RE CHINA SHANSHUI INVESTMENT CO LTD

HCCW 398/2015

IN THE HIGH COURT OF THE

HONG KONG SPECIAL ADMINISTRATIVE REGION

COURT OF FIRST INSTANCE

COMPANIES (WINDING-UP) NO 398 OF 2015

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DECISION

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Introduction

1.  I have before me applications to strike out the petition to wind up the Company issued on 22 December 2015 by Prime King International Limited and Sincere Trading Limited on the grounds of insolvency relying on alleged debts of US$9,918,000 (Prime King) and US$19,827,000 and RMB66,340,000 (Sincere).  The applications have been issued by both the Company and six opposing contributories.

2.  The following facts are in dispute:

(i)   The Petitioners advanced the sums claimed to the Company.

(ii)   The Petitioners and the Company signed short loan agreements in respect of the advances in the Chinese language, a number of which were extended.

(iii)   The advances were not gifts.

(iv)   The advances were recorded as loans in the audited financial statements of both the Company and the Petitioners.

3.  The Company and the opposing contributors argue that the advances are not repayable, because they were intended to be injections of capital into the Company, which was to finance the retirement of various loans that it had taken out with banks to finance its subscription in the shares of China Shanshui (Hong Kong) Limited at the time it was listed. The loan agreements that record the advances claimed by the Petitioners were shams.

Legal Principles

4.  The relevant legal principles are not in dispute.  In order to succeed the Company and the opposing contributors have to demonstrate that the Company has a bona fide defence on substantial grounds.  Various authorities have considered what constitutes a bona fide defence on substantial grounds.  I summarised the principles that emerge from them in Re Yueshou Environmental Holdings Ltd ^[1] paragraphs 9 and 10:

“9. These judgments demonstrate that it is necessary for a company contending that it has a bona fide defence on substantial grounds to put before the court not just a series of assertions of fact that if made out at trial would constitute a defence, but credible evidence that demonstrates sound reasons to think that the asserted facts may be proved at trial.

10. Mr. Strachan and Mr. Wong cited further cases which deal with the impact on the resolution of this issue of various types of matter, which occur where there are disputes over debts, for example an acknowledge of a debt [2]or a request for time for payment[3]. These cases illustrate the rather obvious point that it is harder for a company to satisfy the court that it has a bona fide defence on substantial grounds if it has conducted itself in a way which suggests that the debt is payable.  The authorities referred to in footnotes 3[2] and 4[3] illustrate that as a matter of practicality once a debt is acknowledged the evidence and argument relied on to establish a substantial defence will have to be compelling.  As will become apparent later in this judgment I consider that this is such a case.”

5.  Where the parties to a transaction have a common intention that the document that they sign is not to create the legal rights and obligations it gives the appearance of creating, the documents does not bind the parties: Snook v London West Riding Investments Ltd ^[4]. The test is subjective and in assessing what the parties intended the court may consider extrinsic and circumstantial evidence: Hitch v Stone ^[5].

6.  As Au-Yeung J notes in H v W & others^[6] the court does not lightly find a transaction to be a sham.  There is a strong presumption that documents record genuine transactions.  To rebut this presumption requires cogent evidence.  If the court is invited to draw inferences these must be drawn from factual findings, which are supported by evidence.

7.  In the present context the court is not required to make any findings.  However, it follows from the above principles that in order to find that there is a bona fide defence on substantial grounds I have to be satisfied that the evidence before me demonstrates that the Company has a credible case that it was not intended that the advances were loans repayable on demand, which should go to trial.

Background

8.  The opposing contributories in particular have emphasised that the petition comes to court against a complex background of litigation involving the Company.  It is sufficient to summarise it.  Jinan Shanshui Group Limited (“Jinan Shanshui”) was a state-owned enterprise.  In 2000 it promoted a stock option scheme for its employees.  This involved the acquisition of Jinan Shanshui’s business by a new company and restructuring it as a private enterprise in which employees would have shares.  The senior employees involved in Jinan Shanshui’s business included Zhang Caikui.  By 2005 it had been decided to restructure the business using overseas corporate vehicles with a view to a listing.  As part of that process the Company came into existence.  The employees were to have a substantial beneficial interest in the Company, which in turn was to have a strategic interest in the listed company.  The employees’ shares in the Company were to be held on trust for them by Mr Zhang and another formed senior employee Li Yanmin.

9.  China Shanshui Cement Group Co Ltd (“CSC”) was listed in July 2008.

10.  In November 2013 Mr Zhang presented a proposal to the employees to buy their shares in the Company held by him and Mr Li on trust, the purchase price to be based on CSC’s shares price, but at a discount to it.  The payments were to be completed over an extended period and financed out of the dividends distributed to the trust by CSC.  The employees became concerned that Mr Zhang was attempting to use their money to acquire their shares at a discount and obtain a significant personal interest in CSC.  This resulted in a number of actions being commenced concerning the Company, CSC and Mr Zhang.  The result, to date, is that court appointed receivers manage the Company and Mr Zhang has lost his role in the management of CSC.

