AF5511

Regulatory Framework

Lecture 2

Fundamentals of Company Law

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 Lecture 1: Fundamentals of Company Law

Lecture
A. Vehicles for Doing Business in Hong Kong
1. Partnership
2. Company
• Separate legal entity: limited liability of shareholders
• The theory of separation of ownership and management
B. Articles of Association (AA)

Seminar / Workshop
Group Discussion and Sharing

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A. Vehicles for Doing Business in Hong Kong
• The most common types of business structure are:
• Sole proprietorship (good for small individual or family business)
Examples: a boutique, a cafe
• Partnership (required for certain professional business)
Example: a law firm
• Company (the most popular form of business)
Example: HSBC

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Partnership

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 Partnerships -- Introduction
• Legal framework
• Common law
• Partnership Ordinance (Cap. 38)
• Definition of “partnership”
• “A partnership is the relation which subsists between
persons carrying on business in common with a view of
profit.” – s. 3(1) PO
• Formation of partnership
• By agreement (i.e. contract) between two or more
persons. (Note: not by registration)
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Partnership: between persons carrying on business in common
• All the partners, with the business they operate together, can
be collectively called a “firm”.
• A partnership firm is not a legal entity.
• The firm has no legal capacity, cannot own any assets and
cannot be liable to any debts.
• If a person sues a firm, he is actually suing all the partners Option 1: B, T, S
jointly and severally.
• For convenience sake, HK courts allow partners to sue or Option 2: BTS & Co.
be sued in the name of a firm. (Order 81 of the Rules of
the High Court)
• The partners are personally liable for the debts incurred by
the firm.
[Example: BTS & Co.] 6
 Partnership: business

• Business: any trade, occupation or profession for making

a profit
• The partners started their actual trading activities?

• An association of persons
• Limited liability company
• To do business together as a firm for profit
• Net profit
• Partners need to share costs and liabilities.

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 Rules to decide whether a partnership exists
• No formality is required for the formation of a partnership
• Contractual relationship – oral or in writing
• Co-ownership and the sharing of profit → Rules under PO s. 4
• Co-ownership of property?
• X and Y jointly own a flat and share the rent?
• Sharing of gross returns?
• X and Y jointly operate a business, they share the gross income
equally, but X alone pays all the expenditures?
• Sharing of net returns?
• Prima facie evidence of the existence of a partnership
[see next slide for exceptions] 8
Sharing net profit in any of the following situation does not
create a partnership (EXCEPTION) [PO s.4]:
cant justify with the loan or debt placement
 the money is a debt being repaid by fixed installments
 A bank provides a loan to a business and receives a share of the profits of that
business as installment.
 the payments were made by way of interest on a loan made to the business
 Sharing a portion of the profits of a business with the lender as a means to pay
the interest on the loan provided by that lender
 part of the money was remuneration paid to an employee of the business
 A business gives one employee a share of the profits of that business as his
remuneration.
 the payments were being made to the previous owner of the business who has
sold it
 The seller of a business receives a share of the profits of that business in
consideration of the sale of the goodwill of the business.
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Company

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1. Is there a partnership in the following? Give reasons.

A. Susan and Sarah own an office unit jointly and they share the rent
in 50/50 per cent.
B. The Super Rich Finance Company has provided loan facilities to
Cho & Partners.
C. Chris was promoted to the position of ‘partner’ and his name
together with the title ‘Partner’ appears on all letter heads and
business cards of the partnership firm. What type of ‘partner’ is
Chris?
D. Part of Stephen’s share of the profits in a business is taken to pay
for employee employed to assist running the business.

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1. Is there a partnership in the following? Give reasons.

A. Susan and Sarah own an office unit No. It is not a partnership. they share
the rent / expenses only, so they dont
jointly and they share the rent in form a partnership
50/50 per cent.

B. The Super Rich Finance Company has No. It is not a partnership. a Loan
provided loan facilities to Cho & Arrangement only, so they dont form a
partnership
Partners.

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1. Is there a partnership in the following? Give reasons.

