A plaintiff (or a defendant in a counterclaim) in an action begun by writ may apply for summary judgment against the other party on the basis that the other party has no defence.  This summary judgment procedure enables the plaintiff (or the defendant) to obtain judgment at an early stage in the proceedings without a full trial, thereby minimising costs.  However, it does not apply to certain actions such as an action which includes a claim based on an allegation of fraud (i.e. the fraud exception rule).

Following remarks made by the Honourable Mr. Justice Lam VP (as he then was) in the Court of Appeal case of Zimmer Sweden AB v KPN Hong Kong Limited [2016] 1 HKLRD 1016 questioning the continued existence of the fraud exception rule in Hong Kong’s modern litigation landscape, the Judiciary has reviewed the appropriateness of keeping this exception in Order 14 of the Rules of the High Court (Cap. 4A) and the Rules of the District Court (Cap. 336H) and recommended that legislative amendments be introduced to remove the fraud exception rule.

According to the Legislative Council Brief issued by the Judiciary Administration in August 2021, justifications in support of the removal are as follows:

• there is no practical need to retain the fraud exception rule as there is no right to jury trial in fraud cases in Hong Kong;
• the fraud exception rule cannot be justified in the modern litigation environment in Hong Kong (as stated in the Zimmer case);
• it is questionable whether the potential vindication of a defendant on an alleged fraud claim at trial warrants a plaintiff to be deprived of his right to seek summary judgment, even in cases where the defendant only puts forward a token defence, thus obliging the plaintiff to incur expenses for a full trial in order to obtain relief;
• the fraud exception rule had been abrogated in England since 1992.

Following the gazette of the Rules of the High Court (Amendment) Rules 2021 and the Rules of the District Court (Amendment) (No. 2) Rules 2021 to remove the fraud exception rule on 20 August 2021, they were tabled at the Legislative Council for negative vetting on  25 August 2021.  Subject to completion of the applicable legislative process, the amendments will come into operation on 1 December 2021.

It is worthwhile to note that the removal of the fraud exception rule does not mean that summary judgment would be granted in fraud cases where there are serious defences or triable issues of fact or law. The usual criteria applicable to granting summary judgment continues to apply.

The Court of Appeal recently handed down its judgment in Nomura Funds Ireland Plc v The Collector of Stamp Revenue [2021] HKCA 1040 and held that the vesting of Hong Kong stock in a merger by way of universal succession[1] does not give rise to stamp duty under Hong Kong law.  Prior to the judgment, the applicability of stamp duty in overseas mergers of companies holding Hong Kong stock was not statutorily codified.  The present case is the first time a judicial authority in Hong Kong has confirmed such a position.

1. Background of the Case

The present case concerns a dispute arising from the merger of two funds in the Nomura group (the “Merger”).

Nomura Funds Ireland Plc, the appellant, is an investment company incorporated in Ireland, structured as an umbrella fund consisting of different sub-funds.  The appellant is authorised by the Central Bank of Ireland as an Undertaking for Collective Investment in Transferrable Securities (“UCITS”) pursuant to a directive published by the European Union.  Nomura Funds Ireland – China Fund (“Receiving Sub-Fund”) is one of the sub-funds of the appellant.

Nomura Funds (“Nomura Luxembourg”) was another investment company incorporated in Luxembourg , which was also a UCITS, with Nomura Funds – China Opportunities (“Merging Sub-Fund”) as its sole sub-fund. The assets in the Merging Sub-Fund consisted entirely of securities listed on the Hong Kong Stock Exchange (“HK Securities”).

The appellant and Nomura Luxembourg proposed to merge the Receiving Sub-Fund and the Merging Sub-Fund in accordance with the Luxembourg law relating to UCITS (“Luxembourg UCITS Law”) and based on the following draft key terms set out in a written instrument titled “Common Merger Proposal” (“CMP”):

• the Merger would be made in accordance with the relevant articles of the Luxembourg UCITS Law;
• on the effective date of the Merger, the Merging Sub-Fund would transfer all its assets and liabilities to the Receiving Sub-Fund as a contribution in specie, in exchange for shares in the Receiving Sub-Fund to be issued to the sole shareholder of the Merging Sub-Fund, namely, Samba Capital and Investment Management Company, a company incorporated in Saudi Arabia; and
• the shares of the Merging Sub-Fund would be cancelled and Nomura Luxembourg would cease to exist.

