A Primer on the Provision of Financial Assistance by a Company for the Purchase of its Own Shares
Like many other jurisdictions around the world, Hong Kong law restricts companies incorporated in Hong Kong from providing financial assistance for the purchase of their own shares. These restrictions may, for example, limit the ability of a purchaser of a company from using the assets of the company to secure the debts incurred by the purchaser in financing the purchase.
Subject to prescribed exceptions, the Companies Ordinance (Cap. 622) (“CO”) prohibits a company or any of its subsidiaries from providing financial assistance directly or indirectly for the purpose of either (i) an acquisition or proposed acquisition of the company’s shares before or at the same time as the acquisition takes place, or (ii) reducing or discharging the liability incurred for the purpose of an acquisition of the company’s shares.
Meaning of “Financial Assistance”
The CO defines the term “financial assistance” as:
financial assistance given by way of gift,
financial assistance given by way of a guarantee, security, indemnity (other than an indemnity in respect of the indemnifier’s own neglect or default) or by way of release or waiver,
financial assistance given by way of a loan or any other agreement under which any of the obligations of the person giving the assistance are to be fulfilled at a time when in accordance with the agreement any obligation of another party to the agreement remains unfulfilled or by way of the novation of or the assignment of rights arising under such a loan or agreement, or
any other financial assistance given by a company if the net assets of the company are reduced to a material extent by the giving of the assistance or the company has no net assets.
Notwithstanding the general restriction against the provision of financial assistance by a company for the purchase of its own shares, a company may provide financial assistance under prescribed exemptions. There are 4 broad categories of exemptions.
The CO establishes 3 different exceptions on the basis that the directors confirm that the company is solvent and resolve that the giving of the financial assistance is proper.
In respect of solvency, the directors will need to confirm that (i) immediately after the giving of financial assistance by a company, there will be no ground on which the company could be found to be unable to pay its debts; and (ii) the company will be able to pay its debts as they become due during the 12 months immediately following the provision of financial assistance. In giving the confirmation, the directors must enquire into the company’s state of affairs and prospects and take into account all the liabilities of the company, including contingent and prospective liabilities. The directors will commit an offence if they give a confirmation without reasonable grounds.
In respect of the propriety of the financial assistance, the directors will need to resolve that the company should give the assistance, the giving of the assistance is in the best interests of the company and the terms and conditions of the assistance are fair and reasonable to the company. In making these resolutions, directors will be subject to a statutory duty of care and fiduciary duties. A breach of these duties by a director may result in the director being liable for damages under statutory remedies set out in the CO and in the Companies (Winding-up and Miscellaneous Provisions) Ordinance (Cap. 32).
Provided the directors give the above solvency confirmation and resolution as to propriety, a company may give financial assistance in any of the following circumstances:
De Minimis – The CO permits a company to give financial assistance where the aggregate amount of the assistance (and any other financial assistance given under this exception that has not been repaid) does not exceed 5% of the paid up share capital and reserves of the company.
Majority Shareholder Approval – The CO permits a company to give financial assistance where the giving of the assistance is approved by resolution of the company before the assistance is given. However, in this case, the shareholders holding at least 5% of the voting rights of the company may petition the court for an order restraining the giving of the financial assistance.
Unanimous Shareholder Approval – The CO permits a company to give financial assistance where the giving of the assistance is unanimously approved by the shareholders of the company.
Exemption to Enable Corporate Action
The CO permits the giving of financial assistance in circumstances where a company is undertaking corporate action in accordance with the CO which may be construed as being financial assistance. These circumstances include, for example, a distribution of a company’s assets by way of dividend lawfully made or in the course of winding up the company, the allotment of bonus shares, the reduction of a company’s share capital, and the redemption or buy-back of a company’s own shares.
Principal Purpose Exemption
The CO permits the giving of financial assistance where (i) the principal purpose of the financial assistance is not to give it for the purpose of the acquisition of a share in the company or for reducing or discharging a liability incurred for such acquisition, OR (ii) the giving of the financial assistance for the purpose of the acquisition or the reducing or discharging a liability incurred for such acquisition is only an incidental part of some larger purpose of the company. In practice, there may be difficulties whether a purpose is a principal purpose or a purpose incidental to a larger purpose where there are multiple purposes.
Activity Specific Exemptions
The CO does not prohibit any money lending business conducted in the ordinary course of business and permit the giving of financial assistance for the purposes of employee share schemes or by way of lending money to eligible employees to acquire shares.
Private Limited Companies
The restriction against financial assistance applies to all companies formed and registered under the CO (and its predecessors), including private companies limited by shares incorporated in Hong Kong.
Public Limited Companies
As the restriction against financial assistance applies to all companies formed and registered under the CO (and its predecessors), the restriction applies to public companies limited by shares incorporated in Hong Kong. It does not apply to companies listed on the Stock Exchange of Hong Kong (“SEHK”) unless those companies are so formed and registered. This is so even though such companies may be registered as overseas companies in Hong Kong.
However, in the case of a company listed on the SEHK, the activity specific exemptions (i.e. for money lending, employee share schemes or employee share purchases) apply only if either (i) the company has net assets that are not reduced by the giving of the financial assistance, or (ii) to the extent those assets are reduced, the assistance is provided by a payment out of distributable profits.
Perhaps more significantly, in practice, it will be difficult for a company listed on the SEHK to rely upon the exemption requiring unanimous shareholder approval.
Neither the Rules Governing the Listing of Securities on the SEHK (“Main Board Listing Rules”) nor the Rules Governing the Listing of Securities on the Growth Enterprise Market of the SEHK (“GEM Listing Rules”) contain any provisions which specifically govern financial assistance for the acquisition of a listed company’s own shares. However, listed companies are subject to ongoing notification, disclosure and approval requirements which may apply to transactions to give financial assistance. As a result, transactions involving the giving of financial assistance by a company listed on the SEHK, whether or not it is within the ambit of the CO, may nevertheless be subject to notification, disclosure and approval requirements under the Main Board Listing Rules or GEM Listing Rules.
Consequences Of Providing Financial Assistance
Validity of Contract
Under the CO, if a company gives financial assistance contrary to the CO and without exemption, the validity of the financial assistance and of any contract or transaction connected with it is not affected only because of the contravention.
However, it appears that a breach of a director’s duties in connection with the giving of financial assistance may nevertheless affect the validity of such contract or transaction. This is so even where there has been compliance with the requirements of an exemption, as may arise, for example, where directors improperly resolve that the giving of the financial assistance is in the best interests of the company. In these circumstances, under the CO, a shareholder or creditor of a company may apply to court for a declaration that any contract is void or voidable on the basis of a breach of fiduciary duties.
A breach of the prohibition on giving financial assistance would result in the company and every responsible person of the company committing a criminal offence, the maximum penalty of which carries a jail term of 1 year and a fine of up to HK$150,000.