LEUNG CHUNG PUN v. MASTERWISE INTERNATIONAL LTD AND OTHERS

HCMP 2681 /2012

IN THE HIGH COURT OF THE

HONG KONG SPECIAL ADMINISTRATIVE REGION

COURT OF FIRST INSTANCE

MISCELLANEOUS PROCEEDINGS NO. 2681 OF 2012

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J U D G M E N T

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Introduction

1. I have before me two applications for inspection of records of Masterwise International Limited (“Masterwise”) and Foster Industries Company Limited (“Foster”) made pursuant to Section 152FA of the Companies Ordinance (Cap 32).  In what follows, references to sections are, unless the context indicates otherwise, to sections of the Companies Ordinance.

2. Masterwise and Foster are both companies incorporated in Hong Kong, and are owned, directly or indirectly, by the Leung family.  The following members of the Leung family have featured in the evidence filed in the present cases:

1)  Leung Chung Sun (“Chung Sun”), the 3rd brother;

2)  Leung Chung Po (“Chung Po”), the 4th brother and the 2nd Defendant in both HCMP 2681 and 2682 of 2012;

3)  Leung Chung Sum (“Chung Sum”), the 5th brother;

4)  Leung Chung Pun (“Chung Pun”), the 6th brother and the Plaintiff in HCMP 2681 of 2012;

5)  Leung Chung Lam (“Chung Lam”), the 7th brother and the 3rd Defendant in both HCMP 2681 and 2682 of 2012;

6)  Leung Chung Kwan (“Chung Kwan”), the 8th brother, who passed away in 2006; and

7)  Lam Kit Bing Isabella (“Isabella”), the widow of the 8th brother and the 4th Defendant in both HCMP 2681 and 2682 of 2012.

3. Masterwise and Foster each has 3 directors, namely, (1) Chung Po, (2) Chung Lam and (3) Isabella.

4. Masterwise has an issued share capital of HK$8,000 divided into 8,000 shares of HK$1 each which are held by the following shareholders:

1)  Chung Pun – 3,000 shares (37.5%);

2)  Chung Lam – 4,200 shares (52.5%); and

3)  Isabella – 800 shares (10%).

5. Foster has an issued share capital of HK$4,000,000 divided into 400,000 issued shares of HK$10 each which are held by the following shareholders:

1)  Orient Flight Company Inc (“Orient Flight”) – 90,000 shares (22.5%);

2)  Primate Company Inc (“Primate”) – 90,000 shares (22.5%);

3)  Luxfull Company Inc (Luxfull”) – 90,000 shares (22.5%);

4)  Rin Tin Corporation (Rin Tin) – 90,000 shares (22.5%); and

5)  Bromsley Company Inc (Bromsley) – 40,000 shares (10%).

6. Chung Pun is the sole beneficial owner of Orient Flight. Chung Pun and his wife (“Winnie”) also hold shares in Primate and Bromsley.  The other shares in Primate, Bromsley, Luxfull and Rin Tin are held by the other members of the Leung family.

Brief background facts

7. The business of the Leung family started off as a small-scale assembly business run by Foster which was incorporated in Hong Kong in 1974.  According to Chung Pun, he was responsible for the technical, research and development aspects of the business of Foster, while  Chung Sum and Chung Lam were responsible for the marketing and production aspects of the business of Foster respectively.

8. In 1998, Chung Pun and Winnie set up a company called Triolot Industrial Limited (“Triolot”) which acquired a factory in Shenzhen and started to manufacture parts and semi-finished goods.  Those goods were then sold exclusively to Foster for assembly into finished products at its factory in Hong Kong.  Triolot was deregistered on 9 July 2004.

9. In 1991, Masterwise was incorporated in Hong Kong.  In 1993, it established a wholly-owned subsidiary in the PRC called Fifu Electronics (Shenzhen) Company Limited 快富電子(深圳)有限公司 (“Shenzhen Fifu”) which then set up a factory in Shenzhen (the “Fifu Factory”).  The Fifu Factory started operation in 1994.  Since that time, electronic products and goods manufactured by the Fifu Factory would be sold by Masterwise to Foster which, in turn, would sell them to overseas customers.  According to Chung Pun, since about 2008, Shenzhen Fifu has also been licensed to carry on domestic sales (國內銷售) and has been selling products produced by the Fifu Factory within the PRC.

10. Chung Pun used to be a director of both Foster (since 1974) and Masterwise (since 1971).  Apparently, in around 1994, Masterwise and Foster began to generate substantial profits, and disputes amongst members of the Leung family regarding the business or affairs of Masterwise and Foster started to arise.  For the purpose of the present applications, it is not necessary to go into the details of those disputes. Eventually, Chung Pun resigned from his position as director and all other positions of or in Masterwise and Foster on 30 September 1997, but he remained as shareholder of the two companies.  Since that time, Masterwise and Foster have been managed by other members of the Leung Family, including in particular Chung Po, Chung Lam and Chung Kwan/Isabella.

