ARTAN INVESTMENTS LTD AND OTHERS v. THE BANK OF EAST ASIA LTD AND OTHERS

HCMP 125/2015

IN THE HIGH COURT OF THE

HONG KONG SPECIAL ADMINISTRATIVE REGION

COURT OF FIRST INSTANCE

MISCELLANEOUS PROCEEDINGS NO 125 OF 2015

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D E C I S I O N
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Application and Parties

1. On 16 January 2015 the Plaintiffs, who are shareholders of the 1^st Defendant, The Bank of East Asia, Limited (BEA), issued an originating summons seeking an order for the disclosure of documents by BEA and its directors relating to a placement of shares by BEA to Sumitomo Mitsui Banking Corporation (SMBC).  The documents sought are listed in a schedule to the originating summons, which is appended to this judgment.  The application is made under both section 740 of the Companies Ordinance, Cap. 622, and section 41 of the High Court Ordinance, Cap. 4, although in practice it has been framed and presented as an application under section 740(1), namely, by members of BEA for inspection of the company’s records and documents relating to the placement. 

2. Section 740(6) requires an application under section 740(1) to be brought by members that represent at least 2.5% of the voting rights of all members having the right to vote at the company’s general meetings or at least 5 members of the company.  The Plaintiffs are investment companies, affiliated with Elliott Associates L.P. and Elliott International L.P., which are hedge funds with approximately US$25.6 billion under management.  As I understand the evidence these hedge funds carry on business in Hong Kong through Elliott Advisers (HK) Ltd. (EAHK).  I shall refer to the Plaintiffs, Elliott Associates L.P., Elliott International L.P. and EAHK collectively as “Elliott”.  Elliott hold shares in BEA representing 2.5% of BEA’s capital worth approximately HK$1.8 billion. 

Introduction

3. On 5 September 2014, BEA announced that it had entered into a non-binding memorandum of understanding (MOU) with SMBC in relation to the proposed subscription by it for some 222 million new shares (Proposed Subscription).  The announcement recorded that the subscription was subject to the parties entering into a definitive agreement, 222 million shares represented approximately 9.53% of the current issued shares of BEA and it was expected that the subscription price would be determined by reference to the volume weighted average price of the shares over a prescribed period prior to the execution of a definitive agreement. 

4. Elliott were concerned that, rather than being entered into in the best interests of BEA, the Proposed Subscription was intended to entrench the position of BEA’s management.  They formed this view for the following reasons:

(1) Elliott’s analysis of the available financial information caused Elliott to conclude that BEA had no need for additional capital at the present time;

(2) Even assuming that BEA did need additional capital the decision of the BEA board of directors (Board) to raise the capital by way of a bilateral placing to SMBC in Elliott’s view unfairly prejudices existing shareholders.  The conventional and fair way for a bank such as BEA to raise funds would be by way of a rights issue, to which all shareholders would be entitled to subscribe and only if some shareholders did not take up their full entitlement would a party, be it SMBC or another institution, be entitled to acquire the excess shares as an underwriter of the rights issue; and

(3) The Proposed Subscription has materially diluted existing shareholders’ voting rights and created a significant voting block aligned with BEA’s management.  Since the beginning of 2008, BEA has on three separate occasions issued large blocks of shares to strategic investors (CaixaBank and SMBC), representing an aggregate total of 357,376,800 shares.  Those shares, if combined with the Proposed Subscription of 222,000,000 shares, would result in a total aggregate share issuance of 579,376,800 shares to strategic investors, representing an issuance of close to 37% of the total share capital of BEA (1,574,367,155 shares) as it stood at the end of 2007.

5. Elliott’s concerns were echoed in various comments in the business press, which suggested that certain market watchers also thought that the Proposed Subscription was intended to build alliances with corporate shareholders who would probably support the Li Family’s control over management of BEA rather than because of any genuine economic need. 

6. EAHK exchanged correspondence with BEA concerning the Proposed Subscription between 24 October and 29 December 2014 and representatives of each company met on 12 December 2014.  From 24 December 2014 the parties’ solicitors also began to exchange correspondence.  The correspondence did not allay Elliott’s concerns.  However, it did cause the Board to retain Goldman Sachs to assess (I assume, it not being explained in BEA’s evidence what their instructions were) whether raising more capital was justified and, if so, whether the proposed placement was an appropriate means by which to do so.  Goldman Sachs prepared a presentation for the Board on 14 January 2015.  A board meeting took place on 12 February 2015, by which time the originating summons had been issued, at which a resolution was passed approving the original decision.  On 18 March 2015 BEA announced that it had entered into a subscription agreement for a placement with SMBC.  The placement was subsequently approved by the Listing Committee of the Hong Kong Stock Exchange and on 27 March 2015 the subscription was completed.  Although, the Proposed Subscription has been completed I shall for ease of reference refer to it throughout this decision as the “Proposed Subscription”.

7. It will be appreciated that at the time that the Plaintiffs issued the originating summons on 16 January 2015 and filed their supporting evidence, which took the form of an affirmation from Mr. James Smith, who is the Managing Director of EAHK, its application was based on the information made available in the public announcement of 5 September 2014 that had alerted Elliott to the placement and the correspondence that EAHK had exchanged with BEA.  BEA’s correspondence explains that the decision had been made in the light of its business plans, the requirements of regulators and would strengthen the collaboration with SMBC which was already a substantial shareholder.  In response to the suggestion that a rights issue would, if further capital was required, be a more appropriate means of raising it, it was suggested that this would be complex, time consuming, expensive and put pressure on BEA’s share price.  The initial announcement of 5 September 2014 did not itself give any reason for the Proposed Subscription.

8. The originating summons does no more than seek an order for disclosure and inspection of the documents referred to in the schedule to the originating summons that I have appended to this decision.  It does not, and did not need to, set out any grounds for seeking the order.  This is explained in Mr. Smith’s supporting affirmation.  In paragraphs 12, 42 and 46 he summarises Elliott’s case as follows:

“12. The Plaintiffs have significant concerns that, rather than being entered into in the best interests of the Company, the Proposed Subscription is intended to further deepen the entrenched position of BEA’s management, to the detriment of the Company and its independent shareholders. Elliott has sought to allay those concerns both through correspondence and in discussions with the current BEA management. Unfortunately, however, BEA’s evasive responses have served only to deepen those concerns. Copies of correspondence in relation to the proposed Subscription between Elliott and the Company are located at JNBS-1.

…

42. In all the circumstances, the Plaintiffs believe that there is no proper commercial basis for BEA to pursue the Proposed Subscription. Instead, the Proposed Subscription perpetuates a pattern of misuse of the general mandate in a way which deepens the entrenchment of the Li Family Directors’ control over BEA without requiring them to pay for that consolidation of control. This is achieved at the direct cost of the other shareholders whose ownership interests are significantly diluted.

…

46. In light of the facts and matters set out above, the Plaintiffs are likely to bring a claim against BEA and the Directors under section 725(1)(a) Companies Ordinance on the grounds that the Proposed Subscription is not being entered into in the best interests of the Company but is instead being entered into for an improper purpose and/or that the Directors have failed to take into account all relevant factors or have taken into account irrelevant factors in deciding to pursue the Proposed Subscription.”

