RE CHINA OCEAN INDUSTRY GROUP LTD (“THE COMPANY”)

HCCW 230/2019

[2021] HKCFI 247

IN THE HIGH COURT OF THE

HONG KONG SPECIAL ADMINISTRATIVE REGION

COURT OF FIRST INSTANCE

COMPANIES WINDING-UP PROCEEDINGS NO 230 OF 2019

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D E C I S I O N

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Introduction

1.  The Company is a Bermuda-incorporated entity listed on the Main Board of the Stock Exchange of Hong Kong Limited (“SEHK”).  It is an investment holding company with all its operating subsidiaries based in the Mainland.

2.  The Company is insolvent and is actively pursuing a debt restructuring and raising funds to repay its creditors.  The Company proposes to issue the following instruments as part of a fund raising program:

(1)  up to 68,000,000 ordinary shares (“New Shares”) at HK$0.105 per share; and

(2)  a convertible bond with the principal amount of HK$30,000,000 and the conversion price of HK$0.1 per conversion share (“CB”).

If completed, the issue of the New Shares and the CB will generate approximately HK$36 million.

The Application for a Validation Order

3.  To meet the SEHK’s requirements, the Company has applied for a validation order under section 182 of the Companies (Winding Up and Miscellaneous Provisions) Ordinance (Cap 32) (“Ordinance”) in respect of the Company’s proposed issue of the New Shares and the CB.  The Petitioner does not oppose the application.  However, despite this   in my view no validation order can be granted because issuing the New Shares and the CB does not engage section 182, and the absence of a validation order clearly does not prevent the Company from proceeding with issuing the New Shares and the CB. However, as I explain later there are authorities in Hong Kong in which it seems to have been assumed that a validation order can be properly sought and granted in respect of an issue of new shares.  It is, therefore, necessary to explain the relevant principles in order to demonstrate the SEHK and differently constituted courts on previous occasions have, with respect, misunderstood the position.

The application Section 182 to issue of new shares

4.  Section 182 provides:

“In a winding up by the court, any disposition of the property of the company, including things in action, and any transfer of shares, or alteration in the status of the members of the company, made after the commencement of the winding up, shall, unless the court otherwise orders, be void.”

5.  The Court’s jurisdiction to grant a validation order under section 182 is engaged only if the subject-matter concerns a “disposition of the property of the company”, “transfer of shares”, or “alteration in the status of the members of the company”.  Issue of new shares does not engage section 182 because it does not involve any alteration in the status of the members of the company.

6.  In Bank of China (Hong Kong) Ltd v Oasis HKTL 04A Ltd [1], DHCJ Lisa KY Wong SC held that the issue of new shares did not involve any “alteration in the status of the members of the company” within the meaning of section 232 of the Ordinance:

“I fail to see what alteration in the status of the members of Sub IVA/Sub IVB the issue of new shares would cause. Yes, the new shares would enlarge the issued share capital of Sub IVA/Sub IVB and dilute the holdings of the Founders therein in terms of percentage. However, on the facts known to me, the Founders’ liabilities to contribute in the winding-up of Sub IVs remain fixed at the amounts of the share capital to which they have respectively committed and the expectation to share in the assets of Sub IVs in proportion to their shareholdings is non-existent.”

7.  Similarly, in Sellers; in the matter of Beckley Forge [2], the Federal Court of Australia held that the issue of new shares did not involve “an alteration in the status of members of a company” within the meaning of the former section 437F of the Corporations Act 2001 which was in pari materia with section 182 of the Ordinance:

“[N]one of the rights or privileges which are vested in, nor any of the corresponding duties or obligations which are imposed upon, existing shareholders will in any way be affected by the allotment. For that reason, the proposed allotment is not struck down by s 437F. It may be accepted that, in a practical sense, the effect of the allotment will be to diminish the value of existing shares (if they have any value). But a diminution in the value of a share does not change the status of that share or the status of the shareholder. Section 437F is concerned with a change in legal rights, not with adverse commercial consequences. The application seeking leave to implement the share allotment proposal will therefore be dismissed.”

