Piercing the Corporate Veil in Hong Kong

Hong Kong is a common law jurisdiction and follows the English law case Salomon v Salomon & Co Ltd [1897] AC 22. This landmark decision from the House of Lords established the concept of separate legal entity and limited liability of the shareholders. Under this principle, once incorporate under the Companies Ordinance (Cap. 622), a company is a separate legal entity distinct from its shareholders, and individual shareholders are not liable for the company’s debts.

However, a Hong Kong court may pierce the corporate veil and look behind the company’s legal personality, by treating a company as identical with the person(s) who control the company. In this case, the Hong Kong court will go behind the company’s status as a separate legal entity distinct from its shareholders, and will consider who are the persons directing and controlling the activities of the company, as shareholders or as agents.

Piercing the corporate veil will usually be done by Hong Kong courts in limited cases where the corporate structure is used as a vehicle to evade legal obligations or for the conduct of criminal activities or to perpetrate fraud.

In Hong Kong, the mere fact that a company is a façade or puppet of its shareholders to insulate them from legal liability is not objectionable. However, where the company is used by the shareholders as a façade or puppet for some illegitimate purpose, such as to perpetrate fraud or evade legal obligations and liability, the Hong Kong court will be prepared to lift the corporate veil.

In Hong Kong, the doctrine of lifting the corporate veil seeks to prevent the abuse of corporate legal personality in circumstances where a company is used to perpetrate fraud or evade legal obligations and liability. However, the mere fact that a company is a façade or puppet of its shareholders to insulate them from legal liability is not objectionable. It is only if it can be evidenced that the company is used by the shareholders as a façade or puppet for some illegitimate purpose, such as to perpetrate fraud or evade legal obligations and liability, that the Hong Kong court will be prepared to lift the corporate veil.

In Hong Kong, the principle of separate legal personality established in the case Salomon v Salomon & Co Ltd [1897] AC 22 is a fundamental principle of corporate law. Under this principle, a company has its own legal personality separate from the legal personality of its shareholders and related companies.

However, this principle is not recognised without exception. Indeed, the doctrine of lifting the corporate veil seeks to prevent the abuse of corporate legal personality in circumstances where a company is used to perpetrate fraud or evade legal obligations and liability. In such circumstances, a Hong Kong court can disregard the principle that the company is an independent legal entity and impose the company’s liabilities on the persons who control the company, to avoid abuse.

If shareholders use their limited liability merely to exempt themselves from their personal debts and obligations, a Hong Kong court may intervene by piercing the corporate veil. The doctrine of lifting the corporate veil allows Hong Kong courts to disregard the separate legal personality of a company in circumstances where a company is used to evade legal obligations and liability. If the doctrine is applied, the shareholders may be held personally liable for the company’s debts or obligations. To lift the corporate veil, there must be clear evidence of fraudulent or improper purposes. As illustrated in the case China Ocean Shipping Co v Mitrans Shipping Co Ltd [1995] 3 HKC 123, the court will not pierce the corporate veil where shareholders simply use a limited liability company as a vehicle of business to minimise the risk of business.

The doctrine of lifting the corporate veil may be applied in the case of a so called ‘phoenix’ business, that is where an insolvent company is abandoned by the shareholders and directors and eventually wound up, but the business is transferred to a new private limited company with the same directors, incorporated to defeat creditors and evade liability for outstanding debts. Although the cases where Hong Kong courts pierce the corporate veil are rare, the case Lee Sow Keng Janet v Kelly McKenzie Ltd and Ors [2003] HKCU 909 provides an illustration. In this case, following her dismissal, an employee obtained judgments against her former employer for unpaid commissions and emoluments. The judgments were not satisfied and the former employer was wound up. The employee subsequently found out that a new company was incorporated by two individuals who were directors and shareholders of her former employer. She alleged that the former directors and shareholders diverted her former employer company’s goodwill and business to the new company, rendering her former employer unable to pay its debts. The court found that the new company was a vehicle used by the two former directors and shareholders to evade liability for the judgment debt owed to the employee. The Hong Kong District Court lifted the corporate veil and held the new company and the two individuals jointly and severally liable for the judgment debt.

