MICHEL HAZAN v. HK SINDY FOOTWEARS LTD AND OTHERS

HCMP 1240/2006

IN THE HIGH COURT OF THE

HONG KONG SPECIAL ADMINISTRATIVE REGION

COURT OF FIRST INSTANCE

MISCELLANEOUS PROCEEDINGS NO. 1240 OF 2006

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BETWEEN

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HCA 1337/2006

IN THE HIGH COURT OF THE

HONG KONG SPECIAL ADMINISTRATIVE REGION

COURT OF FIRST INSTANCE

ACTION NO. 1337 OF 2006

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D E C I S I O N

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Applications and proceedings

1.  I am concerned with an application for appointment of interim receivers in 2 proceedings.  The proceedings came before the court in this way.

2.  On 23 June 2006, Michel Hazan (“Mr Hazan”) commenced HCMP No. 1240 of 2006 under section 168A of the Companies Ordinance, Cap. 32 in respect of HK Sindy Footwears Ltd (“Footwears”), seeking an order that his shares in Footwears be bought out by Han Qiong Jane (“Ms Han”).  Mr Hazan and Ms Han each holds 50% shares in Footwears, they are the only directors of this company.  Ms Han is the 2^nd respondent in the proceedings, Footwears is the 1^st respondent, another company called HK Sindy Group Ltd (“Group”) is the 3^rd respondent.

3.  On the same day, Mr Hazan issued a writ in HCA No. 1337 of 2006 endorsed with a general indorsement of claim, the writ action concerns his alleged interest in Group.  He seeks declarations to the effect that he is the beneficial owner of 50% of the issued shares in this company and that the register of members should be rectified accordingly.  He further seeks an account of the income and profits of Group since its incorporation, damages and the appointment of receivers over Group to manage and continue its business.  Ms Han is the 1^st defendant, her brother Han Ming Steven (“Mr Han”) is the 2^nd defendant and Group is the 3^rd defendant.  Ms Han is the registered shareholder of 70% shares of Group, Mr Han is the registered shareholder of the other 30%.  They are the only directors of Group.

4.  On the day the 2 proceedings were commenced, Mr Hazan made an ex parte application to appoint interim receivers for the 2 companies.  The hearing date of 27 June 2006 was given, and his solicitors were directed to give notice of the ex parte application to the other parties.  At the hearing on 27 June 2006, solicitors appeared for the respondents and defendants and informed the court they have instructions to accept service.  I gave directions for Mr Hazan to issue an inter partes summons in each of the proceedings for appointment of interim receivers, with a timetable for evidence to be filed by the parties and adjourned the summonses for argument.  Evidence in opposition and in reply have been filed.

The background

5.  I will relate briefly the background sufficient for an understanding of this decision.

6.  Mr Hazan is an Israeli citizen and a designer of shoes.  He went to do business in the PRC in 2001.  Ms Han and Mr Han are PRC nationals.  Their native place is in Sichuan, but they have been working and living in Guangzhou at all material times.

7.  Mr Hazan has cohabited with Ms Han in Guangzhou since 2002, until they broke up in May or June 2006.

8.  He claims at the time he became personally involved with Ms Han in about April 2002, she suggested and he agreed they should go into the shoe business together, making use of an entity already set up by her known as HK Sindy.  Each was to have an equal interest in the business, they would share profits and bear costs and losses on that basis.  The business they would carry out was for the design and manufacture of the shoes for distribution in the PRC and overseas.  Mr Hazan was to develop designs for new collections, oversee quality control in factories, take care of existing customers (mainly Israeli at that time), and to attend international shoe fairs to solicit new clients.  Ms Han would be responsible for general management, administration matters, financial issues and contracting with local factories.

9.  Mr Hazan claims because of his intimate relationship with Ms Han, he did not insist on the terms of their business joint venture to be put in writing.  Besides, his interest was in the creative and sales side, he relied on Ms Han entirely to attend to administrative and management matters.  He knew that more than one company bearing the name of HK Sindy was set up, but was told by Ms Han this was done for tax reasons.  Ms Han also told him it would be better for him not to be officially named in company documents for his protection, so he could leave the country if there should be any problem with tax authorities.  Mr Hazan did not pay much attention to the names of the companies.  The name of Group was suggested by him when Ms Han sought his opinion on the choice of names for a new company.  He did not know he had no shareholding in Group until about April 2006, he did not know he had no access to the bank accounts of Group until then.  The only company in which Mr Hazan was registered as a shareholder, Footwears, was incorporated only on 15 March 2004, whereas Group was incorporated on 15 September 2003, another company HK Sindy (International) Trading Ltd (“International”; this has since been dissolved) was incorporated on 30 January 2002.