9. In his second affirmation prepared after having had the benefit of reading the memorandum of 5 September 2014, the Goldman Sachs presentation and the affirmations filed by all the directors of BEA, he summarises Elliott’s concerns again in the following terms in paragraphs 6, 6(b), (d) and (e):

“6. For the reasons set out in more detail below, the Defendants’ Affirmations serve to reinforce the serious concerns set out in my 1^st Affirmation regarding the Proposed Subscription and also prompt additional concerns about, in particular, the adequacy and thoroughness of the decision–making process that resulted in the Company entering into the MOU. In summary, notwithstanding the directors’ self-serving reassurances, the evidence strongly suggests that:

…

(b) the level of information actually provided to the Board before it reached a decision was manifestly inadequate in terms of providing the non‑executive directors (i.e. all the director Defendants besides the 2^nd to 4^th Defendants) with a full and proper understanding of the Company’s supposed need for capital and the merits of the Proposed Subscription. This is particularly noteworthy in this scenario involving a transaction which is highly material to the Company (having a reported value of approximately HK$6.5 billion);

…

(d) had the necessary information in connection with the Proposed Subscription been provided to the Board at the appropriate time, it is perfectly possible that, acting responsibly and in compliance with their fiduciary duties, some or all of the directors would have determined that the Proposed Subscription is not in the best interests of the Company;

(e) in the circumstances, it is plainly necessary to investigate whether the Proposed Subscription was indeed, as the Plaintiffs suspect, a self‑serving transaction conceived of by the Li family to protect their own position, which was bulldozed through the Board;… ”

10. I note, and this will become relevant when I come to consider BEA’s criticisms of the application, that Mr. Smith is not suggesting the Board as a whole has connived to entrench the Li Family’s position.  I think it is apparent that Elliott’s case is that the non-executive directors were not provided with adequate information in September 2014 and appear to have gone along with Sir David’s proposal without scrutinising it and having regard to the interests of shareholders as a whole.  At this stage it will be helpful to explain the constitution of the Board.

11. The Board has 18 members.  Three are executive directors: Sir David and his 2 sons, Adrian and Brian.  Sir David is both the Chairman and the Chief Executive.  Four of the non-executive directors are members of the Li Family. According to disclosures to the Hong Kong Stock Exchange they hold together 8.73% of BEA’s issued shares.  The remaining directors represent a cross-section of business interests and experience and include many names familiar in the Hong Kong business community.  None of the directors from outside the Li Family have a material shareholding in BEA, although Dr. Casas is the representative of the Spanish CaixaBank, which holds 17.17%.  SMBC, which as a result of the Proposed Subscription has a 17.43% interest, does not currently have a director on the Board although it has the option to take up a seat. 

12. Elliott say that BEA has not demonstrated a genuine need to increase capital, an issue I address in detail later, there is no evidence that the existing connections with Caixa and SMBC have provided any new business opportunities, which on the evidence before me would appear to be correct, and that it is evident from the evidence filed by BEA and its directors that they did not give proper consideration to the interests of the shareholders as a whole before deciding to approve the placement.

13. Before turning to consider Elliott’s case in more detail and BEA’s criticism of it, I shall consider the relevant legal principles that apply to this application.

Placements and directors’ duties

14. Placements are a relatively common source of controversy.  Minority shareholders express concerns that placements are being used to dilute their interest in a company and reduce their influence over its affairs and increase that of another shareholder or group of shareholders.  Not only is this a commercial concern, but it goes directly to the nature of the rights a shareholder has in respect of his shares.  Shareholders have a personal right not to have the voting power of their shares diminished except for a proper reason, which will generally be a genuine need to raise additional capital.  A shareholder has locus standi to institute and prosecute proceedings to protect that right[1].

15. It was a dispute as to the propriety of an allotment that materially diluted the voting power of shares that gave rise to the Judicial Committee of the House of Lords decision in Howard Smith Ltd v Ampol Petroleum Ltd [2]. Ampol and Bulkship together held about 55% of the issued shares of the company, Millers.  Millers was in need of additional capital.  Ampol offered to buy all of Millers’s issued shares.  Millers’s board unanimously decided to reject the offer as too low.  At approximately the same time members of the board were having discussions with what are referred to in the judgment as “the management team”, which consisted of Millers managing director and, it would appear from the judgment, other non-board executives and, thus, no other directors.  These discussions eventually resulted in Howard Smith proposing to take over Miller.  Howard Smith announced this intention.  Ampol and Bulkship shortly thereafter announced their intention to act jointly in future in relation to their interest in Millers and that they would reject any offer from Howard Smith.  It would, therefore, be pointless for minority shareholders to accept Howard Smith’s offer and for that offer to proceed.

16. Millers’s management team had further discussions with Howard Smith.  It was agreed that Millers would make an allotment to Howard Smith, which would reduce Ampol and Bulkship’s interest below 50%.  At that time Millers required $10,000,000 to finance the on‑going construction of tankers.  On 6 July 1972 Howard Smith applied for 4,500,000 $1 shares at $1.30 per share.  The board met and considered the offer on the same day and approved it.  The allotment took place the next day.  The result was that Ampol and Bulkship’s shareholding was reduced to 36.6% of the issued shares and Howard Smith was in a position to make an effective takeover offer.  Ampol challenged the validity of the issue of shares and sought an order for rectification of the share registry by the removal of Howard Smith as a member in respect of the allotted shares.

17. Millers's directors contended that the primary reason for the issue of the shares was to obtain more capital.  Street J did not accept this argument, but did find that that the directors were not motivated by any purpose of personal gain or advantage or by any desire to retain their positions on the board.  The judge also found that one of the purposes for the placement was to satisfy the company's genuine need for additional capital.  However, Street J also found that the primary purpose for the placement, so far as the management team was concerned, was to issue shares to Howard Smith so as to enable the Howard Smith takeover to proceed.  The Judicial Committee accepted these findings. 

18. The Judicial Committee held that the decision to issue and allot new shares was intra vires the directors’ powers under the articles, but that the power to raise additional capital must be exercised for the purpose for which it was granted[3] and must be exercised in the interests of the company as a whole[4].  Raising much needed capital is an interest which can properly be taken into account, but there may be other material considerations and what they are will vary depending on the circumstances of the particular company under consideration.  In determining whether or not directors have adopted the correct approach in exercising their powers:

“it is necessary to start with a consideration of the power whose exercise is in question, in this case a power to issue shares. Having ascertained, on a fair view, the nature of this power, and having defined as can best be done in the light of modern conditions the, or some, limits within which it may be exercised, it is then necessary for the court, if a particular exercise of it is challenged, to examine the substantial purpose for which it was exercised, and to reach a conclusion whether the purpose was proper or not. In doing so it will necessarily give credit to the bone fide opinion of the directors, if such is found to exist, and will respect their judgment as to matters of management; having done this, the ultimate conclusion has to be as to the side of a fairly broad line on which the case falls.[5] ”

19. As the Judicial Committee made clear this is different from determining a dispute about the wisdom of a particular business dispute, such as the need to raise additional capital, which cannot be appealed to a court of law, but:

“…excepting all of this, when a dispute arises whether the directors of the company made a particular decision for one purpose or for another, or whether, there being more than one purpose, one or another purpose was the substantial or primary purpose, the court, in their Lordship's opinion, is entitled to look at the situation objectively in order to estimate how critical or pressing, or substantial or, per contra, insubstantial an alleged requirement may have been. If it finds a particular requirement though real, was not urgent, or critical, at the relevant time, it may have reason to doubt, or discount, the assertions of individuals that they acted solely in order to deal with it, particularly when the action they took was unusual or even extreme.[6] ”

20. What emerges from this decision is that if directors exercise a power for a primary purpose, regardless of their good faith, which is inconsistent with the purpose for which it was conferred it may be set aside and that in determining whether this has taken place the court will have regard to all relevant material in order to assess what purpose, or purposes, motivated the decision. 

