By Jack W. Flader, Director, Henley & Partners Far East Ltd., Hong Kong
On 2nd July 2003, the Legislative Council of the Hong Kong Special Administrative Region of the People’s Republic of China ("Hong Kong") passed the Companies (Amendment) Ordinance 2003 ("Amendment Ordinance"),1 which is an ordinance to amend the Companies Ordinance of Hong Kong.2 The Amendment Ordinance will be effective on 13th February 2004. The amendments include, among other matters, enhanced shareholders’ rights, changes in requirements regarding directors and shareholders, and procedural improvements.
The purpose of this article is to outline briefly several of the most important elements of the Amendment Ordinance, discuss the impact of the Amendment Ordinance particularly in relation to the Closer Economic Partnership Arrangement between Hong Kong and the People’s Republic of China ("CEPA")3 and consider several outstanding issues not addressed in the Amendment Ordinance.
I. Amendment Ordinance
The Amendment Ordinance represents approximately three years of somewhat tedious and often contentious work by the Standing Committee on Company Law Reform ("SCCLR").4 The Amendment Ordinance seeks in its 153 pages to improve the Companies Ordinance, which governs matters related to Hong Kong companies. It is likely the reader has already been introduced to the Amendment Ordinance. As such, the list below briefly outlines some of the most important amendments.
A. Directors: The Amendment Ordinance permits a private company to have only one director.5 Where a private company has only one director, that director cannot also be the secretary of the company.6 The Amendment Ordinance also provides a statutory definition of "Shadow Director".7
B. Members (Shareholders): The Amendment Ordinance permits a private company to have only one member.8
C. Insurance for Officers and Auditors: The Amendment Ordinance permits a company to purchase and maintain insurance for any officer or auditor of the company against any liability to the company in respect of any negligence, default, breach of duty or breach of trust (except for fraud) or incurred in defending proceedings, whether criminal or civil, in respect of negligence, default, breach of duty or trust (including fraud) of which such officer may be guilty in relation to the company or related company.9
D. Shareholders’ Rights: The Amendment Ordinance grants every member of a company a personal right to sue to enforce the terms of the memorandum and articles of association.10 A director may be removed by an ordinary resolution of members (which may be passed by a simple majority vote) instead of a special resolution (which requires a three-fourth majority vote).11 The threshold for a member’s proposal is reduced from "holders of not less than 5% of the voting rights or not less than 100 shareholders" to "2.5% of the voting rights or not less than 50 members."12
E. Statutory Declarations or Affidavits: The Amendment Ordinance replaces the filing requirements of statutory declarations or affidavits in respect of certain matters with simple written statements.13
II. Impact of Amendment Ordinance
The Amendment Ordinance, to a large extent, reflected the SCCLR’s desire to relax certain corporate formalities for private companies.14 However, equal importance was given to considerations of ensuring that companies would continue to conduct their business in accordance with international standards of corporate governance and that Hong Kong would continue to be perceived as a credible jurisdiction by practitioners and the international business community.15
For many reasons, including an international quality financial infrastructure,16 free economy17 and relatively low and simple system of corporate taxation,18 Hong Kong has been positioned in the offshore world as a credible jurisdiction in which to form a company. However, prior to the implementation of the Amendment Ordinance, several requirements imposed upon Hong Kong companies have deterred some offshore practitioners from actively using the jurisdiction for clients’ international activities.
The decision to allow Hong Kong companies to be formed with only one member and one director is a major step towards positioning Hong Kong in a more competitive posture vis-à-vis other jurisdictions, most notably those in the Caribbean.
The issue of bearer shares was also considered. Although relaxing the requirement of members to only one, the drafters of the Amendment Ordinance were wary of suggestions that Hong Kong companies should also be allowed to issue bearer shares and ultimately rejected such proposals.19 Given the attention afforded to the issuance of bearer shares by the Financial Action Task Force on Money Laundering, among others, this decision should prove beneficial to Hong Kong.20
The one member/one director Hong Kong company that is prohibited from issuing bearer shares should prove more attractive to offshore practitioners forming a wide variety of vehicles for their clients, particularly international trading companies.
In addition, the impact of the Amendment Ordinance in terms of offshore practitioners using Hong Kong companies more for their clients is further strengthened by CEPA. The objective of CEPA is to strengthen trade and investment cooperation between the People’s Republic of China ("China") and Hong Kong.21
The benefits of CEPA only apply to Hong Kong companies. The rapid economic growth of China has attracted the attention of the world and businesses engaged in international activities are keen to begin doing business in or with China. For international businesses willing to form a Hong Kong company, CEPA provides an opportunity to access the World Trade Organization ("WTO") trade liberalization conditions to which China has agreed several years in advance of the implementation of those WTO rules.22
As such, it is likely that the Amendment Ordinance’s relaxation of requirements for members and directors, among other provisions, coupled with CEPA will result in offshore practitioners seeking to use Hong Kong companies more frequently for their clients seeking to do business on a global scale as well as in or with China.
III. Outstanding Issues
Although the Amendment Ordinance is welcomed legislation, many practitioners believe several outstanding issues still need to be addressed.