11. In support of the present applications for inspection of company records, Chung Pun and Orient Flight have raised complaints in respect of the following matters or transactions:

1)  the directors have procured Masterwise and Foster to pay excessive remuneration to themselves, leaving disproportionately small sums or nothing to be paid by way of dividends to the shareholders;

2)  the directors carried out significant transactions of the companies (namely, Shenzhen Fifu’s land sale and factory relocation and Foster’s property sale) in a surreptitious and opaque manner, and refused to provide any meaningful information to Chung Pun when he made inquiries;

3)  there are grounds to suspect that there has been misappropriation of the assets of Masterwise by reason of a missing dividend payment of RMB1,120,416.74 from Shenzhen Fifu;

4)  there are significant irregularities in the accounting practices of Masterwise, including its failure to prepare group and consolidated accounts and its improper claim on tax allowance which led to a substantial claim by the Inland Revenue Department (the “IRD”);

5)  there is a suspicious surge in banking charges shown in Masterwise’s recent audited financial statements.

12. Before I consider these complaints, I shall first set out what I understand are the relevant principles for an application under Section 152FA.

Applicable principles under Section 152FA of the Ordinance

13. Section 152FA states as follows:

“(1) Subject to sections 152FD and 152FE, on application by such number of members of a specified corporation as is specified in subsection (2) (in this section referred to as ‘applicant’), the court may make an order -

(a) authorizing the applicant or any one or more of such members applying as applicant to inspect any records of the specified corporation; or

(b) authorizing a person (whether or not a member of the specified corporation) other than the applicant to inspect any such records on behalf of the applicant.

(2) For the purposes of subsection (1), an application may be made by -

(a) any number of members representing not less than one-fortieth of the total voting rights of all members having at the date of the application a right to vote at a general meeting of the specified corporation;

(b) any number of members holding shares in the specified corporation on which there has been paid up an aggregate sum of not less than $100000; or

(c) not less than 5 members.

(3) The court may only make an order under subsection (1) if it is satisfied that—

(a) the application is made in good faith; and

(b) the inspection applied for is for a proper purpose.

(4) Any person who is authorized by the court to inspect the records of a specified corporation may make copies of the records unless the court orders otherwise.”

14. There is no dispute that (i) Masterwise and Foster each is a “specified corporation” as that expression is defined in Section 2, and (ii) Chung Pun and Orient Flight each meets the shareholding requirement as set out in Section 152FA(2)(a) for the purpose of making an application under Section 152FA(1) in respect of Masterwise and Foster respectively.

15. It can seen immediately that there are two conditions to be satisfied before the court can be called upon to exercise its discretion to make an order for inspection of the records of the specified corporation, namely, (i) the application is made in good faith, and (ii) the inspection applied for is a for a proper purpose.

16. In relation to the twin requirements of “good faith” and “proper purpose”, the following propositions, adapted from the submissions of Miss Linda Chan SC (acting, together with Miss Janet Ho, for the Plaintiffs), are not disputed by the Defendants:

1)  the two requirements constitute two separate and independent tests;

2)  the requirement of “good faith requires that the applicant himself acts honestly with a purpose that he himself believes to be proper”;

3)  as for the requirement of “proper purpose” –

a)  it requires the court to apply an objective test and look at all surrounding circumstances to see whether the purpose for the inspection is indeed proper;

b)  the purpose for which inspection is sought must bear some reasonable relationship to the interests of the applicant qua shareholder;

c)  once the primary or dominant purpose of the application for inspection is deemed by the court to be proper (in that it is germane to the applicant’s status as a shareholder), any further or secondary purpose in seeking the records is irrelevant;

d)  if the purpose is to protect the applicant’s economic interest in a company by finding out whether there has been some impropriety which adversely affects that interest, prima facie the “proper purpose” requirement is satisfied;

e)  a genuinely held desire to assess the value of an applicant’s shareholding, where the possibility of a disposal of his investment is in prospect, is a “proper purpose” for the purpose of Section 152FA.

17. The foregoing propositions are supported by the following authorities referred to by the parties at the hearing: Wong Kar Gee Mimi v Hung Kin Sang Raymond [2011] 5 HKLRD 241; Wu Yang v Dayuan International  Limited and Others (HCMP 2143/2011, Harris J, 4 June 2013); Talal El Makdessi v Team Y&R Holdings Hong Kong Limited (HCMP 1054/2011, Barma J, 11 July 2012); and Re LehmanBrown Ltd [2011] 5 HKLRD 668.

18. On the other hand, as submitted by Mr Victor Dawes (acting for Masterwise and Foster) where the application is made for the purpose of investigation based on some reasonable grounds for believing that misconduct or maladministration has taken place, the court may nevertheless refuse to exercise its discretion to permit inspection where it is satisfied that nothing of utility will come from the inspection or that the company will suffer undue prejudice as a result: see Wong Kar Gee Mimi v Hung Kin Sang Raymond [2011] 5 HKLRD 241 at paragraph 39; Veron International Ltd v RCG Holdings Ltd (CACV 126/2012, 30 May 2013) at paragraphs 36 to 38, per Yuen JA.

19. At the hearing of these applications, the parties differ on an issue of principle, namely, in what circumstances would an applicant be entitled, under Section 152FA, to seek inspection of the records of a “subsidiary” of a specified corporation. 