21. Given a shareholder’s right to not to have its voting rights diminished except where it is a consequence of shares being allotted for the general benefit of the company, and the principles discussed above which circumscribe the exercise of directors’ powers to issue additional shares, one would expect directors in deliberating on a proposal to raise capital to have regard to the impact it will have and the interests of all who might be effected by it.  In Passport Special Opportunities Master Fund LP v Esun Holdings Ltd.[7] Barma J, as he then was, considered an alternative argument by a fund which was questioning the purpose for which a placement had been made, namely, that even if the placement had not been entered into for an improper purpose, it was nonetheless tainted by Esun’s board’s failure to have regard to the placement’s adverse impact on Esun’s shareholders, both in terms of shareholding and dilution of net asset value per share.  This was formulated as the following question for determination at trial:  whether there is a fiduciary obligation on the part of the board of directors, in exercising their power to issue new shares, which it is well established is a fiduciary duty, to have regard to the interests of the company shareholders?

22. Barma J reached the following answer in paragraphs 147 to 150 of his judgment:

“147. In relation to the first question, although I was initially attracted by Mr Sussex’s submission that it would be inappropriate for a court to interfere with the decision of directors in relation to commercial questions such as whether or not, and how, funds should be raised for the company concerned once it is established that the power was exercised in good faith for proper purposes, and was not tainted by an improper primary motivation, I have come to the conclusion that there is an obligation of a fiduciary nature imposed upon directors, when deciding whether or not, and in what manner, to embark on an issue of new shares, to have regard to the interests of shareholders, and to exercise the power (if it is decided to do so) in a way that is fair as between different groups of shareholders.

148. These obligations are recognised in a number of English authorities, including eg, Re BSB Holdings (No. 2) [1996] 1 BCLC 155, in which, in the context of an unfair prejudice petition, the English Court of Appeal concluded that where there are groups of shareholders with differing circumstances and interests, it is necessary for directors to have regard not just to the interests of the company but also to the interests of the different groups of shareholders and act fairly between them. A similar conclusion was reached by Judge Purle QC in Re Sunrise Radio Ltd [2009] EWHC 2893.

149. Further, as noted by Judge Purle QC, there is a clear line of English authority that suggests that when considering whether or not to exercise a fiduciary power, the fiduciary should take into account relevant factors and exclude from consideration irrelevant factors. See, eg Re Hastings Bass [1975] Ch 25 (which was recently considered by the English Court of Appeal in Pitt v Holt [2011] EWCA Civ 197, in which it was held (differing from Re Hastings Bass on this point) that the consequence of a failure to comply with this obligation was that the exercise of the power would be voidable (and not void, as held in Re Hastings Bass). This principle has been echoed in the company law context on a number of occasions, including Re a Company, ex p Glossop [1988] BCLC 570 and Hunter v Senate Support Services Ltd [2005] 1 BCLC 175.

150. Although Mr Sussex urged that this principle should not be imported into the context of the exercise by directors of their fiduciary powers, I have some difficulty in seeing why the fiduciary powers of directors, although admittedly powers that are exercised in different circumstances from the fiduciary powers of, for example, trustees, should be treated in such a different manner because of this. While I accept that the court should not set itself up as a tribunal to which disgruntled litigants can appeal against the commercial decisions of the board of directors, I do not think that this excludes the possibility that the court can and should, in an appropriate case, inquire into the manner in which the decision was reached. If it can be established that the decision was reached with no consideration at all for a clearly relevant factor, it is not immediately apparent why it should not be subject to challenge.”

23. I agree with Barma J’s decision and his reasons for reaching it.  This in practice means that directors should, in deliberating on a matter such as a placement, ask themselves what competing arguments exist for and against the proposed course of action and have regard, when assessing them, on the proposed course of action’s impact on the interests of different groups of shareholders. Directors will have different expertise and experience and one would not expect all of them necessarily to be equally active in the deliberations which result in a board ultimately taking a collective decision.  However, members of a board must scrutinise proposals, particularly important ones, which impact directly on the interests of shareholders not just take it on good faith that if a director tasked with a particular area of responsibility says something within his remit is a good idea it can be approved without critical appraisal. Shareholders who become aware that a board has approved a resolution without properly considering its merits may have grounds for complaint that directors have not met their obligations as directors.  This is relevant to the manner in which the non-executive directors of BEA responded to Sir David’s memorandum of 1 September 2014.

Legal Principles: section 740 of the Companies Ordinance, Cap. 622

24. Section 740 gives the court a discretion on the application of 5 or more shareholders, or members representing 2.5% in value of the voting rights, to order inspection of a company’s records or documents if it is satisfied that:

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

(2) the inspection is for a proper purpose.

25. The expression “proper purpose” is not defined in the section, but its meaning and how the 2 requirements are to be understood and applied has been considered in a number of cases in relation to section 740 and its predecessor sections 152FA and 152FB of the former Companies Ordinance, Cap. 32, which are in all material respects the same.  In Wong Kar Gee Mimi v Hung Kin Sang Raymond [8] I considered in detail the characteristics of the 2 requirements.  I will not repeat the discussion here.  In summary those which are relevant to the present case are as follows:

(1) The “good faith” and “proper purpose” requirements constitute two separate and independent tests.  The applicant must first, establish that he is acting in good faith and second, the court must believe the circumstances are such that the inspection sought is for a proper purpose: §§14-16.

(2) The burden of proof is borne entirely by the applicant: §42.

(3) The fact that an applicant has only recently acquired a small holding in the company may be strong evidence that the application is either not made in good faith or not made for a proper purpose: §23.

(4) Section 740 is not an opportunity for shareholders to challenge the commercial decisions of the company's management: §36.

(5) In order to satisfy the “proper purpose” criteria it is not necessary to satisfy the court that the applicant has a specific or personal right that can only be protected through the inspection of records.  A wish to inspect documents to investigate a genuine and credible belief that there has been corporate mismanagement is capable of constituting a proper purpose[9]. Generally, where the court is satisfied that the “purpose” is germane to a shareholder’s economic interest in the company a “proper purpose” will have been satisfied[10].

(6) “As I have already explained, in my view the court should incline to a liberal interpretation of “proper purpose” with a view to advancing the protection of shareholder rights and interest and the maintenance of appropriate standards of corporate governance.  This is particularly true in the case of publicly listed companies ……… the court should be more willing to grant inspection orders to protect the interests of members in publicly listed companies”[11]. This view was endorsed by Deputy Judge (as he then was) L Chan in Choi Chi Wai v Hong Kong Agriculture Special Zone Limited [12] as being “more in line with the prevailing disposition of the community on corporate governance”.

(7) As part of establishing a proper purpose, the applicant has to show that there is a sufficiently reasonable “case for investigation” as regards past or future wrongful or other undesirable conduct. The shareholder may fail to obtain inspection where he fails to make out on his own material some kind of case for investigation, or where the corporation is able by leading evidence to dispel whatever suspicion has reasonably been aroused: §39.

