FULL WISDOM HOLDINGS LTD. AND OTHERS v. TRAFFIC STREAM INFRASTRUCTURE CO. LTD. AND OTHERS

HCA1939/2002

IN THE HIGH COURT OF THE

HONG KONG SPECIAL ADMINISTRATIVE REGION

COURT OF FIRST INSTANCE

ACTION NO.1939 OF 2002

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REASONS FOR DECISION

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INTRODUCTION

1. There were two applications taken out by the plaintiffs before me on 12 June 2002 : (1) to continue the ex parte interim injunction they obtained from Chu J on 22 May 2002 as varied by Sakhrani J on 31 May 2002 ("the injunction application"); and (2) to add JPMorgan Chase Bank ("the Bank") as the 4th plaintiff. The joinder application was unopposed. I accordingly made an order in terms. On the other hand, the injunction application was contested. After hearing the parties, I allowed the application. I have indicated that I will give my reasons in writing, which I now do.

BACKGROUND

2. The background facts leading to the injunction application may be summarised as follows.

(1) The parties

3. The 1st to 4th defendants are wholly-owned subsidiaries of Traffic Stream (BVI) Infrastructure Limited ("Traffic Stream BVI"), a BVI corporation, which in turn is a subsidiary of Traffic Stream (China) Infrastructure Company Limited ("Traffic Stream China"). Traffic Stream BVI holds interests in certain toll road projects in the Mainland through the defendant companies. The 5th and 6th defendants are directors of each of the defendant companies whereas the 7th defendant was the secretary until the plaintiffs removed him by resolutions dated 14 May 2002. The plaintiffs themselves were appointed as directors of the defendant companies on 3 May 2002.

(2) The Notes, Indenture and Share Mortgage

4. In order to obtain financing for various highway infrastructure projects in the Mainland from financial institutions, Traffic Stream BVI on 6 May 1998 authorised the creation and issue of US$119,000,000.00 worth of 14 1/4% Senior Secured Notes due 2006 ("the Notes") pursuant to an indenture of the same date ("the Indenture"). The indenture sets out the terms on which the Notes were issued, and provides for ongoing liabilities due from Traffic Stream BVI to the various Noteholders, including payment of interest and repayment of principal. The Bank was appointed trustee under the Indenture. The Indenture is governed by New York law and contains a non-exclusive jurisdiction clause in favour of the New York courts. The Notes were placed with various financial institutions and subsequently traded. The parties that stand behind the 1st to 3rd plaintiffs are the current owners of more than 90% of the Notes.

5. As security for the payment and performance by Traffic Stream BVI of its obligations under the Indenture and the Notes, Traffic Steam BVI agreed to grant/charge to the Bank (acting for the holders of the Notes) by way of a first fixed charge or cause to be so granted/charged all of the issues and outstanding capital stock of the defendant companies pursuant to a mortgage of shares dated 6 May 1998 ("the Share Mortgage"). Other security included charges over various accounts which were to be established by the Bank in respect of the Notes and a letter of credit which was to be provided to the Bank pursuant to a separate agreement.

6. Pursuant to the Share Mortgage, Traffic Stream BVI and Traffic Stream China mortgaged and charged the ordinary shares in the defendant companies and the dividends thereon to the Bank, and the 5th and 6th defendants similarly mortgaged and charged the non-voting deferred shares and dividends thereon. The Share Mortgage is governed by Hong Kong law and contains a non-exclusive jurisdiction clause in favour of the Hong Kong courts.

7. The ordinary shares and the non-voting shares were all transferred to the Bank and a Mr Qun Song, an officer of the Bank, at the same time when the Indenture and the Share Mortgage were entered into. New share certificates were issued by the defendant companies in favour of the Bank and Mr Song. However, for reasons unknown, the records kept at the Companies Registry do not reflect such transfers.

