,32 made it easier for the prosecutor todecide how to frame charges against the maker or user of a false creditcard. Previously, the charge had to make reference to the wholly unsuit-able and artificial offence of possessing false dies. Now Sections 71 to 76of the Crimes Ordinance create an array of offenses relating to ‘falseinstruments’, the definition of which (Section 69) has been specificallytailored to include false credit cards. The offenses relate to forgery (Sec-tion 71), copying (Section 72), using (Section 73), using a copy (Section74), possessing (Section 75) and making or possessing equipment formaking a false instrument (Section 76).

31 Ord No 49 of 1992.32 Cap 200, LHK.


‘Going Equipped for Stealing’ under Section 27(1) of the Theft Ordi-nance33 provides an alternative option that may be pursued where there iseither limited or no evidence to indicate an intention to defraud on thepart of an arrested person. Section 27(2) of the Theft Ordinance presumesthat where a person has with him any article that is made or adapted foruse in committing a burglary, theft or cheat, his possession thereof isevidence that he had it with him for such a use. This offence only requiresthe prosecution to show that the defendant had with him a counterfeitcredit card, not at his home, and that a counterfeit credit card is eithermade or adapted for use in the course of a theft or cheat. In most in-stances it would be easier to prove this charge. Although convictions forthe related offenses under the Crimes Ordinance carry a maximum pen-alty of fourteen years, in practice the courts have never sentenced convictedpersons to more than eighteen months for any type of counterfeit creditcard offenses involving only possession.

CONCLUSION

There are changes under consideration by the credit card industry todefend the system internally and to thwart the criminal activity. Becausestationary targets are very tempting, security features will, by necessity,continue to change. Change is never easy, however. Technology is not theissue. There are technologies that are or could be available for card secu-rity. The major problem is the sheer size of implementation and timenecessary to convert all cards and terminals. However, because of thegrowing fraud problem in the industry, this is an issue that is beingconstantly reviewed and changes are in process.

In combination with industry actions to protect the system from fraud,penal legislation, investigations and prosecutions are necessary ingredientsto combat criminal activity. The present magnitude of this problem andits potential for even more staggering increases warrant legislative actionin order to protect the public from fraud in connection with credit anddebit cards. In particular, what is needed is legislation to enable proof ofevents and documents from foreign countries to be received in evidence inHong Kong courts without the need for the cumbersome procedures whichpresently inhibit the speedy disposal of this type of multinational crime.Hong Kong, we like to pride ourselves, is on the cutting edge of world-

33 Cap 210, LHK.


wide technology and efficiency. These qualities should also invest ourjudicial system, especially where fiscal matters, our life-blood, are con-cerned.

The ubiquity of the counterfeit credit card menace has undoubtedlyhad a negative effect on Hong Kong’s image, and the need for the indus-try to close the loopholes in its issuing and enforcement procedures isurgent and acute.

Transnational Insolvency Law*Charles D. Booth**

. CHAPTER THREE .

INTRODUCTION

Insolvency is not a topic that quickly comes to mind when discussingHong Kong’s economy. The rate of personal and corporate insolvency inHong Kong is quite low, both in absolute terms1 and as compared withthe rates in other countries.2 However, with 1997 approaching, increasing

* Copyright © 1996 by Charles D. Booth. All rights reserved. This chapter is an updated andcondensed version of my earlier work, ‘The Transnational Aspects of Hong KongInsolvency Law’ (1995) 2 Southwestern Journal of Law and Trade in the Americas 1. Fora detailed discussion of the need to reform Hong Kong’s transnational insolvency law inlight of 1997, see my article, ‘Living in Uncertain Times: The Need to Strengthen HongKong Transnational Insolvency Law’ (1996) 34 Columbia Journal of Transnational Law.

** I am grateful to Philip Smart for the insights he has shared during our many discussionsabout transnational insolvency law and to Ted Tyler and R. Hearder and his staff in theOfficial Receiver’s Office for their helpful responses to my many enquiries. I would alsolike to thank James Garrity for his research assistance.

1 For example, in 1994–95, receiving orders were made in 325 bankruptcies and winding-up orders were made in 429 compulsory liquidations. Official Receiver’s Office AnnualDepartmental Report, 1994–95 (1995), para 3.7.2, at 5. This total of 754 new insolvenciesrepresented an increase of 17.8 percent over the number of insolvencies in 1992–93 and0.4 percent over the number in 1993–94, and is the highest number of cases over thepast ten years. See ibid, para 3.7.2 at 5, and Annex 5.

2 For example, the average annual corporate failure rate in Hong Kong between 1985–86and 1994–95 was 0.93 percent. Ibid, Annex 6. In contrast, the failure rate in the UnitedKingdom between 1986 and 1988 was 2.27 percent. Edward L.G. Tyler, ‘Current Issuesin Insolvency’ in Caroline Hague, ed, Commercial Law (Hong Kong: The Hong KongLaw Journal Ltd, 1991), 17, 20.

56 Charles D. Booth

uncertainty is beginning to cause a downturn in some parts of HongKong’s economy, most visibly in retailing and the property market. If thistrend continues, it is likely that the number of insolvencies will increaseabove current levels and that many of these insolvencies will havetransnational elements.

A couple of scenarios are possible. For example, if investors loseconfidence in Hong Kong or if economic crises develop in China, fundswill flow out of Hong Kong as quickly as they came in, perhaps causing acrash in the Hong Kong stock and property markets and, in turn, theinsolvency of many Hong Kong companies and individuals. In those casesin which the Hong Kong debtors have property abroad, the liquidators orbankruptcy trustees might well go abroad to claim the foreign assets andto seek recognition of, and assistance for, the Hong Kong insolvencies.Similarly, economic crises abroad could lead to the insolvency of foreigncompanies and individuals that have invested in Hong Kong. The repre-sentatives of these foreign debtors or their estates might come to HongKong to claim local assets and to gain recognition of, and assistance for,the foreign insolvencies. Either scenario would present significanttransnational insolvency issues.

The first part of this chapter introduces the reader to two contrastingtheoretical approaches for resolving questions of transnational insolvencylaw.

The second part sets out the Hong Kong (and relevant English) rulesregarding the recognition of foreign insolvencies. The third part then ex-amines the options available under Hong Kong law to a foreignrepresentative seeking to protect the assets of a foreign debtor in HongKong and to obtain cross-border assistance from Hong Kong courts. It setsout the various options available to a foreign representative for gainingcross-border assistance, including non-insolvency options, the winding upof companies under the Companies Ordinance,3 and the bankruptcy of in-dividuals and partnerships under the Bankruptcy Ordinance.4 Reference ismade to applicable statutory provisions and relevant case law, as well asto some of the proposals made by the Law Reform Commission of HongKong (the ‘Law Reform Commission’) in its Report on Bankruptcy.5 Thediscussion also highlights important weaknesses and omissions in the cur-

3 Companies Ordinance (cap 32, LHK).4 Bankruptcy Ordinance (cap 6, LHK).5 The Law Reform Commission of Hong Kong, Report on Bankruptcy (May 1995)

[hereinafter the Report on Bankruptcy]. These proposals will form the basis for thebankruptcy bill that will be gazetted in 1996 and likely enacted later in the year.

Transnational Insolvency Law 57

rent statutory framework and includes recommendations for the enactmentof comprehensive statutory guidelines regarding cross-border insolvency.

The fourth part of this chapter discusses the ability of Hong Kongliquidators and trustees to seek cross-border assistance in transnationalinsolvencies.

THE TWO PRIMARY APPROACHES FOR RESOLVINGTRANSNATIONAL INSOLVENCY ISSUES6

There are two paradigmatic approaches for resolving transnational insol-vency issues: the ‘universality’ approach and the ‘territoriality’ approach.7

6 Much of this section and many of the related footnotes are adopted from part II of myarticle, ‘A History of the Transnational Aspects of United States Bankruptcy Law Priorto the Bankruptcy Reform Act of 1978’ (1991) 9 Boston University International LawJournal 1, 4–5.

7 See generally, Louis Jacques Blom-Cooper, Bankruptcy in Private International Law(London: The Eastern Press Ltd, 1954), 11–12, 14–17; Ian F. Fletcher, The Law ofInsolvency, 2nd ed (London: Sweet & Maxwell, 1996), 684–685; Joseph Story,Commentaries on the Conflict of Laws, 8th ed (Boston: Little, Brown, and Co, 1883),ss 403–409, at 565–572; John D. Honsberger, ‘Conflict of Laws and the BankruptcyReform Act of 1978’ (1980) 30 Case Western Reserve Law Review 631, 633–635;Barbara K. Unger, ‘United States Recognition of Foreign Bankruptcies’ (1985) 19International Lawyer 1153, 1154–1155; Jay L. Westbrook, ‘Choice of Avoidance Lawin Global Insolvencies’ (1991) 17 Brooklyn Journal of International Law 499, 512–519.In the text, I have merged two related, but distinct, issues in my use of the terms‘universality’ and ‘territoriality’. To be more precise, these terms address the issue ofwhat effect a declaration of insolvency in one country should have on property locatedelsewhere. Blom-Cooper (above), 14–17. A separate issue relates to jurisdiction in cross-border insolvency and is frequently discussed in terms of the ‘unity’ of bankruptcyversus the ‘plurality’ of bankruptcy. Ibid, 14–15. Under the unity approach, only oneinsolvency case should be commenced in relation to a debtor, and its law should beapplied throughout the administration. Ibid, 14. In contrast, under the plurality theoryseveral bankruptcy cases may be commenced, each applying its own law. Ibid, 15. Onecommentator has noted that although ‘universality’ is distinct from ‘unity’, ‘[t]he mostcomprehensive way to conceive of universality is the idea of “unity” of bankruptcy.’Hans Hanisch, ‘“Universality” versus Secondary Bankruptcy: A European Debate’ (1993)2 International Insolvency Review 151, 151–152. I agree with this interpretation andtherefore incorporate many aspects of the ‘unity’ approach into my discussion of the‘universality’ approach. However, the reader should bear in mind that the ‘universality’approach spans the gamut of cooperative behaviour ranging from the more unity-basedexample described in the text above to a more plurality-based form in which a countryapplies its own substantive law (e.g., regarding preferential payments and the avoidanceof local attachments) in a concurrent or ancillary insolvency before ordering the turnoverof assets to the primary insolvency. See ibid, 152.

58 Charles D. Booth

Although these two approaches are not applied in their pure form by thecourts of any country, they are useful in setting the boundaries for thedebate about cross-border cooperation. The goal of the universality ap-proach is the simplification and unification of transnational insolvencyproceedings. Under this approach, a primary insolvency proceeding, whichis intended to resolve all claims worldwide against the debtor’s estate, orthe debtor, as the case may be, occurs in the jurisdiction in which thedebtor is domiciled or where the debtor’s principal place of business islocated. A trustee or liquidator is appointed in this primary proceeding.To collect the worldwide assets of the debtor and to seek the turnover ofall such assets to the primary proceeding, the trustee or liquidator travelsabroad and commences ancillary proceedings in each country in whichassets of the debtor are located.

In each of these ancillary proceedings, the court recognizes and giveseffect to the declaration of insolvency in the primary proceeding, providesassistance to the trustee or liquidator (foreign representative), applies thesubstantive insolvency law of the country in which the primary proceed-ing is occurring, and orders the turnover of all local assets to the primaryproceeding. Since the final adjudication in the primary proceeding is to berespected by all jurisdictions, all creditors worldwide must submit claimsin the primary proceeding or be forever barred from pursuing their claims.8

The primary advantage of the universality approach is equality ofdistribution among creditors worldwide, because all claims will be admin-istered by the same court and under the same law. Moreover, sinceduplicative proceedings and litigation are avoided, distributions will mostlikely be higher than if each jurisdiction pursued independent, full-scaleinsolvency proceedings. Similarly, the administration of claims will cer-tainly be more efficient. Of course, certain creditors who would havebenefitted from local priorities or preferences in their home countries aredisadvantaged under the universality approach. Such creditors might suf-fer hardship, such as the inconvenience and the extra expense in beingforced to participate in the primary proceeding where applicable proce-dural and substantive laws may differ from those of their home jurisdiction.9

The contrasting territoriality approach stresses the inherent power ofa jurisdiction to adjudicate with respect to the res or property only withinthe borders of such jurisdiction. Under this approach, a trustee or liquida-tor appointed in the original insolvency proceeding is limited toadministering assets within his home jurisdiction. Courts in other jurisdic-

8 Unger (note 7 above), 1154; Honsberger (note 7 above), 633. See generally Story (note7 above), ss 403–409, at 565–572.

9 Unger (note 7 above), 1154–1155.


tions do not recognize the original declaration of insolvency. Rather, eachcourt adjudicates claims to the assets of the debtor that are located in itsrespective jurisdiction, often in a separate, full-scale insolvency proceed-ing. Creditors should file claims in the proceeding occurring in the relevantjurisdiction.10

The advantages of the territoriality approach are limited to local credi-tors who will benefit from local preferences and will not suffer theinconvenience and additional expense of being compelled to assert theirclaims abroad under foreign law. The primary disadvantage of the territo-riality approach is that it rejects the principle of equality of distribution tocreditors worldwide, often in favour of a regime that rewards the fastestmoving creditors. Of course, the multiplicity of insolvency proceedingswill result in duplicative administrative expenses and correspondingly lowerdistributions and, therefore, in less efficient proceedings.11

These two approaches serve as a helpful starting point from which todiscuss the transnational aspects of Hong Kong insolvency law.

RECOGNITION OF FOREIGN INSOLVENCIES

Under Hong Kong law there is no statutory provision that governs therecognition of foreign insolvencies.12 Rather, Hong Kong relies on a com-

10 Ibid, 1155.11 See ibid. See also Honsberger (note 7 above), 634–635.12 However, prior to its repeal in 1985, s 122 of the UK Bankruptcy Act 1914 provided

for cooperation among bankruptcy courts throughout the Commonwealth. Section 122provided as follows:

The High Court, the county courts, the courts having jurisdiction in bankruptcyin Scotland and Ireland, and every British court elsewhere having jurisdiction inbankruptcy or insolvency, and the officers of those courts respectively, shallseverally act in aid of and be auxiliary to each other in all matters of bankruptcy,and an order of the court seeking aid, with a request to another of the saidcourts, shall be deemed sufficient to enable the latter court to exercise, in regardto the matters directed by the order, such jurisdiction as either the court whichmade the request, or the court to which the request is made, could exercise inregard to similar matters within their respective jurisdictions.

Section 122 made it easier for trustees from Commonwealth jurisdictions to gainrecognition from, and cooperation of, bankruptcy courts in other Commonwealthjurisdictions.

Re Estate of Aw Hoe [1957] HKLR 401 is the only reported Hong Kong caseinvolving the application of s 122. In this case, the Official Assignee of the then Colonyof Singapore requested the Hong Kong Supreme Court to give effect to an order of the

60 Charles D. Booth

mon law approach. Because the Hong Kong courts have decided fewtransnational insolvency cases, reference below is made to many Englishcases and to commentators on English law.

Foreign bankruptcies are recognized under Hong Kong law when (a)declared by a court in the jurisdiction in which the debtor was domiciledat the commencement of the bankruptcy13 or (b) the debtor submits to thejurisdiction of the foreign court.14 Some English authorities support theproposition that a foreign bankruptcy should also be recognized when thedebtor carries on business within the jurisdiction of the foreign court.15

Singapore High Court that had vested the property in Hong Kong of a deceasedSingaporean bankrupt in the Official Assignee. The Hong Kong court acknowledgedthat the Official Assignee had good title to the property in Hong Kong. Ibid, 404.However, the Hong Kong court found that it had no jurisdiction to make such an order,because the Singapore High Court had failed to submit to the Hong Kong court anorder seeking aid as required under s 122. Ibid. Two months later, upon receipt of boththe appropriate order from the Singapore court and a Letter of Request issued pursuantto the order, the Hong Kong court ordered the relief requested by the Official Assignee.Re Estate of Aw Hoe [1957] HKLR 539.

Section 122 of the UK Bankruptcy Act 1914 was repealed by the UK Insolvency Act1985 and replaced by s 213(3), (4), (9)(d), & (10) of the 1985 legislation, which, inturn, was repealed by the UK Insolvency Act 1986 and re-enacted with some minorchanges as s 426(4), (5), (10)(d), & (11) of the 1986 legislation. Since Hong Kong neverenacted s 122 or a replacement provision into Hong Kong law, at present there is nostatutory provision in the Bankruptcy Ordinance applicable to granting assistance toforeign representatives.

13 Modern Terminals (Berth 5) Ltd v States SS Co [1979] HKLR 512, 513 [hereinafterModern Terminals] (citing Re Blithman (1866) LR 2 Eq 23). See also the followingcommentators, all of whom cite Re Blithman: P.M. North and J.J. Fawcett, Cheshireand North’s Private International Law, 12th ed (London: Butterworths, 1992), 913[hereinafter Cheshire and North]; 2 Dicey and Morris on the Conflict of Laws, 12th ed(London: Sweet & Maxwell, 1993), Rule 167(2)(a) and accompanying Comment, at1172–1174 [hereinafter Dicey and Morris]; Fletcher (note 7 above), 718; Philip St. J.Smart, Cross-Border Insolvency (London: Butterworths, 1991), 83; J.W. Woloniecki,‘Co-operation Between National Courts in International Insolvencies: Recent UnitedKingdom Legislation’ (1986) 35 International and Comparative Law Quarterly 644,656. See also Smart (above), 83–84 (arguing that English courts should recognize aforeign bankruptcy that is recognized as effective in the jurisdiction in which the debtorwas domiciled when the bankruptcy was commenced).

14 Modern Terminals (note 13 above), 513 (citing Re Anderson (1911) 1 KB 896). See alsoCheshire and North (note 13 above), 913–914; 2 Dicey and Morris (note 13 above),Rule 167(2)(b) and accompanying Comment, at 1172–1174; Fletcher (note 7 above),718; Smart, Cross-Border Insolvency (note 13 above), 85–86; Woloniecki (note 13above), 656.

15 Fletcher (note 7 above), 718; Smart, Cross-Border Insolvency (note 13 above), 86–92.See also 2 Dicey and Morris (note 13 above), Comment to Rule 167, at 1174. Somecommentators propose that a foreign bankruptcy should also be recognized on the basisof the residence of the bankrupt within the jurisdiction of the foreign court. Fletcher


For cases involving the recognition of a foreign liquidation, the gen-eral rule is that Hong Kong courts will recognize a foreign liquidationthat is granted under the law of the place of the company’s incorpora-tion.16 However, other grounds exist upon which recognition may bebased,17 including (a) that the debtor carries on business within the juris-diction of the foreign court18 or (b) that the debtor submits to the insolvencyjurisdiction of the foreign court.19 Another possible exception to the gen-eral principle of basing recognition on the place of incorporation arises incases in which there is no likelihood of a liquidation occurring in thejurisdiction in which a company is incorporated.20

Inasmuch as Hong Kong law draws a distinction between the bank-ruptcy of individuals and the liquidation of companies, an issue sometimesarises whether a Hong Kong court should apply the rules regarding the

(note 7 above), 718; Smart, Cross-Border Insolvency (note 13 above), 95–96. See also 2Dicey and Morris (note 13 above), Comment to Rule 167, at 1174. It is unlikely thatthe mere presence of assets within the foreign country would be a sufficient basis forrecognition. Ibid. But see Cheshire and North (note 13 above), 913 (suggesting thatpossession of assets by the debtor in the country of bankruptcy adjudication might besufficient). Lastly, Fletcher also proposes that:

we ought to acknowledge the validity of any foreign adjudication based upon theexercise of a ground of jurisdiction which is utilised by English law itself, andindeed it would be reasonable to go further and assert that a foreign adjudicationshould be recognised where it is pronounced by the courts of a country withwhich the debtor is genuinely and substantially connected.

Fletcher (note 7 above), 718–719.16 See Re Irish Shipping Ltd [1985] HKLR 437, 439; 2 Dicey and Morris (note 13 above),

Rule 160 and accompanying Comment, at 1137–1139, and Second Supplement to theTwelfth Edition 99 (London: Sweet & Maxwell, 1995) [hereinafter Second Supplement];Fletcher (note 7 above), 758–759; Smart, Cross-Border Insolvency (note 13 above),102–103; Woloniecki (note 13 above), 647. Some commentators propose that recognitionshould also be granted where a foreign liquidation is recognized under the law of theplace of the company’s incorporation. Fletcher (note 7 above), 759; Smart, Cross-Border Insolvency (note 13 above), 103–104.

17 But see Woloniecki (note 13 above), 656 (asserting that ‘[i]t is not clear whether theEnglish court will recognise the jurisdiction of a foreign court to wind up a company inany case where the company is not incorporated under the law of that court’).

18 Smart, Cross-Border Insolvency (note 13 above), 107–108 (but noting that there mightbe limits to the consequences of such recognition); 2 Dicey and Morris (note 13 above),Comment to Rule 160, at 1138.

19 Smart, Cross-Border Insolvency (note 13 above), 108–109.20 2 Dicey and Morris (note 13 above), Comment to Rule 160, at 1138–1139; Smart,

Cross-Border Insolvency (note 13 above), 106–107; Re Russo-Asiatic Bank (1930) 24HKLR 16, appeal dismissed, (1930) 24 HKLR 100 (involving the liquidation of a HongKong branch of a Russian company that the court found had not been dissolved byrevolutionary Soviet legislation).

62 Charles D. Booth

recognition of foreign bankruptcies or the rules regarding the recognitionof foreign liquidations. This issue has arisen in the context of whether torecognize the rehabilitation of a foreign company.

In Modern Terminals (Berth 5) Ltd v States Steamship Co (‘ModernTerminals’)21 the plaintiff, a Hong Kong company, sought summary judg-ment against a US company undergoing rehabilitation under Chapter XIof the United States Bankruptcy Act of 1898 (the ‘US Bankruptcy Act’).22

The defendant, the debtor in possession,23 sought a stay of the proceed-ings on the ground that it had obtained protection under US bankruptcylaw. The Hong Kong court reviewed the authority supporting the princi-ple that recognition should be granted to a foreign adjudication inbankruptcy that ‘purports to control the property of a bankrupt whereversituated as vesting the bankrupt’s movable property in Hong Kong orelsewhere in the trustee or other representative of his creditors if thebankrupt was domiciled in that other country or invoked or submitted toits jurisdiction.’24 The Hong Kong court noted that the US BankruptcyAct dealt with corporate liquidations, which would be dealt with in HongKong under the Companies Ordinance,25 but the court nevertheless reliedexclusively on bankruptcy rather than companies law precedent in decid-ing whether to recognize the US rehabilitation proceedings. In so doing,the court focused on the capacity in which the debtor retained possessionof its property and held that:

the property of the defendant is vested in it as if it were a trustee inbankruptcy and that such property wherever situate is under the controlof the bankruptcy court in California and that the court in Hong Kongshould respect that jurisdiction so far as movable property here isconcerned.26

21 [1979] HKLR 512.22 Ibid, 513. United States Bankruptcy Act of 1898, ch 541, 30 Stat 544 (1898) (repealed

1978).23 Under s 342 of Chapter XI, where no receiver or trustee was appointed, the debtor

continued in possession of its property. Similarly, in a reorganization under current USlaw, s 1101(1) of the United States Bankruptcy Code provides that where no trustee isappointed, the debtor becomes a ‘debtor in possession’. Bankruptcy Reform Act of1978, Pub L No 95–598, 92 Stat 2549 (codified as amended in Title 11, United StatesCode, in scattered sections of Title 28, United States Code, and in scattered sections ofother titles).

24 Modern Terminals (note 13 above), 513 (citing Re Blithman (note 13 above) and ReAnderson (note 14 above)).

25 Ibid, 514.26 Ibid, 521. See also ibid, 516–520.


Thus, the Modern Terminals court determined that because the USdebtor in possession held the company’s assets on trust for the benefit ofits creditors, rather than holding them as a beneficial owner, recognitionshould be granted to the US proceedings.27 This interpretation of US lawwas antithetical to the approach taken in Mobil Sales and Supply Corp vOwners of ‘Pacific Bear’ (‘Mobil Sales and Supply’),28 in which the courtfound that a debtor in possession was the beneficial owner of the compa-ny’s assets.29

The English case of Felixstowe Dock and Railway Co v United StatesLines Inc (‘Felixstowe Dock’)30 offers a contrasting approach to the Mod-ern Terminals approach of applying the rules regarding the recognition offoreign bankruptcies. The defendant in Felixstowe Dock was a companyin the process of reorganization under Chapter 11 of the US BankruptcyCode. Although the English court concluded that a debtor in possessionremains the beneficial owner of the company’s assets,31 the court handledthe case as one involving the recognition of a foreign liquidation.32 Theapproach by the court in Felixstowe Dock is preferable to the one inModern Terminals. As Philip Smart has noted, ‘[t]he vesting or otherwiseof property by virtue of foreign proceedings does not determine the choicebetween bankruptcy and liquidation.’33 Rather, the focus of the courtshould be on the extent to which the foreign law confers a separate legalpersonality on the entity that is the subject of foreign insolvency proceed-ings.34

Lastly, although a foreign debtor fulfils the above criteria for therecognition of a foreign bankruptcy or liquidation, recognition may nev-ertheless be barred. A Hong Kong court may refuse to grant recognition:1. where the recognition of the foreign insolvency would be contrary to

Hong Kong public policy;35

27 Ibid, 521, 524–525.28 [1979] HKLR 125 [hereinafter Mobil Sales and Supply].29 Ibid, 133. However, in Mobil Sales and Supply this finding was not made in the context

of applying rules regarding the recognition of foreign bankruptcies, but rather in thecontext of exercising the admiralty jurisdiction of the Hong Kong court. Ibid, 127–132.

30 [1989] QB 360 [hereinafter Felixstowe Dock].31 Ibid, 364–365 (relying on the US Supreme Court case of NLRB v Bildisco & Bildisco,

465 US 513 (1984)).32 Smart, Cross-Border Insolvency (note 13 above), 114. See Felixstowe Dock (note 30

above), 376–379.33 Smart, Cross-Border Insolvency (note 13 above), 114.34 Ibid, 115.35 Ibid, 117–118; Woloniecki (note 13 above), 659.

64 Charles D. Booth

2. where the foreign insolvency decree has been made as a result offraud or in breach of the rules of natural justice;36 or

3. where the foreign insolvency proceedings are an attempt to enforce aforeign penal or revenue law.37

A serious weakness of current Hong Kong statutory law is its silenceabout the recognition of foreign insolvencies. Statutory guidelines shouldbe enacted to replace the common law approach. This is especially impor-tant given the approach of 1997. A first step would be to incorporatedefinitions of ‘foreign representative’ and ‘foreign proceeding’ into therelevant ordinances.38 These definitions should resolve the issue of whetherthe courts should apply the rules regarding the recognition of foreignbankruptcies or the rules regarding the recognition of foreign liquidations.The definition of ‘foreign proceeding’ should also explicitly state whethera debtor’s carrying on of business, a debtor’s residence, or the presence ofa debtor’s assets would each be a sufficient connection between a foreigndebtor and the foreign jurisdiction in which the debtor’s bankruptcy oc-curs to justify the granting of recognition by Hong Kong courts to aforeign bankruptcy. Similarly, the criteria setting forth the required con-nection for foreign liquidations should also be made explicit. Lastly,provisions regarding the recognition of Chinese insolvencies should beenacted.

36 Smart, Cross-Border Insolvency (note 13 above), 118–123. Compare Woloniecki (note13 above), 659 (claiming that these exceptions are examples of situations that would becontrary to English public policy).

37 Smart, Cross-Border Insolvency (note 13 above), 125–131. Compare Woloniecki (note13 above), 659–660 (claiming that these exceptions are also examples of situations thatwould be contrary to English public policy). In cases involving the enforcement offoreign revenue laws, it is generally accepted that this exception to recognition shouldapply only where the sole object of the foreign proceedings is to enforce foreign revenuelaws. Smart, Cross-Border Insolvency (note 13 above), 125–131; Woloniecki (note 13above), 659–660.

38 These terms are defined respectively in ss 101(24) and 101(23) of the US BankruptcyCode. Section 101(24) defines ‘foreign representative’ as a ‘duly selected trustee,administrator, or other representative of an estate in a foreign proceeding’. Section101(23) defines ‘foreign proceeding’ as a ‘proceeding, whether judicial or administrativeand whether or not under bankruptcy law, in a foreign country in which the debtor’sdomicile, residence, principal place of business, or principal assets were located at thecommencement of such proceeding, for the purpose of liquidating an estate, adjustingdebts by composition, extension, or discharge, or effecting a reorganization’. It shouldbe noted that the word ‘bankruptcy’ has a broader meaning in the United States than inHong Kong and refers to a variety of insolvency proceedings under the US BankruptcyCode, including both liquidation and reorganization proceedings involving individuals,partnerships, or corporations.


THE OPTIONS AVAILABLE TO A FOREIGN REPRESENTATIVESEEKING TO PROTECT THE ASSETS OF A FOREIGNDEBTOR IN HONG KONG AND TO OBTAIN CROSS-BORDER ASSISTANCE FROM HONG KONG COURTS

Non-insolvency options

Under Hong Kong law, the issue of whether a foreign insolvency shouldbe recognized is distinct from the issue of what types of assistance may beforthcoming once recognition is granted.39 The question then arises ofwhat options a foreign representative may pursue to protect the assets ofa foreign debtor in Hong Kong and to secure cross-border assistance fromthe Hong Kong courts. At the outset, it should be noted that the HongKong courts have the inherent jurisdiction to assist a foreign representa-tive from any jurisdiction.40

As long ago as 1764, in Solomons v Ross41 an English court held thattrustees appointed in a foreign bankruptcy proceeding were entitled tocollect property in England even though an English creditor had begun(but had not completed) efforts to attach the debt. This case is the foun-dation for the claim of leading English commentators that ‘[t]he Englishcourts have consistently applied the doctrine of universality, according towhich they hold that all movable property, no matter where it may besituated at the time of the assignment by the foreign law, passes to thetrustee.’42 However, in 1910 in Galbraith v Grimshaw,43 the House ofLords overruled Solomons v Ross to the extent that an attachment (though

39 Smart, Cross-Border Insolvency (note 13 above), 79, 135.40 See ibid, 259. See also Re Kooperman [1928] WN 101 (discussed in ibid, 98). In

addition, prior to its repeal in 1985, s 122 of the UK Bankruptcy Act 1914 providedstatutory authorization for granting assistance to bankruptcy trustees fromCommonwealth jurisdictions. See note 12 above.

41 (1764) 1 H Bl 131n, also reported (1764) Wallis 59n. For a discussion of this case, seeKurt H. Nadelmann, ‘Solomons v. Ross and International Bankruptcy Law’ (1946) 9Modern Law Review 154 [hereinafter ‘Solomons v. Ross’].

42 Cheshire and North (note 13 above), 912. But see Nadelmann, ‘Solomons v. Ross’ (note41 above). Nadelmann stresses that the English court allowed the Dutch trustees inSolomons v Ross to take the property only after it had been shown that the Englishcreditor would be allowed to share equally in the Dutch bankruptcy. Ibid, 161–162. Heclaims that ‘[o]ne may wonder whether the theory of universality is part of English law.This theory is not needed to explain Solomons v Ross . . . . ’ Ibid, 163. Nadelmannconcludes that whether a foreign trustee is entitled to collect local assets in England is amatter of discretion. Ibid.

43 [1910] AC 508.

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uncompleted) is obtained prior to the date of the foreign bankruptcyorder.44

Galbraith v Grimshaw is still applicable in Hong Kong today.45 Themaking of a foreign order vesting title in a foreign trustee operates to vestin the foreign trustee movable property in Hong Kong not subject to priorattachment — provided the foreign law extends to movable property inHong Kong.46 Since the ‘vesting is “consequential and instantaneous”upon the making of the foreign order, no confirmation or execution bythe [Hong Kong] court is required.’47 Thus, a foreign trustee in HongKong is entitled to claim a foreign debtor’s movable, but not immovable,property that is not subject to any pre-existing attachment, execution, orvalid charge.48 The same is true in the case of a foreign liquidator vestedunder foreign law with title to the company’s assets.49

44 Kurt H. Nadelmann, ‘Codification of Conflicts Rules for Bankruptcy’ (1974) 30 Annuairesuisse de droit international 57, 83 [hereinafter ‘Conflicts Rules for Bankruptcy’]. CompareSmart, Cross-Border Insolvency (note 13 above), 157, 158 n1 (noting that although thecourt in Galbraith v Grimshaw declined to follow Solomons v Ross, it is not clear fromthe report of Solomons v Ross at (1764) Wallis 59n whether the attachment in Englandwas made prior to the commencement of the Dutch bankruptcy).

In Galbraith v Grimshaw, a Scottish trustee sought property in England that hadpreviously been garnished. The garnishment was void under Scottish bankruptcy lawand could have been voided under English bankruptcy law had a bankruptcy lateroccurred in England. Nadelmann, ‘Conflicts Rules for Bankruptcy’ (above), 83–84.

45 See Modern Terminals (note 13 above), 517, 523, 525.46 Ibid, 521, 525. See 2 Dicey and Morris (note 13 above), Rule 169 & accompanying

Comment, at 1175–1177, and Second Supplement (note 16 above), 102; Smart, Cross-Border Insolvency (note 13 above), 140.

47 Smart, Cross-Border Insolvency (note 13 above), 140 (quoting Neale v Cottingham(1770) Wallis 54, 75 (per Lord Lifford)). However, a foreign representative may requestthe Hong Kong court to give effect to the foreign vesting order. See Re Estate of AwHoe (discussed in note 12 above). Also, if a foreign trustee’s actions are contested by alocal creditor, the Hong Kong court may deny recognition to the foreign bankruptcy ifone of the earlier noted bars to recognition is found to exist. See text accompanyingnotes 35–37 above. See also Nadelmann, ‘Solomons v. Ross’ (note 41 above), 161–163(viewing the decision in Solomons v Ross as one in which the court was exercising itsdiscretion); Cheshire and North (note 13 above), 913.

48 See 2 Dicey and Morris (note 13 above), Rules 169, 170 & accompanying Comments,at 1175–1179, and Second Supplement (note 16 above), 102; Smart, Cross-BorderInsolvency (note 13 above), 140, 147–148; Woloniecki (note 13 above), 657–658. Seealso Cheshire and North (note 13 above), 912. The foreign trustee’s title may alsoextend to after-acquired property in Hong Kong. See Smart, Cross-Border Insolvency(note 13 above), 141–145.

The English/Hong Kong rule has been to uphold the title of the foreign assignee overattachments made after the commencement of the foreign bankruptcy. Cheshire andNorth (note 13 above), 912.

49 See Modern Terminals (note 13 above). See also Woloniecki (note 13 above), 657–658.


Title usually does not vest in a foreign liquidator. Nevertheless, underHong Kong law a foreign liquidator would most likely be allowed torepresent the foreign corporation in Hong Kong and deal with its mov-able assets there, subject to any pre-existing attachment, execution, orcharge50 — again, provided the foreign law extends to property in HongKong.

To gain control over a foreign debtor’s immovable property in HongKong (as such property does not vest in the foreign representative), aforeign representative may seek to be appointed as the receiver of theforeign debtor’s property in Hong Kong, with the power to sell the prop-erty and distribute the proceeds to the debtor’s creditors after satisfyingprior encumbrances.51

In Hong Kong, a foreign representative would also be allowed tocommence civil proceedings, to seek declarations regarding the effect offoreign insolvency proceedings, and to recover debts.52 The remedies avail-able for debt collection in Hong Kong include the following: interimattachment of the debtor’s property;53 a writ of execution;54 garnisheeproceedings;55 a charging order or stop order;56 and an examination of a

50 Smart, Cross-Border Insolvency (note 13 above), 217. See also ibid, 141, 149 n17(quoting Levasseur v Mason & Barry Ltd (1891) 63 LT 700, 703, aff’d, [1891] 2 QB73, 77–78). Smart claims that a foreign liquidator would not have to make a formalapplication to the Hong Kong court. Ibid, 217. But see Fletcher (note 7 above), 764–765 (taking a narrower view of the extra-territorial effect of a foreign winding-up orderand claiming that a foreign liquidator would first have to make a formal application tothe local courts to recover the assets and that the courts might not grant assistance).

51 See 2 Dicey and Morris (note 13 above), Rule 170 & accompanying Comment, at1178–1179, and Second Supplement (note 16 above), 102; Smart, Cross-BorderInsolvency (note 13 above), 140–141; Woloniecki (note 13 above), 647, 658, 661. Seealso Cheshire and North (note 13 above), 914; Mark Gross, ‘Foreign Creditor Rights:Recognition of Foreign Bankruptcy Adjudications in the United States and the Republicof Singapore’ (1991) 12 University of Pennsylvania Journal of International BusinessLaw 125, 149–150 (discussing English and, by extension, Singapore law). See The Rulesof the Supreme Court (cap 4, sub leg A, LHK), O 30; Supreme Court Ordinance (cap 4,LHK), s 21L. The foreign representative should seek such relief through an applicationfor an order in aid.

According to the Official Receiver, it is easier for foreign representatives fromCommonwealth jurisdictions to obtain orders in aid from the Hong Kong courts. Astrong rationale for this practice is that because the insolvency law of all Commonwealthjurisdictions is derived from the insolvency law of the United Kingdom, the Hong Kongcourts are quite familiar with the substantial similarities between Hong Kong insolvencylaw and the insolvency law of other Commonwealth jurisdictions.

52 Smart, Cross-Border Insolvency (note 13 above), 135.53 The Rules of the Supreme Court, O 44A, r 7.54 Ibid, O 46, O 47.55 Ibid, O 49.56 Ibid, O 50.

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judgment debtor.57 Hong Kong law also provides for a variety of harshlegal methods for collecting debts. These include the issuance of an orderprohibiting a debtor from leaving Hong Kong58 and the execution andenforcement of a judgment for money by imprisonment.59 To pursue anyof these options, the foreign representative must first prove that the for-eign law permits him to commence the proceedings in Hong Kong.60

Hong Kong law also permits a foreign representative to prove for adebt in a Hong Kong insolvency, although in so doing the foreign repre-sentative must comply with Hong Kong law.61 Under Hong Kong law, aforeign representative may also seek injunctive relief, including the entryof a stay of a Hong Kong proceeding or execution62 or the entry of aMareva injunction. A Mareva injunction is an interlocutory order soughtto prevent a defendant from dealing with his assets and removing themfrom the jurisdiction in which they are located.63 However, the assetssubject to a Mareva injunction are to be made available to creditorsgenerally and are not security for the petitioner.64

In two cases decided in the late 1970s, Mobil Sales and Supply65 andModern Terminals,66 the Hong Kong courts reached antithetical conclu-sions about whether to grant a stay requested by a foreign representativeand thereby assist rehabilitation proceedings in the United States. In MobilSales and Supply the High Court refused to order the stay of proceedingsagainst a US corporation undergoing rehabilitation under Chapter XI ofthe US Bankruptcy Act. Several creditors of the US debtor had issuedwrits in rem against some of the debtor’s ships. Among the issues ad-dressed by the court was whether the defendant, the debtor in possession,

57 Ibid, O 48.58 Ibid, O 44A, r 2; Supreme Court Ordinance, s 21B; District Court Ordinance (cap 336,

LHK), s 52E(1)(a). See Tam Hing-yee v Wu Tai-wai (1991) 1 HKPLR 261 (upholdingthe issuance of a prohibition order by the District Court under section 52E(1)(a) of theDistrict Court Ordinance as not violating the Hong Kong Bill of Rights). Hong Kong Billof Rights Ordinance (cap 383, LHK). See discussion of this case in 1(2) Hong Kong Billof Rights Bulletin (Dec 1991), 13–14 (Andrew Byrnes & Johannes M.M. Chan, eds).

59 The Rules of the Supreme Court, O 49B; Supreme Court Ordinance, s 21A.60 Smart, Cross-Border Insolvency (note 13 above), 139.61 See Re Kowloon Container Warehouse Co Ltd [1981] HKLR 210 (holding that a

foreign creditor could not receive a distribution in a members’ voluntary winding upuntil first paying a debt owed to the company being wound up).

62 See, e.g., Modern Terminals (note 13 above).63 Gross (note 51 above), 142; J. David Murphy, ‘Mareva Injunctions: Recent

Developments’, in J. David Murphy, ed, Law Lectures for Practitioners 1990 (HongKong: Hong Kong Law Journal, 1990), 19.

64 Gross (note 51 above), 142; Murphy (note 63 above), 20.65 Note 28 above.66 Note 13 above.


was the beneficial owner of the ships. After determining that the defend-ant was, in fact, the beneficial owner of the ships and did not hold themon trust for the creditors of the company, the court turned to the issue ofthe stay.67

The defendant feared that permitting the plaintiffs to seize the shipsmight jeopardize the debtor’s rehabilitation and financially harm the credi-tors and shareholders. The defendant argued that if the plaintiffs provedtheir claims in the US proceedings rather than seizing the ships, their lienwould be given ‘due priority’ and the only disadvantage to be suffered bythe plaintiffs would be that of delay.68 The court, however, rejected thedefendant’s arguments, stating that:

what seems to be taking place at the moment is not a process of universaldistribution but a process of deliberately preferential distribution. Largesums have already been paid out to other creditors. If a stay is nowgranted and the defendants should ultimately become insolvent thosecreditors may have gained substantial advantages over the presentplaintiffs.69

It is not clear from the court’s discussion why the distribution was ‘delib-erately preferential’. However, it is clear that the court adopted aterritoriality-based approach that focused on the low priority that theplaintiffs would likely receive under US law.

In Modern Terminals the High Court adopted a more universality-oriented approach. The plaintiff, a Hong Kong company, sought summaryjudgment against the defendant, a US debtor in possession also undergo-ing rehabilitation under Chapter XI in the United States. The US debtor inpossession sought to have the proceedings stayed on the ground that ithad obtained protection under US bankruptcy law.70

The court held that recognition should be granted to the rehabilita-tion proceedings in the United States, because the defendant held thecompany’s assets on trust for the benefit of creditors.71 Next, the courtconsidered whether to stay the Hong Kong proceedings. The court notedthat a condition of the contract between the plaintiff and the defendantwas ‘that the parties “submit exclusively to the courts of Hong Kong andthis contract shall be governed by Hong Kong Law.”’72 The court also

67 Mobil Sales and Supply (note 28 above), 133.68 Ibid, 134.69 Ibid.70 Modern Terminals (note 13 above), 513.71 Ibid, 521. See notes 21–27 above and accompanying text.72 Modern Terminals (note 13 above), 522.

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noted the defendant’s arguments in favour of staying the proceedings onthe basis of comity and because the plaintiff would be no worse off thanother creditors if it proved its claim in the defendant’s Chapter XI pro-ceedings in the United States.73 The court accepted the argument that theplaintiff would be treated the same as other similarly situated creditors.74

But fearing that the plaintiff’s claim might be disputed by the defendantand that the US court might disclaim jurisdiction, the court refused tostay the Hong Kong proceedings and ordered judgment for the plaintiff.75

The court then considered whether to order a stay of execution. Thecourt was concerned that if it failed to order a stay of execution, theplaintiff would be able ‘to take the money on execution, oust the jurisdic-tion and control of the courts of the United States and divest the defendantas trustee of the creditors of the property here.’76 The court stated that it‘would have had no hesitation in ordering a stay . . . were it not for adecision . . . in the amalgamated admiralty actions of Mobile [sic] Salesand Supply.’77 The court declined to follow the approach of the court inMobil Sales and Supply and instead held ‘that a debtor in possession isnot the beneficial owner of the assets but holds them in trust for thebenefit of the creditors with the right to have the title as beneficial ownerrevested in it if the terms of the arrangement with the creditors are ful-filled.’78 The court noted that the assets in Hong Kong were vested in theUS defendant and that the ‘principle enunciated in Galbraith v Grimshaw’79

was applicable.80 The principle is as follows:

Now so far as the general principle is concerned it is quite consistentwith the comity of nations that it should be a rule of international lawthat if the Court finds that there is already pending a process of universaldistribution of a bankrupt’s effects it should not allow steps to be takenin its territory which would interfere with the process of universaldistribution . . . .81

The court therefore ordered a stay of execution. In reaching its deci-sion, the Modern Terminals court applied rules regarding the recognition

73 Ibid.74 Ibid.75 Ibid, 522–523.76 Ibid, 523.77 Ibid.78 Ibid, 524.79 Note 43 above.80 Modern Terminals (note 13 above), 525.81 Ibid, 517 (quoting Galbraith v Grimshaw (note 43 above), 513).


of foreign bankruptcies that focus on the vesting of assets. As statedabove, it would have been preferable for the court to have instead grantedrecognition on the basis of the recognition of foreign liquidations.82 Thecourt could have ordered a stay under this approach, as well, by recogniz-ing the authority of a foreign liquidator to deal with assets in HongKong.83 In any case, an underlying premise of the Modern Terminalsapproach is that given the existence of an insolvency declared abroad,Hong Kong creditors should not be able to grab a foreign debtor’s assetsin Hong Kong to the detriment of the debtor’s other creditors elsewhere.Thus, Modern Terminals demonstrates a much more cooperative approachthan does Mobil Sales and Supply.

As can be seen, there are a variety of non-insolvency options availableto a foreign representative for protecting the assets of a foreign debtor inHong Kong or for seeking other assistance from the Hong Kong courts.Cross-border cooperation will be extended in respect of movables thathave not previously been attached by Hong Kong creditors, and perhapseven in respect of immovables through an auxiliary receivership. A for-eign representative may also commence civil actions or seek injunctiverelief, although as Mobil Sales and Supply demonstrates, assistance maynot always be forthcoming.

Winding up

Section 176 of the Companies Ordinance provides the High Court withthe jurisdiction to wind up any ‘company’,84 which is defined in Section 2of the Companies Ordinance as a Hong Kong company.85 The HighCourt also has jurisdiction to wind up foreign companies, pursuant toprovisions in Part X of the Companies Ordinance.86 A foreign company in

82 See notes 33–34 above and accompanying text.83 See note 50 above and accompanying text. But see Felixstowe Dock (note 30 above),

389 (recognizing a US reorganization, but refusing to order the discharge of Marevainjunctions; however, the assets subject to the Mareva injunctions could not be distributedto creditors without the commencement of ancillary winding-up proceedings in England).

84 Companies Ordinance, s 176. One High Court judge generally hears company law casesand deals with contested winding up petitions. Unopposed winding-up petitions aredealt with by the Registrar of the Supreme Court in open court. Ibid, s 180A.

85 Section 2 of the Companies Ordinance defines ‘company’ as a ‘company formed andregistered under this Ordinance or an existing company’. An ‘existing company’, inturn, is defined as a company formed and registered under earlier Hong Kong companiesordinances. Ibid, s 2.