In the case Liu Hon Ying T/A United Speedoc Co v Hua Xin State Enterprise (Hong Kong) Ltd and Another [2003] HKCU 706, the plaintiff entered into a profit-sharing agreement with Company A, who failed to honour the agreement, leading to a judgment against Company A. Company A’s business, including its staff, premises, equipment and customers, was gradually transferred to Company B, and later to Company C. The Hong Kong High Court found that the ultimate controller of Company A and Company B orchestrated the transfer of business to evade liability owed to the plaintiff. The corporate veil of Company A and Company B was lifted by the court, and Company B and Company C were held liable for the outstanding judgment debt owed by Company A to the plaintiff.

It is market practice that a controlling shareholder be entitled to a seat on the board of directors of the company. As a director, the controlling shareholder will owe duties to the company, including the duty to act in good faith in the best interests of the company as a whole, the duty to exercise powers for proper purposes and the duty not to place itself in a position of conflict of interest. Even if the controlling shareholder is not formally appointed as board member, it may be disciplined in case it can be evidenced that the controlling shareholder acted as a shadow director of the company.

In the case Cyberworks Audio Video Technology Ltd (in compulsory liquidation) v Mei Ah (HK) Co Ltd [2020] HKCU 743, the Hong Kong Court of First Instance held that a holding company can be held to be a shadow director of a subsidiary where it made the major policy decisions, exercised close control over the subsidiary’s management and financial affairs, and where the directors of the subsidiary were accustomed to act in accordance with the holding company’s directors or instructions. However, the fact that decisions made by the subsidiary’s directors require the sanction or approval of the holding company as shareholder does not automatically make the holding company a shadow director, as long as the subsidiary’s directors exercise their own independent discretion and judgment in making decisions.

If a shareholder is held to be a shadow director of a company, the shadow director will owe the same fiduciary duties to the company as a de jure director validly appointed in accordance with the company’s articles of association. These duties include the duty not to place itself in a position of conflict of interest and to act in good faith in the best interests of the company. A shadow director who prioritises personal interests over the company’s or creditors’ interests would be in breach of its fiduciary duties. If found liable, the shadow director may be liable to the company for equitable compensation for the loss and damage suffered by the company due to the breach of fiduciary duties.

In addition, a minority shareholder may present an unfair prejudice petition to the court if the company’s affairs have been conducted in a manner unfairly prejudicial to the interests of the shareholders generally or to the interests of some minority shareholder(s). The court has wide discretion to make any order that it thinks fit for giving relief, such as a restraining order or ordering that the majority shareholder buys out the minority shareholders’ shares.

Under the principle of separate legal personality established in the case Salomon v Salomon & Co Ltd [1897] AC 22, a company is a separate legal entity distinct from its shareholders, and individual shareholders are not liable for the company’s debts. However, in circumstances where a company is used to evade legal obligations and liability, the courts may lift the corporate veil and the shareholders may be held personally liable for the company’s debts or obligations.

For instance, in the case Lee Sow Keng Janet v Kelly McKenzie Ltd and Ors [2003] HKCU 909, the Hong Kong District Court lifted the corporate veil. In this case, following her dismissal, an employee obtained judgments against her former employer for unpaid commissions and emoluments. The judgments were not satisfied and the former employer was wound up. The employee subsequently found out that a new company was incorporated by two individuals who were directors and shareholders of her former employer. She alleged that the former directors and shareholders diverted her former employer company’s goodwill and business to the new company, rendering her former employer unable to pay its debts. The court found that the new company was a vehicle used by the two former directors and shareholders to evade liability for the judgment debt owed to the employee. The court lifted the corporate veil and held the new company and the two individuals jointly and severally liable for the judgment debt.