20. In Veron International Ltd v RCG Holdings Ltd, Yuen JA (with whom the other members of the Court of Appeal agreed) stated the following at paragraph 40 of the judgment: “If the company has possession of such documents of its subsidiaries, inspection should be given but not otherwise”.  Her ladyship cited paragraph 46 of the judgment of Harris J in Wong Kar Gee Mimi v Hung Kin Sang Raymond [2011] 5 HKLRD 241, where the learned judge stated as follows:

“I accept that records emanating from a subsidiary, which become owned by or possessed as of right by the specified corporation come within ‘records of the specified corporation’: Re Tecnion Investments Ltd [1985] BCLC 434 (CA) per Dillon LJ at 437d-439e; Innovisions Ltd v Chan Sing Chuk & others [1992] 1 HKC 348 per Kaplan J at 354C-356D. Accordingly, documents that have been passed by a subsidiary to the Company, whether to enable the Company to comply with its obligations arising under statute, delegated legislation or Stock Exchange Rules (for example, to produce consolidated accounts), or because the Company requires the subsidiary for commercial reasons and by reason of its managerial control over the subsidiary is able to direct its documents are so provided, become the Company’s ‘records’ for the purposes of section 152FA. However, I do not agree that a subsidiary’s documents, copies of which have not been passed to the Company, and which it is not obliged and able at the time any order is made to obtain, come within section 152FA.”

21. It seems to me abundantly clear, from the language of Section 152FA(1), that the court’s jurisdiction extends to anything which can properly be regarded as forming part of the “records” of the specified corporation, regardless of the sources from which the documents came to become part of the records of the corporation in the first place. However, the “records” referred to in that subsection must, it seems to me, be a reference to the current records of the corporation.  Accordingly, documents which are currently in the possession of the corporation, or of which the corporation is currently entitled as a matter of legal right to have possession, can, in my view, properly be regarded as forming part of the records of the corporation for the purpose of Section 152FA(1).  This having been said, the documents of a subsidiary are, generally speaking, not the documents of its parent company, and they are not within the power of the parent company: see Wong Kar Gee Mimi v Hung Kin Sang Raymond [2011] 5 HKLRD 241 at paragraph 47.

22. In her skeleton submissions, Miss Chan states that if the court is satisfied that Chung Pun’s request for inspection of the records of Shenzhen Fifu (a wholly owned subsidiary of Masterwise) and惠州市快富電子有限公司 (“Huizhou Fifu”) (a wholly owned subsidiary of Shenzhen Fifu) is made in good faith and for a proper purpose, he should be permitted to inspect any such records even though they were originally produced by or on behalf of Shenzhen Fifu and Huizhou Fifu, as long as they have become owned or possessed by Masterwise.  Mr Dawes seems to have read Miss Chan’s submissions to mean that inspection could be given in respect of documents of a subsidiary which were at one time passed by the subsidiary to the parent company but are no longer currently in the possession of the parent company.  This is not, however, my reading of Miss Chan’s submissions, nor is this my understanding of the effect of her oral submissions in court.  In any event, I shall proceed on the basis of the law as I understand it to be and as set out in  paragraph 21 above.

23. There is a further issue which was debated at the hearing of these applications, namely, whether the individual directors of Masterwise and Foster (ie Chung Po, Chung Lam and Isabella) should have been joined as defendants and whether they should be made liable to pay the Plaintiffs’ costs of these applications in the event that the Plaintiffs should succeed in obtaining the orders for inspection sought.  I shall deal with this issue at the end of this judgment.

24. Lastly, before I turn to consider each of the complaints of misconduct or maladministration raised by the Plaintiffs, I shall indicate the approach that I propose to adopt.  It has not seriously been suggested that the Plaintiffs are not acting in “good faith” in pursuing these applications.  Certainly, there is nothing in the materials that I have seen which would cause me to find that the Plaintiffs are not pursuing these applications in good faith.  The focus of the parties’ respective arguments relates to the requirement of “proper purpose”.

25. Where, as in the present case, the application for inspection of a company’s records is for the purpose of enabling the plaintiff to carry out investigation into alleged misconduct or maladministration, it would not be possible or appropriate for the court to reach a firm conclusion on each complaint raised because, amongst other things, the evidence would likely not be complete, it is unlikely that disputes of fact can be resolved on affidavit evidence alone, and the complaint may well be raised again in subsequent proceedings for adjudication.  Accordingly, what I consider the court should do is to assess, on the basis of the available evidence, whether the plaintiff has made out a proper case for investigation taking into account such explanations as may be offered by the defendant.  If the plaintiff is able to make out a proper case for investigation, the court should move on to consider whether, in the exercise of its discretion, the inspection sought ought nevertheless to be refused.  The statute does not lay down any restriction as regards the mattes which the court may take into account when exercising its discretion.  Thus, the court is entitled to take into account a wide spectrum of matters.  However, as cautioned by Harris J in Wong Kar Gee Mimi v Hung Kin Sang Raymond [2011] 5 HKLRD 241 at paragraphs 34 to 37, the court should strike a proper balance between (i) requiring the company to be transparent and (ii) not permitting the statutory jurisdiction to be used by a shareholder to challenge managerial or commercial decisions made by the board of directors of the company.  How this balance should be struck in any given case can only be determined on a case by case basis.

First complaint: excessive directors’ remuneration leaving disproportionately small sums or nothing to be paid by way of dividends

26. The amounts of remuneration paid to the directors and dividends paid to the shareholders of Masterwise and Foster respectively for the period from 1995 to 2011 are summarized in 2 tables in an exhibit (LCP-11) to the Affirmation of Chung Pun affirmed on 26 November 2012. For the sake of convenience, the two tables are reproduced as Annex I to this judgment.