According to Luxembourg UCITS Law, where the merging UCITS is established in Luxembourg, its merger with another UCITS is subject to the prior approval by the Luxembourg Commission for the Supervision of the Financial Sector (“CSSF”) which will determine if the draft CMP prepared by both parties to the merger meets the prescribed statutory conditions.

In March 2015, the CSSF notified Nomura Luxembourg that it had no objection to the Merger.  The Merger proceeded to take place in April 2015 and subsequently the assets of the Merging Sub-Fund, i.e. the HK Securities, were transferred to the Receiving Sub-Fund.  Nomura Luxembourg was later deregistered in May 2015.

2. The Dispute in the Present Case

The HK Securities were Hong Kong stock within the meaning of Section 2 of the Stamp Duty Ordinance (Chapter 117 of the laws of Hong Kong) (“SDO”), and the transfer of any beneficial interest in Hong Kong stock is chargeable to stamp duty under Section 4 and Head 2(3) of the First Schedule to the SDO.  The substantive issue in dispute was whether the Merger constituted a “transfer” of beneficial interest in Hong Kong stock within the meaning of the SDO.

The appellant sought stamp duty relief from ad valorem stamp duty (“AVSD”) under Section 27(5) of the SDO with regards to the vesting of HK Securities on the grounds that (i) there was no “transfer”, but only “transmission” of the HK Securities, which was effected by operation of the Luxembourg UCITS Law, rather than by the CMP; and (ii) no beneficial interest in the HK Securities passed under the CMP as the vesting of HK Securities amounted to a “transmission” or “universal succession” under Luxembourg UCITS Law.  Therefore, the CMP should not be a “stampable” instrument under Head 2(3) of the First Schedule to the SDO.  The appellant’s view was supported by two Luxembourg legal opinions (“Luxembourg Legal Opinions”) and the same were submitted to the Collector of the Stamp Revenue (the “Collector”).

The Collector disagreed with the appellant and held that the CMP was chargeable to AVSD because (i) the Merger operated as a voluntary disposition inter vivos; and (ii) the CMP was made for the purpose of effecting a transaction whereby the beneficial interest in the HK Securities passed.

3. The District Court Decision

The appellant appealed to the District Court, which upheld the Collector’s position on the grounds that (i) the CMP stated that the transfer of the assets and labilities to the Receiving Sub-Fund was to be done “in accordance with” (as contrast to “by operation of”) Luxembourg UCITS Law; (ii) the distinction between “transfer” (by voluntary acts) and “transmission” (by operation of law), if any, and in other contexts (e.g. companies law), is wholly irrelevant to the present case, and in particular, the Collector agreed that “transfer” for the purposes of Head 2(3) of the First Schedule to the SDO should be construed with its natural and ordinary meaning, i.e. “one parting with something to another”; and (iii) the Luxembourg Legal Opinions were inconsistent with each other and the second Legal Opinion lacked legal analysis and was not supported by the plain reading of the statutory provisions of the Luxembourg UCITS Law.  Hence, the CMP should be chargeable to stamp duty.

4. The Court of Appeal Decision

The Court of Appeal overturned the District Court decision and ruled in favour of the appellant.  The Court of Appeal held that the CMP is not itself a stampable instrument and there was no change in beneficial ownership of the HK Securities.  The Court of Appeal set out in the judgment each of the grounds of appeal raised by the appellant, and in summary:

Grounds 1 & 2:  Did the District Court err in law by rejecting the Luxembourg Legal Opinions? Alternatively, did the District Court err in law by interpolating its own interpretation of Luxembourg UCITS Law?

The Court of Appeal was of the view that the Luxembourg Legal Opinions were not inconsistent with each other and that the District Court erred for not accepting the Opinions.  In fact, the Court of Appeal held that the Luxembourg lawyers provided clear and cogent reasons in support of their view that the vesting of the HK Securities in the Receiving Sub-Fund was effected through the operation of transmission by law but not by the CMP.

Ground 3: Did the District Court err in law by finding there was no material distinction to be drawn between a “transfer” and a “transmission” in the context of the charge to AVSD?

Given the reasoning set out above, the Court of Appeal found that it was not necessary to deal with this Ground 3.  Nevertheless, for the sake of completeness, the Court provided its view that the Merger met the essential criteria of a universal succession by law despite the word “transmission” not being mentioned in the relevant articles of the Luxembourg UCITS Law.  It was clear to the Court that the vesting of the HK Securities in the Receiving Sub-Fund was by way of universal succession and as such was not subject to stamp duty under the SDO.

