Business and Commerce
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Business and Commerce



I. Setting up a small or medium-sized business in Hong Kong

A. Types of business organisation – sole proprietorships, partnerships and limited companies

In general, there are three ways to start a small or medium-sized business in Hong Kong : starting a new business, buying an existing business or buying a franchise.

If you choose to start a new business, you should conduct feasibility studies on demand (including customer profiles, buying habits, products and pricing), market share and competition, projected sales and estimated expenses (both fixed and variable).

If you are thinking of buying an existing business, then you should note the following:

  • You should be aware of the business assets (such as buildings, equipment, personnel and inventory, reputation and goodwill), sales revenue (established product and market), costs, debts and profits and losses of the company that you plan to purchase.
  • Care must be taken with the negotiations and purchase agreement, which should include escape clauses that cover financing, the inspection of all records, obtaining the necessary licences and rights and any liability that is to be assumed. You should appoint a lawyer go through the purchase agreement.

Buying a franchise is perhaps the fastest and easiest way to start trading, and carries the additional advantages that the product or service is usually well known and the market has been established. However, you should be aware of the following issues:

  • Training, advice regarding location, advertising and promotion, and probably financing services are usually available from the franchiser.
  • You must be careful of any hidden costs such as royalty arrangements (franchise fee) and supply agreements for equipment and materials, and should be aware of the potential for loss of control over management procedures. You should appoint a lawyer go through the franchise agreement.

1. What are the characteristics of sole proprietorships, partnerships and limited companies? What are the advantages and disadvantages of each type of business?

Sole proprietorships

A sole proprietorship is a business that is run by a single individual who makes all the decisions, although the proprietor may engage employees. The sole proprietor is personally entitled to all of the profits and is responsible for any debts that the company incurs.

Advantages of forming a sole proprietorship

  • Sole proprietorship is the simplest and most flexible business structure.
  • The sole proprietor has total control and full decision-making power over policies, profits and capital investment.
  • It is easy to close down the business.
  • Profits from the business will be taxed at the sole proprietor's marginal tax rate, which may be lower than the corporate (limited company) tax rate. Also, business losses can be offset against the other income of the proprietor (for more details on profits tax please go to another topic – Taxation).

Disadvantages of forming a sole proprietorship

  • Risks that are taken by the sole proprietor may result in personal bankruptcy.
  • The death or prolonged illness of the sole proprietor will lead to the end of the business.
  • Due to the limitations of a one-person business, the sole proprietor may not be able to raise additional capital from outside sources to expand the business.

Partnerships

A partnership is the relation which subsists between persons carrying on a business in common with a view of profit. The law relating to partnership is codified under the Partnership Ordinance, Cap. 38.

However the relation between members of any company or association which is (a) registered as a company under any Ordinance relating to the registration of joint-stock companies; or (b) formed or incorporated by or in pursuance of any other Ordinance, or any enactment or instrument is not a partnership within the meaning of the Partnership Ordinance.

Unlike a limited company, each partner in a partnership is personally liable for the acts of the other partners and for all of the debts of the company. On the other hand, all partners are entitled to share in the profits of the company equally unless they agree otherwise.

The transfer of interests in the company to existing or new partners may be carried out in accordance with the Partnership Agreement or other agreement that is entered into by all of the partners. In practice, there is little market for the transfer of the interests of a partnership to public investors.

The name of a partnership can be formed by combining the names (usually the surnames) of the partners. If there are many partners, then they may name the company "XX Company" or "XX & Co". However, they must not include the words "limited" or "company limited",as this is an offence that carries a fine. Note that a partnership can also use a business name or trade name (for example, XX Café) in addition to the partnership name.

It is important for the partners to prepare a Partnership Agreement that contains provisions for profit sharing, control and the settling of managerial and policy disputes. You are strongly recommended to appoint a lawyer to prepare the Partnership Agreement.

Advantages of forming a partnership

  • It is easier to raise finance as a partnership than as a sole proprietor.
  • Partners pay tax on their share of the partnership profits at their respective marginal tax rates, and their share in the partnership losses can be offset against their other income (for more details on profits tax, please go to another topic – Taxation).

Disadvantages of forming a partnership

  • Partners do not have the benefit of limited liability.
  • The participation of all the partners is needed for most legal transactions, which can result in disputes among the partners.
  • The partnership will be dissolved when a partner dies or becomes bankrupt, unless the Partnership Agreement states otherwise ( section 35 of the Partnership Ordinance).

Limited Companies

A limited company is a company that is registered (or incorporated) in accordance with the new Companies Ordinance (Cap. 622) ("the New CO"), which came into effect on 3 March 2014.

Different types of companies are defined under sections 7 to 12.

The characteristics of a company that is limited by shares can be described as follows:

  • A limited company has a separate legal status that allows it to enter into contracts, to sue or be sued, to own property and to borrow money in its own name.

  • Small and medium-sized businesses are usually run as private limited companies, rather than public limited companies. A private limited company cannot offer shares to the public at large but may have up to 50 shareholders whose right to transfer their shares is limited (section 11 of Cap. 622).

  • A private limited company must have a least one director (section 454 of Cap.622). Section 457 restricts corporate directorship by requiring a private company (other than one within the same group as a listed company) to have at least one director who is a natural person.

  • Under the New CO, the memorandum of association (“MA”) has been abolished for all companies. For existing companies (i.e. companies formed under the old regime), the conditions in the memorandum are deemed to be contained in the articles of association, except for conditions relating to authorised share capital and par value, which are regarded to be deleted for all purposes (section 98 of the New CO).

  • For existing companies (i.e. companies formed under the old regime), the conditions in the memorandum are deemed to be contained in the articles of association, except for conditions relating to authorised share capital and par value, which are regarded to be deleted for all purposes (section 98 of the New CO).

  • Companies to be incorporated under the New CO are required to have certain mandatory articles of association. For instance, the company name (section 81 of the New CO); details of the liabilities or contributions of the members(sections 83 and 84 of the New CO).

  • Company directors must declare any actual or potential conflicts of interest in relation to the company to the board of directors. Nevertheless, company directors should try to avoid dealings which might have conflicts of interest in relation to their company.

  • A limited company must keep minutes of the proceedings of all general meetings and meetings of the board of directors at its registered office.

  • Certain companies are allowed to prepare simplified financial and directors’ reports. Companies which are qualified for simplified reporting are referred to in the New CO as companies “falling within the reporting exemption”. Sections 359 to 366 and Schedule 3 set out the qualifying conditions for companies to prepare simplified financial and directors’ reports.

  • A limited company must not be registered without “limited” as the last word of their English name or “有限公司” of their Chinese name (section 102 of the New CO). However, the Registrar, may, by licence, exercise power to dispense with the use of the word “limited” or “有限公司” (section 102 of the New CO).

  • It is prudent to prepare a Shareholders Agreement that covers the disposal or transmission of shares, the settling of managerial and policy disputes and the protection of interests of minority shareholders. You should appoint a lawyer to prepare this Agreement.

Advantages of forming a limited company

  • The most obvious advantage is that the liability of the shareholders for the company's debts is limited to the amount of their respective shareholding. The liability of the company as a whole is limited to its aggregate issued share capital and its assets.

  • An individual can be both sole shareholder and sole director, and hence have total control and full decision-making power over the company's policies and profits.

  • It is easy to transfer the interests of the business by transferring shares to existing or new shareholders without interfering with the corporate structure by signing an instrument of transfer and a bought and sold note (based on the latest audited balance sheet and management accounts) on which the requisite stamp duty has been assessed and paid, provided that the approval of the company is obtained and the relevant rules that are set out in the company's Articles of Association are followed.

  • The continuity of the business is not affected by the death, bankruptcy, retirement or mental disorder of any shareholder.

Disadvantages of forming a limited company

  • A limited company must pay profits tax at the corporate rate, which is higher than the rate for individuals paid by sole proprietors and partnerships (for more details on profits tax, please go to another topic – Taxation).

  • Shareholders cannot withdraw their capital at will from the company (unless they sell their shares to others).

  • The transfer of shares in a private limited company may be restricted by the right of pre-emption (if any) in the Shareholders Agreement, which states that the existing shareholders must be given the first option to buy shares. The Companies Ordinance also gives the board of directors the right to veto potential new shareholders unless the directors do so in bad faith.

  • Due to the nature of limited liability, many creditors of private limited companies will ask for personal guarantees or bank guarantees from shareholders or directors of such companies, and those shareholders/directors will then have to bear the debt personally if the company is unable to pay it.

  • It is obligatory to publicly disclose the company’s Articles of Association, registered office address, details of shareholders, directors….at the Companies Registry.

    • In order to protect personal data, the New CO introduces the concepts of “withheld information” and “protected information” [Note: The provisions relating to “withheld information” and “protected information” have not yet come into effect. Check with the Companies Registry for latest updates].

    • Section 49 allows the Registrar to withhold from public inspection the usual residential address of a current or former director or a current or former company secretary and the full ID number of any person in specified categories of documents which have been registered with the CR upon application by the persons concerned (“withheld information”).

    • Section 54 provides that the usual residential address of a director and the full ID number of any person in specified categories of documents registered with the CR after commencement of the New CO will not be made available for public inspection (“protected information”).

    • The director’s correspondence address and the partial ID number of the person will be shown on the Companies Register for public inspection.

  • There are prolonged and costly procedures for dissolving a limited company after the business has ceased or if it fails (further details can be found in the Bankruptcy and Winding-up topic).

  • Potential conflicts of interest may arise among the company, its shareholders and its directors.

  • Minority shareholders may not have effective involvement in or control over decision-making or management.

  • A company director may have to take personal liability for a contract that is drawn up in the company's name but subsequently proves not to be enforceable against the company (if a potential director signed a contract before the date of formal incorporation of the company, for example). Directors may also be personally liable for claims if they act negligently in the performance of their job duties.

2. How can I set up a sole proprietorship, partnership or limited company? Do I have to obtain a business registration certificate from the Inland Revenue Department and register with the Companies Registry before commencement of business?

Business Registration

The Business Registration Ordinance (Cap. 310 of the Laws of Hong Kong) requires every person who runs a business in Hong Kong, whether it is a sole proprietorship, partnership or limited company, to register the business at the Inland Revenue Department within one month from the date of commencement of business, and to display a valid Business Registration Certificate at the place of business. For more information about the application procedure, the relevant charges and a sample application form and certificate, please visit the website of the Inland Revenue Department.

Incorporation of a limited company

In addition to obtaining a business registration certificate, a company which applies to be incorporated under the New CO, they need to submit their incorporation form and articles of association.

Any one or more persons may form a company by signing the articles of association of the company intended to be formed and delivering to the Registrar of Companies (the “Registrar”) for registration a copy of the articles in the same form as those signed by the founder members together with a completed incorporation form.

The agreement by the founder members to form a company and take up membership of the company to be formed, previously contained in the memorandum of association, are now contained in the articles (section 67 of the New CO).

For more information about how to register or incorporate a limited company, please visit the website of the Companies Registry or call its hotline at 3142 2822.

It is important to note that a limited company only comes into existence on the date on which its Certificate of Incorporation is issued by the Companies Registry.