86 Ibid, 326–331A.

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Hong Kong is called an ‘unregistered company’87 and is also called an‘oversea company’ if it has established a place of business in Hong Kong.88

Liquidation offers a number of advantages not obtainable outside ofinsolvency. First, a liquidator may avoid uncompleted attachments orexecutions — under Hong Kong law, a creditor may not retain the benefitof his attachment or execution unless the attachment or execution iscompleted before the commencement of the winding up.89 Second, a liqui-dator may exercise other avoidance powers pertaining to floating charges90

and fraudulent preferences.91 (These powers, however, are generally notvery extensive.92) Third, in a liquidation any person who was knowingly aparty to the carrying on of the business of a company ‘with intent to

87 Ibid, s 326. See text accompanying note 115 below.88 Companies Ordinance, s 332.

A foreign company is generally not considered to be a ‘company’ as defined in s 2 ofthe Companies Ordinance. See Insurance Co of Pa v Grand Union Insurance Co [1988]2 HKLR 541, 544 (dealing with an ‘oversea company’.) However, a foreign companymay be deemed to be a ‘company’ to the extent provided by Part X of the CompaniesOrdinance. See Companies Ordinance, s 331, discussed in note 123 below.

89 Companies Ordinance, s 269(1) (subject to the court’s discretion). Section 269(2) providesthat an execution against goods is completed by seizure and sale or by the making of acharging order under s 20 of the Supreme Court Ordinance; an attachment of a debt, byreceipt of the debt; and an execution against land, by seizure, by the appointment of areceiver, or by the making of a charging under s 20 of the Supreme Court Ordinance. Ifthe attachment or execution is not completed before the commencement of the windingup, the creditor is nevertheless entitled to retain moneys received prepetition by thecreditor ‘whether under or in consequence of an execution or not’, Re Andrew [1937]Ch 122, 127; the creditor will lose only the benefit of the remaining charge for thebalance of the debt, ibid, 136. It should also be noted that, as a rule, execution followsjudgment. American Express International Banking Corp v Johnson [1984] HKLR 372,376 [hereinafter American Express].

90 Companies Ordinance, s 267 (providing that in a liquidation of a company, a chargecreated as a floating charge within twelve months of the commencement of the windingup by a company that is insolvent immediately after the creation of the charge shall beinvalid, except to the amount of any cash advanced to the company at the time of orafter the creation of the charge, and in consideration for the charge, together withinterest).

91 Ibid, s 266. The relevant period is six months.In addition, under s 182 of the Companies Ordinance dispositions of the company’s

property made after the commencement of the winding up shall be void, unless thecourt orders otherwise.

92 For example, Hong Kong fraudulent preference law focuses on the voluntary nature ofthe debtor’s act and therefore on the debtor’s state of mind in making a payment ortransfer. Moreover, a payment or transfer made by a debtor under the fear of legalprocess or as the consequence of the pressure of a creditor is not voluntarily made and,therefore, is not a fraudulent preference. Companies Ordinance, s 266; BankruptcyOrdinance, s 49; Sharp v Jackson [1899] AC 419. Sections 266 and 269 of the CompaniesOrdinance do not penalize, and even promote, ‘last minute grabs’ by creditors.


defraud creditors of the company or creditors of any other person or forany fraudulent purpose’ may be held personally liable for any or all of thecompany’s debts.93 Fourth, the liquidator may seek the application ofcertain broad investigative powers.94 Last, a stay commences upon themaking of the winding-up order, or earlier upon the appointment of aprovisional liquidator.95 Under the stay, no action or proceeding may becontinued or commenced against the company, except with leave of court.96

The stay, however, does not prevent secured creditors from exercisingtheir rights in respect of their security.97

Hong Kong companies are wound up by the court pursuant to Sec-tion 177 of the Companies Ordinance, which contains both insolvencyand non-insolvency grounds. Section 177(1) provides that a Hong Kongcompany may be wound up by the court for the following reasons:

(a) the company has by special resolution resolved that the company bewound up by the court;

(b) the company does not commence its business within a year from itsincorporation, or suspends its business for a whole year;

(c) the number of members is reduced below two;(d) the company is unable to pay its debts;98

(e) the event, if any, occurs on the occurrence of which the memorandumor particles provide that the company is to be dissolved;

(f) the court is of opinion that it is just and equitable that the companyshould be wound up.99

The clearest insolvency related ground is that the company is unable topay its debts. Depending on the circumstances, the grounds listed in (a),(e), and (f) might also be insolvency-related.

Under Section 180 of the Companies Ordinance or under the court’sinherent jurisdiction, the court has the discretion to dismiss a winding-uppetition and not make a winding-up order. Although rarely exercised, thecourt also has the discretion under Section 209 to stay winding-up pro-

93 Companies Ordinance, s 275.94 Ibid, ss 221, 222.95 Ibid, s 186.96 Ibid. See also ibid, s 181 (after the presentation of a winding-up petition, but before the

making of a winding-up order or the appointment of a provisional liquidator, actions orproceedings against the company may be stayed).

97 Roy Goode, Commercial Law, 2nd ed (London: Penguin Books, 1995), 850–851.98 Companies Ordinance, s 177(1)(d). In proving the inability of a company to pay its

debts, creditors rely on the use of the demand prescribed under s 178 of the CompaniesOrdinance.

99 Ibid, s 177(1). See also ibid, s 177(2) (specifying the grounds upon which a companymay be wound up by the court on the application of the Registrar of Companies).

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ceedings at any time after the winding-up order has been made. In addi-tion, in the recent case of Bicoastal Corp v Shinwa Co Ltd,100 the Courtof Appeal took the unusual action of staying winding-up proceedingsbefore the winding-up order had been made, thereby staying the prosecu-tion of the petition.101

A Hong Kong liquidator generally has great independence in carryingout his duties and in exercising his powers. Moreover, there is less credi-tor participation in Hong Kong liquidations than there is in liquidationsin other countries, such as the United States. This is generally true ofcompany liquidation procedures in many Commonwealth jurisdictions.102

There is also much governmental involvement in liquidations in HongKong; the Official Receiver often plays a major role. After the presenta-tion of a winding-up petition, but before the making of a winding-uporder, the court may appoint an interim provisional liquidator, and if itdoes so, it usually appoints the Official Receiver.103 Upon the making ofthe winding-up order the Official Receiver becomes the provisional liqui-dator,104 and in most cases he continues on as liquidator.105 In some casesa ‘committee of inspection’ is appointed by the court.106

100 [1994] 1 HKLR 65.101 Ibid, 68 (ordering a stay of all proceedings in the Hong Kong winding up, including the

application to amend the winding-up petition, until a US court determined an appeal bythe Hong Kong debtor from a final judgment entered in a Florida bankruptcy court).

102 See Jay L.Westbrook, ‘Theory and Pragmatism in Global Insolvencies: Choice of Lawand Choice of Forum’ (1991) 65 American Bankruptcy Law Journal 457, 476–477. Seealso Charles D. Booth, ‘Recognition of Foreign Bankruptcies: An Analysis and Critiqueof the Inconsistent Approaches of United States Courts’ (1992) 66 American BankruptcyLaw Journal 135, 206–211 [hereinafter ‘Recognition of Foreign Bankruptcies’] (discussingthe procedures under Australian companies law for protecting the interests of unsecuredcreditors).

103 See Companies Ordinance, s 193.104 Ibid, s 194(a).105 See ibid, s 194(d). The appointment of a private liquidator usually depends on whether

there are sufficient assets to justify such an appointment. Gross (note 51 above), 143n133 (citing R.M. Goode, ‘The Secured Creditor and Insolvency Under English Law’(1980) 44 Rabels Zeitschrift Für Ausländisches und Internationales Privatrecht 674,699). In addition, in Hong Kong, private liquidators are appointed only in complicatedcases.

For the period 1 April 1993 to 31 March 1994, the Official Receiver was appointedliquidator in 424 cases and private liquidators were appointed in nine cases. OfficialReceiver’s Office Annual Department Report, 1993–94 (1994), paras 3.6.2, 3.6.4, at 5.In 1994–95, private liquidators were appointed in an additional six cases. OfficialReceiver’s Office Annual Departmental Report, 1994–95 (note 1 above), para 3.7.4, at5–6.

106 Companies Ordinance, s 206. Other provisions relevant to compulsory liquidations areat ss 169–227F and 263–296 of the Companies Ordinance. Hong Kong law also providesfor a more informal corporate liquidation procedure called a voluntary winding up.


Turning to the winding up of foreign companies, a foreign liquidatorshould realize that it will often be unnecessary to commence a winding upto reach assets in Hong Kong. For instance, to the extent that movableassets in Hong Kong are not subject to any pre-existing attachment, ex-ecution, or charge, the foreign liquidator should be able to get the assetstransferred to him as the representative of the foreign company or es-tate.107 Similarly, a foreign liquidator may attempt to be appointed asreceiver of the foreign company’s immovable property with the power tosell the property and distribute the proceeds to creditors.108 However, ifthese collection attempts prove unsuccessful, the foreign liquidator shouldconsider commencing a liquidation against the foreign company.109 Peti-tioning for liquidation would also be advisable where the foreign liquidatoranticipates that the unsecured creditors would benefit from the exercise ofa liquidator’s avoidance or investigatory powers or from the stay.110 If awinding-up order is made, the foreign liquidator may also request theHong Kong court to order the turnover of Hong Kong assets to theforeign liquidation for distribution abroad.111

At present, there is no provision in the Companies Ordinance thatexpressly authorizes a foreign representative to commence a winding upin Hong Kong of the foreign company that he represents, or whose estatehe represents, in the foreign insolvency. Section 179(1) of the CompaniesOrdinance states:

An application to the court for the winding up of a company shall beby petition, presented subject to the provisions of this section either by thecompany, or by any creditor or creditors . . . , contributory orcontributories or the trustee in bankruptcy or the personal representative ofa contributory, or by all or any of those parties, together orseparately . . . .112

Ibid, ss 228–233. If the company is solvent, the procedure is called a members’ voluntarywinding up and is controlled by the members who are also empowered to appoint theliquidator. See ibid, ss 234–239A, 249–257, 263–296. If the company is insolvent, theprocedure is called a creditors’ voluntary winding up and provides for greater involvementby the creditors. See ibid, ss 240–248, 249–257, 263–296.

107 See note 50 above. Of course, the foreign law would have to extend to the property inHong Kong.

108 See note 51 above.109 See Fletcher (note 7 above), 765.110 See notes 89–95 above.111 A turnover order was made in the liquidation involving Irish Shipping Ltd, Companies

Winding Up No 408 of 1984. See note 147 below.112 This section is applicable to the winding up of foreign companies pursuant to ss 327(1)

and 331 of the Companies Ordinance. See note 123 below and accompanying text.

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Thus, if a foreign representative wants to commence a winding-up pro-ceeding against the foreign company that he represents, or whose estatehe represents, he must either convince one of the foreign company’s credi-tors to file the petition or file the petition himself on behalf of the foreigncompany.113 To fill in the gap in current law, I would propose that anamendment based on Section 303(b)(4) of the US Bankruptcy Code bemade to Part X of the Companies Ordinance to enable a foreign repre-sentative to petition in Hong Kong for the liquidation of the foreigncompany that he represents, or whose estate he represents, in the foreignproceeding.114

The relevant sections for winding up foreign companies are includedin Part X of the Companies Ordinance, which is entitled ‘Winding Up OfUnregistered Companies’. Section 326 defines ‘unregistered company’ asincluding any partnership, limited partnership, association, and companyexcept for the following:

(a) a company registered under the Companies Ordinance 1865 (1 of1865), or under the Companies Ordinance 1911 (58 of 1911), orunder this Ordinance;

(b) a partnership, association or company which consists of less thaneight members and is not a foreign partnership, association, orcompany;115

(c) a partnership registered in Hong Kong under the Limited PartnershipOrdinance (Cap. 37).

Section 327(1), in turn, provides that subject to the provisions of Part Xof the Companies Ordinance, any unregistered company may be wound

113 The latter approach was used in Irish Shipping (note 16 above), 439. Another possiblescenario, albeit more theoretical than likely, is that a company incorporated in HongKong is liquidated abroad and the foreign representative of that company comes toHong Kong to commence a winding up against the company. In that case it would beunlikely that a Hong Kong court would grant recognition to the foreign representative.

114 Section 303(b)(4) of the US Bankruptcy Code provides that an involuntary bankruptcycase may be commenced against a person ‘by a foreign representative of the estate in aforeign proceeding concerning such person.’ Section 101(41) of the US BankruptcyCode defines ‘person’ to include a company.

Of course, the foreign representative should have to demonstrate that she wasauthorized under foreign law to commence the winding up in Hong Kong.

115 Interestingly, although a ‘partnership’ is not a ‘company’ under s 2 of the CompaniesOrdinance, a Hong Kong partnership with eight or more partners and a foreignpartnership are both defined as an ‘unregistered company’ and may therefore be woundup under Part X of the Companies Ordinance. Bankruptcy proceedings may also becommenced against a partnership carrying on business in Hong Kong under s 7(1) ofthe Bankruptcy Ordinance. See also Bankruptcy Ordinance, s 109.


up under the Companies Ordinance. Under Section 327(3), an unregis-tered company may be wound up under the following circumstances:

(a) if the company is dissolved, or has ceased to carry on business, or iscarrying on business only for the purpose of winding up its affairs;

(b) if the company is unable to pay its debts;(c) if the court is of opinion that it is just and equitable that the company

should be wound up.116

The liquidations of foreign companies in Hong Kong usually proceedpursuant to Section 327 of the Companies Ordinance.117 Recently, inSecurities and Futures Commission v MKI Corp Ltd (‘MKI’)118 the HighCourt held that the power to wind up an unregistered company underSection 327 of the Companies Ordinance extends to oversea companiesregistered under Part XI of the Companies Ordinance.

Foreign companies may also be wound up under Section 327A of theCompanies Ordinance,119 although in practice, this section is rarely used.120

Section 327A is entitled ‘Oversea companies may be wound up althoughdissolved’ and provides as follows:

Where a company incorporated outside Hong Kong which has beencarrying on business in Hong Kong ceases to carry on business in HongKong, it may be wound up as an unregistered company under this Part,notwithstanding that it has been dissolved or otherwise ceased to exist as

116 Section 327(4) of the Companies Ordinance, in turn, defines the circumstances in whichan unregistered company shall be deemed to be unable to pay its debts. These criteriaare somewhat broader than the criteria applicable to the winding up of Hong Kongcompanies that are contained in s 178 of the Companies Ordinance because s 327(4)includes provisions regarding unsatisfied actions and executions against members of theunregistered company for debts due from the company.

Section 327(2) provides that an unregistered company may not be wound upvoluntarily under the Companies Ordinance.

117 Philip Smart, ‘Cross-Border Insolvency’, in Jill Cottrell, ed, Law Lectures for Practitioners1991 (Hong Kong: The Hong Kong Law Journal Ltd, 1991), 139, 142. For example,the recent winding up ordered in Re China Tianjin International Economic and TechnicalCo-operative Corp [1994] 2 HKLR 327 [hereinafter CTIETCC] was based on s 327 ofthe Companies Ordinance.

118 [1995] 2 HKC 79 [hereinafter MKI].119 See Dairen Kisen Kabushiki Kaisha v Shiang Kee [1941] AC 373 (PC HK) (involving

the liquidation in Hong Kong (under s 313(2) of the Companies Ordinance (cap 32) 1932,re-enacted with some minor changes as s 327A of the Companies Ordinance) of the HongKong branch of a company incorporated and dissolved in the Republic of China).

120 Smart, ‘Cross-Border Insolvency’ (note 117 above), 142. However, a filing under s327A was recently made in Re Macau-Mokes Group Ltd, Companies Winding Up No62 of 1994 (3 Feb 1994).

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a company under or by virtue of the laws of the place of itsincorporation.121

Recently, in MKI, the High Court noted that Section 327A does notprovide any power to wind up a foreign company that is not alreadycontained in Section 327(3)(a).122

Pursuant to Sections 327(1) and 331 of the Companies Ordinance, inthe winding up of unregistered companies the provisions in Part X of theCompanies Ordinance are supposed to supplement the other winding-upprovisions contained in the Companies Ordinance. However, Sections327(1) and 331 are somewhat inelegantly drafted, and they overlap andeven conflict in scope.123 Additional provisions applicable to the windingup of unregistered companies include the previously mentioned broaderdefinition of the company’s inability to pay its debts,124 and an extension

121 Smart’s observation about the use of the term ‘oversea company’ in the English equivalentto the heading to s 327A of the Companies Ordinance is also relevant for the purposesof Hong Kong law. In terms of Hong Kong law, the argument is that the use of theterm ‘oversea companies’ in the heading to s 327A is inappropriate, because the term‘oversea company’ normally refers to a foreign company that has established a place ofbusiness in Hong Kong. Smart, Cross-Border Insolvency (note 13 above), 68. SeeCompanies Ordinance s 332. However, ‘[a] foreign company may carry on business(within [s 327A]) without being an oversea company (which must have an establishedplace of business).’ Smart, Cross-Border Insolvency (note 13 above), 68.

122 MKI (note 118 above), 86.123 Section 327(1) provides as follows:

Subject to the provisions of this Part [X of the Companies Ordinance], anyunregistered company may be wound up under this Ordinance, and all theprovisions of this Ordinance with respect to winding up shall apply to anunregistered company, with the exceptions and additions mentioned in this section.

Section 331 provides as follows:

The provisions of this Part [X of the Companies Ordinance] with respect tounregistered companies shall be in addition to and not in restriction of anyprovisions hereinbefore in this Ordinance contained with respect to winding upcompanies by the court, and the court or liquidator may exercise any powers ordo any act in the case of unregistered companies which might be exercised ordone by it or him in winding up companies formed and registered under thisOrdinance:

Provided that an unregistered company shall not, except in the event of itsbeing wound up, be deemed to be a company under this Ordinance, and thenonly to the extent provided by this Part [X of the Companies Ordinance].

As can be seen, s 327(1) provides that the general winding up provisions in the CompaniesOrdinance are subject to the ‘exceptions and additions’ of s 327. In contrast, s 331provides that the winding-up provisions elsewhere in the ordinance are to besupplemented, but not restricted, by the provisions in Part X.

124 See note 116 above.


of the stay of actions and proceedings upon the making of a winding-uporder to actions and proceedings against contributories of the company inrespect of company debts.125

The Companies Ordinance, except for the reference in Section 327Ato ceasing to carry on business, is silent as to the jurisdictional connectionthat must exist between the foreign debtor and Hong Kong for a windingup to be commenced in Hong Kong. However, since the English case ofBanque des Marchands de Moscou v Kindersley126 was decided in 1951, ithas been settled that a foreign company with assets in Hong Kong may bewound up in Hong Kong.127 In 1973, this rule was extended further in theEnglish case, Re Compania Merabello San Nicholas SA,128 which involvedinterpreting Section 399 of the Companies Act 1948, the then Englishequivalent to Section 327 of the Companies Ordinance. The court heldthat for the purposes of establishing jurisdiction in a case involving aforeign company:

(1) There is no need to establish that the foreign company ever had aplace of business here.

(2) There is no need to establish that the company ever carried onbusiness here, unless perhaps the petition is based upon the companycarrying on or having carried on business.

(3) A proper connection with the jurisdiction must be established bysufficient evidence to show (a) that the company has some asset orassets within the jurisdiction, and (b) that there are one or morepersons concerned in the proper distribution of the assets over whomthe jurisdiction is exercisable.

(4) It suffices if the assets of the company within the jurisdiction are ofany nature; they need not be “commercial” assets, or assets whichindicate that the company formerly carried on business here.

(5) The assets need not be assets which will be distributable to creditorsby the liquidator in the winding up: it suffices if by the making of

125 Companies Ordinance, s 330. Compare ibid, s 186. See text accompanying note 95above. The court’s power to stay actions or proceedings upon the filing of a winding-uppetition is similarly extended by s 329 of the Companies Ordinance, but without therestriction regarding the collection of company debts. Compare ibid, s 181. See note 96above.

126 [1951] Ch 112.127 Smart, ‘Cross-Border Insolvency’ (note 117 above), 143; Kurt H. Nadelmann,

‘Rehabilitating International Bankruptcy Law: Lessons Taught by Herstatt and Company’(1977) 52 New York University Law Review 1, 25 (discussing the English rule). See 2Dicey and Morris (note 13 above), Comment to Rule 157, at 1120 (citing this 1951case in support of the view that until recently it was thought that having assets inEngland was a jurisdictional requirement for winding up a foreign company underEnglish law).

128 [1973] Ch 75.

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the winding up order they will be of benefit to a creditor or creditorsin some other way.

(6) If it is shown that there is no reasonable possibility of benefit accruingto creditors from making the winding up order, the jurisdiction isexcluded.129

The presence of assets as a basis for jurisdiction for Section 327 caseswas further expanded in later cases, most notably, for our purposes, the1985 Hong Kong case, Re Irish Shipping Ltd.130 Irish Shipping Ltd, acompany being wound up in Ireland, had never carried on business orestablished a place of business in Hong Kong.131 On 8 December 1984,Irish Shipping’s official liquidator petitioned to wind up Irish Shipping asan unregistered company pursuant to Section 327 of the Companies Ordi-nance. The petition was sought on the grounds that the company wasunable to pay its debts and that it was just and equitable for a winding-uporder to be made.132

The official liquidator claimed jurisdiction on the basis of the ‘immi-nent arrival’ of the Irish Rowan (a ship owned by the debtor) in HongKong.133 The liquidator’s goal was to get possession of and sell the IrishRowan and then distribute the sales proceeds among the general credi-tors. When the Irish Rowan arrived in Hong Kong on 14 February 1985,a number of creditors who intended to proceed with their admiraltyactions in rem opposed the liquidator’s petition.

In applying the presence-of-assets test from Re Compania MerabelloSan Nicholas SA, the court in Irish Shipping added in obiter that ‘theliquidator is not precluded from presenting a petition before the asset iswithin the jurisdiction. It is sufficient to found jurisdiction if there areassets here when the petition is heard.’134 However, this additional groundwas not needed to found jurisdiction in Irish Shipping, because the courtnoted that ‘there were in fact assets within the jurisdiction both at thedate of the presentation of the petition and at the date of the hearing.’135

129 Ibid, 91–92.130 Note 16 above. See also the following English cases: Re Allobrogia Steamship Corp

[1978] 3 All ER 423 (expanding the presence-of-assets test to include a right of actionthat has a reasonable possibility of success); Re Eloc Electro-Optieck & CommunicatieBV [1982] Ch 43 (further expanding the presence-of-assets test by finding that theassets upon which to found jurisdiction need not belong to the company, but maybelong to an outside source).

131 Irish Shipping (note 16 above), 439.132 Ibid.133 Ibid.134 Ibid, 444.135 Ibid.


The court’s contention that jurisdiction may be satisfied at the timethe hearing is held is troubling. In my view, the date for determiningjurisdiction should be the date that the winding-up petition is presented.As Philip Smart states: ‘Either the court has jurisdiction when the petitionis presented or it does not.’136

The presence-of-assets test, however, is not the only jurisdictionalbasis for winding up a foreign company in Hong Kong. It is now gener-ally accepted, on the basis of the English decision of Re A Company (No00359 of 1987)137 that it is not essential for assets to be present and that‘provided a sufficient connection with the jurisdiction is shown, and thereis a reasonable possibility of benefit for the creditors from the windingup, the court has jurisdiction to wind up the foreign company.’138 An

136 Smart, Cross-Border Insolvency (note 13 above), 62 n14. See also Smart, ‘Cross BorderInsolvency’ (note 117 above), 143–144. The English case of Re Real Estate DevelopmentCo [1991] BCLC 210 supports the position urged here that the appropriate time fordetermining jurisdiction is at the time the winding up is commenced. In that case, thecourt stated that ‘it seems . . . to be necessary, where there is no asset within thejurisdiction at the presentation of a petition, to establish a link of genuine substancebetween the company and this country.’ Ibid, 217.

137 [1988] Ch 210 [hereinafter Okeanos Maritime Corp].138 Ibid, 225–226 (finding a sufficient connection, including (1) that the debt owed by the

foreign company to the petitioner was incurred in England and governed by English lawand (2) that the foreign company had carried on business in England through itsagents). See also, e.g., the following English cases and commentators that have adoptedthe test from Okeanos Maritime Corp: Re A Company (No 003102 of 1991), ex parteNyckeln Finance Co [1991] BCLC 539, 540 [hereinafter ex parte Nyckeln Finance Co](finding a sufficient connection); Real Estate Development Co (note 136 above), 217(also requiring that the court be able to exercise jurisdiction over one or more personswho will benefit from the making of the winding-up order; not finding a sufficientconnection); 2 Dicey and Morris (note 13 above), Comment to Rule 157, at 1121–1123, and Second Supplement (note 16 above), 96–97. But see Smart, Cross-BorderInsolvency (note 13 above), 64–65 (criticizing the vagueness of the ‘sufficient connection’test and recommending instead the adoption of a jurisdictional test based on the carryingon of business ‘either directly or through an agent’ to supplement the presence-of-assetstest; but retaining the requirement ‘that there is a reasonable possibility of benefitaccruing to creditors from the making of a winding up order.’).

There is also language in Okeanos Maritime Corp (note 137 above), 226, that indetermining whether jurisdiction exists, ‘[i]t is also appropriate for the court to considerwhether any other jurisdiction is more appropriate for the winding up . . . . ’ This testwas also adopted in ex parte Nyckeln Finance Co (above), 540. However, as has beennoted in a later case, as well as by commentators, this factor should certainly be a factorfor the court to consider in exercising its discretion. Re Wallace Smith & Co [1992]BCLC 970, 985; Smart, Cross-Border Insolvency (note 13 above), 64, n5; 2 Dicey andMorris (note 13 above), Comment to Rule 157, at 1121. To hold otherwise wouldmake it impossible for the Hong Kong courts to order an ancillary or concurrentwinding up in Hong Kong. See Re Wallace Smith & Co (above), 985. See also notes146–152 below and accompanying text.

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issue that need to be addressed is whether the presence-of-assets testremains an independent jurisdictional basis, or whether it is now a factorthat should be considered under a ‘sufficient connection’ analysis.139

After finding that the jurisdictional requirements have been met, thecourt must decide whether to exercise its jurisdiction and order the wind-ing up of the foreign company; the ordering of relief is not automatic, butrather is dependent on certain conditions being satisfied.140 Irish Shippingis also noteworthy for its discussion of the criteria to be reviewed whenmaking this decision. After finding that jurisdiction existed for the courtto hear the petition,141 the court in Irish Shipping considered a variety offactors, none of which are specified in the Companies Ordinance. First,the court noted that creditors opposing the making of a winding-up orderare required to give ‘satisfactory reasons’ supporting their position andthat the creditors in Irish Shipping had failed to do so.142 Second, thecourt stressed the need to consider the interests of unsecured creditors(e.g., equality of distribution) and of the public and then noted that it wasin the public interest for the unsecured creditors to benefit from the saleof the vessel.143 Third, the court considered the ‘comity of nations whereby

Two recent Hong Kong cases discuss some of the developing English case lawrelating to jurisdiction to wind up foreign companies. In CTIETCC (note 117 above),328, the High Court noted the requirements from Okeanos Maritime Corp (note 137above) that ‘there is a sufficiently close connection with the jurisdiction and that there isa reasonable possibility of benefit for the creditors from the winding-up.’ The court alsonoted the principle from Real Estate Development Co (note 136 above) ‘that the Courtmust be able to exercise jurisdiction over one or more persons interested in the distributionof the company’s assets.’ Ibid. The court made the winding-up order against ChinaTianjin International Economic and Technical Co-operative Corporation [hereinafterCTIETCC], a company established pursuant to an Order of the Ministry of ForeignTrade and Economic Cooperation and the People’s Government of the Municipality ofTianjin, after finding that ‘there must . . . be a reasonable prospect of there beingsubstantial assets which are liable to be recovered should a winding-up Order be made.’Ibid. Among the factors discussed by the court were the following: that CTIETCC had ashare in the Hong Kong company Tsinlien Economic Cooperation Co Ltd and thatCTIETCC claimed in some published materials to have set up an office or offices inHong Kong and to have established throughout the world, including in Hong Kong,various business ventures. Ibid. In the other recent case, MKI (note 118 above), 84, thecourt also relied on Okeanos Maritime Corp and Real Estate Development Co.

139 See CTIETCC (note 117 above) (collapsing the presence-of-assets test into the substantialconnection test).

140 See Smart, Cross-Border Insolvency (note 13 above), 235–240.141 In addition, the court found that the official liquidator had been given retrospective

sanction from the Irish court to commence the Hong Kong proceedings and that he hadauthority to present the petition in Hong Kong. Irish Shipping (note 16 above), 441–442.

142 Ibid, at 444–445.143 Ibid.


it is desirable that the court should assist the liquidator in another juris-diction to carry out his duties unless good reasons to the contrary havebeen put forward’ and found that sufficient reasons had not been ad-vanced.144

The court ruled that the opposing creditors were not entitled to thepreferences they had claimed, and then the court exercised its jurisdictionto order the winding up.145 The court also noted: ‘The jurisdiction of thiscourt in the liquidation would be ancillary as far as possible to the wind-ing up in Ireland and would provide assistance to the official liquidator inthe collection and preservation of the assets within Hong Kong.’146

When the winding up of Irish Shipping in Hong Kong was concludedin 1985, the Hong Kong court again stressed the ancillary nature of theHong Kong proceeding and ordered the Hong Kong liquidator to turnover the surplus assets (after paying the costs of the Hong Kong liquida-tion) to the Irish liquidator for a pari passu distribution to all creditors ofIrish Shipping (after paying the Irish liquidator’s costs).147

In an ancillary winding up in Hong Kong, a liquidator is appointed, astay comes into effect, and the Hong Kong avoidance powers are applica-ble.148 Moreover, if a turnover order is made, the Hong Kong court wouldmost likely require preferential debts149 and secured creditors’ claims to besatisfied before sending the surplus abroad.150

The general view of authorities on English transnational insolvencylaw is that an ancillary winding up is one kind of concurrent winding upor concurrent insolvency.151 Although adopting this view, Philip Smartstresses the distinctive characteristics of an ancillary liquidation in distin-guishing it from other concurrent insolvencies.152 I take the distinction

144 Ibid, 445. Compare Smart, Cross-Border Insolvency (note 13 above), 236–237 (proposinga more general test of whether ordering an ancillary winding up would be in ‘theinterests of the parties’).

145 Irish Shipping (note 16 above), 446.146 Ibid, 445.147 Re Irish Shipping Ltd, Companies Winding Up No 408 of 1984, Order (25 June 1985)

(the turnover was to be made after receipt by the Hong Kong liquidator of (1) an orderof the Irish court allowing the distribution of the Hong Kong assets in the Irish proceedingand (2) evidence of the giving of security to the Irish court).

148 See notes 89–97 above and accompanying text. However, it might be possible for theforeign court to set aside a transaction under foreign law and then request the HongKong court to give effect to that order. See Smart, Cross-Border Insolvency (note 13above), 264.

149 See Companies Ordinance, s 265.150 See Smart, Cross-Border Insolvency (note 13 above), 248–250. For a discussion of

ancillary liquidations in general under English law, see ibid, 233–252.151 See ibid, 213–214; Fletcher (note 7 above), 766; Woloniecki (note 13 above), 661–662.152 Smart, Cross-Border Insolvency (note 13 above), 213–214, 232–252.

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further and conceive of a continuum of types of concurrent insolvencies,including both concurrent liquidations and concurrent bankruptcies com-menced in Hong Kong by a foreign representative against the foreigncompany, partnership, or individual that he represents, or whose estate herepresents, abroad: at one end of the continuum is an ‘ancillary insol-vency’ (either an ‘ancillary winding up’ or an ‘ancillary bankruptcy’153),where the primary aim of the Hong Kong liquidator or trustee is to assistthe foreign representative; at the other end is a full-scale insolvency, wherethe Hong Kong liquidator or trustee is on equal footing with the foreignrepresentative. When the terms are used in this way, it can be seen that itwould be helpful to enact legislative criteria to assist Hong Kong courts indetermining when ancillary assistance is appropriate.

In any event, if a Hong Kong court decides not to provide ancillaryassistance to a winding up abroad, other forms of cross-border assistancecould still be forthcoming in the concurrent insolvency. All assets couldbe administered and distributed to creditors in a full-scale proceeding inHong Kong, or the Hong Kong court could approve a scheme of arrange-ment entered into by the Hong Kong liquidator and the foreign liquidatorthat provides for distributions to creditors worldwide. Such a schemewould have to be in accordance with the law of the jurisdiction in whichthe debtor is incorporated.154

Cooperation might also be achieved among concurrent insolvencies ofvarious members of one corporate family when the representatives of therespective debtors negotiate settlement agreements. An example of suchcross-border cooperation in which the Hong Kong courts took part in-volved the insolvency of various members of the Deak-Perera group ofcompanies. In December 1984, three members of the Deak-Perera groupeach filed a petition in the United States for reorganization under Chapter11 of the US Bankruptcy Code. Two months later, a winding-up orderwas made by the Supreme Court of Hong Kong against Deak Perera (FarEast) Ltd (‘DPFE’), a wholly-owned subsidiary of one of the US debtorswith its principal place of business in Hong Kong. The Official Receiverwas appointed as the liquidator of DPFE and asserted various claims ofDPFE against the US debtors in the US reorganizations. In December1985 the Official Receiver entered into a stipulation with the US debtorsand the official committee of unsecured creditors appointed in the UScases, pursuant to which the US debtors agreed to pay US$2.36 million to

153 English commentators do not generally use the term ‘ancillary bankruptcy’.154 See Smart, Cross-Border Insolvency (note 13 above), 214–215. See also Woloniecki

(note 13 above), 661–662.


the Official Receiver in full settlement, release, and discharge of all claimsthat DPFE or the Official Receiver may have had against the US debtorsand their affiliates (as defined under US law). This settlement was ap-proved by the US bankruptcy court in December 1985, having beenapproved earlier by the Hong Kong High Court.155

Meanwhile in the Hong Kong liquidation of DPFE, in May 1987 theOfficial Receiver, as liquidator, commenced proceedings against sevendefendants, including R. Leslie Deak (who was sued as the personal repre-sentative of Nicholas Louis Deak) and Otto Emil Roethenmund. NicholasLouis Deak and Roethenmund had been directors of, and had controlled,DPFE in Hong Kong and other corporations in the Deak-Perera group ofcompanies. The Official Receiver asserted that they were liable to DPFEfor breach of their fiduciary duties and for an account of trust moniesmisapplied.156 R. Leslie Deak and Roethenmund contested the issuance ofwrits for service on them outside of Hong Kong, but the Hong KongCourt of Appeal upheld the order for service on both defendants.157

In April 1992 Roethenmund obtained a declaratory judgment in theUnited States to the effect that he was an ‘affiliate’ at the time of thestipulation and that he was released and discharged from all claims thatDPFE or the Official Receiver had or may have had against him.158 How-ever, back in Hong Kong, the Official Receiver sued Roethenmund forbreach of his fiduciary duties. He argued, inter alia, that he had notintended to include Roethenmund in the stipulation (and that the term‘affiliate’ can include an individual is not a concept known in HongKong).159 The defendant applied to strike out the Official Receiver’s claim.He argued (1) that the Official Receiver’s claim had been resolved by thesettlement, the validity of which had not been challenged and (2) thatalthough the Official Receiver had challenged the applicability of thesettlement to him, the New York court had decided that issue, thus bar-ring its relitigation as res judicata.160

In resolving this dispute, the Hong Kong High Court held that theplaintiff’s claim was barred by issue estoppel since ‘the parties [were] thesame, the issue [was] the same, the judgment was conclusive and on themerits and . . . it was pronounced by a Court of competent jurisdic-

155 R. Leslie Deak v Deak Perera Far East Ltd (in liq) [1991] 1 HKLR 551, 555. For acopy of the stipulation, which sets out the facts noted above, see ibid, 555–557.

156 Ibid, 555.157 Ibid, 560.158 Deak Perera (Far East) Ltd (in liq) v R. Leslie Deak [1995] 1 HKLR 145, 149.159 Ibid.160 Ibid.

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tion.’161 The court found that since the Official Receiver had submitted tothe jurisdiction of the US bankruptcy court and since the judgments werefinal on the merits, he was bound by those judgments and could notchallenge the defendant’s defense based on the settlement.162 Furthermore,since the Official Receiver had reached a settlement with the US debtorsin the sum of US$2.36 million, he had suffered no loss.163 The Hong Kongcourt respected the US ruling, thereby fostering cross-border cooperation,notably over the strong objections of the Official Receiver.

As can be seen from the above discussion, since Hong Kong law doesnot provide for the application of foreign insolvency law in a Hong Kongwinding up in aid of a primary insolvency proceeding abroad, it does notallow for the development of what may be called the universality/unityapproach. However, close cross-border cooperation is still possible underwhat may best be characterized as a universality/plurality approach —either through an ancillary winding up, as in Irish Shipping, or through afull-scale concurrent insolvency, as in the insolvency involving Deak Perera(Far East) Ltd.

At present, most of the Hong Kong principles regarding transnationalinsolvency have developed in the case law. It would be beneficial forHong Kong, especially with 1997 approaching, if many of these principleswere incorporated into the Companies Ordinance. Greater consistencyand predictability in the application of these principles would therebymost likely result. For example, as noted earlier, definitions of ‘foreignrepresentative’ and ‘foreign proceeding’ should be included. Moreover, itshould be made explicit that a foreign representative may petition inHong Kong for the winding up of the foreign company that he represents,or whose estate he represents, in the foreign proceeding — provided he isso authorized under foreign law. Jurisdictional requirements regarding theforeign company’s connection with Hong Kong should also be enactedand should clarify the scope of the presence of assets test.

In addition, Part X of the Companies Ordinance should be reviewedand updated, and retitled to refer to foreign companies. A definition of‘foreign company’ should therefore be included in Part X, either as a sub-division of the definition of ‘unregistered company’ or as a separate term.The need to retain Section 327A in its current form should also be ad-dressed. In addition, ‘obsolete references’ in the provisions regardingunregistered companies should be repealed, as has occurred in the United

161 Ibid, 151 (applying the three requirements from The Sennar (No 2) [1985] 1 WLR490).

162 Ibid.163 Ibid, 153.


Kingdom,164 and the inconsistency between Sections 327(1) and 331 shouldbe eliminated.

Other provisions could be enacted in Part X to codify aspects of thedistinction between ancillary liquidations and other types of concurrentliquidations urged here. These sections or other new sections should alsoinclude a list of the criteria to be considered by a Hong Kong court beforegranting assistance to a foreign insolvency, as well as a list of the types ofassistance that a court may order.

Bankruptcy

Because the Hong Kong courts do not recognize the principle of the ‘unityof bankruptcy’, Hong Kong courts have jurisdiction to adjudge a debtorbankrupt in Hong Kong even though the debtor has already been adjudi-cated bankrupt abroad.165 However, given that a vesting order operates tovest movable property in Hong Kong in the foreign trustee (provided theforeign law extends to movable property in Hong Kong), it will be rarefor a foreign trustee to want to commence a bankruptcy in Hong Kongagainst the foreign debtor. To the extent that the foreign vesting orderextends to movable property in Hong Kong, the foreign trustee will beable to claim a foreign debtor’s property that is not subject to any pre-existing attachment, execution, or valid charge.166 Similarly, a foreigntrustee may be able to be appointed as receiver of the debtor’s immovableproperty in Hong Kong.167 Nevertheless, at times a foreign trustee might

164 See L.S. Sealy and David Milman, Annotated Guide to the Insolvency Legislation, 4thed (London: CCH Editions Ltd, 1994), note to UK Insolvency Act 1986, s 220, at 267(discussing some of the ‘obsolete references’ that have been repealed).

165 2 Dicey and Morris (note 13 above), Rule 163 & accompanying Comment, at 1161–1162.

166 See notes 45–48 above and accompanying text.167 See note 51 above. When seeking such relief, the foreign representative should file an

application for an order in aid. Prior to the enactment of the UK Insolvency Act 1985,statutory guidelines regarding orders in aid in bankruptcy cases were in effect in HongKong. These guidelines were set out in s 122 of the UK Bankruptcy Act 1914. See note12 above. As noted earlier, s 122 made it easier for trustees from Commonwealthjurisdictions to gain the cooperation of bankruptcy courts in other Commonwealthjurisdictions. At present, given the absence of statutory authorization regarding cross-border cooperation, a Hong Kong court may continue to assist a foreign representativeunder the court’s inherent jurisdiction. See Re Kooperman (note 40 above). Accordingto the Official Receiver, although s 122 of the UK Bankruptcy Act 1914 has beenrepealed, it remains easier for trustees from Commonwealth jurisdictions to gain theassistance of the Hong Kong courts. See note 51 above.

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find it worthwhile to commence a bankruptcy proceeding in Hong Kongagainst the foreign individual, such as1. to reach immovable property not otherwise obtainable,2. to avoid uncompleted attachments or executions,168

3. to avoid certain settlements169 or fraudulent preferences,170

4. to enable a trustee to seek the application of broad investigative pow-ers,171

5. to gain the benefit of the stay172 (although, as in liquidation, the staydoes not prevent secured creditors from realizing or otherwise dealingwith their security173), or

6. to gain the benefit of the relation back doctrine.174

Hong Kong bankruptcy law still adopts the notion that for a bank-ruptcy proceeding to be commenced, a debtor must first commit an ‘actof bankruptcy’. Section 3(1) of the Bankruptcy Ordinance specifies eightways that a debtor can commit an act of bankruptcy, which, in abbrevi-ated form, include the following:1. making a conveyance of his property to a trustee for the benefit of his

creditors generally;175

2. making a fraudulent conveyance of his property;176

3. making a fraudulent preference;177

4. with intent to defeat or delay his creditors, departing from HongKong, or being out of Hong Kong remaining out of Hong Kong, ordeparting from his dwelling-house or usual place of business, or oth-

168 Bankruptcy Ordinance, s 45.169 Ibid, s 47.170 Ibid, s 49. See notes 91–92 above.171 Bankruptcy Ordinance, s 29.172 After the presentation of a bankruptcy petition, the court may stay any action, execution,

or other legal process. Ibid, s 14. After the making of a receiving order, no creditor witha provable debt in the debtor’s bankruptcy shall have any remedy against the debtor orthe debtor’s property in respect of the debt, or shall commence any action or other legalproceeding, except by leave of the court. Ibid, s 12(1).

173 See ibid, s 12(2).174 Ibid, s 42. This doctrine ‘provides for the “relation back” of the trustee’s title to

property of the bankrupt to the time of the act of bankruptcy on which a receivingorder is made, or, if there has been more than one act of bankruptcy, the time of thefirst of these acts within the three months before the presentation of the bankruptcypetition.’ Report on Bankruptcy (note 5 above), para 14.1, at 133. See also ibid, paras14.2–14.4, at 133–134.

175 Bankruptcy Ordinance, s 3(1)(a).176 Ibid, s 3(1)(b).177 Ibid, s 3(1)(c).


erwise absenting himself, or beginning to keep house, or removing hisproperty or any part thereof beyond the jurisdiction of the court;178

5. having execution levied against him and having the goods subject toexecution either sold or held by the bailiff for twenty-one days;179

6. filing in court a declaration of his inability to pay his debts or present-ing a bankruptcy petition against himself;180

7. failing to comply with a bankruptcy notice issued under Section 4 ofthe Bankruptcy Ordinance;181 and

8. giving notice to any of his creditors that he has suspended or that heis about to suspend payment of his debts.182

The concept of ‘acts of bankruptcy’ is premised on the belief thatcertain types of wrongful conduct by the debtor, rather than the mere‘financial embarrassment’ of the debtor, should trigger a bankruptcy pro-ceeding.183 However, in practice, approximately 95 percent of bankruptcycases commenced in Hong Kong are based on the non-compliance by thedebtor with a bankruptcy notice.184 Currently, the bankruptcy notice isonly available to judgment creditors.185

The provisions regarding jurisdiction are somewhat confusing in thatthey require jurisdiction to exist at the time an act of bankruptcy occursand, in the case of a creditor’s petition, at the time the bankruptcy peti-

178 Ibid, s 3(1)(d). See Re Chan Yue Shan (1908) 4 HKLR 128, 133 (noting that acts ofbankruptcy committed outside Hong Kong, such as the act of being out of Hong Kongand remaining out of Hong Kong (which was included in then s 4(1)(d) of OrdinanceNo 20 of 1891 [hereinafter the Bankruptcy Ordinance 1891] (renumbered as s 3(1)(d),revised edition) and is presently included in s 3(1)(d) of the Bankruptcy Ordinance), areinapplicable to foreign debtors).

179 Bankruptcy Ordinance, s 3(1)(e).180 Ibid, s 3(1)(f).181 Ibid, s 3(1)(g).182 Ibid, s 3(1)(h).183 Douglas G. Baird and Thomas H. Jackson, Cases, Problems and Materials on Bankruptcy,

2nd ed (Boston: Little Brown and Co, 1990), 27.184 Report on Bankruptcy (note 5 above), para 1.13, at 11. The Law Reform Commission

has proposed that the acts of bankruptcy should be abolished and replaced by thefollowing four grounds: (1) failure of a debtor to comply with the terms of a bankruptcynotice; (2) the unsatisfied execution of a judgment against the property of a debtor; (3)the departure, or intention to depart, out of Hong Kong by a debtor knowing that anecessary consequence of his departure would be to defeat or delay his creditors,notwithstanding that his absence from Hong Kong had nothing to do with his debts;and (4) the default by a debtor under a form of voluntary arrangement. Ibid, paras1.10–1.43, at 10–18.

185 Bankruptcy Ordinance, s 4. The Law Reform Commission has recommended that ajudgment should no longer be required for the issuance of a bankruptcy notice. Reporton Bankruptcy (note 5 above), para 1.15, at 11–12.

90 Charles D. Booth

tion is filed or within a year preceding the date of filing. Section 3(2) ofthe Bankruptcy Ordinance provides that ‘a debtor’ includes the following:

any person, whether a British subject or not, who at the time when anyact of bankruptcy was done or suffered by him —(a) was personally present in Hong Kong; or(b) ordinarily resided or had a place of residence in Hong Kong; or(c) was carrying on business in Hong Kong, personally or by means of

an agent or manager; or(d) was a member of a firm or partnership which carried on business in

Hong Kong.186

Section 6(1), in turn, provides that a creditor shall not be entitled topresent a bankruptcy petition against a debtor unless:

(d) the debtor is domiciled in Hong Kong, or within a year before thedate of the presentation of the petition has ordinarily resided, or had adwelling-house or place of business, in Hong Kong, or has carried onbusiness in Hong Kong, personally or by means of an agent or manager,or is or within the said period has been a member of a firm or partnershipof persons which has carried on business in Hong Kong by means of apartner or partners or an agent or manager.187

For a creditor to petition for the bankruptcy of a debtor, the creditormust also fulfil the other requirements in Section 6 of the BankruptcyOrdinance — namely, that the debt owed by the debtor to the petitioning

186 Bankruptcy Ordinance, s 3(2).187 The Law Reform Commission has recommended that the current jurisdictional criteria

be replaced by a Hong Kong version of s 265 of the UK Insolvency Act 1986 as follows:

(1) A bankruptcy petition shall not be presented to the court . . . unless the debtor,irrespective of nationality —(a) is domiciled in Hong Kong,(b) is personally present in Hong Kong on the day on which the petition is

presented, or(c) at any time in the period of three years ending with that day —

(i) has been ordinarily resident, or has had a place of residence, in HongKong, or

(ii) has carried on business in Hong Kong.(2) The reference in sub-section (1)(c) to an individual carrying on business includes —

(a) the carrying on of business by a firm or partnership of which the individual isa member, and

(b) the carrying on of business by an agent or manager for the individual or forsuch a firm or partnership.