Ground 4: If there had been a “transfer” of the HK Securities, would the said “transfer” be exempt under Section 27(5) of the SDO by virtue of being a transfer under which no beneficial interest passes? 

Given the above conclusions, the Court of Appeal found that it was unnecessary to consider this Ground.

5. No interest on Refund of Stamp Duty

Another interesting point to note from the present case is that after the Court of Appeal ordered the Collector to refund the full amount of the stamp duty paid by the appellant, the appellant sought for interest on the refund of the duty paid at the rate of 8% per annum, accruing from the date of its payment to the Collector, based on (i) common law restitution that the Collector was unjustly enriched with the benefit and use of the paid stamp duty proceeds; and (ii) Section 49 of the District Court Ordinance (Chapter 336 of the laws of Hong Kong), pursuant to which the District Court may order simple interest on the debt or damages in respect of which a judgment is given by Court at the rate as it thinks fit.

The Court of Appeal rejected the appellant’s request and agreed with the Collector’s view that the appellant should not be entitled to interest on the refund as the statutory appeal regime under the SDO was not intended to award interest on any refunds for any payer of stamp duty who successfully challenged the Collector’s assessment on appeal.  In the present case, Section 14 of the SDO provided for the statutory regime under which a stamp duty payer can appeal against the Collector’s assessment.  The Court of Appeal was of the view that Section 14 of the SDO was intended by the legislature to provide an exhaustive appeal scheme setting forth the circumstances and terms under which payments of stamp duty wrongly assessed may be recovered.  The Court of Appeal noted that the legislature, as a matter of policy, had balanced the need to have the stamp duty paid to the public purse first despite an ongoing appeal with the prejudice that may be suffered by any payer of stamp duty in the event that it is successful in its appeal.  Accordingly, it could not be the intention of the legislature to allow for interest to be payable on any such recovered amounts.

6. Key Takeaway

This case has set a legal precedent in Hong Kong on the stamp duty implications arising from an overseas merger.  The case also confirms that “transfers” of Hong Kong stock by way of universal succession (i.e. the surviving entity inherits all assets and liabilities of the absorbed entity by operation of law, such that upon merger, the former would be treated as good as the latter in law) should not give rise to any charge to stamp duty.  Although the underlying assets being “transferred” in the present case were Hong Kong stock, it is expected that the same principle will also apply to immovable properties situated in Hong Kong.

[1] The doctrine of universal succession originates from Roman law.  In brief, the doctrine of universal succession provides that where the law of incorporation recognises a succession of corporate personality from one corporate entity to another, then the law of the forum will recognise both the changed status of the company, and the fact that the successor will inherit all rights and liabilities of its predecessor.  Since the doctrine was not in dispute in the present case, we will not further examine it in this Bulletin.

When raising funds for your company, there are certain steps that you can take both before and during the fundraising exercise in order to smoothen the process.  This article provides some general and practical guidance to start-up companies looking to raise funds as well as a brief overview of the key legal documents that you will likely encounter.

Be prepared

Before embarking on a fundraising round, it is important to get your ducks in a row.  As part of your preparations, you should have ready some basic core materials that any potential investor will typically expect to see during the due diligence stage such as:

• a pitch document/ presentation including information about the company and its business, products and/or services;
• historic performance data;
• the actual new product / invention;
• financial statements and recent management accounts of the company;
• biographies and credentials of key persons (including shareholders and directors) and employees involved in the company and an organisation chart; and
• information and documents relating to the company’s cap table, existing assets and liabilities, incorporation and corporate structure (including group chart).

Having a set of well-prepared core documents at the outset can help you in making a good first impression on investors and by expediting the due diligence process (more on this below).

Term sheet

A term sheet (also known as a letter of intent (LOI), memorandum of understanding (MOU) or heads of terms) is by no means mandatory (some just go straight to drafting the final contracts), but it does feature regularly in transactions as a means of recording the principal terms on which the investor(s) will, subject to the satisfaction of any mutually agreed conditions, invest in the target company.