A. Audit requirement
Hong Kong companies must keep accounting records and a profit and loss statement and balance sheet must be laid before the company in an annual general meeting together with the auditor’s report.23 The audit requirement imposes a fairly significant annual cost on a Hong Kong company.24
Many practitioners have argued private companies that generate below a certain level of revenues or assets should be exempted from the audit requirement. This is common in many other jurisdictions.25 However, there are at least three reasons why this exemption was rejected.
- Some practitioners, albeit probably a minority, believe that the audit requirement, as opposed to a voluntary system, lends additional credibility to Hong Kong as a jurisdiction in which to form a company. Although this argument has some merit for Hong Kong as a jurisdiction, it does little for the everyday business concerns related to the ongoing maintenance costs of private companies.
- The Hong Kong Government is running a fairly significant budget deficit.26 It is generally believed that the Inland Revenue Department worked hard to ensure that an exemption was not granted to any member of the Hong Kong business community.
- The accounting profession is quite influential in Hong Kong. If the exemption was granted, then the accounting profession would stand to lose significant revenue. It is generally believed that the Hong Kong Society of Accountants, via its member in the Legislative Council and other avenues, was very active in ensuring that an exemption was not granted.27
Given the political influence of both the Inland Revenue Department and the Hong Kong Society of Accountants, it is unlikely that an exemption for the annual audit of small, private companies will be granted in the near future.
B. Corporate directors
Hong Kong allows for the use of corporate directors for private companies.28 Prior to the Amendment Ordinance, Hong Kong companies were required to have two directors. This often resulted in the promoter of a company being appointed as one director by the subscriber while a corporate "nominee" director was appointed to fulfill the other required directorship. Simply stated, it is not unusual in Hong Kong to see many small, private companies with at least one corporate director.
Some practitioners believe corporate directors should be eliminated as they contribute to a lack of transparency and are often misused.29 These practitioners believe the requirement of individual directors, rather than corporate directors, would lend additional credibility to Hong Kong as a jurisdiction.
However, in addition to the audit function, it is fairly common for accountants to provide corporate directors for clients. Notwithstanding the obvious conflict of interest, which occasionally becomes a problem particularly when tax issues arise with the Inland Revenue Department, the accounting profession apparently has taken a stand against the elimination of corporate directors.
With the requirement of only one director for Hong Kong companies coming into effect under the Amendment Ordinance, it is likely that corporate directors may be prohibited in the near future as their usefulness, arguably, would have largely been eliminated. Having said that, the accounting profession’s influence in such matters may delay or, for that matter, completely derail any future changes in this area.
C. Company secretary
Hong Kong companies must have a resident company secretary.30 The company secretary, among other services, maintains the statutory records of the company, prepares minutes and resolutions and usually provides the registered office address. In addition, the company secretary assists the company with filing annual returns to the Companies Registry.31
Some practitioners believe the office of the company secretary, particularly the requirement of residency in Hong Kong, imposes unnecessary costs on Hong Kong private companies.32 This is particularly true when one considers the costs of the business registration license, which is required,33 and the fact there is no requirement of a company secretary for companies formed in other jurisdictions with which Hong Kong competes, particularly the Caribbean.
However, many practitioners believe the requirements of filing annual returns and maintaining the statutory records of the company necessitate the office of the company secretary. In addition, it is fairly common for accountants to provide the office of company secretary for Hong Kong companies.
Given the continued obligations of filing annual returns and the influence of the accounting profession, it is unlikely the requirement of a resident company secretary will be eliminated in the future.
The Amendment Ordinance has been well-received in Hong Kong and has provided some important improvements in the ever-competitive world of company formation. Depending upon one’s viewpoint, there remains several areas where improvements could be implemented. Given the pace of development of such laws in the past and the influence of certain vested interests in Hong Kong, it would be unreasonable to expect such changes in the near future. In any event, the Amendment Ordinance should serve Hong Kong well in the coming years.
1 Companies (Amendment) Ordinance, Ordinance No. 28 of 2003 ("Companies (Amendment) Ordinance"). If readers would like a copy of the Amendment Ordinance, please send an email to firstname.lastname@example.org with the subject line Amendment Ordinance. A nominal fee of US$75 will be charged for purchasing, handling and sending the document.
2 Companies Ordinance, Chapter 32 ("Companies Ordinance"). If readers would like a copy of the Amendment Ordinance, please send an email to email@example.com with the subject line Companies Ordinance. A nominal fee of US$75 will be charged for purchasing, handling and sending the document.
3 The Closer Economic Partnership Arrangement’s (29th June 2003) various benefits went into effect on 1st January 2004. If readers would like a copy of CEPA, please send an email to firstname.lastname@example.org with the subject line CEPA. A nominal fee of US$75 will be charged for purchasing, handling and sending the document.
4 The Standing Committee on Company Law Reform was created in 1984 to ensure that the Companies Ordinance remained responsive to the day-to-day needs of the business sector and the community at large.
