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Volume 2, issue 4 |
SEPTEMBER 2015 |
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In the 4th issue 2015 of Keep Your Counsel, Winston & Strawn’s bi-monthly Asia e-newsletter, Daniel Tang and David Cheng discuss the approach of the Hong Kong Stock Exchange towards potential reverse takeover cases; Charles Mo and Alex Wong relate how Hong Kong is strengthening its stand in the enforcement of the Trade Descriptions Ordinance; while Vivian Lee, Kathy Ku and Kelvin Li focus on the SFC bringing the first Market Misconduct Tribunal proceedings against a listed company and its officers for breach of disclosure requirements under Part XIVA of Securities and Futures Ordinance.
In the data privacy sphere, Matthew Durham explains how the new Chinese regulations impact employees’ use of corporate mobile devices. On the IP side, Gino Cheng analyzes whether the Federal Circuit chose the strongest response or the best response to the patent exhaustion question in JVC Kenwood v. Nero. Finally, Deirdre Fu draws our attention on the pitfalls to avoid when passing our estate to a discretionary trust by will. |
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| The recent increased activity in the sale and purchase of controlling stake in shell companies (i.e. listed companies that no longer have material business operations or assets) has contributed to their price surge. Some, if not most, of these purchasers would, sooner or later, inject their own assets to the acquired shell company. In doing so, they must beware of the reverse takeover rules promulgated by the Hong Kong Stock Exchange (HKEx). |
| Click here to read more ► |
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| Alex Wong |
| Trainee Solicitor |
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| Significant amendments to the Trade Descriptions Ordinance (the Ordinance) came into effect in July 2013, extending the reach of the Ordinance to include not only goods but also services. However, until the recent arrests of multiple employees of a popular fitness gym, enforcement has been muted. It is timely to take a closer look at the operation of the amendments to the Ordinance. |
| Click here to read more ► |
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| On July 22, 2015, the Securities and Futures Commission (SFC) commenced proceedings in the Market Misconduct Tribunal (MMT) against AcrossAsia Limited (AAL), its chairman and its chief executive officer (CEO), for breach of disclosure requirement imposed on listed companies under Part XIVA of the Securities and Futures Ordinance (SFO). |
| Click here to read more ► |
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| Three government authorities in the People’s Republic of China recently jointly issued a new regulation requiring companies to identify and provide copies of IDs to the Public Security Bureau (police) of any of the company employees using a specific number of a mobile phone device provided by and registered under the name of the company. |
| Click here to read more ► |
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| The U.S. Supreme Court decision in Quanta opened the door for exhausting method claims upon the authorized sale of components that substantially embodied them. |
| Click here to read more ► |
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| Many wealth advisory professionals would generally advise their high net worth clients to pass their wealth to a discretionary trust during their lifetime. Advantages often highlighted are avoidance of the complications of probate, mitigation of estate tax, asset protection for the settlor and beneficiaries, succession planning etc. |
| Click here to read more ► |
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The recent increased activity in the sale and purchase of controlling stake in shell companies (i.e. listed companies that no longer have material business operations or assets) has contributed to their price surge. Some, if not most, of these purchasers would, sooner or later, inject their own assets to the acquired shell company. In doing so, they must beware of the reverse takeover rules promulgated by the Hong Kong Stock Exchange (HKEx).
Reverse takeover, sometimes referred to as backdoor listing, represents an attempt to list assets or businesses while circumventing the new listing requirements. Regulators have expressed their concerns on the quality of the assets or businesses involved, which may not meet the listing requirements. The reverse takeover rules aim to protect the investors by applying the new listing requirements to backdoor listings (i.e. full due diligence by sponsors and full and quality disclosure of information in their listing documents). In addition, the new listing must be approved by the Listing Committee of HKEx for main board companies (or the Listing Division of HKEx for GEM companies) which will decide that the enlarged group meets all listing requirements and the assets to be acquired meet the trading record requirement before the transaction can proceed. As new listing usually comes with higher degree of uncertainty, longer closing timetable and higher costs, business owners are tempted by alternative ways to inject their business into listed companies without triggering the new listing requirements.
HKEx’s policy on reverse takeover aims to strike a balance between allowing legitimate business expansions through acquisitions without imposing unnecessary burden and the need to maintain market quality, which would be downgraded by the backdoor listing of inferior assets. Under the current reverse takeovers rules, HKEx applies two tests, namely the “bright line test” and the “principle based test”, to determine whether an acquisition should be regarded as a reverse takeover or not. |
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Under the bright line test, a transaction will be considered as a reverse takeover if it meets any of the criteria below:
- the acquisition or series of acquisition constitutes a very substantial acquisition involving a change of control of the listed company;
- the acquisition or series of acquisition from the incoming shareholder or his associates within 24 months of the incoming shareholder gaining control, either individually or together constitute a very substantial acquisition.