C. Chris was promoted to the position of No. Salaried partner - a matter of face to
him in the eyes of the client. He received a
‘partner’ and his name together with the salary as remuneration rather than a share
title ‘Partner’ appears on all letter heads of the profits.

and business cards of the partnership In nature, it is NOT a partnership or

firm. What type of ‘partner’ is Chris? partner, without legal meaning.
There are three types of partnership:
1. General Partner
2. Salaried Partner
3. Sleeping Partner

D. Part of Stephen’s share of the profits in a No. Part of the money

was remuneration paid
business is taken to pay for employee to an employee of the
employed to assist running the business. business

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Companies -- Introduction Leading Case

• Legal Framework
• Companies Ordinance (Cap.622)
• Common law cases
• Formation
• By registration with the Companies Registry
• Certificate of Incorporation
• Two most important concepts of company law
• Separate legal entity: limited liability of shareholders
• The theory of separation of ownership and management
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 Types of Companies
Limited by Shares
Limited Company
Liability Limited by Guarantee

Unlimited Company

Private Company
Open to the public Unlisted Company
Public Company
Listed Company

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 Number of listed companies at the Hong Kong Stock Exchange (HKEX) from 2015 to 2022

3,000
2,538 2,572 2,597
2,500 2,449
Number of listed companies

2,315
2,118
1,973
2,000 1,866

1,500

1,000

500

0
2015 2016 2017 2018 2019 2020 2021 2022
Note(s): Hong Kong; 2022
Further information regarding this statistic can be found on page 8.
Source(s): HKExnews; ID 981586
 Largest public companies in Hong Kong as compiled by the Forbes Global 2000
ranking of 2022, by market value (in billion U.S. dollars)
Largest public companies in Hong Kong 2022, by market value
Market value in billion U.S. dollars
0 20 40 60 80 100 120 140 160

China Mobile 147.05

AIA Group 120.19
CNOOC 62.6
Hong Kong Exchanges 54.13
Sun Hung Kai Properties 34.81
MTR 33.32
China Resources Land 32.45
CITIC 31.96
CK Hutchison 27.91
Techtronic Industries 26.31
Note(s): Hong Kong; 2022
Further information regarding this statistic can be found on page 8.
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Source(s): Forbes; ID 1254375
 Incorporation procedure Issue of the
Certificate of
Incorporation
Submission of
the registration
documents
Incorporation
Form
Preparation of
the Articles
Checking of the
proposed name

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 Understanding the concept of limited liability
• ABC Ltd has issued 20,000 fully-paid shares of HK$2.00 each, of which
Amy owned 10,000 (shares). Now, ABC Ltd is insolvent and goes into
liquidation. It has an outstanding debt of $50,000 and its remaining
assets worth HK$10,000. As the shareholder, what is the liability of
Amy to the creditor of ABC Ltd?

A. $0
B. $10,000
C. $20,000
D. $25,000
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Concept 1:
Separate legal entity: limited liability of shareholders
Legal Person vs Natural Person
• A company has a separate legal personality.
• A company is a separate legal entity from its members or
shareholders.
• A third party cannot treat the company and its shareholders as
being the same.

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 Following common law, so we track the ordinance + the case

Consequences of incorporation (1)

• A company is a legal entity distinct from its members Legal Principle
• Salomon v. Salomon & Co Ltd (1879) Leading Case/ Landmark Case
• Salomon had for many years carried on business as a boot
manufacturer.
• He registered a company and sold his business to the
company for £39,000 and became a majority shareholder
and director of the company.
• The company paid him the consideration by:
i. 20,000 shares of £1.00 each issued to him and his family
members, credited as fully paid;
ii. £9,000 cash paid to him; and
iii. £10,000 treated as a loan by him to the company,
secured by a charge on all the assets of the company. 21
Salomon v. Salomon & Co Ltd (1879)

• After an economic depression, the company went into

liquidation. The assets were sufficient to satisfy the
secured debt (Salomon’s debt) but the unsecured
creditors (suppliers) received nothing.
• The unsecured creditors argued that
• the secured debentures in favour of Mr. Salomon
were invalid because he was the person who
controlled the company
• Mr. Salomon and the company were the same entity.
• Mr. Salomon should be personally liable for the
debts incurred by the company.
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Salomon v. Salomon & Co Ltd (1879)
• Held:
• the secured debenture was valid and Salomon was
entitled to be paid before the unsecured creditors.
• As the company was lawfully registered and was a
separate legal entity to Salomon, Salomon could
contract with the company and be a secured
creditor of the company.
• Debts of the company were separate to those of
Salomon (i.e. shareholders would not be liable for
the debts incurred by the company).

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Consequences of incorporation (2)
Concept 1:
Separate legal entity: limited liability of shareholders
• A company has it own name and legal personality
• Own assets, enter into contracts, sue and being sued
in its own name
• A company has perpetual succession
• A company will exist until it is wound up and
dissolved.
• A company is capable of exercising all the functions that
an individual could exercise

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Concept 2: separation of ownership and management

• Ownership and management are separate in the company.