(3) Events of default

8. Section 501 of the Indenture provides as follows :

"'Event of Default', wherever used herein, means any one of the following events (whatever the reason for such Event of Default and whether it shall be voluntary or involuntary or be effected by operation of law or pursuant to any judgment, decree or order, any court or any order, rule or regulation or any administrative or governmental body) :

(1) default in the payment of any interest, including Additional Interest, if any, and Additional Amounts, if any, in respect of interest on any Note when it becomes due and payable and continuance of such default for a period of five Business Days; or

(2) default in the payment of the principal of or premium, if any, on any Note when it becomes due and payable at its Stated Maturity, or the failure to redeem Notes in the required principal amounts on any Mandatory Redemption Date; or

(3) ... ...

(4) the failure to deliver to the Trustee the LOC on or before January 6, 1999 as provided in the LOC and Deposit Agreement (unless the Deposit shall have been made on or before January 6, 1999), or the failure to make the Deposit into the Construction Funding Account on or before May 6, 1999 as provided in the LOC and Deposit Agreement (unless as a result of such failure the Trustee shall have the right to draw such amount under the LOC, in which case no Event of Default shall occur unless and until the drawing thereunder shall have been dishonored by the issuer of such LOC), each on the respective terms and conditions set out in the LOC and Deposit Agreement as in effect on the date hereof and the LOC; or

(5) ... ...

(6) any default by the Company or any Subsidiary of the Company in the payment of the principal of or premium, if any, on Indebtedness aggregating US$2 million or more, when the same become due and payable at the final maturity thereof, or Indebtedness of the Company or any Subsidiary of the Company aggregating US$2 million or more shall have been accelerated or otherwise declared due and payable, or required to be prepaid or repurchased (other than by regularly scheduled required prepayment), prior to the Stated Maturity thereof; or

... ..."

9. It is the plaintiffs' case that the following events of default as defined under section 501 had occurred.

10. First, in breach of section 501(4), Traffic Stream BVI failed to deliver a letter of credit for the sum of US$8,058,750.00 to the Bank by 6 January 1999. Second, on 24 March 1999 the holders of more than 25% of the Notes delivered to Traffic Stream BVI a declaration of acceleration pursuant to section 502 of the Indenture. As a result of this notice, the Notes became immediately due and payable. The acceleration notice also demanded, pursuant to section 503 of the Indenture, the immediate repayment in full of the Notes. Despite the acceleration of the Notes and the demand for immediate payment, Traffic Stream BVI has failed to pay any amounts due pursuant to the Notes, contrary to section 501(2) or section 501(6). Third, Traffic Stream BVI has failed to tender the May 1999 interest payment, and any subsequent interest payments, which was required, even in the absence of the acceleration notice, pursuant to the Notes, contrary to section 501(1).

11. Further, Traffic Stream BVI has also failed to provide any reports and financial information, as required by section 1009 of the Indenture for the last two years.

(4) US proceedings

12. On 3 June 1999, the Bank commenced an action in the United States District Court for the Southern District of New York against Traffic Stream BVI. In its Answer filed in that action dated 6 August 1999, Traffic Stream BVI basically admitted the existence of facts which would constitute such events of default but sought to raise a defence of impossibility of performance. In essence, they argued that they were unable to perform the various obligations in question because the central government of the Mainland had changed its policy and as a result, the Chinese partners to the joint ventures failed to make payments to them as agreed. On 31 January 2000, the judge granted summary judgment in favour of the Bank, rejecting the defence of impossibility of performance. On 8 May 1999, the same judge granted a deficiency judgment stating the amount outstanding pursuant to the Notes after the Bank foreclosed on certain funds held by the Bank in certain reserve accounts.

13. Dissatisfied, Traffic Stream BVI appealed to the United States Court of Appeal for the Second Circuit. On 24 May 2001, the Court of Appeal reversed the judgment of the District Court on the sole basis that the District Court did not have subject matter jurisdiction because Traffic Stream BVI's incorporation in BVI had rendered it a "stateless entity". The Court of Appeal in the circumstances did not deal with the substance of the appeal, namely, whether the doctrine of impossibility of performance was available to Traffic Stream BVI.