Rather than setting up a new limited company, you can purchase a ready-made limited company (also called a "shelf company") from a company formation agent. After paying the prescribed service charge, the agent will arrange to transfer the shares of the selected company to you (and any other shareholders who may be involved) and handle the relevant documentation. You are recommended to consult a certified accountant or qualified solicitor before you buy a shelf company.

B. Location of business premises, licences, documents of guarantee and human resources matters

In deciding whether to lease or buy office or retail premises for your business, you should consider the cash or credit that is available and the potential return on the investment. Note that for taxation purposes, any rent that is paid to lease a premises, or the capital costs that are incurred in purchasing, maintaining and repairing a premises can be deducted from the income of the business.

If the business premises are leased, then attention should be paid to the following:

  • Whether the rent is fixed or based on a percentage of sales (also called "turnover rent", which means that the rent will be calculated at a specified percentage of the sales turnover).
  • Whether the tenant has the right to sublet if the business is to be downsized or closed down (thereby minimising the financial loss involved).
  • Whether there is any option to renew the lease and how any rent increase is to be determined.
  • Whether there are any restrictions on the use of the premises.
  • Whether there is any right of access to shared facilities.

The advice of a lawyer should be sought in relation to these matters. Please also refer to the Landlord and Tenant topic for basic information about tenancy law.

You must also take out appropriate insurance against occupiers' liability. The Occupiers' Liability Ordinance imposes a duty of care on you (as the owner or occupier of the premises) in relation to injuries to any visitors, including guests, workmen, and people who deliver goods to your premises.

1. Do I have to obtain a licence(s) from the Government for my business?

The following list contains some examples of the types of business that require a licence. You may have to obtain other statutory licences in relation to your particular business area.

  • An appropriate food licence must be obtained from the Licensing Office of the Food and Environmental Hygiene Department to run a general restaurant, light refreshment restaurant, seafood restaurant, bakery, cold store, factory canteen, food factory, fresh provisions shop, frozen confectionery factory, milk factory or "siu mei" and "lo mei" shop.
  • A liquor licence or club liquor licence must be obtained from the Liquor Licensing Board to sell, advertise or expose for sale, supply or possess for sale and supply liquor. More information on food or liquor licensing is available from the website of the Food and Environmental Hygiene Department.
  • A certificate of compliance and a licence must be obtained from the Office of the Licensing Authority of the Home Affairs Department to run a club with bedspace, hotel, guesthouse or karaoke establishment. More information is available from the website of the Home Affairs Department.
  • Registration with the relevant professional bodies is required for a company that provides professional services in areas such as law, accounting or insurance brokerage.
  • All motor vehicles that are used by business organisations of any form must be registered with the Transport Department. More information is available from the website of the Transport Department.
  • Factory registration with the Trade and Industry Department is necessary for factories that manufacture products that require a certificate of origin. More information is available from the website of the Trade and Industry Department.
  • Approval must be obtained from the Immigration Department to employ foreign workers (please go to the Immigration topic for further information).
  • A licence must be obtained from the Education and Manpower Bureau to run an educational institute or tuition classes. More information is available from the website of the Education and Manpower Bureau.
  • A licence must be obtained from the Commissioner of Customs and Excise to manufacture optical discs. More information is available from the website of the Customs and Excise Department.
  • Business registration – please refer to the relevant question and answer.

2. Are there any legal stipulations about human resources management that apply to running a business in Hong Kong?

Some of the important legal matters concerning human resources management are laid out in the following answer.

Labour law

The common law (case law) and various statutes (such as the Employment Ordinance, the Trade Unions Ordinance and the Labour Relations Ordinance) give employees the following rights and obligations:

  • Implied rights concerning rest days, holidays, maternity leave, dismissal with notice or wages in lieu of notice, severance and long service payment. Implied rights are rights that are granted to employees even if they are not expressly stated in their contract of employment (please refer to the Employment Disputes topic for further details).
  • The obligation to take reasonable care when performing their job duties, to be honest to their company, to be obedient to relevant job commands and to maintain the confidentiality of the company's restricted information.

Mandatory Provident Fund and Occupational Retirement Schemes

All employers are required to join a mandatory provident fund or occupational retirement scheme for their employees under the Mandatory Provident Fund Schemes Ordinance and the Occupational Retirement Schemes Ordinance. Employers must make contributions to the funds in accordance with the relevant rules. More information is available from the website of the Mandatory Provident Fund Schemes Authority.

Anti-discrimination policy

Care should be taken when offering employment and formulating human resources policy to avoid violation of the provisions of the Sex Discrimination Ordinance, the Disability Discrimination Ordinance and the Family Status Discrimination Ordinance. More information is available in the Anti-discrimination topic.

Vicarious liability

Employers may be liable for the negligence of their employees. For example, if an employee negligently damages a customer's property, then the employer may be liable to pay compensation to that customer. Appropriate insurance should be taken out to cover these risks.

Protective industrial and occupational safety law

The Factories and Industrial Undertakings Ordinance gives the Commissioner for Labour the authority to make detailed industrial safety rules. It is a criminal offence for an employer to terminate, threaten to terminate or in any way discriminate against an employee who speaks out against the working, health and safety conditions in their factory. Non-industrial employers also have a general common law duty to provide a safe working environment for their employees. They must also insure against their potential liability for their employees under the Employees' Compensation Ordinance (a no-fault accident compensation scheme that is financed by a compulsory levy imposed on all employers in Hong Kong , but that does not cover independent contractors or outworkers). More information is available in the Employment Disputes topic.

Insurance

Employers must take out business insurance policies that cover employees compensation, fire and all risks (or general liability), product liability, professional indemnity, motor vehicles (third-party risks) and group healthcare, etc.

3. What are "personal guarantees" and "bank guarantees"? When will I be required to provide these documents to other parties in business transactions?

In a business transaction, if a party (e.g. the buyer) is either unwilling or unable to pay in advance, or if that party is a limited company and its creditworthiness is unknown, then the other party (e.g. the seller) may require some form of guarantee of payment. The person who gives the guarantee is called the "guarantor" (or sometimes called the "surety").

The following two examples illustrate the differences between a personal guarantee and a bank guarantee.

Personal Guarantee

Party A (a limited company) has entered into a contract with Party B. Due to Party A's limited liability, Party B requires Party A's shareholders or directors to sign a personal guarantee of payment. By signing this guarantee, the shareholders or directors (the guarantors) will be personally liable for the debt or compensation if the company fails to pay.

Bank Guarantee

Party A has entered into a contract with Party B. Party A does not pay in advance, and therefore Party B requires Party A to provide a bank guarantee to secure the payment. Party A obtains the guarantee from a bank and provides it to Party B. If Party A subsequently fails to pay, then the bank will be liable for the debt or compensation, and will have to pay Party B.

You should note that if you have signed a personal guarantee as a guarantor, it will be difficult for you to avoid liability from that guarantee unless you can prove that you were misled or forced to sign the document, which is not easy to establish.

In respect of bank guarantee, you may have to pay a deposit in order to obtain a guarantee from a bank. Alternatively, the bank may ask you to sign a separate personal guarantee, which means that if the bank pays any debt or compensation as a result of the bank guarantee, the bank will then seek the same amount from you (or your company).

Before you sign any document of guarantee, you must scrutinise all of the terms and conditions, and, if possible, try to consult a lawyer beforehand.

C. Making a business contract

You will probably have to draw up and sign many contracts as part of your company's daily business transactions. Some of the most common business contracts include:

  • sale and purchase agreements for premises;
  • lease/tenancy agreements for premises;
  • hire-purchase or lease agreements for equipment;
  • employment contracts;
  • insurance contracts;
  • sales contracts with customers;
  • procurement contracts with suppliers;
  • financing contracts (including loan agreements, mortgages and guarantees).

A contract can be made orally or in writing. In practice, many consumer contracts are made orally (see Consumer Complaints), but some contracts are required by law to be made in writing. Examples of such contracts include cheques, insurance policies, the transfer of shares of registered companies, hire-purchase agreements, leases and agreements for the sale and purchase of real estate.

For business transactions, it is always preferable that contracts are entered into in written form. If the contract involves a substantial amount of money, you should consult a lawyer before signing.

1. What are the basic requirements for making a valid contract?

A valid contract normally contains the following five basic elements.

(i) Intention to create legal relations

It is generally presumed that in a commercial transaction, the contracting parties must have the intention to create a legally binding contract. In other words, if you have signed a contract for business-related activities, then you will be able to sue the other party if that party does not fulfil the contractual provisions, and vice versa.

This presumption can only be rejected if the parties expressly state that they do not intend to make a legally binding contract. Sometimes you may see the words "subject to contract" printed on a document. These words have the legal meaning that the document is not a contract, and that all of the contents will be bound by a subsequent contract (if the parties sign that contract). A party that is acting “subject to contract” can withdraw from the negotiation at any time before the contract is concluded. In case of dispute, the burden of proof that the intention was to create a binding contract rests on the person who wishes to rely on the contract.

You may also come across the words "without prejudice". These two words are used to indicate that nothing that is written in the relevant document is legally binding.

(ii) Offer

An offer is an expression of readiness to do something which, if followed by the unconditional acceptance of another person (see item (iii)), results in a contract. For example, if a company tells you that it will sell you 100 boxes of red wine at the price of $100,000, that company is making you an offer.

If no time limit is specified, an offer is valid for a reasonable length of time before the offeror (the person who makes the offer) can revoke or cancel it. To avoid potential disputes, however, the offeror should specify the deadline for the acceptance of an offer.

It is also important to note that the offeror cannot take silence as a form of acceptance. This means the offeror cannot say "If I do not hear from you within 10 days, then I will assume that you have accepted my offer and will pay for the product".

An offer must be distinguished from an "invitation to treat", which merely invites other people to make offers but is not in itself an offer. Examples of invitations to treat include: invitations to tender, displaying goods on the shelves of a shop, and the advertisement of goods or services in newspapers or on television (unless it is expressly stated that the advertisement is an offer).

(iii) Acceptance

There is no contract unless and until the offer is accepted by the person to whom the offer is addressed (sometimes called "the offeree"). Acceptance is normally made orally or in writing, but if the contract allows that the acceptance and performance of contractual duties are to be carried out simultaneously, then acceptance can also be made by conduct. For example, when a supplier receives your cheque, that supplier may immediately deliver the goods to you without saying or writing anything.

It is recommended that both of the contracting parties clearly specify and agree to the method of acceptance.

If the method of acceptance is not specified by the offeror, then the following rules may apply.

  • Postal Rule – If it is reasonable to use the post for the offer and acceptance process, then the contract is formed at the time of posting the letter of acceptance, even if the letter is lost in the post.
  • Receipt Rule – When an acceptance is sent by fax, it is deemed to be valid when the message is received, even if the offeror does not in fact read the fax immediately. This rule also applies to e-mail messages (see section 17 and section 19 of the Electronic Transactions Ordinance).

Another important point to note is that a conditional (or partial) acceptance is only a "counter-offer" and does not constitute a valid contract. In other words, if the person to whom the offer is addressed only accepts some of the terms or proposes some new terms, then that person is not accepting the offer but is making a new offer to the other party. In the business world, there may be a series of counter-offers before a final acceptance comes out.