(8) Once the court is satisfied that the applicant has established a “proper purpose” the company should be required to be transparent[13].

26. The court is not required, and should not endeavour, on an application under section 740 to reach conclusions about the merits of the matters relied on as constituting a “proper purpose”.  The court needs to be satisfied that a proper purpose has been established and that in the exercise of the court’s discretion it is a proper case in which to make an order for inspection.  Recorder Anderson Chow gave a useful summary of what this process involve in paragraph 25 of his judgment in Leung Chung Pun v Masterwise International Ltd [14] :

“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 matters 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 (supra), [34]-[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.”

27. BEA argues that confidentiality is amongst the discretionary matters to which the court should have regard.  I agree.  I also accept that a shareholder is not entitled to substitute an inspection order under section 740 for a pre-action discovery exercise, since such an approach would be excessively intrusive and beyond what is reasonably necessary[15].

28. BEA also argues that a shareholder’s rights are governed by a statutory contract, the articles of agreement, and this being the case a shareholder making an application under section 740 should be treated no differently to an applicant under section 41 of the High Court Ordinance who has a potential claim in contract against another and has to resort to section 41 for any pre-action discovery application.  In both cases, says BEA, the applicant has an economic interest via a contract.  After all, its argument develops, section 740 serves a purpose similar to that of section 41, namely, to enable an application for inspection to be made for the purposes of determining whether or not proceedings should be commenced.  I do not accept that this is a proper characterisation of section 740.  As I have already noted in my view it is not necessary for a shareholder to satisfy the court that he requires inspection of documents with a view to taking action to protect a particular right.  It may be sufficient depending on the facts of the case to demonstrate that there is reason to be concerned that there has been a failure of corporate governance, which a shareholder legitimately wishes to investigate.  However, I understand that BEA’s argument in this respect was primarily advanced to support the narrower point that the use of inspection should be restricted to the purpose for which it was sought and the court should be careful not to allow section 740 to be abused.  In particular the court should have proper regard to the possibly confidential nature of documents.  With that I do agree, but with this caveat.  As I have also noted in my view the court, when satisfied that a proper purpose has been demonstrated, should be slow to accede to arguments designed to encourage a restrictive approach to what is disclosed.  As I explain in Wong Kar Gee Mimi supra, the fact that the Legislature thought it desirable to enact section 152FA, the predecessor to section 740, suggests that it was intended to provide shareholders with a right which allowed them to something other, or more, than pre-action discovery, which was not necessary as this already existed in section 41 of the High Court Ordinance. 

29. Necessarily section 740 creates a right to inspect, if the statutory requirements are met, documents which are normally confidential.  A company will have a legitimate interest in ensuring that information is not made public that may damage its commercial interests.  The court will be concerned to ensure that this does not take place and that section 740 is not misused to obtain information to damage the company’s interests.  However, directors should not be allowed to exploit this concern to restrict access to documents that will substantiate a legitimate concern that they have failed in their duties in some way.  Once the court has been satisfied that a shareholder properly wishes to investigate the way in which directors have addressed a particular matter the court should err on the side of ordering full inspection and concerns of confidentiality should be addressed by requiring undertakings restricting the use of information obtained as a result of inspection.

30. The application is also brought under section 41 of the High Court Ordinance seeking an order for disclosure before action.  Mr. Sussex acknowledged that in practice this added little to the application and the hearing before me focused only on section 740.  As I have explained in my view section 740 has a broader scope than section 41 and, although I would expect most, possibly all, applications that satisfy the requirements of section 41 also to satisfy section 740 the opposite is not the case.

31. Under section 41 the application must be against a person who appears to be likely to be a party to the contemplated proceedings, and is likely to have or have had documents directly relevant to an issue arising or likely to arise out of that claim.  Whilst the expression “likely to be parties” in section 41 is liberally construed to include a case where the bringing of the action may depend on the result of the discovery, this requirement will not be satisfied unless the claim has a reasonable basis and is not speculative[16]. Section 740 does not, for the reasons explained in paragraphs 29 to 32 of Wong Kar Gee Mimi supra, require an applicant to demonstrate that proceedings are likely to be commenced or commenced against the person against whom inspection is sought.

32. In the context of section 41 the court deals with confidentiality by balancing a demonstrated need to preserve confidentiality against the probative value of the documents concerned in disposing fairly of the contemplated case[17]. In practice a similar approach may be adopted under section 740, but the considerations may be different.  Regard must be had to the interests of the company rather than the interests of directors whose conduct is likely to be the subject of the application and who will be giving instructions to defend it.  It may be undesirable that what would otherwise be confidential is made public, but it may be that this consideration needs to yield to the broader interest of transparency.

33. BEA argues that the court should have regard to principles emerging from cases on section 41 because of the similarity of the provisions.  I accept that similar considerations may commonly apply in relation to both sections, but as I have explained they are not identical and I do not think that they add anything material to what can be found in the cases on section 740.

34. Given the way in which the case developed I shall, in any event proceed to deal with the application on the basis that it will be determined by the outcome of the section 740 application.

The decision to approve the Proposed Subscription

35. There is no evidence of any Board meeting before 14 January 2015 to discuss the Proposed Subscription.  Neither does the evidence refer to any earlier informal meetings between directors, discussions or the circulation of any documents concerning the need to raise capital.  There is reference in Sir David’s affidavit to a meeting in August 2014 between unspecified members of the Hong Kong Monetary Authority (HKMA) and members of BEA’s audit committee, which consisted of Winston Lo (the Chairman of the audit committee), Allan Wong, Kenneth Lo, William Doo and Valiant Cheung.  Each of those directors confirms this.  Their recollection is all the same, namely, that the HKMA advised them that it expected the Bank to increase its capital buffer and to provide an adequate cushion for any possible deterioration in the external economic environment and the full implementation of the Basel III requirements.  It seems to me slightly odd that if this is the substance of the discussion the HKMA did not give any indication, in terms of percentages or figures, of what increase it had in mind rather than leaving it this vague, but be that as it may, there is no evidence of Sir David and the members of the audit committee subsequently deliberating on what was required or reporting the meeting to other directors.  The impression given by the memorandum and the evidence filed by Sir David is that the matter was left to Sir David and the executives of BEA to deal with without reference to non‑executive board members and the next thing that occurs is the circulation of a memorandum dated 1 September 2014 and the signing of the memorandum, without discussion, by all directors indicating their approval to the Proposed Subscription.

36. The placement was substantial, 9% of BEA’s issued capital, and in my view shareholders were entitled to expect the Board to give careful consideration to whether it was necessary and justified the dilution that it would cause.  If the matter ended there in my view there would be substantial grounds for concern that the Board as a whole failed adequately to carry out its task of scrutinising the reasons for the Proposed Subscription.  However, the matter does not end there.  As I have mentioned after Elliott began to query the proposed placement BEA retained Goldman Sachs to advise the Board.  Before considering how subsequent events impact on the application it is helpful to consider Elliott’s concerns in more detail as they existed at the time the application was issued, which was before they were aware of Goldman Sachs’s presentation.

