BILLION LEAD INVESTMENT LTD v. UNION JOYCE LTD AND OTHERS

HCMP 2145/2011

IN THE HIGH COURT OF THE

HONG KONG SPECIAL ADMINISTRATIVE REGION

COURT OF FIRST INSTANCE

MISCELLANEOUS PROCEEDINGS NO 2145 OF 2011

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DECISION
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1.  By a Summons dated 9 February 2015 and amended on 27 May 2015 (“Summons”), the 1^st to 3^rd Respondents (“Respondents”) ask this court to give further valuation directions to the valuer, Ernst & Young Transactions Limited (“Valuer”) concerning its valuation of 100% of the equity interest of the 4^th Respondent, i.e. the Company in question.

2.  The appointment of the Valuer was made and the valuation exercise was carried out pursuant to the terms of settlement between the parties as contained in the Schedule (“Schedule”) to a Tomlin Order made by Harris J on 18 March 2014:

(1) Paragraph 1 of the Schedule says the 1^st Respondent shall purchase the Petitioner’s shares in the Company at a consideration to be determined in accordance with paragraphs (2) to (6) below.

(2) Paragraph 2 of the Schedule says the consideration for the purchase of the shares shall be the value of the shares as assessed by the Valuer in accordance with paragraphs (3) to (6) below, plus interest and minus HK$1 million.

(3) Paragraph 3 of the Schedule says the valuation of the shares shall be carried out by a valuer to be agreed.

(4) Paragraph 5 of the Schedule sets out the basis of the valuation. Paragraph 5(i) says the value of the Company including that of its subsidiary shall be assessed at its market value on a going concern basis as at 28 October 2011. Paragraph 5(iii) says no discount of whatsoever nature shall be given to the value of the shares.

(5) Paragraph 6(iii) is the critically important paragraph for the present purpose. It reads:

“upon the completion of the final draft of the valuation report, it should be circulated among the parties, who may within 35 days thereafter submit written representation to the Valuer (with a copy served on the other side at the same time) for consideration and the decision of the Valuer on the written representation submitted by the parties shall be final and conclusive”.

(6) Paragraph 13 gives liberty for the parties to apply to the court for directions in connection with valuation and generally.

3.  By a letter of engagement dated 1 April 2014, the Valuer was jointly appointed by the parties. Attached to the letter of engagement is a Statement of Work which describes the scope of the services to be provided by the Valuer. In the Statement of Work, the Valuer says its analysis is undertaken in accordance with International Valuation Standards (“IVS”). According to IVS, “market value” is defined as “the estimated amount for which an asset should exchange on the valuation date between a willing buyer and a willing seller in an arm’s length transaction, after proper marketing and where the parties had each acted knowledgeably, prudently and without compulsion”.

4.  On 19 December 2014, the Valuer circulated a draft valuation report to the parties (“December Report”). The market value of 100% equity in the Company as at the valuation date was assessed at HK$155.8 million.

5.  On 23 January 2015, the Respondents submitted their written representations (“Written Representations”) to the Valuer asking for substantial adjustments to the valuationas set out in the December Report.

6.  At paragraphs 6 to 9 of the Written Representations, the Respondents submitted that in calculating the “Net Debt”, the Valuer should take into account the entry of “Bills Payable” in the sum of slightly over HK$101 million. This is because as defined in the December Report, “Net Debt” includes the interest bearing bank loans and cash balances at the consolidation level. The Respondents submitted that the entry of “Bills Payable” is also interest bearing bank loans and the interest accrued thereon contributed partly to the “Bank Interest” as reported in the Consolidated Profit and Loss Account for the financial year 2011. In this regard, the amount of “Bills Payable” in the sum of HK$101 million should be added to the “Interest bearing bank loans” under the calculation of “Net Debt”. 