(iv) Consideration (benefit given to the other party)

In contract law, consideration means a detriment to the person who made the promise or a benefit conferred on the other party, both of which are measurable in economic terms. Money, goods and services are the most common examples of consideration. You should note that consideration need not be adequate, which means that if the seller or service provider is contracted to sell a product or service at a price that is below the market price, then that seller or provider cannot subsequently go to court to claim the shortfall.

A promise of a gift is not enforceable in law because of the lack of mutual exchange of consideration (the recipient does not have to pay anything in return). An exception to this rule is when a contract is executed in a specific form called a "deed", in which case the recipient may not be required to give consideration to the other party.

(v) Capacity (the authority or ability to make contracts)

Persons under the age of 18 (called "minors") and lunatics (mentally disordered or intoxicated persons) do not have the capacity to enter into contracts. Any contracts that are made by persons who are lacking in legal capacity are voidable: that is, the party who needs the protection can seek to avoid the contractual liability.

An exception to this rule arises when the parties enter into a contract for "necessaries" (a legal term for "necessities", which means the goods or services that are suitable to the condition of life of a minor and to that minor’s actual requirements at the time of the sale and delivery, such as clothes or food). A minor who fails to pay for "necessaries" can be sued by the seller.

2. Other than the essential elements as mentioned on question 1, what are the other important matters that the parties should note when making a contract?

Privity of contract

Normally speaking, a third party cannot sue or be sued regarding a contract, and only the parties to a contract can rely on the contract terms to take legal action. However, there are some exceptions to this principle, such as:

  • If the contract is signed by an agent or representative on behalf of one of the parties, then that agent (who is a third party) may also bear the liability if he or she acted fraudulently or signed the contract without authorisation.
  • It is common in insurance contracts to subrogate the insured person's rights to the insurance company. For example, if someone injures you and the insurance company subsequently pays your claim for the injury, then that insurance company (as a third party) can take over your legal rights to claim against the wrongdoer.

Express or implied terms of a contract

Generally speaking, the contracting parties are free to agree on the terms of a contract (unless such terms are illegal). However, some of the terms may not be expressly stated on the contract. These terms, known as "implied terms", are terms that have not been orally mentioned or written down by the parties, but that are still incorporated into the contract according to the law or previous dealings between the parties.

Liquidated damages (compensation)

Liquidated damages are a genuine pre-estimation of the loss or damage that would result if a certain event were to happen during the performance of the contract. A contract term that specifies liquidated damages binds the parties, whereas a "penalty clause" in the contract (i.e. when there is no genuine pre-estimation and the amount of compensation is arbitrary stated) is not binding.

Legality

Certain contracts are illegal under the law. Here are some examples: a contract to insure the life of a person in whom the insurance buyer has no insurable interest, contracts to commit a crime, contracts to corrupt public life (to bribe government officials), contracts to defraud the Inland Revenue Department, and contracts to oust the jurisdiction of the courts.

Genuine consent of the parties

There must be no threats of physical danger in the drawing up of a contract (i.e. a party cannot be forced by the other party to enter into a contract). Otherwise the contract may be voidable, in which the party who needs the protection can seek to avoid the contractual liability.

Discharge of contract

A contract may be discharged by mutual agreement, performance of contractual duties, breach or frustration (the occurrence of certain unforeseen events that make a contract impossible to perform). With regard to the performance of contractual duties, the law requires the parties to perform all of their obligations under the relevant contract.

(Note: This answer highlights only a few of the important issues. There may be other information that you need to know before signing a contract, in which case a lawyer is in a better position to help you.)

3. If one party breaches a contract term, what can the other party do? What are the possible liabilities of the defaulting party?

The first issue is whether the contract violation is a breach of condition or a breach of warranty. A condition is a central (major) term of the contract. If a party breaches a condition, the other party has the right to be discharged from the contract and to claim damages (compensation). A warranty is a minor term. Breach of a warranty by a party gives the other party the right to claim compensation, but not to be discharged from the contract.

Whether a contractual term is a condition or a warranty should be determined using common sense, but it also depends on the seriousness of the infringement. The trade custom or previous dealings between the parties (if any) should also be considered. If such a dispute is brought before a court, then the judge will make the final decision.

You should try to seek legal advice before taking legal action. Generally speaking, the innocent party can choose to take the following measures:

  • treat the contract as discharged and sue for compensation (if a condition has been breached);
  • continue to act on the contract but sue for compensation; or
  • request the court to grant an order for specific performance, injunction, rectification or rescission (*note), provided that no third party’s rights are affected.
  • (*Note: "Specific performance" aims to compel the defaulting party to carry out its contractual obligations. "Injunction" means requiring the defaulting party to stop doing something. "Rescission" means cancelling the contract and restoring the parties to the position that they were in before the contract was made (e.g. refund of any money paid or return of any goods delivered)).

The innocent party's duty to mitigate (minimise the loss)

A party who suffers loss as a result of a breach of contract must take reasonable steps to avoid further loss and to prevent the effects of the breach from multiplying unnecessarily, otherwise that party may not be entitled to full compensation from the defaulting party.

4. To avoid certain liabilities, some business people insert exemption or exclusion clauses into their contracts. Are these contract terms valid under the law?

Exemption clauses are used to avoid liability when things go wrong. Such clauses are not always effective, and are regulated by the Control of Exemption Clauses Ordinance (Cap. 71 of the Laws of Hong Kong). Exemption clauses that exclude liability for death and personal injury are usually not effective. For those that exclude liability for financial loss or damage to property, their validity is subject to a "reasonableness" test. Schedule 2 of the Control of Exemption Clauses Ordinance sets out some guidelines on what may be considered "reasonable".

Exemption clauses are also controlled by the rules of common law. For example, an exemption clause must be incorporated into the contract, and the person who is seeking to rely on the exemption clause must show that reasonable steps have been taken to bring the clause to the attention of the other party.

5. What if I am misrepresented (misled) by others in entering into a contract. Will the law help me to discharge the contract or claim compensation?

A person who makes a false statement of fact that induces (persuaded) another person to enter into a contract is guilty of making a misrepresentation. The three pre-requisites for misrepresentation are: i) someone has given a statement of fact, ii) that statement is wrong, and iii) that false statement induced the innocent party to enter into the contract.

Note that a "statement of fact" is different from a "statement of opinion". For example, a car seller would only have given a statement of opinion if he told you that a van might be able to carry 1,000 kg of goods and asked you to try it before confirming your order. However, he would have made a statement of fact if he told you that the van had a 2,500 cc engine. The seller would be liable for misrepresentation if you confirmed your order as a result of his statement, but subsequently discovered that the actual capacity of the van's engine was only 1,500 cc.

The Misrepresentation Ordinance (Cap. 284 of the Laws of Hong Kong) allows the innocent party to apply to court to rescind the contract (cancel the contract and restore the parties to where they were before the contract was made) and to claim compensation.

6. What if I need to use a middleman (such as an agent) to act on my behalf to negotiate for business or enter into contracts with others. What should I be aware of in such kinds of business dealings?

When a person or company sells products through sales agents, that person or company (as the principal) is liable for any contracts that are entered into by its agents, and may be sued on these contracts. The agent, who is not a party to the contracts, is generally not bound by the contracts between the principal and the other party. However, the agent may be personally liable if he acted without the necessary authority (did not act according to the principal's instruction).

The duties of the agent towards the principle include acting in accordance with the principal's instructions with due care and skill, avoiding conflicts of interest, keeping confidential all aspects of the principal's business affairs (in particular avoiding the disclosure of confidential information to competitors), keeping proper accounts and disclosing any personal interest that might influence the principal in making the contract of agency.

The duties of the principal towards the agent include paying the agreed remuneration (or the amount that the services are worth if not expressly stated in the agency contract), and indemnifying the agent for all liabilities and out-of pocket expenses that are reasonably incurred during the course of carrying out the agent's duties, unless such expenses are expressly excluded in the contract of agency.

D. International trade and Internet transactions

If you have business dealings with foreign companies, you may need to consider the following issues.

  • Customs duties are only levied on imported liquor, tobacco, hydrocarbonate oil and methyl alcohol at the rates that are set out in schedule 1 to the Dutiable Commodities Ordinance (Cap. 109 of the Laws of Hong Kong). You can also obtain more information from the website of the Customs and Excise Department.
  • Import and export regulations cover packaging for shipment, means of transportation, freight cost and delivery time, insurance, import broker services, warehousing costs, packaging for local distribution, health and labelling requirements, method of distribution (by mail from home, agent or retailer), pricing, discounts and delivery costs. More information can be found on the website of the Hong Kong Trade Development Council.
  • You may need a letter of credit, which is a bank's promise to pay the seller on behalf of the buyer against certain documents (e.g. bill of lading or other documents of title or ownership to the goods) to be received. This is a common method of payment in international trade. More information can be found on the website of the Hong Kong Trade Development Council.
  • You need to know which country's law is applicable to your contract. In addition, you can rely on the United Nations Commission on International Trade Law Arbitration Rules (please refer to the website of the Hong Kong International Arbitration Centre) if no compromise can be reached between the contracting parties. Please note that the relevant legal points are very complex, and legal advice should therefore be sought.

1. What should I be aware of before making a contract with others through the Internet?

According to section 17 of the Electronic Transactions Ordinance (Cap. 553 of the Laws of Hong Kong), contracts can be made by means of electronic records (such as e-mails) unless otherwise agreed by the contracting parties. In addition, electronic records that can be accessed for subsequent reference are allowed as evidence in court proceedings, except those that are set out in schedule 1 to the Electronic Transactions Ordinance (which include wills, power of attorney, contracts for sale of land or real estate and mortgages).

If the contract requires the signatures of the parties (but does not involve government organisations), then the parties can use any form of electronic signature that is reliable, appropriate and agreed by the recipient of the signature. For example, the parties may sign a hard copy, scan the document into a computer and then send it via e-mail. If the contract involves government or banking services, the parties must use "digital signatures", which are supported by a recognised certificate that is issued by the Postmaster General. For more information about digital signatures, please go to the website of the Hongkong Post.

If a contract is made between two persons or companies in different countries over the Internet, then that contract will be enforced by the law of the place with the closest connection to the contract (* note ). In terms of taxation, the tax law of the place where the profits are made will apply (unless otherwise stated). For example, if you ship your goods to Japan and sell them there, then you will be liable for Japanese tax. Although this is the basic rule, you should consult an expert in that field before proceeding with such business.

(* Note : In determining which place has the closest connection to the contract, the British courts list the following factors that can be taken into consideration: the place of contracting, the place where the contractual duties are performed, the places of residence or businesses of the parties, and the nature and subject matter of the contract. However, the courts stress that these factors are not exhaustive, and that any other factors which are relevant to the contract may also be considered. You should therefore seek legal advice if there is a query or dispute.

Care must also be taken when submitting personal information through the Internet. The Personal Data (Privacy) Ordinance (Cap. 486) provides for specific controls over the use of the data by merchants and the rights of consumers to access their own data. You can obtain more information concerning this matter from the Personal Data Privacy topic.