The terms “very substantial acquisition” refer to an acquisition or a series of acquisitions of assets by a listed company where the percentage ratio resulting from any of the five test indicators (i.e. assets, revenue, consideration, profits and equity capital) is 100% or more (as defined under Chapter 14 of the Main Board listing rules and Chapter 19 of the GEM listing rules), whereas “control” normally refers to the holding of 30% or more of the voting rights in the listed company.
If an acquisition falls within any of the two situations above, it will be regarded as a reverse takeover and subject to its rules, unless a waiver is granted by HKEx. For example, in the listing decision LD-59-2013, HKEx granted a waiver to a listed company even though its acquisition of a number of patents was caught by the bright line test, and treated it as a very substantial acquisition instead of a reverse takeover on the basis that the acquisition was related to the principal business of the listed company and not motivated by the circumvention of the new listing requirements.
To discourage business owners to defer the disposal of existing business until the asset are injected in the listed company, hence avoiding the classification as being a very substantial acquisition, the listing rules further provide that a listed company may not dispose of its existing business for a period of 24 months after a change in control unless the assets acquired after the change in control can meet the trading record for a new listing.
However, this doesn’t prevent certain companies from planning around the bright line test and structure their backdoor listing accordingly. For example, incoming shareholders who intend to circumvent the bright line test may hold off injecting material assets until after the 24-month period expires. The parties may also structure an acquisition where the listed company issues highly dilutive convertible securities with a conversion restriction avoiding triggering a change of control. In case the listed company raises fund for the purpose of subsequent acquisition, there is also a possible implication on whether the listed company will be treated as a cash company (i.e. its assets consist entirely or largely of cash or short dated securities) and if so, it may lead to the listed company not being regarded as fit for listing and trading in its securities being suspended (for example in Listing Decision LD95-1).
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The principle based test is a complementary test developed by HKEx to address the shortcomings of the bright line test. The principle based test empowers HKEx to give an opinion on whether an acquisition is an attempt to achieve a listing of assets to be acquired and a means to circumvent the new listing requirements or not. HKEx will take into account the following factors to draw its conclusion:
- size of the acquisition compared to the size of the listed company;
- quality of the acquired business (i.e. whether it can meet the trading record requirements for listings, or whether it is unsuitable for listing);
- nature and scale of the listed company’s business before the acquisition;
- any fundamental alterations to the listed company’s principal business;
- any other events and transactions which, coupled with the acquisition, form a series of arrangements designed to circumvent the reverse takeovers rules; and
- whether the listed company issues any highly dilutive convertible securities with a conversion restriction mechanism that doesn’t trigger a change of control while providing the vendor with de facto control of the listed company.
When HKEx considers an acquisition (or a series of acquisitions) to be “extreme” based on the above factors, the case will be passed to the Listing Committee who will then decide whether such acquisition(s) should be considered as reverse takeover or an extreme “very substantial acquisition”. The Listing Committee is likely to treat such acquisitions as extreme “very substantial acquisition” (instead of reverse takeover) if the assets to be acquired can meet the minimum profit requirement under the listing rules, hence making the circumvention of new listing requirements immaterial.
If the Listing Committee concludes the acquisition is:
- a reverse takeover, the listed company will be treated as if it were a new listing applicant and will be subject to all applicable listing requirements for new applicants;
- an extreme “very substantial acquisition”, the listed company will be required to prepare a transaction circular under an enhanced disclosure and vetting approach, and to appoint a financial adviser to conduct due diligence akin to the new listing requirements.
In either case, the acquisition is also conditional upon the listed company’s shareholders’ approval in general meeting.
Under the principle based test, it is not necessary to invoke any change of control of the listed company before any acquisition(s) is(/are) treated as reverse takeover. In one of our recent projects on a proposed very substantial acquisition that passed the bright line test, HKEx is prepared to treat the acquisition as a reverse takeover under the principal based test, on the ground that:
- there is a change in de facto control in the listed company as the vendor would become the single largest shareholder and its interest will exceed 30% upon full conversion of the convertible securities held;
- neither the target assets nor the enlarged group after acquisition can meet the track record requirements;
- the target assets are not suitable for listing because the viability and sustainability of the business model are not robust;
- the acquisition may lead to a fundamental change in the listed company’s principal business; and
- the size of acquisition is significant to the listed company.
If the factors above and listing decisions published by HKEx provide insight on whether an acquisition will be caught by the reverse takeover rules, the underlying subjectivity of the principle based test enables HKEx to judge on a case-by-case basis, which means that any material acquisitions, in particular those involving the change in the principal business of the listed company, may be caught. Therefore it is prudent to seek guidance from HKEx before finalising the structure of any material acquisition that may constitute a reverse takeover, and avoid incurring unnecessary costs and time.