Generally term sheets are not binding on the parties except for certain provisions such as confidentiality and the governing law clause.  Nevertheless, it is an important document because it sets the basis and tone for the negotiation and drafting of the definitive transaction documents and, once signed, the investor(s) may be reluctant to deviate from the agreed terms.  Therefore, you should consider having a lawyer review your term sheet before signing it.  In addition, you should also pay attention to any exclusivity clauses which could restrict your ability to approach or otherwise deal with other potential investors.

Due diligence

Due diligence is the process by which a third party investor obtains information and documents about a target company (including financial and legal information and documents).  Seasoned investors will usually kick-start the process by sending their preferred form of due diligence questionnaire to the company’s management and/or representatives who must then provide the requested information and documents in the agreed manner and, if applicable, by the agreed deadline. Generally speaking, the due diligence process becomes lengthier and more complex with the maturity of a start-up company. In contrast, due diligence should be a relatively straight-forward exercise with younger start-up companies.

As mentioned above, advance preparation of core documents can greatly assist in expediting the due diligence process.  Insofar as the legal due diligence is concerned, a start-up company which is incorporated in Hong Kong should be prepared to provide the following corporate information and documents when requested by an investor:

• certificate of incorporation;
• certificate of change of name;
• business registration certificate;
• articles of association;
• copy of the shareholders’ agreement relating to the company (if any);
• copies of the company’s registers of members, directors and transfers;
• copies of all documents filed at the Companies Registry in respect of the company since the date of incorporation (or in respect of a period specified by the investor);
• complete set of executed documents relating to previous financing rounds and share cap table (if any);
• copies of all convertible notes / bonds, options, warrants and other securities convertible into shares that have been issued by the company;
• copies of all loan / facility agreements, security, guarantee and finance documents;
• copies of employment contracts of key employees and option schemes and benefits (if any);
• copies of all material contracts of the company (e.g. client contracts and supply contracts);
• documents relating to any premises owned and/or leased by the company;
• documents relating to intellectual property owned and/or used by the company including licences and evidence of registration; and
• information regarding any pending or threatened litigation, arbitration or other proceedings involving or affecting the company or any of its assets.

The above list is not exhaustive and will be tailored to suit the circumstances including the potential investment amount, the sector in which your start-up company operates, and the maturity of your start-up company.

After you have responded to the investor’s due diligence questionnaire, you may receive further rounds of follow-up questions and requests.  You should answer them honestly and avoid withholding information for fear of scaring off the potential investor.  Most issues are capable of being resolved or managed from a risk allocation perspective.  For more complex requests concerning legal issues and documentation, a lawyer can assist you.

Involving a lawyer in the legal due diligence process is helpful when it eventually comes to negotiating the representations and warranties to be given by the company and/or the founders to the investor.

The transaction documents

If you have cleared the due diligence stage, the next step is to negotiate, agree and execute the transaction documents.  Each round of investment is usually labelled as a ‘Series’ (such as a Series A Investment) with the earliest rounds being labelled as ‘Seed Round(s)’. Institutional investors will usually invest in the equity of your start-up company (though there are different types of investment), which means that such institutional investors will become shareholders of your start-up company. In an equity investment involving a subscription for shares, the transaction documents will generally include a subscription agreement, a shareholders’ agreement (or, as the case may be, an amended shareholders’ agreement) and amended articles of association.

A subscription agreement, as the name suggests, is the contract that governs the terms for subscribing for new shares that will be issued by the start-up company. Such an agreement would contain key terms for the subscription such as subscription price and the number of shares that will be subscribed. A subscription agreement will also set out representations and warranties about the start-up company and, where relevant, its subsidiaries. Contractual warranties are statements made by a person (whether that person be a founder, the start-up company, or the relevant subsidiary) in favour of an investor (or the investors) about the conditions of the relevant company to which the warranties relate. The main purpose and effect of such warranties is to impose legal liability upon the warrantor making such statements and to provide the investor with a remedy if the statements made about the relevant company prove to be incorrect, and the value of start-up company thereby reduced (i.e. where the investor suffers a loss). As an investor will have direct recourse against the person who gives the warranties, it is not uncommon to request a subsidiary of the start-up company, that owns the relevant assets and operates the actual business, to be a party to the subscription agreement and to give warranties.