27. As earlier mentioned, Chung Pun ceased to be a director of Masterwise and Foster on 30 September 1997.

28. The following features relating to the amounts of remuneration paid to the directors and dividends paid to the shareholders of Masterwise and Foster are of note.  In the case of Masterwise, the amounts of dividends paid to the shareholders for the 3 years ending on 31 March 1999, 2000 and 2001 were substantial (HK$34,000,000, HK$26,000,000 and HK$12,000,000 respectively), while the amounts of remuneration paid to the directors for the same years were HK$1,140,000, HK$1,668,187 and HK$4,315,701 only.  However, starting from 2002 onwards, the amounts of dividends paid to the shareholders were kept at between HK$1,200,000 and HK$2,000,000 (with no dividends being paid for the years ending on 31 March 2002, 2009 and 2011 respectively), while the amounts of remuneration paid to the directors exceeded the amounts of dividends paid to the shareholders (except for the year ending on 31 March 2010) by substantial margins.

29. In the case of Foster, the amounts of dividends paid to the shareholders for the 4 years ending on 31 March 1995, 1996, 1997 and 1998 were substantial (HK$12,000,000, HK$32,000,000, HK$22,000,000 and HK$28,000,000 respectively), while the amounts of remuneration paid to the directors for the same years were HK$2,819,358, HK$4,094,561, HK$4,641,278 and HK$4,619,668 only.  However, starting from 1999 onwards (with the exception of the years ending on  31 March 2001 and 2011 respectively), the amounts of dividends paid to the shareholders were kept at between HK$1,200,000 and HK$4,000,000 (with no dividends being paid for the years ending on 31 March 1999, 2000, 2002 and 2010 respectively, and the amounts of HK$10,000,000 and HK$9,000,000 being paid as dividends for the years ending on 31 March 2001 and 2011 respectively), while the amounts of remuneration paid to the directors exceeded the amounts of dividends paid to the shareholders (except for the years ending on 31 March 2001 and 2011) by substantial margins in most years.  In this regard, the dividends of HK$9,000,000 paid to shareholders for the year ending on 31 March 2001 were, apparently, of a special nature arising from Foster’s disposal of a property at Texaco Road Industrial Centre.

30. From these figures, it would seem that there has been a general shift of policy of Masterwise and Foster, starting from around 2002, to substantially reduce the dividends paid to the shareholders while paying a lot more to the directors by way of remuneration.

31. On behalf of Masterwise and Foster, Mr Dawes argues that the amount of remuneration paid to a director is generally a commercial decision for the board, that the quantum of remuneration must be assessed by reference to objective criteria and it is for the Plaintiffs to show that the level of remuneration is out of line with that paid to the executive directors of other companies of comparable size and turnover, that the amounts of the remuneration paid to the directors over the years should be viewed having regard to the substantial retained profits of Masterwise and Foster, that Chung Pun was all along fully aware of the remunerations paid to the directors but chose to do nothing about them, that the payments were ratified at a shareholders meeting on 23 March 2013, and that they could in any event be justified by reference to Article 15(b) of Foster’s Articles of Association and Regulation 110 of Table A applicable to Masterwise.  Various other minor points have also been taken by Mr Victor Dawes on behalf of the companies in answer to this ground of complaint raised by the Plaintiffs.

32. On the other hand, Miss Chan contends that the amounts paid to the directors by way of remuneration from 1998 are void because the payments were not approved by shareholders at general meetings of Masterwise and Foster.  Miss Chan also contends that the companies’ belated explanations that Chung Po, Chung Lam and Isabella were paid in their capacities as “managing director” or “working director” as authorised by Article 15(b) of Foster’s Articles of Association and Regulation 110 of Table A applicable to Masterwise are recent fabrications.  There is also a complaint raised regarding the additional remuneration (of about HK$1,500,000 per year from 1999 to 2007) paid to the directors under the guise of “directors’ quarter expenses”.

33. For the purpose of the present applications, it is neither possible, nor appropriate, for me to reach any firm conclusions on these rival contentions of the parties.  What seems to me to be clear is that, on the undisputed figures as set out in the 2 tables mentioned above, there is at least a proper case for further investigation as to whether the directors have unjustifiably paid excessive remuneration to themselves while failing to pay adequate dividends to the shareholders thereby acting in a manner which is unfairly prejudicial to the interests of Chung Pun qua shareholder.

Second complaint: significant transactions of the companies carried out in a surreptitious and opaque manner, and refusal to provide meaningful information to Chung Pun when he made inquiries

34. The transactions complained of by the Plaintiffs relate to (i) Shenzhen Fifu’s sale of the Fifu Factory and the relocation of the factory to a new site in Huizhou, and (ii) Foster’s sale of its property at Rooms 1 to 8, 12/F, Block B and Car Parking Space No C15, Texaco Road Industrial Centre, 14-22 Wang Lung Street, Tsuen Wan, New Territories (the “Tsuen Wan Property”) for HK$13,215,724 in April 2010.