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| Alex Wong |
| Trainee Solicitor |
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| Significant amendments to the Trade Descriptions Ordinance (the Ordinance) came into effect in July 2013, extending the reach of the Ordinance to include not only goods but also services. However, until the recent arrests of multiple employees of a popular fitness gym, enforcement has been muted. It is timely to take a closer look at the operation of the amendments to the Ordinance. |
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| Prior to the amendments, the Ordinance prohibits, inter alia, the sale of goods that are not as described, for example, by misstating the place of origin. Amendments were then passed by the Legislative Council in July 2012 to extend the coverage of the Ordinance to trade practices such as false descriptions of services including misleading omissions, aggressive commercial practices, bait advertising, bait-and-switch tactics and wrongly accepting payment. The Customs and Excise Department is the Government body in charge of enforcing the Ordinance. The Unfair Trade Practice Investigation Group was also established in 2014 for this purpose. |
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| In July and August 2015, four employees of Physical Fitness & Beauty (Physical Fitness), including a saleswoman, a manager, and two directors, were arrested for allegedly pressuring a customer to pay for a 10-year fitness club membership worth HK$38,000. Physical Fitness is a popular chain of gyms and beauty centers in Hong Kong and such aggressive tactics are prevalent in the industry. According to the press, the female customer, who only signed up for a 10-year membership at Physical Fitness in 2014, was persuaded to buy another 10-year membership notwithstanding that she had repeatedly told the saleswoman that she was not interested. She was asked by the saleswoman to hand over her Hong Kong ID card and credit card in order to “check for discounts”. The saleswoman then allegedly used the credit card to execute the payment without the customer’s consent. The customer then signed the contract after being told that the transaction could not be canceled and she subsequently lodged a complaint with the Customs and Excise Department. |
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| In another, unrelated case in February 2015, the Customs and Excise Department arrested three beauticians of a beauty parlor, including the beauty director, the regional manager and a therapist, following a complaint by a customer about the exertion of undue influence in the course of sale of beauty services. The beauticians were alleged to have threatened the customer that she may be suffering from infectious disease which could mutate into cancer and hence advised the customer to purchase an expensive beauty service. |
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The abovementioned arrests were based on section 13F of the Ordinance, pursuant to which a salesperson commits an offence if he or she engages a consumer in an aggressive manner, which includes any act, omission, course of conduct, representation or commercial communication (including advertising and marketing) by that salesperson. A commercial practice is regarded as “aggressive” if:
- it significantly impairs or is likely to significantly impair the average consumer’s freedom of choice of conduct in relation to the product or services through the use of harassment, coercion or undue influence, and
- it can therefore cause or likely to cause the consumer to make a transactional decision that the consumer would not have made otherwise.
In considering whether there has been harassment, coercion or undue influence, a number of factors must be taken into account, including:
- its timing, location, nature or persistence;
- the use of threatening or abusive language or behavior;
- the exploitation by the trader of any specific misfortune or circumstance, of which the trader is aware and which is of such gravity as to impair the consumer’s judgment, to influence the consumer’s decision with regard to the product (for example, a death in the family);
- any onerous or disproportionate non-contractual barrier imposed by the trader where a consumer wishes to exercise rights under the contract, including rights to terminate the contract or to switch to another product or another trader (for example, unconscionable contractual terms); and
- any threat to take any action which cannot legally be taken.
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Although the cases mentioned above are currently still under investigation, there are two points to note.
Firstly, section 18 of the Ordinance provides that a salesperson who is convicted of carrying out an aggressive commercial practice under section 13F cited above would be liable to a fine up to HK$500,000 and to imprisonment for up to 5 years.
Secondly, and perhaps more importantly from a management perspective, under section 20 of the Ordinance, the directors or other managers of a company are also personally liable for offences committed by the staff of the company if the offences were committed with their consent or connivance or are attributed to their neglect. This explains why in both cases above the directors were also arrested even if they were not directly involved in the untoward conduct. |
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| With the more aggressive enforcement of the Ordinance, we expect to see a growing number of unfair trading cases, especially in the service sector. From a risk management perspective, it would be prudent for all consumer facing businesses to review their internal policies and provide adequate training to their sales personnel in light of the recent arrests, as the legal risks are now not only restricted to the staff or the company, but also to the directors who may not have any knowledge of what is happening on the shop floor. |
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| On July 22, 2015, the Securities and Futures Commission (SFC) commenced proceedings in the Market Misconduct Tribunal (MMT) against AcrossAsia Limited (AAL), its chairman and its chief executive officer (CEO), for breach of disclosure requirement imposed on listed companies under Part XIVA of the Securities and Futures Ordinance (SFO). This is the first set of proceedings in the MMT brought by the SFC in relation to the disclosure obligations imposed on listed companies under the SFO since they became effective on January 1, 2013. |
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AAL is a Cayman Islands-incorporated investment holding company listed on the Growth Enterprise Market of The Stock Exchange of Hong Kong Limited. Its major asset is a 55.1% holding and controlling interest in PT First Media Tbk (First Media), a company listed on the Stock Exchange of Indonesia. AAL’s income and profit is derived from the business operations of First Media and its subsidiaries. First Media is an unrivalled multimedia service provider in Indonesia offering broadband Internet and digital-quality cable TV services, and is the first pay-TV network in Indonesia offering High-Definition TV programs.