5 Section 56, Companies (Amendment) Ordinance amending Section 153A of the Companies Ordinance.
6 Section 59(1B), Companies (Amendment) Ordinance amending Section 154 of the Companies Ordinance.
7 Section 2((1)(b), Companies (Amendment) Ordinance. "Shadow Director", in relation to a company, means a person in accordance with whose directions or instructions the directors or a majority of the directors of a company are accustomed to act, but excludes any person giving advice in a professional capacity
8 Section 4(1), Companies (Amendment) Ordinance.
9 Section 73, Companies (Amendment) Ordinance amending Section 165 of the Companies Ordinance.
10 Section 9(1A), Companies (Amendment) Ordinance.
11 Section 60, Companies (Amendment) Ordinance amending Section 157B of the Companies Ordinance.
12 Section 46, Companies (Amendment) Ordinance.
13 Section 100, Companies (Amendment) Ordinance.
14 Companies Ordinance, Section 29. Private company means "a company which by its articles (a) restricts the right to transfer its shares; and (b) limits the number of its members to 50, not including persons who are in the employment of the company and persons who, having been formerly in the employment of the company, were while in that employment, and have continued after the determination of that employment to be, members of the company; and (c) prohibits any invitation to the public to subscribe for any shares or debentures of the company."
15 Standing Committee on Company Law Reform, Corporate Governance Review (July 2001, June 2003). Throughout the article, the authors refer to the viewpoints of "practitioners" and "business community". These viewpoints are based on the authors’ years of experience working in Hong Kong with primarily an international clientele.
16 Hong Kong is often referred to by commentators as one of the leading international finance centres along with New York, London and Tokyo.
17 Heritage Foundation Index of Economic Freedom (http://www.heritage.org/Press/Commentary/ed011304a.cfm ). "Hong Kong, for the 10th straight year, rates first in economic freedom…"
18 Taxation in Hong Kong is based on the territorial source principle and Hong Kong companies often are operated as tax-free entities. Profits tax is levied at a rate of 17.5%.
19 Caribbean jurisdictions have for many years only required one member and one director and many jurisdictions still permit, albeit with restrictions, the issuance of bearer shares.
20 Readers are referred to http://www.fatf-gafi.org/, which includes extensive literature dealing with the subject of, among other matters, the issuance of bearer shares and the contribution of the same to money laundering.
21 Mainland and Hong Kong Closer Economic Partnership Arrangement, Chapter 1, Article 1, states in relevant part as follows:
"To strengthen trade and investment cooperation between the Mainland and the Hong Kong Special Administrative Region (hereinafter referred to as "Hong Kong") and promote joint development of the two sides, through the implementation of the following measures: progressively reducing or eliminating tariff and non-tariff barriers on substantially all the trade in goods between the two sides; progressively achieving liberalization of trade in services through reduction or elimination of substantially all discriminatory measures;
promoting trade and investment facilitation."
22 Specific requirements of CEPA need to be considered prior to international businesses forming a Hong Kong company to access such benefits.
23 Companies Ordinance, Sections 122 and 129C.
24 Auditors must be a member in good standing of the Hong Kong Society of Accountants. Audit fees are based on number of transactions. Minimum fees start at approximately US$1,000.
25 In the United Kingdom, small and medium sized companies are exempt from the requirement to file full accounts and to state whether or not the accounts have been prepared in accordance with applicable accounting standards. A company qualifies as "small" if for the year in questions and, except in the case of a new company, for the preceding financial year, two or more of the following conditions are satisfied: (a) the amount of its turnover for the year is not more than GBP2.8 million, (b) the balance sheet total is not more than GBP1.4 million, (c) the average number of persons employed by the company in the year (determined on a weekly basis) does not exceed 50.
26 The forecasted budget deficit for 2003/2004 is HK$78 billion or approximately US$10 billion.
27 The Hong Kong Society of Accountants, via Hong Kong’s system of functional constituencies, has a permanent member sitting on the Legislative Council of Hong Kong. The Legislative Council of Hong Kong is the chief law making body.
28 Companies Ordinance, Section 154A(2) and (3).
29 It is fairly common for corporate directors to issue general powers of attorney, thus delegating all powers usually reserved for directors to third parties. In effect, the directorship is illusory in such cases.
30 Companies Ordinance, Section 154.
31 Companies Ordinance, Section 107.
32 Firms in Hong Kong charge upwards of US$1,000 per annum to take on the office of company secretary for private companies.
33 Companies Ordinance, Section 92(1) requires every company to have a registered office in Hong Kong and the Business Registration Ordinance, Chapter 310, Section 5 requires every person carrying on any business to register that business within one month of the commencement of the business. Failure to do so may result in a fine of HK$5,000 (approximately US$650) and imprisonment for one year. The cost is approximately US$325 per annum.
About the Author
Jack W. Flader, Jr. is the director of Henley & Partners Far East Ltd. in Hong Kong, which provides a focused range of fiduciary services, including the formation and administration of Hong Kong companies. The Hong Kong office also plays a key role in servicing clients from the Asia-Pacific region, and it advises and assists clients who are involved in direct investments in China.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.