8.  In Lollback v Brakepower [3], the New South Wales Supreme Court held that the issue of new shares to existing members did not involve an “alteration in the status of members of a company” within the meaning of section 468A(8) of the Corporations Act 2001 which is also in pari materia within section 182 of the Ordinance:

“[T]here was an assumption, it seems, that an issue of new shares to an existing member entails a change in the status of that member (or of the members), that being the matter regulated by s 468A(8). This is not so. Finkelstein J held in Sellers; in the matter of Beckley Forge Pty Ltd [2003] FCA 523 that a prohibition in the terms now contained in s 468A(8) did not preclude the issue of new shares. As his Honour explained, an allotment does not alter the ‘status’ of existing members …”

9.  As these authorities demonstrate the issue of convertible bonds also would not engage section 182.

10.  The conclusion that issuing new shares and convertible bonds does not engage section 182 is consistent with the rationale behind section 182 because issuing new shares and convertible bonds would not lead to existing contributories evading their liability.  The prohibition on share transfers and alteration in members’ status is to prevent existing contributories from evading liability by transferring shares to an impecunious person after the commencement of a winding-up.  Many Commonwealth authorities dealing with legislation in pari materia with section 182 have made the legislative rationale clear.  In Singapore the Court of Appeal explain in Seah Teong Kang v Seah Yong Chwan [4] that:

“[I]t appears clear from some of the leading English insolvency texts that the object of s 127 of the 1986 Act is to prevent shareholders from evading liability as contributories by transferring their shares to a man of straw after winding up has commenced …

…

We do not see any reason why the position in Singapore should be any different from that which obtains in the UK.  The aim of preventing the evasion of liability behind s 127 of the 1986 Act is also what underpins s 259 of our Companies Act …”

Lord Millett sitting in the House of Lords in IRC v Laird Group plc[5] explains the purpose of the equivalent provision in England:

“Any transfer of shares made after the commencement of the winding up is void unless made to or with the sanction of the liquidator: section 88 of the Insolvency Act 1986 [in pari materia with section 232 of the Ordinance] …

It is not difficult to see why the effect of the liquidation in making the shares non-transferable should not be regarded as a transaction relating to the shares. It is because it is only the right to transfer legal title to the shares which is affected; shareholders remain free to deal with the beneficial interest in their shares. The purpose of making the legal title to the shares non-transferable is merely to freeze the company’s register of members at the date of the winding-up so that the liquidator can safely deal with the shareholders whose names appear on the register at that date” (emphasis added).

11.  Despite the above authorities in a number of cases the Hong Kong court has granted validations orders in respect of the issue of news shares and convertible bonds, seemingly having assumed, not having had the relevant authorities brought to the Judge’s attention, that these matters fell within section 182.  In Singasia Holdings Ltd v 劉新生[6],  Au-Yeung J granted a validation order in respect of the issue of new shares.  Her Ladyship reasoned as follows:

“The proposed allotment is to raise funds for the Company to keep it going. The Company intends to use the funds raised for general working capital and for repayment of liabilities. This will be beneficial to the Company and has the effect of preserving and/or enlarging its assets for the general body of creditors.

The proposed allotment is unobjectionable and [the petitioner] does not object to it.  I grant a validation order accordingly.”

In Re China Ocean Industry Group Ltd [7], Au-Yeung J also granted a validation order in respect of the issue of convertible bonds.  Her Ladyship described the transaction as follows:

“Upon the actual issue and subscription of the convertible bonds, the Company would receive gross proceeds of HK$110 million and net proceeds of HK$109 million. It is the intention of the Company to apply the net proceeds towards repayment of debts owed to the group and the balance for general working capital.

The fund raising and re-structuring exercise will generate net cash to reduce indebtedness and is for the benefit of the Company’s creditors.  A validation order should be granted.”

12.  In my view it is clear that in the present case section 182 is not engaged because issuing the New Shares and the CB would not involve any “transfer of shares” or “alteration in the status of the members” of the Company.  Accordingly, the Court has no jurisdiction to validate the issue of the New Shares and the CB.  It follows that the SEHK was mistaken in requiring the Company to obtain a validation order before proceeding with issuing the New Shares and the CB.

Conclusion

13.  The correct course in my view is for the Court to dismiss the summons dated 19 January 2021 (“Summons”) and confirm that the absence of a validation order does not inhibit the Company from proceeding with issuing the New Shares and the CB.  The position is identical to the decision in Sellers; in the matter of Beckley Forge [8] in which Finkelstein J held:

“I am unable to make the [validation] order sought by the administrators of Beckley Forge Pty Ltd (Administrators Appointed) and Beckley Appliance Components Pty Ltd (Administrators Appointed), but not for reasons which would prevent the allotment of the shares to which the proposed order relates.”

14.  I, therefore, will make an order dismissing the Summons with no order as to costs.  I would add that if section 182 had been engaged I would have granted a validation order as plainly raising fresh capital would not prejudice the interests of creditors or contributories.