On June 30, 2011, AAL entered into a loan facility agreement with First Media whereby AAL borrowed US$44 million from First Media at an interest rate of 4.75% per annum for a period of three months, with an option to automatically roll over for up to one year. When the loan has remained unpaid by AAL, First Media commenced arbitration proceedings against AAL at the Indonesian National Board of Arbitration and obtained an arbitration award to recover the principal loan which was due on June 30, 2012 (Award). Subsequently, when AAL failed to satisfy the Award, First Media commenced insolvency-related proceedings in Indonesia against AAL by way of a petition dated December 20, 2012 and a summons dated December 28, 2012 (Insolvency Proceedings). The Insolvency Proceedings sought, among other things, to temporarily suspend AAL’s obligation for payment of debts to enable a plan to be presented to First Media and to appoint an Indonesian judge and administrators to manage AAL’s assets.
The documents in relation to the Insolvency Proceedings were received by AAL on January 2, 2013, and the English translations of these documents were provided to AAL and circulated amongst its officers, including its chairman and CEO, on January 4, 2013. However, the information was not disclosed to the public in a timely manner until January 17, 2013, resulting in a 13-day delay.
AAL sought a suspension of trading on January 15, 2013 and when trading resumed on February 22, 2013, the share price of AAL had plunged 22.5%. |
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The SFC alleges that the information in relation to the Insolvency Proceedings was “inside information” within the meaning of section 307A of the SFO, given that it was specific information about AAL, and not generally known to the persons who were accustomed or would be likely to deal in the listed securities of AAL, but would, if generally known, be likely to materially affect the price of those securities.
Section 307A(1) of the SFO states that "inside information", in relation to a listed corporation, means specific information that:
- is about
- the corporation;
- a shareholder or officer of the corporation; or
- the listed securities of the corporation or their derivatives; and
- is not generally known to the persons who are accustomed or would be likely to deal in the listed securities of the corporation but would if generally known to them be likely to materially affect the price of the listed securities.”
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Pursuant to section 307B(1) of the SFO, a listed company must disclose inside information to the public as soon as reasonably practicable. The SFC alleges that AAL’s delay in issuing an announcement in relation to inside information of the Insolvency Proceedings after it came into its knowledge on or about January 4, 2013 was in breach of section 307B(1) of the SFO.
The SFC has also commenced proceedings in the MMT against AAL’s chairman and CEO for their reckless or negligent conduct in causing the alleged breach by AAL under section 307B(1) of the SFO. Section 307G(2)(a) of the SFO requires the officers of listed corporations to take all reasonable measures to ensure that proper safeguards exist to ensure the corporation’s compliance with its disclosure obligations. Accordingly, the officers of AAL were also alleged to be in breach of the disclosure requirement pursuant to section 307G(2)(a) of the SFO. |
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| The SFC has previously indicated that it is their intention to catch senior management, not middle- or low-ranking staff. The action brought by SFC against AAL highlights that while the obligation of disclosure lies with the listed corporations, it is important for the officers (i.e. directors and senior management) of the listed corporations to ensure that the listed corporations observe the statutory disclosure obligation to avoid being personally liable for breaches under the Part XIVA of the SFO. |
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Three government authorities in the People’s Republic of China recently jointly issued a new regulation requiring companies to identify and provide copies of IDs to the Public Security Bureau (police) of any of the company employees using a specific number of a mobile phone device provided by and registered under the name of the company. The full name of the regulation is the Notice from the Ministry of Industry and Information Technology, Ministry of Public Security, and State Administration of Industry and Commerce for Issuing Work Plan for Special Corrective Action Against Cellphone “Black Simcard” 2015. The stated purpose is to reduce and curb illegal activities conducted by individuals using devices with simcards which are not registered with the state mobile telecommunications providers.
This requirement comes against a backdrop of increasing fraud and related criminal activities in mainland China and increasing difficulties in tracking down perpetrators who use unregistered simcards. On a corporate level, however, it is common for employers to issue staff with mobile devices for work purposes and for these devices to be registered under the company name rather than the name of the individual. The new regulation does not provide any guidance on data privacy aspects.