35. In respect of the sale of the Fifu Factory and the relocation of its factory to Huizhou, Chung Pun’s complaints are essentially that: (i) the EGM convened for the purpose of approving the proposed sale did not mention anything about any relocation of the factory, (ii) little, if any, information was provided in relation to the sale and relocation during the EGM, (iii) the board persistently refused to provide information and documents relating to the sale and relocation sought by Chung Pun on the basis that the details of those transactions were matters for the directors, (iv) the only document provided to Chung Pun relating to the sale and relocation was a 2-page document entitled “報告：土地出售及遷廠事宜” (“the Report”) which did not specify its author or sources of information, and the information set out in the Report is criticized by the Plaintiffs as being vague, incomplete and unsatisfactory and unsupported by any document, (v) the reasons offered by Chung Po in his first and second affirmations filed in HCMP 2681/2012 to justify the relocation of the factory (which had something to do with an application to the authorities in Shenzhen to convert staff quarters into factory premises) are said to be inconsistent and not truthful.  There is also a complaint about a penalty clause in the sale contract which apparently required Shenzhen Fifu to pay liquidated damages of up to RMB 45 million if vacant possession could not be delivered to the purchaser by 1 September 2013.

36. In response to these allegations, Mr Dawes argues that: (i) the relocation of the factory is a matter within the powers of the directors to decide, (ii) Chung Pun was aware that Masterwise was a manufacturing company and must have appreciated that Masterwise would need to relocate the factory to another site after the sale of the  Fifu Factory, (iii) the Report contained sufficient information about the relocation such that there is no case for further investigation, (iv) the explanations given by Chung Po in his first and second affirmations regarding the approval for conversion of the staff quarters into factory premises are not inconsistent, (v) there is nothing extraordinary about the penalty clause in the contract for the sale of the Fifu Factory, and (vi) the details about the relocation of a manufacturing base must involve sensitive financial information which the board is justified not to disclose to Chung Pun, who is said to be a “competitor”.

37. In considering Chung Pun’s complaints under this head, it seems to me that the relocation of the Fifu Factory is a commercial or managerial decision which is a matter within the powers of the directors to decide.  There is force in Mr Dawes’ submission that Chung Pun must have appreciated that Shenzhen Fifu’s factory would have to be relocated after the sale of the Fifu Factory.  The further resolutions passed at the EGM relating to the relocation of the factory were, in my view, consequential upon the resolution for the sale of the factory falling within the scope of the notice for convening the EGM.  I also take into account the fact that at the EGM, Chung Pun in fact approved the resolution relating to the sale of the factory site by Shenzhen Fifu, although Chung Pun said that at the time of giving his approval to the sale, he was not aware that further resolutions would be proposed at the EGM to approve the re-location of the factory.

38. It also seems to me that the acceptance of a penalty clause in the contract for the sale of the Fifu Factory is a commercial decision within the powers of the directors to decide.  In any event, Chung Po has stated in his fourth affirmation that Shenzhen Fifu was able to deliver vacant possession of the Fifu Factory to the purchaser on 5 July 2013 and thus there is no question of Shenzhen Fifu being required to make any payment under the penalty clause.

39. While there may be some validity in Chung Pun’s complaint regarding the contents of the Report, as stated above, the court’s statutory jurisdiction under Section 152FA should not be permitted to be used to enable a shareholder to challenge a commercial decision reached by the board of directors.  Lastly, I accept Mr Dawes’ submissions that the explanations given by Chung Po in his first and second affirmations regarding the approval for conversion of the staff quarters into factory premises are not inconsistent.  Overall, I am not satisfied that a sufficient case has been made out for further investigation regarding the sale of land by Shenzhen Fifu and the relocation of its factory to Huizhou.

40. In so far as Foster’s sale of the Tsuen Wan Property is concerned, Orient Flight’s case is that at the 2009 AGM of Foster held on 30 December 2009, the proposed disposal of that property was discussed and the shareholders agreed that it should be sold at HK$720-750 per square foot, subject to an understanding that upon Foster receiving an offer within the agreed price range from a third party purchaser, the shareholders would be informed about the offer and would have the priority to purchase the Tsuen Wan Property at the same price.  Orient Flight further says that the directors caused Foster to sell the Tsuen Wan Property to a third party without informing the shareholders of the price that had been offered and giving them the priority to purchase the property in accordance with the said understanding.

41. In support of the alleged understanding, Orient Flight relies on two previous occasions in 2004 and 2006 when the shareholders were given priority to purchase Foster’s other properties (namely, various units on 8/F, Texaco Road Industrial Centre) which it proposed to sell, and also an occasion in 2005 when Chung Po had allegedly telephoned Chung Pun to inform him of the price offered by a potential purchaser of the said properties and asked him whether he was interested to buy them at that price.

42. Chung Po has in his 1^st affirmation filed in HCMP 2682/2012 denied the alleged understanding and made the obvious point that merely because the shareholders were given priority to purchase Foster’s properties on isolated occasions in the past does not mean that this has become an established practice binding on the company and its shareholders.  Without deciding this point, it seems to me that if Orient Flight has any valid complaint to make regarding the disposal of the Tsuen Wan Property contrary to some understanding or established practice that it would be given priority to purchase the property, it is a complaint that Orient Flight can make without inspection of the documents referred to in paragraphs 1.4 and 1.5(1) to (8) (in so far as they relate to the sale of the Tsuen Wan Property) of the Schedule to the Originating Summons in HCMP 2682/2012.