7.  At paragraphs 11, 17 and 18 of the Written Representations, the Respondents submitted that the Company and its subsidiary are unlisted entities and do not qualify for listing. When adopting listing entities as comparables in the valuation of shares of private companies, one should be wary as to the difference (often substantial) on the scale of operation as well as the fact that the price or the enterprise value of a listed entity has always taken into account the premium attributed to its listing status. Further, giving that the operating scale of the Group is far smaller than those of Kam Hing International Holdings Limited and Pacific Textiles Holdings Limited and therefore the Group necessarily enjoys lesser economy of scale in its business and operation, adjustment to the multiples as derived above should be made in order to reflect such discrepancies. In this regard, the Respondents submitted that a discount of  25 to 30 per cent on the multiples would fairly reflect the difference between the Group and the comparable companies.

8.  The net result of these adjustments, if accepted, would be a downward adjustment to the value of the shares of the Company.

9.  On 6 February 2015, the Valuer said having considered the points raised in the Respondents’ Written Representations, it was of the opinion that the valuation in the December Report reasonably reflected the fair value of the Company and planned to issue its final report the next week.

10.  On 9 February 2015, the Respondents issued the present Summons and asked the Valuer to withhold issuing the final report. In response, the Valuer said it would do so.

11.  On 12 March 2015, the Petitioner’s solicitors wrote to the Valuer.They said:

“Having had the chance to consider the points raised by the Respondents in the Summons, we agree that the valuation of the 100% of the equity interest of [the Company] should not take into account paragraph 5(iii) of the Schedule of the Order of Harris J. As such, we would ask [the Valuer] to:

(1) reconsider paragraphs 11, 17 and 18 of the Respondents’ Written Representations without taking into account paragraph 5(iii); and to issue any further response thereto (with reasons for such decision); and

(2) issue a final valuation report within 28 days with appropriate amendments (if any) as a result of such reconsideration.”

12.  On 31 March 2015, the Respondents applied to amend the Summons which was subsequently allowed by Harris J.

13.  On 4 May 2015, the Valuer issued its final report (“May Report”) to the parties. The Valuer maintained the valuation of HK$155.8 million for the Company. In the covering letter, the Valuer said:

“We understand that the court has yet to provide instructions on how to interpret paragraph 5(iii) of the Schedule of the Order of Harris J. However, as a 100% equity interest in an unlisted company is generally considered to be marketable, it is a common valuation practice not to apply the discount for lack of marketability in the valuation of a 100% equity interest of a private company. Given that we were engaged to value 100% of the equity interest in [the Company], we considered it appropriate not to apply any discount for lack of marketability in our valuation analysis.”

14.  On 5 May 2015, the Petitioner’s solicitors again wrote to the Valuer and asked the Valuer to clarify whether in coming to the valuation in the May Report, it had reconsidered paragraphs 11, 17 and 18 of the Respondents’ Written Representations, as requested in their email on 12 March 2015. They said:

“This is of paramount importance so that the parties can be clear what exactly was the basis of the valuation in the [May] Report.”

15.  In reply on the same day, the Valuer said:

“We would like to confirm that, to arrive at our conclusion in the Final Report, we have considered all relevant facts and circumstances, including but not limited to paragraphs 11, 17 and 18 of the Respondents’ Written Representations.”

16.  For the purpose of this hearing, the parties are content to adopt the statement of principles set out in paragraphs 22 and 23 of Re Goldsfine Development Limited unrep.; HCCW 211 of 2007; a decision of this court on 3 July 2013. At paragraph 22 of that decision, this court said in cases where the parties have expressly or impliedly agreed that an expert valuation is to be binding, it is settled law that the valuation cannot be challenged on the ground that mistakes have been made, unless it can be shown that the expert has departed from the instructions given to him in a material respect, or if there is fraud or collusion.

17.  Fraud and collusion are not being relied upon by the Respondents in the present case. In so far as the Respondents suggest that there are questions as to the impartiality of the Valuer, I find that suggestion to be no more than a bare assertion, unsupported by evidence. The suggestion is based little more than the Valuer’s refusal to revise the valuation after receiving the Respondents’ Written Representations and its decision to issue the May Report without waiting for the outcome of this application.