Existing legislation allows employers to collect and use personal information of staff for the purposes of administering the employment relationship. However, there is no express authority allowing or restriction preventing employers providing employee information to the police in order to comply with the new regulation. It is not clear how strictly the new regulation will be enforced, but technically companies may be reprimanded and fined for failure to comply. |
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| TIP: Given the increasing (albeit still fragmented) regulation of data privacy in China over the last two years or so, especially in the e-commerce and the consumer space, employers in China should consider notifying relevant employees of the new legal requirement and obtaining their consent before providing the required information to the police. |
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| The U.S. Supreme Court decision in Quanta opened the door for exhausting method claims upon the authorized sale of components that substantially embodied them. The Federal Circuit grappled with Quanta’s implications in LifeScan,and determined in Helferich how the licensed sale of a product that embodies some method claims does not necessarily exhaust other method claims that cover complementary products or services. Close on the heels of Helferich, the Federal Circuit decided in JVC Kenwood Corp. v. Nero, Inc. (hereinafter, “Nero II”) whether a software provider is liable for contributory or induced infringement of standard-essential patents. Nero II turned on the related question: are purchasers of licensed, standard-compliant DVD and Blu-ray discs liable as direct infringers if they use the authorized discs in combination with unsanctioned software (assuming such combined use necessarily practices the standard-essential patents)? Instead of substantively critiquing the finer points of the lower court’s analysis of Nero’s patent exhaustion defense, the panel unanimously vacated that portion of the ruling and affirmed the finding of non-infringement on other grounds. How does one explain the way in which Nero II turned out? |
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The case reached the Federal Circuit on appeal from the District Court for the Central District of California’s grant of summary judgment of non-infringement (hereinafter, “Nero I”). In the first instance, JVC had asserted multiple patent that included both method and apparatus claims. Its indirect infringement case against Nero hinged on the theory that purchasers of both the licensed optical discs and Nero’s software would directly infringe JVC’s standard-essential patents whenever those purchasers used any standard, patented functions, such as fast-forwarding, setting regional control, recording, rewriting, etc.
JVC did not provide evidence of direct infringement specific to any end user, but instead advanced a standards-compliance theory of infringement. Its theory was that (a) because the asserted patent claims were essential to playing, copying, locking, and recording data on an optical disc compliant with the corresponding DVD or Blu-ray standard specification, then (b) Nero’s software must also practice the patents when used with standard-compliant discs to perform those functions.
Nero moved for summary judgment of non-infringement on two theories—patent exhaustion and express release—each of which foreclosed direct infringement by the end-users of the licensed, standard-compliant discs.
Conducting the 2-step analysis dictated by Quanta, the district court found that: (i) the licensed DVD and Blu-ray optical discs substantially embody the inventive aspects of the asserted JVC patents (which the DVD6C and One-Blue licensing consortiums had also deemed standards-essential to the corresponding optical disc products); and (ii) the only reasonable and intended use of the licensed DVD and Blu-ray optical discs is to play, copy, and record data in conformance with the DVD and Blu-ray standards specifications.
Quanta further requires the initial sale be authorized. To that end, the district court divided the types of sales into three potential categories (unlicensed, partially licensed, and fully licensed) and ultimately concluded that Nero had carried its burden showing that all of the discs allegedly used with Nero’s software had been authorized under at least one license. The court further concluded that the licensing scenario served as a complete defense to infringement, reasoning that “[e]nd users should not be faced with the possibility of patent infringement if they purchase and use an authorized product that embodies a patent and is intended for use only to practice the patent.” The district court thus observed that licensees (and their purchasers) could not be direct infringers, thereby dooming JVC’s claims of indirect infringement.
Moreover, JVC had acknowledged that its express release also provided to the end users—not merely the licensed manufacturers—a complete defense. In light of this express release and, having already determined JVC’s claim for present infringement was barred under the doctrine of patent exhaustion, the district court further held that the doctrine of express release likewise barred JVC’s claim for past infringement. The court having agreed with Nero and granted summary judgment on both grounds, JVC appealed.
Of note, JVC relied on the standardized disc specifications to show infringement by Nero’s software when used in conjunction with the discs. Ironically, however, that approach ended up cutting the other way, supporting the district court’s finding that the discs and their use by end-users were licensed. |
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As the most senior Circuit Judge on the 3-judge panel, Judge Newman had the prerogative of penning the unanimous opinion. Together with Judges Dyk and Reyna, she upheld the grant of summary judgment finding non-infringement, agreeing with the lower court’s conclusion that: “JVC cannot have it both ways—either the Patent is essential and licensed or JVC cannot rely on the standards to show infringement as it has chosen to do.” In a nutshell, since the optical discs comply with the standards, and their use complies with the standards to which JVC alleges its asserted Patents are essential, both the discs and their necessarily infringing use are licensed.
Curiously, however, the panel decided to transpose the lower court’s primary rationale of patent exhaustion with its secondary, bootstrap argument of express release (on which the district court had spent little time elaborating). After characterizing Nero’s patent exhaustion defense as a mere “alternative” theory, the panel decided to affirm the summary judgment on express release grounds only, vacating the district court’s ruling with respect to patent exhaustion.