E. Taxation and accounting matters

Taxation

The main taxation items in Hong Kong include profits tax, salaries tax, property tax, stamp duty and customs duties (click the link for information about duties connected with the import of goods).

Profits tax is charged for each year of assessment on persons or companies that carry on a trade, profession or business in Hong Kong on assessable profits that have been generated in or derived from Hong Kong for that year. More information about taxation for sole proprietorships and partnerships can be found in the Taxation topic.

If you are running a limited company, you should clarify with your auditor or accountant on any taxation matters. Under the Companies Ordinance, every limited company must appoint an auditor at the company's annual general meeting ( section 131 of the Companies Ordinance) to handle the taxation matters of the company (section 129C).

If you have business dealings in Hong Kong and Mainland China , you should note the special policies in relation to the avoidance of double taxation on income. The new Arrangement for the Avoidance of Double Taxation on Income and Prevention of Fiscal Evasion, which will become effective in Hong Kong on 1 April 2007, extends the scope of the original agreement on business profits and income from personal services to cover direct income (such as operating rights and employment income) and indirect income (such as dividends, interest and royalties). More details about this Arrangement can be found on the website of Inland Revenue Department.

Record-keeping system

Regardless of whether you are running a small business or a big corporation, you are obliged to keep proper records of all documents that are related to the business, including the following:

  • Transaction records: order forms, cash register records, delivery dockets, invoices, credit notes, cheque stubs and deposit slips.
  • Accounting records: petty cash, accounts receivable, accounts payable.
  • Employment records: copies of identity cards and resumes (these records must be strictly controlled for protection of personal data privacy).
  • Stock records: stock location, levels, suppliers and delivery information, cost price, selling price and possible substitute products.
  • Supplier records: reliability, quality, service, delivery times and price of potential and existing suppliers.
  • Customer records: contact information, credit terms, arranged payment terms and special delivery instructions.

If you have further questions on taxation or record-keeping matters, you should seek advice from a professional accountant or tax lawyer.

F. Business disputes and legal action

Employment disputes

If you are involved in a dispute about employment contracts, including wages payment and other conditions of employment, then you may go to the Labour Relations Division of the Labour Department to seek a preliminary consultation or voluntary conciliation service. If you wish to initiate legal action or defend a claim that has been made, then your case will be heard by the Labour Tribunal. Claims for work-related injuries must be taken to the District Court. More information can be found in the Employment Disputes topic.

Disputes in contract or tort

Cases that involve monetary claims that do not exceed $50,000 will be heard by the Small Claims Tribunal. If the amount of the claim is over $50,000 but not more than $1,000,000, the case will be heard by the District Court. If the plaintiff is claiming for more than $1,000,000, such a case will be handled by the Court of First Instance of the High Court.

Further details about the procedures for legal action concerning breach of contract, debt recovery or claims for compensation can be found in the topic of bringing or defending a civil case.

You can also consider settling the dispute through mediation or arbitration without going to court. Please refer to the website of the Hong Kong International Arbitration Centre for more details of this option.

Bankruptcy and winding-up

Bankruptcy and winding-up are methods of closing down a business (or other person's business), and should only be considered as a last resort. Bankruptcy is an insolvency court action that is taken against sole proprietorships or partnerships, whereas winding-up targets limited companies. For more details, please refer to the Bankruptcy & Winding-up topic.

G. The new Companies Ordinance

Introduction

The new Companies Ordinance (Cap. 622) (“the New CO”) came into effect on 3 March 2014.

The New CO replaced the provisions under the old Companies Ordinance, Cap. 32 (“Cap. 32”) on the formation and operation of companies, and is divided into 21 parts.

The provisions which were not repealed relate mainly to prospectuses and insolvency. Cap.32 was renamed the Companies (Winding up and Miscellaneous Provisions) Ordinance.

There are 12 pieces of subsidiary legislation which also came into effect on 3 March 2014:

The following are highlights of some parts of the New CO.

Note: This article only contains highlights of the changes introduced by the New CO and is by no means exhaustive. For more details and updates, please contact the Companies Registry directly.

Enquiry Hotline: 3142 2822
Website: www.cr.gov.hk

1. Part 1 Preliminary

Part 1 defines key terms used in the New CO.

Responsible Person

In the New CO, the term “responsible person” was adopted to replace the previous term “an officer who is in default” in the old Cap.32.

Section 3(2) defines a “responsible person” of a company or non-Hong Kong company as an officer or shadow director of the company or non-Hong Kong company who “authorises or permits, or participates in, the contravention or failure”.

Different types of companies are defined in sections 7 to 12.

2. Part 2 Registrar of Companies and Companies Register

This part deals with the general functions and powers of the Registrar of Companies (“the Registrar”).

Under section 23, the Registrar may specify the form of any document required for the purposes of the Ordinance.

The Registrar may issue guidelines—

  1. indicating the manner in which the Registrar proposes to perform any function or exercise any power; or
  2. providing guidance on the operation of any provision of the New CO (section 24).

According to section 45, the Registrar must make the Companies Register available at all reasonable times for public inspection.

“Withheld and Protected Information”

In order to protect personal data, the New CO introduces the concepts of “withheld information” and “protected information”. Note that the provisions relating to “withheld information” and “protected information” have not yet come into effect. Check with the Companies Registry for the latest updates.

Section 49 allows the Registrar to withhold from public inspection the usual residential address of a current or former director, or a current or former company secretary and the full ID number of any person in specified categories of documents which have been registered with the CR upon application by the persons concerned (“withheld information”).

If the usual residential address of an individual is withheld from public inspection, the correspondence address provided by the individual in lieu of the withheld address must be made available on the Companies Register for public inspection. Part of the individual’s ID number must remain available on the Companies Register for public inspection.

Section 54 provides that the usual residential address of a director and the full ID number of any person in specified categories of documents registered with the CR after commencement of the New CO will not be made available for public inspection (“protected information”).

The director’s correspondence address and partial ID number will be shown on the Companies Register for public inspection.

Sections 55 and 56 provide that, in case communication with a director at the director’s correspondence address is not effective, the Registrar may, after considering the representations of the director and the company concerned, put the director’s usual residential address on the Companies Register as the director’s correspondence address, thereby making it available for public inspection.

The Registrar’s decision to put the director’s usual residential address on the Companies Register will last for five years.

To ensure that the “withheld and protected information” will continue to be accessible by those who have a legitimate need, sections 51 and 58 permit the use or disclosure of such information by the Registrar for specified purposes -

  1. for communicating with the director, company secretary or individual;
  2. for the performance of the Registrar’s functions; or
  3. for disclosure upon application to certain types of persons proposed in the Companies (Residential Addresses and Identification Numbers) Regulation (not yet come into effect), which include the person whose personal information has been withheld or protected and his authorized representative, a member of the company concerned, public officers, public bodies, a liquidator and other specified persons.

Further, sections 52 and 59 provide that a creditor of the company concerned or any other person having a sufficient interest may have access to the withheld or protected information by applying to the court for an order for disclosure by the Registrar of the withheld or protected information.

3. Part 3 Company Formation and related matters, and Re-registration of Companies

Company Formation

Section 66 sets out the types of companies that may be formed under the New CO : –

  1. private companies limited by shares;
  2. public companies limited by shares;
  3. private unlimited companies with a share capital;
  4. public unlimited companies with a share capital; and
  5. companies limited by guarantee without a share capital.

Abolishing the Memorandum of Association

Under the New CO, the memorandum of association (“MA”) is no longer required for any company.

For existing companies (i.e. companies formed under the old regime), the conditions in the memorandum are deemed to be contained in the articles of association, except for conditions relating to authorised share capital and par value, which are regarded to have been removed for all purposes (section 98).

Companies which apply to be incorporated under the New CO need to submit only their incorporation form and articles of association.

Any person or persons may form a company by signing the articles of association of the company intended to be formed and delivering to the Registrar for registration a copy of the articles in the same form as those signed by the founding members, together with a completed incorporation form.

The agreement by the founding members to form a company and take up membership of the company to be formed, previously contained in the memorandum of association, is now contained in the articles (section 67).

Mandatory Articles of Association

Companies incorporated under the New CO are required to have certain mandatory articles of association: for instance, the company name (section 81), details of the company’s liabilities, or contributions of the founding members (sections 83 and 84).

For the most part, these mandatory articles have the same conditions as in the MA of companies incorporated under the old Companies Ordinance.

Companies incorporating under the New CO are required to have as one of their mandatory articles a statement of their capital and initial shareholdings, which is also required to be contained in their incorporation forms.

According to section 85(1), this requirement applies only to companies incorporated under the New CO. It is not necessary for companies incorporated under the old regime to amend their articles to include this provision.

Model Articles of Association

According to section 79, a company may choose to adopt any or all of the provisions of the model articles of association prescribed for the type of company to which it belongs.

These model articles are prescribed in Schedules 1 to 3 of the Companies (Model Articles) Notice (Cap. 622H).

Three sets of model articles are prescribed by the Notice: one set for public companies limited by shares, one for private companies limited by shares, and one for companies limited by guarantee.

The model articles prescribed for each type of company form part of the articles of a company if it does not register any other articles, and the model articles apply unless they are excluded or modified by the company’s registered articles (section 80).

Optional Articles

Under section 82(2), companies may still choose to include objects in their articles.

The articles of a company with a share capital may also state the maximum number of shares that the company may issue.

“Limited”/ “有限公司”

Limited Companies can only be registered with “limited” as the last word of their English name or “有限公司” of their Chinese name (section 102).

However, the Registrar, may, by licence, exercise his/her power to dispense with the use of the word “limited” or “有限公司” (section 103).

Common Seal

The old regime required that every company have a common seal with the company name engraved in legible characters.

Under the New CO, a common seal is no longer mandatory. The keeping and use of a common seal is optional.

A company can now contract under seal or in writing (section 127).

4. Part 4 Share Capital

Abolishing Par Value

Section 135 provides that shares in a company have no nominal value. This applies to shares issued both before and after the commencement of the New CO.

As a result, concepts such as “par value”, “share premium” and “authorized capital” are no longer used.

Under section 98(4), upon commencement of the New CO, conditions in the memorandum of association of a company incorporated under the old Cap.32 relating to authorized capital and par value are for all purposes regarded as obsolete.

Under the New CO, share capital represents the total amount that the company actually receives from its shareholders as capital contribution; there is no need to maintain a separate share premium account.

Alteration of Share Capital

With the elimination of par value, a company can consolidate and subdivide shares more easily by simply reducing or increasing the number of shares without affecting its share capital.

Bonus shares may still be issued in the absence of a share premium, as shares can be issued without transferring an amount to the share capital account.

Under section 170, a company may—

  1. increase its share capital by allotting and issuing new shares in accordance with Part 4;
  2. increase its share capital without allotting and issuing new shares, if the funds or other assets for the increase are provided by the members of the company;
  3. capitalize its profits, with or without allotting and issuing new shares;
  4. allot and issue bonus shares with or without increasing its share capital;
  5. convert all or any of its shares into a larger or smaller number of shares;
  6. cancel shares—
    1. that, at the date the resolution for cancellation is passed, have not been taken or agreed to be taken by any person; or
    2. that have been forfeited.