18.  In my view, the fact that the Valuer disagreed with the Respondents cannot be regarded as an indication of its bias against the Respondents any more than its agreement with the Respondents can be regarded as an indication of its bias in their favour. The Valuer is expected to exercise its independent judgment in arriving at the valuation and it is inevitable that it might agree or disagree with the representations made to it. Concerning the decision to issue the May Report, if the Valuer did not think it necessary to wait for the court’s adjudication of the Summons, it is a matter for it to decide.

19.  At paragraph 23 of Re Goldsfine Development Limited supra, this court said, where the parties have not expressly agreed to be bound by a valuer’s report, on a matter of opinion, (as opposed to fact or law), the  court should be very slow to interfere with the chosen expert’s determination, unless patent errors can be demonstrated on the face of the report. The reason for this approach is that valuation of shares in a private company is notoriously difficult, and any number of experts, however reasonable, can reasonably differ on the valuation. Unless some sensible restrictions are placed on the grounds on which an agreed expert’s determination can be challenged, the advantage to be gained from an out‑of‑court share valuation by an independent expert will become illusory.

20.  The first issue before this court is whether the valuation by the Valuer is final and binding on the parties. There are two reports: the December Report and the May Report. Mr. Wong, for the Respondents, says neither of them is binding. His argument is that because the Respondents have issued the Summons seeking directions from the court in connection with the valuation under paragraph 13 of the Schedule, neither report is final and binding on the parties until the adjudication of the Summons by the court.

21.  Mr. Dawes, on the other hand, submits that the May Report is final and binding pursuant to paragraph 6(iii) of the Schedule.

22.  Paragraph 6(iii) of the Schedule contemplates the final four stages in the valuation process to be as follows: first, the issue of a final draft report by the Valuer; second, the making of written representations by the parties; third, the consideration of the representations by the Valuer; and lastly, the making of a decision by the Valuer on the representations which decision completes the valuation exercise.

23.  Paragraph 13 of the Schedule gives the parties liberty to apply to court for directions in connection with the valuation and generally. Liberty to apply has a well-established meaning when it is contained in a court order. It enables the parties to ask the court to deal with matters in the working out of an order. But it does not confer a right on the parties to ask the court to vary the order.

24.  It is important to note that paragraph 6(iii) and paragraph 13 are not interdependent. On their face, neither is subject to the other.

25.  Once the valuation process has gone through the final four stages contemplated in paragraph 6(iii), the decision of the Valuer becomes final and binding. The operation of paragraph 6(iii) does not depend on whether a party chooses to invoke the liberty to apply under paragraph 13.Otherwise, a dissatisfied party can hold up the completion of the valuation exercise by issuing one summons after another for directions. If that is indeed what the parties have expressly agreed, so be it. After all, the Schedule embodies their agreed terms of settlement. But in the absence of clear wording to that effect, this court is not prepared to construe the Schedule in a way which will give rise to that result.

26.  On the other hand, the completion of the valuation and the issue of a final and conclusive decision by the Valuer under paragraph 6(iii) will not preclude the parties from exercising the liberty to apply under paragraph 13. As the authorities show, even if the parties have agreed that an expert valuation is to be final and binding, the valuation can still be challenged on the ground that the expert has departed from the instructions given to him in a material way.In those circumstances, one party or another can still justifiably ask the court to work out that part of the order which remains outstanding i.e. whether the purchasing party should pay the purchase price of the shares as valued by the valuer or whether there should be some adjustments to the valuation.

27.  In the present case, the valuation process has gone through the four stages contemplated by paragraph 6(iii). The Valuer’s decision is contained in the May Report and that decision is in my judgment final and conclusive. It follows that the test to be applied in the present case is whether the Valuer has departed from the instructions given to it in a material way.

28.  In their written submissions, the Respondents suggest the Valuer has departed from the instructions given to it in two material ways.