Report on Bankruptcy (note 5 above), paras 2.7–2.11, at 21–23.


creditor (or creditors) amounts to more than $5,000 and is liquidated andthat the act of bankruptcy upon which the petition is grounded hasoccurred within three months of the filing of the petition.188

Current Hong Kong bankruptcy law explicitly provides for only acreditor or the debtor to file a bankruptcy petition.189 On its face, thislanguage would appear to exclude the filing of a petition in Hong Kongby a foreign representative against the foreign debtor whose estate herepresents abroad. However, according to the Official Receiver, the prac-tice in Hong Kong is to permit a foreign trustee to file a bankruptcypetition as a creditor of the foreign debtor.190 Thus, if a foreign repre-

188 Bankruptcy Ordinance, s 6(1)(a), (b), (c).189 Ibid, ss 9–10. For a case involving a petition filed by a foreign debtor, see Re Chan Yee

Nam (1918) 14 HKLR 1 (ordering that a receiving order be made in the case of adebtor who, having a Hong Kong judgment and execution outstanding against him,remained out of Hong Kong after (1) finding that there had not been an abuse ofprocess and (2) noting that s 8(1) of the Bankruptcy Ordinance 1891, which wasapplicable to a case commenced by a debtor’s petition, stated that the court ‘shall’ makea receiving order, unlike s 7(3) of the Bankruptcy Ordinance 1891, which was applicableto a case commenced by a creditor’s petition and used the word ‘may’: the word ‘may’has been retained in current s 9(3) of the Bankruptcy Ordinance; although the word‘shall’ has been retained in current s 10(1) of the Bankruptcy Ordinance, an amendmentmade in 1986 gives the court the discretion not to make a receiving order if there is‘sufficient cause for no order to be made’). For a case involving a petition filed by acreditor against a foreign debtor, see Chan Yue Shan (note 178 above), 137, 138–140(interpreting applicable sections in the Bankruptcy Ordinance 1891, revised edition,some of which have been incorporated into current law and some of which have not).See note 191 below.

The Hong Kong High Court has jurisdiction over bankruptcy cases. BankruptcyOrdinance, s 2. Petitions that are unopposed may be heard by the Registrar of theSupreme Court sitting in open court. Ibid, s 99(3)(a).

190 There is conflicting case law regarding the ability of a trustee to file a bankruptcypetition as a creditor of the debtor. In support of the proposition, see Hutcheson vTaylor [1931] Scots L Times, 356, 360–361. But see the Canadian case, Re EadesEstate [1917] WWR 65, 90 (stating that the official receiver ‘is not a creditor of thebankrupt, either in his own right, or as trustee for the creditors.’).

Interestingly, s 218 of the UK Bankruptcy Act 1861 explicitly enabled a foreignrepresentative to commence a bankruptcy abroad as follows:

If any Person who shall have been duly adjudged or declared bankrupt orinsolvent in India, or any of the Foreign Dominions, Plantations, or Colonies ofHer Majesty, shall be resident or shall be possessed of Property in England,Ireland, or Scotland, or in any Colony, Plantation, or Foreign Possession of theCrown, it shall be lawful for the Assignee, Trustee, or other Representative of theCreditors of such Bankrupt or Insolvent to apply for and obtain an Adjudicationof Bankruptcy, Sequestration, or Insolvency against such Person in the Court ofBankruptcy in England, and in the proper Court in Scotland, Ireland, and suchColony, Plantation, or Foreign Possession of the Crown respectively, and by

92 Charles D. Booth

sentative wants to commence a bankruptcy in Hong Kong against a for-eign debtor, he may file the petition himself as a creditor of the debtor, orconvince a creditor or the debtor himself to file the petition. It would bebetter for the foreign representative to have the debtor file the petition,because when a creditor (which for these purposes would include thetrustee as a creditor) files, it might prove difficult to meet the jurisdic-tional requirements of Section 6(1)(d) of the Bankruptcy Ordinance.191

The Bankruptcy Ordinance should be amended to explicitly authorizea foreign representative to commence bankruptcy proceedings against theindividual or partnership whose estate she represents in the foreign pro-ceeding. It would also facilitate the bringing of such a petition to makethe presence of assets a sufficient jurisdictional criterion. Unfortunately,

virtue thereof the same Order and Disposition shall be had and taken withrespect to the Person and Property of the Bankrupt or insolvent, as would havebeen if he had been originally adjudged bankrupt or insolvent by the Court orTribunal so applied to.

UK Bankruptcy Act, 1861, 24 & 25 Vict, ch 134 (emphasis omitted). Under thisprovision, the foreign representative did not have to give proof of any act of bankruptcyor petitioning creditor’s debt. Ibid. (I am grateful to Philip Smart for bringing s 218 andthe two cases noted above to my attention.)

Section 218 was eventually replaced by s 122 of the UK Bankruptcy Act 1914. Seenote 12 above. Section 122 broadened the principles of prior s 218 through the notionof acting in aid, but deleted the explicit authorization for a foreign representative tocommence a bankruptcy case elsewhere. As noted in note 12 above, s 122 of the UKBankruptcy Act 1914 has been replaced by subsections in s 426 of the UK InsolvencyAct 1986. Section 426(5) has been interpreted as enabling a foreign representative torequest the commencement of an insolvency case in the United Kingdom without havingto fulfil the jurisdictional criteria. See Re Dallhold Estates (UK) Pty Ltd [1992] BCC394, 398–399 (making an administration order in respect of a foreign company under s426(5), which would not otherwise have been possible under s 8 of the UK InsolvencyAct 1986). See also Sealy and Milman (note 164 above), note to UK Insolvency Act1986, s 426, at 490.

191 See Chan Yue Shan (note 178 above), in which the court applied the jurisdictionalcriteria in s 6(1)(d) of the Bankruptcy Ordinance 1891 (renumbered as s 5(1)(d), revisededition), as amended by s 4 of Ordinance No 2 of 1901, which were incorporated intocurrent s 6(1)(d) of the Bankruptcy Ordinance. The court held that a Chinese traderfrom Annam (formerly part of French Indochina, now part of present day Vietnam)was not domiciled in Hong Kong, ibid, 133, and within a year of the filing of thepetition did not have a dwelling-house or ordinarily reside in Hong Kong, but did havea place of business there, ibid, 134–137. In a later decision, the court considered theapplication of s 3(c) of Ordinance No 6 of 1902 [hereinafter the Bankruptcy (Amendment)Ordinance 1902], which is not retained in current law. See ibid, 138–140. The courtalso held that it was legitimate to exercise bankruptcy jurisdiction over non-residentforeign debtors and that all of the extra-territorial provisions in the Bankruptcy Ordinance1891, revised edition, including the Bankruptcy (Amendment) Ordinance 1902, wereintra vires. Ibid, 140–143.


the Law Reform Commission has recently decided not to recommend theadoption of a presence of assets test.192

When a bankruptcy is commenced in Hong Kong, a bankruptcy trus-tee, like a liquidator, also has much independence in carrying out hisduties and exercising his powers. Creditor participation is often minimal;in contrast, the Official Receiver plays a role in every bankruptcy.193 Afterthe presentation of a bankruptcy petition, the court has the discretion tomake a receiving order for the protection of the estate.194 If a receivingorder is made, the Official Receiver is appointed as the receiver of thedebtor’s property.195 If an adjudication order follows,196 which occurs inthe majority of cases,197 the Official Receiver is almost always chosen bythe creditors to serve as the trustee.198 (Between 1959 and 1992 therewere only four cases in which the Official Receiver was not appointedtrustee.199) Although discharge is theoretically available to bankrupts, the

192 Report on Bankruptcy (note 5 above), para 2.19, at 25.193 The Law Reform Commission has proposed that the role of the Official Receiver should

even be increased. See, e.g., ibid, paras 8.7–8.15, at 69–71.194 Bankruptcy Ordinance, s 5. At the hearing of a bankruptcy petition, the court will

usually make a receiving order if the debtor claims that he cannot pay the debt onwhich the petition is based. If the debtor claims that he is able to pay, then the courtwill usually adjourn the hearing to a later date to enable the debtor to pay. Report onBankruptcy (note 5 above), para 5.1, at 41.

At any time after the presentation of the petition and before the making of areceiving order, the court may also appoint the Official Receiver as an interim receiverof the debtor’s property. Bankruptcy Ordinance, s 13.

195 Bankruptcy Ordinance, s 12(1). The receiving order does not, however, make the debtora bankrupt. Report on Bankruptcy (note 5 above), para 5.2, at 41.

196 Bankruptcy Ordinance, s 22(1). It is the adjudication order that adjudges the debtorbankrupt, and it is at that moment that the property of the bankrupt vests in the trustee.Ibid, s 58(1).

197 Report on Bankruptcy (note 5 above), para 5.8, at 42 (noting that it is rare for a debtorto settle his debts after the making of a receiving order). See also Bankruptcy Ordinance,ss 20–21 (compositions and schemes of arrangement); Report on Bankruptcy (note 5above), para 6.2, at 46; paras 6.8–6.11, at 50. Of the 294 bankruptcy cases in 1991–92in which a receiving order was made, an adjudication order followed later in at least212 cases. Annual Departmental Report of the Hong Kong Registrar General, 1991–92(1992), para 108, at 40.

198 See Bankruptcy Ordinance, s 23(1). This will be even truer under the Law ReformCommission’s proposals, pursuant to which the two-step bankruptcy procedure consistingof the receiving order and the adjudication order will be replaced by a one-step processconsisting of a bankruptcy order only. Under this new scheme, the Official Receiver willhave the discretion whether to serve as the trustee. See Report on Bankruptcy (note 5above), chs 5, 8.

199 Annual Departmental Report of the Hong Kong Registrar General, 1991–92 (note 197above), para 108, at 40.

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Law Reform Commission has noted ‘that for the overwhelming majorityof bankrupts bankruptcy is a life sentence’.200

Under its inherent jurisdiction, the court has the discretion to dismissany bankruptcy petition, and under Section 9(3) of the Bankruptcy Ordi-nance, the discretion to dismiss a creditor’s petition.201 The court also hasthe discretion under Section 100(2) to adjourn any proceedings before it,and under Section 104 to stay bankruptcy proceedings permanently or fora limited time. This power to stay proceedings is rarely exercised.202 In theunusual event that a bankruptcy is brought in Hong Kong against adebtor who has been adjudicated bankrupt abroad, the more likely sce-nario would be for there to be a concurrent bankruptcy in Hong Kong.203

The Hong Kong court could issue a turnover order204 or could settle allclaims in the Hong Kong proceedings. Alternatively, the court could ap-prove a scheme of arrangement agreed upon by the Hong Kong bankruptcytrustee and the foreign representative for a pooling of the debtor’s assetsand a ratable distribution among creditors generally.205

Although the Hong Kong courts have the discretion to issue turnoverorders in concurrent bankruptcies, the term ‘ancillary bankruptcy’ is notgenerally used to describe a bankruptcy in which such cooperation oc-curs. As noted above, I believe that the term is appropriate and conceiveof a continuum of types concurrent insolvencies under a universality/plurality approach that runs from an ‘ancillary bankruptcy’, where theaim is to assist the foreign trustee, to a full-scale concurrent bankruptcy,where the Hong Kong trustee and the foreign trustee are on equal foot-ing.206 If the Law Reform Commission had recommended the enactmentof a jurisdictional ground based on the presence of assets, more cases

200 Report on Bankruptcy (note 5 above), para 17.1, at 156. See Bankruptcy Ordinance, s30 (discharge provision). The Law Reform Commission has proposed that the dischargeprovisions be liberalized and that an automatic discharge be adopted in the majority ofcases. See Report on Bankruptcy (note 5 above), ch 17.

201 Under Section 10(1) of the Bankruptcy Ordinance, the court also has the discretion notto make a receiving order in a case commenced by a debtor’s petition. See note 189above.

202 Smart, Cross-Border Insolvency (note 13 above), 34. See also ibid, 43–55.203 See ibid, ch 11. The Privy Council case of Lyall v Jardine, Matheson, & Co (1870) LR 3

PC HK 319, 330–331 is also of interest (involving a partnership that carried on businessin London and Hong Kong; the Privy Council held that a bankruptcy adjudicationagainst a partner of the firm resident in England would not prevent the subsequent jointbankruptcy adjudication against the firm in Hong Kong).

204 See Smart, Cross-Border Insolvency (note 13 above), 216–217.205 Ibid, 214–215, 220. See also Woloniecki (note 13 above), 661–662.206 See text accompanying note 153 above. Local law, rather than foreign law, would be

applicable in both ancillary and concurrent bankruptcies.


would likely have arisen in which an ancillary bankruptcy would havebeen appropriate.

The administration of transnational bankruptcy cases would be im-proved if changes were made to the Bankruptcy Ordinance that are similarto the reforms recommended above for enactment in the companies legis-lation. For example, the Bankruptcy Ordinance should be amended toinclude definitions of ‘foreign representative’ and ‘foreign proceeding’.The ordinance should also provide for the filing of a bankruptcy petitionin Hong Kong against a debtor by a foreign representative whose estatehe represents in the foreign proceeding, provided the foreign representa-tive is so authorized under foreign law. Other provisions could be enactedto codify aspects of the distinction between ancillary bankruptcies andother concurrent bankruptcies. These sections or other sections shouldalso include guidelines for a court to consider when determining whetherto grant assistance to foreign bankruptcies, as well as a list of the types ofassistance that a Hong Kong court may order.

ABILITY OF HONG KONG TRUSTEES AND LIQUIDATORSTO SEEK CROSS-BORDER ASSISTANCE INTRANSNATIONAL INSOLVENCIES

Hong Kong bankruptcy law adopts the universality approach in definingthe property that vests in a trustee appointed in a bankruptcy in HongKong. Section 43(i) of the Bankruptcy Ordinance provides that the prop-erty of the debtor divisible among his creditors includes ‘all such propertyas may belong to or be vested in the bankrupt at the commencement ofthe bankruptcy or may be acquired by or devolve on him before hisdischarge’. Section 58 of the Bankruptcy Ordinance, in turn, provides thatimmediately upon a debtor being adjudged bankrupt, the property of thebankrupt vests in the trustee.207 Finally, Section 2 of the BankruptcyOrdinance defines ‘property’ expansively as including ‘money, goods, thingsin action, land and every description of property, whether real or personaland whether situate in Hong Kong or elsewhere’.208 Thus, Hong Kong

207 See also Bankruptcy Ordinance, s 42 (providing for the relation back of the trustee’stitle).

208 (Emphasis added). The language quoted above was also part of the definition of ‘property’in s 3 of the Bankruptcy Ordinance 1891. As noted earlier, the court in Chan Yue Shan(note 178 above), 140–143, held that all of the extra-territorial provisions in the 1891Ordinance, revised edition, were intra vires.

96 Charles D. Booth

law seeks to vest immovable property abroad in Hong Kong trustees,though Hong Kong will not recognize the effect of a foreign vesting orderon immovable property located in Hong Kong.209 Of course, althoughHong Kong law provides that a trustee’s title extends to property abroad,whether or not such property actually will pass to the Hong Kong trustee‘must depend in the last resort on the lex situs’.210

In regard to the extraterritorial jurisdiction of Hong Kong liquidations,the Companies Ordinance is silent.211 However, it is clear from the deci-sion in the Hong Kong case of American Express International BankingCorp v Johnson (‘American Express’)212 that a Hong Kong liquidator maygo abroad to protect the overseas property of a company being wound upin Hong Kong.213 In the court’s view, a liquidator may commence insol-vency proceedings abroad for that purpose, but should first take legaladvice and must seek judicial approval, as the liquidators in AmericanExpress had done.214

The more difficult issue in American Express was whether Section269 of the Companies Ordinance, which governs the avoidance of un-completed attachments and executions, has extraterritorial effect. SeveralUS creditors sought (a) declaratory relief that they were entitled underHong Kong law to retain the benefits of their US attachments and (b) aruling that the Hong Kong liquidators should withdraw the Chapter 7liquidation that they had commenced under Section 303(b)(4) of the USBankruptcy Code against Axona International Credit and Commerce Ltd.215

209 See 2 Dicey and Morris (note 13 above), comment to Rule 164, at 1163; notes 45–48above and accompanying text. However, the Hong Kong courts would considerappointing a foreign trustee as an auxiliary receiver with the power to sell the propertyand distribute the proceeds. See note 51 above and accompanying text.

210 2 Dicey and Morris (note 13 above), comment to Rule 164, at 1164, and SecondSupplement (note 16 above), 102. Section 55 of the Bankruptcy Ordinance was enactedin 1984 to assist trustees in their handling of property overseas. Section 55 provides asfollows:

Where the bankrupt is possessed of any property out of Hong Kong, the trusteeshall require him to join in selling the same for the benefit of the creditors and tosign all necessary authorities, powers, deeds and documents for the purpose, andif and so often as the bankrupt refuses to do so he may be punished for acontempt of court.

211 The Companies Ordinance should be amended to clarify the effect that Hong Kongliquidations are intended to have on property located abroad.

212 Note 89 above.213 Ibid, 378, 382–383.214 Ibid, 379–380. The court also noted that the liquidators had acted with the authority of

the committee of inspection. Ibid, 379.215 Ibid, 378–379.


The US creditors asserted that Section 269 of the Companies Ordi-nance governed their attachments in the United States. They contendedthat they should be able to retain the benefit of their attachments, sincethey had received actual payment of their debts and had thereby com-pleted their attachments before the commencement of the liquidation inHong Kong.216 The Hong Kong liquidators and the Official Receiverargued, in contrast, as follows: the Companies Ordinance ‘is a domesticcode. It governs domestic executions against goods and lands within thejurisdiction of the court, or attachments which have occurred in HongKong, and does not extend to matters . . . outside the jurisdiction of thiscourt. Such matters . . . are governed . . . by the lex situs . . . .’217 Thecourt favoured the latter submission and stated:

There is nothing whatever in the Companies Ordinance to suggestthat the legislature in Hong Kong, adopting in this respect (withmodification) parliamentary legislation from the United Kingdom, wasintending any of the words used to extend or operate beyond thejurisdiction of this court. On the contrary, if you look at the words used,all the indications are against it.218

The court noted that in relation to executions against goods or landor attachments of debts, ‘[o]ne thing which is plain as a pike staff is thatthere is no suggestion that the Hong Kong Court here can exercise juris-diction over land, under any principle, outside the jurisdiction of thiscourt.’219 The court did note that the definition of property in Section 2 ofthe Bankruptcy Ordinance expressly applies ‘to property anywhere’, butthen added that ‘that is the only extended meaning given to any term inthe corresponding bankruptcy provisions. So, the direct application ofnormal principles of construction, lead[s] one to the conclusion that thisis a domestic code.’220 In the court’s view, therefore, Section 269 of theCompanies Ordinance does not govern transactions abroad; rather, thosematters arising in liquidations involving executions and attachments areto be decided by the lex situs of the property in question.221

216 Ibid, 380–381. See Companies Ordinance, s 269. See also note 89 above andaccompanying text.

217 American Express (note 89 above), 381.218 Ibid, 384. See also ibid, 383.219 Ibid, 384.220 Ibid.221 Ibid, 381–385. The court added in obiter that questions of preference in insolvency

should also be decided by the lex situs. Ibid, 382. The related question of how thesematters should be resolved in the context of bankruptcy has not yet been addressed bythe Hong Kong courts. It would be helpful if the insolvency legislation could be amendedto clarify whether the avoidance powers are to have extraterritorial effect.

98 Charles D. Booth

The court also rejected the creditors’ contention that the Hong Kongliquidators should have commenced a case under Section 304 of the USBankruptcy Code, which would have made it impossible to avoid thepreferences in the United States.222 Therefore, the court refused to orderthat the Chapter 7 proceedings commenced in the United States underSection 303(b)(4) should be withdrawn.223

Of course, if the actions or proceedings commenced abroad provesuccessful, the Hong Kong liquidator may return to Hong Kong with theforeign assets, if so ordered by the foreign court, and distribute themunder Hong Kong law. This was the result reached in the US bankruptcycase of In re Axona International Credit and Commerce Ltd (‘Axona’).224

As noted above, it is clear that Hong Kong law provides for the titleof a bankruptcy trustee to extend to property abroad. Similarly, it is clearthat a Hong Kong liquidator may seek judicial assistance abroad to pro-tect the overseas assets of a company being wound up in Hong Kong.However, it is a separate matter whether the foreign courts will be recep-tive to the claims of a Hong Kong representative. This matter may beresolved by multilateral or bilateral treaties and, in the absence of treaties,by reference to the law of the jurisdiction in which recognition is sought.To date, Hong Kong is not a member of any international conventionregarding the recognition of cross-border insolvencies.

Although Hong Kong and England have not entered into a reciprocalagreement, England has unilaterally provided for the recognition of HongKong insolvencies through the enactment of Section 426(4) of the UKInsolvency Act 1986 (co-operation between courts exercising jurisdictionin relation to insolvency). This section states that ‘[t]he courts havingjurisdiction in relation to insolvency law in any part of the United King-dom shall assist the courts having the corresponding jurisdiction in anyother part of the United Kingdom or any relevant country or territory.’225

Section 426(11)(b) of the UK Insolvency Act 1986, in turn, specifies that‘relevant country or territory means any country or territory designatedfor the purposes of this section by the Secretary of State by order made by

222 Ibid, 385–388.223 Ibid, 388.224 88 B.R. 597 (Bankr SDNY 1988), aff’d, 115 BR 442 (SDNY 1990), appeal dismissed,

924 F2d 31 (2d Cir 1991).225 UK Insolvency Act 1986, s 426(4). For further analysis of s 426, see Smart, Cross-

Border Insolvency (note 13 above), 259–264. See also Fletcher (note 7 above); Woloniecki(note 13 above), 648–663. Section 426 replaced s 122 of the UK Bankruptcy Act 1914.Until its repeal in 1985, s 122 provided for bankruptcy courts throughout theCommonwealth to assist each other. See note 12 above.


statutory instrument.’226 In 1986 the Secretary of State of England speci-fied that Hong Kong was a relevant territory.227 Thus, in a case involvinga request made to a court in the United Kingdom by a Hong Kongliquidator or trustee, the United Kingdom court ‘shall’ assist the HongKong court.228 Such assistance was provided in a 1992 case in which anEnglish court appointed the Hong Kong Official Receiver as receiver ofthe Hong Kong bankrupt’s real property in England, with the power tosell and deal with the proceeds of sale.229

The courts in the United States have also been receptive to the claimsof Hong Kong representatives in the two reported cases to date.230 In bothcases the US court recognized the Hong Kong insolvency: Axona231 (in-volving the recognition of a Hong Kong liquidation) and In re Chan232

(involving the recognition of a Hong Kong bankruptcy). Axona is espe-cially noteworthy for the high degree of cooperation between the UStrustee and his Hong Kong counterparts. In that case, after finding thatHong Kong law satisfied the relevant criteria under the US BankruptcyCode, the US court ordered the transfer of assets to Hong Kong to beadministered in the Hong Kong liquidation under Hong Kong law.

In contrast, in China’s only reported transnational insolvency case todate, Liwan District Construction Co v Euro-America China PropertyLtd,233 the Chinese court applied a territoriality approach and refused torecognize a Hong Kong liquidator. More precisely, the Chinese court

226 UK Insolvency Act 1986, s 426(11)(b).227 UK Co-operation of Insolvency Courts (Designation of Relevant Countries and Territories)

Order 1986, SI 1986, No 2123.228 UK Insolvency Act 1986, s 426(4). Under s 426(5) of the UK legislation the English

court would have a discretion to apply either English law or relevant Hong Kong law.See Smart, Cross-Border Insolvency (note 13 above), 260, 263–264.

229 Official Receiver of Hong Kong v Keith Thomas Philcox, Ch 1992 O 6052, Order(High Court of Justice, Chancery Div, 13 Aug 1992).

230 For a general discussion of US transnational insolvency law, see Booth, ‘Recognition ofForeign Bankruptcies’ (note 102 above).

231 Note 224 above. For further discussion and analysis of this case, see Booth, ‘Recognitionof Foreign Bankruptcies’ (note 102 above), 220–229, and Charles D. Booth,‘Transnational Insolvency: Cross-Border Co-operation Between the United States andHong Kong—In re Axona International Credit and Commerce Limited ’, Case Comment(1993) 23 HKLJ 131.

232 1993 US Dist LEXIS 7864 (SDNY, 9 June 1993). See also Scientex Corp v Harry Kay,Memorandum of Decision and Order, CV 82–0410-RJK, unrep (CD Cal 28 July 1986)(for reasons of comity, dismissing a cross-claim against a company that was in the midstof liquidation in Hong Kong).

233 A Court in Guangdong (Reported 9 Feb 1990). For discussion and analysis of this case, seeCharles D. Booth and Donald J. Lewis, ‘Liwan District Construction Company v Euro-America China Property Limited ’, Case Comment (1990) 6 China Law & Practice 27.

100 Charles D. Booth

found that the liquidator appointed in Hong Kong to liquidate a HongKong company lacked authority to represent the Hong Kong company ina contract action in the Chinese courts. One would have hoped that theChinese court would have been more receptive to the claims of a HongKong liquidator, given the approach of 1997 and the increasing cross-border investment by both Hong Kong and Chinese companies.

CONCLUSION

Over the years, common law principles have developed and have beenapplied in Hong Kong to matters involving both the recognition of for-eign insolvencies and the consequences of recognition. Under Hong Konglaw, a foreign trustee or liquidator may claim movable property in HongKong that is not subject to prior attachment, execution, or valid charge.Hong Kong law also enables a foreign representative to pursue a varietyof other non-insolvency options, as well as to commence a liquidation orbankruptcy in Hong Kong. In transnational insolvencies the Hong Kongcourts can foster cross-border cooperation under a universality/pluralityapproach through ancillary insolvencies or other types of concurrentinsolvencies.

Although cross-border cooperation is possible at present, even greatercooperation would most likely occur if detailed statutory guidelines wereenacted for handling transnational liquidations and bankruptcies. It wouldbe best if these new guidelines were enacted before 1997.

These guidelines should incorporate many of the existing statutoryprovisions and common law principles, some of which should first beclarified or supplemented. The enactments should include rules for therecognition of foreign insolvencies, jurisdictional requirements, criteria toassist courts in deciding whether to grant ancillary assistance to foreigninsolvencies, and examples of the types of assistance that a court maygrant.

Special attention should be given to updating and restructuring Part Xof the Companies Ordinance. Some of the obsolete provisions should berepealed and the inconsistency between Section 327(1) and Section 331should be removed.

Hong Kong trustees and liquidators are permitted to seek recognitionand assistance from foreign courts, although whether such assistance isprovided is a matter to be addressed by foreign courts. Further thoughtshould be given in Hong Kong regarding how best to ensure that foreigncourts continue to cooperate with Hong Kong insolvencies. In addition,


the bankruptcy and companies legislation should be amended to clarifythe extraterritorial effect of Hong Kong insolvencies, particularly withrespect to the application of the avoidance powers. Lastly, given theapproach of 1997 and the resulting uncertain economic climate in HongKong, it is important that Hong Kong and China attempt to resolve cross-border insolvency matters.

Oversubscription of Initial Public Offerings:Success or Failure? An Analysis of Directors’ Duties

When Issuing SharesI.A. Tokley

. CHAPTER FOUR .

INTRODUCTION

In August of 1993, one of Hong Kong’s leading businessmen spoke on thesubject of initial public offerings (‘IPOs’) of shares in Hong Kong.1 Hewas replying to comments made on the response by the public to theoffering of shares in Shanghai Petroleum Company. Mr Tose had sug-gested that the same level of oversubscription of an IPO in London orNew York would have been considered a success. The offering, whichwas 1.5 times oversubscribed,2 was considered by some in the media inHong Kong as a relatively ‘poor response’.3 Certainly, in comparison withan earlier offer which had been oversubscribed 650 times, this may haveseemed the case.4 Indeed, oversubscription of IPOs had not been unusualin the previous twelve months5, and it had become so commonplace that

1 Mr Philip Tose of Peregrine Holdings Limited.2 That is, the number of applications for shares by the company exceeded the number of

shares on offer by 50 percent.3 South China Morning Post, Business Post, 28 August 1993.4 The table contained in page 3 of the report of the Joint Working Party of the Securities

and Futures Commission and the Stock Exchange of Hong Kong shows that theoversubscription of eight particular listings ranged from 99 times to 658 times, with theaverage being over 350 times. The Joint Working Party of the Securities and FuturesCommission and the Stock Exchange of Hong Kong, The Securities Market Implicationsof the Level of Over-Subscriptions in Recent Public Offerings (Aug 1993) [hereinafterthe Joint Working Party Report].

5 Ibid, para 9, at 3.

104 I.A. Tokley

merely being fully subscribed was seen as a failure rather than a success.For example, in eight IPOs during 1992 and 1993, the average level ofoversubscription was 358 times; the average amount committed by appli-cants was US$11.22 billion per IPO; and the average actually sought bythe IPO was only US$37.3 million.6 This chapter examines whether, fromthe company’s perspective, there is reason to question the ebullience overthe issue of oversubscription of shares.7

Oversubscription is also a matter that concerns the regulators of thefinancial market, with a number of different bodies undertaking reviews.The Stock Exchange of Hong Kong and the securities watchdog, theSecurities and Futures Commission, have prepared a joint working partyreport on the problem.8 Moreover, the Hong Kong Monetary Authorityhas also produced a report containing a number of guidelines.9 However,for the most part, these reports involve matters that differ from thoseconsidered here. This chapter concentrates on the offer price of an IPOand the responsibilities of those who set that price.

The offer price

Is the offer price relevant to oversubscription of an IPO? There are anumber of reasons why a person chooses to apply to subscribe for sharesin a particular company. One reason, although not the only one, will un-doubtedly be the offer price of the shares.10 The market will determine thevalue of those shares on a number of criteria, including the following:11

1. the value of a company’s existing assets;2. the potential growth and profitability of a company; and3. the market demand for the shares.

If, on those criteria, the market determines that an IPO is at anappropriate level, then the offering should be successful. Where there is agreat disparity between the number of shares offered by a company and

6 Ibid, para 14, at 4.7 See ibid, para 12, at 4 (raising a similar concern).8 See note 4 above. See also discussion of oversubscription of IPOs in I. Ramsay and R.

Sidhu, ‘Underpricing of Initial Public Offerings and Due Diligence Costs: An EmpiricalInvestigation’ (1995) 13 Companies & Securities Law Journal 186; C. McGuinness, ‘AnExamination of the Underpricing of Initial Public Offerings in Hong Kong 1980–90’(1992) 19 Journal of Business Finance and Accounting 165.

9 Hong Kong Monetary Authority, Financing the Subscription of New Share Issues (1993).10 The Joint Working Party noted that there was ‘no single cause of the over-subscription

phenomenon’. Joint Working Party Report (note 4 above), para 10, at 3.11 Those criteria listed are not, by any means, the only ones.

Oversubscription of Initial Public Offerings: Success or Failure? 105

the number of applications to subscribe for shares to be received, thequestion must be asked whether the same criteria that the market used toevaluate an offering was used by the company itself in setting the offerprice.12 The concern is whether a company could have obtained addi-tional capital if the offer price had been set higher or, alternatively, couldhave raised the same amount by issuing fewer shares. If so, then from acompany’s perspective, an oversubscribed IPO might not be as successfulas the media and market proclaim.

It has been alleged that the cause of oversubscription was simply thevery liquid state of the Hong Kong economy.13 This oversupply of fundscreated conditions for greater demand on the supply of shares which, inturn, led to oversubscription. However, this was not the only cause; onefundamental element necessary for oversubscription, underpricing, mustalso have been present.14 Indeed, on the basis of its investigations, theJoint Working Party concluded that ‘it would appear that some newissues may have been under-priced when compared with what the marketis prepared to pay for similar listed assets and businesses.’15

The Joint Working Party looked at the question from a differentperspective from that considered here. The concern of the regulators wasto determine whether the high levels of oversubscription warranted inter-vention.16 Essentially, oversubscription was perceived as a market-createdphenomenon.17 Accordingly, the Joint Working Party considered ways ofremedying defects within the market and suggested that changes be madein the following four areas:• the application and allotment process;• the environment in which prices are set;• the funding of brokers; and• market education.18

In looking at the offer price, the Joint Working Party concentrated ontwo areas: (1) the calculation of the issue price through the use of PriceEarning Multiples (‘PEMs’);19 and (2) the regulation of the ‘Grey Market’.20

12 And, if not, why not.13 Joint Working Party Report (note 4 above), para 11, at 3.14 Ibid, para 12, at 3. See also ibid, para 40, at 10 (noting that pricing plays a very

important part in the success or failure of a new issue).15 Ibid.16 Ibid, para 1, at 1.17 Ibid, paras 9–15, at 3–4.18 Ibid, para 21, at 14.19 Ibid, para 39, at 10.20 Ibid, paras 41–42, at 10.

106 I.A. Tokley

The Joint Working Party considered the ability of the ‘unsophisticatedretail investor’21 to understand the PEM. In Hong Kong, it was explained,the practice was to present the PEM calculated on the basis of a weightedaverage number of shares in issue during the relevant period.22 (In otherinternational markets the PEM is calculated on a fully diluted basis. Thiswould generally result in an increase of the PEM, with the possible resultthat the offer price would seem less attractive, reducing the possibility ofoversubscription. The recommendation of the Joint Working Party wasthat the PEM should be ascertained on a fully diluted basis. This recom-mendation was immediately accepted and implemented by the StockExchange of Hong Kong.23) This practice, however, cannot account forthe significant oversubscription which took place in the Hong Kong mar-ket. It remains to be seen whether the implementation of the Joint WorkingParty’s recommendation will result in a reduction in the level, or number,of oversubscriptions. However, the recommendation deals at only onelevel with the question of the setting of an offer price. The Joint WorkingParty did not examine in any detail the criteria used by management ofthose companies whose IPOs were so heavily oversubscribed. In the caseof Denway Ltd, the company sought to raise $402.6 million and receivedapplications amounting to $217 billion. Such a large discrepancy cannotbe solely attributed either to the method of calculating the PEM or,indeed, to the high liquidity of the Hong Kong market.

The primary issue considered in this chapter is whether the failure toset the appropriate offer price results in a notional loss to a company.Three related legal issues are also addressed:1. Who is responsible for the notional loss and why?2. Is there any possibility of redress against those responsible?3. Who may take action for redress?

It is acknowledged that, in practice, these issues are complicated bythe difficulty in establishing loss and proving that it would have beenpossible for an offer to have been fully subscribed if the offer price hadbeen set at a higher level.

These matters are further complicated by the consequences that flowfrom a high level of oversubscription, most importantly, that the marketprice of shares upon listing on the Stock Exchange will generally increase.From a simplistic point of view, this might appear to benefit individualshareholders at the expense of the company as a whole.

21 Ibid, para 39, at 10.22 Ibid.23 Ibid, para 40, at 10.


It is outside the scope of this chapter to look closely at the economicquestions which underpin the success of an IPO.24 As such, an assumptionis made that in certain cases25 it is possible to establish that an offer priceof shares could have been increased with full subscription still beingachieved. It is not necessary to identify the level at which the increase inthe offer price would begin to affect the number of applications, althoughit is certainly acknowledged that any increase would have some down-ward effect on the level of applications.26

THE RESPONSIBILITY OF DIRECTORS WHEN ISSUINGSHARES

It is necessary to look first at the ability of directors to issue shares in acompany. The ability of directors to issue shares has been made clear in anumber of cases.27 The exercise by the directors of this power is subject toa number of duties. In Hong Kong, in addition to certain limited statutoryduties,28 directors are subject to common law and fiduciary duties. Direc-tors owe these duties individually even where they may have acted as abody. More importantly, directors owe common law and fiduciary dutiesto the company29 and not, contrary to some opinion,30 to shareholders.Indeed, unlike corporation law in the United States, company law inCommonwealth jurisdictions has a more limited concept of shareholders’rights.31 There are historical, cultural, and practical reasons for theselimitations, which continue to exist notwithstanding calls for change.32

24 Ibid, para 12, at 4.25 That is, those of great oversubscription.26 These are, in essence, evidentiary issues and it is assumed that it would be no less

difficult to ascertain the loss of potential capital than it is to establish future loss in atort case.

27 See, e.g., Marshall’s Valve Gear Co Ltd v Manning Wardle & Co [1909] 1 Ch 267.28 Companies Ordinance (cap 32, LHK).29 Percival v Wright [1902] 2 Ch 421.30 During 1993 the Stock Exchange of Hong Kong and the Securities and Futures

Commission published notices in the newspapers identifying that directors owed dutiesto the company and the shareholders. It is clear though that directors are not expectedto disregard the interests of members when considering what to do (e.g., when declaringdividends).

31 See Briess v Woolley [1954] AC 333 (HL).32 See the Cohen Committee, United Kingdom, Committee on Company Law Reform,

Cmnd 6645 (1945). See also the Jenkins Committee, United Kingdom, Committee onCompany Law Amendment, Cmnd 1749 (1962).

108 I.A. Tokley

The common law duty on directors is a duty to exercise care and skill.The precise meaning of this duty has been discussed at length.33 It issometimes difficult to distinguish between the limits and obligations im-posed under this head of duties and those under the other areas. In ReCity Equitable Fire Insurance Co,34 Romer J identified the following threepropositions that reflect the common law position:1. A director need not exhibit in the performance of his duties a greater

degree of skill than may reasonably be expected from a person of hisknowledge and experience.

2. A director is not bound to give continuous attention to the affairs ofhis company. His duties are of an intermittent nature to be performedat periodic board meetings even though the director is not bound toattend all meetings.

3. A director is entitled to delegate some of his activities to officials andto rely on experts where, having regard to the articles and the natureof the circumstances, such matters may be properly delegated.

The issues raised under the first two propositions are not directlyrelevant to the matters considered here. Whilst the third proposition isrelevant, it is more appropriate to discuss this issue together with aspectsof fiduciary duties. The fiduciary duties owed by directors are well knownbut, in the context of this discussion, only two arise:35

1. to act in good faith for the benefit of the company; and2. to exercise the company’s powers only for proper purposes.36

Duty to act in good faith

The rule that directors must act honestly and in good faith is one forwhich it is difficult to give a definitive meaning. Indeed, in most cases, the

33 See, e.g., Re Denham & Co (1883) Ch D 752; Selangor United Estates Ltd v Craddock(No 3) [1968] 1 WLR 1555; Dovey v Cory [1901] AC 477 (HL).

34 [1925] Ch 407.35 It may be argued that a third duty may also arise: to avoid possible conflicts between personal

interests and interests of the company. This may arise when a director is a substantialshareholder in the company. If there is a large oversubscription then it is common that themarket value of the shares will rise significantly in the days following listing. This will greatlyand directly benefit an existing shareholder. The conflict arises because the company doesnot receive the benefit of extra capital. This is discussed in more detail below.

36 There is some dispute as to whether in fact this is a separate duty. The court in TeckCorp Ltd v Millar (1972) 33 DLR (3d) 288 [hereinafter Teck] said that the purpose forwhich directors had acted would not be improper if they were acting in the company’sbest interest and there were reasonable grounds for the belief. See also discussion inMayson and French, Company Law, 10th ed (London: Blackstone Press Ltd, 1993).


courts have had to rely on a common-sense approach as to what conductfalls short of the criteria. Directors are to be judged by their standardsand not by what a court thinks is appropriate. In Re Smith & Fawcett,37

the court said that directors are required to act ‘bona fide in what theyconsider — and not what a court may consider — to be in the bestinterests of the company.’38 This view was reinforced by the Privy Councilin Howard Smith Ltd v Ampol Petroleum Ltd (‘Howard Smith’)39 whereLord Wilberforce said

There is no appeal on merits from management decisions to courts oflaw: nor will courts assume to act as a kind of supervisory board overdecisions within powers of management honestly arrived at.40

In the earlier case of Charterbridge Corp Ltd v Lloyds Bank Ltd,41

Pennycuick J had said

The proper test . . . must be whether an intelligent and honest man in theposition of a director of the company concerned, could, in the whole ofthe existing circumstances, have reasonably believed that the transactionswere for the benefit of the company.42

These decisions, however, also imply that directors may be foundwanting if they fail to turn their minds to whether or not a transaction isin the best interests of the company. An ‘honest’ person cannot reason-ably believe something unless he or she first considers it.

In general, there is great difficulty in presenting a clear and definitiveexplanation of the meaning of the requirement that directors act in goodfaith. Indeed, from an academic perspective, the decision by courts to relyon a so-called ‘common-sense’ approach is unsatisfactory. This decisionhas resulted in a lack of certainty as to the meaning of the duty and indifficulty in enforcing the duty against directors in other than extremeand blatant cases of breach. Notwithstanding these difficulties, it is neces-sary to consider whether a director is acting in the company’s best interestwhen he or she sets an offer price at a level lower than the market price.This is complicated by the reliance of directors on financial advisers whensetting the price of an IPO. These advisers may suggest that there are anumber of good reasons for the determination of a low offer price, for

37 [1942] 1 All ER 542.38 Ibid, 543. See also Re W & M Roith Ltd [1967] 1 WLR 432.39 [1974] AC 821 (PC) [hereinafter Howard Smith].40 Ibid, 832.41 [1970] Ch 62.42 Ibid, 74.

110 I.A. Tokley

example, that this practice is standard in the Hong Kong market43 and isnecessary for the company’s future good image. Although an offering ofshares at an undervalue may reduce the company’s capital, the IPO willbe a success and future issues may be equally successful as investors willbe encouraged by the success of past issues.

On the basis of the case law, it may be difficult to establish that a di-rector has breached his or her duty when advised by the company’s advisers:directors are clearly entitled to rely on experts.44 However, this argumentassumes one important fact: that the directors have understood or giventhought to both arguments as to price. Thus, it is submitted that to satisfythe test of bona fides, the directors should turn their minds to the poten-tial loss of capital and, in light of that fact, to decide whether the possibilityof future successful issues is in the best interests of the company.

What if a director never read the adviser’s report? The courts couldnot have intended that directors’ subjective ignorance of, or failure tounderstand concepts of, company law could be an excuse under this headof directors’ duties. Indeed, it has been said that there has always been anobjective element to the test45 and that the directors must have truly andreasonably believed at the time that what they did was for the benefit ofthe company.46

In contrast to this objective requirement must be viewed the policy ofthe duty to act bona fide. Is it enough to satisfy the test that the directorhad been acting bona fide in his or her ignorance? The meaning of bonafides was considered by Bowen LJ who said

What would be the natural limit of their power . . . ? Bona fides cannotbe the sole test, otherwise you might have a lunatic conducting theaffairs of the company, and paying away its money with both hands in amanner perfectly bona fide yet perfectly irrational.47

Moreover, courts have always approached such issues on the basis ofvalue judgments rather than of strict principles or legal analysis of theappropriate conduct. As Jacobs J said in Crumpton v Morrine Hall PtyLtd:48

43 This would be supported by comments in the Joint Working Party Report (note 4above), para 12, at 3.

44 See, e.g., the third proposition from City Equitable Fire Insurance Co on page 108 above.45 H. Lindgren, ‘The Fiduciary Nature of a Company Board’s Power to Issue Shares’

(1971) Western Australia Law Review 364, 372.46 Hirsche v Simms [1894] AC 654, 661 (per Earl of Selbourne).47 Hutton v West Cork Rlwy Co (1883) 23 Ch D 654, 671 (CA).48 [1965] NSWLR 240 (SCt NSW).


49 Ibid, 244.50 I. Sealy, ‘Bona Fides and Proper Purposes in Corporate Decisions’ (1989) 15 Monash

Law Review 263, 276.51 This approach would also be consistent with the first proposition in City Equitable Fire

Insurance Co on page 108 above.52 See the discussion in Sealy (note 50 above), 276.53 Howard Smith (note 39 above).54 Ibid; Piercy v Mills [1920] 1 Ch 77; Hogg v Cramphorn Ltd [1967] Ch 254.

It seems to me that no amount of legal analysis or analytical reasoningcan conceal the fact that the decision has in the past turned, and mustturn ultimately, on a value judgment formed in respect of the conduct ofthe majority — a judgement formed not by any strict process of reasoningor bare principle of law but upon the view taken of the conduct.49

Notwithstanding the protection offered to directors by the uncer-tainty of the law, it is clear that there has been a shift in the policy ofcourts towards directors. Sealy remarks as follows:

But it is becoming apparent that we cannot rely on yesterday’s law formuch longer; and some major shifts are already perceptively under way,both in the rules and concepts being used, and in judicial attitudes andtechniques.50

It is difficult, without the benefit of more recent authority, to see howa court in the 1990s would approach the matter of bona fides. It wouldnot be surprising or unreasonable for courts to impose a higher standardon directors of publicly listed corporations, given that they are entrustedwith control of funds subscribed to by the public and are remuneratedgenerously.51 Indeed, there is evidence that greater responsibility has, infact, been placed on directors in jurisdictions which have recently beenaffected by recession.52

Exercise powers only for their proper purpose

Under this head of directors’ duties, it is clear that where directors haveused a power of a company to gain advantage for themselves, the powerhas been used for an improper purpose.53 However, what is less wellunderstood is that directors may be liable for breach if they have exer-cised a power for a different purpose from that for which it was intended,even if the directors have used this power honestly.54 It is this secondaspect of the duty that is pertinent to this discussion.

112 I.A. Tokley

It is best to avoid using emotive language in this area and therebyavoid unnecessary confusion. For example, the exercise of a power forother purposes is occasionally referred to as a ‘fraud on a power’. Theterm was explained in Vatcher v Paull55 as follows:

The term ‘fraud’ in connection with a fraud on a power does notnecessarily denote any conduct on the part of the appointor amountingto fraud in the common law meaning of the term or any conduct whichcould properly be termed dishonest or immoral. It merely means that thepower has been exercised for a purpose, or with an intention, beyond thescope of or not justified by the instrument creating the power.56

In the context of the discussion here, the relevant power being exer-cised by directors is the power to issue shares. The primary purpose is toraise capital that is to be used for the businesses carried on by the com-pany. In Howard Smith57 it was argued that the only proper purpose forwhich the power to issue shares could be used was to raise capital. ThePrivy Council, however, rejected this restrictive interpretation, although itfailed to elucidate other purposes for which the use of the power could besaid to be proper. One commentator58 has suggested that the issue ofshares to secure financial stability59 or as part of an agreement relating tothe exploitation of mineral rights could fall within proper use.60 However,both of these uses of the power involve a form of acquisition of capital,whether as an asset (the mining rights) or as access to assets (those of alarger company). The failure by the Privy Council to identify examples ofthese ‘other uses’ is regrettable.