14. The Bank in turn appealed to the United States Supreme Court. On 10 June 2002, the Supreme Court allowed the appeal, reversed the decision of the Court of Appeal on the jurisdiction point and remitted the case back to the Court of Appeal for determination on the merits.

(5) Appointment of the plaintiffs and the plaintiffs' requests

15. Under clause 6.2 of the Share Mortgage, the Bank is upon an occurrence of event of default entitled to exercise the rights and powers attaching to the ordinary shares and the non-voting deferred shares and otherwise to enforce its security. Thus, on 3 May 2002, the Bank and Mr Song appointed the plaintiffs as directors of the defendant companies. The plaintiffs then sought to inspect the defendant companies' books and records pursuant to their duties as directors on 10 May 2002. The request was however flatly refused by Messrs Chiu & Partners, solicitors then representing the defendant companies by letters dated 11 and 16 May 2002 on the ground that the defendant companies refused to recognise the appointment of the plaintiffs as directors. (Chiu & Partners now act for the 5th to 7th defendants whereas the defendant companies are represented by another law firm.)

16. On 14 May 2002, the plaintiffs by resolution removed the 7th defendant as secretary and asked him to deliver up of various chattels of the defendant companies. That similarly has not been complied with.

(6) Ex parte injunction

17. On 22 May 2002, the 1st to 3rd plaintiffs obtained ex parte from Chu J for an interim injunction in the following terms :

"1. each of the Defendants whether by himself/itself, his/its officers, servants or agents or any of them or otherwise howsoever be restrained from destroying, removing, disposing of, altering or amending (save for the purpose of updating), or permitting to be destroyed, removed, disposed of, altered or amended, any of the property, books and records of any of the 1st to 4th Defendants in their possession, custody, power or control, including but not limited to the property, books, and records specified in the Schedule hereto until after the hearing and determination of the said inter partes summons or further order;

2. each of the Defendants whether by himself/itself, his/its officers, servants or agents or any of them or otherwise howsoever be restrained from :

(a) drawing upon any account of any of the 1st to 4th Defendants maintained with any bank or financial institution wherever situated,

(b) conducting or dealing with any arbitration or litigation proceedings to which any of the 1st to 4th Defendants is party wherever situated,

(c) handling or negotiating or dealing with any joint venture arrangements on behalf of any of the 1st to 4th Defendants wherever situated,

(d) entering into any transaction on behalf of the 1st to 4th Defendants, or

(e) expending or transferring any funds of the 1st to 4th Defendants,

without the prior written consent of the Plaintiffs until after the hearing and determination of the said inter partes summons or further order;

3. each of the Defendants do provide and/or produce to the Plaintiffs such documents as the Plaintiffs may reasonably require in order to enable the Plaintiffs to determine whether or not to consent to the doing by the Defendants or any of them of any such act as is mentioned in paragraph 2 above.

4. Each of the 5th to 7th Defendants whether by himself, his servants or agents or any of them or otherwise howsoever be restrained from using or causing to be used the funds of the 1st to 4th Defendants in relation to the defence of this action by the 5th to 7th Defendants or any of them, until after the hearing and determination of the said inter partes summons or further order;

5. each of the 5th and 6th Defendants do, within 14 days of the making of this order, disclose to the Plaintiffs by affidavit, details of all accounts maintained by each of the 1st to 4th defendants with any bank or financial institution whether in Hong Kong or elsewhere."

18. On 31 May 2002, that is, the return date of the inter parte summons, Sakhrani J varied the order by (1) adding a proviso to paragraph 2(c) in effect enabling the defendants to conduct negotiations in respect of such joint ventures but not to conclude any binding agreement without giving the plaintiffs at least 96 hours notice to their intention to enter into such agreements and at the same time supplying the plaintiffs with a written report of the negotiations; and (2) extending the time in paragraphs 5 and 6. He then adjourned the summons for argument before me on 12 June 2002.

19. At the ex parte hearing and the return date, the Bank was not made a party yet. But apparently, no particular problem arose out of that.