11.  It is suggested by the Company and the opposing contributories that the present petition has been presented as an attempt by Mr Zhang, who, along with his son, controls the board of the Petitioners to gain some leverage in their dealings with the affairs of the Company and CSC, the former in which Mr Zhang has a beneficial interest in addition to the shares he held on trust for other former employees.

The alleged defence

12.  The defence advanced by the Company and supported by the opposing contributors is this: at the time the advances were made, which was between September 2010 and September 2013, the Company had substantial bank borrowing in Hong Kong, which had been incurred in order to finance its subscription for shares in CSC.  During that period Jinan Shanshui, which was a company holding assets that had originally formed part of Jinan Group and had not formed part of the listed business, realised those assets putting it in a position to retire the Company’s loans.  Jinan Shanshui was owned by two Mainland companies, Jianxin and Lixin, whose shareholding was the same as the Company, namely, Mr Zhang and Mr Li held 81.26% of the shares on trust for the employees including themselves.  It was decided to use some of the money that had become available to retire the Company’s loans.  It is apparent from contemporaneous documents, in particular, a report dated 30 September 2010 prepared by Jinan Shanshui’s Securities Management Department to Mr Zhang that the first stage of this was to be affected by establishing companies in Hong Kong into which the necessary funds were to be injected as capital.  As the report explains this structure was necessary to satisfy Mainland foreign exchange regulations. 

13.  There are no documents containing information about the intended arrangement in respect of the next state of the process, which was for the transfer of the monies received by the new Hong Kong companies (which became the Petitioners) to the Company in order that the bank loans could be retired.

14.  The Petitioners have the same directors: Mr Zhang, his son and Mr Huang.  Both affirmations filed on behalf of the Petitioners in these proceedings have been made by Mr Huang, who became a director after the advances were made.  There is no evidence from the Petitioners, which explain why the advances were made, so they say, as loans.  The Petitioners’ position is that the original loan agreements and the audited financial statements speak for themselves.  There is nothing to suggest that the arrangement reflected anything other than the intention of the boards of the Petitioners and the Company, which had common directors.

15.  The Company argues that in assessing the intent of the controlling minds of Jinan Shanshui, the Petitioners and the Company one should have regard to the fact that Mr Zhang, who was director of each and I accept can be assumed, on the basis of evidence filed in these proceedings and the various others that have proceeded it, to have been in control of them was a trustee holding shares for the benefit of the employees.  The intent that the court is concerned to identify is that of the trustees acting bona fide and consistently with their duties.  Mr Barlow SC submitted that there are substantial grounds for suggesting that what emerges from the report and the principal reason for making the advances is an intention to transfer capital to the Company in order to allow it to retire the bank loans.  This would be consistent with Mr Zhang’s obligations as a trustee, namely, to make decisions that advance the interests of the beneficiaries, which would most obviously be achieved by ensuring that the company in which the trusts assets vest, namely, the shares in CSC was properly capitalised and not carrying unnecessary liabilities.

16.  The Petitioners’ case seems to be that a conscious decision was made by Mr Zhang to replace one set of liabilities, bank loans, with another set of liabilities, loans (albeit interest free) from the Petitioners.  This does not make any obvious sense and seems to me to be at least arguably inconsistent with Mr Zhang’s obligations as a trustee.  It seems to me that it is at least reasonably arguable that if the intention of the controlling minds of Jinan Shanshui, the Petitioners and the Company is assessed on the basis that Mr Zhang, and while he was involved Mr Li, are to be assessed on the basis of what if they were acting mindful of their duties should have been their intention, the loan agreements were a sham.  It seems to me that the Company and the opposing contributories have demonstrated a bona fide defence on substantial grounds.

17.  I would end with this observation.  A peculiar and unsatisfactory feature of this case given the history of Mr Zhang’s activities, is that Mr Zhang, who controls the Petitioners by virtue of his position as a trustee, is attempting to wind up the Company, in which he has the same shareholding as he has in the Petitioners as trustee for the same beneficiary.  The substance of what Mr Zhang is attempting to do by demanding repayment is to transfer valuable assets, which are hold on trust controlled by the receivers appointed by the court because Godfrey Lam J was satisfied it was necessary in order to protect the underlying assets from Mr Zhang’s machinations, to companies which he controls and in which the assets would not be protected. There is, thus, every reason to question Mr Zhang’s motives in causing the petition to be issued.

18.  I will hear the parties on costs.