An analysis of other cases is helpful as a guide, but there is clearly nodefinitive approach to the question of what are other proper purposes.Examples of impropriety are where there is an absence of any considera-tion of the capital to be raised;61 securing control by allotting shares topersons favourable to the directors;62 or offering allotments of shares to

55 [1915] AC 372 (PC).56 Ibid, 378.57 Note 39 above.58 L.C.B. Gower, Principles of Modern Company Law, 5th ed (London: Sweet & Maxwell,

1992), 199.59 Harlowe’s Nominees Pty Ltd v Woodside (Lakes Entrance) Oil Co (1968) 121 CLR

483 (HCA) [hereinafter Harlowe’s Nominees].60 Teck (note 36 above).61 Ansett v Butler Air Transport Ltd (No 1) (1958) WN (NSW) 299 (SC NSW).62 See, e.g., Fraser v Whalley [1903] 2 Ch 506; Piercy v Mills (note 54 above); Harlowe’s

Nominees (note 59 above); Hogg v Cramphorn Ltd (note 54 above).


shareholders that are not pro rata.63 Moreover, it has been held that thepurpose of issuing shares for capital is not conclusive that an issue isvalid.64

In Re Lee Behrens & Co Ltd65 it was said that there were three teststo see whether a company had an implied power to do something:

(i) Is the transaction reasonably incidental to the carrying on of thecompany’s business?

(ii) Is it a bona fide transaction? and(iii) Is it done for the benefit and to promote the prosperity of the

company?66

Again, however, this test focuses on the confusing notion that forpower to be used properly it must be used bona fides. It demonstrates theconfusion over what has been described as the ‘inevitable use of morallycharged terms to refer to the actions of directors who use a power for anunwarranted purpose’.67 Such obfuscation arises from the relationshipbetween purpose and good faith.

Are there two rules or only one?

Before dealing with whether directors have breached a duty in an over-subscribed IPO, it is necessary to consider whether one or two rules areapplicable. The issue of whether there is one rule encompassing bothbona fides as well as proper purpose, has been the subject of muchacademic debate. The confusion appears to have arisen out of the judg-ment of Buckley J in Hogg v Cramphorn Ltd,68 in which the court acceptedthat the directors had believed resisting a takeover would be better for thecompany. However, Buckley J said

It is not, in my judgment, open to the directors on such a case to say ‘wegenuinely believe that what we seek to prevent the majority from doingwill harm the company and therefore our act in arming ourselves or ourparty with sufficient shares to out vote the majority is a conscientious

63 See Ngurli Ltd v McCann (1953) 90 CLR 425 (HCA).64 Harlowe’s Nominees (note 59 above).65 [1932] 2 Ch 46 [hereinafter Lee Behrens]; cited with approval in Rolled Steel Products

(Holdings) Ltd v British Steel Corp [1986] Ch 246.66 See Lee Behrens (note 65 above), 51.67 Lindgren (note 45 above), 371.68 Note 54 above.

114 I.A. Tokley

exercise of our powers under the articles, which should not be interferedwith. Such a belief even if well founded would be irrelevant.’69

This statement appeared to establish a separate and distinct issue asto the use of the power and hence, two duties. However, recent decisionsin the Commonwealth have cast doubt upon this separation of purposefrom bona fides. In Teck Corp Ltd v Millar (‘Teck’),70 the Supreme Courtof British Columbia held that the issue of shares for the purpose ofdefeating a takeover was acceptable provided that this was a bona fidepurpose for the benefit of the company:

My own view is that the directors ought to be allowed to find out who isseeking control and why. If they believe that there is going to be substantialdamage to the company’s interests if the company is taken over, then theexercise of their powers to defeat those seeking a majority will notnecessarily be categorised as improper.71

The decision in Teck was referred to by the Privy Council in HowardSmith.72 It did not, however, directly approve of the formulation by BergerJ. Indeed, there is some dispute as to whether the decision was approvedor rejected by the Privy Council.73 For example, Birds is of the view thatthe Privy Council rejected the argument advanced in Teck.74 The decisionin Teck was discussed by one member of the High Court in Australia, inWhitehouse v Carlton Hotel Pty Ltd,75 who cited it with approval.76

However, none of the other members of the High Court even mentionedthe decision in Teck and it is still unclear whether this ‘new’ formulationcarries any real weight.

Turning to the question of oversubscription, let us assume that A Ltdwishes to issue shares. Its purpose for doing so, in addition to ensuring itslisting on the stock exchange, is to raise $10 million in capital, an amountthat the directors consider necessary for the company to conduct its busi-ness. The company may issue $10 million by offering one million shares

69 Ibid, 268.70 Note 36 above.71 Ibid, 290.72 Note 39 above.73 See J. Farrar, ‘Abuse of Power by Directors’ (1973) Cambridge Law Review 221;

Lindgren (note 45 above); Mayson & French (note 36 above).74 Birds, ‘Proper Purposes as a Head of Directors Duties’ (1974) 37 Modern Law Review

580, 583.75 (1987) 162 CLR 285.76 Wilson J.


at $10 per share. However, in line with current market practice in HongKong, its advisers recommend offering shares at a level less than $10 pershare to ensure that the IPO is oversubscribed. A Ltd then issues twomillion shares at a price per share of $5, and, not surprisingly, the IPO isoversubscribed. It would doubtless be argued by the directors that thestock issue raised sufficient capital for the company and thus, in accord-ance with the strictest of those principles discussed in Howard Smith,77

was a use of the power for its proper purpose.However, one can characterize the share issue in another way. For the

sake of this example, let us assume that the price at which full subscrip-tion could have been achieved was $8 per share. Thus, to raise $10million in capital, it was only necessary for A Ltd to offer 1,250,000shares. The remaining 750,000 shares have been issued to support theprice of the offer of the first 1,250,000 shares. The offer price of theseshares could be characterized at a notional zero value. Whether the issueof the zero value shares is a proper use of the directors’ power depends onthe extent to which the issue of these shares can fall into the other properpurposes mentioned in Howard Smith or, in other words, whether there isone or two rules.

In this example, the purposes for which the directors exercise thepower to issue the notional zero value shares are:(a) to support the raising of capital;(b) to induce oversubscription;(c) to foster some form of goodwill or, at least, good publicity in relation

to the IPO; and(d) to ensure that there is a market for the shares upon listing.

Of these four purposes only (a) is a purpose that is prima facie proper.However, (b) is closely related to (a); and (c) and (d) may not be properpurposes but they flow from (b). Moreover, although (d) may not be aproper purpose, it is only not a proper purpose if it is a dominant pur-pose. However, as discussed earlier, a court will determine whether apurpose is a dominant purpose by looking to the motives of the directors.The motivation implies aspects of intent which, under the approach inTeck, requires analysis of whether the intent of the directors was bonafide and in the best interests of the company. Moreover, this evaluationvaries depending upon which of the purposes is identified as the dominantpurpose. The reasoning that is used to determine whether the use of apower is proper is Kafkaesque. Furthermore, it leads to a conclusion that

77 Note 39 above.

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apparently supports the view that issuing shares need not have the effectof raising any form of capital. According to the principles in Teck, if thedirectors believed bona fide that issuing shares at a zero value was in thecompany’s best interests, then the use of the power was proper. It issubmitted that such a proposition cannot be correct.

Moreover, Bennett argues that these purposes cannot be logicallyseparated.78 He gives the example of a person getting into his car to travelto a restaurant to have dinner with a friend. If asked why he opened thecar door, the person might answer ‘to enter the car’ or ‘to go to arestaurant’.79 Bennet criticizes those who try to evaluate which of thosepurposes was the ‘dominant’ purpose: ‘the purposes . . . are connected . . .and one can neither regard one as excluding the other nor regard one asgreater than the other.’80

The difficulty, as Bennett explains, is that the introduction of bonafide intent in assessing whether the use of a power is proper is that thequestion cannot be answered:

To ask whether they wish to resist a takeover or to act for the benefit ofthe company is like asking the man who opens his car door whether hewishes to get into the car or to go to the restaurant and, if both, which ishis predominant purpose.81

This dilemma can only be resolved if courts limit the scope of thequestion to the following: what is a proper use of the power to issueshares? The answer must be, prima facie, to raise capital (of whateverkind) for the company. Any other use is improper despite the best motivesfor the improper use. As Farrar says: ‘The notion of purpose if it has anyuse at all has to be more sophisticated and read in the light of the objectsof the company as a whole.’82

He goes on to say that the court should first consider the nature ofthe power and prescribe in the light of modern conditions the limitswithin which it must be exercised.83 It is submitted that the approachapparently adopted by courts in the Commonwealth should be rejected.The effect of this approach is to do the very thing that courts have alwayssaid they would not do, namely, to interfere in management decisions. To

78 D.M.J. Bennett, ‘The Ascertainment of Purpose When Bona Fides Are in Issue — SomeLogical Problems’ (1989) 12 Sydney Law Rev 5.

79 Ibid, 6.80 Ibid.81 Ibid, 7.82 Farrar (note 73 above), 223.83 Ibid.


satisfy themselves whether directors have acted bona fide, the courts mustfirst identify the directors’ purpose and then characterize it as improper ornot. In these situations, courts have exhibited a tendency of making ‘na-ked value judgments’:84

To lay down the limits of the purposes within which a power may beproperly exercised is a question of law — although the exact nature ofthe process involved is largely concealed from us, first, because the judgeshave consistently declared that the question can only be settled ‘uponbroad lines’ and, secondly, because in practice they work with hindsight,by first determining on the evidence what the directors’ purpose (or,frequently, motive) in fact was, and then by declaring without closelyreasoned argument whether it lies within or without the bounds ofpermissibility.85

It is submitted that the appropriate determination of whether some-thing is a proper use of a power is to look at the power itself and itspurpose. If the purpose of a power to issue shares is to defeat a takeover,then the issue of shares to defeat a takeover is a proper purpose. If theproper purpose is to raise capital (or obtain property for the company insome form), then the issue of shares to defeat a takeover is not a properpurpose. The concept of ‘improper’ should be separate from that of bonafides and courts should resist the temptation to combine the two rules.On this basis, it is submitted that in the above example the issue of someshares at a notional zero value, to support the issue of other shares, is nota proper use of the power to issue shares.

Conflict of interest

Where directors of a company are substantial holders of shares, they maywell benefit from an oversubscription of shares. This will occur becauseoversubscription will generally create a heavy market for the new shares.This demand will usually increase the value of the company’s shares uponlisting. In such circumstances, it could be argued that a conflict may ariseas this indirect benefit may encourage directors actually to seek oversub-scription. It is clear that directors must not place themselves in a positionwhere there is or may be a conflict between their interests and duties tothemselves or others and their duty to the company and the company’s

84 Sealy (note 50 above), 276.85 Ibid.

118 I.A. Tokley

interests. It is therefore necessary to deal briefly with the issue of conflictof interest.

It is generally considered that disclosure of the conflict will relievedirectors of liability. However, it has been argued that disclosure to them-selves as directors is not sufficient to avoid the duty. In the absence of anexpress provision in the company’s articles, the only effective step is tomake full disclosure to the members and have the contract ratified by thecompany in general meeting.86

Moreover, the legislature has intervened to ensure that a director isrequired to declare his interests even where a provision in the articles ofassociation may allow the director to enter into contracts that appear toinvolve a conflict.87 The statutory provision does not, however, affect thecontract entered into by the company and only involves the imposition ofa penalty or fine on a director for failing to comply with the statute.88

REMEDIES

Fiduciary duties are owed by a director to the company. The consequenceof this is that, subject to certain exceptions, only the company can sue forbreach. In the context of a breach by directors in an IPO, the followingtwo issues arise: (a) what is the nature of the loss suffered by the com-pany? and (b) who may take action for the breach?

In the examples previously discussed,89 the loss to a company couldbe (a) the notional loss of capital raised by issuing shares at a zero value,or (b) the cost of carrying out another offering of shares.

The notional loss of capital is relatively easy to ascertain: the issue of750,000 shares at $8.00 per share would raise $6 million. However, itcould be argued that the company could simply issue a further 750,000shares. This would raise the ‘lost’ amount and thus no loss would besuffered.90 Moreover, it could also be argued that, in mostoversubscriptions, applications for shares must be accompanied by pay-ment for the shares. Companies are entitled to, or at least do, keep any

86 Transvaal Lands v New Belgium [1914] 2 Ch 488; Benson v Heathorn (1842) 1 Y &CCC 326.

87 Companies Ordinance, s 162.88 Hely-Hutchison v Brayhead [1968] 1 QB 549; Guinness v Saunders [1990] 2 AC 663.89 See pages 114–115 above.90 With the exception of the costs incurred in making the additional offering of shares to

the public.


interest that is paid on the deposit of these amounts even where theapplication is unsuccessful.91

Thus, in the cases of large oversubscription, a considerable amount ofmoney is generated.92 This sum, it could be argued, compensates the com-pany for the notional loss and any expenses incurred. Such an argumentmisconceives the nature of share capital. The money raised from interestearned on applications is not capital. These funds are most likely to betreated as extraordinary profits and are available for dividend to share-holders in the year in which they were earned.93 Share capital cannot bedistributed to shareholders except in a winding up. To understand the lossto the company, it is necessary to look briefly at the concept of share capital.

The nature of share capital

One reason for confusion in this area might be that the concept of sharecapital is not well developed or understood.94 What is the nature of theshares that are offered to the public? Is potential share capital95 propertyof the company? The issue of shares creates a special category of asset ina company’s accounts. The payment of the offer price of a share is sepa-rated into payment of par value and, if there is any, payment of a premium,which is to be transferred to the share premium account.96 Ownership ofa share gives the owner a number of rights including the right to partici-pate with other owners in a winding up of a company. In most

91 See Joint Working Party Report (note 4 above), para 19, at 5. This practice is subject tocriticism, particularly on the ground that it encourages oversubscription. Moreover, it isarguable that the company takes the money upon a form of trust. If the application issuccessful and shares are issued, the money is to be used to pay for the shares. If theapplication is unsuccessful, the money and any interest earned on the money ought tobe returned. The company has no property in the application money until shares areissued: it thus has no right to the interest.

92 Ibid.93 In the case of Denway Ltd, the figure was HK$132.87 million. This sum was declared

an ‘exceptional profit’ and distributed to shareholders as a dividend. See ‘OversubscriptionInterest Powers Denway’, South China Morning Post, Business Post, 11 May 1994, at 1.

94 See Gower, Principles of Modern Company Law (note 58 above) (noting that ‘[t]heconcept of capital is of fundamental importance to a proper understanding of companylaw in general). But see the comments of Barwick CJ in Federal Commissioner ofTaxation v St Helens Farm (ACT) Pty Ltd (1981) 34 ALR 23, 26 (HCA) [hereinafter StHelens Farm] where the principles discussed by the High Court of Australia are describedas ‘trite law’.

95 That is, unissued shares and the potential to raise capital by the company.96 Companies Ordinance, s 48B(1).

120 I.A. Tokley

circumstances, the payment of a premium does not entitle the owner ofthe share to any greater right in respect of a company’s assets.97 The valueof the premium reflects the value of a company’s assets over and abovethe par value of the shares.

This question of whether shares are the property of the company hasbeen considered by Australian commentators,98 who, despite the tradi-tional interpretation of the decision in Mosely v Koffeefontein Mines,99

were of the view that unissued shares were not property of a company.This view was based on the principles discussed in a number of Australiantaxation cases.100 In Federal Commissioner of Taxation v St Helens Farm(ACT) Pty Ltd,101 the High Court of Australia considered the provisionsof the Australian Gift Duty Assessment Act.102 The court held that theearliest time that a share could be an item of property was when thecompany entered into a contract with an applicant to take a share and theapplicant accepted that offer. Furthermore, the applicant’s title to theshare only became complete when the applicant’s name was entered onthe register of members:103

Until allotment and issue, which includes the entry of the allottee’s nameon the share register in respect of the allotted share or shares, there is noproperty in the unissued shares; and, in particular, there is not then, orfor that matter at any other time, any property or proprietorial right inor of the company in the unissued shares in its capital. The company hasthe capacity to allot and issue shares in the capital up to the amount ofthat capital, its nominal capital. But that capital is not property of thecompany. Indeed, when allotted and issued, the nominal amount ofissued share or shares constitutes in accounting terms a liability of thecompany. But it is not property which comes to the allottee from, or bytransfer from, the company. It is property which comes into existence bythe allotment and issue or, more precisely, which is the consequence ofsuch allotment and issue. The property consists of rights which maythereafter be exercised by virtue of the membership of the company thusgained in accordance with its Memorandum and Articles of Association.104

97 The exception possibly being where redeemable preference shares are issued by thecompany and the holders of these shares are entitled to additional benefits under theterms upon which they were issued.

98 Ford and Austin, Principles of Modern Company Law, 6th ed (Sydney: ButterworthsAustralia, 1992).

99 [1911] 1 Ch 73.100 Ford and Austin (note 98 above), 177.101 Note 94 above. Ord Forrest Pty Ltd v Federal Commissioner of Taxation (1974) 130

CLR 124 (HCA).102 Gift Duty Assessment Act (Cth Australia) 1941–1967.103 St Helens Farm (note 94 above), 26. See discussion in Ford and Austin (note 98 above), 178.104 St Helens Farm (note 94 above), 26 (per Barwick CJ).


105 John Farrar, Nigel Furey and Brenda Hannigan, Farrar’s Company Law, 3rd ed (London:Butterworths, 1991).

106 UK Companies Act 1985.107 Although share capital can be recognized as a form of debt, most ordinary shares do not

carry with them the right to attract interest at commercial rates.108 It is very difficult indeed to obtain sufficient evidence to establish some of the matters

set out in the example. See discussion in Lindgren (note 45 above), 381.

However, as Farrar points out,105 it is well established that an issuedshare is a ‘chose in action — a species of intangible property’ and, inaddition, a share is regarded as personal property under the UK Compa-nies Act.106

The misconception regarding share capital arises out of its seeminglyunlimited supply; up until the limit of the authorized capital, directorsmay continue to issue shares. If directors wish to go beyond that point,they have the relatively minor inconvenience of calling a meeting to createnew authorized capital. The simplicity in creating new shares misleadsmany directors and advisers into believing that no benefit or detrimentcan arise by issuing them at certain values so long as existing shareholdersare not disadvantaged: ‘we can simply issue more’.

However, every new issue of shares will dilute the entitlement ofexisting members. For example, A Ltd has ten shareholders, each of whomholds one share that is valued at $10. If A Ltd then issues ten shares at$8.00 per share, the total share capital is $180. There are now twentyshareholders each of whom has a share valued at $9. In addition, thecompany has less capital than it could have obtained had the shares beenoffered at full value. It would have had an additional $20 to use for itspurposes. Notwithstanding the issue of whether an unissued share is com-pany property, the loss to a company of additional funds is a loss that canbe ascertained. Moreover, if the principle that a company has separatelegal personality distinct from its shareholders is to have any meaning,then the failure to obtain that capital must be treated as a loss. Theproblem is made more complex where a company, having been heavilyoversubscribed, requires additional finance at some time in the near fu-ture. Where this finance is obtained by way of loan then the questionmust be asked whether this debt107 could have been avoided had the offerprice of an IPO been set at the appropriate level.

It is acknowledged that such a hypothesis faces a number of practicaland evidentiary difficulties.108 However, the aim of the paper is not tomake accusations against individuals or corporations but rather to exam-ine certain transactions on the basis of principles of company law. It issubmitted that there is a loss of capital to the company where shares are

122 I.A. Tokley

offered at a lower, or zero, value. Moreover, oversubscription is primafacie evidence of an offer of shares at a lower, or zero, value, which, inturn, is prima facie evidence of an improper use of the power to issueshares.

Action against directors

If it were possible to establish a breach of duty by directors, the nextquestion would be who has the right to take such action. In 1991, theLegislative Council considered introducing statutory codification of direc-tors’ duties. Such codification already exists in Australia. In Hong Kong,the bill was not enacted and company law in Hong Kong remains withouta suitable alternative to action against directors by their company.109

In practical terms, the possibility of action by a company against itsdirectors for any of the breaches outlined in this paper, is unlikely. Theshareholding structure of most publicly listed companies in Hong Konggenerally reveals one powerful controlling shareholder. Directors are likelyto be appointees of that shareholder. Action against the directors is thushighly unlikely.110 It is not possible within the scope of this paper todiscuss in detail the exceptions to the rule of Foss v Harbottle,111 or thelimitations on the part of members to take action in the name of thecompany. In any event, perhaps the only body with sufficient resources toinvestigate and consider action is the Securities and Futures Commission.Currently, even the Securities and Futures Commission’s ability to takeaction is limited to the more substantial investigations by the FinancialSecretary under the Companies Ordinance.

The only other possible litigants might be a liquidator, should a com-pany fail, or a rival for control of a company. In terms of publicly listedcorporations in Hong Kong neither of these scenarios is particularly com-mon. The likelihood of action, in the absence of codification of duties, isthus slim.

109 The issue of whether there should be codification of directors duties is, in itself, veryinteresting. Unfortunately, it is beyond the scope of the discussion in this paper toconsider it.

110 This is not intended to imply any lack of good faith on the part of the directors — asdemonstrated by the paper, many directors would genuinely not consider that they haddone anything wrong.

111 (1843) 2 Hare 461.


Ratification, release and board minutes

It may also be possible for directors to pre-empt the exercise of any actionagainst them. They could, for example, seek ratification of the actionstaken or release by the members from any breaches, or make adequatedisclosure in the minutes of a meeting of directors (‘board minutes’).

Ratification is only available in a limited number of circumstances. Asseeking ratification might lead to unwanted publicity, the nature of theresolution that might be put to shareholders would need to be carefullydrafted:

RESOLUTIONThat the exercise of the power to issue shares used by the directors inissuing XXX ordinary $10.00 shares at $XX.XX per share be and herebyis confirmed and ratified.

Release by the members is the least attractive alternative. Not merelymay it result in unwanted publicity as to directors’ actions; it implies thatwrongdoing has occurred. It is thus unlikely that the directors themselveswould be convinced of its value.

Instead, directors could contemplate identifying in the board minutesthat such matters have been considered by the board as a whole as well asthe manner in which matters have been considered. It is doubtful, how-ever, that such a practice will occur. It is more likely that advisers willattempt to imply that this had been done by the tabling of a report or theadvice of a listing broker or advising merchant banker. Nevertheless, it ispossible for directors to use board minutes to properly identify the proc-ess by which they have reached the conclusion. For example:

Initial Public Offering Of Shares: Report Of AdvisersThe Chairman tabled a report prepared by Messrs XXXX being advisersto the Company on the proposed initial public offering of the Company’sshares and application for listing of the Company’s shares on the StockExchange of Hong Kong. Directors considered the report in detail, inparticular, the advice relating to:a) the state of the securities market in Hong Kong;b) the valuation of the Company’s business and assets;c) the recommended offer price of the shares and the potential and

importance of obtaining full subscription for the offering of theshares.

The directors having considered that it was in the best interests of theCompany to issue shares to obtain full subscription of the offering it wasRESOLVED THAT

124 I.A. Tokley

However, whilst such a resolution, if passed, may assist in dealing withthe first duty imposed upon directors, it will not make the improper useof a power, proper.

CONCLUSION

The aim of this paper has been to demonstrate that an oversubscription ofan IPO, from the company’s perspective, is not a matter to be celebrated.Rather, an oversubscription demonstrates the directors’ failure to prop-erly ascertain the market for IPOs or to correctly value the company, itsbusiness and assets. It should be recognized as such.

Disqualification of Company DirectorsCaroline Hague

. CHAPTER FIVE .

INTRODUCTION

Generally speaking, anyone over the age of eighteen1 can be a director ofa Hong Kong company; no formal qualifications are required. In addi-tion, there is no specific definition in the Companies Ordinance that setsforth the duties of an appointed director. Rather, the duties of a directorin Hong Kong can be found by reference to various sources, including theCompanies Ordinance, the common law and the rules of equity. Fordirectors of publicly listed companies, the Securities (Disclosure of Inter-ests) Ordinance,2 the Securities (Insider Dealing) Ordinance3 and the StockExchange listing rules4 are also relevant. In addition, reference must also

1 Companies Ordinance (cap 32, LHK), s 157C.2 Cap 396, LHK.3 Cap 395, LHK.4 The provisions in relation to directors of publicly listed companies are contained in the

Rules Governing the Listing of Securities published by the Stock Exchange of HongKong Limited [hereinafter the Securities Listing Rules]. New provisions came into effectfrom 1 August 1993. Sections 3.08–3.15 of the Securities Listing Rules concern directors.Section 3.08 sets out the basic rule that directors of an issuer (defined in s 1 ascompanies whose equity or debt securities are listed, or who are applying for listing, onthe Hong Kong Stock Exchange) must:

fulfil the fiduciary duties and duties of skill, care and diligence to a standard atleast commensurate with the standard established by Hong Kong law. This meansthat every director must, in the performance of his duties as a director:

126 Caroline Hague

be made to the Articles of Association of the relevant company. In consid-ering the duties of a director, one must principally look at the relevantcase law, which shows that there are two main aspects to be taken intoaccount: the fiduciary duties of a director to act honestly and in goodfaith, and the level of competence expected of directors in the perform-ance of their duties.

The whole issue of how the affairs of a company are conducted, i.e.,corporate governance, has recently come into focus in Hong Kong. Thereappears to be increased concern about the conduct of directors, particu-larly with reference to the protection of minority shareholders. The resultsof a survey commissioned by the accountants Price Waterhouse into atti-tudes in Hong Kong to corporate governance were published in January1995.5 These indicated, inter alia, that a clearer definition of directors’responsibilities is needed.

An attempt was made to define the fiduciary duties of directors in HongKong with the introduction of the Companies (Amendment) Bill 1991, butfollowing considerable criticism the legislation was allowed to lapse. Al-though the provisions were without prejudice to the existing common lawrules it was perhaps felt that having specific legislation in this area couldprove too inflexible. Thus, a director’s fiduciary duties can at present besummarized as the duties to act in good faith in the best interests of thecompany, to exercise a director’s powers for their proper purposes andnot to allow any conflict to arise between a director’s duties to the com-pany and a director’s own interests. The classic statement of the degree ofexpertise expected of directors is contained in the case of Re City Equita-ble Fire Insurance Co,6 which imposed a subjective and none too stringenttest, stated by Romer J as follows: ‘A director need not exhibit in the per-formance of his duties a greater degree of skill than may reasonably be

(a) act honestly and in good faith in the interests of the company as a whole;(b) act for proper purposes;(c) be answerable to the issuer for the application or misapplication of its assets;(d) avoid actual and potential conflicts of interest and duty;(e) disclose fully and fairly his interests in contracts with the issuer; and(f) apply such degree of skill, care and diligence as may reasonably be expected of

a person of his knowledge and experience and holding his office within theissuer.

In addition, directors of listed issuers have to satisfy the Exchange that they have thecharacter, experience and integrity and can show a standard of competence commensuratewith their position as director of a listed issuer.

5 Ray Heath, ‘Time for change in rules on directors’, South China Morning Post, 24 Jan1995 (Business Post), 1; Ray Heath, ‘Grappling with gaps in conduct of firms’, SouthChina Morning Post, 24 Jan 1995 (Business Post), 3.

6 [1925] Ch 407.

Disqualification of Company Directors 127

expected from a person of his knowledge and experience’.7 Recent caseshave, however, imposed a stronger test. In Re D’Jan of London Ltd8

Hoffmann LJ reviewed the conduct of a director in signing an insuranceproposal which he had not read. He stated that ‘the duty of care owed bya director at common law is accurately stated in Section 214(4) of the[UK] Insolvency Act 1986. It is the conduct of “a reasonably diligent per-son having both — (a) the general knowledge, skill and experience thatmay reasonably be expected of a person carrying out the same functionsas are carried out by that director in relation to the company, and (b) thegeneral knowledge, skill and experience that that director has.”’9 In theevent that shareholders are dissatisfied with a company’s directors, theshareholders can remove the director from office by a special resolution10

or require them to vacate their office as directors pursuant to regulationsset out in the Company’s Articles of Incorporation.11

There is a growing initiative in common law jurisdictions to monitorthe standards of the conduct of directors12 and to make directors moreaccountable for their actions.13 Until recently, Hong Kong did little tofollow this movement. However, the Companies (Amendment) Ordinance1994 (No 30 of 1994) introduced revised provisions in relation to thedisqualification of directors by repealing the existing disqualification pro-visions in Sections 157E and 157F of the Companies Ordinance andreplacing them with a new Part IVA.14 This new Part IVA is based on theUK Company Directors Disqualification Act 1986 and includes morestringent legislative provisions in relation to the regulation of the conductof directors.15 The intent of the UK legislation is to protect a company’s

7 Ibid, 408.8 [1994] 1 BCLC 561.9 Ibid, 563.10 Companies Ordinance, s 157B11 For example, see art 90 in Table A, Part I of the First Schedule to the Companies

Ordinance.12 For an interesting review of developments, see A.S. Sievers, ‘Farewell to the Sleeping

Director — The Modern Judicial Approach to Director’s Duties of Care, Skill andDiligence’ (1993) 21 Australian Business Law Review 111–151.

13 See, for example, the UK Insolvency Act 1986, s 214 and the case of Re ProduceMarketing Consortium Ltd (No 2) [1989] BCLC 520. Directors in the United Kingdommay be made personally liable for a company’s debts for wrongful trading, i.e., continuingto trade while the company is insolvent. There is similar legislation in Australia under s592 of the Australian Corporations Law.

14 The Companies (Amendment) Ordinance 1994 came into operation on 13 May 1994.15 There are also broadly similar provisions in ss 229(1), (3), 230 and 599 of the Australian

Corporations Law. A helpful review of these provisions can be found in Julie Cassidy,‘Disqualification of Directors Under the Corporations Law’ (June 1995) 13 Companyand Securities Law Journal, 221–39. The Australian legislation contains an additional

128 Caroline Hague

creditors from the mismanagement of the company’s affairs by its direc-tors and to disqualify those directors who abuse the privilege of limitedliability.16 This legislation has led to many successful applications for thedisqualification of directors of companies on the grounds that they are‘unfit’ to act as such. From 29 December 1986, when the UK CompanyDirectors Disqualification Act came into effect, until 15 August 1995, atotal of 2,614 disqualification orders were made.17 (In contrast, under theHong Kong legislation prior to the recent amendment there had been onlyone recorded case of disqualification.) The UK courts’ interpretation ofthe meaning of the word ‘unfit’ is considered at length below.

Although the wording of the new Hong Kong legislation closely fol-lows that of the UK provisions, it also contains many of the previousprovisions of the Companies Ordinance in relation to the disqualificationof directors. Given the similarity between the Hong Kong and the UKdisqualification provisions, as well as the lack of any decisions by theHong Kong courts regarding disqualification orders under the previousSections 157E and F of the Companies Ordinance, the decisions of theUK courts prove helpful in construing the new Hong Kong provisions.

THE PREVIOUS LEGISLATION IN HONG KONG

Prior to the enactment of the recent amendments, Sections 157E and157F of the Companies Ordinance dealt with the disqualification of direc-tors. These sections contained powers for the court to prevent ‘fraudulentpersons’ from managing companies, and to disqualify the directors of

provision in s 600 which gives the Australian Securities Commission the power withoutcourt approval to disqualify for a maximum period of five years if it considers itappropriate to do so, where someone is a director of two or more corporations in thetwelve months prior to their winding up, that in the previous seven years a liquidatorwas appointed to each company and the liquidator reports on the directors’ conduct orthe corporation could not pay its unsecured creditors more than 50 percent of theamount due. The provisions of s 600 were considered but rejected by the StandingCommittee on Company Law Reform in Hong Kong in reviewing the disqualificationprovisions in the Companies Ordinance.

16 Re Sevenoaks Stationers (Retail) Ltd [1991] BCLC, 325, 329 [hereinafter SevenoaksStationers] (stating that it is beyond doubt that the purpose of s 6 of the UK CompanyDirectors Disqualification Act 1986 is to protect the public, and in particular potentialcreditors of companies, from losing money through companies becoming insolvent wherethe directors of those companies are people unfit to be concerned in the management ofa company).

17 UK Government Press Releases, 15 August 1995 (Reuter Headline: UK: DTI — ‘DodgyDirectors’ Top of Insolvency Service’s Hitlist).


insolvent companies. The provisions of the old Section 157E in relation torestraining fraudulent persons from managing companies have largelybeen continued and amplified in the new Sections 168E, F and G of theCompanies Ordinance, which are discussed below. For example, the maxi-mum five-year period of disqualification under the previous legislationhas, in some of the revised provisions, been increased to a maximumperiod of fifteen years.

The same trend can be seen in the provisions regarding the disqualifi-cation of directors of insolvent companies. The old Section 157F allowedthe court to make a disqualification order for a maximum period of fiveyears. For a disqualification order to have been made under that provi-sion a person must, within a five-year period, have been a director of twocompanies that had gone into liquidation whilst insolvent and such per-son’s conduct in relation to either of the companies must have been suchas to make him ‘unfit to be concerned in the management of a company’.The equivalent new provisions in Sections 168H and I of the CompaniesOrdinance are set out in detail below, but, briefly, now provide thatinvolvement with one insolvent company, if the director is found to beunfit, requires mandatory disqualification. The period of disqualificationhas been extended to a maximum of fifteen years.

DISQUALIFICATION OF UNDISCHARGED BANKRUPTS

The legislation in respect of undischarged bankrupts remains the same.An undischarged bankrupt may not be a director, or take any part in themanagement of a company, unless given permission to do so by the courtthat made the bankruptcy order.18 Court permission cannot be soughtunless the Official Receiver has been given prior notice of the intention toapply, and the Official Receiver must oppose any such application if hebelieves it to be contrary to public interest. Anyone acting in breach ofthese provisions is liable to imprisonment and a fine. The penalties are set

18 Companies Ordinance, s 156. Similar provisions are contained in s 229(1) of theAustralian Corporations Law. See Cassidy (note 15 above), 224–225, for a review of ReAltim Pty Ltd [1968] 2 NSWR 762 and the matters to be taken into account by thecourt in giving permission, which include:(a) the financial history of the applicant;(b) the losses of third-party creditors;(c) the cause of the bankruptcy; and(d) the applicant’s integrity, although the need to protect the public may be of

greater concern.

130 Caroline Hague

out in the Twelfth Schedule to the Companies Ordinance. This is anabsolute offence and it is no defence for an undischarged bankrupt to sayhe acted as a director without leave from the court, in the genuine beliefthat he had been discharged from his bankruptcy.19

THE NEW HONG KONG LEGISLATION

The new regulations regarding the disqualification of directors set out inSections 168C to 168T of the Companies Ordinance are more stringentthan the previous provisions, and also give some guidance as to the mat-ters to be taken into account in deciding whether a director is unfit to actas such, both generally and specifically in relation to insolvent companies.

Sections 168E, F, G, J and L of the Companies Ordinance now con-tain provisions under which a person may be disqualified from acting as adirector, and section 168H, the circumstances in which the court shallmake a disqualification order. In addition, Section 168D sets out thepowers of the court to make a disqualification order and provides that aperson subject to such an order shall not, without the leave of the court:

(a) be a director of a company;20

(b) be a liquidator of a company;(c) be a receiver or manager of a company’s property; or(d) in any way, whether directly or indirectly, be concerned or take part

in the promotion, formation or management of a company, for aspecified period beginning with the date of the order.21

19 See R v Brockley [1994] 1 BCLC 606.20 The definition of the word ‘company’ in s 168D has been examined by Philip Smart in

his article ‘Disqualification of directors: another (major) foul up’ (June 1995) The NewGazette 53. He points out that the definition comes from s 2 of the Ordinance and anextended definition of company in s 168C is only applied to ss 168H and 168I:

surprisingly, this extended definition applies expressly only to ss 168H and 168I:it does not apply to s 168D. Thus, although a disqualification order can be madein relation to a foreign company which has gone insolvent (ss 168H and 168I),the consequences of any disqualification order (whether made in respect of aforeign or Hong Kong company) are laid down by s 168D; and s 168D does notprevent a disqualified person being a director or taking part in the managementof a foreign company.

21 Halsbury’s Statutes, 4th ed (London: Butterworths, 1991–), Vol 8, Companies, 783defines ‘for a specified period’ as follows: ‘An order made on the occasion of anaccused’s conviction should impose the disqualification from the date of the convictionrather than from a future date such as the date of completion of a sentence ofimprisonment; see R v Bradley [1961] 1 All ER 669.’


Section 168D further states that the court can make an order that aperson shall not ‘without the leave of the court . . . in any way, whetherdirectly or indirectly, be concerned or take part in the management of acompany.’ The same wording is also used in Section 156 of the Compa-nies Ordinance in relation to undischarged bankrupts. How widely shouldthis provision be construed? This point was reviewed in the English caseof R v Campbell 22 by the Court of Appeal (Criminal Division) where adisqualified director, who had been employed by a company as a manage-ment consultant to advise on its financial management and reconstruction,appealed against his conviction for taking part in the management of acompany while subject to a disqualification order under Section 188(1) ofthe UK Companies Act 1948. The relevant wording of Section 188(1) isthe same as that used in the Hong Kong legislation in relation to beingconcerned in the management of a company. In his judgment Beldam Jstressed that it was a matter of fact for the jury to decide whether theappellant had been concerned in the management of a company. He alsocommented that the relevant words of the section should not be given anarrow construction: ‘the wording is so widely cast that it is the opinionof this court that it is intended to insulate persons, against whom an orderof disqualification has been made, from taking part in the management ofcompany affairs generally. It is cast in the widest of terms . . . .’23 Review-ing the meaning of the words ‘in any way, whether directly or indirectly,be concerned or take part in the management of a company’, Beldam Jwent on to say that ‘it would be difficult to imagine a more comprehen-sive phraseology. It is designed to make it impossible for persons to bepart of the management and central direction of company affairs.’24 BeldamJ further advised that anyone in doubt as to whether his or her activitieswould be in breach of a disqualification order should apply to the courtfor leave to act.

Anyone acting in breach of a disqualification order is liable to impris-onment and a fine pursuant to Section 168M of the Companies Ordinance.On summary conviction the maximum fine is $25,000 and the maximumperiod of imprisonment is six months, and on indictment, $100,000 andtwo years. These penalties are the same as those previously in force forbreach of an order under the old sections 157E and 157F.

22 [1984] BCLC 83.23 Ibid, 88.24 Ibid.

132 Caroline Hague

Application for a disqualification order

Who can apply for a disqualification order? The relevant provisions areset out in Sections 168 I, J, and P. Applications for orders under Section168F may be made by the Registrar of Companies. Applications underthe provisions of Sections 168E to 168G can be made by the OfficialReceiver, the Financial Secretary, the liquidator, or any past or presentmember or creditor of the company concerned. Applications under Sec-tion 168H may be made by the Financial Secretary or the Official Receiver,and applications under Section 168J may be made by the Financial Secre-tary. Anyone intending to apply for an order must give the person againstwhom the order is sought not less than ten days’ notice of the application.It is also open to the court to make a disqualification order, whether ornot anyone has applied for one, if it thinks fit to do so during proceedingsfor the prosecution of an offence under the Companies Ordinance.

Disqualification on conviction of indictable offence

Section 168E provides that the court may make a disqualification orderagainst a person convicted of an indictable offence in connection with thepromotion, formation, management or liquidation of a company, thereceivership or management of a company’s property or any other indict-able offence involving fraud or dishonesty. The ‘court’ is defined as theHigh Court or the court in which the person is convicted of the offence.The maximum period of disqualification depends on the court in whichthe order is made. The relevant periods of disqualification for whichorders can be made are fifteen years by a High Court judge, ten years by aDistrict Court judge, and five years by a magistrate. In the event of thedisqualification order being issued by a magistrate, the person who ap-plied for the order may apply to the High Court, if he feels that a longerperiod of disqualification should have been imposed.25

25 The transitional provisions set out in s 168T of the Companies Ordinance provide thata person (with the exception of a person acting in his capacity as a liquidator, receiver,or manager) who committed an offence under ss 168E and G before Part IVA came intoeffect, will be subject to disqualification for a maximum period of five years. Howeverin R v Chan Suen Hay [1995] 1 HKC 847, the provisions of s 168T were challenged unders 8, art 12(1) of the Hong Kong Bill of Rights Ordinance (cap 383, LHK). The defendanthad committed the offences of obtaining a pecuniary advantage by deception andfurnishing false information in October 1988. The defendant was not sentenced untilFebruary 1995 at which point the prosecution applied for a disqualification order unders 168E. The question to be decided was whether such a disqualification order amounted


Disqualification for breaches of Companies Ordinanceprovisions

Section 168F provides that the court may make a disqualification orderfor persistent default in the filing of any returns, accounts, notices orother documents that are required to be lodged at the Companies Regis-try. Persistent default can be proved if a person has been guilty of three ormore defaults within a five-year period.26 The maximum period of dis-qualification for an offence under this section is five years.

The responsibility for filing documents generally lies with the officersof the company who are defined in Section 1 of the Companies Ordinanceas including a director, manager or secretary. An example of the require-ment to file documents is found in Section 81 of the Companies Ordinance,which requires the registration of charges created by a company. Section81(3) provides as follows:

If any company makes default in sending to the Registrar for registrationthe particulars of any charge created by the company . . . then, unless theregistration has been effected on the application of some other person,the company and every officer of the company who is in default shall beliable to a fine and, for continued default, to a daily default fine.

The term ‘officer who is in default’ is defined in Section 351(2) of theCompanies Ordinance as meaning ‘any officer of the company, or anyperson in accordance with whose directions or instructions the directorsof the company are accustomed to act, who knowingly and wilfully au-thorizes or permits the default, refusal or contravention’ of the relevantsection of the Companies Ordinance.

to a penalty under s 8, art 12(1) of the Hong Kong Bill of Rights Ordinance, in whichcase it would be invalid as imposing a heavier penalty than was applicable at the timethe original criminal offences were committed. It was held that such an order wouldamount to a penalty. The defendant faced a greater detriment than that to which he wouldhave originally been liable at the time the offence was committed, and the ability of thejudge to exercise discretion in determing the length of disqualification and the power unders 168M to imprison anyone acting in breach of a disqualification order were indicationsof a penal regime. A distinction was drawn between automatic disqualifications as civildisabilities and discretionary disqualifications within the power of the courts. It was notedthat even if the court did have the discretionary power to disqualify the defendant, suchpower would not be exercised in this instance due in part to the staleness of the case.

26 Section 351 of the Companies Ordinance sets out the provisions concerning thepunishment of offences under the Ordinance. The Twelfth Schedule to the Ordinancecontains a list of offences under the Companies Ordinance, states whether they arepunishable on conviction, on indictment or on summary conviction and sets out themaximum punishment which can be imposed by way of fine or imprisonment.

134 Caroline Hague

Sub-section 3 of Section 168F provides that a person will be adjudgedguilty of a default either if convicted of such an offence or if a courtmakes an order against such person under the provisions of the followingsections of the Companies Ordinance:1. Section 279, which concerns enforcing the duty of a liquidator to

deliver any returns, accounts or other documents or give any notices.If he fails to do so within fourteen days after service of notice requir-ing him to make good the default, the court can make an orderrequiring the liquidator to make good the default on the applicationof the Registrar or any creditor or contributory of the company;

2. Section 302, which contains a similar provision in relation to the dutyof a receiver to deliver returns and accounts, and in addition concernsthe duties of a receiver or manager of the property of the company, torender proper accounts to the liquidator, to vouch for the same, andto pay over any amount due to the liquidator; or

3. Section 306, which enables a creditor, a contributory of the companyor the Registrar to apply to the court for an order requiring anyofficer of the company to comply with the requirements of the Com-panies Ordinance if they have failed to do so within fourteen days ofservice of notice to do so.

As these three sections concern the issue of default orders by thecourt, they are not included in the Twelfth Schedule to the CompaniesOrdinance, which deals with the punishment of offences under the Ordi-nance.

Disqualification for fraud

Section 168G of the Companies Ordinance provides that a disqualifica-tion order may be made if in the course of a winding up it appears that aperson has been guilty of an offence under Section 275 (whether con-victed or not), or has been guilty of any fraud or breach of duty whileacting as an officer (which includes shadow directors) or liquidator of acompany, or as a manager or receiver of a company’s property.27 Further,under Section 168L if a person is made personally liable for a company’sdebts under Section 275, a disqualification order may be made. The maxi-mum period of disqualification under Sections 168G and L is fifteenyears.

27 This section is subject to the transitional savings provisions contained in s 168T referredto in relation to s 168E. See note 25 above.


Section 275 contains the fraudulent trading provisions in relation tocompanies in the process of being wound up. Under this section it is opento the Official Receiver, the liquidator or any creditor or contributory ofthe company to make an application to the court, which may then declarethat anyone who was knowingly a party to the business having beencarried on with intent to defraud creditors of the company or creditors ofany other person or for any fraudulent business will be personally liablefor the debts of the company.

Disqualification of unfit directors of insolvent companies

Sections 168H and 168I replace the previous Section 157F of the Compa-nies Ordinance. They provide the court with stronger powers to disqualifyunfit directors of insolvent companies and impose reporting requirementson the liquidators and receivers of companies under Section 168I(3), if itappears to them that the provisions of Section 168(H)(1) are met in re-spect of the directors of any company to which they are appointed. Theliquidators and receivers are required to report these matters to the Offi-cial Receiver who may, or in cases not involving companies being woundup must, in turn, report them to the Financial Secretary. The FinancialSecretary or Official Receiver can then require the liquidator or receiverto provide information and allow inspection of any records relevant tothe conduct of the person concerned. Applications under Section 168Hcan be made by the Financial Secretary or the Official Receiver if eitherthinks it is in the public interest that a disqualification order be made.The leave of the court is required to make an application under this provi-sion if four28 years or more have expired since the day on which the windingup commenced, or the day on which the receiver’s appointment terminated.

Section 168H provides that the court shall make a disqualificationorder of not less than one year and not more than fifteen years if it issatisfied that:1. a person is or has been a director of a company which has become

insolvent while he was a director or subsequently; and2. that his conduct as a director in relation to that or any other company

makes him unfit to be involved in the management of a company.

References to director here include a shadow director as well.

28 Contrast this with the equivalent provision in s 7(2) of the UK Company DirectorsDisqualification Act 1986 where the application must be made within two years of therelevant company becoming insolvent.

136 Caroline Hague

Section 168H defines a company becoming insolvent as a companygoing into liquidation whose assets are not enough to satisfy all its liabilities(including the expenses of winding up) or a company that has a receiverappointed. Unlike the previous provisions, Section 168K now providesguidance to courts for determining whether the conduct of any personmakes him unfit to be a director. In relation to an insolvent company, thematters set out in Part II of the new Fifteenth Schedule to the CompaniesOrdinance are to be taken into consideration. These are as follows:

1. The extent of the director’s responsibility for the causes of thecompany becoming insolvent.

2. The extent of the director’s responsibility for any failure by thecompany to supply any goods or services which have been paid for(in whole or in part).