43. In all, I am not satisfied that Chung Pun and Orient Flight are entitled to inspect the records of Masterwise and Foster respectively under the second complaint.

Third complaint: misappropriation of the assets of Masterwise by reason of a missing dividend payment of RMB 1,120,416.74 from Shenzhen Fifu

44. Chung Pun’s complaint is that Shenzhen Fifu’s audited report for the year of 2000 recorded that the company had paid a dividend in the sum of RMB 1,120,416.74, but the financial statement of Masterwise for that year (or any other year) did not record receipt of this dividend from Shenzhen Fifu.

45. Masterwise’s case is that there was no actual payment of the dividend because the amount of the dividend had been set off against debts owing by Masterwise to Shenzhen Fifu.  In support of this position, Masterwise has produced a letter from Shenzhen Fifu’s auditor,  Shenzhen Yida Certified Public Accountants Co Ltd, dated 26 March 2013, which stated that the entry in the “cash flow balance” in Shenzhen Fifu’s audited reported for 2000 showing a cash withdrawal of RMB 1,120,416.74 was a “mistake”.

46. It is not, however, easy to understand how a mistake of this nature can be made since the amount of any substantial cash outflow from Shenzhen Fifu ought to be reflected in its cashbook and, likely, a bank statement as well.

47. In my view, Chung Pun has laid a sufficient foundation for further investigation of the “missing” dividend such as to justify the application for inspection of Masterwise’s records under this head of complaint.

Fourth complaint: significant irregularities in the accounting practices of Masterwise

48. Chung Pun complains of two matters under this head of complaint.  First, Masterwise has failed to prepare group and consolidated accounts over the years despite the fact that it has a wholly owned subsidiary, ie Shenzhen Fifu, which owns and operates the entire manufacturing operations of Masterwise in the PRC, contrary to  Section 124(1).

49. Masterwise argues that the duty to prepare group and consolidated accounts is not absolute, and reliance is placed on Section 124(2)(b)(i), which provides that group accounts need not deal with a subsidiary of the company if the company’s directors are of opinion that it is impracticable, or would be of no real value to members of the company, in view of the insignificant amount involved, or would involve expense or delay out of proportion to the value to members of the company.

50. Masterwise says that the fact that no consolidated accounts were prepared is a practice that commenced when Chung Pun was still a director and signed off the audited accounts of Masterwise between 1991 and 1995.  Masterwise also relies on a letter from its auditor, M B Lee & Co, dated 20 April 2011 which explains the background and rationale behind the practice.  Apparently, for tax reasons, Shenzhen Fifu was treated or regarded as Masterwise’s manufacturing department such that all the expenses for manufacturing and administration incurred by Shenzhen Fifu and all its assets including the factory building and plant and machinery were incorporated in Masterwise’s financial statements and reflected therein as Masterwise’s “Manufacturing Account” and as part of its fixed assets.  Masterwise has also filed an affirmation of Lai Shuk Ching, an accounting manager of Masterwise and Foster, to explain how the financial position of Shenzhen Fifu, including its assets, was at all material times amalgamated with those of Masterwise.

51. On behalf of Chung Pun, Miss Chan relies on paragraph 18(4) of the Tenth Schedule to the Companies Ordinance, which provides that where group accounts are not submitted, there shall be annexed to the balance sheet a statement showing the reasons why subsidiaries are not dealt with in group accounts.  It is not in dispute that there is no such statement in the balance sheets of Masterwise over the years.

52. In Re Italina (Holdings) Ltd [2009] 1 HKLRD 307, which related to an application by a shareholder and former director of a company seeking directions for group accounts of the company to be prepared and laid before the company for consideration and approval at an AGM, Kwan J (as she then was) stated at paragraph 28 as follows:

“As mentioned earlier, no statement in compliance with paragraph 18(4) of the 10th Schedule to Cap 32 has been annexed to the balance sheet of the Accountsfor the years ended March 2005 and March 2006. Had such a statement been made, the reasons given why subsidiaries are not dealt with in Group Accounts would of course be considered by the court. But there is no such statement. I do not think I should consider any other reason advanced by the respondents’ counsel to support or explain the opinion they held, as those reasons were not the respondents’ reasons in forming the opinion they held, on the evidence they have adduced to this court. I should concern myself with assessing the opinion of the Company’s directors by looking at their own grounds, not an opinion as rationalised ex post facto by their counsel.”

53. Based on this passage, Miss Chan submits that the court should not consider any explanation given by a company for failing to prepare group accounts dealing with the state of affairs and profit and loss of the company’s subsidiaries unless such explanation appears in a statement annexed to the balance sheet of the company in compliance with paragraph 18(4) of the Tenth Schedule to the Companies Ordinance.  However, it seems to me that the focus of the learned Judge’s statement is on whether the reasons proffered by the company for not preparing group accounts were the directors’ reasons in forming the relevant opinion at the time of preparation of the company’s accounts, as opposed to  ex post facto reasons offered by the company’s counsel in support of the decision not to prepare group accounts.  M B Lee & Co’s letter dated  20 April 2011 explaining why Masterwise did not prepare group accounts dealing with Shenzhen Fifu is, it seems to me, a statement which purports to set out the reasons of the directors of Masterwise for not preparing group accounts at the time of the preparation of Masterwise’s accounts, and not some ex post facto justification.