Transitions and Savings

Section 149 provides that a company may apply its capital to writing off the preliminary expenses of the company, commissions paid, or any other expenses of any issue of shares.

Sections 194 to 199 modify the merger and group reconstruction relief under sections 48C to 48E of the Old Ordinance, so the two types of relief may operate in a no-par environment.

Sections 35 to 41 of Schedule 11 contain transitional provisions relating to migration from shares having nominal value to shares having no nominal value. The contractual rights defined by reference to par or nominal value and related concepts will not be affected by the migration to no-par.

5. Part 5 (Transactions in relation to Share Capital)

Uniform Solvency Test

Section 204 provides that a uniform solvency test be applicable to a reduction of capital, buy-backs, or financial assistance.

The test is essentially a solvency statement in a specified form made by directors (section 206) who have formed the opinion that the company satisfies the solvency test in relation to the transaction concerned (section 205).

In forming their opinion, the directors must inquire into the company’s state of affairs and prospects, and take into account the contingent and prospective liabilities of the company. The solvency statement must be made and signed by all directors for buy-backs or reductions of capital, and made and signed by a majority of directors for financial assistance.

Unlike the old regime, there is no requirement for an auditors’ report to be attached to the solvency statement.

Reduction of Capital based on Solvency Test

It is now possible to achieve reduction of capital by special resolution (without the necessity of court proceedings), subject to satisfaction of the solvency test and certain specified procedures, as follows:

  1. All the directors need to sign the solvency statement in support of the proposed reduction (section 216).
  2. The company needs to obtain members’ approval by a special resolution (sections 215 and 217).
  3. The company must publish notices with the relevant information in the Gazette and newspapers, and must register the solvency statement with the Registrar (section 218).
  4. Any creditor or non-approving member of the company may, within five weeks after the special resolution is passed, apply to the court for cancellation of the resolution (sections 220, 221 and 222). During this five-week period, the company must make available the special resolution and solvency statement for members’ and creditors’ inspection (section 219).
  5. The company must deliver to the Registrar after the five-week period (but no later than seven weeks) a return in specified form if there is no court application (section 224), or within 15 days after the court makes the order confirming the special resolution or the proceedings are ended without determination by the court (section 225).

The reduction of share capital takes effect when the return is registered by the Registrar.

6. Part 9 Accounts and Audit

Reporting Exemption

Certain companies are allowed to prepare simplified financial and directors’ reports.

Companies which qualify for simplified reporting are referred to in the New CO as companies “falling within the reporting exemption”.

Sections 359 to 366 and Schedule 3 set out the qualifying conditions for companies to prepare simplified financial and directors’ reports–

A “small private company” or a private company that is the holding company of a “group of small private companies” that satisfies any two of the following conditions automatically qualifies for simplified reporting –

  1. total (or aggregate total) annual revenue of not more than HK$100 million;
  2. total (or aggregate total) assets of not more than HK$100 million;
  3. no more than 100 employees.

An “eligible private company” or an eligible private company that is the holding company of a “group of eligible private companies” that satisfies any two of the following conditions and has the approval of members holding at least 75% of the voting rights with no other members objecting qualifies for simplified reporting –

  1. total (or aggregate total) annual revenue of not more than HK$200 million;
  2. total (or aggregate total) assets of not more than HK$200 million;
  3. no more than 100 employees.

A “small guarantee company” or a guarantee company that is the holding company of a “group of small guarantee companies” automatically qualifies for simplified reporting if its total annual revenue or aggregate total annual revenue (as the case may be) does not exceed HK$25 million.

For more details on the types of companies defined in the New CO under this part, please refer to the following sections:

Types of companies as stated in the New CO

Relevant sections

“small private company”

Section 359(1)(a)(i)
Section 361
Schedule 3 section 1(1) and (2)

“group of small private companies”

Section 359(2)(a),(b) and (c)(i)
Section 364
Schedule 3 section 1(7), (8) and (9)

“eligible private company”

Section 359(1)(c)
Section 360(1)
Section 362
Schedule 3 section 1(3) and (4)

“group of eligible private companies”

Section 359(2)(a),(b) and (c)(ii)
Section 360(2)
Section 365
Schedule 3 section 1(10), (11) and (12)

“small guarantee company”

Section 359(1)(a)(i)
Section 363
Schedule 3 section 1(5) and (6)

“group of small guarantee companies”

Section 359(3)
Section 366
Schedule 3 section 1(13) and (14)

 

Section 380(7) provides that these companies are not required to give a “true and fair view” of the financial position of the company as at the end of the financial year or the financial performance of the company for the financial year in their financial statements.

Under section 388(3)(a), they are not required to include a business review in the directors’ report to comply with Schedule 5.

Under sections 3(3A), 4(3), 8(3) and 10(7) of the Companies (Directors’ Report) Regulation (Cap. 622D), they are not required to disclose the following in the directors’ report:-

  • directors’ interests in arrangements to enable directors to acquire benefits through the acquisition of shares or debentures;
  • donations;
  • directors’ reasons for resignation or refusal to stand for re-election; or
  • the material interests of directors in transactions, arrangements or contracts of significance entered into by a specified undertaking of the company.

Under section 23 of the Companies (Disclosure of Information about Benefits of Directors) Regulation (Cap. 622G), there is also no requirement to disclose in the notes to financial statements the material interests of directors in transactions, arrangements or contracts of significance entered into by the company.

7. Part 10 Directors and Company Secretaries

This part re-organises, with some modifications, the provisions of the old Cap. 32 relating to the appointment, removal or resignation of directors or company secretaries.

Number of Directors

Section 454 requires that all Private Companies have at least one director.

Section 453 requires that Public Companies and Companies with a limited Guarantee have at least two directors.

Section 457 restricts corporate directorship by requiring a private company (other than one in the same group as a listed company) to have at least one director who is a natural person.

Directors’ Duty of Care, Skill and Diligence

As stated in section 465(1), a director must exercise reasonable care, skill and diligence.

In deciding whether a director has exercised reasonable care, skill and diligence, his or her conduct is compared to the standard that would be exercised by a reasonably diligent person having –

  1. the general knowledge, skill and experience that may reasonably be expected of a person carrying out the functions carried out by the director in relation to the company (section 465(2)(a)); and
  2. the general knowledge, skill and experience that the director has (section 465(2)(b)).

The test is a mixed objective and subjective test.

Section 465(5) states that the duty applies to a shadow director.

Section 466 preserves the existing civil consequences of breach (or threatened breach) of the duty.

Ratification of the Conduct of Directors involving Negligence, etc.

Section 473 states that any ratification by a company of conduct by a director amounting to negligence, default, breach of duty or breach of trust in relation to the company must be approved by a resolution of the members of the company disregarding the votes in favour of the resolution by the director, any entity connected with the director, or any person holding shares of the company in trust for the director or for the connected entity.

Section 473(7) states that section 473 does not affect:

  1. any other Ordinance or rule of law imposing additional requirements for valid ratification; or
  2. any rule of law as to acts that are incapable of being ratified by the company.

Indemnity to Directors

Section 469 permits a company to indemnify a director against liability incurred by the director to a third party if the specified conditions are met.

Certain liabilities and costs must not be covered by the indemnity, such as criminal fines, penalties imposed by regulatory bodies, defence costs of criminal proceedings where the director is found guilty, or defence costs of civil proceedings brought against the director by or on behalf of the company or an associated company in which a judgment is given against the director (section 469(2)).

A company which provides any permitted indemnity to its directors or its associated company’s directors must disclose the indemnity provision in the directors’ report (section 470) and make it available for inspection by any member on request (sections 471 and 472).

8. Part 12 Company Administration and Procedures

Written Resolutions in lieu of Meetings

Section 548 provides for procedures for proposing, passing and recording written resolutions in lieu of passing resolutions in general meetings.

Section 549 provides that directors or other members of a company may propose a resolution as a written resolution.

Under section 551, the member of the company who proposes the resolution may request the company to circulate with the resolution a statement of not more than 1,000 words on the subject matter of the resolution.

Once a written resolution is proposed, the company has a duty to circulate the resolution to every member for agreement if it has received a request to do so from members representing not less than 5% of the total voting rights or a lower percentage specified in the company’s articles (section 552).

According to section 553, the circulation may be effected by sending the copies in hard copy form or electronic form, or by making a copy available on a website.

Under section 558, the period for agreeing to the proposed written resolution is 28 days from the time of circulation or such period as specified in the company’s articles.

Members may signify their agreement to a proposed written resolution and send it back to the company either in hard copy form or electronic form (section 556).

Under section 559, if a resolution is passed as a written resolution, the company must send a notice of that fact to every member and the auditor of the company within 15 days.

Companies can dispense with AGMs by the unanimous consent of members (sections 612, 613 and 614).

9. Part 19 Investigations and Enquiries

This part deals with investigations and enquiries into a company’s affairs by Inspectors appointed under sections 840, 841 and 853, or the Financial Secretary (“FS”).

This part also provides a new power for the Registrar to obtain documents, records and information for the purpose of ascertaining whether there has been any conduct that would constitute specified offences relating to giving a false or misleading statement.

An Inspector can require a person to preserve records or documents before presenting them to the Inspector (section 846(1)(b)), and can require a person to verify by statutory declaration any answer or explanation given to the Inspector (section 848(2)).

Under section 863, criminal sanctions are introduced for non-compliance with a request made by an Inspector.

Section 864 introduces an express provision to allow the court to order compliance with a request made by an Inspector, not just to punish for non-compliance.

These powers are based on similar powers found in the Securities and Futures Ordinance, Cap.571 and the Financial Reporting Council Ordinance, Cap.588.

Sections 880 to 882 contain confidentiality provisions relating to information obtained in both investigations of a company’s affairs by an Inspector under the provisions set out in Division 2 of Part 19, and enquiry into a company’s affairs by the FS under the provisions set out in Division 3.

Section 880 imposes a statutory obligation to preserve secrecy, and section 881 defines expressly how such information may be disclosed to other regulatory authorities.

Section 882 creates an offence for breach of the secrecy provisions.

Section 884 introduces provisions to provide protection (by granting immunity from liability for disclosure) to persons who volunteer information to facilitate an investigation of a company’s affairs or enquiry into a company’s affairs.

Section 885 gives additional protection by expressly stating that the identity of an informer should be kept anonymous in civil, criminal or tribunal proceedings.

Section 873 gives the Registrar the power to require records or documents to be produced, to make copies of the records or documents, and to require information or explanations in respect of the records or documents, for the purpose of ascertaining whether there has been any conduct that would constitute an offence under section 750(6) or section 895(1) relating to the giving of false or misleading information in the documents delivered to the Registrar.

Section 875 provides criminal sanctions for non-compliance with the Registrar’s request.



II. Setting up a small or medium-sized business in Mainland China

A. Types of Mainland Chinese business organisation – joint ventures, wholly foreign-owned enterprises and representative offices

The following information gives a brief introduction to the various forms of business organisation in Mainland China that can be run or invested in by foreigners. You should consult a lawyer who specialises in Mainland China if you have further queries concerning the establishment of a company in the Mainland.

