Law L4 & 5

Company Law II – Lecture 4 & 5 – Fundraising by Public Issue

Part 1 – Propsectus

1. Laws governing fundraising by public issue Companies seek to raise funds through a public issue of shares need to comply with the CO Pt

II Some provisions of the Securities and Futures Ordinance (Cap 571) are also Relevant Common Law also applies

2. Requirements for a prospectus – basic prohibitions A company must not issue any form of application for shares unless the form is issued with a

prospectus – S38(3) o Traditionally, the prospectus is issued as a written document, but it is also possible for

companies to issue electronic prospectuses – Securities and Future Commission, Guidelines For Electronic Public Offerings

The requirement for a prospectus is limited to public offers as offers of shares otherwise than to the public are exempted – S38(3)(b)

For the meaning of an offer to the public, see S48A ‘

S38(3) only catches public offers where a form of application is issued o Where a form of application is not actually issued to potential investors, but some

written document is used offering shares or inviting applications for shares, the propsectus regime under Pt II will also be applicable

o Reason S38(1) requires that a propsectus issued by a company comply with the contents

requirements set out in the provision, and S38D(1) prohibits a company from issuing a propsectus which does not comply with the Ordinance and which has not been registered with the Companies Registrar

Prospectus is defined to mean any prospectus, notice, circular, brochure, advertisement or other document offering shares to the public or calculated to invite offers by the public to acquire shares (S2) – Any written document containing an offer or invitation to take up shares would need to comply with SS38(1) and 38D(1)

Oral offers are not caught by the CO, but is prohibited under SFO S103

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3. Exemptions from the propsectus requirements A prospectus is not required to be issued with an application form under S38(3) if –

o The offer is issued to an underwriter to enter into an underwriting agreement (para (a)); or

o The offer is an exempted offer under Pt 1 of Sch 17 (para (c)) The definition of propsectus under S2 also exempts documents relating to an exempted offer

under Pt 1 of Sch 17 Written offers within Sch 17 need not comply with the prospectus requirements in Pt II The exemptions include small scale offerings, offers to professional investors, and offers to

underwriters – Sch 17

4. Contents of prospectus CO provides a detailed checklist of information that needs to be included in the prospectus –

S38(1), Sch 3 and Sch 18 Pt 1 – S38D(2)

Apart from the specific matters listed under the above provisions, there is a general disclosure oblgiation contained in Sch 3, Pt 1, item 3, which requires that “sufficient particulars and information to enable a reasonable person to form as a result thereof a valid and justifiable opinion of the shares or debentures and the financial condition and profitability of the company at the time of the issue of the prospectus”.

Where the prospectus contains a statement made by an expert, it is necessary for the company to obtain a written consent of the expert for the inclusion of the statement in the prospectus – S38C

Companies applying for listing must also comply with the Stock Exchange Listing Rules in relation to the contents of the prospectus – Listing Rules Ch.11

5. Non Compliance Non-Compliance with content requirement shall subject the company and/or every person

who is knowingly a party to the issue a fine S38 Defenses available for non-compliance under S38(4)

a) As regards any matter not disclosed, he proves that he was not aware of the non-compliance or contravention;

b) He proves that the non-compliance or contravention arose from an honest mistake of fact on his part; or

c) The non-compliance or contravention was inmaterial or it was something which in considering the circumstances would be a reasonably excused in the opinion of the court.

6. Civil liability for misstatements – general Where the propsectus contains a mistatement, civil liability can arise under

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o CO S40;o The law of misrepresentation – under the common law and the Misrepresentation

Ordinance; or o SFO SS108, 245, 227 and 281

6.1 Companies Ordinance S40 S40 applies where a prospectus contains any untrue statement Untrue statement would include false statements

o Also include statements which are misleading in the form and context in which they are included in the propsectus, as well as material omission – S41A

The person who can recover under S40(1) are persons who subscribed for shares on the faith of the prospectus and who suffered loss by reason of the untrue statement

The persons who are liable to pay compensation under S40(1) are – o Directors of the company issuing the shares (Paras (a) and (b));o Promotors of the company (Para (c));o Any person who has authorized the issue of the prospectus (Para (d))

Although there may be prima facie liability under S40(1), a person can escape liability under the section if any defence under subs (2) or (3) is applicable – S40(2), (3)

6.2 SFO

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S108 of the SFO imposes civil liability on any person who makes a fraudulent, reckless or negligent misrepresentation which has induced another to enter into or offer to enter into an agreement to subscribe for securities o Does not apply in any case to which CO S40 applies