Shareholders
• Shareholders own the
company
• BUT they have no automatic
right to manage the business.
• Exception: they are elected
as directors in a listed
company.
Directors
• Directors have the general
authority to manage daily
operation and business of the
company.
• Model Articles
Article of Association

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 Advantages of companies
• Limited liability
• Shareholder or directors are not liable for the debts incurred by
the company (Salomon v. Salomon)
• Partners bear unlimited liability
• Ability to raise finance
• Companies can issue shares to raise fund / issue debentures to
borrow money
• Perpetual succession
• Death of shareholder does not affect the existence of the company.
• Unless agree otherwise, a partnership will be dissolved if any
partner is dead.
• Transfer of ownership (directors vs shareholders)
• Company is operated by directors, not shareholders. Change of
shareholders theoretically will not affect the business of a
company. 26
 Disadvantages of companies Improve the transparency

• Formation and maintenance cost

• Cost of complying with various regulations of
the Companies Ordinance.

• Tax: 16.5% for company / 15% for partnership

(subject to change)

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 Partnership vs Company
Partnership Company
Formality No [contract] Yes [register]
Less flexible More flexible
Financing
[partners or bank] [shares]
Unlimited Limited
Liability
[partners] [shareholders]
Separate
No Yes
personality
Cost Lower Higher
Tax Lower Higher

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 Discussion Problem
You has been running a business to invest in a new technological product.
As the business grows, you wish to invite your friend, Lucy to take part in
the business and run it together. However, you wish to keep the
controlling power.
Lucy suggests that you should form a company to run the business so Lucy
can join as a shareholder. Discuss the key features of a company and
advise if this is a suitable arrangement in this case.
→ Partnership? Company?

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 Discussion Problem
Partnership Company
Formality No [contract]
More flexible
Financing
Limited
Liability
Cost Lower Higher

Tax Lower Higher

Liability You may hold > 50% shares

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Group Companies
• Concept of separate legal personality applicable in the
case of group companies.
• Parent company has its separate legal personality while
its subsidiary also has its own separate legal personality.

See:
• Multinational Gas & Petrochemical Co v Multinational
Gas &Petrochemical Services Ltd (1983)
• Adams v Cape Industries plc (1990) VS Chandler v Cape
plc (2012)

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Multinational Gas & Petrochemical Co v Multinational
Gas & Petrochemical Services Ltd. (1983)
• The MGP Co and MGP Services were owned by 3 giant oil companies.
• The 3 giant oil companies were the sole shareholders of both companies
and appointed the directors of both.
• The MGP Co went into liquidation and was sued for alleged breach of
duty.
• Held:
• The court would not lift the corporate veil and its shareholders - the 3
giant oil companies - could not be sued as the company was NOT a
sham.

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Adams v Cape Industries plc (1990)
• Cape was incorporated in the UK and was the holding company of a group
of companies involved in mining asbestos【石棉】in South Africa.
• The employees of one of the subsidiaries in the USA claimed damages from
Cape for the personal injuries they had suffered because of exposure to
asbestos dust.
• Cape failed to appear before the USA court. Cape was not operating in the
USA and the employees had no basis to pursue Cape for damages.

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 Adams v Cape Industries plc (1990)
• Held:
• There was no general principle that all companies in a group should be
regarded as a single economic entity
• Each company in a group of companies is a separate legal entity and has
separate rights and liabilities

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 Liability of Parent Company

Parent company will be held liable for some of the debts of the
subsidiary company if it was a guarantor for the loan granted to the
subsidiary company.
Parent company could be held liable for some of the debts of the
subsidiary company if there is evidence of negligence by the parent
company see:
• Chandler v Cape plc [2012]
• Lungowe v Vedanta Resources plc [2017]

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Chandler v Cape plc (2012)
• David Chandler had been employed by a wholly owned subsidiary
company of Cape plc between 1959 and 1962.
• In 2007, Chandler discovered that as a result of exposure to
asbestos 【石棉】during that period of employment, he had
suffered from asbestosis 【石棉沉著病】.
• However, the subsidiary no longer existed and had no policy of
insurance covering claims for damages for asbestosis. Chandler
brought a claim against Cape plc, alleging it had owed (and
breached) a duty of care to him. Cape plc denied that it owed a
duty of care to the employees of its subsidiary company.