All formal foreign businesses in Mainland China (including those invested by Hong Kong companies and individuals) are called foreign investment enterprises (FIEs) , and must be registered in the form of a Sino-foreign equity joint venture, a Sino-foreign cooperative joint venture or a wholly foreign-owned enterprise.

Sino-Foreign Equity Joint Ventures (EJV)

EJVs are established in accordance with the People's Republic of China (PRC) Sino-Foreign Equity Joint Venture Law 《中華人民共和國中外合資經營企業法》 and associated implementation regulations 《中華人民共和國中外合資經營企業法實施條例》 . An EJV is a limited liability entity with legal person status (that is, the company can sign contracts and sue or be sued by the others) . It is jointly invested in and managed by foreign and Chinese partners. The parties that are involved each contributes capital either in cash or in kind in such forms as equipment, right to use land and office or factory premises (subject to certain restrictions), and takes a shareholding in accordance with the percentage of equity that the party has invested. Each shareholder is entitled to receive dividends (after the EJV has complied with the relevant requirements) in proportion to its own equity share (note: the equity share of a shareholder is decided by the total investment of that shareholder, in cash or in kind, relative to the contribution of the other parties).

Sino-Foreign Cooperative Joint Ventures (CJV)

CJVs are established in accordance with the PRC Sino-Foreign Cooperative Joint Venture Law《中華人民共和國中外合作經營企業法》and associated implementation regulations《中華人民共和國中外合作經營企業法實施細則》. A CJV can be set up either:

  1. with each partner remaining a separate legal entity who bears liability in accordance with the relevant provisions of PRC civil law and with all of the partners cooperating to establish the joint management setup of the CJV; or
  2. with all of the partners putting in their investment and delegating non-investing staff to form a single company with limited liability.

The partners or shareholders can decide on the rate at which the investment is to be recovered, and profits can be shared irrespective of the level of capital contribution that is made by each party (subject to the CJV contract being approved by the relevant authorities and compliance with the relevant requirements). This means that, in contrast to an EJV, the profit/loss-sharing ratio of the shareholders in a CJV may not be equivalent to their respective investment ratio.

Wholly Foreign-Owned Enterprises (WFOE)

WFOEs are established in accordance with the Foreign-Owned Enterprise Law《中華人民共和國外資企業法》and associated implementation regulations《中華人民共和國外資企業法實施細則》. A WFOE is also a limited liability entity with legal person status, and the foreign investor can run the business without the involvement of a Chinese partner.

An advantage of joint ventures is that they give the foreign party access to the Chinese party's sales, marketing and distribution network, thus reducing the level of new investment that is required before business operation can begin. A CJV is a good option for scenarios in which foreign investment is restricted to less than 50% in equity but the foreign party wishes to recover a larger share of the joint venture's revenue. However, the foreign investor in a joint venture must obtain the consent of the Chinese party on major management decisions, and thus many foreign investors prefer to establish WFOEs if the option is available.

Representative Office

Some foreign companies choose to set up representative offices in China as a means of liaising with their customers and suppliers in Mainland China. These representative offices can also carry out market research and business promotion. However, they can only conduct business in Mainland China in the name of the foreign company that they represent and cannot issue invoices for the products and services that their company supplies in Mainland China.

Other types of organisation

To establish a company or office in Mainland China that can engage in business activities, a foreign company can establish a branch organisation in accordance with the PRC Company Law. However, the branch organisation does not have legal person status, which means the civil liability in any commercial dispute is borne by the head office.

An alternative for Hong Kong companies and individuals is to make arrangements to have portions of their processing and assembly operations carried out by factories in Mainland China or to establish a small domestic business in the name of a Mainland Chinese relative. However, these forms of doing business in Mainland China are governed by different sets of laws and regulations, and are in many ways restricted, as they do not have legal person status.

Since the Closer Economic Partnership Arrangement (CEPA) and its supplemental agreement 《內地與香港關於建立更緊密經貿關係的安排》補充協議 came into affect , Hong Kong companies or individuals have enjoyed preferential treatment and may invest in certain businesses in Mainland China in the form of a partnership under the PRC Partnership Law 《中華人民共和國合夥企業法》 or a sole proprietorship under the PRC Individual Enterprise Law 《中華人民共和國個人獨資企業法》 . However, these alternative forms of business organisation do not enjoy the benefits of limited liability.

1. Do I need to engage professional advisors or registered agents to set up a company in Mainland China?

Depending on the business sector and the size of the potential investment, a Hong Kong investor may choose to engage professional advisors to give advice on the relevant laws and regulations, market analysis, contract drafting and negotiation. A PRC lawyer, accountant or other registered agent, such as the local international trade development committee or a foreign services company, can be engaged to carry out registration matters and applications for approval or licences.

Foreign services companies such as the Beijing Foreign Enterprise Human Resources Service Co. Ltd. (FESCO) (a state-owned corporation) also provide services such as recruiting qualified Chinese employees and ensuring that policies and procedures comply with the statutory requirements regarding social insurance and welfare for staff, importing or local purchasing, the leasing and maintenance of office equipment and consumables, and their transportation and storage.

2. What licences or approval must I obtain to run a small or medium-sized business in Mainland China?

The most common licences or approval that must be obtained from the Mainland authorities are as follows.

  1. The approval of the State Administration for Industry and Commerce (SAIC) or relevant local administration of industry and commerce must be obtained for the name that is chosen for the foreign investment enterprise (FIE). Please note that all formal foreign investment in Mainland China , including those of Hong Kong companies and individuals, are called "foreign investment enterprises".
  2. The approval of the Ministry of Commerce of the PRC or relevant local department of commerce must be obtained in respect of the investors and their respective amount and mode of capital contribution, the total amount of investment and registered capital, the scope of business, the joint venture contract (for Equity Joint Ventures or Cooperative Joint Ventures), the articles of association or by-laws, the business operation period and the category of company to be established.
  3. A business licence will be issued after successful registration with the SAIC or relevant local administration of industry and commerce.
  4. Special licences must also be sought if the FIE is to engage in certain industries or sectors (e.g. training, serving food and beverages, selling liquor or tobacco).
  5. Following China 's accession to the World Trade Organisation (WTO), all types of business organisations in Mainland China , including sole proprietorships and foreign companies that are not registered in China , are gradually allowed to import and export most types of goods into and out of the Mainland. Foreign investors should make themselves familiar with the import and export customs declaration system and customs clearance procedures. If they conduct import and export business in the Mainland, they must seek an Export Quota Certificate and an Import or Export License from the Export Quotas Department and the Import and Export Licenses Department, respectively, of the Ministry of Commerce of the PRC.
  6. Hong Kong investors, who wish to establish a foreign investment enterprise in Mainland China in one of the service sectors that are covered by the Closer Economic Partnership Arrangement (CEPA), will have their applications for establishment processed and approved by the relevant department of the State Council or other local Chinese government authorities in accordance with the principles and procedures that are set out in the CEPA. However, a Hong Kong Service Supplier (HKSS) Certificate from the Trade and Industry Department of the Hong Kong SAR Government must first be obtained before approaching the Mainland authorities. Please visit the website of the Trade and Industry Department for more details.

Remarks:

All FIEs are required to have their accounts audited annually by a PRC-qualified accountant, and are subject to an annual joint inspection by the relevant local department that oversees foreign trade and economic cooperation, finance, customs, national and local tax, industry and commerce and foreign exchange control.

B. Making a business contract in Mainland China

The People's Republic of China (PRC) Contract Law 《中華人民共和國合同法》 and its judicial interpretation by the Supreme People's Court ( 最高人民法院 ) is, to certain extent, a combination of the legal principles of contract in the major common law jurisdictions in the world (such as the United Kingdom and Hong Kong). In terms of the requirements for making a legally binding contract, the contract law of Mainland China is quite similar to that of Hong Kong, especially with regards to invitation to treat, offer, acceptance, counter-offer and capacity to enter into contract (see the section on Hong Kong contract law).

However, Mainland Chinese contract law does not have a specific requirement for "consideration" before a contract becomes legally binding. This means that not all kinds of contracts in Mainland China require a mutual exchange of consideration (such as money, goods or services) between the contracting parties. There are also differences between contract law in Mainland China and Hong Kong regarding exemption clauses in standard contracts and damage to property as a result of fraud.

In addition to the general legal principles that have been mentioned, there are specific provisions in the PRC Contract Law for 15 types of contracts: the purchase and sale of goods; the supply and consumption of electricity, water, gas or heating; donations; loans; leases; finance leasing; contracting work; construction projects; carriage (passenger and freight transport); technology (development, transfer, consultation and service); safe-keeping; warehousing; authorisation; brokerage; and intermediary services.

These contracts are subject to special rules. In a contract concerning the purchase and sale of goods, for example, the seller must comply with the PRC Anti-unfair Competition Law. That means when a seller sells a product to a buyer, that seller cannot sell another product to the buyer at the same time or impose other unreasonable conditions that are contrary to the buyer's desire.

Due to the variety and complexity of contract law in Mainland China, it is advisable to consult a PRC lawyer before signing a contract.

C. Staff employment and taxation matters

A foreign investment enterprise (FIE) can recruit its staff in the Mainland from an authorised local employment agency. Subject to the consent of the local labour bureau, a FIE may also directly recruit its staff either from the area in which it is located or from other areas.

As employers, FIEs are required to comply with the statutory requirements for social insurance for local staff (which are mainly concerned with medical expenses, unemployment and retirement), and must support the labour union that their staff are entitled to establish in accordance with the People's Republic of China (PRC) Labour Law 《中華人民共和國勞動法》 . Employers must also deduct personal income tax and contributions to the social insurance fund from the salaries of their staff and make payments on their behalf to the PRC Government.

An FIE can hire its staff by signing labour contracts directly with individual staff members. Alternatively, the FIE may sign a collective labour contract with the labour union that represents its employees. The PRC Labour Law requires labour contracts to include provisions that govern the duration of the contract, job description, labour protection and conditions of work, remuneration, labour discipline, conditions for termination and liability for breach of contract. All individual labour contracts must be endorsed by and registered with the local labour authority.

Foreign services companies such as the Beijing Foreign Enterprise Human Resources Service Co. Ltd. (FESCO) (a state-owned corporation in China ) also provide services such as recruiting qualified Chinese employees and ensuring that policies and procedures comply with the statutory requirements regarding social insurance and welfare for staff.

1. To which aspects of taxation should I pay attention when running a small or medium-sized business in Mainland China?

The PRC Income Tax Law for Foreign Investment Enterprise and Foreign Enterprises 《中華人民共和國外商投資企業及外資企業所得稅法》 states that foreign firms are liable for the following types of taxation.

(a) Corporate income tax. Some important notes are that gains which arise from the disposal of an FIE's assets are generally included as part of its taxable income, although wear and tear allowances are granted on fixed assets and other capital assets that are used in the production of income. Bad debts that are written off in accordance with the relevant rules must be reported to the local tax authorities for examination and confirmation. Any entertainment expenses that are incurred in relation to the FIE's production and business operation must be backed up by reliable records or vouchers and are deductible within stipulated limits. Donations to approved charitable organisations are allowed as deductible expenses. However, foreign social insurance premiums for employees working inside Mainland China , fines and penalties, and management fees that are paid to related companies are not allowed as deductible expenses. The losses that were incurred by an FIE in previous years may be offset against profits in future years for a period not exceeding five years.