29.  First, it has misconstrued and misapplied paragraph 5(iii) of the Schedule. In my view, that is water under the bridge. On 12 March 2015, the Petitioner’s solicitors asked the Valuer to reconsider paragraphs 11, 17 and 18 without taking into account paragraph 5(iii) of the Schedule, and it is reasonably clear from the Valuer’s covering e‑mail when it circulated the May Report and from the report itself that was what the Valuer had done.

30.  Second, the Valuer has also departed from the IVS which recognize the importance of adjustments of P/E multiples taken from comparable listed companies in order to compensate for differences, for example, in the scale of operation of the listed companies as compared to the Company as well as the listing status of the comparable companies. The Respondents submit that the Valuer’s departure from the IVS is evident from its failure to properly address paragraphs 11, 17 and 18 of their Written Representations concerning such adjustments.

31.  In my view, the Valuer has not departed from its instructions to apply the IVS in evaluating the market value of the shares. What itdiffered from the Respondents was how the IVS should be applied in the present case. At paragraphs 56 and 57 of the IVS Framework, market approach is explained in this way:

“The market approach provides an indication of value by comparing the subject asset with identical or similar assets for which price information is available.

Under this approach, the first step is to consider the prices for transactions of identical or similar assets that have occurred recently in the market.  If few recent transactions have occurred, it may also be appropriate to consider the prices of identical or similar assets that are listed or offered for sale provided the relevance of this information is clearly established and critically analysed.  It may be necessary to adjust the price information from other transactions to reflect any differences in the terms of the actual transaction and the basis of value and any assumptions to be adopted in the valuation being undertaken.  There may also be differences in the legal, economic or physical characteristics of the assets in other transactions and the asset being valued.”

32.  At paragraph C19 of the IVS commentary on market approach, the authors said this:

“Through analysis of the publicly traded businesses or actual transactions, valuation ratios, usually price divided by some measure of income or net assets, are calculated. In calculating and selecting these ratios, consideration is given to the following matters:

....

(b) adjustments may need to be made to render the ratio appropriate for the subject business. Examples include adjustments for differences in risk and expectations of similar businesses and the subject business;

(c) adjustments may be required for differences in the subject ownership interest and interests in the similar businesses with regard to the degree of control, marketability, or the size of the holding.”

33.  As to be expected, these IVS only set out the different approaches to valuation in general terms and leave the application of these approaches to the discretion and judgment of the valuer in any individual case. The fact that a valuer may make adjustments in accordance with the IVS implies that, in the exercise of his judgment, he may not. It cannot be said that the valuer is acting within his instructions to follow the IVS if he makes adjustments, but he is acting outside them if he does not.

34.  For completeness, I should add that the Valuer’s decision not to include the Bills Payable as part of the Company’s Net Debt but include them as part of the Company’s working capital has been duly explained as for the purpose of achieving consistency.  I do not see any possible basis for criticizing it for so doing.

35.  For the reason set out above, this court is not minded to disturb the valuation made by the Valuer in the May Report. The Respondents’ Summons is hereby dismissed.

36.  There is also before this court a summons issued by the Petitioner on 6 May 2015, paragraph 1 of which asks the Respondents to forthwith reimburse it US$88,500, being the outstanding fees of the Valuer. 

37.  It is accepted by the Respondents that, in principle, an order should be made in terms of paragraph 1 of the Petitioner’s summons once their Summons is dismissed.  And I shall so order, save that “forthwith” is replaced by “14 days”. 

38.  As to paragraph 2 of the Petitioner’s summons which concerns the definition of “Completion Date”, I have been asked by Mr. Dawes to make an order in these terms: 

“The Completion Date under paragraph 7 of the Schedule to the Order of Harris J dated 18 March 2014 shall be 28 days from the date of this Order.”

39.  And I shall so order as well.

40.  Costs of both summonses to follow the event i.e. to the Petitioner to be taxed if not agreed, with certificate for two Counsel.