3. The extent of the director’s responsibility for the company enteringinto any transaction or giving any preference, being a transaction orpreference liable to be set aside under Section 18229 or 266.30

4. The extent of the director’s responsibility for failure by the directorsof the company to comply with Section 241.

5. Any failure by the director to comply with any obligation imposedon him by or under any of the following provisions — Section 190;31

Section 211;32 Section 228A;33 Section 241;34 and Section 300A.35

29 Companies Ordinance, s 182 provides that in a winding up by the court any dispositionof company property or alteration in the members’ status after commencement of thewinding up is void unless the court orders otherwise.

30 Ibid, s 266 contains the fraudulent preference provisions whereby certain disposals ofproperty by a company made within six months of the commencement of such company’swinding up may be declared invalid.

31 Ibid, s 190 provides that in a winding up by the court there is a requirement to submitin the prescribed form a statement of the company’s financial affairs to the OfficialReceiver within twenty-eight days of the relevant date. The statement must be verifiedby affidavit by one or more directors and the company secretary, or such other peopleinvolved in the management of the company in the year preceding the relevant date asdefined, as the Official Receiver may designate.

32 Ibid, s 211 requires officers of the company, inter alia, at the direction of the court todeliver property of the company to the liquidator.

33 Ibid, s 228A(2) provides that any director who makes a declaration that the companycannot continue in business because of its liabilities, thereby initiating the special procedurefor a voluntary winding up, without having reasonable grounds for so doing, is liable toa fine and imprisonment. The directors also have responsibilities under this clause toappoint a provisional liquidator, convene meetings of the company and its creditors,and give public notice of the winding up in the Gazette.

34 Ibid, s 241 concerns the duty of directors in relation to creditors’ meetings in a creditors’voluntary winding up to (1) call meetings and (2) put notices of the meetings in theGazette and one English and one Chinese newspaper.

35 Ibid, s 300A sets out the duties of a receiver or manager of the whole, or substantially


Part I of the Fifteenth Schedule of the Companies Ordinance of theCompanies Ordinance sets out the matters that are applicable to all caseswhere the unfitness of directors is being considered. These are as follows:• Any misfeasance or breach of any fiduciary or other duty.• Misapplication or retention by a director of any money or other

property of the company, or anything done by the director giving riseto a liability to account for the same.

• The extent to which a director is liable for a company failing tocomply with certain specified provisions of the Companies Ordinance.36

• The extent of a director’s responsibility for a failure by the company’sdirectors to comply with Section 122 (presentation of profit and lossaccount and balance sheet to the Annual General Meeting) and Sec-tion 129B (approval of balance sheet by Directors and its signature bytwo directors).

Shadow directors

References in Sections 168G, H, I and K and in the Fifteenth Schedule tothe conduct of persons acting as directors (or officers) are where relevantexpressed to include a shadow director. Shadow director is defined inSection 168C as ‘a person in accordance with whose directions or instruc-tions the directors of a company are accustomed to act but a person shallnot be considered to be a shadow director by reason only that the direc-tors act on advice given by him in a professional capacity.’ In Re CityInvestment Centres Ltd 37 (‘City Investment’) where a group of companieswent into insolvent liquidation, the person in control of all the companies

the whole, of a company’s property and requires that within fourteen days of receipt ofnotice of appointment a statement of the financial affairs of the company be submittedto the receiver pursuant to the provisions of s 300B. (See also Companies Ordinance,s 190.)

36 These sections of the Companies Ordinance are as follows:(a) s 81, Registration of charges;(b) s 95, Register of members;(c) s 96, Maintaining an index of members;(d) s 107, Making an annual return for a company with a share capital;(e) s 108, Making an annual return for a company without a share capital;(f) s 109, Filing annual returns;(g) s 119A, Notification of where minute books are kept;(h) s 121, Obligation to keep and preserve proper books of account;(i) s 158, Obligation to keep a register of directors and secretaries; and(j) s 158A, Notification of where a register of directors and secretaries is kept.

37 [1992] BCLC 956 [hereinafter City Investment].

138 Caroline Hague

resigned as a director well before the companies all went into liquidation,but the judge found as a matter of fact that the person concerned re-mained in control of all the companies, and that he acted as a shadowdirector from the date of his resignation to the date each company wentinto liquidation.

Investigation of a company’s affairs

Under Section 142 of the Companies Ordinance, on the application of notless than a hundred members or members holding not less than one-tenth ofa company’s shares, the Financial Secretary can appoint one or moreinspectors to investigate the affairs of a company. The inspectors must thenmake a report to the Financial Secretary under Section 146. Suchapplications by company members, in practice, are rare. Following theCompanies (Amendment) (No 2) Ordinance of 1994, however, Section152A(1)(b) empowers the Financial Secretary to inspect a company’s booksand papers, if it appears that there is ‘good reason to do so’. The FinancialSecretary has the power to require documents to be produced under Section152A and, on a warrant being issued by a magistrate pursuant to Section152B, to enter and search premises. Under Section 168J of the CompaniesOrdinance if, as a result of these investigations, the Financial Secretarythinks that it is in the public interest to do so, he can apply to the courts fora disqualification order against a director or shadow director. If the courtsare satisfied that the person is unfit to act as a director, a disqualificationorder can be imposed for a maximum period of fifteen years.

It is perhaps worth mentioning here that the Securities and FuturesCommission (Amendment) Ordinance 1994 has introduced new regula-tions in relation to the investigation of the affairs of listed companies. Thenew Section 29A enables the Securities and Futures Commission to directsuch companies to produce specified records and documents if it appearsto the Commission that there are circumstances suggesting:1. that the company’s business has been conducted with intent to de-

fraud creditors;2. that those engaged in the formation or management of the company

have been guilty of fraud, misfeasance or other misconduct towardsits members; or

3. that members have not been given all the information which it wouldbe reasonable for them to expect.

Section 29A also provides that if the documents are produced, thenpresent and past officers of the company and employees can be required


to provide explanations of the documents, and that if the documents arenot produced the person required to produce them should state wherethey are located.

In the United Kingdom there is equivalent legislation in Section 447of the UK Companies Act 1985. Information from investigations underthis section has been used as a basis for affidavits made in support of anapplication for disqualification of directors.38

Corporate directors

The Companies Ordinance provides under Section 154A that private com-panies that do not belong to a group of companies, one or more of themembers of which is listed on the Stock Exchange in Hong Kong, arepermitted to have corporate directors. Under Section 168N of the Com-panies Ordinance if a body corporate that has been made subject to adisqualification order subsequently acts in breach of such an order, thenany officer of the corporate director, or anyone purporting to act as anofficer of the corporate director who was a party to such breach, will beguilty of an offence together with the corporate director. This can includemembers of the company if the affairs of the company are managed by itsmembers.

Personal liability for a company’s debts

Section 168O of the Companies Ordinance introduces provisions wherebyanyone acting in breach of a disqualification order or of Section 156 (anundischarged bankrupt acting as a director) becomes liable for the debtsof a company incurred during the time that such person was involved insuch company’s management. In addition, anyone who knowingly acts oris willing to act on the instructions of a disqualified person or anundischarged bankrupt (unless with the leave of the court) also becomespersonally liable for the company’s debts during the period when he orshe either so acted or was willing to so act.

38 See Re Rex Williams Leisure plc [1994] 4 All ER 27 [hereinafter Rex Williams] wherethe use of such information was unsuccessfully challenged on the grounds that it washearsay. It was held that the circumstances of each case would have to be looked at and,if necessary, the affidavit evidence might have to be reinforced by affidavits from theinformants concerned.

140 Caroline Hague

Regulations

Section 168S provides for the Chief Justice to make regulations concern-ing High Court proceedings for disqualification and for the FinancialSecretary to make regulations concerning reporting to the Official Re-ceiver under Section 168I(3). To date the Companies (DisqualificationOrders) Regulation (the ‘Disqualification Orders’), the Companies (Re-ports on Conduct of Directors) Regulation (the ‘Reports on Conduct’)and the Companies (Disqualification of Directors) Proceedings Rules (the‘Proceedings Rules’) have been published as subsidiary legislation I, J andK respectively to the Companies Ordinance.

Schedules 1, 2 and 3 of the Disqualification Orders set out the formsaddressed to the Registrar of Companies containing the particulars of adisqualification order, the particulars of the grant of leave in relation to adisqualification order and the particulars of the variation or cessation of adisqualification order.

The Reports on Conduct apply to the returns which have to be madeby liquidators (other than the Official Receiver) and receivers within sixmonths of certain specified dates (e.g., in a compulsory winding up, thedate of the court’s winding-up order, and in a receivership, the date ofappointment). Failure to comply with these regulations renders the liqui-dator or receiver liable to a fine not exceeding $5,000. A report must bemade in respect of each director of the company concerned, with anindication if the report is on a shadow director and whether the directoris considered to be unfit to be concerned in the management of a com-pany. If so, details of the director’s conduct must be provided in thereport. The form for the report provides for details to be set out of theremuneration and other benefits received by the director in the preceedingthree years and of any civil or criminal proceedings taken or likely to betaken against the director.

The Proceedings Rules provide for service of a summons by post. Therespondent then has twenty-eight days to file any affidavit evidence in op-position to the application. The applicant can then within twenty-one daysof receipt of the respondent’s evidence, file further evidence in reply. Theapplication is to be held in open court before the Registrar, within eightweeks from the issue of the summons. The Registrar can either decide thecase or adjourn it, and if he thinks it appropriate, adjourn it to a judge.The requirement for directors to file affidavit evidence was challenged inRe Rex Williams Leisure plc (‘Rex Williams’).39 The directors in this casewished to appear at the hearing to give evidence or call other witnesses.

39 Ibid.


They did not want to file affidavit evidence, but wanted to maintain theright to submit that there was no case to answer without disclosing theirown evidence. This application was dismissed and Hoffman LJ ruled thatthe right of a respondent to give evidence was qualified by the procedureset out in the Proceedings Rules which required affidavit evidence.40

DISQUALIFICATION ORDERS

Since the Hong Kong legislation follows that of the United Kingdom soclosely, the relevant UK cases are of interest. The number of actions fordisqualification has risen considerably since the introduction of revisedlegislation in the United Kingdom in 1986.41 Most of the cases havecentred around consideration of the unfit behaviour of the directors ofinsolvent companies pursuant to Section 6 of the UK Company DirectorsDisqualification Act 1986.

In deciding what is necessary for a finding of ‘unfitness’ Gibson J inRe Bath Glass Ltd (‘Bath Glass’)42 stated:

the court must be satisfied that the director has been guilty of a seriousfailure or serious failures, whether deliberately or through incompetence,to perform those duties of a director which are attendant on the privilegeof trading through companies with limited liability. Any misconduct ofthe respondent qua director may be relevant, even if it does not fallwithin a specific section of the Companies Act or the Insolvency Act.43

He went on to stress that in every case, whether any proven instancesof misconduct would justify a finding of unfitness would depend on thefacts of each individual case.

40 Hoffman LJ went on:

of course the court retains a residuary control over its own procedure (see, forexample, RSC Ord 2, r 1). A judge will commonly allow a witness in proceedingsunder the 1986 Act to supplement his affidavit with a few answers in chief beforebeing cross-examined. And no doubt if a respondent wishes to call a witness overwhom he genuinely has no influence and who has refused to swear an affidavit,the court will allow him to do so on subpoena. But the circumstances in whichoral evidence in chief will be allowed at the hearing are exceptional and neitherapplicant nor respondent is entitled to insist on it.

Ibid, 36.41 See text accompanying note 17 above.42 [1988] BCLC 329 [hereinafter Bath Glass].43 Ibid, 333.

142 Caroline Hague

Unfit behaviour

A line of cases has considered what might constitute unfit behaviour, andit appears that an increasingly strict test of the conduct of directors hasbeen applied. A review of three leading cases, Re Lo-Line Electric MotorsLtd,44 Bath Glass, and Sevenoaks Stationers45 demonstrates how the courts’application of the legislation has developed.

Competence of the directors

Lo-Line Electric Motors considered the meaning of unfit behaviour in thecontext of the old legislation. The Official Receiver applied under Section300 of the previous legislation, the UK Companies Act 1985, for an orderto disqualify one of its directors from acting as a director of a company,on the grounds that he had been director of several companies that wereinsolvent when they were wound up, and that his conduct made him unfitto be concerned in the management of a company. It was alleged that thedirector allowed various companies to trade on when he either knew, orought to have known, that they were insolvent, and that the companieswere trading with money belonging to the Crown. There were also al-leged failures to file annual returns and accounts.

Browne-Wilkinson VC emphasized that the powers of the court setout in the UK Companies Act in relation to the disqualification of direc-tors were not ‘fundamentally penal’, but were intended to protect thepublic. He went on to state as follows:

But, if the power to disqualify is exercised, disqualification does involvea substantial interference with the freedom of the individual. It followsthat the rights of the individual must be fully protected. Ordinarycommercial misjudgment is in itself not sufficient to justify disqualification.In the normal case, the conduct complained of must display a lack ofcommercial probity, although I have no doubt that in an extreme case ofgross negligence or total incompetence disqualification could beappropriate.46

This statement has been quoted and relied upon in the many casesbrought to the courts under the provisions of the revised legislation con-tained in the UK Company Directors Disqualification Act of 1986.47

44 [1988] BCLC 698.45 Note 16 above.46 Lo Line Electric Motors (note 44 above), 703.47 See for example Re Keypak Homecare Ltd [1990] BCLC 440, 444; Re Austinsuite

Furniture Ltd [1992] BCLC 1047, 1065.


The later case of Bath Glass is also referred to in many subsequentcases and is of particular interest in that there, the application for adisqualification order against two directors was not successful. The factsof the case are that the company dealt in craft products, originally as awholesaler but later as a manufacturer. It ran into financial difficulties in1980–81. The company’s bankers employed a firm of accountants toreview the company’s position, and although the company followed itsrecommendations it still failed to prosper. In 1982 the bank took addi-tional security by way of charges over the homes of the two directors. Thedirectors decided that a new product manufactured by the company wouldbe managed by another company, Collective, which came to be owned bythe two directors, who were also its directors. In 1984 some of the com-pany’s major customers stopped making purchases from the company andit appeared that the company’s only hope of survival was to do sub-contract work for Collective. The company continued to make losses andwas unable to pay some of its creditors, including the Crown.

The company stopped trading in January 1986 when its bankers re-fused to provide further financial support. At that time both Collectiveand the company were using the same premises, of which the companywas the tenant. The lease had four years left to run and the rent was low.Collective took over the lease, paying the arrears of rent owed by thecompany. The company’s work-force also transferred to Collective. Atthe bank’s insistence, the two directors paid off the company’s overdraftwith the bank, pursuant to the guarantees that they had given. The com-pany was compulsorily wound up on 14 July 1986, owing creditors anestimated £128,000, of which £14,000 were trade debts, the principalindebtedness being amounts owed to the Crown for VAT, PAYE andNational Insurance Contributions. Collective continued in business andits profits improved.

The Official Receiver applied for a disqualification order against thetwo directors of Bath Glass on the following grounds: First, failure toensure the filing of accounts for the year to 30 June 1985. Gibson J didnot regard this as serious misconduct. Second, misfeasance and/or breachof trust for transferring the company’s lease to Collective without anyconsideration. Gibson J was not satisfied that there was any misconducthere. There was an allegation by the Official Receiver that the lease had apremium value, but it was decided that this was hearsay and in any eventdismissed, because Collective had paid arrears of rent for the company,which it had not claimed back from the company. Third, allowing thecompany to continue trading while it was insolvent and while it retained£106,000 which was owed to the Crown. Here the judge conceded thatthe directors were at fault, given that the company was insolvent in 1982

144 Caroline Hague

and had continued to trade in a worsening situation, dependent on thesupport of the bank and using money due to the Crown in the business:

In particular, they knew in the last six months of trading that the Crowndebts were going unpaid and increasing while the Bank borrowings wentdown. There was an increasing risk that creditors would be left unpaid ifthe Bank could not be persuaded to grant substantial overdraft facilities.In my judgment, that is improper conduct and a wrong way in which toconduct business. They must have known that they were trading at therisk of creditors.48

In this case two companies were involved, Bath Glass and Collective,and the judge emphasized the danger of directors treating two companiesas one. Distinct and separate duties are owed to both companies, and ifone is favoured at the expense of the other, there is likely to be a strongsuspicion of misconduct.

Despite this, however, the directors in this case were not disqualifiedbecause they did not act dishonestly or with the intention of benefittingthemselves at the expense of the company’s creditors. Other relevantconsiderations were that they demonstrated their own financial commit-ment to the company by repaying the company’s bank overdraft inconsideration for shares in the company. They relied on professionaladvice and produced regular budgets and financial forecasts for the com-pany (even though these subsequently proved to be over-optimistic). Therewas some foundation for the directors’ view that the company wouldtrade out of its financial problems. Several matters outside the directors’control contributed to the eventual collapse of the company. Summingup, Gibson J stated that ‘[i]mprudent and indeed improper although Ithink the directors’ conduct to have been, in all the circumstances I amnot satisfied that their conduct as directors of Bath Glass alone is soserious as to make them unfit to be concerned in the management of acompany.’49

The later case of Sevenoaks Stationers is important because it was thefirst case in which a disqualification order under the Company DirectorsDisqualification Act 1986 was appealed to the Court of Appeal. In thiscase, a disqualification order of seven years was made against a directorwho had been a director of five companies. Winding-up orders were madeagainst two of the companies on 18 April 1983, and against the otherthree on 1 April 1985, 24 November 1986 and 3 June 1986, respectively,

48 Bath Glass (note 42 above), 339.49 Ibid, 340.


with total net deficits respectively (including lost share capital) of £74,591,£89,506, £79,948, £230,576 and £124,780.

In the appeal case, Dillon LJ referred to the judgment in Lo-LineElectric Motors and deplored the tendency of barristers applying on be-half of the Official Receiver to treat certain statements50 in that judgment‘as judicial paraphrases of the words of the statute which fall to beconstrued as a matter of law in lieu of the words of the statute. The resultis to obscure that the true question to be tried is a question of fact.’51

In reviewing the facts in Sevenoaks Stationers, Dillon LJ stated:

I have no doubt at all that it is amply proved that Mr Cruddas is unfit tobe concerned in the management of a company. His trouble is notdishonesty, but incompetence or negligence in a very marked degree andthat is enough to render him unfit; I do not think it is necessary forincompetence to be ‘total’ as suggested by the Vice-Chancellor in Re Lo-Line Electric Motors Ltd to render a director unfit to take part in themanagement of a company.52

In considering the appropriate period of disqualification, Dillon LJalso endorsed the division of the maximum sentence of fifteen years intothree brackets:

(i) The top bracket of disqualification for periods over ten years shouldbe reserved for particularly serious cases. These may include caseswhere a director who has already had one period of disqualificationimposed on him falls to be disqualified yet again.

(ii) The minimum bracket of two to five years’ disqualification shouldbe applied where, though disqualification is mandatory, the case isrelatively not very serious.

(iii) The middle bracket of disqualification for from six to ten yearsshould apply for serious cases which do not merit the top bracket.53

It is clear, therefore, that a marked degree of incompetence or negligence,rather than total incompetence, may be sufficient to justify the making ofa disqualification order and that any lack of commercial probity willweigh heavily against the directors concerned.

50 See the discussion of Lo-Line Electric Motors (note 44 above) and the comments ofBrowne-Wilkinson VC in the text accompanying note 46 above.

51 Sevenoaks Stationers (note 16 above), 330.52 Ibid, 337.53 Ibid, 328.

146 Caroline Hague

Maintenance of accounting records

The need to ensure that proper accounts are kept must be stressed:

When directors do not maintain proper accounting records they cannotknow their company’s financial position with accuracy. There is thereforea risk that the situation is much worse than they know and that creditorswill suffer in consequence. Directors who permit this situation to arisemust expect the conclusion to be drawn in an appropriate case that theyare in consequence not fit to be concerned in the management of acompany.54

The ‘Phoenix’ factor

The courts have particularly deplored the behaviour of directors in trans-ferring a business from one company to another and leaving behind astring of unpaid creditors as each company in turn becomes insolvent.55

Commenting on this type of behaviour in Re Travel Mondial (UK) Ltd,56

Browne-Wilkins VC on said:

This was an attempt to carry on the same business on the same premises,leaving behind the creditors of the old business. This is exactly the kindof behaviour by directors that is most to be deplored in that it is the useof the fabric of a limited company to deprive creditors of their moneyand simply to change the cloak in which that is done from one companyto the next. It is in my judgement a serious case of unfitness to be adirector.57

Crown debts

The UK cases have also focused on the way in which directors of insol-vent companies have continued to trade to the detriment of their creditors,in particular the Crown. In the United Kingdom, companies are placed in

54 Re Firedart Ltd [1994] 2 BCLC 340, 352. The director here, in addition to failing tokeep proper accounts, continued to trade when the company was insolvent and tookmore than a proper amount of remuneration from the company. He was disqualified forsix years.

55 See the comments of Harman J in Keypack Homecare (note 47 above) where in a‘Phoenix’ situation the forced-sale value given to the transfer of stock from an insolventcompany to a new company was described as amounting to a want of proper observanceof standards, and despite several substantial mitigating factors, the directors concernedwere disqualified for three years.

56 [1991] BCLC 120 [hereinafter Travel Mondial].57 Ibid, 123.


the position where they collect revenue on behalf of the government fromtheir employees in the form of income tax and national insurance contri-butions, and from their customers in the form of Value Added Tax.Companies in financial difficulties often tend to use these revenues, ratherthan accounting to the government for them.

Breach of fiduciary duties

Although nearly all the cases where applications for disqualification or-ders have been brought involve insolvent companies, this is not always so.Schedule 1 to the UK Company Directors Disqualification Act 1986 andthe new Fifteenth Schedule to the Companies Ordinance set out variousmatters for determining the unfitness of directors. Those set out in Part Iof the Schedule to the Companies Ordinance are applicable to all cases,and those in Part II, to insolvent companies. The first point listed in Part Iis: ‘Any misfeasance or breach of any fiduciary or other duty by thedirector in relation to the company.’ This was the only relevant groundfor a disqualification order in the case of Re Looe Fish Ltd.58 There adisqualification order was imposed on a director under Section 8(1) of theUK Company Directors Disqualification Act59 for breach of fiduciaryduty in his exercise of the power to allot shares. Allotments of shareswere made on two occasions, which made it possible for the directorconcerned to block changes to the Board of Directors. On each occasionthe shares allotted were subsequently repurchased by the company. ParkerJ stated that each allotment was a clear breach of duty and ‘displayed aclear lack of commercial probity. A director who chooses deliberately toplay fast and loose with his powers . . . in order to remain in control ofthe company’s affairs, is . . . unfit to be concerned in the management of acompany, and it is expedient in the public interest that a disqualificationorder be made.’60 Parker J therefore made a two-and-a-half year disquali-fication order against the director.

58 [1993] BCLC 1160.59 Section 8(1) of the UK Company Directors Disqualification Act 1986 authorizes the

Secretary of State to apply for a disqualification order following the investigation of acompany under the relevant provisions of the UK Companies Act 1985, the UK FinancialServices Act 1986 or the UK Criminal Justice Act 1987. The equivalent provision in theCompanies Ordinance is in s 168J. See discussion above under ‘Investigation of acompany’s affairs’ at page 138.

60 Looe Fish (note 58 above), 1172.

148 Caroline Hague

Mitigating Factors

In considering the period of disqualification to be imposed, the courtshave taken into account the factors set out below.

Age

The courts have indicated that the age of the directors concerned can betaken into account. For example, in Re Chartmore Ltd,61 a director wasdisqualified from acting for two years. He was the director of a companythat had acquired its business from his father’s company, Drew Packag-ing, of which he had also been a director and which had also beeninsolvent. Harman J found that the director had been grossly incompetentin allowing Chartmore Ltd to trade when it was grossly under capitalizedand failing to keep proper accounts. In only disqualifying the director fortwo years, Harman J drew attention to the fact that the director wasroughly thirty years old and had been very young when Drew Packagingwent into liquidation.

Undertakings

Directors who are made subject to a disqualification order may be al-lowed to continue in office subject to certain conditions imposed by thecourt. For example, on a further application by the director’s counsel inChartmore, Harman J gave leave for the director to continue as directorof another company for a one-year period from the date of the judgment,leaving it to the director to apply to court for a further one-year exten-sion. This was on the basis of an undertaking by the director to continueadministering the company with monthly board meetings attended by arepresentative of the auditors.

The system of allowing a director to continue in office in relation tocertain specified companies has been seen in other cases. In Re GodwinWarren Control Systems plc62 a director was disqualified for three yearsbut given leave to continue as director of two other companies providedthat the boards of directors of these companies were notified.

Honesty

If the court is of the opinion that directors have acted honestly and not

61 [1990] BCLC 673.62 [1993] BCLC 86.


with a view to their own personal benefit, this can be taken into accountin deciding on the period of disqualification. City Investment illustratesthis point, because in this case the controlling director, who stood to gainpersonally from his activities, was disqualified for ten years, but twodirectors who did not act for personal gain and cooperated fully with theOfficial Receiver were each disqualified for only six years.

Professional advice

The court can also take into account if the directors have tried to actresponsibly and have taken professional advice. This was one of themitigating factors in the case of Bath Glass, mentioned above, where thedirectors took the advice of accountants appointed by the company’sbank.

Strict liability

It is not possible for a director to evade the responsibilities of his office byleaving matters to be dealt with by other directors. This is illustrated inCity Investment, where two directors were made subject to disqualifica-tion orders for a very marked degree of negligence. One of these directorsdescribed himself as merely a ‘compliance’ director, and the other statedthat he was merely concerned with marketing aspects of the company’sbusiness and left everything else to the other directors. These argumentswere not accepted by Morritt J who stated that ‘in my judgment thisattitude displays a woeful ignorance of the duties attaching to the officeof a director of a company.’63 Both directors were disqualified for sixyears.

Procedures on application for an order

The Lo-Line Electric Motors case emphasized that because the conse-quences of disqualification are penal, due regard must be given to naturaljustice, and a director should therefore be notified of the charges that willbe made against him, though this should not lead to ‘the technicalitiesassociated with criminal charges’.64 It was noted that it was the practice

63 City Investment (note 37 above), 969.64 Lo-Line Electric Motors (note 44 above), 704.

150 Caroline Hague

of the Official Receiver to summarize in his affidavit the allegations to bemade against a director.

In Sevenoaks Stationers, Dillon LJ also referred to the obligation ofthe Official Receiver to summarize the allegations against any director inthe affidavit in support of the application65 and the difficulties that mayarise if, because of new evidence coming to light, the Official Receiverwishes to amend or add to the original allegations. It was decided that thecourt has a discretion to allow this to be done, provided that doing so isnot an injustice to the director. As everything turns on the facts of thecase, it might be necessary to give notice of any changes and an adjourn-ment may or may not be required. The overriding requirement is ‘that thedirector facing disqualification must know the charges he has to face.’66

It had been suggested on behalf of the Official Receiver that when theperiod of disqualification is being decided, it would be in order to takeinto account matters in relation to the director which were not containedin the Official Receiver’s report. Dillon LJ strongly rejected this sugges-tion, stating:

It is inconsistent with the whole conception of giving notice of the chargesthe director has to meet . . . if in fixing the period of disqualificationother matters could be alleged of which no notice had been given. Mattersof mitigation can of course be taken into account in favour of the directorsin fixing the period of disqualification, but otherwise the period shouldbe fixed by reference only to the matters properly alleged against himwhich have been found to be established and to make him unfit to beconcerned in the management of a company.67

The penal consequences of disqualification were also noted in the caseof Re Copecrest Ltd,68 where an application for a disqualification orderwas made by the Secretary of State for Trade and Industry who requestedleave to commence the disqualification proceedings out of time. The ap-plication was refused and Davies J endorsed the comments ofBrowne-Wilkinson VC in the Lo-Line Electric Motor case by stating ‘al-

65 In Hong Kong, where applications are being made under the Companies Ordinance,ss 276, 275(1), (2), (4), or 358(2), or, presumably, also under the new Part IVA, in thecourse of winding up the equivalent requirement is set out in r 58 of the Companies(Winding-Up) Rules (cap 32, sub leg H, LHK). Where the Official Receiver or liquidatormakes a report to the court, copies of the report and any supporting affidavits must beserved on the person against whom the order is sought at least four days before thehearing of the summons.

66 Sevenoaks Stationers (note 16 above), 331.67 Ibid.68 [1993] BCLC 1118–1125.


though the primary purpose of the legislation is not penal, disqualifica-tion involves a substantial interference with the freedom of the individual.The rights of the individual must be protected’.69 In considering the cir-cumstances in which leave would be given, Davies J cited Harman J in ReCrestjoy Products Ltd,70 who had confirmed that the court has to besatisfied that there is a good reason for allowing an extension.71 Davies Jalso referred to the statement of Scott LJ in Re Probe Data Systems Ltd(No 3) (Secretary of State for Trade and Industry v Desai)72 that thefollowing four matters should be taken into account: ‘the length of thedelay, the reason for the delay, the strength of the case against the direc-tor, and, the degree of prejudice caused to the director by the delay.’73

Striking out

Delay in proceeding with an application for disqualification may lead tothe court striking the application out. In Re Manlon Trading Ltd,74 pro-ceedings to disqualify a person who had acted as a shadow director of acompany were commenced on 7 June 1990, the day before the expiry ofthe two-year period allowed under the UK Company Directors Disqualifi-cation Act.75 In March 1994 the respondent applied to strike out theoriginal application for want of prosecution. In agreeing to this applica-tion for striking out, Evans-Lombe J distinguished disqualification caseswhere the applicant is a regulatory authority from cases involving privatelitigation. He stated that by contrast with private litigation: ‘there will al-most always be serious collateral prejudice inherent in the existence of theproceedings which in private litigation would justify striking out.’76 He laiddown the following practical guidelines as to whether or not to strike out:1. Having decided that there had been inordinate and inexcusable delay,

does such delay mean a substantial risk a fair trial is no longer possi-ble?

2. If a fair trial is not possible, the proceedings will generally be dis-missed.

3. If a fair trial has not been prejudiced, the case should proceed unless:

69 Ibid, 1122.70 [1990] BCLC 677.71 Ibid, 685.72 [1992] BCLC 405.73 Ibid, 416.74 [1995] 1 All ER 988.75 See note 28 above.76 Manlon Trading (note 74 above), 1004.

152 Caroline Hague

having regard to all the circumstances of the case including (a) thenature of the allegations, (b) the likely period of disqualificationwhich would be imposed if those allegations were proved, (c) thetime which has elapsed since the relevant winding up or thecommencement of the disqualification proceedings and the applicationto strike out these proceedings, (d) the continuing inherent prejudiceto the respondent (which can usually be assumed), (e) the impactand seriousness of specific prejudice to the respondent which thecourt finds to have resulted or which is resulting from the pendencyof the proceedings, there has ceased to be an obvious public interestin obtaining a disqualification order against the particular respondentfor the protection of the public, which outweighs the interest of therespondent (and of the public) in the respondent being able to pursuehis business affairs without fetter.77

It should be noted that under Section 168H, in Hong Kong, applica-tions for disqualification can be made up to four years after thecommencement of winding up or termination of the receiver’s appoint-ment, rather than up to two years as in the United Kingdom. Because ofthis longer time limit, any delay in proceeding with applications for dis-qualification in Hong Kong may well be an issue raised by a directoragainst whom an application is instituted.

The fact that other actions against a director may be pending providesno grounds for striking out disqualification proceedings. In Rex Williams78

an action against a director for the return of £200,000 to the companyhad been pending for three years. An application was lodged to strike outsubsequent disqualification proceedings on the ground that it was anabuse of process for the disqualification proceedings to be heard while theother action was still proceeding. Hoffman LJ dealt with this very shortly:‘I think it would be quite absurd. The Secretary of State has a public dutyto apply for the disqualification of unfit directors. He cannot be held upindefinitely by other proceedings over which he has no control’.79

CONCLUSION

In reviewing the recent amendments to the Companies Ordinance as awhole, perhaps the most interesting features are the mandatory require-

77 Ibid.78 Note 38 above.79 Ibid, 41.


ment that a disqualification order must be made in the circumstances setout in Section 168H and the reporting requirements imposed on theOfficial Receiver and liquidators and receivers of companies by Section168I. It may be that these provisions taken together will, in contrast tothe previous provisions, result in more frequent applications being broughtfor the disqualification of directors in Hong Kong.80

In the event that such applications are brought, the UK cases — thevast majority of which involve insolvent companies — emphasize thefollowing points:1. Each case must be tried on its own facts.2. Dishonesty does not need to be proved, although its presence may

lead to an increased period of disqualification, but a marked degree ofnegligence or incompetence is sufficient for a director to be deemed‘unfit’.

3. Various mitigating factors can be taken into account.4. Although subject to a disqualification order, a director may, with the

leave of the court and subject to such conditions as the court mayimpose, continue in office as a director either of any company con-cerned in the application or any other company.

One must, however, recognize the many differences between the posi-tion in Hong Kong and that in the United Kingdom. A major point is thatcompared to the United Kingdom, Hong Kong has a comparatively lowrate of corporate insolvency.81 Another consideration is that the UK casesoften involve directors using what are generally described as Crown Debtsto subsidize the continued trading of insolvent companies. This positionwould not arise in Hong Kong, where Salaries Tax is paid directly to thegovernment by employees, and there are no National Insurance Contribu-tions or Value Added Taxes. The government in Hong Kong thereforecannot be an involuntary creditor of insolvent companies to the sameextent as is possible in the United Kingdom.

A further recurrent feature of the UK cases is the situation in whichdirectors use a string of companies, transferring a business from one

80 On a preliminary point in relation to the new legislation, in Re Rank Yam InvestmentsLtd (in liq), Re Walk Fit Shoes Factory Ltd (in liq), and Re Kan King Investment Ltd (inliq), Winding Up Nos 3605, 3606 and 3607 of 1994 (31 March 1995), Rogers Jconfirmed that the provisions of s 168H of the Companies Ordinance could be appliedin respect of offences committed prior to its having come into effect. See also note 25above and the application of the Hong Kong Bill of Rights Ordinance.

81 For a discussion of possible reasons for this see Edward LG Tyler, ‘Current Issues inInsolvency’ in Caroline Hague, ed, Commercial Law (Hong Kong: The Hong Kong LawJournal Ltd, 1991), 19, 20–22.

154 Caroline Hague

company to the next as each in its turn becomes insolvent.82 In HongKong the existence of the Transfer of Businesses (Protection of Creditors)Ordinance83 (which broadly provides that, subject to notice being given toall creditors, when a business is transferred the liabilities automaticallyattach to the business), perhaps prevents this situation from occurring asfrequently in Hong Kong.

These factors together may well mean that the new legislation inHong Kong will have less of an impact than the equivalent legislation hashad in the United Kingdom. In the United Kingdom a separate unit hasbeen established by the Department of Trade and Industry called theCompany Directors Disqualification Unit, to administer the regulationsimposed by the new legislation. One should query whether the HongKong government will commit similar resources. As the legislation hasonly recently come into force it will be some time before one will be in aposition to judge its effectiveness in bringing to book those who fail tomeet their true responsibilities as company directors.84

82 See Re Linvale Ltd [1993] BCLC 654; Travel Mondial (note 56 above), 120.83 Cap 49, LHK.84 It would appear that to date most applications for disqualification have been on the

grounds that the directors concerned have either failed to keep proper accounts or failedto cooperate with the Official Receiver in providing Statements of Affairs. The applicationshave therefore not been contested. In the financial year 1995/1996, approximatelyforty-five disqualification orders were made on that basis.

Legal Dysfunctionalism:Hong Kong Company Law in the 1990s

Anne Carver*

. CHAPTER SIX .

INTRODUCTION

Hong Kong’s Companies Ordinance (the ‘Companies Ordinance’)1 is nowundergoing a thorough review to ensure that Hong Kong company lawreflects today’s business environment. One important issue underlying themove towards such reform is how Hong Kong company law can bestserve the territory as a major international financial centre before andafter 1997. Another issue is whether the Companies Ordinance remainsconsistent with its original objectives. In the circumstances it seems rel-evant to suggest that the social and economic objectives of company lawshould be expressly articulated by those concerned with company lawreform rather than left as unstated assumptions in the legislation.2

An essential problem is that the objectives of the Companies Ordi-nance are difficult to discover either in the legislation itself or elsewhere.Furthermore, the English model is possibly no longer appropriate for HongKong’s company law reform.3 The result is that there is a growing legal

* The author wishes to thank her colleagues, Steve Nathanson and Ian Tokley, and theSecretary to the Standing Committee on Company Law Reform for their comments andassistance with this chapter.

1 Cap 32 (LHK).2 Sian Ellis, ‘Company Law in the 1990’s’ in John Farrar, ed, Contemporary Issues in

Company Law (New Zealand: Commerce Clearing House, 1987), chs 1, 5.3 The current debate, for example, in the United Kingdom on the advantages and

disadvantages of Part IV of the UK Companies Act 1989 (concerning the registration of

156 Anne Carver

dysfunctionalism between the objectives and the operation of Hong Kongcompany law. The argument is divided into three parts: the first analysesthe influences that have increasingly widened the gap between Hong Kongand English company law; the second identifies three principles of com-pany law involving the protection of outsiders dealing with a company;4

and the third surveys the approaches of two other jurisdictions for dealingwith the protection of outsiders and concludes that the Australian approachmay best serve the needs of Hong Kong’s business community.

INFLUENCES ON HONG KONG LAW

In examining the objectives of Hong Kong company law and its commer-cial role, Professor Goode’s much quoted comment that sometimes it isnecessary ‘to throw off the shackles of rules and practice, of the latestcase and the most recent business technique, and to examine the moredurable abstract principles on which the network of case law is sup-ported’5 seems particularly appropriate for Hong Kong given the imminentarrival of 1997. Lawyers and businesspersons alike should be able tounderstand the existing law and its underlying principles if the law is toremain useful after 1997. To reduce the risk of misinterpretation by thosewho operate within the framework of company law, it is important thatthe overall structure and objectives of the legislation should not be buriedunder the weight of historical detail.

company charges) gives Hong Kong lawyers a focus for identifying and unravellingfrom the patchwork of Hong Kong company law those principles that may no longer beconsistent with Hong Kong business. Hong Kong can now look towards the possibilityof adopting ‘models’ for company law from jurisdictions such as Australia, Canada, theUnited States and Singapore, and deciding for itself which of these models best suits theHong Kong context.

Parts of the UK Companies Act 1989 are not yet in force in England and arecurrently being debated in the United Kingdom. The Hong Kong government prefers toawait the outcome of these discussions in the United Kingdom before tabling its owndraft of the equivalent legislation. The particular sections not yet in force are Part IV,relating to the registration of charges, and Schedules 15 and 16, relating to overseacompanies. It may be that these will be ‘reformed’ once again in the United Kingdom.The author is grateful to the Secretary to the Standing Committee on Company LawReform for access to the Department of Trade and Industry’s Consultative Documenton Proposals for Reform of Part XII of the Companies Act 1985 and Part IV of theCompanies Act 1989 URN 94/635 on possible reforms to the UK company legislation.

4 The three principles are the doctrine of constructive notice, the rule in Turquand’s case(Royal British Bank v Turquand (1856) 6E & B 327), and the doctrine of ultra vires.

5 Roy Goode, Commercial Law, 2nd ed (London: Penguin, 1995), 1205.

Legal Dysfunctionalism: Hong Kong Company Law in the 1990s 157

The crossword puzzle of Hong Kong company law — Englishdevelopments

The English Law Society in 1991 commented that company law in theUnited Kingdom is ‘not of a high enough standard’.6 It has also beendescribed as more ‘like a crossword puzzle than a vital feature of thenation’s business and commercial life’.7 Could the same be said of HongKong company law?

One commentator on Hong Kong company law has said:

even where the Companies Ordinance appears to deal expressly andconclusively with a particular issue, it may sometimes be the case thatthe received English case law requires a seemingly contradictory result.Accordingly, it may be unwise for the practitioner faced with a specificproblem to seek guidance first from the Companies Ordinance. Insteadthe case law, as explained in the classic practitioner texts on Englishcompany law may be taken as a more useful starting point.8

Hong Kong company law is clearly diverging from its UK parent, andthere appear to be three factors influencing this development. The firstidentifiable factor is that an independent Hong Kong case law is emerg-ing; the second is that Hong Kong has not enacted many of the changesthat have been made to UK company law since 1985; and the third is thatUK legislation is now greatly influenced by the European CommunityDirective on UK legislation.

First of all, Hong Kong cases can be, and frequently are, decidedindependently from UK case law. Furthermore, Hong Kong judges drawnot only upon decisions of the Privy Council and the House of Lords, butalso upon decisions of the Canadian, Australian, New Zealand, Singaporeand Malaysian courts. Whilst American decisions are of interest, theyhave not to the author’s knowledge been used as precedents for HongKong case law. This chapter does not attempt to discuss the reasons forthe Hong Kong courts’ willingness to ‘window shop’ in available commonlaw jurisdictions, but simply comments upon this as an underlying factorin the divergence of Hong Kong law from the UK model.

6 The Law Society’s Company Law Committee, The Reform of Company Law, LawSociety Memorandum, No 255 (London: Law Society, 1991), 1.

7 Stephen Mayson, Derek French and Christopher Ryan, Company Law, 11th ed (London:Blackstone Press, 1994), 17 (describing English company law).

8 Philip Smart, ‘Business Associations’, in Philip Smart and Andrew Halkyard, eds, Tradeand Investment Law in Hong Kong (Hong Kong: Butterworths, 1993), 41, 43.

158 Anne Carver

The second factor concerns the rapid developments in the UK legisla-tion, with which Hong Kong has not kept pace. For example, UK companylaw now has the Companies Act 1985, the Insolvency Act 1986, theCompany Directors Disqualification Act 19869 and the Companies Act1989. In particular, changes in the UK Companies Act 1989 to the rulesregarding the protection of third parties dealing with companies illustratethe increasing divergence between Hong Kong and UK company law. The1989 changes have gone some way to implement the fundamental reformssuggested in the Diamond Report of 1989,10 the Prentice Report of 1986,11

the Cork Report of 1982,12 the Crowther Report on Consumer Credit of1971,13 and the Jenkins Report of 1962.14 For over thirty years compre-hensive reforms and profound changes have been proposed to redress theinequities in English law regarding the balance of rights between outsidersand the limited liability company, and UK law has adopted some of thesereforms.

Hong Kong, not surprisingly, has produced fewer reform proposalsand has attempted a less comprehensive overview of the structure andobjectives of company law. The Second Report of the Company LawDivision Committee in 197315 advised that the Hong Kong governmentshould set up the Standing Committee on Company Law Reform to com-pare, assess and suggest relevant company law reform where appropriate.The Standing Committee was established in 1984, and the Ninth Reportof the Standing Committee on Company Law Reform in 1992 specificallyraised the issue of ultra vires in considering whether Hong Kong shouldcontinue to follow the UK model or should instead adopt Canadian orAustralian precedents.16 The last major overhaul of Hong Kong company

9 Hong Kong, however, has enacted most of the UK Disqualification of Directors Act1986 through amendments to the Companies Ordinance. These changes become law on13 May 1994. For a detailed commentary, see Caroline Hague, Chapter 5 above.

10 Department of Trade and Industry, Review of Security Interests in Property, UnitedKingdom (1989) [hereinafter the Diamond Report].

11 Daniel Prentice, Reform of the Ultra Vires Rule: A Consultative Document, UnitedKingdom (1986) [hereinafter the Prentice Report].

12 Report of the Review Committee, Insolvency Law and Practice, United Kingdom, Cmnd8558 (1992) [hereinafter the Cork Report].

13 Report of the Committee on Consumer Credit, United Kingdom, Cmnd 4596 (1971)[hereinafter the Crowther Report].

14 Committee on Company Law Reform, United Kingdom, Cmnd 1749 (1962) [hereinafterthe Jenkins Report].

15 Second Report of the Company Law Division Committee on Company Law Reform(1973).

16 Ninth Report of the Standing Committee on Company Law Reform (1992) 34–44. Theauthor is grateful to the Secretary of the Standing Committee on Company Law Reformfor supplying this Report.


law was in 1984,17 although the 1984 updates were themselves based onchanges made in the UK that were ten or twenty years old.18 Since theenactment of the 1984 amendments there have been frequent piecemealadditions to Hong Kong company law,19 but not a comprehensive rethinkof the whole legislation. As a result, the Financial Secretary is voicing realconcerns about the consistency and coherence of the legislation.

The third factor that has caused Hong Kong company law to divergefrom the UK model is the effect of Britain’s participation in the EuropeanUnion and the need to harmonize its laws with those of the EuropeanUnion. The policy has been to create a system of minimum legal stand-ards to be observed by all member states. In relation to company law, theDepartment of Trade and Industry in Britain drafts the necessary com-pany legislation to implement such harmonisation.20

One of the key results of the European Directive on Company Law hasbeen the abolition of the doctrine of deemed (i.e., constructive) notice of acompany’s memorandum and articles,21 the consequent abolition of thetechnical application of the rule in Turquand’s case22 and the abolition ofthe doctrine of ultra vires23 as applied to the capacity of a company as au-thorized by its objects clauses in its memorandum of association. Althoughthe balance between the rights of outsiders and the interests of the companyin the United Kingdom has shifted in favour of the outsider and away fromthe protection of the company, the changes have not gone far enough.

Although Hong Kong is theoretically not influenced by EuropeanUnion Law, the development of European legal notions in English com-pany legislation cannot be overlooked. For example the designation of thepublic company in England as ‘plc’, the formatting of public companies’accounts, alterations to the ultra vires rule, changes to the insider tradinglaws, product liability and the preparation of group accounts are all theresult of Directives from the European Commission.24

17 See Christopher Bates, ‘Companies Amendment Ordinance 1984’ (1985) 15 HKLJ 167.18 Examples of such 1984 ‘up-dates’ were the ‘new’ Companies Ordinance, s 28A,

prohibiting a subsidiary from being or becoming a member of its holding company, andthe ‘new’ s 57A, introducing provisions to ensure that any special rights attached tonon-voting shares or shares with restricted voting rights are adequately described in public.

19 See for example Edward Tyler, ‘Company and Securities Law’ in Judith Sihombing, ed,Annual Survey of Hong Kong Law (Hong Kong: HK Law Journal Ltd, 1990/91).

20 See, e.g., the Department of Trade and Industry’s annual publication, Company LawHarmonisation, cited in Mayson, French and Ryan (note 7 above), 18.