(b) Various categories of turnover tax. These include: (i) value-added tax (VAT) which is levied during the phases of production, distribution and importation; (ii) consumption tax on certain high-margin consumer goods; and (iii) transaction tax on services and the transfer of intangible property or sale of real property.

(c) Other taxes that are payable by FIEs include land VAT, deed tax, real estate tax, vehicle and vessel licence tax, stamp duty and customs duties.

(Note: There are various types of tax that are chargeable in the Mainland and the rules are complex. You should consult a PRC accountant for more information on taxation matters).

Under the Closer Economic Partnership Arrangement (CEPA), imports into Mainland China of products (except those that are prohibited in the Mainland) which are originated in Hong Kong are duty free from 1 January 2006 . More information on this zero-tariff policy is available from the website of the Trade and Industry Department of the Hong Kong SAR Government.

Hong Kong investors should also note the new Arrangement for the Avoidance of Double Taxation on Income and Prevention of Fiscal Evasion for Mainland China and Hong Kong , some general information on which can be found on the website of the Hong Kong Inland Revenue Department.

D. Introduction to the Mainland and Hong Kong Closer Economic Partnership Arrangement (CEPA)

The objectives of the CEPA are to strengthen trade and investment cooperation between Mainland China and Hong Kong and to promote the joint development of both places through the implementation of measures to:

  1. reduce or eliminate tariff and non-tariff barriers to trade in goods;
  2. liberalise the trade in services through the reduction or elimination of discriminatory measures;
  3. promote and facilitate trade and investment.

The current measures of the CEPA are implemented in four phrases in January 2004, January 2005, January 2006 and January 2007. Discussions between Mainland China and Hong Kong will continue to aim for further liberalisation and greater market access for Hong Kong companies and workers to the Mainland market. It is anticipated that further measures will be implemented in the future.

Trade in goods (export of Hong Kong products to Mainland China)

Products with a Hong Kong origin enjoy zero tariffs on importation to Mainland China . It is important to note that under the rules of the CEPA, all Hong Kong products must first obtain a Certificate of Hong Kong Origin (which can be issued by the Trade and Industry Department (TID) of the HKSAR Government or other authorised organisation) before they are eligible for tariff free status. More details on the criteria for product origin and the procedure for obtaining a Certificate of Hong Kong Origin are available from the website of the Trade and Industry Department.

Trade in services (export of Hong Kong service suppliers to Mainland China)

Mainland China will progressively reduce or eliminate the restrictive measures that currently apply to services and service suppliers from Hong Kong (who have engaged in substantive business operations in Hong Kong for 3-5 years), and will implement new measures to liberalise the trade in services. Currently, 27 service areas have benefited under this arrangement. These service areas include accountancy, advertising, medicine and dentistry, law, management consultancy, real estate and tourism (the full list is available from the TID website).

Hong Kong organisations (including limited companies, partnerships and sole partnerships) must first obtain a Hong Kong Service Supplier Certificate from the TID before they can seek permission from the Mainland authorities to provide services in Mainland China with reduced restrictions. More information can be obtained from the TID website (note: individual persons are not required to apply for this certificate).

As part of the CEPA, Mainland China and Hong Kong also encourage the mutual recognition of professional qualifications and promote the exchange of professional talent.

Trade and investment facilitation

Mainland China is committed to the promotion and facilitation of trade and investment through greater transparency, the conformity of standards and enhanced information exchange. Areas of cooperation include customs clearance, commodity inspection and quarantine, food safety, and standardisation management.

The liberalisation measures of the CEPA permit wider accessibility to the Mainland market for Hong Kong investors. Mainland China has also expanded the business scope for individually owned stores that are set up by Hong Kong permanent residents who have Chinese citizenship. The CEPA expedites the flow of talent and capital, and opens up opportunities for Hong Kong professionals to establish and develop their careers in Mainland China .

A summary of the trade and investment facilitation measures can be found on the website of the TID.

E. Resolving commercial disputes in Mainland China

The following information gives a general introduction to the resolution of commercial disputes by legal means. Settling disputes through the legal process in Mainland China should not be carried out without the advice of a lawyer who specialises in the laws of the People's Republic of China (PRC).

Generally speaking, there are three ways of resolving commercial disputes in Mainland China: consultation and mediation, arbitration, and litigation.

Consultation and mediation

Consultation can be facilitated by a third party if agreed on by the disputing parties. It is largely an informal way of dispute settlement, but the result can still be legally binding if it is properly recorded in an agreement between the parties.

Mediation that is presided over by a judge is a required step during litigation procedures according to the PRC Civil Procedure Law《中華人民共和國民事訴訟法》. The judge who hears the case will usually conduct mediation after the initial presentation of the case in court with evidence and argument by both parties.

If the mediation process is conducted out of court, then the parties will try to reach an agreement to settle the dispute before an impartial third party. The Beijing Conciliation Centre of the China Council for Promotion of International Trade (CCPIT) conducts formal mediation between Chinese and foreign parties in accordance with its own mediation rules.

However, the choice of mechanism for dispute resolution is usually between arbitration and litigation.

Arbitration

In simple words, arbitration is a legal process in which the dispute of the parties is heard by a private individual or panel of several private individuals (qualified arbitrators), rather than the courts. Arbitration results in an award or decision being made by the arbitrator(s).

Arbitration between Chinese and foreign parties in China is usually conducted by the China International Economic and Trade Arbitration Commission (CIETAC) in Beijing, Shanghai or Shenzhen in accordance with its own Arbitration Rules and subject to the PRC Arbitration Law 《中華人民共和國仲裁法》 and other relevant laws.

Most foreign investors prefer to resolve commercial disputes by international arbitration. As in this way, arbitrators with expertise at international level can be appointed and the local favouritism of the courts in Mainland China can be avoided. It is important to have a well-drafted arbitration clause in the contract to ensure that international arbitration is the choice that is implemented.

There are also some special provisions regarding the resolution of certain types of dispute in Mainland China. For instance, attempts to settle labour disputes should be made through arbitration by the relevant local labour arbitration committee (with or without prior mediation) in the first instance. If either party is dissatisfied with the arbitral award, then the case can be brought to the relevant People's Court.

Litigation

The basic framework for civil litigation in Mainland China is laid down in the PRC Civil Procedure Law. Other relevant sources of authority include various judicial interpretations by the Supreme People’s Court or the Supreme Procurate (最高人民檢察院), the PRC Contract Law, the laws and regulations that govern foreign investment enterprises, and the Foreign Investment Enterprise Winding Up Measures《外商投資企業清算辦法》.

There are four levels of court in Mainland China, each of which has specified jurisdiction over certain kinds of litigation.

Supreme People's Court


Higher People's Courts


Intermediate People's Courts


Basic Level People's Courts

Most of the cases that involve commercial disputes are heard in the first instance (at the first time) by the Basic Level People's Courts with the relevant territorial jurisdiction. For contractual disputes that involve foreign elements (for example, one of the parties to the contract is a foreigner or foreign company, or the place of performance of the contract is in a foreign country), cases may be heard by the Intermediate People's Courts with the relevant territorial jurisdiction. The Higher People's Courts of the relevant territorial jurisdiction hear cases that have a substantial impact in the respective jurisdictional territory. Cases that have a substantial nationwide impact or that are deemed to be appropriate are heard in the first instance by the Supreme People's Court.

Any party that disagrees with the decision of the court of first instance (which heard the case at the first time) may appeal once to the court immediately above.

Judicial review

Under the PRC Administrative Review Law 《中華人民共和國行政復議法》, foreign investors also have the right to seek a judicial review of sanctions and decisions that are made by the Chinese government organisations.

Accidents, loss of identity documents and criminal matters

If you (as a Hong Kong resident) have met with an accident or are arrested or detained for involvement in a criminal case in the Mainland, you can seek help from the Office of the Hong Kong Special Administrative Region in Beijingor the Hong Kong Economic and Trade Office in Guangdong. The Immigration Department of the HKSAR Government provides a summary of such assistance services at http://www.gov.hk/en/residents/immigration/outsidehk/assistmainland.htm.



III. Case illustration

A. Scenarios in Hong Kong

Scenario 1

Company A advertised a conference table for sale for $50,000 in a local daily newspaper. They received one telephone call in response to the advertisement, and the manager of Company A arranged to meet the caller, the representative of Company B, at the showroom of Company A. Having inspected the conference table, the representative of Company B said that Company B would buy it but that they would need time to arrange the payment. Before leaving the showroom, the manager of Company A and the representative shook hands and exchanged business cards. Three days later, the representative of Company B telephoned the manager of Company A to say that he would deliver the cash to Company A the next day. The manager of Company A said nothing in response. Can the manager of Company A refuse to sell the conference table to Company B when the representative of Company B arrives at the showroom of Company A with the $50,000?

Answer to Scenario 1

Scenario 2

The manager of Company A, a printing company, ordered a new colour printing machine from Company B to be delivered on 1 November. The machine was not delivered on time, but because there is a low demand for printing services between November and February, the manager of Company A did not contact Company B about the matter until 20 February of the next year, when he sent a fax to Company B enquiring about delivery of the machine. He was told by return fax that the machine would be delivered the following week. However, the machine was not delivered for another three months. Since the time when the manager of Company A enquired about the delivery of the machine, Company A has only been able to fulfil 50% of the printing jobs that it could have handled had they had the machine.

Can Company A purchase the printing machine from another manufacturer and sue Company B for damages (compensation)? Would the basis for the calculation of the damages be different if Company A had also lost a profitable printing order because they were not able to meet the deadline for delivering the work without the new machine?

Answer to Scenario 2

Scenario 3

Mr. A and his brother Mr. B were partners in a garment manufacturing company business for many years. On the advice of their accountant, they formed a limited company (A & B Ltd) and invited Mr. B’s son to join them in the business. It was agreed that Mr. A and Mr. B would each hold 40% of the shares and that B’s son would hold the remaining 20%. Recently, Mr. A and Mr. B have been unable to agree on the design, quality of fabric or colour of their products, and consequently have neglected the business. They have failed to pay their suppliers and are unable to fulfil their contracted orders. Mr. B’s son always agrees with his father. As a result, Mr. A now refuses to communicate with either of them. Are there any grounds on which A & B Ltd can be wound up by the court?

Answer to Scenario 3

Scenario 1

Company A advertised a conference table for sale for $50,000 in a local daily newspaper. They received one telephone call in response to the advertisement, and the manager of Company A arranged to meet the caller, the representative of Company B, at the showroom of Company A. Having inspected the conference table, the representative of Company B said that Company B would buy it but that they would need time to arrange the payment. Before leaving the showroom, the manager of Company A and the representative shook hands and exchanged business cards. Three days later, the representative of Company B telephoned the manager of Company A to say that he would deliver the cash to Company A the next day. The manager of Company A said nothing in response. Can the manager of Company A refuse to sell the conference table to Company B when the representative of Company B arrives at the showroom of Company A with the $50,000?