10.  As far as Mr Hazan was concerned, he had conducted himself all along on the express understanding that he owned 50% interest of the business operations with Ms Han as an equal partner.  Thus, when he joined HK Sindy, he shared with Ms Han the details of his contacts with Israeli clients, he took responsibility in overseeing the production of orders of HK Sindy’s existing Italian client, he contributed to outgoings of business on an equal basis and his contribution was deducted from his share of profits, profits were distributed to him for the years of 2002 onwards on what he thought was an equal basis, he was given internal accounts of the business although the accounts did not bear the name of any company, he had arranged for an accountant to attend offices of the business in Guangzhou to carry out an audit, and he was regarded by staff and customers as a boss of the business.

11.  Mr Hazan alleges that the affairs of Footwears were conducted in a manner unfairly prejudicial to him: there was no annual general meeting or directors’ meeting; he was not given any accurate information concerning the financial position of the business operations; he has now been excluded from management and operations of the business; there is deadlock in the management; payments have been made to parties who do not appear to be entitled to the monies; profits from the business would appear to have been dissipated, transferred or diverted with no proper explanation; and customers had been told their orders should be placed with Group instead of Footwears.

12.  As for the affairs of Group, Ms Han has insisted that Mr Hazan has no interest at all in this company, so he is not entitled to any information.

13.  Ms Han denies that there was any agreement with Mr Hazan in 2002 to enter into business together on the basis that each was to own 50% interest.  In 2000, she already had an established shoe business in Guangzhou serving customers in Italy, South Africa and Russia with the turnover of RMB 8 million.  In January 2002, she incorporated International in Hong Kong and gave 30% shares to Mr Han.  By 2002, the turnover of her business was over RMB 10 million.  She persuaded Mr Hazan to work for her company as a shoe designer in 2002.  His status was just an employee.  He was entitled to be paid a salary and bonus.  That was the only agreement they ever had.

14.  After they had lived together, there were serious conflicts between Mr Hazan and Mr Han.  To appease Mr Han, Ms Han incorporated another company, Group, in September 2003 and gave 30% shares to her brother.  She alleges Mr Hazan knew about this.  Mr Hazan was very upset and this time to appease him, Ms Han incorporated a third company, Footwears, in March 2004, and gave him 50% of the shares.  Mr Hazan at all times knew the existence of the 3 companies and that he only has an interest in one of them.

15.  Ms Han alleges that Mr Hazan was not content with a 50% interest in Footwears and sought a half share in Group as well.  To achieve this purpose, he had lured her with a promise of marriage.  She even agreed, at his request, to change the mandate of her personal bank account in Hong Kong to the joint names of herself and Mr Hazan in May 2006. She later discovered this was all a trick and claims Mr Hazan has left her for another woman.  She also discovered in July 2006 that Mr Hazan intended to set up a competing business with a sub-contractor of Group called Hongmin Shoe Trading Ltd (“Hongmin”).

16.  Mr Hazan denies there was any proposal of marriage or that he has an affair with another woman.

17.  Both Footwears and Group would appear to be solvent.  Group, according to Ms Han, is doing very profitable business.  However, no financial statements of either company, professionally prepared and audited, have been placed before the court.

The case for appointment of interim receivers

18.  It was submitted by Mr Sheppard on behalf of Mr Hazan there is clearly a need for interim receivers in this situation.  Interim receivers are needed to identify, collect and preserve the assets of Footwears and Group and protect the goodwill pending the resolution of disputes which may take some time.  He referred to the dicta of Harman J in Re A Company (No. 00596 of 1986)[1987] BCLC 133 at 135g to 136e on the propriety of appointing interim receivers in the context of a company with equal shareholding, in which the concept of mutual trust and confidence would apply:

“In a partnership dispute it is almost as of course for the court, where the partners have fallen out and there has to be a dissolution, to order the appointment of a receiver, on motion, at an early stage of the partnership action.  That is done to hold the ring, to ensure that the partner or partners who happen to be in possession of the partnership trading assets do not obtain advantage, nor damage the partnership assets to the harm of the dissenting partner, nor siphon them away or otherwise maltreat the partnership affairs.  It is done without any judgment of the rights or wrongs in the partnership action or any attempt to take a view as to why the partnership has broken up.  It is simply designed to hold the ring and ensure that the status quo of the assets is preserved, that the value of the business is there, so that the whole thing may best be realised for the advantage of all partners in due course.  That is particularly the case where there is a business with a going concern and a good-will.