21 UK Companies Act 1989, s 142.22 UK Companies Act 1985, s 35A(1).23 Ibid, s 35(1), as amended by UK Companies Act 1989, s 108(1).24 Since 1980, UK company law has only defined a ‘public company’, thus leaving the

‘private company’ as the residual class. However the position in Hong Kong is still the

160 Anne Carver

One particularly important change to UK company law that resultedfrom its harmonization with European law has been the amendment tothe old Section 24 of the 1985 Companies Act. Section 24 required thatall companies should have at least two members (the Hong Kong equiva-lent to this requirement is included in Section 4(1) of the CompaniesOrdinance). However, since the enactment of the UK Companies (SingleMember Private Limited Companies) Regulations 199225 private compa-nies limited by shares or guarantee can now exist with a single member.Such a private company can be formed with a single subscriber, andfunction wholly through a single member with the purchase of all sharesby one person. The 1992 European Commission Regulations require thatthe single member evidence in writing all resolutions or decisions andimpose the duty to do so upon himself or herself. Thus, the introductionof the single member private limited company into UK company law hasfundamentally altered the relationship between management and the share-holders in company law and, by extension, highlights the tension betweenthe protection of the company (particularly with regard to the newlypermitted ‘one person company’) and the interests of outsiders. ShouldHong Kong’s company law reformers ignore the impact of the UK Com-panies Act 1989, which is influenced by the European CommunityDirectives on the harmonization of company laws within the EuropeanUnion, whilst considering the commercial needs of the community as aninternational financial centre?26

This brief introduction to the three factors underlying the increasinglyapparent divergence of Hong Kong company law from the UK modelemphasizes the inherent problems for Hong Kong as the child of the UK

same as in the pre-1980 UK law — s 29(1) of the Companies Ordinance defines a‘private company’ in terms of the restrictions imposed by its articles on the right totransfer its shares, the limitation of its members to 50 and the prohibition of anyinvitation to the public to subscribe for shares or debentures in the company. If thearticles do not accord with s 29 then the company is a public company, but there is stillno definition of a ‘public company’ in the ordinance. The Hong Kong position istherefore to appear to treat the public company as the residual class — again possibly asymptom of the legal dysfunctionalism of Hong Kong company law.

25 S1 1992/1699.26 Some of the influences of the European Community Directive on English company law

could have an impact on Hong Kong company law if the Hong Kong government wereto proceed with its own draft of the equivalent of the UK Companies Act 1989.However, because of current criticism of part IV of the 1989 Act in England, the HongKong government prefers to wait until the problems and difficulties associated with PartIV of the 1989 Companies Act have been fully identified and resolved in the UnitedKingdom. Thus, it may be that raising the question of the influence of the EuropeanCommunity Directive on English company law becomes an irrelevant issue post-1997.


parent. The following section examines the Hong Kong position regard-ing the rights of outsiders dealing with the company.

THE ‘CONTRACTARIAN’ MODEL AND THE PROTECTIONOF OUTSIDERS

The question of the protection of outsiders dealing with companies is oneof the key areas of company law reform in Hong Kong and must beaddressed when considering the objectives of the legislation itself, particu-larly in view of the charges to UK company law introduced as a result ofthe European Union’s influence.

The history of the law on the protection of outsiders, particularlycreditors, can be traced back to the political issue discussed in 1844 onthe ethics of limited liability and the function of the UK Equity JointStock Companies Registration and Regulation Act.27 The ethics of busi-ness were summarized as follows: ‘[U]nlimited liability was thought to bethe best way of insuring the standards of behaviour in business sought bythe community.’28 Accordingly, a judgment creditor could levy executionon individual members of the company registered under the 1844 Act ifthe company failed to pay.29

Despite the focus on the ethics of business and the insistence onunlimited liability, the UK Equity Joint Stock Companies Registration andRegulation Act 1844 is ‘the legislative ancestor of modern company law’,30

with a two-stage procedure for incorporating a joint stock company (theprecursor of our limited liability company). First, applicants had to com-plete the prescribed forms showing particulars and paying fees to theRegistrar of the Joint Stock Companies, and, second, applicants had todraw up a deed of settlement for filing with the Registrar. The deed ofsettlement contained a series of mutual promises between the subscribersand the trustees and is the precursor of the English ‘contractarian’ modelin which memorandum and articles of association are designated as acontract between the members and the company itself. It was not, how-

27 1844 (7 & 8 Vict, chs 110 & 111).28 Mayson, French and Ryan, Company Law (note 7 above), 32.29 Re Sea Fire and Life Assurance Co (Greenwood’s case) (1854) 3 De GM & G 459, cited

in ibid, 32.30 Harold Ford and Robert Austin, Ford’s Principles of Corporations Law, 6th ed (Sydney:

Butterworths, 1992), 7.

162 Anne Carver

ever, until the UK Limited Liability Act 185531 that the concept of limitedliability was introduced, and the legislation was comprehensively restruc-tured in the UK Joint Stock Companies Act 185632 with one stage ofregistration replacing the previous two stages described earlier. The directancestor of the modern memorandum of association and the articles ofassociation was therefore the deed of settlement, and the contents of thememorandum of association in the deed of settlement appeared in termssimilar to the form used today.33

The Victorians saw the issue of the protection of the company asagainst the interest of outsiders in terms of the constitutional frameworkof the company, giving the members contractual rights based on fiduciaryobligations owed to the members as a result of the directors’ trusteeshipof the company. The available equitable doctrine of constructive noticeand the available principles of agency law in relation to the rule inTurquand’s case were allowed to protect outsiders only to the extent thatcommercial dealings were not seriously hampered. The doctrine of ultravires, however, was intended to keep a constitutional framework withinwhich the directors of the company operated as the essential substratumof late nineteenth century company law. Despite the legislative changes inthe United Kingdom, this doctrine remains the focus of much of HongKong law concerning the protection of outsiders in the 1990s.

Constructive notice as a commercial tool

The equitable doctrine of constructive notice first emerged in the case ofEspin v Pemberton34 as a commercial tool in the hands of commerciallyminded English judges. This case established that there are three kinds ofnotice: actual, implied and constructive, and each of them is dealt withbriefly here by way of introduction to the question of the protection ofoutsiders dealing with agents of companies.

31 (18 & 19 Vict, ch 133).32 (18 & 19 Vict, ch 133).33 Ford and Austin (note 30 above), 8.34 [1859] 44 ER 1380, 1383. See also Lord Wilberforce’s comment in Re Quistclose Trust

[1970] AC 567, 581–582, that common law rules in commercial situations can as apractical matter be blended with equitable rules and that in those situations equitabledoctrines will not be regarded as ‘infiltrators’ but as a necessary part of the doctrine. SeeThe Hon Mr Justice LJ Priestly, ‘The Romalpa Clause and the Quistclose Trust’, in PaulFinn, ed, Equity and Commercial Relationships (Sydney: Law Book Co, 1987), 217,232, for a full discussion of the commercial application of equitable doctrines.


Actual and implied (or imputed) knowledge

Actual knowledge means knowledge as opposed to mere rumours or sus-picions brought to the notice of the party concerned. Implied (or imputed)knowledge is the notice that an agent has received or should have receivedhad he made proper enquiries — the principal is said to have imputedknowledge of that which his agent should properly have discovered.35 Theobligations of the principal are thus upheld towards third parties despitethe failure to investigate on the part of the agent or the agent’s failure tocommunicate to the principal.

Constructive knowledge

Constructive knowledge is the knowledge or notice that a person wouldhave received had he made the investigations usually made in similartransactions or had he investigated a fact which had come to his noticeand into which a reasonable man ought to have enquired. It thereforefollows that all cases in which a person is said to have constructive noticeof a fact or thing are cases in which he failed to enquire, either sufficientlyor at all.36

Since the nineteenth century the view has prevailed that ‘commercialdealings would be seriously hampered if subject to the full rigour of thedoctrine of constructive notice’.37 Goode draws an obvious but usefuldistinction between traders and consumers buying goods in the ordinarycourse of business who cannot be expected to search in the CompaniesRegistry or elsewhere before doing business and against whom the doc-trine of constructive notice should not be used, and banks or financialinstitutions who can be expected to search against documents38 (and pre-sumably employ lawyers to search and explain the contents thereof). Thedistinction is important to Hong Kong commercial law but it is stilldebatable whether the doctrine of constructive notice ought to be appliedin commercial transactions or to chattels. However, courts adopt a ‘flex-ible approach’39 and consider the circumstances of each particular set of

35 See Wyllie v Pollen [1863] 46 ER 767: ‘a person who employs an agent in a transactionis presumed by law to have had brought to his notice all information which his agenthas acquired or ought to have acquired in the course of the transaction and relevant toit. Normally this presumption cannot be rebutted . . .’, cited in Roderick Meagher,William Gummow and John Lehane, Equity Doctrines & Remedies, 3rd ed (Brisbane:Butterworths, 1992) 252.

36 Meagher, Gummow and Lehane (note 35 above), 253.37 Goode (note 5 above), 719.38 Ibid.39 Ibid.

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facts. Focusing on the doctrine from the perspective of the protection ofthe company that files its constitutional and public documents in theCompanies Registry (and thus can be said to be entirely open to publicinspection), the Hong Kong position is that everyone dealing with a com-pany is deemed to have notice of its public documents such as thememorandum and articles of association, special resolutions, and the reg-ister of charges filed at the Companies Registry under Section 80 of theCompanies Ordinance.

The doctrine cannot be said to support the dealings of the commercialcommunity in Hong Kong as the following two cases illustrate. The casesare examples of the difficulty in maintaining consistency in commercialtransactions and in relying on the predicted outcome of contracts. Theyhighlight the level of protection given to the company under quasi-consti-tutional reasoning and the importance accorded to the company’smemorandum and articles of association in contrast to the legitimatebusiness expectations of outsiders dealing with the company.

A classic example of the doctrine of constructive notice protecting thecompany and working against outsiders dealing with the company oc-curred in Irvine v Union Bank of Australia.40 In this case, the Union Bankof Australia (the ‘Union Bank’) sent money to the Irvine company in theUnited Kingdom. The amount sent exceeded limits laid down in the com-pany’s memorandum and articles. No special resolution authorizing thedirectors to exceed their borrowing powers, as laid down in the compa-ny’s articles of association, was ever passed. The Union Bank failed toinspect the Companies Registry for such a resolution and were held tohave constructive notice of the contents of the company’s file at theCompanies Registry. Such constructive notice therefore operated againstthe Union Bank, which could only recover up to the amount authorizedby the articles of association.41

The second example is the case of Re Jon Beauforte (London) Ltd(‘Jon Beauforte’).42 It demonstrates how the strict ultra vires rule (dis-cussed below) and the doctrine of constructive notice work against theinterest of the outsiders who deal with the company. The object of thecompany was to manufacture dresses, but the company had for some timemanufactured wooden panels. When the company went into liquidation,all but one of the creditors’ claims were held to be invalid because thecreditors were presumed to have had either actual knowledge of the com-

40 (1877) 2 AC 366 (PC).41 See, for example, Companies Ordinance, s 305. The memorandum, inter alia, is open to

inspection by any person on the payment of the prescribed fee.42 (1953) CH 131.


pany’s objects clause or constructive knowledge of the clauses and there-fore to have known that contracts signed by directors of the companyrelating to the supply of wood were in no way related to the business ofmanufacturing of dresses.

The two cases are instructive on the current Hong Kong law on thispoint. The English position is, however, quite different and as a result ofthe European Communities Act of 197243 and the 1986 Prentice Report,44

the doctrine of deemed (constructive) notice was abolished.Such legislative changes have not yet been made in Hong Kong com-

pany law. The law in Hong Kong remains biased in favour of the companyand against the outsider. The practical effect of the doctrine in HongKong company law is to create an unnatural and highly artificial set ofsteps for traders to follow in the conduct of their business. The existinglaw fails to distinguish between banks and financial institutions on theone hand (who usually retain solicitors to check the Companies Registrybefore sending money to companies) and ordinary business people such assuppliers, purchasers or consumers on the other (who usually do notcheck the Companies Registry). In Hong Kong the doctrine of construc-tive notice applies to everyone dealing with a company and affords aprotective shield to companies that enables them to rely on their ‘constitu-tional’ rights. In 1994 the Standing Committee on Company Law Reformrecommended that the doctrine of constructive notice be abolished tobring Hong Kong company law in line with UK Companies Act 1985,Section 711A(1) and 711A(3) (now Section 142 of the UK Companies Act1989) and possibly Section 711A(4)45 ‘if considered appropriate’.46

43 UK European Communities Act 1972, s 9(1), and see the relevant UK legislation, now s142 of the UK Companies Act 1989, as follows:

Abolition of doctrine of deemed notice(1) In Part XXIV of the [UK] Companies Act 1985 (the Registrar of Companies,

his functions and offices), after section 711 insert — ‘711A Exclusion ofdeemed notice (1) A person shall not be taken to have notice of any mattermerely because of it its being disclosed in any document kept by the Registrarof Companies (and thus available for inspection) or made available by thecompany for inspection’ and (3) in this section ‘document’ includes any materialwhich contains information.

44 Note 11 above.45 Section 711A (4) of the UK legislation reads as follows:

Nothing in this section affects the operation of—(a) Section 416 of this Act under which a person taking a charge over a company’s

property is deemed to have notice of matters disclosed on the companiescharges register), or

(b) Section 198 of the [UK] Law of Property Act 1925 as it applies by virtue of

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The doctrine of constructive notice was developed in tandem with thecommercial principles of agency law. However, as governing law it isparamount, and supersedes rules of agency that would normally be ac-ceptable in commerce. It therefore raises difficult questions as to what the‘acceptable’ rules of agency might be in the commercial world once thedoctrine of constructive notice has been abolished. The continued applica-tion of Turquand’s case47 highlights the dysfunctionalism of existing HongKong law.

The rule in Turquand’s case

The rule in Turquand’s case is a principle of agency law that was incorpo-rated into English company law as a device to protect outsiders. Turquand’scase established that a third party can assume that the internal manage-ment rules and procedures have been correctly followed, and is not requiredto make enquiries as to whether or not, for example, a company resolu-tion has been passed or whether the company directors are exceedingtheir authority. This has come to be known as the ‘indoor managementrule’. The rule, however, cannot always be relied upon by a third party asprotection since the doctrine of constructive notice presumes that thethird party has constructive knowledge of publicly registered documents,48

thus negating any practical assistance afforded by the rule in Turquand’scase. Thus, the ‘outsider’ often finds that any protection afforded by theindoor management rule is overridden by circumstances in which thedoctrine of constructive notice takes precedence.

The rule, however, is important since it highlights the conflict be-tween the outsider and the company in the clearest possible terms, andthe facts of the case are repeated here as an illustration of the protection

section 3(7) of the [UK] Land Charges Act 1972 (under which the registrationof certain land charges under Part XII or chapter III of Part XXIII, of this Actis deemed to constitute actual notice for all purposes connected with the landaffected.

Unfortunately, a comparison between the Hong Kong and UK positions on companycharges is outside the scope of this chapter.

46 Information supplied to the author by the Secretary to the Standing Committee onCompany Law Reform, June 1994.

47 See note 4 above.48 Among some of the most important matters requiring special resolutions to be filed

under Companies Ordinance, s 116 are the alteration of the articles (s 13), the alterationof the objects (s 8) and the change of name (s 22).


given to the ‘outsider’ in the case itself. It concerned the liquidator of acompany who argued that, qua liquidator, he had no obligation to repaya debenture issued by the company for £2,000 based upon the authorityof an ordinary resolution passed in general meeting that failed to specifythe amount that the directors might borrow. The liquidator, Turquand,argued that the doctrine of constructive notice must apply, and that thebank ought to have had notice of the articles requiring the ordinaryresolution to specify the amount to be borrowed. In the liquidator’s view,the debenture was therefore invalidly drawn as it was based upon aninvalid resolution. The liquidator’s argument rests on a vital but subtlepoint illustrating the conflict between constructive notice protecting thecompany and the protection of an outsider who is entitled to rely on theassumption that the indoor management of a company has been properlyconducted. The court based its decision upon the fact that a bank had noway of knowing whether or not a valid ordinary resolution had beenpassed since ordinary resolutions are not publicly registered at the Com-panies Registry and the rule is therefore that a person who deals in goodfaith with the company and without actual notice of a failure to followmanagement procedures is entitled to assume that proper managementprocedures have been followed.

The position, however, is further complicated by the doctrine of ap-parent authority, which provides that a company is bound by the acts ofits agent even though the agent lacks actual authority. The rule inTurquand’s case is therefore subject to exceptions that may create subtleparadoxes for outsiders who are not familiar with the doctrines of con-structive notice, apparent authority and ultra vires.

Perhaps more important and problematic in Hong Kong companylaw is the fact that when an outsider has actual notice of an irregularityor has been put on inquiry of such an irregularity, the protection given toan outsider seeking to rely on the rule of Turquand’s case disappears (asdemonstrated in the case of Jon Beauforte49). The doctrine of constructivenotice in Hong Kong company law finds its most practical expression inthe context of ultra vires transactions, since an outsider dealing with thecompany is deemed to have constructive notice in Hong Kong of theobjects clause of the company. Next discussed is how the doctrine of ultravires also protects the limited liability company to the disadvantage ofoutsiders.

49 Note 42 above.

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The doctrine of ultra vires

In 1875 an English court50 distinguished for the first time between actsthat were ultra vires the capacity of the company and beyond ratificationby its members (i.e., ultra vires in the narrow sense of being outside thecompany’s objects), and acts that were ultra vires the power of the direc-tors of the company because they were beyond the powers of the directorsas delegated to them in the company’s articles of association (i.e., ultravires in the wider sense).

In Ashbury Railway Carriage and Iron Co Ltd v Riche (‘Ashbury’)51

the House of Lords held that a company did not have the contractualcapacity to enter into contracts that were outside the stated objectives ofthe company as set out in the company’s memorandum. The Law Lordswere convinced that this rule would protect outsiders. The objects of thecompany gave the directors their contractual capacity, and without theobjects of the company authorizing the directors to enter into the contractthe company had no legal capacity to contract whatsoever.

The position in Hong Kong today is as stated in Ashbury and resultsin an ambiguous situation for outsiders. The key distinction is whethercontracts can be ratified by the shareholders because they are ultra viresthe powers of the directors or whether contracts can never be ratifiedbecause they are ultra vires the company itself. The latter transactions arevoid, and the outsider cannot enforce the performance of the contract.

Outsiders can and do lose money and the remedies52 available to theoutsider may not succeed because of the doctrine of constructive notice.As we have seen, the outsider is deemed to know of the contents of thememorandum of the company and thus is deemed to know that thetransaction is ultra vires the company’s objects.

The purpose of the doctrine has therefore been, since 1875, expresslyto protect creditors of the company and the shareholders of the companywho are said to rely, as investors, on the fundamental nature of thebusiness not being changed without their consent. The consequence to thecommercial world of the doctrine of ultra vires in the narrow (i.e., strict)

50 (1875) LR 7 HL 653.51 Ibid.52 The available remedies might include tracing (at common law or equity) the identifiable

property or proceeds thereof forming the substance of the contract avoided because ofthe ultra vires rule; suing the officer or agent of the company in tort for deceit if theoutsider can prove that the officer or agent had deliberately misrepresented his powersto the outsider; or suing the officer, agent or director of the company for breach ofwarranty of authority as to the reason why money or goods were being acquired by thecompany.


sense is that a company cannot ratify or cure a defect even by unanimousagreement, where the objects do not give the directors capacity — i.e.,there can be no cure by the shareholders where the objects clauses in thememorandum simply do not authorize the directors to undertake a par-ticular transaction. Therefore, all such transactions are quite simply voidin Hong Kong law. In particular, an outsider who has not read thecompany’s objects clause is deemed to know the objects since the opera-tion of the doctrine of constructive notice works against the outsider andin favour of the company. Therefore if the main objects do not authorizea particular transaction then an outsider is deemed to have knowledgethat the transaction is ultra vires the company and the transaction itself isvoid. This can work either to a company’s advantage or against it but thedoctrine of constructive notice applies throughout to the outsider.

Gower describes the result of the drafting devices used by the lawyersas ‘merely a nuisance to the company and a trap for the unwary’.53 Thenuisance was to some extent averted by Section 5 of the UK CompaniesAct 1948, which allowed a company to alter its objects without theconsent of the court. Section 8 of the Companies Ordinance is the HongKong equivalent of this UK section. Nevertheless, as demonstrated below,innocent people who contract with company directors who change theircompany’s line of business without changing its objects clauses, can findthemselves without a remedy. Equally, the company could suffer from thedoctrine, for as ‘a crowning absurdity, it seems that, such contracts beingvoid, not only could the incapable company not be sued but it could notsue the other party’.54

European Asian Bank v Reicar Investments Ltd 55

This Hong Kong case illustrates the importance of the topic in HongKong company law and highlights the inconsistency of the doctrine inmeeting the commercial expectations of the contracting parties. It con-cerned proceedings instituted by a bank for repayment of a loan secured

53 Laurence Gower, Gower’s Principles of Modern Company Law, 5th ed (London: Sweetand Maxwell, 1992), 168. See, e.g., Cotman v Brougham [1918] AC 514 andIntroductions Ltd v National Provincial Bank Ltd [1970] Ch 199 (CA) for an illustrationof the ultra vires doctrine’s application in the law equivalent to the current Hong Kong law.

54 Gower (note 53 above), 168. Note that since 1989 the English position is as follows:Section 108(1) Companies Act 1989 (substituted for s 35(1) [UK] Companies Act 1985)provides that ‘[t]he validity of an act done by a company shall not be called intoquestion on the ground of lack of capacity by reason of anything in the Company’sMemorandum’. Thus, acts which are ultra vires in the narrow sense are no longer void.

55 [1988] 1 HKLR 45.

170 Anne Carver

by a mortgage and charges given by Reicar Investments Ltd (‘Reicar’) forbanking facilities granted to the second defendant. The loan was made atthe request of Reicar which put up four properties as security and as-sumed a primary obligation to repay the loan. When the bank claimedrepayment of the loan, Reicar argued that it had not authorized themortgage or charges and that they were ultra vires the memorandum ofassociation and beyond its powers. Of particular relevance to this discus-sion is the defendant company’s assertion that the bank could not rely onthe rule in Turquand’s case because of the doctrine of constructive noticeoperating adversely against the outsider.

Barnett J was not required to decide upon the ultra vires point (sincethis was an appeal from an originating summons and he was requiredonly to decide whether there was a triable issue), but his comments illus-trate the difficulty of the application of the doctrine for those in business:‘It is, in the circumstances, not necessary for me to decide upon the ultravires point. I feel bound to say, however, that I should have resolved thisin favour of Reicar’.56 That is to say, that nowhere in Reicar’s objectsclauses could the judge discern anything that resembled the giving of anindemnity by Reicar to the bank if the second defendant should defaulton its banking facilities.

Barnett J therefore held that there were sufficient irregularities (in-cluding a possible absence of a quorum, non-disclosure of a materialinterest by directors, uncertainty as to whether charges had been ap-proved by directors, apparent abuse of directors’ powers, not to mentionthe application of the doctrines of ultra vires and constructive notice) tomerit a trial of the issues. Unfortunately, however, we do not know theoutcome as the case was presumably settled before trial.

Ultra vires in the wider sense

Both English and Hong Kong law still use the term ultra vires in the widersense to describe acts of a company are authorized by the objects clauseof the memorandum, but are not within the powers of the directors. Thequestion of ultra vires in the wider sense was considered in Rolled SteelProducts (Holdings) Ltd v British Steel Corp (‘Rolled Steel’)57 and re-mains valid law for both England and Hong Kong today for establishingwhether company directors have abused their powers and for the rem-edies available to those aggrieved as a result of such abuse. The clear

56 [1988] 1 HKLR 45, 48 (per Barnett J).57 [1986] Ch 246.


ruling in Rolled Steel is that a company has the capacity (used in the senseof capacity in contract law) to carry out a transaction even though carriedout by the wrongful exercise of the powers given to the directors. Theessential point to note is that such transactions are voidable.58

Questions of ultra vires in the wider sense thus focus on the compa-ny’s implied power to enter into a transaction and whether the directorshave in fact abused their powers. If the directors have abused their pow-ers, both shareholders and outsiders who are affected might seek aninjunction against the company and the possible imposition of a construc-tive trust on any company property transferred. The question of thedirectors’ misuse of their powers has been neatly summarized by oneHong Kong commentator as ‘a question of agency law’.59 The questiontherefore comes down to whether in the absence of actual authority, thedirectors have ostensible authority to conduct a particular transaction. If,however, outsiders receive actual notice that the directors do not haveauthority, they cannot rely on the ostensible authority of the directors andcannot hold the company to the transaction. The question becomes evenmore complicated in the context of Hong Kong’s doctrine of constructivenotice: what should the outsiders know and what is it reasonable forthem not to know? The question has not yet been satisfactorily answeredin Hong Kong law and the apparent and real conflict between the doc-trines of ultra vires, constructive notice and the rule in Turquand’s casecontinue to present a series of complex inconsistencies in Hong Kongcompany law.

The current Hong Kong practice is to distinguish between an illegalact, for which by definition a company would have no capacity, and anact beyond the directors’ powers (i.e., the company has the capacity asdefined by its objects clause but the directors have no authority). TheHong Kong Standing Committee on Company Law Reform is consciousof the confusion caused by these subtle distinctions between powers andobjects and is considering abolishing the doctrine of ultra vires.60 Onepossible approach is to protect third parties who deal with a company ingood faith so as to reflect the English position as contained in the UKCompanies Act 1989. Unfortunately for Hong Kong company law re-

58 To the extent that the company’s memorandum does not expressly state the company’spowers, the powers will be those laid down by the Seventh Schedule of the CompaniesOrdinance. (See Companies Ordinance, s 5(5).)

59 Betty Ho, Security for Credit Law and Practice in Hong Kong (Hong Kong: Butterworths,1992), 21.

60 Information supplied to the author by the Secretary to the Standing Committee orCompany Law Reform, June 1994

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form, it has been said that ‘English case law developed, analysed, distin-guished and ultimately confused the traditional doctrine of ‘ultra vires’ inmany ways and now the legislators are having a go with new provisionscontained in sections 108–112 (inclusive) of the [UK] Companies Act1989’.61 Some of the problems associated with the new English ‘model’are discussed below for comparative purposes.

The English model and its defects

Discussed above were reasons why English and Hong Kong company lawhave developed differently. It is equally important to identify the differ-ences between the two regimes on the issue of ultra vires. Section 9(1) ofthe UK European Communities Act 1972 attempted to comply with theEuropean Community’s First Company Law Directive (the ‘First Direc-tive’). It was enacted in Section 35 of the UK Companies Act 1985 andprovided that any transaction decided on by the directors should be deemedto be within the capacity of the company and free from any limitationsunder the memorandum and articles in favour of the outsider dealingwith the company in good faith. Furthermore the outsider was under noduty to inquire about such matters.

The problem with Section 35 was that it only covered transactionsdecided upon by directors and only protected a person dealing in goodfaith. A further point not addressed in the First Directive was that theoutsider could invoke ultra vires against the company, although Gowerpoints out that until ‘the entry of the common law countries it did notoccur to anyone concerned with the [First] Directive that any legal systemcould be so asinine as to allow a third party to invoke ultra vires againstthe company’.62

The Prentice Report recommended that companies should be affordedthe capacity to do any act whatsoever and should have the option of notstating their objects in their memoranda.63 The 1989 Act however did notgo this far; rather, it inserted a new Section 3A to encourage the use ofsimple general statements of objects. The fundamental change to the lawwas the introduction of new Sections 35, 35A, and 35B. Gower suggeststhat the new Section 35(1) is an improvement on the former Section 35because it makes clear that neither the company nor a third party caninvoke strict ultra vires. ‘Short of admitting that companies have full legal

61 David Glass, ‘“Ultra Vires” — the saga continues’ (1990) 11 Company Lawyer 138.62 Gower (note 53 above), 177.63 Ibid.


capacity we (i.e., the English) could hardly have done better’.64 The onlyquestion for outsiders wishing to bind companies to their transactions iswhether the agents of the company acted outside their actual or apparentauthority. However, the unfortunate subsection (2) complicated what wouldotherwise have been a useful solution, and has added a new twist toEnglish company law and questions of ultra vires. Subsection (2) providesas follows:

A member of the company may bring proceedings to restrain the doingof an act which but for subsection (1) would be beyond the company’scapacity; but no such proceedings shall lie in respect of an act done infulfilment of a legal obligation arising from a previous act of thecompany.65

Thus, a company cannot be restrained from performing its obligations toa bona fide third party under a contract where the contract is already alegal obligation to do so.

Despite Gower’s plaudits, the current UK legislation is now so opaquethat another commentator has concluded:

Nevertheless, it is regrettable that new legislation in such an importantarea of English company law should be so uncertain in its effect that thebest advice is simply to ignore it and to carry on as if nothing hadchanged and the ultra vires rule and its relatives, such as the constructivenotice rule, retained their full force and effect.66

Needless to say, the Standing Committee on Company Law Reformprefers to move away from the confusion that persists in the UK modeland, on the basis of the Canadian paradigm, has recommended that HongKong should abolish the ultra vires rule.67 However, as demonstratedbelow, the Australian position on ultra vires may provide a more suitablemodel for Hong Kong.

64 Ibid, 175.65 Subsection (2) preserves the well established exception to the rule in Foss v Harbottle

(1843) 2 Hare 461 that a single member may sue to restrain an act that is ultra vires.66 Ellis Ferran, ‘The Reform of the Law on Corporate Capacity and Directors’ and Officers’

Authority: Part 2' (1992) 13 Company Lawyer 177, 183 (emphasis added).67 Information provided to the author by the Secretary to the Standing Committee on

Company Law Reform, July 1995.

174 Anne Carver

ALTERNATIVES FOR HONG KONG

Australian and Canadian law offer two possible ‘models’ for Hong Kongto follow in the search for coherence and consistency in its company lawof the 1990s. In many jurisdictions there have been considerable develop-ments in the law relating to the protection given to an outsider who dealswith a company. The current trend is for company law to favour theinnocent outsider, if need be, at the expense of investors in the company.For example, in Australia the Corporations Law (the ‘Australian Corpo-rations Law’) has gone further than the UK legislation by not requiring acompany to register its memorandum or its articles as a concession to theprivate nature of a company that by definition cannot solicit investmentby the public.68

The Australian model

The Australian decision not to require companies to state their objectsradically altered the capacity of Australian companies. An Australian com-pany now has the legal capacity of a natural person and, in addition,under Section 161 of the Australian Corporations Law has the followingspecific powers:1. to issue and allot fully or partly paid shares;2. to issue debentures (outside the capacity of a natural person);3. to distribute the company’s property among members;4. to give security by charging uncalled capital (outside the capacity of a

natural person);5. to grant a floating charge on the property of the company;6. to procure the company’s registration or recognition as a body corpo-

rate outside its place of incorporation; and7. to do any other act it is authorized to do by any other law.

As Ford and Austin state, ‘Section 161 is about capacity to perform basicjuristic acts such as dealing with property and contracting in the course oftransactions which are open to companies under other laws’.69

The legislative aim of the Australian law reformers was to abolish thedoctrine of ultra vires and to ensure that the outsider is not affected bythe provisions in the memorandum or articles that have not been properly

68 Australian Corporations Law, s 118.69 Ford and Austin (note 30 above), 95–96.


observed by the company’s officers and members. Section 164(3)(a) of theAustralian Corporations Law therefore allows a person dealing with thecompany to make the following assumption: the company cannot laterdeny ‘that, at all relevant times, the company’s constitution has beencomplied with provided that person does not have actual knowledge ofnon-compliance or is not so connected with the company that he or sheought to have that knowledge’.70 Thus, in Australia an outsider who actsin good faith is protected even if it later appears that the company actedotherwise than in accordance with its stated objects or contrary to anexpress restriction or prohibition.

Australian law therefore envisages two situations in which an outsidermay seek to rely on a company’s contractual capacity. First, the statementof objects in the memorandum, which as we have seen is an optionalstatement, can be embarrassing to an outsider who has actually seen itand knows that a particular transaction is improper because the transac-tion conflicts with the objects. In that event, the outsider is said to haveknowledge of the breach, and the transaction will be voidable at theoption of the company. If the outsider has no knowledge of the statementof objects, then the transaction cannot be invalidated.

Section 162(1) of the Australian Corporations Law provides that theconstitution of the company may contain express restrictions or prohibi-tions of the exercise of a power of the company by the company. It is thepower of the company as a corporate entity that may be expressly re-stricted or prohibited and not the powers of the directors or otherauthorized agents of the company.

What happens if an outsider transacts with a company in a contractthat is contrary to an express restriction and prohibition? The transactionitself remains valid for the outsider, but there may be grounds for amember of the company to obtain an injunction and for the officers oragents of the company to be ordered to pay damages where appropriate.What however is the Australian position on the rule in Turquand’s case?

The doctrine of apparent (ostensible) authority

Section 164 of the Australian Corporations Law provides that a personhaving dealings with a company is allowed to make certain assumptionswhich the company cannot contest, inter alia, the authority of certainpersons who act for the company.71 One particular assumption set out in

70 Ibid, 100.71 Ibid.

176 Anne Carver

Section 164(3)(c) is ‘that a person who is held out by the company to bean officer or agent of the company has been duly appointed and hasauthority to exercise the powers and perform the duties customarily exer-cised or performed by an officer [or agent] of the kind concerned’.72

We have briefly examined the Australian approach on ultra vires andthe protection of outsiders.73 The Hong Kong Standing Committee onCompany Law Reform has however recommended that Hong Kong shouldadopt the model set out the Ontario Business Corporations Act of 1982(as amended), and we turn to the specifics of the Canadian legislation asit affects Hong Kong company law.

The Canadian model

The Standing Committee on Company Law Reform intends to recom-mend that the Companies Ordinance be amended by adopting the relevantprovisions on the ultra vires rule and the capacity of directors equivalentto those contained in Sections 15, 17, and 19 of the Ontario BusinessCorporations Act 1982.74 The new Canadian approach has been describedas being ‘unique’ in many ways.75 It is based on the statutory division ofpowers model and contrasts with the English and Hong Kong models thatare based upon the contract in the memorandum and articles of associa-tion (giving rise to issues of contract law and rights under the contract).As Welling describes the Canadian model:

[T]he corporations statute imposes a division of powers upon theparticipants — directors, officers, shareholders and to a limited extentcreditors — in the internal workings of the corporation.

72 See Australian Corporations Law, s 164(3)(c).73 The Australian model, with its clear intent to protect outsiders, seems to provide a basis

for meeting the needs of Hong Kong’s commercial community. A similar approach wasadopted by Singapore in the drafting of Section 25 of the Singapore Companies Act1990 (cap 50) on the question of ultra vires. The Singaporean company law has beenclosely modelled upon the Australian uniform legislation described above and HongKong company law reformers might also consider the Australian model for Hong Kongon the question of ultra vires and the protection of outsiders. See Singapore CompaniesAct 1990, s 25(1) (diminishing the effect of ultra vires in that, if a transaction isotherwise valid and binding on a company, the fact that it is ultra vires is irrelevant).

74 Information provided to the author by the Secretary to the Standing Committee onCompany Law Reform, June 1994.

75 B.L. Welling, Corporate Law in Canada: The Governing Principles, 2nd ed (Toronto:Butterworths Canadian Legal Text Series, 1991), 52.


76 Ibid, 54–55.77 Ibid, 224.78 Ibid. See also Section 19 of the Ontario Business Corporations Act 1982.79 Francis Buckley and Mark Q. Connelly, Corporations Principles and Policies, 2nd ed

(Toronto: Edmond Montgomery Publications Ltd, 1988), 173.

The corporation constitution is not a contract among the participatingindividuals. The constitutional model is designed to give him [sic] twochances:(a) he can attempt to persuade the majority to his point of view;(b) he is given an extensive list of statutory remedies to which he has

access because of his status, not because of any personal ‘rights’ hemay be able to identify.76

Thus, it is important to examine those sections in the Ontario Busi-ness Corporations Act 1982 (as amended) that the Hong Kong StandingCommittee on Company Law Reform proposes to use as the appropriate‘model’ for Hong Kong, since these sections represent a divergence fromthe Hong Kong contractarian model.

The abolition of the ultra vires rule (Sections 15 and 17 of theOntario Business Corporation Act 1982)

Canadian company law has substantially abolished the ultra vires rule bythe device of not requiring corporations to stipulate corporate ‘objects’.‘Corporations like individuals, have the capacity to pursue whatever busi-ness endeavours they like’77 (within the limits of the criminal law andCanadian constitutional law). Therefore, the company cannot raise thequestion of a violation of an objects clause against the outsider and viceversa. Furthermore, Canadian company law clarifies the point that inter-nal limitations on what the corporation may do has no effect on outsiders,and, according to the statute, corporations are capable of contracting likeindividuals.78 It requires two distinct steps to abolish the ultra vires rule:‘The first step in legislative abolition is the prima facie conferral of thebroadest possible capacity upon corporations’;79 that is to say, Section 15of the Ontario Business Corporations Act 1982 states that a corporationhas the capacity and the rights, powers and privileges of a natural person.The second step is to restrict the authority of the majority of the board ofdirectors in small corporations by providing in Section 17(2) that ‘[a]corporation shall not carry on any business or exercise any power that itis restricted by its articles from carrying on or exercising’ and places theburden of monitoring for default upon the shareholders.

178 Anne Carver

By extension, Section 17(3) states that ‘no act of a corporation includ-ing a transfer of property to or by the corporation is invalid by reasononly that the act is contrary to the articles, by-laws, a unanimous share-holders agreement or this Act’. Section 17(3) is intended ‘to prevent thecorporation and persons with whom it contracts from raising an ultravires defense in a breach of contract action’80 but has not entirely achievedthat end. It is argued below that the provisions of Section 19 of theOntario Business Corporations Act 1982 may mean that if a person oughtto have known that a contract was contrary to the corporation’s articles,then the corporation is entitled to use this as a defence for the corpora-tion’s refusal to perform if the outsider sues for non-performance.81 Buckleyand Connelly argue that, in practice, in Canada the monitoring costs tothe third party who ought to know the articles of the corporation are‘trivial’82 and the current legal practice is for third parties to require aclear demonstration that the corporation with which one deals is in factauthorized to carry out the transaction. ‘In practice this results in thesame demand for certified copies of corporate letters as occurred prior tothe CBCA’83 (the model for the Ontario Business Corporations Act 1982).

The abolition of the doctrine of constructive notice (Section 18)and the rule in Turquand’s case (Section 19)

Hong Kong’s company law reformers believe that Section 19 of the On-tario Business Corporations Act 1982 serves as an appropriate ‘model’ fordealing with the problems of agency, both actual and ostensible, that runthrough so much of the English (and Hong Kong) judicial precepts con-cerning company law and the protection of outsiders. Section 19 of theOntario Business Corporations Act 1982 describes the rule in Turquand’scase as the ‘Indoor Management Rule’. This section provides that the com-pany may not assert defects in documents or in the appointment of itsdirectors or agents; nor may the company claim that its registered office isnot as shown in the articles, or that documents issued by a director, of-ficer, or agent of the company are invalid or that financial assistance wasnot authorized unless the outsider has or ought to have knowledge of thesedefects by reason of his relationship to the corporation. In other words,the outsider in normal circumstances is not expected to make inquiries,nor is he expected to know of any defects if he is truly an ‘outsider’.

80 Ibid.81 Ibid.82 Ibid.83 Ibid.


The Australian model clings to vestiges of the traditional Englishcontractarian model in which the memorandum and articles are the basisfor the contractual capacity of the corporation and its officers and agents.By contrast, the Canadian model adopts a statutory division of powers asthe basis for company law on the questions of ultra vires and agency. Ifthe Canadian changes are enacted, the result may lead to further confu-sion unless Hong Kong also moves away from the contractarian model.

CONCLUSION

The doctrine of ultra vires represents a pluralism of policies that are noteasy to reconcile — investor protection, creditor protection, and the pub-lic interest. There are four basic approaches to reform summarized byFarrar84 as follows:1. Total abolition of the doctrine following New Zealand, Canada and

Australia.2. Abolition with regard to third parties who are protected from its

harsh effect, but keeping it the subject of internal redress against thedirectors.

3. Partial abolition with regard to the protection of third parties butretaining it as an internal doctrine to remedy default by directors.

4. The specification of a list of ancillary objects and powers which areimplied unless excluded (as is the case with the Australian legislation).

The United Kingdom adopted the third approach, and since the enact-ment of the UK Companies Act 1989, the ‘new’ Section 35 achieves mostof the stated objectives of the company law reformers in removing theeffects of lack of capacity from the company dealing with outsiders. Nowultra vires has become a question of directors’ authority.

In the interests of coherence and consistency, given the adoption byHong Kong of the contractarian model, the Australian approach ratherthan the Canadian model is more appropriate for enaction in Hong Kong.In any case, in the upcoming company law review, the principle of theprotection of outsiders must be more clearly articulated in line with com-mercial expectations.

84 John Farrar, Nigel Furey and Brenda Hannigan, Farrar’s Company Law, 3rd ed (London:Butterworths, 1991), 111.

Tax Aspects of Cross-Border Tradeand Investment

Jefferson P. VanderWolk

. CHAPTER SEVEN .

INTRODUCTION

Lawyers practising in Hong Kong have thus far been spared the onerousburden, borne by lawyers in many other jurisdictions, of advising oncomplex and highly technical tax laws and regulations. The primary rea-son for this is that Hong Kong’s tax system is territorial in nature: onlyincome arising in Hong Kong and property located in Hong Kong aretaxed.1 Concepts of residence, domicile, nationality, and citizenship, whichare relevant in determining the extent of tax liability in most jurisdictions,are generally irrelevant for purposes of the scope of the charge to any ofthe various Hong Kong taxes. Therefore, the Hong Kong legislation hasremained relatively free of complicated rules regarding relief from doubletaxation and other issues arising from the taxation of foreign-source in-come and foreign property.

Two other aspects of Hong Kong’s tax system contribute to its sim-plicity. First, no tax is imposed on capital gains or other income from

1 See Inland Revenue Ordinance (cap 112, LHK), ss 5, 8, and 14 (containing the chargesto property tax, salaries tax, and profits tax, respectively); Estate Duty Ordinance (cap111, LHK), s 10(b) (exempting from estate duty all property situated outside HongKong); and Stamp Duty Ordinance (cap 117, LHK), s 4 and First Schedule (limitingstamp duty liability to instruments evidencing transactions involving Hong Kong stockand immovable property in Hong Kong).

182 Jefferson P. VanderWolk

investment.2 Second, Hong Kong’s tax rates have always been relativelylow. The standard rate for property tax, salaries tax, and profits tax hasremained in the range of 15 to 17 percent for many years.3 With tax ratesat this level, most taxpayers have found that it is wiser simply to pay thetax than to engage in complicated tax-avoidance schemes. Therefore, therehas not been a great need in Hong Kong to supplement the tax law withloophole-plugging amendments. This is changing, however, as increasingnumbers of taxpayers have become aware of tax planning opportunitiesand the Inland Revenue Department has become more sophisticated in itsapproach to tax enforcement.4

The importance of taxation to international investors

As the world’s economy becomes increasingly integrated, national lawsthat impinge on the free flow of capital, goods, services, and peoplebetween countries become increasingly important to economic actors suchas business corporations. Tax laws epitomize such interference with thefree market because they are the most direct form of government inter-vention. Thus, even a tax system that is as relatively benign as that ofHong Kong can be perceived to be an obstacle to both inbound andoutbound cross-border trade and investment.

With respect to inbound trade and investment, companies based injurisdictions that impose tax on foreign-source income — which meansmost companies based outside Hong Kong — will usually be highly sensi-tive to the risk of double taxation of income earned in Hong Kong orelsewhere in the Asia Pacific region. Thus, the interplay between HongKong’s rules for determining the source of income for taxation purposesand the sourcing rules of the investor’s home jurisdiction may be crucialin determining the investor’s expected return from an investment in HongKong. If Hong Kong taxes a stream of income on the basis that theincome arises in Hong Kong, but under the home jurisdiction’s sourcingrules the income is considered to arise elsewhere, the investor may not beable to claim tax relief at home in respect of tax paid in Hong Kong. This

2 Section 14 of the Inland Revenue Ordinance expressly exempts gains from sales ofcapital assets from profits tax. The courts have held that s 14 does not apply to anyform of capital receipt. See, e.g., Commissioner of Inland Revenue v Far East ExchangeLtd (1979) 1 HKTC 1036.

3 Inland Revenue Ordinance, Schedule 1.4 See, e.g., ibid, s 21A , which was amended in 1993 so as to prevent tax benefits from

arising from the sale and licenseback of intellectual property in certain circumstances.

Tax Aspects of Cross-Border Trade and Investment 183

would render the Hong Kong tax an irrecoverable cost, which wouldmake the Hong Kong investment a less attractive proposition for theinvestor. Another jurisdiction in the region, such as Singapore, mightoffer tax incentives that would induce the investor to make the investmentthere instead.

Regarding outbound investment by Hong Kong companies, doubletaxation will be less of a problem. However, tax issues will neverthelessbe important to the outbound investor, because foreign tax rates aregenerally substantially higher than the low rates encountered in HongKong. The typical Hong Kong investor is simply not willing to bear a taxof 35 percent or more on business profits unless it is absolutely necessaryto do so. The difficulty of avoiding or reducing foreign taxes is exacer-bated by the fact that Hong Kong is not a party to any tax treaties.5 Forthe Hong Kong legal adviser, this presents the challenge of working withforeign advisers in a manner that is cost-effective for the client and ulti-mately produces the proper investment structure.

The role of the Hong Kong practitioner

Tax advice and tax planning are sometimes thought to be the province ofthe accountancy firms in Hong Kong. No doubt, accountancy firms arefirmly entrenched in the tax consulting business, which complements neatlythe tax compliance work that is normally performed by accountants.However, Hong Kong lawyers who are involved in commercial workmust have an awareness and understanding of tax issues in order toprovide valuable assistance to their clients. This is doubly true in respectof cross-border transactions, for the reasons indicated above. Not everylawyer can be a tax expert — indeed, few commercial lawyers would wishto devote the amount of time necessary to become a specialist in the area— but every commercial lawyer should be aware of tax issues that typi-cally arise in commercial transactions, including cross-border transactions.

Of course, Hong Kong lawyers are expected to know Hong Konglaw, first and foremost. Thus, the primary role of the Hong Kong practi-tioner is to advise (or obtain expert advice) on Hong Kong tax issues.This will normally involve questions of both taxation per se and tax

5 With one exception: Hong Kong has entered into an agreement with the United Statesthat exempts shipping income from tax if certain conditions are met. See Double TaxationRelief (Income From Shipping Operations)(United States of America) Order 1989 (cap112, LHK), s 49, reprinted in CCH Hong Kong Revenue Legislation (Singapore: CCHAsia Ltd, 1995), 19,351.


planning. The former requires the lawyer to provide advice concerningthe Hong Kong tax rules and how they apply, or might apply, to theclient’s proposed investment or other activities. The latter — tax planning— demands that the lawyer recommend a structure for the transaction, ora method of conducting the proposed operations, which will result in thelowest possible tax liability in Hong Kong.

It is not enough, however, for a Hong Kong practitioner to adviseonly on Hong Kong taxation and tax planning. The client may be based,or investing, in a foreign jurisdiction with a tax rate significantly higherthan that of Hong Kong. Consequently, the tax implications of the pro-posed investment or operations may be far more serious in the foreignjurisdiction than in Hong Kong. Since the client may not be aware of thisfact, it is up to the Hong Kong adviser to alert the client to the need fortax advice and tax planning that takes into account the tax consequencesin both the foreign country and Hong Kong. The Hong Kong lawyer maythen be required to identify and work with foreign advisers who have thenecessary foreign tax expertise.