Having approved the grant of summary judgment on the grounds of licensing, the panel could have more easily sidestepped and dispensed with the “alternative” grounds—patent exhaustion—with a simple one-liner explaining that it was unnecessary to decide that issue. It did not do so. Instead, the panel was unable to simply leave intact the lower court’s treatment of exhaustion, even as dicta. What, then, was the motivation to eradicate the district court’s analysis?
As a preliminary matter, the patent exhaustion section of the Nero II opinion suggests that the Circuit Judges were able to agree on the proper test for exhaustion, but not its application. To keep the decision unanimous, Judge Newman may have been forced to stop short of mapping the facts to the legal elements, punted on evaluating the correctness of the reasoning below, and reached the desired result on a different theory.
Also noteworthy, LifeScan was one of two Federal Circuit cases cited—in the now apparently superfluous section of the opinion—but merely for an unremarkable point of law. Nonetheless, the decision offers a potential backstory explaining how the instant panel arrived at where it did (and could proceed no further). |
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Nero II nearly could have been a replay of LifeScan. As in Nero II, the 3-judge panel in LifeScan included Circuit Judges Dyk and Reyna. Also similar to Nero II, LifeScan was another case where patent exhaustion was invoked as a defense to contributory and induced infringement for supplying perishable, complimentary products for a device sold by the patentee. In LifeScan, the appellate panel was split on whether the authorized first sale of the device—a blood-glucose measuring meter—exhausted method claims covering the use of the device in combination with the test strips that it was designed to receive. Writing the opinion for the panel majority, Judge Dyk held for the accused replacement test strip supplier, concluding that the asserted method claims for using the strips together with the meters were exhausted by the sale of those meters.
The asserted method claims were directed to a more reliable and accurate way of measuring blood-glucose levels from blood samples and required “measuring an electric current at each working sensor part proportional to the concentration of said substance in the sample liquid; comparing the electric current from each of the working sensor parts to establish a difference parameter; and giving an indication of an error if said difference parameter is greater than a predetermined threshold.” LifeScan’s meter carried out the claims by detecting, measuring, and comparing the electric currents through three corresponding electrodes on the received test strip (i.e., providing two working signals and one reference signal).
Going through Quanta’s analysis for method claims, because the meter alone could not practice the method without the test strip, the panel majority focused on whether the meter “substantially embodies the patent”—i.e., whether the additional features needed to transform the product into the completed invention are themselves “inventive” or “noninventive.” The panel majority reasoned that (a) because test strips with multiple electrodes were known in the prior art and (b) because the meter was the component that actually carried out the measuring, comparing, and indicating steps, therefore (c) any and all of the inventive aspects of the claim were substantially embodied in the meter. Thus, the sale of the meter, having been authorized by LifeScan, exhausted those method claims. The exhaustion shielded purchasers using the meters from direct infringement and the test-strip supplying defendants from indirect infringement.
Judge Reyna dissented, disagreeing with the majority’s “substantially embodying” analysis. He was at odds with Judge Dyk’s framework that mistook the meter as the component that was implementing the inventive features of the claimed method. Judge Reyna’s view was that “the test strips, and not the meters, embody those essential features.” He further criticized the majority’s overemphasis—during its Quanta analysis—on the patentability of the individual component in the mutually complementary combination, rather than the component’s contribution to the ultimately claimed invention. In other words, he thought Judge Dyk may have missed the forest for the trees.
To Judge Reyna, the complementary meter was old, existing technology. He observed that any diabetic patient with “a pencil, a pad of paper, and an ammeter” (to measure current—amperage) could determine his or her blood-glucose level” without the assistance of a blood glucose meter.” Basically, without the uniquely designed test strip, the meter was merely a “standard component in the system and only involves the application of common processes” that “does not embody the essential features of its patented method because the steps it performs are common and noninventive.” Thus he concluded that the test strips, rather than the meter, embodied the method claims, and so the meter’s sale would not have exhausted the patents.
“Fast-forwarding” ahead back to Nero II, Judges Dyk and Reyna would find themselves on the same panel and again deciding whether asserted method claims were substantially embodied in one device such that they were exhausted with respect to its post-sale use with complementary products. Having cited LifeScan in Nero II, Judge Newman was, no doubt, aware of her colleagues’ disagreement in the earlier case.
Practitioners reading the Nero II opinion might speculate that Judge Newman and her fellow judges were reliving the same debate, with Judge Dyk finding all of the inventive steps embodied in the disc and Judge Reyna finding at least one inventive step in Nero’s software (or vice-versa), thereby coming out on opposite sides of the exhaustion issue. If so, this impasse would explain why Judge Newman would go out of her way to bring into the foreground the express release argument and shelve the central exhaustion question. If so, this route, in her view, may have been preferable to suffering a fractured opinion and further muddling the law in this nuanced area of the doctrine. |
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| Nero II, an uncontroversial, reserved opinion, may be a product of Judge Newman’s diplomacy, carefully negotiated with her fellow panelists who may have been dueling over how to apply Quanta to the “undeveloped facts” of Nero I. So, instead of overextending herself in search for an illusory checkmate, she may have simply played a quiet waiting move. On any given turn at the board, there’s the strongest move and the best move, and here, Judge Newman may have opted for the latter. |
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Many wealth advisory professionals would generally advise their high net worth clients to pass their wealth to a discretionary trust during their lifetime. Advantages often highlighted are avoidance of the complications of probate, mitigation of estate tax, asset protection for the settlor and beneficiaries, succession planning etc.
