SEHK sanctions directors for failure to procure proper due diligence or internal controls

In a recent disciplinary action, the Stock Exchange of Hong Kong Limited (SEHK) censured two executive directors (the chairman and the vice chairman, respectively) of a listed company (the “Listco”) for their failure to fulfil fiduciary duties and duties of skill, care and diligence to a standard at least commensurate with the standard established by Hong Kong law. SEHK also criticised two non-executive directors, three independent non-executive directors and a former independent non-executive director of the Listco. All the aforementioned directors (the “Relevant Directors”) were directed to attend 24 hours of training on regulatory and Listing Rules compliance.

In this particular case, the Listco granted four loans to certain borrowers, the principal amount of which totalled RMB 1.11 billion. The borrowers were in financial difficulty and were themselves creditors of debts secured by certain properties and equities of the ultimate borrowers.

The Listco saw this as a fire sale opportunity, where if one of the borrowers defaulted it would then have the opportunity to purchase the collateral at a discounted price. The collateral consisted primarily of a property in Beijing.

The Relevant Directors failed to conduct sufficient due diligence prior to granting the loans, even though they knew of the substantial risks of lending to these borrowers. They also did not devise a proper strategy for the Listco to recover the loans if the fire sale opportunity failed.

Eventually, the borrowers failed to repay and the Listco made a loss provision of RMB 619.9 million in total.

The Listing Committee found that the Relevant Directors were in breach of the directors’ general duty of exercising due skill, care and diligence under Rule 3.08 in relation to the granting and enforcement of the loans and the internal control deficiencies. The Relevant Directors were also found to have not used their best endeavours to ensure the Listco complied with the Listing Rules in breach of Rule 3.09B(2).

The two executive directors were censured for they were responsible for procuring such due diligence and for implementing the transactions.

Key takeaway:

Even in the absence of conflict of interest or involvement in the underlying matter in question, if a director fails to exercise his or her fiduciary duty, which includes procuring proper due diligence and internal controls, he or she may still be held personally liable under the Listing Rules.