Elliott’s concerns

37. Although BEA has 18 directors only 3 of them are executive directors. They consist of Sir David and his 2 sons.  This is despite the fact that the Li Family has a relatively modest interest in BEA: 8.73%.  In addition the roles of Chairman and Chief Executive are both held by Sir David.  There is, therefore, no independent chairman.  Elliott also point out that as the only executive directors are Li Family members, necessarily they control much of the information flow to the Board, and that the key executive management decisions will be taken by them.  Sir David also holds a key role in determining the composition of the Board as he is the Chairman of the Nominations Committee.  Eric Li Fook‑chuen, his Uncle, is the Deputy Chairman of that Committee and Aubrey Li also is a member of it.  Of the remaining 15 directors, a further 4 are members of the Li Family including Eric and Aubrey Li.

38. The other 11 directors who are not members of the Li Family represent a cross-section of business and professional experience including many well known and senior business figures.  Other than Dr. Isidro Fainé Casas, who represents CaixaBank, all of them, I think it can reasonably be said, are members of the higher echelons of Hong Kong’s business establishment with its common community of interest.  Elliott suggest that the response to the memorandum of 1 September indicates that these busy men, who whilst as a group possessing considerable experience, in practice leave even important decisions to Sir David on the unspoken understanding that he can be trusted to run things and they are there to bestow credibility on BEA, not interfere in its management.

39. BEA has been a serial user of its general mandate to issue new equity to strategic investors, namely SMBC and CaixaBank.  Details of the various placements are summarised in the following table:

Date	Event
27 December 2007	CaixaBank through a subsidiary subscribed for 78,700,000 BEA shares to take its interest from 4.34% to 8.89%
17 November 2008	BEA and SMBC entered into a memorandum of understanding on strategic partnership
22 June 2009	CaixaBank group agreed to certain arrangements with BEA in what is described as a “Strategic Investment Agreement” pursuant to which CaixaBank has agreed to follow any formal recommendation of the Board in relation to any offer for BEA
30 December 2009	CaixaBank (through a subsidiary) subscribed for 120,837,000 BEA shares to take its interest from 9.81% to 14.99%.  SMBC subscribed for 46,267,200 BEA shares to take its interest from 1.91% to 4.05%
4 December 2012	SMBC subscribed for 111,572,600 BEA shares to take its interest from 4.73% to 9.5%

40. As a result of these placements and the Proposed Subscription these 2 banks hold approximately 34.6% of BEA’s share capital.  In conjunction with the Li Family they hold approximately 43% of BEA’s voting equity.

41. Elliott identify three questions which they say are relevant in determining whether the Board has behaved properly in pursuing the Proposed Subscription:

(1) Does BEA need to raise additional capital at this point?

(2) Is the Proposed Subscription a usual or appropriate means of raising capital for a listed bank such as BEA?

(3) Does the proposed collaboration between BEA and SMBC otherwise justify the Proposed Subscription?

BEA’s need for capital

42. The placement has raised approximately HK$6.9 billion.  BEA is subject to certain capital requirements which are set by the HKMA with reference to the Basel III framework developed by the Basel Committee on Banking Supervision, which has been implemented in Hong Kong and is reflected in the Banking (Capital) Rules, Cap. 155L (Rules).  As a listed company, BEA regularly publishes (among other matters) details of its financial position, including its capital adequacy position.  Details of BEA’s reported capital adequacy position can be found in, for example, BEA’s latest Annual Report for the year ended 31 December 2013, its Interim Report for the six months ended 30 June 2014, and other disclosures, such as one dated 30 June 2014.  Based on these materials, it would appear that:

(1) as at 31 December 2013, BEA reported a Common Equity Tier 1 capital ratio (a “CET1 capital ratio”, as defined in the Rules) of 11.4% and BEA itself declared that “[t]he Group and its individually regulated operations have complied with all externally imposed capital requirements throughout the year ended 31st December, 2013 and 31^st December, 2012 and the Group are well above the minimum required ratio set by the HKMA”; and

(2) by 30 June 2014, BEA’s CET1 capital ratio had increased further.  As at that date BEA had surplus capital.

Accordingly, Elliott suggest that in the middle of 2014 BEA plainly considered itself to be well capitalised.

43. There is also no suggestion in any other information published by BEA or by the HKMA that BEA requires additional capital in order to satisfy any regulatory requirements.  On the contrary, so far as the banking sector in Hong Kong generally is concerned, Elliott say that the HKMA has recently stated its view that capital adequacy ratios for banks in Hong Kong have been maintained at a very high level, well in excess of the statutory requirement; that all authorised institutions are able to meet the Basel III capital requirements without difficulty; and that there should be no need for large scale capital raising activities for such authorised institutions to meet the new Basel III requirements.  Elliott point to a Legislative Council Paper prepared for a meeting of the Panel on Financial Affairs on 7 July 2014 as demonstrating this.

44. On 24 October 2014, EAHK wrote to BEA and the Board asking the Board to explain why it considered it appropriate to seek further equity funding through the Proposed Subscription.  On 3 November 2014, the Company responded as follows:

“The directors of this Bank regularly consider the capital requirements of the company in light of our business plans and the requirements of the regulators. Having carefully weighed these factors, and with a view to maximising shareholder values [sic], they consider it prudent to raise additional capital to allow the company to further develop its business.”

45. Elliott suggest that this position cannot be reconciled with BEA’s public position that it was well capitalised.  So far as the reference to the “business plans” is concerned, this was further explained (at least to a limited extent) in a letter received by EAHK from BEA on 26 November 2014.  In that letter, BEA referred to the Proposed Subscription being “an optimal way to help fund the Bank’s important growth initiatives, particularly in China.” The Plaintiffs do not accept, however, that this “plan” could ever justify the Proposed Subscription.  Elliott say that it is clear from the publically available financial information that BEA has more than adequate liquid assets currently on hand, should any of its growth initiatives require further capital cover in the short‑term.  For example, as at 31 December 2013, BEA had reported liquefiable assets of HK$148.8 billion, of which HK$35.6 billon was cash and placements with banks and other financial institutions, and HK$47.3 billion was held in available-for-sale securities.  The proceeds of the Proposed Subscription would be small in comparison to these existing liquid assets.  Elliott also point to BEA’s announcement dated 19 February 2014 in which it stated that its Mainland China subsidiary, The Bank of East Asia (China) Limited, “continues to have one of the strongest capital bases of any foreign‑owned subsidiary bank in China”.

46. Elliott also point out, as I have already mentioned, that they are not alone in questioning the reasons given by the Company for the Proposed Subscription.  CLSA published a commentary shortly after the date of the Announcement and advanced the view that “[s]ince [SMBC] has been building its stake over time and is clearly aligned with the controlling Li family, we see this dilutive transaction as driven more by corporate alliance than economic fundamentals”, and stated further that, “the issue of new shares has more to do with adjusting the balance of power among BEA’s large shareholders”.  JP Morgan and Morgan Stanley also produced commentaries suggesting that the placement to SMBC did not appear to be driven by any need for more capital.

Is the Proposed Subscription a usual or appropriate means of raising capital for a listed bank such as BEA?

47. BEA is the only bank in Hong Kong to have raised capital in the past 10 years by way of a bilateral share issuance of a large block of shares to a “strategic” shareholder, and had done so 3 times prior to the Proposed Subscription.  Other share issuances by banks in Hong Kong appear to have been carried out by way of pre-emptive rights issues and share issuances to multiple investors through a book building process.  A bilateral share issuance of the type which BEA has carried out by way of the Proposed Subscription, certainly in the context of BEA having already carried out three such issuances since the end of 2007, therefore, appears to be unusual.