S277 of the SFO applies where a person discloses false or misleading information as to a material fact that is likely to induce another to subscribe for securities, where the firstmentioned person knows or is reckless or negligent as to whether the information is false or misleading o Conduct within S277 constitutes market misconduct under S245, which can lead to

civil liability under S281 to compensate persons who have suffered loss as a result of the conduct

6.3 Law of misrepresentation Under the common law, a person who has induced into a contract by a misrepresentation has a

right ot rescind the contract – Urquhart v Macpherson (1878) Damages are also available under the following actions –

o In the tort of deceit in relation to fraudulent misrepresentation – Derry v Peek (1889) o In the tort of negligence (Hedley Byrne & Co Ltd v Heller and Partners Ltd (1964))

or under the Misrepresentation Ordinance S3(1) in relation to negligent misrepresentations; and

o Under Misrepresentation Ordinance S3(2) in relation to innocent misrepresentations

7. Civil liability for innocent misstatements Liabililty under CO – S40(1)

o Defences – S40(2)(d)(i), (ii) and S40(3)(c) SFO SS108 and 277 would not apply Under the general law of misrepresentations, there would be a right ot rescind a contract for

innocent misrepresentation, and the court may also award damages in lieu of rescission under Misrepresentation Ordinance S3(2)

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8. Civil liability for negligent misstatements or fraudlent mistatements Civil liability can potentially arise under CO S40, SFO SS108, 277 and 281, and the general

principles of misrepresentation Duty of care Caparo Industries plc v Dickman [1990] 2 AC 605

Duty of Care: What emerges is that, in addition to the foreseeability of damage, necessary ingredients in any situation giving rise to a duty of care are that there should exist between the party owing the duty and the party to whom it is owed a relationship characterised by the law as one of "proximity" or "neighbourhood" and that the situation should be one in which the court considers it fair, just and reasonable that the law should impose a duty of a given scope upon the one party for the benefit of the other…pp. 817-18

Who owes the duty? – Individuals who are in the business of examining books, accounts etc.

9. Statements of opinion/intention There is no misstatement or misrepresentation purely where an opinion turns out to be false or

where a stated intention is not carried out o Only incorrect statements of fact can amount to misstatement or misrepresentation –

Bisset v Wilkinson (1927) Where a person makes the statement of intention without belief that the intention will be

carried out, there is a misstatement of fact – Edgington v Fitzmaurice (1885) Edgington v Fitzmaurice (1885)

Facts: The prospectus stated that the object of the issue of debentures was to finance the

extension of the company’s buildings, to purchase horses and vans, and to develop the trade of the company

The real purpose of the issue though was to raise funds to enable the company to pay off certain debts

Held: There could be liability in the tort of deceit in those circumstances If a statement of opinion is made, then the person impliedly makes a statement of fact, namely

that the person does in fact hold the opinion, and that the person has reasonable grounds for the opinion – If either of those two impled facts are false, then there could be an actionable misrepresentation – Smkith v Land and House Property Corp (1885)

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10. Omissions

10.1 Mere silence Under law of misrepresentations, mere silence or the failure to disclose facts does not amount

to a misrepresentation – R v Kylsant (1932) Material omissions can lead to liability under CO S40 – S41A(2) SFO S108 also applies where there is an omission of a material fact that results in a statement

being false or misleading – SFO S108(7) SFO S277 also covers information that is false or misleading through the omission of a

material fact – SFO S277(1)(c)

10.2 Partial truths or literal truths There is some uncertainty as to whether statements literally true but which give rise to a

misleading impression can amount to a misrepresentation under the common law As to whether such statements can be misleading within the statutory provisions of the CO or

the SFO –R v Kylsant (1932) o Prospectus stated that company had paid dividends every year from 1921 to 1927 o Literally true, but false impression (dividends paid out of war profits) – but

misleading, it is a half truth

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11. Liability for reports by third parties Under the common law, it has been held that where the company issues a prospectus

containing extracts from a report made by a third party expert or containing statements based on the expert’s report, an action in misrepresetnation can still lie against the company arising from misrepresentations in the report as the share allowment is made prusuant to a contract that is formed on the basis of representations set out in the prospectus – Re Pacaya Rubber and Produce Co Ltd (1914)

HOWEVER, not liable if there is exemption clause in the prospectus Re Pacaya Rubber and Produce Co Ltd (1914)

Held: The court accepted however that the company would not be liable for the

misrepresentations where the company makes it clear in the propsectus that it is not vouching for the accuracy of the report quoted or referred to in the propsectus