In addition, in case a shareholder holds a seat at the board of directors or can be held as a shadow director, the director will owe duties to the company. If the company becomes financially distressed and formal insolvency proceedings become likely (the twilight period), the directors’ duties to act in good faith in the interests of the company as a whole switch from being owed to the shareholders as a whole to being owed to the creditors as a whole. The directors must preserve the company’s value to maximise the return to creditors.

In an insolvency context, de jure and shadow directors who breach their duties may:

• be ordered to contribute personally to the company’s funds to increase the amount available to creditors: as illustrated in the case Cyberworks Audio Video Technology Ltd (in compulsory liquidation) v Mei Ah (HK) Co Ltd [2020] HKCU 743, if the breach of fiduciary duties resulted in the company’s insolvency or exacerbated its financial difficulties, the shadow directors can be held liable for the shortfall in the company’s assets caused by their breach;
• face personal liability pursuant to the Companies (Winding Up and Miscellaneous Provisions) Ordinance (Cap. 32), which sanctions misfeasance, fraudulent trading and voidable transactions;
• be disqualified from being involved in company management.

Hong Kong recognises the notions of de facto and shadow directors:

• a de facto director is a person that acts as and claims to be a director, although that person has not actually been appointed as director;
• a shadow director is a person in accordance with whose directions or instructions the directors or a majority of the directors of the company are accustomed to act, although that person has not actually been appointed as director.

Both a de facto director and a shadow director owe statutory and common law duties to the company as a de jure director validly appointed as director. Directors’ duties include the duty to act in good faith in the best interests of the company as a whole, the duty to exercise powers for proper purposes and the duty not to place itself in a position of conflict of interest.

Where a company becomes financially distressed and formal insolvency proceedings become likely (the twilight period), the directors’ duties to act in good faith in the interests of the company as a whole switch from being owed to the shareholders as a whole to being owed to the creditors as a whole. The directors must preserve the company’s value to maximise the return to creditors. In an insolvency context, directors who breach their duties may:

• be ordered to contribute personally to the company’s funds to increase the amount available to creditors: as illustrated in the case Cyberworks Audio Video Technology Ltd (in compulsory liquidation) v Mei Ah (HK) Co Ltd [2020] HKCU 743, if the breach of fiduciary duties resulted in the company’s insolvency or exacerbated its financial difficulties, the shadow directors can be held liable for the shortfall in the company’s assets caused by their breach;
• face personal liability pursuant to the Companies (Winding Up and Miscellaneous Provisions) Ordinance (Cap. 32), which sanctions misfeasance, fraudulent trading and voidable transactions;

be disqualified from being involved in company management.

In Hong Kong, the principle is that each group company incurs its own liabilities as a separate legal entity. The fact that a subsidiary is wholly owned by its holding company is not sufficient to allow a court to pierce the corporate veil.

In the case China Ocean Shipping Co v Mitrans Shipping Co Ltd [1995] 3 HKC 123, the Hong Kong Court of Appeal recognised that a court cannot lift the corporate veil merely because it considers it just to do so. A Hong Kong court will only be prepared to pierce the corporate veil where a subsidiary is used merely as a façade or instrument of the holding company to conduct criminal activities, to evade legal liability or to perpetrate fraud. In such circumstances, a Hong Kong court may pierce the corporate veil and treat the subsidiary as a mere agent of the holding company, and allow claims to proceed directly against the holding company instead of its subsidiary. The holding company would then be liable for the conduct of its subsidiary.

In the case Winland Enterprises Group Inc v Wex Pharmaceuticals Inc & Anor [2012] 5 HKC 494, the Hong Kong Court of Appeal emphasized that the use of a subsidiary as a façade or as a puppet of the holding company by itself, without finding of illegitimate purpose behind the façade, does not justify the lifting of the corporate veil. In addition, the court found that undue emphasis should not be placed on the fact that companies of a same group share common management, common directors and common staff, with the subsidiary being one economic unit with its holding company. The lifting of the corporate veil would only be justified if a subsidiary is used as a façade in conjunction with some illegitimate purpose, such as to evade legal obligation and liability.