48. In its letter dated 3 November 2014, BEA stated that, compared with a bilateral placing, a rights issue is “… a more complex, expensive and time-consuming process … and would put unnecessary pressure on the company’s share price and involve the raising of capital at a substantial discount”. However, Elliott suggest that both in terms of value impact on shareholders and timing a rights issue has clear benefits over a bilateral placing such as the Proposed Subscription.

49. First, any downward share price movement resulting from a rights issue would be likely to have a neutral value impact for existing BEA shareholders. This is because the benefit of the rights issue to existing equity holders, namely, being able to subscribe for new shares at a discount to market (or sell their nil-paid rights), should offset any loss on the value of existing shareholdings which may result from any downward pressure on BEA’s share price.  The transfer of value from existing shareholdings to the newly issued equity would normally, in the case of a rights issue, balance out for existing shareholders.  Elliott also suggest that their own analysis suggests that both existing and new equity rights issues by banks in Hong Kong over the past 10 years have had a positive value impact for shareholders.

50. Secondly, a rights issue for a bank in Hong Kong can normally be completed relatively swiftly.  A rights issue does not involve bilateral negotiations with a subscriber, and does not usually create any relative shifts in material shareholders’ holdings.  As a result there are not normally any difficult regulatory issues to address. 

Does the proposed collaboration between BEA and SMBC otherwise justify the Proposed Subscription?

51. BEA suggested in its letter to EAHK dated 3 November 2014, what was at the time, the Proposed Subscription would strengthen collaboration between BEA and SMBC.  Elliott say that there is no public information which suggests that either BEA’s collaboration with SMBC, or the ‘strategic’ investment by, and intended collaboration with, CaixaBank, has to date yielded any material or measurable benefits to BEA.

52. Elliott say that their concern about the negative impact of repeated dilutive share issuances by BEA is illustrated by BEA’s earnings per share and share price movement in recent years.  BEA’s reported earnings per share have only (despite BEA’s net income rising in line with its listed peers) increased by 5% from 2007 to 2013, in contrast to an average of 41% for its Hong Kong listed peers during the same period.  In addition, BEA’s share price has declined by 34% from 27 December 2007 up to 14 January 2015, significantly lagging behind its Hong Kong listed peers, which declined by only 6% on average over the same period.

53. A review of historical bilateral share issuances made by BEA under the general mandate reveals that, since 27 December 2007, BEA has already issued an aggregate of 357.4 million shares to CaixaBank and SMBC, representing a dilution of approximately 23% to other BEA shareholders since that date and there has been no evidence of any measurable benefit having accrued to BEA from any strategic relationship with CaixaBank or SMBC which could in any way off-set this level of dilution.

54. Elliott’s concern is that these matters all suggest that the placements have been primarily motivated by some other consideration, namely, strengthening the position of strategic shareholders with whom the Li Family are on good terms and who provide them with protection from any attempts to interfere with their control of the management of BEA.  As is apparent from public announcements, CaixaBank has agreed formally with BEA that CaixaBank will follow the Board’s recommendation in respect of any takeover offer which is received in respect of BEA and vote in favour of capital raising resolutions which are put to a shareholders’ vote. 

55. I accept that these matters, taken in conjunction with the unsatisfactory way in which the non-executive directors responded to the memorandum of 1 September give grounds for concern not only about the level of supervision that the Board provided, but also the motives behind the original Proposed Subscription.

Developments from December 2014

56. By the time the application was issued there had been a number of other developments.  According to Sir David, in December 2014 the HKMA wrote to BEA noting that its CET1 capital ratio compared less favourably with the average of local banks, and advised that BEA should maintain vigilance in its capital planning and should maintain an adequate capital buffer to accommodate any adverse changes in the external environment. 

57. Secondly Goldman Sachs had been retained. Before considering in detail Goldman Sachs’s views I will address Sir David’s evidence explaining his approach to the original Proposed Subscription.  It is unclear from Sir David’s affidavit at what point in time he began to think of a possible placement to SMBC and when he first approached SMBC.  It would appear, however, to have occurred sometime after receipt of a letter of December 2013 from the HKMA and during discussions between the two banks on possible ways of further strengthening their strategic business cooperation.  Sir David does not explain what the strategic business cooperation involved.  He says that he and other members of BEA’s executive management thought that it was commercially sensible for BEA to raise equity capital by issuing new shares to SMBC in the light of the guidance given by the HKMA.  Sir David says that there were various reasons why they thought a placement to SMBC was beneficial.  First it would be a positive endorsement of the business strategy by SMBC’s parent company the Sumitomo Mitsui financial group.  Secondly, the potential availability of funding support from SMBC.  Thirdly, the potential for access to SMBC’s customers seeking to do business in Hong Kong and the Mainland.  Fourthly, the opportunities for sharing know‑how and expertise between the two banks.

58. As a result the discussions between BEA and SMBC continued and resulted in the memorandum of 1 September 2014.  The September memorandum summarises Sir David’s thinking.  It emphasises what he considered to be the prudence of increasing BEA’s capital ratio.  He took into account the HKMA’s advice, the fact that BEA’s then capital ratio were slightly lower than the average for other banks in Hong Kong and the fact that its current capital position needed to be capable of withstanding any periods of stress caused by negative economic developments and BEA’s projected average annual loan growth of some 10% over the five‑year period from 2014 to 2018.  It would also have the benefit of strengthening the relationship with SMBC.

59. In the light of Elliott’s correspondence Sir David thought that it would be beneficial to retain Goldman Sachs in order to advise the Board further on the proposed placement.  Sir David summarises Goldman Sachs’s advice in paragraph 25 of his affidavit, which rather than paraphrase I quote:

“25. Against this background, Goldman Sachs was engaged to advise the Board and gave a presentation to the Board at a Board gathering held on 14 January 2015. Goldman Sachs’s presentation provided advice on the following issues:

25.1 the Bank’s current and expected capital requirements, and specifically:

(i) it was anticipated that, in implementing the Basel III capital ratio standards, the HKMA would introduce more stringent requirements than the minimum requirements recommended by the Basel Committee, and that the HKMA would likely introduce its own SIB surcharge in the range between 1% and 3.5%, as well as a countercyclical capital buffer proposed to be in the range between 0.25% and 2.5%. These anticipated regulatory changes would create a need for additional capital and a need, out of prudence, for the Bank to maintain a reasonable capital buffer above the regulatory requirements to support the growth of its business operations and to protect against any adverse changes in the macro-environment and unexpected stresses in the market;

(ii) although the Bank’s capital level is broadly in line with those of its peer banks in Hong Kong, the rapid growth in its loan portfolio in the PRC highlighted additional exposure and would require more capital as a result;

25.2 the respective pros and cons of a bilateral placing or a right issue as a means of raising primary capital and, in particular:

(i) it is common for listed companies in Hong Kong to raise primary capital by way of share placings. For example, in the period between 2010 and 2014, more than 80% of primary capital raisings (by number of issues) on the part of Hong Kong listed companies were conducted by way of placings, and of the total value of the capital raised by way of rights issues and placings in Hong Kong, more than 60% was raised by way of placings;

(ii) although the Proposed Placing would have a dilutive effect on the shareholdings of the Bank’s existing shareholders, there would be little (if any) value dilution to existing shareholders if the placement shares were priced at or close to market price (as would be the case in the context of the Proposed Placing);

(iii) the Proposed Placing would foster a closer partnership with SMBC and thereby lead to various strategic benefits to the Bank in terms of availability of credit lines from SMBC to support the Bank’s funding needs, potential for referrals of Japanese customers requiring banking services in Hong Kong and the PRC, sharing of knowhow and expertise in technology and digitalization for banking and business line collaboration; and

(iv) when compared with a right issue, a share placing would achieve costs savings as no underwriting fee would be paid, but its completion would likely require a longer timeframe for the necessary regulatory approvals to be obtained.