SETTING ASIDE

20. Seeking to set aside the ex parte injunction, the defendants took two main points :

(1) There was a lack of urgency justifying the plaintiffs moving ex parte before Chu J.

(2) The plaintiffs were guilty of material non-disclosure.

They further contended that if Chu J's order as varied was to be set aside, I should not exercise my discretion afresh to grant an interim injunction. I shall deal with these points in turn.

(1) Lack of urgency

21. It is trite that ex parte applications are for cases of real urgency that require prompt and immediate disposal where there has been a true impossibility or undesirability of giving notice of the application. Inordinate delay in taking out the application in some circumstances is fatal : see e.g. Bates v. Lord Hailsham of St. Marylebone & others [1972] 1 WLR 1373.

22. Four reasons had been given in the first affidavit of Mr Hield dated 22 May 2002 to justify urgency before Chu J :

(1) First, he referred to a meeting he had with Mr Wu Jin ("Mr Wu"), a former senior employee of Traffic Stream group of companies on 17 January 2002. Mr Wu made a number of serious allegations against the Traffic Stream group and the 5th defendant. Mr Hield had prepared a note of the meeting and exhibited the same to his affidavit. For reasons which will become apparent in a moment, it is not necessary to set out the allegations in detail.

(2) The failure of Traffic Stream (BV) to provide any financial statements or reports as required by section 1009 of the Indenture. As will be seen in a moment, this also gave rise to a debate whether the plaintiffs were guilty of material non-disclosure.

(3) The failure of the defendant companies and the 5th to 7th defendants as officers thereof to allow the plaintiffs access to the books and records : see paragraph 15 above.

(4) The failure of the defendants to recognise the appointments of the plaintiffs as directors without justification : see also paragraph 15 above.

I will deal with each of the reasons in turn.

23. At the hearing before Chu J, senior counsel for the plaintiffs conceded that the concerns raised by Mr Wu alone did not justify urgency. The concession must be right in view of the fact that the meeting took place four months before the ex parte application and that Mr Wu's allegations, as admitted by Mr Hield, had not been subsequently verified. I do not accept they could justify urgency. I therefore do not propose to set out the defendants' evidence in this regard, including how untrustworthy Mr Wu was, or to address counsel's related submissions any further.

24. It is not in dispute that a report dated 2 March 2002 had been provided by Traffic Stream BVI's financial advisor to the Noteholders ("the Report") for the purpose of discussing settlement the disputes between the parties. The Report contained audited accounts, details of development of joint ventures project, legal and arbitration proceedings, income generated from toll roads. The defendants complained that it was wrong for Mr Hield to say that of Traffic Stream (BV) had failed to provide any financial statements or reports as required by section 1009 of the Indenture. However,, both Mr Tang, SC for the 1st to 4th defendants and Mr Leo for the other defendants readily conceded that the Report was not prepared or submitted pursuant to section 1009 of the Indenture. Accordingly, I do not find any substance in this complaint. But I do not find the breach of section 1009 assisted the plaintiffs. For the breach first arose more than two years ago. Absent any change of circumstances, that continuous breach alone, in my view, does not justify urgency. I will address the question of material non-disclosure arising from the Report in a moment.

25. The third and fourth reasons can be conveniently dealt with together. They boiled down to the defendants' refusal to recognise the appointments of the plaintiffs as directors of the defendant companies on 3 May 2002 and the subsequent exercise of their rights as directors.

26. Mr Tang first submitted that the alleged event of default the plaintiffs relied on took place back in 1999. The Bank was then already alleging that they would be exercising their voting rights including the right to change the directors of the defendant companies. Time and again, the Noteholders have been using the same threat as part of their negotiation tactics. For more than three years, there had been no challenge the right of the 1st to 4th defendants to run their business under the management of the 5th to 7th defendants. He further submitted that pending the resolution of the US proceedings, the issue whether there is any event of default within the meaning of the Indenture and hence the claims of the plaintiffs that they have the right to assume control of the defendant companies remains a matter of serious dispute between the parties. There is no reason why the Hong Kong court should prejudge that issue which is still pending in the American court. Counsel thus asked rhetorically : what is there to justify the plaintiffs suddenly moving for an ex parte injunction as if something urgent has happened? The delay lies in the inaction for the past three years when an ex parte application could have been made at any time.