The remainder of this chapter is divided into three parts. The firstpart deals with Hong Kong tax issues that arise in connection with invest-ments in Hong Kong or other activities in Hong Kong by foreign personsor entities. The second part discusses the tax issues that must be consid-ered when advising a Hong Kong client with regard to an investment orother activity outside Hong Kong. Finally, the third part briefly highlightscertain overriding issues that the Hong Kong adviser should always con-sider in relation to any tax-based investment structure.

TAX ASPECTS OF FOREIGN TRADE AND INVESTMENT INHONG KONG

An investment in Hong Kong assets or the conduct of business activity inHong Kong by a person or company based outside Hong Kong may giverise to liability for profits tax, property tax, stamp duty, capital duty andimport duty, and, in the case of an individual investor, salaries tax andestate duty. The Hong Kong legal adviser must consider all of thesepotential taxes and duties when advising on the consequences of theinvestment or activity.


Profits tax issues

Profits tax is charged in respect of assessable profits arising in or derivedfrom Hong Kong from a trade, profession or business carried on in HongKong by any person.6 This charge contains three requirements:1. that a trade, profession or business be carried on in Hong Kong;2. that profits arise in or derive from Hong Kong; and3. that such profits derive from such trade, profession, or business.7

If the first two elements have been found to exist, the third element isusually not contentious. The first two elements, however, are often diffi-cult to identify with certainty. They have been characterized as the twolimbs of the source test that limits the charge to profits tax.8 It is essentialthat the two limbs be kept separate and not collapsed into one. Thecourts have made it clear that profits from a trade or business carried onin Hong Kong will not necessarily arise in or derive from Hong Kong.9

Carrying on a trade or business in Hong Kong

How is the Hong Kong legal adviser to determine what level of activity orinvestment is required for a foreign person to be considered as carryingon a trade or business in Hong Kong? The first distinction to be made isbetween a foreign person who trades with Hong Kong and one whotrades in Hong Kong. Clearly, where sales to Hong Kong customers aremade in response to the customers’ orders that are sent to a foreignsupplier in a foreign jurisdiction, the foreign seller cannot be consideredto be carrying on a trade or business in Hong Kong merely by virtue ofhaving dealt with Hong Kong customers and having shipped products toHong Kong. In such a case, the foreign seller has no presence in HongKong, and therefore does not fulfil the first limb of the profits tax charge,which requires that the foreign person be present in Hong Kong in someform or another.

What then constitutes a presence in Hong Kong for this purpose? Theregistration of a branch in Hong Kong under Part XI of the CompaniesOrdinance10 would seem to give rise to a presumption that the oversea

6 Inland Revenue Ordinance, s 14(1).7 See Commissioner of Inland Revenue v Hang Seng Bank Ltd (1990) 3 HKTC 351 (PC

HK).8 See Andrew J. Halkyard and Jefferson P. VanderWolk, Hong Kong Tax Law: Cases and

Materials (Hong Kong, Singapore, Malaysia: Butterworths Asia, 1993), 41.9 Commissioner of Inland Revenue v Hang Seng Bank Ltd (note 7 above).10 Cap 32, LHK.


company in question is carrying on a trade or business in Hong Kong forprofits tax purposes. A branch must be registered if the company hasestablished a ‘place of business’ in Hong Kong.11 The definition of theterm ‘place of business’ in the Companies Ordinance excludes ‘a place notused by the company to transact any business which creates legal obliga-tions’.12 Thus, a foreign company may, for example, use an office in HongKong to distribute promotional literature or perform administrative ac-tivities without being required to register under Part XI.13

It is not at all clear, however, whether this standard has any relevancefor the purposes of profits tax. It has been argued that the threshold forcarrying on a trade or business in Hong Kong within the meaning ofSection 14 of the Inland Revenue Ordinance is lower than the thresholdfor branch registration.14 Perhaps more germane to the profits tax inquiryis the test for business registration under the Business Registration Ordi-nance,15 namely, ‘carrying on business in Hong Kong’, which is defined toinclude ‘any form of trade, commerce, craftsmanship, profession, callingor other activity carried on for the purpose of gain . . . .’16 The BusinessRegistration Ordinance is administered by the Inland Revenue Depart-ment, and registered businesses normally receive an initial profits taxreturn within eighteen months after the initial registration. However, thelanguage of the Business Registration Ordinance does not clarify whatnature or amount of activity is required to trigger the registration require-ment. It does suggest, at a minimum, that there must be activity carriedon in Hong Kong for the purpose of gain.

In practice, many Hong Kong tax advisers rely on the language ofRule 5 of the Inland Revenue Rules17 to determine whether a foreigncompany is carrying on a trade or business in Hong Kong for profits taxpurposes. Rule 5, which is entitled ‘Profit of Hong Kong Branch Offices’,is concerned with the ascertainment of ‘the Hong Kong profits of a per-son having a permanent establishment in Hong Kong, but whose headoffice is situated elsewhere than in Hong Kong.’18 The term ‘permanentestablishment’ is defined as

11 Companies Ordinance, s 332.12 Ibid, s 341.13 Elscint (Asia-Pacific) Ltd v The Commercial Bank of Korea Ltd, unrep, CL No 7 of

1994 (High Court, 22 Apr 1994).14 See Andrew J. Halkyard, ‘Hong Kong Profits Tax: The Source Concept, Part 1’ (1990)

20 HKLJ 232.15 Cap 310, LHK.16 Business Registration Ordinance (cap 310, LHK), s 2(1) .17 Cap 112, sub leg A, LHK.18 Person is defined in s 2 of the Inland Revenue Ordinance as including ‘a corporation,

partnership, trustee, whether incorporated or unincorporated, or body of persons.’


a branch, management or other place of business, but does not includean agency unless the agent has, and habitually exercises, a generalauthority to negotiate and conclude contracts on behalf of his principalor has a stock of merchandise from which he regularly fills orders on hisbehalf.19

It should be stressed that Rule 5 is part of subsidiary legislation thatcan have no effect on the scope of the charge to profits tax as expressed inSection 14 of the Inland Revenue Ordinance. Section 14 makes no refer-ence to a permanent establishment; rather, it refers to the carrying on of atrade, profession or business in Hong Kong. Technically, therefore, thedefinition of permanent establishment in Rule 5 does not tell us anythingother than that a foreign entity that has a permanent establishment inHong Kong will be considered to be carrying on its trade or business inHong Kong. Arguably, Rule 5 implies, through the application of themaxim of interpretation expressio unius est exclusio alterius (‘the expres-sion of one thing is the exclusion of another’), that a foreign-based businesswill only be subject to Hong Kong profits tax if it has a permanentestablishment in Hong Kong. This argument has never been tested in thecourts, however.

Nevertheless, Rule 5 is instructive, for it indicates a dividing linebetween the type of presence that is likely to have tax consequences andthe type of presence that is unlikely to have tax consequences. Into thelatter category we may place, by implication from the words of Rule 5,activity performed through a Hong Kong agent who does not have ageneral authority to conclude contracts on behalf of the offshore princi-pal. For example, a foreign person could carry on an active trade inshares listed on the Hong Kong Stock Exchange through an independentstockbroker in Hong Kong without thereby having a permanent establish-ment in Hong Kong, provided the stockbroker was only authorized to actpursuant to instructions from the offshore principal in respect of eachtransaction. Although we cannot be certain that the foreign trader is notcarrying on his trade in Hong Kong for profits tax purposes, we knowthat Rule 5 will not apply so as to cause the stockbroker to be viewed as apermanent establishment of the foreign trader. As there is nothing in theInland Revenue Ordinance or Inland Revenue Rules that definitely indi-cates that the profits of a share trader who does not have a permanentestablishment in Hong Kong are subject to tax, it is at least open to theHong Kong legal adviser to tell the foreign trader that he may reasonablytake the view that he is not subject to tax.

19 Inland Revenue Rules, r 5.


Similarly, if a foreign-based company wishes to establish a representa-tive office (sometimes called a ‘liaison office’) in Hong Kong for purposesof marketing and information-gathering, it would appear to be reasonablefor the company to take the view that it would not thereby be carrying ona trade or business in Hong Kong for profits tax purposes. The activitiesconducted by the personnel in the representative office would not, in andof themselves, include the effecting of business transactions. Thus, theoffice would not appear to be a place of business and, therefore, wouldnot be a permanent establishment within the meaning of Rule 5. Thecompany might wish, however, to register under the Business RegistrationOrdinance to avoid any risk of penalties for failure to comply with theregistration requirement. Later, when the company is asked to file a prof-its tax return, it can simply claim that it is not carrying on a trade orbusiness in Hong Kong within the meaning of Section 14 of the InlandRevenue Ordinance. This approach is sometimes adopted in practice.

The Inland Revenue Ordinance contains specific provisions relating tothe withholding of tax from an agent or other person in Hong Kongthrough whom a non-resident person receives certain types of income sub-ject to tax in Hong Kong. These provisions are further discussed below.

Profits arising in or derived from Hong Kong

Unlike the trade-or-business limb of the charge to profits tax, which hasnot been interpreted by the courts, the profits-arising limb of the charge(or, as it is more frequently called, the ‘source question’) has produced asignificant number of court decisions.20 The courts have established sev-eral principles relating to the determination of whether profits arise inHong Kong, and the Commissioner of Inland Revenue has publicly an-nounced his adherence to them.21 These principles are as follows:1. Profits arise in or derive from the place where the operations take

place which, in substance, produce the profits.2. This raises a question of fact that depends on the facts and circum-

stances in each particular case.3. The determination must be made in respect of the gross profits de-

rived from particular transactions, on a transaction-by-transactionbasis.

20 For a comprehensive overview of the case law regarding the source question, see JeffersonP. VanderWolk, The Source of Income: Tax Law and Practice in Hong Kong (HongKong: Longman Asia, 1993), Part One.

21 See Departmental Interpretation and Practice Notes No 21, ‘Locality of Profits’ (HongKong: Inland Revenue Department, Nov 1992).


4. The place where the decision to enter into a transaction is made isirrelevant.

5. The lack of a permanent establishment outside Hong Kong does notnecessarily mean that all of the taxpayer’s profits arise in Hong Kong.

6. A profit from a transaction can arise partly in Hong Kong and partlyelsewhere, if the relevant operations occurred partly in Hong Kongand partly elsewhere.22

Although these principles go some way towards clarifying the properapproach to be taken into account in determining the extent to which acompany’s profits arise in Hong Kong for tax purposes, they do notresolve all doubts. For example, in 1992 the Hong Kong Court of Appealcould not reach a consensus on the question of whether commissionrebates received by a Hong Kong portfolio manager from foreign brokersarose in Hong Kong.23 The majority of the court held that the InlandRevenue Board of Review had erred in taking into account the operationsof the foreign brokers. A dissenting judge, however, felt that the brokers’actions were precisely those that produced the profits for the Hong Kongtaxpayer in the form of a share of the brokers’ commissions.24

Similarly, there currently is a conflict among different panels of theInland Revenue Board of Review as to whether the profits of a HongKong trading company arise in Hong Kong if the company does nothingbut (a) transmit to affiliated suppliers orders received from customersoutside Hong Kong and (b) issue invoices to the customers. In such cases,the activities of third parties performed outside Hong Kong on behalf ofthe Hong Kong company, so as to enable it to perform its contractualobligations to deliver goods to buyers outside Hong Kong, have some-times been disregarded in determining whether the Hong Kong company’sprofits arose in Hong Kong.25 The High Court recently decided thatprofits derived in this manner arise in Hong Kong for profits tax pur-poses.26 The court did not, however, consider the issue of whether theperformance of the taxpayer’s contractual obligations outside Hong Kongwas relevant in determining the source of the taxpayer’s profits. Indeed,the decision does not have much value as a precedent, because the tax-

22 See Commissioner of Inland Revenue v Hang Seng Bank Ltd (note 7 above).23 Commissioner of Inland Revenue v Wardley Investment Services (Hong Kong) Ltd

(1992) 1 HKRC para 90–068.24 Ibid, paras 100–602 to –603.25 Compare, e.g., D65/91 (1992) 6 IRBRD 527 with D17/93 (1993) 8 IRBRD 126.26 Commissioner of Inland Revenue v Euro Tech (Far East) Ltd (1995) 1 HKRC para 90–

074.


payer was not represented by counsel and failed to advance any of thelegal arguments that might have been made in its favour.

The Inland Revenue Department has issued a practice note concern-ing the determination of whether profits arise in Hong Kong.27 Publishedin an effort to clarify the tax position of Hong Kong businesses, thepractice note actually created confusion in a number of respects. Forexample, in relation to the important question of how to determine whethertrading profits arise in Hong Kong, the practice note states that1. profits from the purchase and sale of goods will normally be treated

as arising wholly in Hong Kong if either the purchase or the sale was‘effected’ in Hong Kong;

2. in this regard, a purchase or sale will be considered to have been‘effected’ where ‘the actual steps leading to the existence of the con-tracts including the negotiation and, in substance, conclusion of thecontracts’ took place.28

These guidelines clearly deviate from the principle that a profit arises,for tax purposes, where, as a factual matter, the operations take placethat, in substance, produce the profit. A mere purchase of goods in HongKong does not justify the conclusion that profit from the sale of the goodsmust arise in Hong Kong. Moreover, there is no reason to conclude thatprofits arise from the negotiation and conclusion of contracts alone. Per-formance of the contracts would seem to be a necessary consideration. Inaddition, the reference to conclusion of a contract ‘in substance’, withoutfurther explanation, is unclear. Contract formation is a matter of legalrules of offer and acceptance. The question of substance versus formseems irrelevant.

The practice note is similarly vague or illogical in other areas.29 There-fore, Hong Kong advisers and their clients must, in many cases, live witha degree of uncertainty about the client’s exposure to Hong Kong profitstax. Minimizing this exposure is the goal of much of the tax planning thatis done by Hong Kong companies. Typically, the strategy is to shiftprofits to a commonly owned company that does not have any presencein Hong Kong and is not subject to any tax elsewhere — i.e., a tax havensubsidiary. As will be discussed below, however, there are risks associatedwith this type of planning as well.

27 Note 21 above.28 Note 21 above, paras 6 and 7.29 For a critical discussion of the practice note, see Jefferson P. VanderWolk, ‘The

Commissioner’s Practice Note on locality of profits: No light in the tunnel’ (1993)Taxation No 11, 7–12 and VanderWolk, The Source of Income: Tax Law and Practicein Hong Kong (note 20 above), ch 5.


Profits subject to withholding tax in Hong Kong

As noted earlier, certain types of payments received by non-residents aretaxed through the mechanism of a withholding tax on the Hong Kongpayor. These include the following:1. sums paid for the use of, or the right to use, intellectual property in

Hong Kong (i.e., outbound royalties);30

2. sums paid for the use of, or the right to use, movable property inHong Kong (i.e., outbound lease payments);31

3. sums paid to a non-resident entertainer or sportsman in respect of aperformance in Hong Kong;32 and

4. proceeds of sales in Hong Kong by a consignee of goods.33

Notably, there is no withholding tax on outbound payments of inter-est or dividends. Capital gains of non-residents from the disposition ofinvestments in Hong Kong shares or property are similarly tax-free. Therate of withholding tax on outbound royalties for the use of intellectualproperty in Hong Kong is low (1.65 percent for the 1995–96 year ofassessment, assuming the licensor is a corporation), except in cases wherethe licensed property was previously owned by a Hong Kong taxpayerand the licensee and licensor are associated within the meaning of thestatute.34 The low rate results from a statutory presumption that only10 percent of the gross royalty represents net profit to the licensor.35

The taxation of outbound lease payments, in contrast, involves nosuch statutory presumption. It is necessary to calculate the lessor’s de-ductible costs (including depreciation allowances) with respect to the HongKong leasing activity in order to determine the percentage of the grosslease payment that represents net profit to the lessor and is thereforesubject to tax.

Similarly, non-resident entertainers and sportsmen are able to claimdeductions for expenses related to the earning of income in Hong Kong.In the absence of proof of such expenses, the Inland Revenue Departmentwill normally allow for deduction of one-third of the gross payment tothe non-resident entertainer or sportsman.36 It should be noted that the

30 Inland Revenue Ordinance, ss 15(1)(a), (b), 20B, 21A .31 Ibid, ss 15(1)(d), 20A .32 Ibid, s 20B.33 Ibid, s 20A(3).34 Ibid, s 21A (providing for a 16.5 percent rate in such circumstances).35 Ibid.36 Departmental Interpretation and Practice Notes No 17, ‘The Taxation of Persons

Chargeable to Profits Tax on Behalf of Non-Residents’ (Hong Kong: Inland RevenueDepartment, Mar 1989), para 14.


Inland Revenue Department is reportedly very thorough in keeping trackof performances in Hong Kong by visiting professional artists, presum-ably by reading newspaper advertisements, concert schedules, and thelike. Apparently the Hong Kong Philharmonic Orchestra was once askedfor information regarding payments allegedly made to JS Bach and otherdeceased composers.37

The taxation of non-residents who sell goods in Hong Kong througha Hong Kong consignee is provided for in Section 20A(3) of the InlandRevenue Ordinance. This Section requires the consignee to file quarterlyreturns and pay 1 percent of the gross proceeds of sale to the InlandRevenue Department. In practice, the Commissioner of Inland Revenuehas reduced the rate to 0.5 percent. The basis for this so-called ‘consign-ment tax’ is somewhat shaky, as the statute does not expressly deem thesales proceeds to be trading receipts arising in Hong Kong. Moreover, inthe case of goods that were manufactured outside Hong Kong, the con-signment tax conflicts with the Inland Revenue Department’s publishedpractice concerning the locality of profits from the sale of manufacturedgoods. The Commissioner’s practice note on locality of profits38 statesthat profits of a manufacturer are considered to arise where the manufac-turing occurs, regardless of where sales occur.39 Thus, if a Hong Kongconsignee sells goods in Hong Kong on behalf of a non-resident manufac-turer, the Commissioner should, in principle, forgo collection of theconsignment tax, because Section 20A(3) does not extend the charge toprofits tax to profits arising outside Hong Kong. In practice, however, theCommissioner can be expected to demand that tax be paid.

Other tax issues

A foreign company or individual who trades or invests in Hong Kongmay incur other Hong Kong tax liabilities besides profits tax. For exam-ple, rental income from land or buildings will be subject to property tax.40

Similarly, the transfer of immovable property in Hong Kong or HongKong stock (e.g., shares of a Hong Kong company) will give rise to aliability for stamp duty.41 The investment of share capital in a Hong Kong

37 See Peter G. Willoughby, Hong Kong Revenue Law (New York: Matthew Bender &Co, 1991), Vol 2, s 2.01/20B.11.

38 Note 21 above.39 Note 21 above, para 15.40 Inland Revenue Ordinance, s 5.41 Stamp Duty Ordinance, ss 4, 19 and First Schedule.


company produces a liability for capital duty, currently imposed at therate of 0.6 percent of the amount invested.42 If the non-resident is anindividual, the holding of Hong Kong assets will create exposure to estateduty should the person die while owning the assets.43 In addition, if theindividual receives director’s fees or employment income from a HongKong company or in relation to work done in Hong Kong, liability forsalaries tax may result.44

Detailed discussion of the exposure of foreign investors to these li-abilities is beyond the scope of this chapter. Nevertheless, the final sectionof the chapter, concerning tax planning, will allude to some of theseissues.

TAX ASPECTS OF OVERSEAS TRADING OR INVESTINGBY HONG KONG COMPANIES

When a Hong Kong company trades or invests in a foreign country, itmay be exposing itself to liability for tax in that country in respect of profitsearned there, or perhaps in respect of gross proceeds of sale (to which avalue-added tax might apply) or gross payments of royalties, rent, inter-est, or dividends (to which withholding tax might apply). The amount oftax payable overseas will directly affect the investor’s return from the in-vestment. Therefore, it is essential that the investor be fully apprized ofthe extent of the foreign tax exposure before deciding whether or not toproceed with the investment or other activity in the foreign market.

The Hong Kong adviser must take responsibility for ascertaining thelikely exposure to foreign taxes and for considering alternatives that maysucceed in reducing the tax exposure. This will almost always require theassistance of foreign tax experts. Thus, part of the job of the Hong Kongadviser in these circumstances is to identify reliable foreign advisers andto use them, and their advice, intelligently and efficiently. The latter as-pect requires an initial understanding of the typical features of foreigncountries’ tax systems.

42 Companies Ordinance, Eighth Schedule. The rate is expected to decrease to 0.3 percentwith effect from 1 April 1996.

43 Estate Duty Ordinance, s 5.44 Inland Revenue Ordinance, s 8. See also Departmental Interpretation and Practice Notes

No 10, ‘The Charge to Salaries Tax’ (Hong Kong: Inland Revenue Department, Dec1987).


Foreign taxation of non-resident corporations

Most countries impose a tax on corporate income. This tax may be aslow as 25 to 27 percent (e.g., in Taiwan and Singapore) or as high as50 percent (e.g., in Japan, where the effective corporate income tax rate in1993 was 51.7 percent).45 Usually the foreign corporate income tax rate isabout double the rate of Hong Kong profits tax on corporations.46 Inmost countries, the tax is imposed directly on non-resident corporationsonly if they carry on a trade or business in the country and derive incomefrom a source in the country.47 In this respect, foreign taxation of theHong Kong investor is very similar to Hong Kong taxation of foreigninvestors in Hong Kong.

In another respect, however, foreign taxation of Hong Kong investorsis significantly different from Hong Kong taxation of foreign investors. Asnoted above, Hong Kong imposes no withholding tax on dividends, inter-est, or capital gains derived by foreign investors from a source in HongKong, and the withholding tax that is imposed under the Inland RevenueOrdinance on royalties, lease payments, performance fees, and consign-ment sales proceeds is relatively mild. In most foreign jurisdictions, on theother hand, withholding tax is imposed on some or all of these items at asubstantially higher rate.48 Moreover, foreign withholding taxes tend tobe imposed on the gross amount of the payment flowing to the HongKong investor from a source in the foreign country.

Withholding taxes on interest, dividends, royalties, and other types ofincome are typically reduced or eliminated under an applicable incometax treaty.49 Unfortunately for Hong Kong investors, Hong Kong is not aparty to any comprehensive income tax treaties.50 Therefore, it is difficult(although not impossible, as noted below) for Hong Kong companies to

45 See Horwath International, 1992 International Tax Handbook (Sydney: CCH AustraliaLtd, 1992), 471 [hereinafter 1992 International Tax Handbook].

46 The current maximum rates of tax on corporate income in a number of jurisdictions inwhich Hong Kong companies trade and invest frequently are as follows: China, 33percent; the United States, 35 percent; the United Kingdom, 33 percent; Malaysia, 32percent; and Australia, 39 percent.

47 See, e.g., United States Internal Revenue Code of 1986 (Title 26, United States Code)[hereinafter the US Internal Revenue Code], ss 882, 861–864.

48 See, e.g., ibid, s 1442 (providing for a withholding tax of 30 percent on the grossamount of US-source interest, dividends, rent, salaries, and other ‘fixed or determinableannual or periodic gains, profits, and income’ that is not effectively connected with theconduct of a trade or business in the United States).

49 See 1963 and 1977 OECD Model Income Tax Treaties and Commentaries (Deventer:Kluwer, 1987), arts 10, 11, 12 [hereinafter OECD Model Income Tax Treaties].

50 See note 5 above.


obtain relief from withholding taxes under tax treaties. Moreover, thelack of treaty protection renders Hong Kong companies more exposed todirect taxation in foreign jurisdictions than they would be if treatiesapplied, because treaties typically provide that business profits of a non-resident to whom the treaty applies may not be taxed in the country ofsource unless the profits are attributable to a permanent establishmentthat the non-resident maintains in the country of source.51 The definitionof ‘permanent establishment’ normally raises the threshold of taxablepresence significantly in comparison to the ‘carrying on of a trade orbusiness in the jurisdiction’ threshold otherwise applicable under domes-tic law.52

Most countries view the question of whether a foreign person is car-rying on a trade or business in the country as a question of fact. Substantialand continuous activities are generally required.53 The use of a domesticagent can cause a foreign person to have a taxable presence in a coun-try.54 Each country’s law and practice must be carefully considered by theHong Kong adviser. For example, some countries will allow a representa-tive office or liaison office to operate on a tax-free basis; others will not.55

The source-of-income rules of the foreign jurisdiction will be crucialin determining the Hong Kong investor’s exposure to foreign taxation.Income of a non-resident corporation is generally taxable only if it arisesin the taxing jurisdiction.56 Typically, the source-of-income rules of acountry that has a sophisticated tax law will be set out in the tax statutewith some specificity, in contrast with the lack of detail in the InlandRevenue Ordinance.57

If the Hong Kong investor’s income from the foreign investment isconsidered to arise in the foreign jurisdiction, it does not necessarilyfollow that tax will be imposed on the income. The income may be tax-free because it (a) is of a type that is not subject to withholding tax anddoes not arise from the conduct of a trade or business in the jurisdiction

51 OECD Model Income Tax Treaties (note 49 above), art 7.52 See ibid, art 5. For example, the definition of ‘permanent establishment’ normally

excludes an independent commission agent who sells goods in the jurisdiction on behalfof the non-resident in the ordinary course of its agency business. This is clearly inconsistentwith domestic law regarding taxable presence in many jurisdictions. See, e.g., withrespect to US law, Rev Rul 70–424, 1970–2 CB 50.

53 See, e.g., with regard to US law, Elizabeth Herbert v Commissioner, 30 TC 26 (1958).54 Note 52 above.55 See, e.g., 1992 International Tax Handbook (note 45 above), 394 (re Indonesia:

representative office taxable) and 832 (re Taiwan: representative office may operate tax-free).

56 Ibid, passim.57 See, e.g., US Internal Revenue Code, ss 861–863.


(e.g., a gain from an isolated sale of property), (b) is exempt from with-holding tax under a specific provision of domestic law,58 or (c) is exemptunder a tax treaty.

On the other hand, if the Hong Kong investor’s income is not exemptfrom taxation, it becomes necessary to consider whether the income willbe taxed more than once in the foreign jurisdiction. There may be onlyone level of taxation, as in the case of either (a) gross-basis withholdingtax on domestic-source dividends, interest, royalties, rents and the like, or(b) direct, net-basis tax on branch income, with no tax on the remittanceof after-tax branch profits back to Hong Kong. Alternatively, two levelsof tax may apply, as where there is a direct, net-basis tax on branchincome, and a further tax on the remittance (or deemed remittance) ofafter-tax branch profits to Hong Kong.59

A similar issue relates to the taxation of distributed corporate profits.If the Hong Kong investor is investing through a local subsidiary in theforeign jurisdiction, the dividends that will ultimately be paid to the HongKong investor may be subject to withholding tax, in addition to thecorporate tax that has already been paid on the profits out of which thedividends are paid.60 On the other hand, if the jurisdiction has an imputa-tion or franking system in relation to the taxation of corporate dividends,the distribution may not result in any additional tax liability.61

Tax incentives

Most countries offer tax incentives of some kind to foreign investors toencourage the flow of foreign capital into the country. Industrializingcountries such as China and Malaysia offer tax holidays to foreign-in-vested domestic ventures in manufacturing and other activities viewed asdesirable by the host government.62 Singapore law provides for a numberof tax incentives, such as the much-touted operational headquarters re-gime under which the rate of income tax is reduced from 27 percent to 10percent for companies that meet various conditions regarding the owner-

58 See, e.g., ibid, s 882(c) (providing an exemption from withholding tax for certainportfolio interest).

59 See, e.g., ibid, s 884 (providing for a second-level branch profits tax of 30 percent).60 This two-tier system of taxation of distributed corporate profits is known as the ‘classical’

system of corporate taxation. Its most prominent adherent is the United States.61 Singapore, Australia, and the United Kingdom are examples of jurisdictions that employ

the imputation or franking system of taxation of corporate dividends.62 See 1992 International Tax Handbook (note 45 above), 215–217 (re Chinese incentives)

and 555–567 (re Malaysian incentives).


ship and management of subsidiary companies in the region.63 Severalother Asian countries offer incentives designed to encourage high-technol-ogy investment.64

Industrialized countries such as the United States offer different kindsof incentives. For example, US law provides a tax exemption for portfolioinvestors in US securities.65 In addition, US bank deposits owned by non-residents are not subject to US estate tax when the owner dies.66

Foreign investment in real property

In countries where foreigners are allowed to purchase real property, thereare often special tax rules designed to ensure that foreign owners ofdomestic real property cannot sell the property on a tax-free basis. In theUnited States, for example, any gain realized by a foreign person from thesale of a US real property interest (which includes both property and theshares of a US company that owns mostly property) is deemed to havebeen earned in the course of a trade or business conducted by the foreignperson in the United States.67 Moreover, the buyer of the property isobliged to withhold a portion of the purchase price and pay the withheldportion to the Internal Revenue Service pending final determination of theseller’s US income tax liability.68

Anti-avoidance rules

Various types of anti-avoidance rules are potentially applicable to HongKong investors in foreign jurisdictions. Transfer pricing rules, which seekto ensure that commonly controlled parties deal with one another on arm’s-length terms for taxation purposes, generally apply equally to domestic andforeign taxpayers.69 In an effort to obtain sufficient information from for-eign taxpayers to be able to enforce the transfer pricing rules, countries suchas the United States have begun to require that foreign-owned domesticcorporations report details of all transactions with related parties.70

63 Ibid, 723–727 (re Singaporean incentives).64 Ibid, e.g., 499–505 (re Korean incentives) and 826–828 (re Taiwanese incentives).65 US Internal Revenue Code, ss 864(b), 871(h), 882(c).66 Ibid, s 2105(b).67 Ibid, s 897.68 Ibid, s 1445.69 See, e.g., ibid, s 482.70 See ibid, ss 6038A, 6038C.


A similar type of anti-avoidance rule may apply so as to deny interestexpense deductions to a foreign-owned company that pays interest onshareholder loans. Most countries allow interest expenditure to be de-ducted in computing taxable income.71 This provides an incentive forshareholders to finance corporate operations with debt rather than equitycapital. In some instances, the use of debt financing deprives the govern-ment of tax revenue, because the lender might be exempt from tax, or besubject to a reduced rate of tax on its interest income, while at the sametime the borrower is able to claim deductions for its interest expenditure.For example, the lender might be a non-resident who is able to qualify foran exemption or reduction of withholding tax on interest under a taxtreaty.

To prevent tax avoidance through excessive debt financing, somecountries’ tax laws include rules that deny the borrower a deduction forthe portion of its interest expenditure that is attributable to excess debt.72

In common law countries, these rules have largely been judge-made, al-though specific applications of the doctrine appear in the statute books aswell (for example, the US ‘earnings-stripping’ provisions, which restrictthe deduction for tax-advantaged interest paid to a related party, if thepayor’s debt-to-equity ratio exceeds 1.5-to-1 and certain other conditionsare satisfied).73 If the excess interest is recharacterized as a dividend fortax purposes, a withholding tax liability may arise in respect of both theprincipal and interest portions of the purported debt repayment.

Most sophisticated tax systems include the legal doctrine of ‘sub-stance over form’, or ‘fiscal nullity’, which allows judges to disregardintermediate steps in a prearranged series of transactions that appear tohave no purpose apart from enabling the taxpayer to gain a tax benefit.74

For example, a taxpayer might attempt to avoid an arm’s-length pricingrule by making an interest-free loan to an unrelated person on the under-standing that the unrelated person would on-lend the funds, interest-free,to a person related to the taxpayer. The composite-transaction doctrinewould allow the court to disregard the unrelated party and apply thetransfer pricing rule.

Such ‘back-to-back’ transactions are often used in international taxplanning. The structure may be designed to take advantage of tax treatybenefits, or to exploit a tax incentive provided in domestic law, or to fit

71 See, e.g., ibid, s 163(a).72 See, e.g., 1992 International Tax Handbook (note 45 above), 284–285 (re French debt/

equity rules).73 US Internal Revenue Code, s 163(j).74 See, e.g., Furniss v Dawson [1984] AC 474 (HL).


into a loophole in the tax net. It is important, when using such structures,to find out whether the host country’s tax authorities might have a legalbasis, under their tax law, for attacking the structure.

It should be noted that some tax treaties contain provisions that denythe benefits of the treaty to corporations, which, although resident in atreaty country, are owned or controlled by residents of a third country.The purpose of such provisions, which are known as ‘limitation of ben-efits’ clauses, is to prevent so-called ‘treaty shopping’. This is thephenomenon of investors from a non-treaty country, such as Hong Kong,‘shopping around’ for a tax treaty under which they can use a treaty-qualified subsidiary (for example, a company incorporated in theNetherlands) to make a tax-advantaged investment in a country that is aparty to an applicable tax treaty (e.g., a treaty with the Netherlands). AHong Kong investor might, for example, form a Dutch subsidiary for thepurpose of having that company make an investment in Singapore orIndonesia, both of which have entered into tax treaties with the Nether-lands. Some recently executed tax treaties include a limitation-of-benefitsprovision designed to prevent such ‘treaty shopping’,75 but the majority oftreaties do not have such a clause. However, this is a new and developingarea where the tax planner must use extreme caution.

TAX PLANNING: OVERRIDING CONSIDERATIONS

As noted earlier, few commercial lawyers will have the necessary expertiseto engage in international tax planning for their clients without theassistance of a tax specialist. Nevertheless, tax issues cannot be ignored.Inevitably, the adviser will be required to consider whether alternativestructures for an investment or other business operation produce asignificantly greater or lesser tax liability for the client. Often, the clientwill give great importance to the commercial lawyer’s recommendation asto which structure is the best. Therefore, the lawyer must be prepared toparticipate in the tax planning process to some degree, even if thesuggestions as to alternative structures emanate from independent taxspecialists.

75 See, e.g., art 26 of the Convention Between the United States of America and theKingdom of the Netherlands for the Avoidance of Double Taxation and the Preventionof Fiscal Evasion With Respect to Taxes on Income, signed 18 December 1992. See alsoPhilip D. Morrison and Mary C. Bennett, ‘The New U.S.-Netherlands Treaty: Part I —Limitation on Benefits and Related Issues’ (1993) 6 Tax Notes International 331.


Any lawyer is well-advised to keep certain overriding principles inmind when evaluating a proposed tax-based structure. First, the structurecannot be recommended if it involves fraud on the government, illegalnon-disclosure of information, or other elements of illegality. Second, if itis not clear that the proposal involves any violation of law but there is arisk that a court would find a violation if the matter were before thecourt, the adviser must consider the risk of penalties in addition to thecost of back taxes and interest on such taxes. Third, the structure isunlikely to produce a satisfactory result if it is commercially unrealistic.Not only might it be attacked by the relevant taxing authorities underanti-avoidance rules or doctrines, but it might also backfire on the clientin the form of extra costs incurred in connection with maintaining andadministering companies and operations that have no commercial justifi-cation. Fourth, in relation to any cross-border investment or activity, thelawyer must consider the tax effect of the proposed structure in both theclient’s home jurisdiction and the jurisdiction where the investment ismade or the activity conducted. A tax savings in one country is a Pyrrhicvictory if it is offset by an equal or greater tax increase in another coun-try. Finally, the lawyer has to take a very practical look at what isinvolved in terms of implementation and follow through on an ongoingbasis after the structure is set up.

Ultimately, the lawyer must step back, consider the proposal from theclient’s point of view, and ask whether the client will be happy with thestructure in the future, given the attendant risks and costs (of which therewill always be some). In this regard, it is essential that the lawyer knowthe client’s management style and attitude toward taxation.

With respect to obtaining advice on foreign tax laws, two prudentialconsiderations apply. First, the exact language of statutory and regulatoryprovisions is important. Taxation in every country is based on statutesand regulations. The international tax adviser, therefore, should endeav-our in every case to obtain advice from foreign tax experts that reflectswhat the relevant foreign tax provisions actually say. It is always possiblethat the language of the foreign law does not cover your client’s situation,either because of sloppy drafting or because the situation was not envis-aged by the drafters.

Second, it is essential to obtain advice from local experts in foreigncountries, for they usually know what the local authorities are likely to do(or not do) in response to the client’s activities in the country. The lawsand regulations may be misleading in cases where particular rules are notenforced in practice, or, in the opposite case, where there are de factorules that do not appear in the law or regulations. Most commonly, thelocal experts will be able to tell you how the local revenue authorities


interpret the applicable rules. In most cases, it would not be in the client’sinterest to adopt a course of action that would be likely to result in adispute with the local tax authorities.

CONCLUSION

The taxation of cross-border trade and investment is increasingly of con-cern to commercial lawyers in Hong Kong and elsewhere. Both inboundtrade and investment into Hong Kong and China by foreign investors,and outbound trade and investment by Hong Kong and Chinese compa-nies, are steadily growing. Taxes on income and property may arise intwo or more jurisdictions as a result of carrying on a single business, oreven from entering into a single transaction. Minimizing tax costs is animportant goal of traders and investors. Therefore, their lawyers must befamiliar with the tax issues that are likely to arise with respect to cross-border activity.

Asset Protection? Estate Planning?(Unit) Trust Me

Andrew J. Halkyard

. CHAPTER EIGHT .

Unlike many other jurisdictions where personal rates of income tax areboth progressive and high,1 Hong Kong essentially has a flat low rate ofincome tax.2 Therefore it comes as no surprise that, for income splittingpurposes, trust structures are a rarity in Hong Kong.3 Conversely, the useof trusts for asset protection purposes is widespread.4 Although suchmotivation goes well beyond the desire to minimize estate duty,5 the

1 The United States and Canada being excellent examples.2 The standard rate is currently 15 percent: see Inland Revenue Ordinance (cap 112,

LHK), Schedule 1. Although marginal rates of tax under the ordinance are as high as20 percent, they do not apply once the average rate of tax reaches 15 percent. Ibid,Schedule 2.

3 On the other hand, it is no coincidence that pre-immigration trust structures are derigueur for wealthy Hong Kong emigrants to the United States and Canada.

4 Surprisingly little has been published in Hong Kong in relation to this matter, theexception being Peter Willoughby and Andrew Halkyard, Encyclopaedia of Hong KongTaxation: Estate Duty (Butterworths: Singapore, 1993–) at I [385]-[396] and [864] andII [455] et seq. The field has, however, provided fertile ground for the plethora ofbusiness conferences held in Hong Kong over recent years. See, e.g., Peter Edwards,‘Choosing a Jurisdiction for Your Trust’ (IIR, 24 Sept 1987); Peter Edwards, ‘Trusts forTax Planning and Asset Protection’ (4 Feb 1988); Brian Kieran, ‘Implications of HongKong Tax, Estate and Stamp Duty for Trusts’ (April 1988); Paul Tan, ‘Estate DutyPlanning’ (Streeter Communications, 12 June 1990); Adrian King, ‘Estate Duty: Tipsand Traps for Businessmen’ (IIR, 12 March 1993). Copies of all these papers are in theauthor’s possession.

5 The use of trusts in Hong Kong is not confined to, or necessarily primarily motivatedby, a desire to mitigate estate duty. In an unpublished paper entitled ‘Trusts’ (31 October

204 Andrew J. Halkyard

estate duty implications are critical and must be understood by thoseadvising in this area. They form the subject matter of this chapter.

This chapter focuses on how estate duty can best be minimized whenstructuring a typical offshore trust to be used for asset protection andestate planning in Hong Kong. Particular attention will be paid to thenature of a beneficiary’s interest in a unit trust and a discretionary trust.Among the issues discussed are how transfers of property to the trusteeshould be structured and documented, and why, subject to compellingcontrary reasons, gifts should be avoided. The chapter also considers thenecessity for the trustee being independent from the settlor or notionalsettlor of the trust, namely, to ensure that, for estate duty purposes, thesettlor will not be competent to dispose of the underlying trust property.

AN INTRODUCTION TO HONG KONG ESTATE DUTY

In the absence of any applicable exemption, estate duty is payable atprogressive rates where the principal value of dutiable property located inHong Kong and passing upon a person’s death exceeds $6,500,000.6

Property that a deceased is competent to dispose of is deemed to pass forthis purpose, as is property settled by a deceased during his lifetime overwhich he has reserved a power to restore to himself.7 The maximum rate

1983), a copy of which is in the author’s possession, an eminent Hong Kong trustlawyer, Peter Edwards, focused upon asset protection as the most important reason forestablishing a trust structure. Edwards set out the following related uses to which trustsare put in Hong Kong: (1) to provide the ultimate holding vehicle for family assetswhere family members are concerned about an uncertain long-term political future; (2)to ensure maximum freedom for trustees to manage family assets, uninhibited bygovernmental restrictions such as exchange control and capital taxation; (3) to ensuremaximum confidentiality; and (4) to provide a mechanism for the transmission of aperson’s assets to his heirs quite separate from the free estate that passes under his willor on intestacy (i.e., formalities of probate in Hong Kong can be simplified or evendispensed with). Edwards then examined various advantages associated with the use oftrusts, including: (1) establishing a so-called ‘protective trust’ to prevent a spendthriftfrom squandering capital; (2) to protect minors and young people; (3) to keep a family’sassets together and prevent the fragmentation of holdings that would result from propertybeing distributed amongst numerous heirs; and (4) to enable a family to keep a controllinginterest in a company. In addition, discretionary trusts are used in Hong Kong to avoidthe reporting requirements of substantial shareholders under the Securities (Disclosureof Interests) Ordinance (cap 396, LHK).

6 Estate Duty Ordinance (cap 111, LHK), s 5 and Schedule 1, Part 22.7 Ibid, s 6(1)(a), (e).

Asset Protection? Estate Planning? (Unit) Trust Me 205

of duty, 18 percent, applies when the value of a person’s dutiable estateexceeds $9,500,000.8

A key provision is Section 6(1)(c) of the Estate Duty Ordinance,which provides, inter alia, that if an individual disposes of property byway of gift within three-years before death, such property will be subjectto estate duty if it is situated in Hong Kong at the date of death. Thethree-year period will run only where the deceased is entirely excludedfrom any benefit arising from the gifted property. Therefore, if aftermaking a gift, the deceased reserves an interest in, or continues to enjoythe use of, the gifted property, estate duty will be payable in respect ofthat property even though the three-year period has expired.9

As with all Hong Kong taxation legislation, the key to estate dutyliability is source — Section 10(b) of the Estate Duty Ordinance providesan exemption from duty for all property located outside Hong Kong atthe date of death. Concepts of residence and domicile are irrelevant forthis purpose.

It is sometimes (erroneously) said that a simple method of avoidingestate duty would be for a person to transfer Hong Kong assets, typicallyland and shares in companies incorporated or listed in Hong Kong,10 to atax haven company controlled by the transferor or associates of thetransferor. Such a method relies upon the fact that registered shares re-corded on a register maintained outside Hong Kong of an offshore companywould be offshore property and would thus qualify for exemption fromduty under Section 10(b).11 However, under the ‘controlled company’provisions of the Estate Duty Ordinance,12 a slice of the Hong Kongassets held by such an offshore company could nevertheless be subject toestate duty on the death of the transferor.13

8 See note 6 above.9 See Willoughby and Halkyard (note 4 above), at I [95] et seq and II [394] et seq.10 Unlike other items of property, such as bank deposits and most forms of movable

property, the situs of Hong Kong immovable property and shares in companiesincorporated in Hong Kong cannot be transferred outside Hong Kong for estate dutypurposes. They can, however, be metaphorically transferred by charging the relevantproperty and placing the proceeds outside Hong Kong in order to take advantage of theexemption provided by s 10(b). See Willoughby and Halkyard (note 4 above), at I[862]. As property values and asset holdings can change rapidly, this clearly cannot be apanacea for estate planning.

11 See Standard Chartered Bank v IRC [1978] 1 WLR 1160.12 Estate Duty Ordinance, ss 34–45 and Schedule 2.13 This would be so regardless of (1) when the transfer took place, (2) the value of the

property transferred, or (3) whether the transfer was for value or operated as a voluntarydisposition inter vivos.


Although the published policy of the Estate Duty Office is to applythe controlled company provisions only in cases where a company hasbeen established for the purpose of estate duty avoidance,14 these provi-sions are exceedingly technical and wide ranging.15 Thus, notwithstandingthat these provisions have apparently been sparingly applied by the EstateDuty Office for a number of years, it is no coincidence that structuresinvolving offshore private companies have generally been eschewed byestate planners in Hong Kong in favour of trust structures.16 An analysisof the type of trust structure commonly used in Hong Kong and anexamination of the possible estate duty pitfalls involved follow.

A TYPICAL OFFSHORE TRUST STRUCTURE

As indicated above, a rational fear of the controlled company provisions17

has caused estate planners in Hong Kong to focus increasingly upon truststructures as a method of mitigating estate duty. The popularity of suchstructures has been enhanced by the fact that they typically form the basisof pre-immigration tax planning for the most popular jurisdictions, theUnited States and Canada, as well as for the United Kingdom.

Typically, where family interests are diversified, Hong Kong assets aretransferred18 to a unit trust whose units are held by a non-exhaustivediscretionary trust in modern form. This structure is illustrated in thefollowing diagram:

14 See The Law Society of Hong Kong Circular to Members No 8/74 (1 Feb 1974),reproduced in Willoughby and Halkyard (note 4 above), at III [4].

15 See Gerard Horton, ‘Hong Kong Estate Duty Legislation Relating to ControlledCompanies’ (1977) 7 HKLJ 186 (graphically describing the possibility of multiple dutybeing payable as a result of the operation of the controlled company provisions to agroup of companies).

16 It should not be forgotten that a trust is not a panacea for global tax planning. Whileholding assets through a trust structure is generally preferable for Hong Kong estateduty purposes, as distinct from holding assets through a company, in other jurisdictionsthe reverse may very well be true.

17 See note 12 above.18 The form of the transfer must be very carefully considered because the estate duty

consequences flowing from a voluntary disposition inter vivos, as distinct from a transferat market value, can significantly vary . This matter is discussed in detail below at pages215–218.


Offshore Trustee1

Discretionary Trust2

Offshore Trustee3

Unit Trust

Trust PropertyUnits in theUnit Trust

Trust Property 4

HK Assets, typicallyimmovable propertyand shares in HK

Companies

Notes:1. Incorporated outside Hong Kong, typically in a tax haven. Ideally, the trustee should be inde-

pendent of the settlor or transferor of the trust property to the Unit Trust.2. Ideally, the beneficiaries should not include the settlor or transferor of the property to the Unit

Trust. In any event, the settlor or transferor must not be in any position so as to be competent todispose of any trust property.

3. Incorporated outside Hong Kong, typically in the same tax haven. Ideally, the trustee should beindependent of the settlor or transferor of the trust property.

4. Typically purchased from the settlor or transferor at fair market value.

19 See generally, Paul Matthews, ‘Letters of Wishes’ (1995) 5(3) The Offshore Tax PlanningReview 181; Andrew Halkyard, ‘Tax Corner’ (Feb 1994) The New Gazette 24.