60. Sir David felt that this advice vindicated his own thinking.  At a Board meeting held on 14 January 2015 the Board agreed and affirmed its earlier decision.

61. Mr. Smith in his 2^nd affirmation explains why Elliott are not satisfied that the more extensive reasons advanced by BEA in its evidence justified proceeding with the Proposed Subscription.  However, the fact that Elliott may be able to demonstrate credible reasons for questioning the wisdom of the commercial decision to proceed with the Proposed Subscription is not of itself sufficient to constitute a proper purpose for ordering inspection, because, as I have explained earlier in this decision, section 740 does not provide a mechanism by which disgruntled shareholders can challenge a commercial decision of a board.  Elliott need to show that even if it proved possible for BEA to, with the assistance of Goldman Sachs, construct ex post facto a plausible rationale for proceeding with the Proposed Subscription there remains sufficient reason to question whether or not this genuinely represented the motive for placing shares with SMBC in the first place, and thus a matter which it properly wishes to investigate, to constitute a proper purpose.  Mr. Smith’s evidence has to be considered from this perspective.

Elliott’s concerns having seen BEA’s evidence

62. Mr Smith observes that other than for the members of the audit committee none of the other non-executive directors appear to have been involved in any consideration of the Proposed Subscription, despite its size and importance, until four days prior to the announcement made to investors.  

63. Mr. Smith then considers the contents of the 1 September memorandum.  He notes, in my view correctly, that given the significance of the Proposed Subscription, it is short on detail.  It does not consider alternative means of raising capital.  It contains a relatively brief summary of the capital position of BEA.  It does not explain and consider with any precision what the changes in regulatory standards will, or are anticipated to be and how they will impact on the capital requirements of BEA.  Neither does the memorandum explaining what the perceived strategic benefits of further collaboration with SMBC are.  As I have already noted the memorandum does not suggest a board meeting or invite questions or comments from other directors.

64. As I have already explained I accept that the way in which the Board dealt with the issue in early September was unsatisfactory.  I also accept that it is difficult to reconcile the contents of the memorandum and what we know took place, or rather did not take place, namely, a Board meeting or discussions, with BEA’s letter of 3 November 2014 to Elliott.  The letter implicitly suggests that the Board as a whole had had regard to considerations referred to in the letter, and deliberated upon those considerations, when that was not in fact the case.

65. Mr Smith also observes that it is unclear when discussions between BEA’s executive management and SMBC commenced.  The evidence indicates that it was probably well before the meeting with the HKMA in August 2014.  He says that based on his understanding of representations made by SMBC to the Federal Reserve Bank of New York in connection with the Proposed Subscription, it seems SMBC’s legal counsel consulted with the SFC about certain regulatory issues in connection with the Proposed Subscription as early as February 2014.

66. Mr Smith says that his suspicion is that Sir David “may have wanted to create the impression that the Proposed Subscription was developed in response to an alleged perceived need for more capital.  In a similar vein, I would note that in paragraph 19 of his Affirmation, the 2^nd Defendant says that he thought it was commercially sensible for the Company to raise equity finance by issuing new shares in light of the guidance given by HKMA.  However, most of the guidance to which he refers was given from August 2014 onwards, when the Proposed Subscription was already at an advanced stage of development and/or had already been announced ”.

67. Mr Smith explains that there is no evidence at all to substantiate the suggestion that there are any strategic benefits in further collaboration between BEA and SMBC.  He says that this also appears to be the same in respect of the suggested strategic collaboration with CaixaBank. 

68. So far as the Goldman Sachs’s presentation is concerned Mr Smith makes the following comments.  It contains no analysis of what BEA’s actual capital adequacy requirements are from a business, operational and regulatory perspective.  There is no analysis of how BEA’s capital requirements are likely to be impacted by factors other than the raising of new equity finance, such as capital accumulation from business operations and any sales of non-core assets and, therefore, no assessment based on any actual or projected capital shortfall. It follows, he says, that the directors had no indication of what, if any, additional capital was required.  

69. Mr Smith also questions the adequacy of Goldman Sachs’s presentation in respect of alternative methods of raising capital.  He queries their views and suggests that there are good reasons to think that a successful rights issue would send an equally positive message to the market.  However, it seems to me that the issue of whether or not a placement or a rights issue is the better course is very much a commercial decision and although it may be possible for business people to disagree over which is preferable it seems to me that this of itself is not material. What is material is the fact that, as Mr Smith has earlier observed in his affirmation, this is not a matter that was considered by the Board in September and, in particular, no consideration was given by the executive directors or the non-executive directors to the impact of the dilution effect on shareholders’ interests in BEA.

70. The implication of this, suggests Mr. Smith, is that the Li Family took advantage of the opportunity to increase the shareholding of an investor who they knew was likely to support their continued management control of BEA, an opportunity that was possible because they appreciated that the non-executive directors were unlikely to scrutinise the proposed placement as evidenced by the willingness of all of them to sign the 1 September memorandum without requesting a board meeting or raising any questions at about its justification despite the relatively superficial information contained in the memorandum.

BEA’s Case

71. BEA attacks Elliott’s concerns and Mr. Smith’s evidence on the grounds that they are speculative.  There is no reason, BEA says, to question the veracity of Goldman Sachs’s advice or the Board’s subsequent affirmations about the Proposed Subscription.  It also suggests that in any event what is under consideration is a commercial decision and disputes over commercial decisions are not capable of constituting a proper purpose; as I have accepted.

72. If the executive directors had engaged Goldman Sachs to advise on the desirability of raising more capital and the means by which to do so at the outset, the Board had attended a presentation by Goldman Sachs, deliberated on the issue and then at a board meeting approved the Proposed Subscription, it would have been very difficult to question that decision.  It might be that Elliott would have been able to advance credible reasons for suggesting that the decision was poor, and perhaps had the better of that argument; but that argument would have been properly characterised, I anticipate, as concerning a commercial decision and not one subject to review through the court and, accordingly, not a “proper purpose” for the purpose of section 740.  That is not, however, what happened.

73. Goldman Sachs were only engaged after Elliott began to object to the Proposed Subscription.  BEA has not suggested that Goldman Sachs were kept in the dark about Elliott’s objections in order to ensure that they did not tailor their advice to justify a decision that had already been taken.  I think it reasonable to assume that the Board would have felt a reluctance to change a decision that had already been made and announced.  I do not think it takes an especially skeptical turn of mind to suspect that the Board wanted to justify its earlier decision if at all possible.