However, Asian high net worth individuals (“HNWI”) are sometimes weary of parting with their wealth during their lifetime and opt for an alternative solution: establish a “standby” trust and execute a will which stipulates that any residuary estate would go to the trust upon death. In Hong Kong, where estate duty has been abolished, this alternative seems attractive. Although probate procedure remains necessary, HNWI would keep full control of their wealth until death, be able to prepare a detailed distribution plan within the trust arrangement (usually by letter of wishes), and save any payment of annual fees to the professional trustees during their lifetime! |
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Nina Wang, former Chairlady of the Chinachem Group, set up the Chinachem Charitable Foundation (“Foundation”) as a company limited by guarantee and, according to reported cases, injected a relatively small amount of her assets during her lifetime. Although the Foundation has its own constitution and board, Mrs. Wang was dictating how the charitable donations should be made and only transferred funds to the Foundation prior to each donation.
Mrs. Wang’s elusive four-clause Chinese will to pass her wealth to the Foundation after her death generated debates on its construction: should the Foundation take the estate as an “absolute gift” and have discretion to administer the estate pursuant to the terms of its constitution; or should it take the estate on trust as a trustee of a “will trust” holding such property pursuant to the terms as stated in her will?
The Courts decided (Secretary of Justice vs Joseph Lo Kin Ching (HCMP 853/2012, [2014] HKEC 621, [2015] HKEC 825)) that due to the imperative language of the will to set up a “will trust”, the Foundation must take the estate as a trustee, to apply and administer the estate according to the terms of the charitable trust as established by the will rather than take the estate absolutely. The Foundation should submit a detailed scheme for administering the estate for further approval by the Courts.
This brings up an important consideration for will drafters. If the testator intends to provide a testamentary gift to a particular named trust or charity, the initial question to be ascertained would be whether the testator intends his legacy to be applied according to the terms of such trust or charity, or pursuant to some other special rules/limitations.
The case also touches on another issue concerning gifts to specified charities and trusts by will. If the Foundation were to take the estate absolutely, whether it should hold the estate according to the terms of its constitution i) at the time of the will; ii) at the time of death; or iii) at some other time. The question was not dealt with by the Courts further since the absolute ownership argument did not stand. |
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Before considering what terms of the charity/trust should govern testamentary gifts, we should actually consider whether testamentary gifts to discretionary trusts are generally valid. This was raised in another high profile probate/trust litigation in Hong Kong concerning the will of the Queen of pops, Ms. Anita Mui (Tam Mui Kam vs HSBC (HCAP2/2004, [2010] 6 HCA 10, [2011] HKCU 964 )). Ms. Mui executed a will at the Hong Kong Sanatorium which bequeathed all her residuary estate to a discretionary trust set up by her with a bank trustee. She passed away less than a month later.
Usually, the trustee of a discretionary trust (or more specifically a “trust with discretionary powers”) has wide “powers of appointment” or “dispositive powers”.1 These include powers to select from the list of Beneficiaries the person(s) to benefit from the trust assets and power to add to the list of Beneficiaries (or more precisely the “objects” of the trust powers). The trustee may also by deed amend the terms of the trust instrument from time to time.
Not only was the testamentary capacity of Ms. Mui challenged but also the validity of a testamentary gift to a discretionary trust based on the notion of “non-delegation of testamentary powers”.2 The basis of the rule stems from the lack of “certainty of objects” as well as lack of formalities. The first issue is if the trustee has wide powers, such as power to add beneficiaries to the trust (which may not be to the testator’s knowledge) who may then benefit from the estate, the trustee is in fact exercising testamentary powers which belong to the testator and cannot be delegated. Secondly, if a trust set up as recipient of an estate can be amended without the formalities required3 for a testamentary disposition, such trust arrangement cannot bind any property comprised in the estate.