CO – S40(2), (3) and 41A S40(2), (3)

SFO S108 applies where a “misrepresentation” has been made by a person o Unless the company has warned in the propsectus that it does not vouch for the accurarcy

of the contents of the report, the company would be treated as holding out the truth of the contents – applying Re Pacaya Rubber and Produce Co Ltd (1914)

o The company can properly be regarded as also being a party who makes the representationo If the representation is false, then the company has made a misrepresentation within S108

SFO S277 can apply to impose liability on a person who discloses, circulates, disseminates, or is concerned in the disclosure, circulation or dissemination of the false or misleading information

o Arguable that by including extracts from or statements based on a false report, the company has circulated or disseminated the false information

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12. Civil Liability for misstatements – reliance on misstatement – Remedies

12.1 Common law Under common law principles of misrepresentation, a remedy would be available to the

plaintiff only if the plaintiff relied on the misrepresentation in entering into the contract However not necessary for the misrepresentation to be the sole factor influencing the plaintiff

to contract – Edgington v Fitzmaurice (1885)

12.2 CO A person who acquired shares on the faith of the prospectus can recover compensation for the

loss sustained by reason of the untrue statement contained therein – S40 This indicates that there must be a causative connection between the loss and the untrue

setatement before compensation is available

12.3 SFO A person can recover damges only if the person was induced by the misrepresentation into

entering into the agreement to acquire the shares – SFO S108 The causative connection between the misrepresentation and the loss also needs to be satisfied

for a person to seek compensation under SFP S277 and S281 Under these provisions, the person can recover for any loss arising from the false or

misleading information (whether or not the loss arose as a result of the person being induced to enter into a transaction to acquire shares)

13. Civil liability for misstatements – third parties relying on propsectus – Remedies

13.1 Common Law

Peek v Gurney (1873)

Facts + Held: The plaintiff sued the directors of a company for indemnity. The action failed because it was found that the plaintiff was not a representee (an

intended party to the representation) and accordingly misrepresentation could not be a protection.

It is not required that in order to be a representee, the representation must be received directly.

It is sufficient that the representation was made to another party with the intention that it would be made known to a subsequent party and ultimately acted upon by them as a representee.

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13.2 CO Only persons who subscribe or shares on the faith of the prospectus can seek compensation

under S40 Purchasers in the secondary market who relied on the propsectus cannot seek compensation

under S40 for any misstatements contained therein

13.3 SFO A person can seek damages if the person was induced by the misrepresentation into acquiring

or subscribing for shares – S108o This covers situations where a person purchased shares in relaince on the

misrepresentation o It is not entirely clear whether the section would cover purchasers in the secondary

market who relied on a propsectus provided for the primary marketo The requirement that the plaintiff seeking recovery be “induced” by the

misrepresentation might indicate that the representor must have intended the plaintiff (or a class of persons including the plaintiff) to rely on the representation before there is liability

If that is the case, it could be aergued that the company only intends persons subscribing for shares to rely on the prospectus

HOWEVER, S107 refers to (criminal) liabiity where a misrepresentation is made “for the purpose of induing another person” to acquire shares, while S108 simply refers to a person being “induced” by the misrepresentationo It might be argued that S108 is applicable so long as the plaintiff relied on the

misrepresentation into acquiring the shares even though the company did not have the purpose of inducing him to acquire the shares on the basis of the misrepresentations

S277 applies where the disclosure of the false or misleading information “is likely to induce another person to subscribe for securities” or “to induce the sale or purchase of securities”o Purchasers in the secondary market can potentially rely on SS277, 281 to recover

compensationo HOWEVER, where a purchaser has relied on a prospectus, it is necessary to show that

the false or misleading information in the prospectus was “likely to induce” the purchase

Might be argued that if the prospectus was only intended for the purpose of the offer for subscription in the primary market and not the secondary market, then the propsectus would not have been likely to induce persons in the secondary market to purchase shares on the faith of the prospectus

YET, could be argued that in secondary trading occuring soon after the public subscription, there is a real possibility of purchasers still being able to access copies of the prospectus and therefore the prospectus is “likely to induce” purchases, esepcially given the close proximity between the time of purchase and the time when the prospectus was issued.