Answer

In contract law, an advertisement is only an invitation to treat (an invitation requesting the other party to make an offer, see the relevant question and answer) unless there is other evidence to the contrary. Therefore, the advertisement of Company A was not an offer, and no contract can be invoked at this stage.

The gesture of Company B's representative that was made at the showroom probably did not constitute an offer to buy the table, as there was still some doubt as to when or whether payment could be arranged. The second telephone call from the representative of Company B constituted an offer, but the silence of the manager of Company A cannot be construed as an acceptance of that offer. As Company A has not made a valid acceptance, no contract has been created. The manager of Company A can thus refuse to sell the conference table to Company B.

Scenario 2

The manager of Company A, a printing company, ordered a new colour printing machine from Company B to be delivered on 1 November. The machine was not delivered on time, but because there is a low demand for printing services between November and February, the manager of Company A did not contact Company B about the matter until 20 February of the next year, when he sent a fax to Company B enquiring about delivery of the machine. He was told by return fax that the machine would be delivered the following week. However, the machine was not delivered for another three months. Since the time when the manager of Company A enquired about the delivery of the machine, Company A has only been able to fulfil 50% of the printing jobs that it could have handled had they had the machine.

Can Company A purchase the printing machine from another manufacturer and sue Company B for damages (compensation)? Would the basis for the calculation of the damages be different if Company A had also lost a profitable printing order because they were not able to meet the deadline for delivering the work without the new machine?

Answer

Time of delivery is vital to the performance of a sale of goods contract. Company A is entitled to damages if it can show that the late delivery caused actual business loss. If Company A has to pay a higher price for a new printing machine from another manufacturer to meet its printing deadlines, then it can also claim for the additional purchase price (provided that Company A has exercised reasonable effort to obtain the best offer in the market).

However, Company A may not be entitled to claim for the loss of profits from the profitable order, as the order had not been converted into a formal contract and it is difficult for Company A to justify the loss.

Scenario 3

Mr. A and his brother Mr. B were partners in a garment manufacturing company business for many years. On the advice of their accountant, they formed a limited company (A & B Ltd) and invited Mr. B’s son to join them in the business. It was agreed that Mr. A and Mr. B would each hold 40% of the shares and that B’s son would hold the remaining 20%. Recently, Mr. A and Mr. B have been unable to agree on the design, quality of fabric or colour of their products, and consequently have neglected the business. They have failed to pay their suppliers and are unable to fulfil their contracted orders. Mr. B’s son always agrees with his father. As a result, Mr. A now refuses to communicate with either of them. Are there any grounds on which A & B Ltd can be wound up by the court?

Answer

A & B Ltd can be wound up by the court on any of the following grounds under section 177(1) of the Companies (Winding Up and Miscellaneous Provisions) Ordinance:

  1. After the three owners have arranged to pay all of the outstanding amounts to their suppliers, they (as the members (shareholders) of A&B Ltd) pass a special resolution agreeing to have the company wound up.
  2. The business of A&B Ltd has been suspended for a whole year.
  3. The debts that A&B Ltd owe to its suppliers exceed $10,000 and a statutory demand has been served on the company.
  4. The court is of the opinion that it would be just and equitable for A&B Ltd to be wound up, as there is a breakdown of mutual trust and confidence among the three persons who are the shareholders and directors of A&B Ltd that prevents the proper management of the company.
  5. For more information about the winding-up of a limited company, please go to the Bankruptcy and Winding-up topic.

B. Scenarios in Mainland China

Scenario 1

Company A signed a contract with Company B on the following terms:

  1. Company B agreed to deliver 100 tons of wool on or before the specified delivery date.
  2. Company A agreed to pay Company B a deposit of 15% of the purchase price upon signing the contract, and to pay the balance by bank telegraphic transfer upon delivery and presentation of the VAT invoice by Company B.

Ten days before the specified delivery date, Company A sent a letter to Company B saying that it could not pay the balance of the purchase price in full in accordance with the contract, and proposing to pay another 15% of the purchase price upon delivery (which with the deposit would make 30% of the total amount) and then the balance in two instalments within 30 days of delivery.

Company B did not agree with the proposed changes to the payment terms and delivered 30% of the wool before the specified delivery date. Company A refused to accept the partial delivery, but Company B insisted that it would deliver the quantity of wool for which Company A could afford to pay and that Company A would have to present a bank draft before Company B would arrange for the delivery of the rest of the wool. Because of such dispute, Company B took back the delivered wool from Company A.

Ten days after the specified delivery date, Company A sent another letter to Company B stating that they could pay 50% of the purchase price and that Company B should deliver 50% of the wool and present the VAT invoice. Company B replied in writing on the same day that it would agree to deliver 50% of the wool if Company A paid the purchase price on a pro-rata basis in accordance with the payment terms of the contract, and that if Company A failed to take delivery and pay the purchase price in accordance with the said payment terms, then Company B would cancel the contract. Company A presented a guarantee that was issued by the representative office of the intermediary company for the parties. The guarantee stated that the guarantor would give Company B bills for 39.5% of the purchase price that would be negotiable at a bank after 75 days upon presentation of the VAT invoice for 50% of the wool, and that if Company B could not obtain payment from the bank, then the guarantor would pay Company B the stated amount. Company A also stated that if Company B did not present the VAT invoice, then a draft for the amount of 1% of the purchase price would be retained by the guarantor. Company B refused to deliver the wool because Company A did not accept the payment terms of the contract.

Can Company A sue Company B for breach of contract and request Company B to refund the deposit and pay compensation equivalent to the deposit that was paid by Company A in accordance with the PRC Contract Law?

Answer to Scenario 1

Scenario 2

Mr. A bought a brand XYZ car for his personal use from his own funds from a car dealer for RMB55,200. The car dealer issued two invoices (neither of which carried the chop of the car trading market management department of the relevant local administration of industry and commerce), a quality inspection certificate and a temporary car registration licence.

Driving the car home, Mr. A found some serious problems with it. He telephoned the car dealer the next day. On the following day, Mr. A drove the car to the appointed service centre of brand XYZ for inspection and repair. Two days later the service centre reported that the car was not manufactured by the XYZ automobile company.

Mr. A asked the car dealer to take back the car, refund the amount that he had paid, reimburse him for the inspection and repair fee of RMB928 and pay damages of RMB55,200 in accordance with the PRC Consumer Rights Protection Law《中華人民共和國消費者權益保護法》. Can the car dealer take the car back after refunding the amount that was paid by Mr. A and reimbursing the inspection and repair fee, and also to treat the rights and obligations of both parties in respect of the sale and purchase of the car as settled given that Mr. A has not suffered any loss?

Answer to Scenario 2

Scenario 1

Company A signed a contract with Company B on the following terms:

  1. Company B agreed to deliver 100 tons of wool on or before the specified delivery date.
  2. Company A agreed to pay Company B a deposit of 15% of the purchase price upon signing the contract, and to pay the balance by bank telegraphic transfer upon delivery and presentation of the VAT invoice by Company B.

Ten days before the specified delivery date, Company A sent a letter to Company B saying that it could not pay the balance of the purchase price in full in accordance with the contract, and proposing to pay another 15% of the purchase price upon delivery (which with the deposit would make 30% of the total amount) and then the balance in two instalments within 30 days of delivery.

Company B did not agree with the proposed changes to the payment terms and delivered 30% of the wool before the specified delivery date. Company A refused to accept the partial delivery, but Company B insisted that it would deliver the quantity of wool for which Company A could afford to pay and that Company A would have to present a bank draft before Company B would arrange for the delivery of the rest of the wool. Because of such dispute, Company B took back the delivered wool from Company A.

Ten days after the specified delivery date, Company A sent another letter to Company B stating that they could pay 50% of the purchase price and that Company B should deliver 50% of the wool and present the VAT invoice. Company B replied in writing on the same day that it would agree to deliver 50% of the wool if Company A paid the purchase price on a pro-rata basis in accordance with the payment terms of the contract, and that if Company A failed to take delivery and pay the purchase price in accordance with the said payment terms, then Company B would cancel the contract. Company A presented a guarantee that was issued by the representative office of the intermediary company for the parties. The guarantee stated that the guarantor would give Company B bills for 39.5% of the purchase price that would be negotiable at a bank after 75 days upon presentation of the VAT invoice for 50% of the wool, and that if Company B could not obtain payment from the bank, then the guarantor would pay Company B the stated amount. Company A also stated that if Company B did not present the VAT invoice, then a draft for the amount of 1% of the purchase price would be retained by the guarantor. Company B refused to deliver the wool because Company A did not accept the payment terms of the contract.

Can Company A sue Company B for breach of contract and request Company B to refund the deposit and pay compensation equivalent to the deposit that was paid by Company A in accordance with the PRC Contract Law?

Answer

The contract is valid and legally binding. Because no subsequent agreement to vary the payment terms was agreed, both parties are obliged to fulfil their obligations in accordance with the original terms of the contract. The first letter of Company A constitutes an anticipatory breach (Company A gave notification before the specified payment date that it would not pay), and thus Company B has the right to suspend delivery of the wool.

The last two letters that were exchanged by the parties constitute a variation of the contract regarding the amount of wool to be delivered. In that case, Company B was in breach of the contract (with varied terms) by refusing to deliver the wool after receiving the guarantee that demonstrated the ability of Company A to pay. As both parties are in breach of the contract, Company A is entitled to a refund of the deposit from Company B but not to damages (compensation) for breach of contract.

Scenario 2

Mr. A bought a brand XYZ car for his personal use from his own funds from a car dealer for RMB55,200. The car dealer issued two invoices (neither of which carried the chop of the car trading market management department of the relevant local administration of industry and commerce), a quality inspection certificate and a temporary car registration licence.

Driving the car home, Mr. A found some serious problems with it. He telephoned the car dealer the next day. On the following day, Mr. A drove the car to the appointed service centre of brand XYZ for inspection and repair. Two days later the service centre reported that the car was not manufactured by the XYZ automobile company.

Mr. A asked the car dealer to take back the car, refund the amount that he had paid, reimburse him for the inspection and repair fee of RMB928 and pay damages of RMB55,200 in accordance with the PRC Consumer Rights Protection Law《中華人民共和國消費者權益保護法》. Can the car dealer take the car back after refunding the amount that was paid by Mr. A and reimbursing the inspection and repair fee, and also to treat the rights and obligations of both parties in respect of the sale and purchase of the car as settled given that Mr. A has not suffered any loss?

Answer

A car is now considered to be a consumable good in Mainland China, and thus Mr. A falls into the category of consumer. This means that the PRC Consumer Rights Protection Law applies to this case, which overrides the relevant stipulation in the PRC Civil Code《中華人民共和國民法通則》and its various judicial interpretations by the Supreme People’s Court that relate to damages from the fraudulent supply of goods or services. The PRC Consumer Rights Protection Law states that if fraud has been committed in the provision of a product or service by the seller, then the seller must pay compensation that is equivalent to the price of the product or service upon the request of the consumer. Therefore, the car dealer must refund Mr. A the price of the car and further pay RMB 55,200 in compensation.

Mr. A is also entitled to be reimbursed for any other reasonable expenses that he incurred in the process of making his claim (including any legal costs and travelling expenses).



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