In the Mui case, the Court of First Instance decided that the notion of “non-delegation of testamentary powers” has no application in Hong Kong, but even if it applies, the testamentary gift to the trust settled by Ms. Mui should fall within one of the exceptions.4
Even though the “non-delegation” rule (which may be peculiar to Australia) may not apply in Hong Kong, there are common law practitioners who have expressed skepticism about testamentary gifts to a trust arrangement.5 The basis of objection relates mainly to the issue of formalities and “incorporation by reference”- if the trust provisions contained in a separate document is to govern the estate, then such provisions should have been “incorporated by reference” to the will.6 This means that the trust document must be in existence before the execution of the will and must be clearly referred to and be identified in the will. Gifts to a trust created after the date of the will therefore cannot be a valid testamentary gift. Nor can changes to the terms of an existing trust, made after the date of the will without observing the formalities required for execution of a will bind the property comprised in the estate.7 |
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Gifts to a “pre-existing” discretionary trust which is validly set up8 is generally accepted as an exception and a valid testamentary gift.9
One may think that it is easy to have a “pre-existing” trust. However, in the Mui case, arguments had to put forward that the trust had actually come into existence before the execution of the will. The issue arose because the trust was executed by Ms. Mui on the same day as her will. Indeed, most bank trustees require a few weeks after the execution of the trust deed by the settlor for the trustee to countersign and for the trust set up to be completed. In order to avoid any arguments that the trust was not properly constituted prior to the execution of the will, it is advisable for the trust deed to be executed by the settlor sufficiently ahead of the execution of the will.
The question remains - what terms of the pre-existing trust actually govern the testamentary gift? What if the trustee made amendments to the terms affecting dispositive powers after the date of the will? |
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| If the will clause merely specifies that the testator shall pass his residuary estate “to the trustee of a specific trust to hold on the terms of the trust”, the view is that in order for the clause to be valid, it should be construed as meaning the terms of the trust as at the time of the will.10 Hence, any exercise of dispositive powers or change to the dispositive provisions in the trust after the date of the will should not bind the property in the estate. For example, if discretionary objects were added to the trust after the “date of the will, such objects should not be considered by the trustee for distribution when the trustees are distributing property in the trust which is sourced from the estate. |
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Would a will clause specifically drafted to accommodate for future changes, e.g. that the testamentary gift is to a pre-existing trust to be “held by the trustee in accordance with the terms of the trust as amended by the trustee from time to time”, help to overcome the issues?
A review of the case law11 suggests that such a will clause would be invalid. A will clause which reserves the power for the trustee to make changes to, or to exercise dispositive powers BETWEEN the date of the will and the date of death of the testator/settlor would be invalid, unless the part of the clause reserving power for future changes by the trustee is ignored. This will effectively leave the testamentary gift to be passed to the trust in accordance with terms of the trust as at the date of the will.12
It has therefore been recommended13 that a valid will clause to effect gifts to a pre-existing trust should contain a proviso such as that the trustee shall hold the estate on condition “that no modification to the trust which occurred through exercise of any dispositive powers between the date of this will and the date of death [of the testator] shall apply in relation to the [residuary estate]”. |
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It is always possible for the testator/settlor to re-execute his will or to execute a codicil as a supplement to the will, referring to the deed which amended the original trust.
Following the example above, if additional objects are added by the trustee after the date of the will, then the testator should re-execute the will (or execute a codicil referring to the “Deed of Addition of Beneficiaries”) to ensure that such additional objects may also be considered for benefit from the estate.14 |
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Settlors of discretionary trusts often rely on letters of wishes to give guidance to the trustee on how exactly the trust assets are to be distributed. What is the effect if the settlor amends a letter of wishes and sends the same to the trustee of the pre-existing trust (the recipient of the estate) after the date of will?
Letters of wishes are by design not meant to be legally binding for reasons such as asset protection. As such, no formalities are required for the execution of such letters.
Nonetheless, if the updated wishes are intended to guide the testamentary gift, the settlor should consider executing the letter according to the formalities required for a will, or re-executing the will after a new letter is sent to the trustee. This will avoid any uncertainties or disputes if the trustees were to take into account the updated wishes when administering the estate as part of the trust property. |
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When testators consider making testamentary gifts to a specific named trust arrangement, the first question to ask should be whether they intend to make an absolute gift to the trust or whether the gift is subject to specific rules other than those contained in the trust arrangement.
In a case of absolute gift, trustee and testator/settlor should ensure that the discretionary/“standby” trust be executed and validly constituted well ahead of the execution of the will, to make sure that it qualifies as a “pre-existing” valid trust.
When drafting the clause in a will to gift to the pre-existing trust, a proviso similar to the above should be added to stipulate that no changes to the dispositive terms of the trust shall bind the estate.
In addition, if the trustee of the pre-existing discretionary trust exercises any dispositive powers which alters the terms of the trust after the date of the will, the testator should re-execute the will right after (or execute a codicil which make reference to the amendment). The same procedure should be taken if any new letters of wishes are given to the trustee after the date of the will.
If the testator/settlor is willing to part with more of his wealth and inject it directly to the trust during his lifetime, the problem would be minimized - assets directly injected to the trust would unquestionably be governed by terms of the trust and be guided by letters of wishes as amended from time to time. No complications surrounding testamentary gifts to a trust would arise. |
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