54. This having been said, Chung Pun has criticised the suggestion made on behalf of Masterwise that all the assets, liabilities and expenses of Shenzhen Fifu had already been incorporated into Masterwise’s accounts and that Shenzhen Fifu generated no revenues because it had never sold goods in China or to any person other than Masterwise, and pointed to the fact that apparently Shenzhen Fifu had domestic sales of RMB 115,100, RMB 127,600 and RMB 173,744 for the years of 2008, 2009 and 2010 respectively.  In answer to this allegation, Chung Po in his second affidavit filed in HCMP 2681/2012 says that the so-called domestic sales were in fact not sales of products manufactured by Shenzhen Fifu, but represented sales of scrap raw materials generated in the course of Shenzhen Fifu’s manufacturing process.  Chung Po further says that the proceeds of such sales were used to reduce the “raw materials” costs in the manufacturing section of the audited accounts of Masterwise.  This explanation is not accepted by Chung Pun, who has in his third affirmation filed in HCMP 2681/2012 raised various doubts on the documents produced by Chung Po in support of the explanation.  On the basis of the existing materials, it seems to me that further investigation by Chung Pun into the validity of this explanation would be justified. 

55. The second matter which Chung Pun complains of under this head of complaint relates to Masterwise’s tax dispute with the IRD. Apparently, what happened was that Masterwise previously obtained certain tax benefits for the period from 1 April 1997 to 31 March 2011 on the basis that Shenzhen Fifu was Masterwise’s manufacturing arm in the PRC, but the tax benefits were subsequently considered by the IRD to have been improperly granted in view of the fact that Shenzhen Fifu was a separate legal entity which carried on a manufacturing business in the PRC while Masterwise carried on a trading business in Hong Kong, and thus Masterwise and Shenzhen Fifu ought to report their respective manufacturing and trading results separately. According to Chung Po, Masterwise “recently” settled this “dispute” with the IRD, resulting in an additional tax payment of about HK$11.8 million.  Chung Pun’s complaint is that this settlement with the IRD is a matter of importance on the financial position of Masterwise, but no information or explanation has been provided by the directors to him, in particular why they chose to contest the IRD’s claim for additional tax for such a long period of time, and he says that he is entitled to investigate into what is prima facie an improper decision of the directors in continuing to spend considerable time and costs to contest the IRD’s claim.

56. It seem to me that the way in which tax benefits were being claimed on behalf of Masterwise, and the manner in which the tax dispute with the IRD was handled, are commercial or managerial decisions which are within the powers of the board of directors to decide.  There is nothing on the face of the materials before the court to suggest that the board of directors of Masterwise knowingly made unjustifiable claims for tax benefits, or handled the tax dispute improperly.  I do not therefore consider that Chung Pun is entitled to seek inspection of Masterwise’s records to investigate the alleged improper claim for tax allowance or improper decision to spend time and costs to contest the IRD’s claim for additional tax.

57. Overall, taking into account Masterwise’s apparent failure to comply with the obligation to prepare group accounts as required by Section 124(1), the absence of any statement in Masterwise’s balance sheets showing the reasons why Shenzhen Fifu was not dealt with in group accounts as required by paragraph 18(4) of the Tenth Schedule to the Companies Ordinance, and the allegation relating to “domestic sales” by Shenzhen Fifu, I consider that Chung Pun has produced sufficient materials to justify investigation of the alleged irregularities in the failure to prepare group or consolidated accounts of Masterwise.

Fifth complaint: suspicious surge in banking charges

58. The last substantial complaint raised by Chung Pun relates to an alleged recent surge in banking charges incurred by Masterwise, from HK$84,435 (for the period ending on 31 March 2010) to HK$439,653 (for the period ending on 31 March 2011).  Masterwise’s explanation for the increase in banking charges is that they were incurred as a result of a loan of HK$12 million borrowed by Masterwise under the Government’s SME scheme to finance the purchase of land and constructing a factory in Huizhou.

59. On behalf of Chung Pun, it is argued that there has never been any suggestion by the directors that Masterwise was in need of funds, Masterwise’s accounts show that the company had ample cash (HK$9.4 million and HK$15.7 million in the audited financial statements for the years ending 31 March 2010 and 31 March 2011 respectively) which could be used for its business, and Shenzhen Fifu raised the total of RMB 65 million from the sale of the Fifu Factory.

60. However, Chung Po’s evidence is that Masterwise estimated that the relocation of Shenzhen Fifu’s factory would cost RMB 88 million.  Thus, the sale proceeds of the Fifu Factory were not sufficient to pay for the relocation of the factory to Huizhou.  I accept Mr Dawes’ argument that how Masterwise would finance the balance required for the relocation of the factory is a commercial or managerial decision for its board of directors to decide.  On the existing materials before the court, I do not consider that Chung Pun has made out a sufficient case for investigation under this head of complaint.