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14. Fraudulent misstatements – concept of fraud To establish civil liability in deceit, it is necessary for plaintiff to prove actual fraud, namely

that the person made the false representation (1) knowingly, (2) without belief in its truth, or (3) recklessly, careless whether it be true or false – Derry v Peek (1889)

HOWEVER, under Misrepresentation Ordinance, there is effectively a reversal of onus of proof, the burden is placed on the defendant to show that he had reasonable grounds to believe and did believe that the facts represented were true – S3(1) of MO

CO S40(1) & (2)(d)(i) SFO SS108(7)(a), S277(1)(c)(ii)

15. Criminal Liability

15.1 CO Criminal liability under the CO is imposed not only for fraudulent misstatements in the

prospectus but also negligent misstatements S40A – Persons who authorise the issue of the prospectus are subject to ciminal liability for

any untrue statement contained in the prospectus unless they prove that o The statement was immaterial; oro They had reasonable grounds to believe and did believe up to the time of issue of the

prospectus that the statement was true

15.2 SFO Ciminal liability imposed on person who makes a fradulent or reckless misrepresentation for

the purpose of inducing a person to enter into an agreement for acquisition or subscription for securities – S107

Where a company is liable under S107, officers of the company might also be liable under principles of accesorial liability set out in S390

16. Other prohibitions in relation to public offerings

16.1 Private companies Only public companies can offer its shares to the public – S29 Private companies which wish to offer shares to the public must alter its articles to remove the

restriction, and must deliver to the Registrar a prospectus or a statement in lieu of propsectus – S30

16.2 Non-compliant prospectuses If a company issues a prospectus that does not comply with the requirements of the CO, then

there could be criminal liability under CO S38(1B)

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16.3 Registration of prospectuses A company must not issue a prospectus unless the prospectus has been authorized in

accordance with S38D and registered by the Registrar under that section Prima facie, the prospectus is required to be sent to the SFO for authorization – S38D Where the company is seeking listing of its hares on the HKSE, the company should send the

prospectus (listing document) to the HKSE o The HKSE is responsible for pre-vetting tand authorization of the prospectus, though

the SE would also pass on copies of the listing documents to the SFC for their review Once the prospectus has been authorized, the Registrar can register the propsectus – S38D(7)

16.4 Advertising restrictions

16.4.1 CO S388(1) prohibits any person from publishing extracts from or abrdiged versions of a

propsectus or any advertisement in relation to a prospectus Exception – S38B(2)

o Advertisements approved by the SFC – SFO S105o Publications within Sch 19 )offer awareness statements or “tombstone advertising”)

The issue of written advertisement by or on behalf of the company might potentially contravene SS31(1B) and 38D o Those sections specify contents requirements and the requirement for registration of

propsectus o The issue of such a document by the company which does not comply with the contents

and registration requirements of SS38 and 38D could amount to a contravention of those provisions

16.4.2 SFO SFO S103(1) prohibits the issue of an advertisement, invitation or document inviting offers

from the public to subscribe for shares unless there is authorization by the SFC under S105 Exceptions – S103

16.4.3 Listing Rule For offerings involving listing on the SE, once the application is made to the SE for listing,

advertisement must be approved by the SE – LR 9.08

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Part 2 – Official Listing

1. Listing of securities Companies can only have their shares or securities traded on the stock exchange in Hong

Kong if the shares are listed on the HKSE Application for listing are made pursuant to the Listing Rules of the HKSE. Securities can be listed either on the Main Board of the Growth Enterprises Market (GEM) The GEM was established to facilitate public fundraising by new enterprises which have good

business ideas and growth potential but which do not fulfil all the requirements for listing on the Main Board o The listing requirements for the GEM are accordingly relatively less stringent,

compared with the requirements for the Main Board

2. Methods of listing

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3. Qualifications for listing

4. Application procedures and listing documents Applications for listing are made to the Listing Division of the SE pursuant to LR2A.05 The applications are then considered by the Listing Committee Application procedure and requirements – LR Ch.9 Requirements for the listing document (prospectus) – LR Ch.11 and Appendix 1 Prospectuses are vetted and authorized by SE – Ch. 11A Requirements as to publication of the prospectus after it has been authorized by SE and

registered by the Companies Registrar – LR Ch.12 and LR 2.07C Ch.10 of LR imposes certain restricions regarding preferential treatment of employees or

directors of the issuer in the allocation of shares pursuant to public offering o No preferential treatment is to be given to directors – LR 10.03o No more than 10% of the securities can be offered to employees on a preferential basis –

LR 10.01

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5. Continuing disclosure obligations