74. Most importantly, and as I have already discussed, in my view there is at least a respectable argument that the Board failed in its duty to scrutinise Sir David’s proposal properly in September 2014.  I think that a shareholder is entitled to be concerned about the way the Board dealt with the matter and for a professional investor with a sizable interest in BEA to want to investigate the way in which a major decision, which impacted on its economic interest in BEA and its right not to have its shareholding diluted except for a proper purpose, was made and whether or not it involved a breach of fiduciary duty by the directors, which demonstrates inadequacies in BEA’s corporate governance.  I do not think that BEA’s attempts, after it received Elliott’s correspondence, to deal with the matter properly fully resolves those concerns for the reasons I have discussed in the previous paragraph.

75. BEA took a number of other objections to the application.  It was argued that Elliott had applied for inspection on the grounds that it anticipated commencing proceedings against the directors.  Elliott did not apply to enjoin BEA from completing the Proposed Subscription, which has now been completed.  There is no realistic prospect, BEA argues, of setting aside the placement, because there is no basis for impugning SMBC’s good faith in entering the transaction. Therefore, allowing inspection of the documents would be an exercise in futility, which could only serve to damage BEA’s interests by revealing confidential information.  It does not seem to me that this is an answer to the application.

76. I accept that the application has been formulated in such a way as to suggest that it is envisaged that proceedings will be commenced against the directors.  This is apparent from the fact that it is made under both section 740 of the Companies Ordinance and section 41 of the High Court  Ordinance,as well as the way in which Mr. Smith describes the purpose of the application.  However, completion of the Proposed Subscription does not exclude the possibility of a remedy being sought in respect of  a possible breach of duty in September, even if it were limited to a declaration sought with a view to establishing a significant failure in BEA’s corporate governance.  As I have already mentioned, in my view part of the purpose of section 740 is to assist in the maintenance of appropriate standards of corporate governance and this is particularly the case in the context of public companies such as BEA.  In my view obtaining documents in order to determine whether to commence proceedings for the purpose of advancing the protection of shareholder rights and maintaining appropriate standards of corporate governance, is in my view capable of constituting a “proper purpose”.

77. BEA suggests that the substance of Elliott’s case is more specific than a general concern about the state of BEA’s corporate governance and the process that led to all the directors signing the 1 September memorandum.  Elliott’s complaint is that the board of BEA in some way contrived with the Li Family to entrench the latter’s control.  I accept that at certain points of Mr. Smith’s first affirmation this is what he seems to be suggesting.  I do not, however, accept as BEA argues, that the application should be judged by reference to this allegation and that if the evidence does not even at this preliminary stage support it, I should find that a “proper purpose” has not been established.

78. Elliott are now in possession of far more information about the Proposed Subscription and subsequent events that led to the Board ratifying its initial decision in January than it was when the Plaintiffs issued the application. When it filed Mr. Smith’s first affirmation it only knew what appeared in the public announcements and the letters it received from BEA.  The second affirmation was filed before the Proposed Subscription was completed and the concerns expressed in it reflect that fact and explain why it is not in the interests of shareholders who are not aligned with the Li Family for it be completed.  The Proposed Subscription has, however, been completed.  I accept that the evidence before the court does not support a suggestion that the Proposed Subscription resulted from a conscious decision by the Board to entrench the control of the Li Family.  But that in my view does not detract from what I see as the substance of Elliott’s complaint, namely, that there was a serious failure by the Board of BEA to consider properly the Proposed Subscription in September 2014.  It seems to me that investigating the process by which the Board approved the Proposed Subscription with a view to taking action against the directors constitutes a “proper purpose” for applying for inspection of documents.  It also seems to me that the apparent shortcomings in the way the Proposed Subscription came to be approved in September taints the credibility of what took place subsequently. In my view BEA’s retention of Goldman Sachs is not, therefore, an answer, or not a sufficiently complete answer, to the concerns about the initial decision.

79. BEA advances one further ground in opposition to the application.  It points out, correctly, that the Plaintiffs only became shareholders on 14 January 2015 and in the knowledge of the Proposed Subscription.  Therefore, BEA says, they cannot properly now seek inspection of documents on the grounds that they are dissatisfied with the placement.

80. As I explain in paragraph 23 of Wong Kar Gee Mimi supra “it may be that the fact that an applicant may have only recently acquired a small holding in the company is strong evidence the application is either not made in good faith or not for a proper purpose”.  If it were the case that the application was being brought by a number of very small shareholders who had acquired shares only after the matter of which they express concern became common knowledge then I would probably take the view that the application was not brought in good faith or for a proper purpose.  However, that is not the reality of the situation before me.  The Plaintiffs are part of the Elliott group and have acquired shares to ensure that there is no issue over meeting the requirements of section 740(1).  The reality is quite clear: the application is being brought by the Elliott group which holds shares in BEA worth somewhere in the order of HK$1.8 billion.  In my view it would artificial to approach the application on the basis that it is made by few small shareholders who have only recently acquired shares in BEA.

Confidentiality

81. BEA argues that even if I am satisfied that the application has been made bona fide and for a proper purpose the confidential nature of the contents of the documents of which inspection is sought, particularly those between BEA and the HKMA, which BEA suggests are caught by paragraph 4 of the schedule, militates heavily against ordering inspection and is a sufficiently powerful consideration in the present case to justify refusing the order.

82. I accept that confidentiality is an important consideration and should properly be given due weight in considering what, if any, order to make.  It does not seem to me that BEA has made out a case for it being a sufficiently strong consideration in the present context to justify refusing the application.

83. In the case of the HKMA the evidence from BEA suggests that such suggestions as they made were couched in general language.  There is nothing to suggest that the contents of the correspondence between the HKMA and BEA involved a discussion of anything of particular sensitivity to either organization.

84. In my view concerns about confidentiality can be adequately dealt with by appropriate undertakings about the use of information gleaned from documents inspected, which brings me to the terms of order.

Terms of order

85. It has become clear from the evidence filed by the directors that they do not have any of the documents falling within category 6 referred to in the schedule appended to this judgment.  The application against them individually falls away.

86. So far as the remaining categories of documents are concerned they were formulated before the Plaintiffs became aware of the various matters described in BEA’s evidence.  I think it sensible for the Plaintiff’s to formulate the precise form of order that they now seek and provide the draft to BEA’s solicitors for consideration.  If this cannot be agreed promptly the application should be relisted before me.

87. I will make an order nisi that the costs of the application are paid by the Defendants.

APPENDIX

The Schedule

From the 1^st Defendant:

1.   The Memorandum of Understanding (“the MOU”) between The Bank of East Asia, Limited (“the Bank”) and Sumitomo Mitsui Banking Corporation (“SMBC”) as referred to in the Bank’s announcement dated 5 September 2014 (“the Announcement”).

2.   The Definitive Agreements as referred to in the Announcement (or the drafts thereof if such agreements have not yet been executed).

3.   The minutes of meetings of the board of directors of the Bank, the Board papers provided to the directors in respect of such meetings, the resolutions thereof, and any written communications between the directors, with respect to the entering into of the MOU and the Definitive Agreements.

4.   All documentation reflecting the capital position and/or the capital requirements of the Bank at the times when the MOU and the Definitive Agreements were concluded.

5.   The Memorandum of Mutual Understanding on Strategic Partnership concluded between the Bank and SMBC on or about 17 November 2008.

From the 2^nd to the 19^th Defendants:

6.       Copies of any notes taken by the directors, whether in manuscript or electronic format, of any discussions concerning the Proposed Subscription.