Majority Rules? What are the limits to the Irregularity Principle and what remedies are there for an aggrieved director?

02 March 2021

This Case Report was authored by DVC’s Benny Lo and external Junior Counsel,  Lawrence Pang

Introduction

When an aggrieved member of a company challenges the lawfulness of a decision made by a company, the latter may deploy the established “irregularity principle” and argue that, even though the decision might be irregular, the Court should nevertheless refrain from interfering in its internal management: see MacDougall v Gardiner (1875) 1 Ch D 13; Burland v Earle [1902] AC 83; Yip Peter v Asian Electronics Ltd [1998] 2 HKC 96; Re Hong Kong Sailing Federation [2010] 1 HKLRD 801.  If what has been done irregularly is capable of being and will inevitably be confirmed by the majority, the Court would not interfere: see Re Dalny Estates Ltd [2018] 1 HKLRD 409 (CA).

The recent case Chen Pao-Tzu v Chen Sheng Kuei & Ors [2021] HKCFI 299 (Linda Chan J) presented the High Court with an opportunity to clarify the true scope and limits of the irregularity principle.  In the judgment, the Court also expressly held that an aggrieved director (who is not also a member) of a company does have the locus standi to commence proceedings under section 42 of the Companies Ordinance (Cap. 622) (“Ordinance”) to challenge the relevant decision and seek declaratory relief.

Material Facts of the Case

The subject company, Fully Hong Kong Limited (“Company”), is a Hong Kong corporation used by the Chen family as a vehicle to hold various Mainland Chinese subsidiaries that operate a substantial chemical and fertilizer business.  At the material times, the Company’s issued capital was held as to 10% by the patriarch Mr. Chen, while the remaining 90% was held by Full Kang Co Limited (“Full Kang”) a Seychelles company whose shares were also held by the second generation of the family.

As part of a boardroom battle between the siblings after the father fell ill, an extraordinary general meeting was convened by Full Kang, which was then controlled by the majority faction of the siblings.  Prior to the meeting, the only directors of the Company were the plaintiff and Mr Chen.  Among the resolutions passed at the meeting were those to remove the plaintiff as director and appoint the principal defendants as new directors of the company.  Even though the quorum of the Company’s general meetings was two members in person or by proxy, those resolutions were only passed by two representatives of the same member, Full Kang, each purporting to hold a split portion of Full Kang’s total shareholding in the Company in voting, as if the quorum was present.  An ND2A form was then subsequently filed with the Companies Registry to report the purported changes in directorship.  

Shortly after the meeting, the plaintiff applied under section 42 of the Ordinance to impugn the resolutions.  He argues, inter alia, that the member’s meeting was inquorate and seeks, inter alia, (i) declarations that the resolutions purportedly passed thereat and the ND2A form were void and (ii) an order that the ND2A form be expunged or struck out from the company register.

At the substantive hearing, the defence did not dispute that the general meeting was inquorate, but resisted the application on the basis of the irregularity principle.  The argument is that since Full Kang held 90% of the shareholding in the Company and voted in favour of the impugned resolutions, it was plain that the resolutions would have been passed by a majority had there been a quorum.  The defence also challenged the locus standi of the plaintiff (who was not a member) to make the application.

Decision

In rejecting the defence’s argument based on the irregularity principle, Linda Chan J made clear that the Court would look at more than what the majority shareholders would think:-

“19.…As the authorities explain, the Court does not simply look to ascertain whether the result of the resolution was one which the majority shareholders would approve of.  Rather, it considers whether the same result would have been obtained had the correct procedure been followed (Re Dalny Estates, §18 per G Lam J).  There is thus an implicit requirement that the irregularity was one which could have been cured by the majority.  In other words, the principle does not operate to validate a resolution which the majority shareholders could not have lawfully passed.” (emphasis added)

On the evidence, the defence was unable to show that Full Kang could have been able to convene and hold member’s meeting that would comply with the quorum requirement.  In fact, on the defence’s own evidence, it was impossible for Mr Chen (being the only other member of the Company) to attend such a meeting to constitute a two-member quorum.  It was also far from inevitable that the majority would have obtained an order, under section 570 of the Ordinance, for the members’ meeting to be held without a quorum.  The Court also considered it relevant to note that Full Kang never sought to convene a fresh general meeting to ratify the purported resolutions nor did he make any application under section 570 of the Ordinance. 

As to the plaintiff’s locus standi, the Court acknowledged the wide ambit of the wordings under section 42 of the Ordinance (“The Court may, on application by any person, by order direct the Registrar…”) and found that the plaintiff had sufficient legitimate interest to invoke the section and ensure that the public records accurately reflected the true position with regards to the directorship of the Company.  The Court also noted that a person who is not an officer of a company also has a legitimate interest in ensuring that he/she is not named as an officer in the public records concerning the company.

Accordingly, the Court acceded to the plaintiff’s application and declared the resolutions purportedly passed at the general meeting void and of no legal effect, and ordered the ND2A form be removed.

Commentary

This decision is significant for practitioners in two aspects.

First, it clarifies the limits of the irregularity principle.  It is now clear that the majority shareholders cannot just get around with irregular decisions simply by saying that they are in control of the company and that they are in favour of those decisions.  The fact that the majority agrees with a decision made irregularly is not the end of the matter.  To invoke the irregularity principle, the majority must show that the same result would inevitably be obtained had the correct procedure been followed.

In this regard, practitioners should read the earlier decision of Lim Jonathan v She Wai Hung [2011] 1 HKLRD 305 (where DHCJ Louis Chan applied the irregularity principle in relation to an inquorate general meeting and refused to declare that the directors that were elected there were invalidly appointed) with the present case in mind.  Practitioners should further note that when seeking to invoke the irregularity principle, they should make sure (i) the irregularity is one that could and would be remedied by the majority and (ii) the same decision would inevitably be reached.

Second, the decision confirms that an aggrieved director, despite not being a member of the company, may seek redress under section 42 of the Ordinance to ensure that the company’s information filed with the Companies Registry is accurate and correct.  Section 42 confers a wide jurisdiction to the Court to deal with applications made by “any person” and a director has a legitimate interest to ensure that the public records of a company are accurate.  Furthermore, practitioners should note that the irregularity principle and the proper plaintiff rule (that an irregularity in decision is a wrong done to the company and it is the company alone who is the proper plaintiff to bring a suit for redress, see Foss v Harbottle (1843) 2 Hare 461) are the flip sides of each other.  When an irregularity is not capable of being regularised by the majority, the proper plaintiff rule does not operate as a bar to a claim made by the minority.

DVC's Benny Lo and external Junior Counsel, Lawrence Pang authored this Case Report and represented the successful plaintiff director.

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