Assessment of value of shareholdings

61. In support of the present applications, the Plaintiffs contend that inspection of Masterwise and Foster’s records also serves the purpose of providing them with the necessary information to assess the true value of their shareholdings in the companies.  However, unlike the situation in Talal El Makdessi v Team Y&R Holdings Hong Kong Limited where the applicant shareholder had a put option under a sale and purchase agreement with the defendant’s related company to compel it to purchase the applicant’s shares in the company, the Plaintiffs here have no legal right to have their shares purchased by the Defendants or other parties.  Also, the Plaintiffs have not gone so far to suggest that they are entitled to force a purchase of their shares in Masterwise and Foster by means of an application under Section 168A.

62. In all, I am not satisfied that, on the facts of the present case, the Plaintiffs are entitled to an order under Section 152FA for the purpose of assessment of the value of their shareholdings in Masterwise and Foster respectively.

Position of the directors

63. Mr Jose-Antonio Maurellet (acting for the directors of Masterwise and Foster) submits that the directors have unnecessarily, and inappropriately, been made parties to the present applications for inspection of the companies’ records in circumstances where the proper defendants are the companies themselves.  On the other hand, Miss Chan argues that the directors have been joined as defendants because (i) the present applications were necessitated by the refusal of the directors to provide any proper account of their dealings with the assets and affairs of the companies, despite the repeated requests of the Plaintiffs, (ii) it is wrong as a matter of principle to require the companies to bear the costs occasioned by the default or breach of duties of the directors, (iii) the general principle of company law is that the company’s money should not be expended on what is in effect a dispute between the shareholders, and it is clear that the present applications are in substance disputes between shareholders, and (iv) where (as here) the directors were dictating the decisions of the board and caused the company to deny the plaintiff’s request for access to the documents there is justification for the court to make a costs order against them personally.

64. There is, it seems to me, no doubt that directors can, in appropriate circumstances, be joined in an application under Section 152FA.  As rightly pointed out by Miss Chan, in a number of previous applications under Section 152FA, the directors were joined as parties without adverse comment from the court.

65. Mr Maurellet has cited a number of authorities which mentioned the restrictive circumstances in which directors may properly be joined.  In Re Opes Asia Development Ltd (HCMP 447/2012, 17 May 2012), Harris J said at paragraph 42 of his judgment that “[i]t would only be in a rare case in which there is strong evidence of particular directors of a company, dictating the decisions of the board that there would be justification for making individual directors parties to an application such as this simply with a view to obtaining a costs order against them”.

66. In Wong Kar Gee Mimi v Hung Kin Sang Raymond [2011] 5 HKLRD 241, a director was joined in an application under Section 152FA solely for the purposes of seeking an order that he should be required to pay the costs of the application on the basis that it was he who directed the decisions of the company and thus he, rather than the company’s shareholders, should be liable for the consequences of the company’s decisions (paragraph 1).  That attempt failed because, according to Harris J, on the evidence the court could not realistically be expected to determine whether the director was the puppet master who controlled the company and orchestrated its response to the application, and the plaintiff was ordered to pay the director’s costs on the ground that he was unnecessarily made a party (paragraph 99).

67. In my view, the principle of company law that Miss Chan relies upon, namely, that the company’s money should not be expended on what is in effect a dispute between the shareholders, which is well established in relation to unfair prejudice petitions or winding up petitions on just and equitable grounds, cannot be extrapolated generally to other types of litigation between a company and its shareholder.

68. In the present case, the Plaintiffs have joined all 3 directors of Masterwise and Foster as Defendants in the 2 applications. The decisions not to entertain the Plaintiffs’ requests for inspection of documents appear to have been made by the directors collectively acting as the board in each case.  In substance the dispute is between the company acting through its board of directors on one side and a shareholder of the company on the other, and not between two fractions of shareholders.  On the materials before me, I do not consider that there is any special or exceptional reason why the directors ought to be joined as parties or be made personally liable to bear the costs of these applications.

Disposition

69. As indicated above, I consider that the Plaintiffs’ application for inspection of Masterwise and Foster’s records are well founded in respect of the first, third and fourth complaints (but excluding the complaint regarding the tax dispute with the IRD).

70. Accordingly, in respect of each application, I make an order against the 1st Defendant, but not the 2nd, 3rd or 4th Defendants, in terms of paragraphs 1 to 4 of the Originating Summons subject however to appropriate modification of the Schedule thereto to give effect to this judgment.  My order shall cover the documents sought as described in the 2 Schedules save that (i) documents relating to the second and fifth complaints and the complaint regarding the tax dispute with the IRD should be excluded, and (ii) documents relating to Shenzhen Fifu and Huizhou Fifu should be restricted to those forming part of the current records of Masterwise as explained in paragraph 21 above.  I shall leave it to the parties to work out the precise form of the Schedule to be attached to the formal order of the court, with liberty to the parties to apply in the event that no agreement can be reached on the form of the Schedule.

71. As for costs, the Plaintiffs have been partly successfully in their applications.  I order the 1st Defendant in each case to pay 50% of the Plaintiff’s costs (excluding the costs incurred in pursuing the application against the 2nd to 4th Defendants).  I also order the Plaintiff in each case to pay the costs of the 2nd to 4th Defendants.  All the above costs are to be taxed if not agreed.

72. Finally, it remains for me to thank counsel for their helpful submissions and assistance rendered to the court.

Annex I

Exhibit LCP-11 referred to Affirmation of Leung Chung Pun

Table on dividends and directors’ remuneration of master wise and Foster