27. Mr Leo for the 5th to 7th defendants adopted similar submissions.

28. Mr Fok, SC for the plaintiffs submitted that the proper time frame to consider urgency is not the past three years when parties were undoubtedly engaging in negotiations. The plaintiffs are not guilty of any delay in the meantime as the parties were negotiating. In this connection, he relied on Foseco International Limited v. Fordath Limited [1975] FSR 507 and T J Smith & Newphew Ltd v. 3M United Kingdom Plc [1983] RPC 92. In Foseco International Limited v. Fordath Limited, while the parties were engaging in negotiations concerning the subject contract (between 1972 and 1974), the defendant committed certain breach of the contract, for which the plaintiffs moved for an interlocutory injunction. The court granted the injunction, rejecting the argument that the plaintiffs had been guilty of any inexcusable delay so as to disentitle it to interlocutory relief. In T J Smith & Newphew Ltd v. 3M United Kingdom Plc, the patentee learnt of possible infringing act of the defendant in 1981. The parties then had discussions in two meetings, one in September 1981 and the other in February 1982. When the defendants started to commit infringing acts in September 1982, the plaintiffs commenced proceedings and obtained an interlocutory injunction. The English Court of Appeal held that the plaintiff's claim was not bared by any laches since the defendant was aware that the plaintiffs would have to defend their patent position in the February meeting and since then, the defendant had been warned off in other countries and when they started to market their products in Australia, they met with an immediate application for and grant of an interlocutory injunction.

29. Mr Fok contended that urgency arose only when the defendants refused to acknowledge the valid appointment of the 1st to 3rd plaintiffs as directors. He said that it is important to note that the security mechanism whereby the various financial institutions that provided capital to Traffic Stream BVI by subscribing for the Notes was that their trustee, the Bank, took a mortgage of the shares of the underlying infrastructure project companies and could exercise full voting control over those companies in the event of default. The security of the Noteholders is thus less tangible when compared with an ordinary security in the form of cash or charge against listed shares or real property. The ability to exercise voting control over the defendant companies would be vital. It is only by careful management and the exercise of proprietary control over them that the Noteholders may be able to convert their security into a tangible recovery against Traffic Stream BVI's liabilities. The immediate and full recognition of the 1st to 3rd plaintiffs' rights as duly appointed directors is of paramount importance. Without such recognition, the Noteholders are deprived of the benefit of their security.

30. With respect, I agree with Mr Fok entirely. In my judgment, when the Noteholders and the Bank took the view that an event of default occurred under the Indenture, they were quite entitled to exercise their voting power forthwith. The fact that they did not do so does not necessarily mean that they are guilty of an inordinate delay. The parties were then negotiating. On the one hand, the defendants were all along aware of the possibility of the Bank exercising the voting power to appoint new directors. On the other, the Bank was aware of the defendants' position regarding the occurrence of any event of default. It is true that the voting power had not been exercised over the past three years but once it was exercised, the plaintiffs would certainly expect that the appointment of the new directors are recognised by the defendants. If the validity of their appointments was denied, it would immediately put the Noteholders' interests under the security mechanism in jeopardy. In these circumstances, urgency did arise only when the validity of the plaintiffs' appointments was denied.

31. For these reasons, I rule that the plaintiffs were not guilty of any delay and there was mounting urgency justifying the ex parte application before Chu J.

(2) Material non-disclosure

32. It is trite that a party seeking ex parte injunctive relief is under a duty of make full and frank disclosure of all material facts. All matters which the court should have put in the weighing scales are material. The test is not whether the matters not disclosed would, if they had been disclosed, have caused the court to refuse to grant the ex parte injunction : Citibank NA v. Express Ship Management Services Ltd [1987] HKLR 1184. Material non-disclosure alone justifies the discharge of the ex parte order.