20 Alternatively, the protector can be given the power to veto the trustee’s decisions. It ismore common, however, to provide that key decisions made by the trustee must be

A great advantage of using a discretionary trust as in the above struc-ture is that it gives maximum flexibility for distributing trust assets duringthe life, or following the death, of the settlor or transferor. Typically, thetransferor will give a non-binding letter of wishes19 to the trustee thatstipulates the guidelines the trustee is expected to follow in administeringthe trust. Further protection is usually sought by designating a person tobe a ‘protector’ under the trust. The protector may be a close relative orconfidant of the transferor or a lawyer or bank trustee company whoseprior written consent is needed before the trustee can exercise variouspowers under the trust. For example, the protector’s consent might beneeded before any distribution of the capital or income of the trust prop-erty is made; before any change is made to the investments of the trust;and before any change is made to the terms of the deed establishing thetrust. The protector is sometimes given power to remove the trustee andappoint a new trustee.20


ANALYSIS OF A TYPICAL TRUST STRUCTURE

The following estate duty analysis is based upon the combined discretion-ary trust/unit trust structure outlined above.

May a unit trust be a company?

A threshold question is whether a unit trust may be considered a com-pany and, therefore, capable of being a controlled company, for thepurposes of the Estate Duty Ordinance.21

Under Section 3(1) of the Estate Duty Ordinance a company ‘includesany body corporate, wheresoever incorporated’. This leaves open the pos-sibility that an unincorporated body could be categorised as a companyfor the purposes of the controlled company provisions. However, thecontrolled company provisions in the Estate Duty Ordinance generallyindicate that the legislation is only concerned with bodies corporate.22

Moreover, a major distinction between a unit trust and a company isthat unlike a corporation (which has articles of association binding thecorporators), or a joint venture or a partnership, there is generally nocontract between the unit holders inter se. It is hard, therefore, to envis-age how a unit trust could be treated as a company.

All in all, this appears to be a theoretical rather than a practicaldifficulty. For all intents and purposes, the controlled company provisionspresuppose the existence of a body corporate, and it can safely be con-cluded that a unit trust is not a company for the purpose of theseprovisions.23 For the avoidance of doubt, however, it is suggested that the

communicated to the protector before they take effect and, allied with this, that theprotector has power to remove the trustee and appoint a new trustee if such decisionsdo not meet with the protector’s approval. See generally, John Mowbray, ‘Protectors’(1995) 5(3) The Offshore Tax Planning Review 151.

21 A very useful summary is provided by M. Walsh, ‘Unit Trusts’ in Yuri Grbich, GregoryMunn and Harry Reicher, Modern Trusts and Taxation (Butterworths: Melbourne,1978), 38–49 (distinguishing unit trusts from other types of arrangements or organizationssuch as agency, partnership and other associations both corporate and unincorporate).See also H. Ford, ‘Public Unit Trusts’ in Robert Austin and Richard Vann, The Law ofPublic Company Finance (Sydney: Law Book Company, 1986), ch 15.

22 See, e.g., Estate Duty Ordinance, s 40(4), the provision that ensures that double duty isnot paid under the general charging provision as well as the controlled companyprovisions, which only applies where ‘shares or . . . debentures of the company’ aresubject to duty.

23 There has never been any indication from the revenue authorities in Hong Kong to thecontrary.


Unit Trust Deed should prevent any implication that the unit holders arein a position to control the activities of the trustee. In particular it shouldbe stated that:1. the unit holders are not permitted to direct the trustee in relation to

any investments to be made or business to be carried on;2. there is no agreement between the unit holders inter se; and3. the trustee is not the agent of the unit holders.24

The nature of a beneficiary’s interest in a unit trust

A working definition of a unit trust is that:

it is a trust in which the beneficiaries generally have fixed interests incapital and income quantified by the number of units each holds. Itusually provides for a fluctuating class of beneficiaries.25

A useful way to help determine the nature of a unit in a unit trust isto contrast it with the nature of shares in a company. Superficially, a unitlooks like a share in a company because, depending on the terms of thetrust, unit holders may assign their interests by sale or otherwise to newunit holders in much the same way as shares in a company are transferred.However, as the decision of the High Court of Australia in Charles v FCT26

shows, these types of property are fundamentally different:

a unit held under this trust deed is fundamentally different from a sharein a company. A share confers on the holder no legal or equitable interestin the assets of the company; it is a separate piece of property; and if aportion of the company’s assets is distributed among the shareholdersthe question whether it comes to them as income or capital depends onwhether the corpus of their property (their shares) remains intact despitethe distribution: IRC v Reid’s Trustees [1949] AC 361, 373. But a unitunder the trust deed before us confers a proprietary interest in all theproperty which for the time being is subject to the trusts of the deed:Baker v Archer-Shee [1927] AC 844; so that the question whether moneysdistributed to unit holders under the trust form part of their income orof their capital must be answered by considering the character of thosemoneys in the hands of the trustees before the distribution is made.

24 This provision is also important in ensuring, particularly where the trust is a tradingtrust, that the unit holders cannot be made directly liable to third parties.

25 See Walsh (note 21 above), 36–37.26 (1954) 90 CLR 598, 609.


On this basis, it would seem that the ‘property passing’27 on the deathof a unit holder is not the unit itself. Although as a matter of general lawit follows that the location of the unit and indeed of the register shouldnot be determinative for estate duty purposes,28 caution dictates that theUnit Trust Deed should be drafted in such a way so as to prevent thebeneficiaries from having any rights in any trust property other than inthe cash proceeds upon sale.29 Moreover, the register should be main-tained outside Hong Kong and the trustee, incorporated and residentoutside Hong Kong.

The possibility that the nature of the property passing on the death ofa unit holder is akin to the interest of a beneficiary of a discretionary trustcan also be eliminated. Unlike the beneficiary of a non-exhaustive discre-tionary trust (who has no proprietary interest in the trust fund30), a unitholder can have a proprietary interest in all the assets subject to the trust.31

Similarly, the analogy between the unit holder’s interest and the inter-est of a beneficiary under an unadministered estate can be discounted.Whereas a unit holder can have a proprietary interest in all the assetssubject to the trust, a beneficiary under an unadministered estate has noestate, right or interest, legal or equitable in the underlying property.32

By a process of elimination, the nature of a unit holder’s interest in aunit trust is arguably more similar to that of a partner in a partnershipthan to the other items of property discussed above. Section 22 of thePartnership Ordinance33 requires partnership property to be held for part-nership purposes and in accordance with the partnership agreement. Thissection gives each partner an interest in all the property, which ultimatelycan be realised only by dissolving the partnership. Each partner then has aright under Section 41 of the ordinance to have the partnership property,after payment of partnership debts, applied in payment of what may bedue to the partners respectively. On the basis of this analysis, a partner’sinterest is a chose in action, i.e., property that can only be enforced by anaction.

27 Estate Duty Ordinance, s 5.28 Unless the unit is a bearer instrument in which case it would be located where it was

physically present at the date of death. See Attorney General v Bouwens (1838) M & W171; 150 ER 1390.

29 See items 1–7 at pages 211–212.30 See Gartside v IRC [1968] AC 553, discussed below in text accompanying notes 44–45.31 See Charles v FCT (note 26 above); Costa & Duppe Properties Pty Ltd v Duppe [1986]

VR 90, 96; Australia-wide Management Ltd v CSD (NSW) 92 ATC 4740.32 See CSD (Qld) v Livingston [1965] AC 694, 708; Kleinwort Benson (Hong Kong)

Trustees Ltd v Wong Foon Hang [1993] 1 HKC 649; Re Law Ip Po [1994] 2 HKLR610.

33 Cap 38, LHK.


However, as all partnership property is held by the partners as co-owners under a trust for sale, a partner’s interest is also a form of equitableinterest under a trust. Courts in Australia have grappled with this issue. InCanny Gabriel Castle Jackson Advertising Pty Ltd v Volume Sales (Fi-nance) Pty Ltd34 the High Court of Australia held:

The partner’s share in the partnership is not a title to specific propertybut a right to his proportion of the surplus after the realization of assetsand the payment of debts and liabilities. However, it has always beenaccepted that a partner has an interest in every asset of the partnershipand this interest has been universally described as a ‘beneficial interest’,notwithstanding its peculiar character. The assets of a partnership,individually and collectively, are described as partnership property . . .[which] acknowledges that they belong . . . to the members of thepartnership.

Subsequently, in Federal Commissioner of Taxation v Everett35 the HighCourt of Australia held:

Although a partner has no title to specific property owned by thepartnership, he has a beneficial interest in . . . each and every asset of thepartnership . . . . His share in the partnership consists of a right to aproportion of the surplus after the realization of the assets and paymentof the debts and liabilities of the partnership . . . . A partner’s interest inthe partnership is a chose in action assignable in whole or in part.

These judgments provide support for the view that the nature of a part-ner’s interest is both (a) a chose in action and (b) an undivided interest ineach partnership asset.

Although this matter can only be definitively answered by the courts,appropriate drafting of a Unit Trust Deed can lend support to the propo-sition that the unit holder’s interest is not of a proprietary nature inrelation to the underlying assets. In this regard, it would be helpful tostate specifically in the Unit Trust Deed that:1. the trust is a trust for sale;2. the units are personal property;3. the trustee may not make any distribution by way of a transfer in

specie to the unit holders;4. no unit holder has any beneficial or other interest in any particular

asset or part of the trust fund;

34 (1974) 131 CLR 321, 327 (per McTiernan, Menzies and Mason JJ).35 (1980) 143 CLR 440, 446–447 (per Barwick CJ, Stephen, Mason and Wilson JJ).


5. the unit holder is only entitled to receive cash in a currency other thanHong Kong dollars from the sale of property by the trustee, and theunit holder is able to enforce this right only in the place of incorpora-tion of the trustee outside Hong Kong;

6. the unit register must be maintained outside Hong Kong; and7. the location of the unit, at least under the terms of the deed, is outside

Hong Kong.

Under traditional rules, the nature of a reversionary beneficiary’s rightunder a settlement on trust for sale is a chose in action against the trusteeand that chose in action is located where the trustee resides.36 Green’sDeath Duties37 suggests that this principle may extend to property specifi-cally devised, if such property is in fact required to be sold for purposessuch as the payment of debts but a balance will be left. Dymond’s DeathDuties38 also suggests that this principle applies to an interest in posses-sion, in the absence of an assent, if there is a trust for sale and more thanone beneficiary and no case has arisen for the division of the assets inspecie.

On the other hand, the authorities establish that there is a sound basisfor arguing that the beneficiaries of fixed trusts can have an interest inspecie for tax purposes.39 Furthermore, a person entitled indefeasibly inpossession to a fractional share of property held on trust for sale, withpower to postpone has a right to have that share transferred to thatperson.40 More significantly, in Australia-wide Management Ltd v CSD(NSW) (‘Australia-wide’)41 Allen J in the Supreme Court of New SouthWales held that the unit holders as a whole have the entirety of thebeneficial interest in all the assets making up the trust fund and thatspecific provisions in the trust deed — similar to those referred to previ-ously relating to the interest of a unit holder in trust property — did notaffect this principle.

36 See, e.g., the leading case of Sudeley (Lord) v Attorney General [1897] AC 11 [hereinafterSudeley] and Re Smyth, Leach v Leach [1898] 1 Ch 89.

37 6th ed (Butterworths: London, 1967), 636.38 14th ed (London: The Solicitors’ Law Stationery Society Ltd, 1965), 1049.39 See particularly, Baker v Archer-Shee [1927] AC 844 discussed in Yuri Grbich, ‘The

Mechanics of Discretionary Trusts’ in Grbich, Munn and Reicher (note 21 above), 19.See also the Irish case of Cuff Knox, unrep, (Supreme Court of the Irish Republic, Dec1961), discussed in Dymond’s Death Duties (note 38 above), 1049–1052, where anabsolute interest in the whole of a trust fund of movable property was held to amountto an interest in specie in that property.

40 See Re Marshall [1914] 1 Ch 192; Re Weiner, Wyner v Braithwaite [1956] 1 WLR 579.41 Note 31 above.


Using a discretionary trust to hold units in the unit trust

Although the matter is not entirely free from doubt, and notwithstandingan appropriately drafted Unit Trust Deed, one could not be entirely confi-dent that on the death of a unit holder the property passing on death forestate duty purposes will be a chose in action. Thus, even though the trustis a trust for sale, the situs for estate duty purposes of the propertypassing on death will not necessarily be determined by the place wherethe trustee is located, regardless of the nature of the underlying trustproperty.42 In short, on the basis of the decisions in Baker v Archer-Shee,Charles v FCT, Australia-wide and Cuff Knox, as well as the line of casesrepresented by Re Marshall, all discussed above, it cannot be discountedthat a court might hold that the nature of a unit holder’s interest isproprietary in nature, relates to the property in specie and that its situswill be determined by the location of the underlying trust property.

It is for this reason that, from an estate planning perspective, it iscertainly preferable to have the units held by a discretionary trust. Inthis event, given the nature of a discretionary object’s interest in a dis-cretionary trust43 it will not matter whether the nature of a unit holder’sproperty is a chose in action or a proprietary interest in the underlyingproperty or, indeed, where the underlying property is located for estateduty purposes.

If the conclusion in the preceding paragraph is accepted, strictly speak-ing it does not matter whether the trustee is incorporated, and managedand controlled, outside Hong Kong and whether a Unit Trust Deed (1)provides for an offshore register with the units to be recorded on thatregister, (2) provides for a trust for sale or (3) tries to ensure that the unitholders are not entitled to receive distributions in specie. Nevertheless,there is no compelling reason not to provide for these matters and to draftthe Unit Trust Deed accordingly.

Nature of a discretionary object’s interest in a discretionarytrust

If a discretionary object only has a possibility that trust income or capitalmay be distributed to him, this right is a mere spes.44 The beneficiary’s

42 Contrast Sudeley (note 36 above) and Barnado’s Homes v Special Commissioners ofIncome Tax [1921] 2 AC 1.

43 This matter is discussed below in text accompanying notes 44–45.44 See Gartside v IRC (note 30 above).


only present right is a chose in action to have the trust properly adminis-tered; the beneficiary has no interest in the underlying trust assets.45

It follows that when a beneficiary who has a mere spes of this kinddies, the beneficiary’s right will not pass on death because the chose inaction to have the trust administered disappears on death. It is an interestceasing on death, not an interest passing on death within Section 5 of theEstate Duty Ordinance. Even if it does pass on death, the property thatpasses under Section 5 will be, at most, the mere chose in action to havethe trust administered. This would have no, or at best marginal, value.The underlying assets would not pass under Section 5.

On the basis of this analysis, in the ordinary case involving a continu-ing discretionary trust, the death of any beneficiary will not give rise toduty under Section 5 of the Estate Duty Ordinance.

In the typical case, should operating companies be liquidatedor should the shares therein be transferred to a unit trust?

If the settlor or transferor owns shares in Hong Kong operating compa-nies, a question which must be addressed is whether those companiesshould be liquidated prior to the transfer of all relevant assets into thetrust structure. This question arises because a simple restructuring ofshareholdings in these companies would not alleviate all concerns regard-ing the controlled company provisions of the Estate Duty Ordinance. Theoperating companies would invariably be controlled companies. This leavestwo imponderables that would prevent an unequivocal conclusion beingreached that the controlled company provisions would not be applied.These are (a) the existing practice of the Estate Duty Office,46 whichapplies the controlled company provisions with apparent reluctance, maychange and (b) the difficulties in reducing the benefits flowing to thetransferor from any controlled company.47

On the other hand, Peter Willoughby and I, after discussing a stand-ard offshore trust arrangement, argue that ‘furthermore, there could be acharge on the assets of the liquidated private company by virtue of Sec-tion 35(3).’48 Reference could also be made to paragraph 3 of Schedule 2to the Estate Duty Ordinance, which clearly envisages that Section 35 can

45 See ibid and Re Weir’s Settlement [1971] 1 Ch 145.46 See note 14 above.47 Arguably an impossible task. See Horton (note 15 above).48 See Willoughby and Halkyard (note 4 above), at II [306].


apply to a company that was liquidated prior to the death of the personsubject to estate duty.

Who then is accountable for the duty in a case where a company isliquidated prior to death? Apart from the company, Section 43(1)(c) statesthat liability under Section 35 is also imposed on any person who receivedany distributed assets of the company on their distribution.49 The unittrust will not normally receive any property on distribution unless thetrustee is a shareholder at the time of liquidation. However, any assetsowned by the company that are distributed in specie on liquidation, suchas a debt owed to the company by the trustee for the purchase of businessassets, could be caught by this provision. Where duty is payable underSection 35, a floating charge arises over any assets of the company thathave been distributed.50 Moreover, an executor who fails to account forproperty liable to duty under Section 35 can also be liable for duty.51

On the basis of the above analysis, residual estate duty problems52 willexist whether or not the operating companies are liquidated prior to es-tablishing an offshore trust arrangement. Although it is tempting simplyto take the view that all operating companies should be liquidated and anybusiness assets should be transferred to the relevant trust that would, wherenecessary, operate as a trading trust, on reflection it seems that this deci-sion should be governed by non-estate duty commercial considerations.

How should the property be transferred into the unit trust?

Gifts of the underlying property should clearly be avoided as Section6(1)(c) of the Estate Duty Ordinance will deem as property passing ondeath of the donor any disposition of property operating as a gift intervivos made within three years of death or at any time where the donorreserved an interest in, or obtained a benefit from, the gifted property.Accordingly, unless excellent commercial considerations dictate to thecontrary, all transfers of trust property to the unit trust should take placeat fair market value.

A related question is how the purchase by the trustee of the unit trustshould be financed. The choice is two-fold: by way of gift or a sale at

49 Section 43(1)(b) of the Estate Duty Ordinance does not seem relevant as that provisiononly applies to assets owned by the company at the time of death or thereafter.

50 Estate Duty Ordinance, s 43(6).51 Ibid, s 14(17).52 At the present time most problems relating to the controlled company provisions are

theoretical, but none should be ignored simply on this ground.


market value. Although each option presents difficulties, from an estateduty perspective it is clear that a gift of cash (even if effected offshore)made to the trustee to purchase property located in Hong Kong is fraughtwith problems and should generally be avoided. The analysis supportingthis conclusion is as follows.

A recent decision of the House of Lords, Countess Fitzwilliam v IRC(‘Countess Fitzwilliam’)53 upheld the effectiveness of a very complicated taxavoidance scheme relating to capital transfer tax (which replaced estate dutyin the United Kingdom). In the course of its decision, the House of Lordsrefused to apply the anti-avoidance doctrine arising from cases such asRamsay v IRC (‘Ramsay’)54 and Furniss v Dawson55 on the basis that inCountess Fitzwilliam there was no pre-ordained transaction containing ar-tificial steps that could otherwise be disregarded for fiscal purposes.

The court thus rebuffed another attempt by the Inland Revenue to ap-ply Ramsay and Furniss v Dawson in the context of the United Kingdomequivalent to Hong Kong estate duty. Arguably, this reinforces the view thatthere is a fundamental problem of applying the doctrine set out in thesecases to estate duty because an estate planning scheme does not avoid anyliability at the time it is implemented (duty can, of course, be avoided onlyat death). It is also hard to see how the doctrine could apply to charge dutyin a case where the end result of a scheme is the creation of an offshore assetexempt from duty under Section 10(b) of the Estate Duty Ordinance.56

Of greatest interest in Countess Fitzwilliam, however, was that LordBrowne-Wilkinson concluded his judgment with a remark that is boundto give estate planners very mixed feelings. He pointed out that the capitaltransfer tax legislation contains provisions that render taxable disposi-tions effected by ‘associated operations’. This is also true of the EstateDuty Ordinance, which contains a wide definition of associated opera-tions that is essentially the same as that for capital transfer tax. ‘Associatedoperations’ are defined by Section 3(1) as follows:

“associated operations” means any 2 or more operations of any kind being -(a) operations which affect the same property, or one of which [a]ffects

some property and the other or others of which affect propertywhich represents, whether directly or indirectly, that property orincome arising from that property, or any property representingaccumulations of any such income; or

53 [1993] 1 WLR 1189; [1993] STC 502.54 [1982] AC 300 [hereinafter Ramsay].55 [1984] AC 474.56 Compare Kwok Chi Leung, Karl v Commissioner of Estate Duty [1988] 1 WLR 1035

[hereinafter Kwok’s case] and IRC v McGuckian [1994] STC 888.


(b) any 2 operations of which one is effected with reference to the other,or with a view to enabling it to be effected or to facilitating its beingeffected, and any third operation having a like relation to either ofthose two, and any fourth operation having a like relation to any ofthose three, and so on,

whether those operations are effected by the same person or by differentpersons, whether they are connected otherwise than as aforesaid or not,and whether they are contemporaneous or any of them precedes orfollows any other.

Lord Browne-Wilkinson then observed:

This [definition] amounts to a statutory statement, in much wider terms,of the Ramsay principle which deals with transactions carried throughby two or more operations which are inter-related. . . . It can thereforebe argued that there is no room for the court to adopt the Ramsayapproach in construing an Act which expressly provides for thecircumstances and occasions on which transfers carried through by‘associated operations’ are to be taxed.57

At first glance this appears to be good news for estate planners. Onreflection, however, Lord Browne-Wilkinson’s observation, focusing uponthe often neglected definition of associated operations, could seriously af-fect estate planning techniques typically used in Hong Kong. This is becausethe definition is important for the purpose of the charge in Section 6(1)(c)as expanded by Section 7 in relation to dispositions in favour of rela-tives.58 The combined effect of the definitions of ‘disposition’59 and‘associated operations’ is that a gift made through a series of linked op-erations or transactions will be regarded as a gift of the underlying asset.

From the above analysis it follows that schemes relying upon gifts ofcash offshore to purchase Hong Kong assets are clearly at risk of beingattacked by the Commissioner.60 Accordingly, unless excellent commer-cial considerations dictate otherwise, the purchase of Hong Kong assets

57 [1993] 1 WLR 1189, 1228.58 Although there is no equivalent in Hong Kong to s 35(3) of the United Kingdom

Finance Act 1959, which provided that a benefit obtained by ‘associated operations’, ofwhich a gift is one, is to be treated as a benefit by ‘contract or otherwise’.

59 Defined in s 3(1) of the Estate Duty Ordinance as follows: ‘“disposition” includes anytrust, covenant, agreement or arrangement, whether made by single operation or byassociated operations . . .’ (emphasis added).

60 In other words, the combined effect of these definitions can nullify the effect of theoffshore exemption contained in s 10(b) of the Estate Duty Ordinance where cash giftedoutside Hong Kong is then used to purchase Hong Kong assets. See further, Willoughbyand Halkyard (note 4 above), at I [19].


by the trustee of the unit trust should not be financed by way of a gift ofcash, whether that cash is gifted in or outside Hong Kong. If independentfinancing is not available, and the settlor, or transferor, of assets to theunit trust must lend the relevant funds to the trustee to finance the pur-chase of the assets, the debt must be structured so that it qualifies for theoffshore exemption provided by Section 10(b) of the Estate Duty Ordi-nance. In this regard, an appropriate method would be to ensure that thedebt is evidenced by deed executed under seal, that it is in law a specialtydebt,61 and that the deed is retained outside Hong Kong. Under thesecircumstances, for estate duty purposes the debt would be located outsideHong Kong62 and thus exempt from duty by virtue of Section 10(b).63

Does the fact that the trustee of the unit trust will be controlledby the transferor cause concern?

In view of the conclusion above that where a unit trust is established theunits should invariably be held by a discretionary trust, no major con-cerns are apparent.

The real problem relates to the necessity to ensure that the settlor ortransferor for whom a trust structure is established cannot be said to be

61 See generally, R v Williams [1942] AC 541, 554–557; Willoughby and Halkyard (note4 above), at I [442]. The law relating to execution of deeds is technical, e.g., a deedexecuted by a company must be executed under the common seal of the company andnot merely by an agent signing on behalf of the company (unless the agent is authorizedto execute deeds on the company’s behalf, pursuant to a power of attorney executedunder the company’s common seal and as a deed). Under Hong Kong law, precisecorporate formalities are not so important if the common seal is witnessed by either (1)the secretary and a director of the company or (2) two directors of the company (seeConveyancing and Property Ordinance (cap 219, LHK), s 20(1)). However, if only onedirector is to witness the affixing of the company’s common seal, the deeming provisionin s 20(1) does not apply and it is therefore essential to ensure that the proper corporateformalities as set out in the company’s Articles of Association are followed. In any case,a board resolution will need to be prepared expressly authorizing the affixing of thecommon seal to the deed.

62 Once the deed is executed, the debt that it evidences will be located for estate dutypurposes at the place where the deed happens to be as at the date of death. SeeCommissioner of Estate Duty v Ramchandani [1982] HKLR 153; (1982) 1 HKTC1229; Kwok’s case (note 56 above). Care should be taken not to locate the deed in ajurisdiction that would impose death duty, or other taxes, on the document or on theunderlying debt.

63 It should be noted, however, that in the case of a so-called ‘death bed’ scheme, wherethe only justification for restructuring ownership of Hong Kong assets is the avoidanceof estate duty, an attack by the Commissioner on the basis of Ramsay (note 54 above)cannot be discounted. See Kwok’s case (note 56 above), 1039–1040.


competent to dispose of the underlying assets through control of thetrustee of the discretionary trust.64

Does the fact that a discretionary trust owns all the units of theunit trust cause concern?

If one person holds all the units in a unit trust beneficially, that personbecomes solely and beneficially entitled to the trust property. Effectively,the unit trust ceases to exist because, as a matter of trust law, whateverthe terms of the Unit Trust Deed, such person by virtue of being solelyand beneficially entitled can force the trustee to hand over all the underly-ing assets. This may effectively destroy any limitation of liability thatmight otherwise attach to the unit trust. It should therefore be the invari-able practice that there must be a minimum of two unit holders.

However, if a unit trust structure were established with one individualsimply holding the units directly, the argument that the nature of the unitholder’s interest relates to the underlying trust property in specie ratherthan to a chose in action would be very strong.65

THE TRUSTEE OF THE DISCRETIONARY TRUST MUST BEINDEPENDENT

As indicated above, it is crucial to ensure that the settlor or transferor forwhom any offshore trust arrangement is set up cannot be said to becompetent to dispose66 of the underlying assets through control of thetrustee of the discretionary trust.

Although a discretionary beneficiary does not have any interest in theunderlying assets and, therefore, would not ordinarily be competent todispose of the underlying assets at the time of his death, there are certaincircumstances that could give rise to a competency to dispose of theunderlying assets. Care must be taken to ensure that these circumstancesdo not arise.

Under Section 3(2) of the Estate Duty Ordinance a person is deemedcompetent to dispose of property if he has such general power as would,if he were sui juris, enable him to dispose of the property. ‘General

64 This matter is examined in further detail below at pages 219–220.65 See CS (Vic) v Yellowco Five Pty Ltd 93 ATC 4025.66 Within the terms of s 6(1)(a) of the Estate Duty Ordinance.


power’ includes every power or authority enabling the donee or otherholder thereof to appoint or dispose of property as he thinks fit, whetherexercisable by instrument inter vivos or by will, or both. Under Section3(5) references to a power being exercised or exercisable by any personinclude references to it being exercised or exercisable by him and anotherjointly or by another at his direction or by a company of which he hadcontrol or powers equivalent to control within the meaning of Section44(3) whether with or without the consent of any other person havingsimilar powers.

It was held in Re Penrose67 that a person has a power to do an act ifhe has to do it by two or more steps just as much as if he had the powerto do it by one. It follows that if the settlor is a beneficiary or potentialbeneficiary of the trust and is the person or controls the person who canappoint the trustee, then he could appoint himself or a company under hiscontrol as trustee. Additionally, he could then cause himself to be namedas a beneficiary if he was not already one, and cause the trust assets to bedistributed to himself. In such a case, therefore, the settlor or notionalsettlor would be competent to dispose of the trust assets. If the trust assetswere in Hong Kong, then on the death of the settlor estate duty wouldarise. If a beneficiary who is not the settlor or a notional settlor cancontrol the trust in this way, he would also be competent to dispose of thetrust assets.

Subject to the above concerns, there seems to be no reason why asettlor cannot be a beneficiary of a discretionary trust established by him,provided he does not make any gifts of Hong Kong property into the trustor its underlying structures, whether by means of associated operations orotherwise, so as to give rise to a liability under Section 6(1)(c).

It is essential that neither the settlor nor any notional settlor who canbe a beneficiary be appointed as trustee or be capable of appointinghimself or any company under his control as the trustee. It is best, there-fore, to ensure that the person who has power to appoint the trustee isnot the settlor or a notional settlor. In any event, the person who haspower to appoint the trustee, the settlor, any notional settlor and anycompany under the control of any of these persons should be specificallydisqualified under the trust deed from being trustee. Such a provisionshould prevent this problem arising in relation to a settlor, a notionalsettlor or a beneficiary.

67 [1933] Ch 793.


CONCLUSION

On the basis of the analysis above, when utilizing an offshore structurefor asset protection, from the perspective of minimizing estate duty, themost effective method is to replace (where this is commercially feasible)all operating companies with an appropriate trust and have the trusteehold all underlying property directly. Transfers of property to the trusteeshould be at fair market value; offshore gifts to the trustee for the purposeof purchasing Hong Kong assets should be avoided; and the settlor ortransferor of property to the trust should not be rendered competent todispose of the trust property.

Where only one family is interested in the underlying property, it maybe sufficient simply to utilize a non-exhaustive discretionary trust withoutalso establishing a unit trust. Where several families are interested, orplanning must take into account the future diversification of interests, itmay be appropriate to replace (again only where this is commerciallyfeasible) all operating companies with a unit trust. In such a case, theunits should be held by separate non-exhaustive discretionary trusts rep-resenting the different interests.

IndexAndrew J. Halkyard

. CHAPTER EIGHT .

anti-avoidance rules, 197–199asset protection, see trustsAustralia

corporate income tax, 194n‘short term patent’ system, 19, 26–28

Australian Advisory Council onIndustrial Property, 28

Axona International Credit andCommerce Ltd, 96

Bach, J Spayment allegedly made to, 192

bank cards, 31, 32Bank of America, 32, 33BankAmericard, 32–33bankruptcy, 1–2, 57n, 87–95Bankruptcy Act 1861 (UK), 91n, 92nBankruptcy Act 1898 (US), 62, 68Bankruptcy Act 1914 (UK), 59n, 60n,

65n, 87n, 92n, 98nBankruptcy (Amendment) Bill 1996, xBankruptcy (Amendment) Ordinance

1902, 92nBankruptcy Code (US), 62n, 63, 64n,

76, 84, 96, 98Bankruptcy Ordinance 1891, 89n, 91n,

92n, 95n

Bankruptcy Ordinance, 56, 72n, 76n,88–95, 97

Bankruptsundischarged, 129–30

Basic Lawprovision for SAR to protectpatents, 8n

Berne Union, 14Business Registration Ordinance,

186

Canadacredit card fraud in, 37personal income tax, 203n

capital duty, 184, 193capital gains, 181–182, 191carrying on a trade or business

determination of, 185–188, 195charge cards (see also credit cards),

31, 32China

application of international patentconventions to Hong Kong, 14

corporate income tax, 194ncounterfeit credit card manufacture

in, 36intellectual property laws, 29

224 Index

joined Patent Cooperation Treaty,15

member of Paris Convention, 15patent protection for nationals of,

15patent system, 28–29territorial approach in transnational

insolvency case, 99–100China Tianjin International Economic

and Technical Co-operativeCorporation, 82n

Chinese languagepatent applications in, 19

Community Patent Convention, 20,23–24

companies (see also protection ofoutsiders)investigation of, 138–139

Companies Act 1948 (UK), 79, 131,169

Companies Act 1985 (UK), 121n, 139,142, 147n, 158, 159n, 160, 165,169n, 172

Companies Act 1989 (UK), 155n,156n, 158, 159n, 160, 165, 169n,171, 172–173, 179

Companies (Amendment) Bill 1991,126

Companies (Amendment) Bill 1996, xCompanies (Amendment) Ordinance

1994, 127Companies (Amendment) (No 2)

Ordinance 1994, 138Companies Ordinance 1865, 76Companies Ordinance 1911, 76Companies Ordinance, 72n, 83n, 96,

97, 118n, 119n, 159n, 160, 164n,166n, 169, 171, 185, 186, 193ndirectors’ duties, 125disqualification of company

directors, 3, 127, 128–129, 130–140, 147, 150n, 152, 153n

proposed amendment of, 76, 86–87,100–101, 176

review of, 155winding up, 56, 62, 71, 72n, 73,

74n, 75–80

Companies (Single Member PrivateLimited Companies) Regulations1992 (UK), 160

Company Directors DisqualificationAct 1986 (UK), 3, 127–128, 135n,141, 142, 144, 147, 158

Company Directors DisqualificationUnit, 154

company law, 3approaches to reform, 179Australian model, 174–176Canadian model, 176–178divergence between Hong Kong and

United Kingdom, 157–161objectives, 155, 156reform in

Hong Kong, 158–159United Kingdom, 158, 179

United Kingdom model, 172–173‘consignment tax’, 192conspiracy

in credit card fraud, 44, 47, 49–51constructive knowledge, see construc-

tive noticeconstructive notice

doctrine of, 3, 156n, 159, 162–167,170, 171abolished in Canada, 178

Convention for the Protection ofIndustrial Property, see ParisConvention

Copyright Ordinance, 7Cork Report, 1982, 158corporate governance, 126corporate income tax, 194Corporations Law (Australia), 127n,

128n, 129n, 174–176counterfeiting

credit cards, 36–38credit card fraud, 2, 31–54

acquirer fraud, 41applications, 38, 42conspiracy, 44, 47, 49–53counterfeiting, 36–38, 40, 42investigation, 43–52jurisdiction and, 44–47‘lending’, 38

Index 225

losses from, 34, 37, 40, 41–42lost cards, 35, 42manual alteration, 35measures against, 37mens rea and, 51–52merchant collusion, 35overseas evidence in, 43–44, 53‘points of compromise’, 36, 37presentation of fake cards, 47–49prosecution of, 52–53‘shave and paste’, 35stolen cards, 34–35, 42telecommunications and, 39telemarketing and, 39‘white plastic’, 35–36, 43

Credit Card Fraud Act 1984 (US), 37credit cards, 47

history, 31–33impact of technology on, 39security, 37, 40, 53transactions, 33–34

Crimes (Amendment) Ordinance 1992,52

Crimes Ordinance, 52, 53Criminal Justice Act 1987 (UK), 147ncross-border insolvency, see trans-

national insolvencycross-border trade and investment (see

also foreign trade and investment)lawyers to be aware of tax issues

relating to, 183, 200tax systems perceived as obstacle to,

182Crown debts, 146–147, 153Crowther Report on Consumer Credit,

1971, 158

Deak, R. Leslie, 85Deak Perera (Far East) Ltd, 84–86Denway Ltd, 106, 119nDiamond Report, 1989, 158Diners Club, 32directors

accountability of, 3action against

avoidance of, 123–124for breach of duty, 122

breach of duty by, in IPO, 118conflict of interest, 117–118, 126corporate, 139disqualification of, see disqualifica-

tiondistinction between bona fide intent

and proper purpose, 113–117duties, 125

codification of, 122duty of care, 108, 127duty of skill, 108, 126duty to act in good faith, 108–111,

126exercise of powers for proper

purpose, 111–113, 126fiduciary duties, 107, 108, 126improper use of power to issue

shares, 122maintain proper accounting records,

146misuse of powers, 171responsibility when issuing shares,

107–118shadow, 135, 137–138strict liability, 149ultra vires acts, 168

disqualification (of company directors)(see also Companies Ordinance;Company Directors DisqualificationAct 1986 (UK)), 125–154competence of directors, 142–145corporate directors, 139differences between Hong Kong and

United Kingdom, 153–154grounds for

breach of Companies Ordinance,133–134

breach of fiduciary duties, 147conviction of indictable offence,

132fraud, 134–135negligence, 149unfit director of insolvent

company, 129, 130, 135–137,141

unfitness to act as director, 128,138, 141–147

226 Index

mitigating factors, 148–149orders

application for, 132, 138breach of, 131, 139effect of, 130–131form of, 140made in United Kingdom, 128,

141procedures on application for,

149–151reports on conduct, 140rules for service, 140striking out application for, 151–

152personal liability for company debts,

139previous legislation on, 128–129regulations, 130, 140–141shadow directors, 135, 137–138,

140undischarged bankrupts, 129–30,

139domestic agent, 195

English languagepatent applications in, 19

entertainers, non-resident, 191–192Equity Joint Stock Companies

Registration and RegulationAct 1844 (UK), 161

estate duty, 184, 193anti-avoidance provisions, 205associated operations, 216–217controlled companies

liability to duty of, 205–206liquidation of, 214–215

estate planning, use of trusts for,203–204, 206–221

gifts, liability to duty of, 205, 215,217, 220

introduction to, 204–206offshore property, exemption from,

205, 217n, 218use of trusts to mitigate, 4

Estate Duty Ordinance, 181n, 193n,204n, 205, 208, 210, 214–220

European Asia Bank v Reicar

Investments Ltd, 169–170European Communities Act 1972 (UK),

165, 172European Community Directive on

Company Lawinfluence on United Kingdom

legislation, 157, 159–160, 172European Patent Convention, 12, 14,

15–16, 18, 19–20, 24, 25evidence

in credit card fraud, 43–44, 53

Financial Services Act 1986 (UK),147n

Firearms Act 1968 (UK), 45‘fiscal nullity’

doctrine of, 198foreign companies (see also unregis-

tered companies)winding up, 75–87

foreign insolvenciesrecognition of, 59–64, 65

foreign representativeoptions available to, in transnational

insolvencies, 65–95foreign taxation

of non-resident corporations, 194–199

foreign trade and investmentby Hong Kong companies, tax

aspects of, 193–199in Hong Kong, tax aspects of, 184–

193France

patent protection in, 19Franklin National Bank, 32fraud, see credit card fraud

Gift Duty Assessment Act (Australia),120

Hong Kongcredit card fraud in, 34–43, 45–47,

53–54insolvency in, 55–56, 153

Hong Kong Bill of Rights Ordinance,68n, 132n, 133n, 153n

Index 227

Hong Kong Philharmonic Orchestraalleged payments to deceased

composers by, 192Hong Kong Special Administrative

Region (SAR)establishment of, 6,8transition to, 4

IBANCO, 32, 33import duty, 184Independent Commission Against

Corruption (ICAC), 36Indonesia,

tax treaty, 199initial public offerings (IPOs)

oversubscription, 2, 103–124Inland Revenue Department

practice note onlocality of profits, 192profits arising in Hong Kong, 190

Inland Revenue Ordinance, 181n,182n, 185–190, 191n, 192, 193n,194, 195, 203n

insolvency (see also transnationalinsolvency)in Hong Kong, 55–56, 153

Insolvency Act 1985 (UK), 60n, 87nInsolvency Act 1986 (UK), 60n, 90n,

92n, 98, 99n, 127, 158intellectual property, 5, 29Intellectual Property (World Trade

Organisation Amendments) Bill1995 (UK), 10n

Internal Revenue Code (US), 194n,195n, 196n, 197n, 198n

investment, see cross-border trade andinvestment; foreign trade andinvestment

Irish Rowan (ship), 80

Japancorporate income tax, 194

Jenkins Report, 1962, 158Joint Stock Companies Act 1856 (UK),

162Joint Working Party of the Securities

and Futures Commission and the

Stock Exchange of Hong Kong, 104,105–106

jurisdictionbankruptcies, 89–95, 100credit card fraud, 44–47tax planning, 184, 200winding up foreign companies, 79–

83

law reformbankruptcy, 2, 89n, 90n, 94commercial, 1, 4company, 86–87, 100–101, 158–

159, 165, 176, 177, 179patent system, 8, 17–28

Law Reform Commission, 2, 89n, 90n,93, 94report on bankruptcy, 56

lawyersrole in taxation and tax planning,

183–184lease payments, 191Limited Liability Act 1855 (UK), 162Limited Partnership Ordinance, 76liquidation, see winding upliquidators

ability to seek assistance in trans-national insolvencies, 95–101

Macaucounterfeit credit card manufacture

in, 36Malaysia

corporate income tax, 194nMasterCharge, 32mens rea

in credit card fraud, 51–52

National BankAmericard Inc, 32Netherlands

tax treaties, 199

Ontario Business Corporations Act1982, 176–178

Paris Convention, 14–15, 27Partnership Ordinance, 210

228 Index

Patent Cooperation Treaty, 14, 15–16,24

Patent Steering Committee, 8report, 8, 17–19

patent systemapplication of international conven-

tions to Hong Kong, 14–16dependent on United Kingdom,

8, 9effectiveness of, 10–13localisation, 17–18present system in Hong Kong,

9–10reform of, 8, 17–28

patentsapplications filed internationally, 6limited interest in, protection in

Hong Kong, 6–7nature of, 6

Patents Act 1949 (UK), 11, 12Crown user provisions, 10

Patents Act 1977 (UK), 7n, 9, 11, 12,13, 20 23, 24, 25

Patents Bill, 2, 5–6, 8provisions

amendment of patent, 23applications, 20employee’s inventions, 23formal requirements, 21–22infringement, 23–24maintenance of patent, 22request for registration and grant,

22revocation, 25right to apply, 21‘short term patent’, 2, 19, 26–28surrender of patent, 22threats, 25time limits, 20–21transition to SAR, 25–26validity, 25

‘permanent establishment’, 186–188,195

Prentice Report, 1986, 158, 165, 172Privy Council

failure to elucidate proper use ofdirectors’ powers, 112

profitsarising in or derived from Hong

Kong, 188–190subject to withholding tax, 191–192taxation of distributed corporate,

196profits tax, 184, 194, 196

basis for charge to, 185–190property tax, 184, 192protection of outsiders, 156

actual knowledge, 163Australian approach, 174–176Canadian approach, 176–178constructive knowledge, 163–166,

167doctrine of ultra vires, 168–173history of law on, 161–162implied knowledge, 163rule in Turquand’s case, 162, 166–

167

real propertytax on sale of, 197

records (company)inspection of, 138maintenance of accounting, 146production of, 138–139

Registration of Patents Ordinance, 9–10, 11, 12, 14

Report of the Company Law DivisionCommittee, Second, 1973, 158

Report of the Standing Committee onCompany Law Reform, Ninth,1992, 158

Report on Bankruptcy, 1995, 56Report on Reform of the Hong Kong

Patent System, 1993, 8, 17–19, 23, 26representative office

effect on tax liability, 188, 195Roethenmund, Otto Emil, 85royalties, 191

salaries tax, 184, 193sale of goods, 191, 192Securities and Futures Commission,

122Joint Working Party, 104, 105–106

Index 229

Securities and Futures Commission(Amendment) Ordinance 1994,138–139

Securities (Disclosure of Interests)Ordinance, 125

Securities (Insider Dealing) Ordinance,125

Shanghai Petroleum Company, 103share capital

loss of, 118, 121–122nature of, 119–122

sharescreation of market in, 115, 117directors’ responsibility when

issuing, 107–118initial public offering, 103–124interest on application payments,

118–119issue at notional zero value, 115,

117, 122offer price, 104–107, 115oversubscription, 103–124

‘shave and paste’credit card fraud, 35

Singaporecorporate income tax, 194tax treaty, 199

Sino-British Joint Liaison Group,6

source-of-income rules, 195sportsmen, non-resident, 191stamp duty, 184, 192Stamp Duty Ordinance, 181n, 192nStanding Committee on Company Law

Reform, 3, 158, 165, 171, 173, 176,177

Stock Exchange of Hong Kong, TheJoint Working Party, 104, 105–106rules relating to directors, 125

Supreme Court Ordinance, 67n, 68n,72n

Taiwancorporate income tax, 194counterfeit credit card manufacture

in, 36tax incentives, 196–197

tax planning, 182–183, 184, 190, 198,199–201

tax ratesforeign, 183, 194, 203Hong Kong, 182, 203

tax treaties, 199Hong Kong not a party to, 183,

194–195taxation, 3

anti-avoidance rules, 197–199corporate dividends, 196double, 182enforcement, 182importance of, to investors, 182–

183liability in

foreign jursidictions, 193–199Hong Kong, 184–193

system in Hong Kong, 181–182telecommunications

credit card fraud in, 39telemarketing

credit card fraud in, 39Theft Act 1968 (UK), 45, 47Theft Ordinance, 53Tose, Philip, 103trade, see cross-border trade and

investment; foreign trade andinvestment

Trade Descriptions Ordinance, 7, 24Transfer of Businesses (Protection of

Creditors) Ordinance, 154transfer pricing rules, 197transnational insolvency, 2, 55–101

ancillarybankruptcy, 84, 94, 95winding up, 83–84, 86–87

approaches to resolving, 57–59bankruptcy, 87–95concurrent

bankruptcy, 84, 94, 95insolvency, 83, 84, 86winding up, 83, 84, 86

foreign insolvencys, recognition of,59–64, 65

foreign representatives, optionsavailable to, 65–95

230 Index

Hong Kong trustees and liquidators,assistance to, 95–101

impact on Hong Kong, 56non-insolvency options, 65–71winding up, 71–87

trusteesability to seek assistance in

transnational insolvencies, 95–101

trusts, 4analysis of typical structure, 208–

221asset protection, use of trusts for,

203competency to dispose, need to

avoid, 219–220discretionary

designation of protector under,207

flexibility, 207letter of wishes for, 207nature of beneficiary’s interest in,

213–214preferred for estate planning, 213trustee to be independent, 220

estate planning, use of trusts for,203–204, 206

typical offshore, structure, 206–207unit

nature of beneficiary’s interest in,209–212

not a company, 208sole unit holder in, 219

Turquand’s case, 3, 156nAustralian position on rule in, 175–

176rule abolished in Canada, 178rule in, 159, 162, 166–167, 170,

171

ultra viresdoctrine of, 3, 156n, 158, 162, 167,

168–173in the narrow sense, 168–169

in the wider sense, 170–172rule

abolished in company law inCanada, 176–178

altered by European Directive onCompany Law, 159

Australian approach to, 174–176Union Bank of Australia, 164United Kingdom

corporate income tax, 194nrecognition of Hong Kong

insolvencies, 98–99United States

corporate income tax, 194ncredit card fraud in, 35, 37personal income tax, 203nrecognition of Hong Kong

insolvencies, 99sale of foreign owned real property

taxed in, 197telemarketing fraud in, 39

Universal Copyright Convention, 14unregistered companies

definition, 76proposed amendment of, 86

winding up of foreign companies as,76–78

Visa Card, 33, 40Visa International, 33

Western Unionfirst charge card issued by, 31

‘white plastic’credit card fraud, 35–36, 43

winding upadvantages, 72–73ancillary assistance, 83–84, 86–87companies in Hong Kong, 71–74foreign companies, 75–87unregistered companies, 76–78

withholding tax, 191–192, 194World Intellectual Property Organisa-

tion (WIPO), 14

Documents

HONG KONG COMMERCIAL LAW - University of Hong Kong · Kong and in England and Wales. She is the author of Hong Kong Busi-ness Law and also writes in the areas of trade union and employment