The shareholder rights of an institutional investor are usually different from (and usually better than) that of a founder. For instance, an institutional investor may request that certain critical matters (commonly known as reserve matters) can only be carried out with the consent of such investor. An investor may also ask for liquidation preference where their rights to a distribution of assets of the company will rank ahead of an ordinary shareholder (e.g. the founder). Different shareholder rights can be distinguished by different ‘classes’ of shares. Usually institutional investors’ shares that have better rights are called ‘Preferred Shares’. The rights of the shareholders are usually set out in the articles of the start-up company and the shareholders’ agreement. The model articles that are prescribed to a Hong Kong company at its incorporation do not provide for a separate class of shares, and would need to be amended in order to accommodate an investor’s request for different class rights. It is also important to amend the articles so that they are consistent with the terms of the shareholders’ agreement. A failure to do so may cast doubt on the enforceability of a specific right or obligation to the extent that there exists any inconsistency.

A lawyer can guide you through the entire fundraising process and advise you on the legal risks and implications of the terms of your transaction.  For more information on fundraising and how MinterEllison LLP can assist you, please contact George Tong or Caroline De Souza.

The Government introduced the Financial Reporting Council (Amendment) Bill 2021 (the “Bill”) into the Legislative Council for scrutiny on 21 July 2021.

At present, the Financial Reporting Council (“FRC”, which according to the Bill will be renamed as the “Accounting and Financial Reporting Council”) serves as the independent regulator of auditors of public interest entities (“PIE”) and exercises powers of inspection, investigation and discipline over PIE auditors and their responsible persons in relation to their engagements for listed entities. Meanwhile, practice units and certified public accountants (“CPAs“) are, in general, regulated by the Hong Kong Institute of Certified Public Accountants (“HKICPA“) in all other respects.

The Bill seeks to extend the FRC’s regulatory functions to cover all practice units and CPAs by transferring certain regulatory powers currently exercised by the HKICPA to the FRC. These include proposals to:

• empower the FRC to issue practising certificates to CPAs and register CPA firms, corporate practices and local PIE auditors; and
• expand the FRC’s current powers of inspection, investigation and discipline over PIE auditors to cover practice units and CPAs.

Under the proposed regime, the HKICPA will continue to discharge various functions under the oversight of the FRC, including registering individuals as CPAs, ascertaining qualification for registration as CPAs by conducting examinations, arranging for mutual or reciprocal recognition of accountants, setting requirements for continuing professional development, setting accounting, auditing and ethical standards, and providing training.

The Bill is currently being considered by the Bills Committee of the Legislative Council, which is inviting interested parties to make submissions on their views regarding the Bill, with a closing date of 3 September 2021. For further information about the Bill, please refer to the Legislative Council website.

Launch of Anti-Sexual Harassment Hotline

With the widespread development of the #MeToo movement and additional funding from the Government, the Equal Opportunities Commission (“EOC“) established the Anti-Sexual Harassment Unit (“ASHU“) in November 2020 to strengthen efforts in combating sexual harassment through prevention, research, policy advocacy, policy guidance and training.

On 25 January 2021, the EOC announced the launch of the Anti-Sexual Harassment Hotline (the “Hotline“) operated by the ASHU, the goal of which is to provide a first port of call service to the public with information on provisions of the law, advice on where to lodge complaints of sexual harassment and seek redress, and referral to counselling and therapy services.

The introduction of the Hotline is a clear indication of the Government’s increasing emphasis on combatting sexual harassment in the workplace.  As such, it is vital for employers to take all reasonable actions in line with the government’s initiative.

Employers should review, and where necessary, revise their internal policies and handbooks to ensure that adequate anti-harassment policies are in place to both prevent and handle sexual harassment in the workplace.  Such policies should be extended to protect non-employees, such as independent contractors (e.g. consultants or workers on secondment), interns and volunteers.  Regular training should be conducted on the policy to ensure that both management personnel and employees are well informed of the company’s anti-harassment policy, and are aware of the internal complaint-lodging platforms and investigation procedures.  Moreover, employers should handle with caution when imposing appropriate disciplinary sanctions (such as suspension or summary dismissal) against an employee under investigation or found responsible for harassment to ensure that any such sanctions are imposed in accordance with the law.  Other legal issues that employers should also be aware of include the proper collection and handling of personal data during the course of an investigation in accordance with the Personal Data (Privacy) Ordinance, as well as the safeguarding of the confidentiality and anonymity of the parties involved.

Sexual harassment complaints expose employers to potential legal claims, and may also have serious implications on an employer’s reputation, company culture as well as morale.  Employers should therefore ensure that sexual harassment complaints are promptly and properly handled with a proactive approach.