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Chandler v Cape plc (2012)
Tort Claim
• Held:
• Cape plc owed Mr. Chandler a duty of care, applying the threefold
test (foreseeability, proximity and fairness) laid down in Caparo
Industries plc v Dickman.
• Cape plc had had actual knowledge of the subsidiary employees'
working conditions, and the asbestos risk was obvious.
• Direct duty may be owed in tort by a parent company to a person
injured by a subsidiary.
if the case is involved in fraud, the
court would not consider it as
separate legal entity

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B. Articles of Association (AA)
• AA is the company’s constitutional document.
• It sets out the internal rules of the company, such as powers of directors,
procedure of directors’ meeting, procedure of shareholders’ meeting,
dividend policy, etc.
• Companies (Model Articles) Notice sets out model articles for different
types of companies. In particular, Schedule 2 of the Notice is for private
companies limited by shares.
• A company may adopt the Model Articles in whole, or in part, or exclude
Model Articles entirely and adopt its own regulations.

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 Provisions in AA
• Taking the Model Articles as an example, AA may include provisions in
respect of the following matter:
• Directors’ powers and responsibilities
• Decision making by directors’
• Appointment and retirement of directors
• Appointment and removal of company secretary
• Decision-making by members
• Shares and dividends
• Communication to and by the company
• Administrative arrangements

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 Legal Effects of the Articles

• AA has the effects of a contract under seal [s.86 CO]

• the contract takes effect as:
• between the company and each member, AND
• between a member and every other member
• each member has a personal right to sue other
members or the company to enforce the terms of AA;
and so has the company against each member.
• s.86
• Wood v Odessa Water Works Co. (1889)

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 Wood v Odessa Water Works Co. (1889)

• The articles empowered the company to declare a dividend ‘to be

paid’ to the shareholders. The company passed an ordinary resolution
proposing to pay no dividend but to give the shareholders debenture
bonds. Wood, a shareholder, sought an injunction to restrain the
company from acting on the resolution.
• Held:
• the proposal was inconsistent with the articles; to be ‘paid’ prima
facie means to be paid in cash. ‘The debenture bonds proposed to
be issued are not payments in cash but mere agreements or
promises to pay.’
• The injunction was accordingly granted.
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 Alteration of Articles
• General rule 1:
• A company may alter its articles (s.87(1)). [Legislation]
• The general principle that a company can alter its AA was confirmed in
Allen v Gold Reefs of West Africa Ltd (1900) [Case law]
• Alterations of AA may be done only to the extent authorized by
the CO
❑ Alteration of Articles in general (s.88(2))
- requires special resolution
Requirement ❑ Alteration of the objects clauses (s.89)
- requires special resolution
❑ Alteration of maximum number of shares to be issued (s.88(3))
- by ordinary resolution
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 Resolutions at General Meeting
Ordinary resolution
• > 50% of those who attend the meeting
Special resolution
• A resolution passed by a majority of at least 75%.
• A special resolution is only passed if a 75% majority is attained.

• Exception: shareholder’s agreement specifies how they will exercise their

voting rights on a resolution to alter the company’s articles. This is valid and
enforceable between the relevant shareholders.

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 Alteration of Articles

• General rule 2:
• Any change must be ‘bona fide in the interest of the company as
a whole’. (Greenhalgh v Arderne Cinemas Ltd (1950), Brown v
British Abrasive Wheel Company (1919) and Sidebottom v
Kershaw Leese (1920))
• Certain sections of the CO limit the ability of company to alter AA
(s.87 and related sections mentioned in s.87)
If anyone of the
members need to alter
the AA, it needs to
consider the interest of
the company.

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 Seminar Question
Amy, Bob, and Candy were the three directors and
shareholders of a small private company (“the Company”) to
run the restaurant in Tsim Sha Tsui 2019. In June 2021, Amy
and Bob have known that Candy has been running another
restaurant in Mongkok. Amy proposed inserting a new clause
in the Company’s Articles of Association: “In the event that a
shareholder has an interest in any business that is competing
with the Company, the directors shall have the right to buy
out the relevant shareholder’s shares. The directors shall Bob Amy Candy
have absolute discretion to determine whether a business is
competing with the Company”.

Advise Amy as to whether she can successfully alter the

Articles of Association of the Company.
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 Seminar Question

Issue ❑ The issue is whether Amy can successfully alter the

Articles of Association of the Company.
❑ This is related to ____________________.
alteration of article

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 Seminar (iii) Question

• Resolutions at General Meeting

❑ Assumption 1: equal shareholding
❑ Assumption 2: unequal shareholding

• Any other alterative(s)/remedies?

❑ Shareholders’ meeting
❑ _____________________
❑ _____________________
❑ _____________________

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