5.1 Rules – SE Once a company is listed on the SE, the company must at all times, while listed, comply with

obligations imposed under the LR – LR 13.01, 13.02 There are continuing obligations imposed in relation to disclosure – Ch.13 The guiding principle is that information which is expected to be price-sensitive should be

released immediately it is the subject of a decision – LR 13.05 The general disclosure obligation is set out under LR 13.09(1), which requires the issuer to

disclose the following information as soon as reasonable practicable – o Information necessary to enable the public to appraise the position of the group; oro Information necessary to avoid the establishment of a false market in its securities; or o Information which might be reasonably expect materially to affect the market activity in

and the price of its securites

5.2 Rules – SFO Rules – o Listed issues are obliged to disclose to the public as soon as practicable any “inside

information” that is price sensitive that has come to its knowledge – S307o Disclosure in an “equal, timely and effective access by the public” – S307Co Safe harbours – S307D

Inside information (內幕消息), in relation to a corporation, means specific information that- o is about-

The corporation; A shareholder or officer of the corporation; or The listed securities of the corporation or their derivatives; and

o Is not generally known to the persons who are accustomed or would be likely to deal in the listed securities of the corporation but would if generally known to them be likely to materially affect the price of the listed securities;

Inside information same as relevant information in “insider trading regime” SFC enforcement agency and market Misconduct Tribunal have jurisdiction

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5.3 Materiality Test

TSC Industries v Northway

Whether there is substantial likelihood that a reasonable shareholder would consider it important in making the investment decision

The standard of materiality does not require proof of a subtantial likelihood that disclosure of the omitted facts would have caused the reasonable investor to change his decision, but contemplates a showing of a substantial likelihood that, under all the circumstanes, the omitted fact would have assumed actual significance in the reasonable shareholder’s deliberations

Information is not material if it is only information which a reasonable shareholder “might” consider important

5.4 Notifiable and connected transactions Under LR 13.23, the issuer must disclose details of acquisitions and realizations of assets and

other transactions as required by Ch 14 (Notifiable transactions) and Ch 14A (Connected transactions)

5.4.1 Notifiable transactions Mainly refer to major acquisitions and disposals of assets in the company – LR 14.01 Notifiable transactions – Disclosure specifically required under LR 13.23 and Ch 14 (In

particular LR 14.33)

o Examples: major disposals and acquisitions of assets5.4.2 Connected transactions

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Connected transactions within Ch 14A must be disclosed and approval sought from shareholders – LR 14A.02

The term “connected transaction” is defined in LR 14A.13 o Includes a transaction between the listed issuer and a connected person

“Connected person” is defined in LR 14A.11, includes directors, the chief executive and substantial shareholders and associates of the listed issuer

Connected person includes – A director, chief executive or substantial shareholder of the listed issuer; A]ny person who was a director of the listed issuer within the preceding 12 months; A supervisor of a PRC issuer; Any associate of a person referred to in rules 14A.11(1), (2) or (3) (a) any person or

entity with whom a persono Has entered, or proposes to enter, into any agreement, arrangement, understanding or

undertaking with respect to the transaction which is such that, in the opinion of the Exchange, that person or entity should be considered a connected person;

o Any person cohabiting as a spouse with, and any child, step-child, parent, step-parent, brother, sister, step-brother and step-sister of, a person referred to in rules 14A.11(1), (2) or (3); and (ii) a company which the party referred to in rule 14A.11(4)(b)(i) can exercise or control the exercise of more than 50% of the voting power at general meetings or control the composition of a majority of the board of directors; and

o A father-in-law, mother-in-law, son-in-law, daughter-in-law, grandparent, grandchild, uncle, aunt, cousin, brother-in-law, sister-in-law, nephew and niece of a person referred to in rules 14A.11(1), (2) or (3); and

o A company which the party referred to in rule 14A.11(4)(c)(i) can exercise or control the exercise of more than 50% of the voting power at general meetings or control the composition of a majority of the board of directors

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6. Status and enforcement of the LR Under LR 13.01, an issuer whose securities have been admitted to listing is required to

comply with the Listing Rules Issuers undertake to comply with the rules pursuant to the issuer’s application for listing The effect of these provisions is that a listed issuer is bound to the rules as a matter of contract The SE has power to suspend dealings in any securities or cancel the listing of any securities,

including where an issuer fails, in a manner which the SE considers material, to comply with the listing rules – LR 6.01

The Listing Committee of the SE can also exercise disciplinary powers under LR 2A.09 in relation to breaches of the rules.

The sanctions that can be imposed under this rule include – o Issue a private reprimando Issue a public statement which involves criticism o Issue a public censureo Require breaches to be rectified

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Law L4 & 5

Documents

Transcript of Law L4 & 5