33. In this connection, Mr Tang took three points. First, the plaintiffs had failed to disclose to the court the nature of the arbitration proceedings in China and the potential devastating damage that would be caused to the defendant companies if the defendants are hindered in their effort to defend those proceedings. It was clearly known to the plaintiffs that there was a colossal counterclaim made by the Chinese partner which, if left undefended, would result in an award which will be catastrophic to the defendants. Secondly, the plaintiffs had failed to disclose to the court that in fact back in 1999, the Bank had already threatened to exercise their voting rights in the defendant companies and then did not proceed with it. If that had been disclosed to the Chu J, the judge was likely to inquire as to why it had become suddenly "urgent" for the Bank to seek to interfere with the management of the companies at this point and why there had been apparent inaction for more than three years. Thirdly, the plaintiffs were wrong to have informed the court that Traffic Stream BVI had failed to provide financial statements or reports as required by section 1009 of the Indenture. It is now admitted by the plaintiffs that the Report was in fact received on 3 March 2002. Thus, the Report, including the audited financial statements of Traffic Stream BVI, were all known to the plaintiffs.

34. The points that Mr Leo took are similar.

35. In reply, Mr Fok first submitted that the arbitration proceedings had been disclosed in Mr Hield's first affidavit in support of the ex parte application. And according to Mr Hield's third affidavit, the arbitration proceedings have in fact concluded and the parties are simply awaiting an award. At the very most, further submissions might be called for, but this is speculative and a far cry from suggesting that the injunctive relief obtained by the plaintiffs will lead to a catastrophe. In this respect, I agree with Mr Fok.

36. Mr Fok next submitted that the Report was not submitted under section 1009, that it was produced to the Noteholders for settlement discussion purpose and hence privileged and inadmissible, and that the Report was in any event unreliable as it is heavily qualified by the auditors. On the inadmissibility point, Mr Fok relied on Kuang Teng Indsutrial Co. Ltd & another v. Multispark Ltd & others, HCA1143/2000 & 9619/2000 where Chu J observed at p.11D-I that without prejudice negotiations are wholly irrelevant, inadmissible and should not have placed before the court, especially in ex parte applications. Having examined the Report, I again find myself in entire agreement with Mr Fok.

37. In connection with the earlier threats to exercise voting rights, Mr Fok submitted that the fact that the Noteholders had previously given consideration to exercising their voting rights was disclosed in Mr Hield's first affidavit. It was however not exercised for reasons stated in Mr Hield's third affidavit. I do not think it is necessary to set these reasons out. As I have ruled above, urgency only arose after the voting powers had been exercised to appoint the 1st to 3rd plaintiffs as directors, the earlier threats of exercising the voting power was in my view immaterial.

38. Even if I were wrong on any of the three points about material non-disclosure, I am of the view that the omission was innocent. Such failure would not be a bar to reinstating the injunction by exercising my discretion afresh.

WHETHER TO CONTINUE THE INJUNCTION

39. Having disposed of the defendants' contentions to set aside the ex parte injunction, I now turn to consider if the order as varied by Sakhrani J should be continued.

40. The plaintiffs no doubt have established a serious question to be tried regarding their rights. As I understand Mr Tang and Mr Leo, they did not seem to have argued the contrary.

41. On the question of balance, I am satisfied that the balance tilts strongly in favour of granting the injunction. I accept Mr Fok's submissions that the injunction is not to stifle the normal operations of the defendant companies, that it is indeed the common interest of the plaintiffs and the defendants that the defendant companies should continue to operate normally, that the injunction will ensure transparency of the management and give the plaintiffs means to properly monitor the management of the defendant companies. Mr Leo took a point that the 5th defendant as the authorised representative in the joint venture projects may attract personal liability if he is prevented to perform his function because of the injunction. But I do not think he will be so inhibited by the injunction especially with the proviso to paragraph 2(c) in place.

42. It is for the above reasons that I continued the injunction as varied.