That analogy seems to me to have considerable, though by no means total, aptness to this case and indeed to almost all cases of private companies formed on the basis of quasi-partnership between two sides both having substantial shares in the equity and having come together with a view to all being involved in the trading of the company.  The analogy cannot be perfect because a company is a separate legal creature for which statutory remedies of winding-up petitions, petitions under ss 459 to 461 of the Companies Act 1985 and so forth are provided; and the dissolution of the company does not automatically follow on a falling-out of the corporators as the dissolution of a partnership, certainly at will, would inevitably follow on the falling-out of partners.  Thus the analogy is not perfect. Yet, in my view, it provides a correct and desirable base from which to approach the whole matter.

The reasons which apply to cause the court almost as of course to appoint a receiver in a partnership dispute have considerable similarities to, and are in my judgment properly applicable as guides to the court in a company of this sort.  A decision which I myself made (and which I cited in the motion by the petitioner to have a receiver appointed under her debenture) was the decision, again in a case called Re a company [1985] BCLC 80, to the effect that while a section 75 of the old Act (ss 459 to 461 of the 1985 Act) petition proceeded it was of great importance to preserve the status quo, to hold the ring, to ensure that the assets remained undiluted, undiverted and properly administered; so that, if the court came to the conclusion, as it frequently does, or if the parties reached a sensible decision that one should buy out the other as a matter of compromise, the assets would be capable of specific valuation in much the same state as they had been before the breakdown had taken place.”

19.  Mr Sheppard submitted this is a classical situation for the appointment of interim receivers.  Here, there is jeopardy to assets of the business of Footwears, the ownership issues of the shareholding in Group would need to be resolved, there are serious dissensions between Mr Hazan and the Hans and difficulty in managing Footwears pending the resolution of the dissensions and the deadlock of the board, Mr Hazan has been ousted from the business operations, he has total loss of confidence in the integrity of those running the businesses, there was misapplication of assets of Footwears by Ms Han for the benefit of herself, her family and friends.  Interim receivers are needed to preserve and protect assets, and to investigate the position, otherwise it would not be possible to reconstitute the affairs of the companies given the passage of time.  There are already enormous inconsistencies in the evidence of the parties as to what had happened in the last few months.

20.  The principles for the exercise of this discretionary remedy are not in dispute.  They are to be exercised on the same principles as those on which interlocutory injunctions are to be granted (Re Niceline Co Ltd [2003] 2 HKLRD 736I to 738D).

The case against the appointment of interim receivers

21.  Mr Yuen, SC, submitted for the respondents and the defendants that there are a number of reasons why an appointment should not be made.  They are as follows:

(1) in the writ action, there is a sharp dispute between Mr Hazan and the Hans whether the former has any interest in Group at all;

(2) there is no serious question to be tried in the writ action, alternatively there is clear evidence the case of the Hans has better prospects of success than Mr Hazan’s case;

(3) in the writ action, it is unlikely that Mr Hazan can obtain relief in the declarations sought that he is beneficially entitled to 50% of the issued shares in Group and that the share register be rectified, at best he can only obtain monetary compensation.  Monetary compensation would be an adequate remedy and there is no suggestion Ms Han cannot pay;

(4) in the petition proceedings, a buy-out order is the only relief sought and Ms Han has indicated willingness to buy out Mr Hazan’s shares if the court finds unfairly prejudicial conduct;

(5) there is no risk of dissipation of assets;

(6) there would be adverse impact on the businesses;

(7) there is no undertaking as to damages and no fortification of undertaking as to damages;

(8) there is misconduct on the part of Mr Hazan; and

(9) there is an alternative protective regime in the undertakings offered by the Hans.

I will consider each of these objections in the order set out above.

Dispute as to ownership of the shares

22.  As I understand Mr Yuen, he is not saying that the dispute of ownership in the shares of Group will in itself bar the court from appointing a receiver.  Nevertheless, a dispute of this kind is a relevant factor to be taken into account, citing Floydd v Cheney [1970] 1 Ch 602 at 610A to E, per Megarry J in which he endorsed the dicta of Long Innes J in Tate v Barry (1928) 28 SR(NSW) 380 at 387:

“that there is no such rule of practice is now suggested, and that the denial of an alleged partnership is merely one of the factors to be taken into consideration in each case, and does not, of itself, debar the court from appointing a receiver until that issue is determined; but it may well be that where the partnership is denied, the court, having regard to the serious consequences entailed by the appointment of a receiver, will be reluctant to appoint a receiver in a case where such appointment would inflict irreparable injury upon a defendant who might succeed at the hearing, or where adequate protection can be otherwise afforded to the plaintiff.”

23.  In Floydd, Megarry J came to the view on the facts of that case that no prima facie case was made out for the existence of a partnership, nor was there a real case of jeopardy of assets.

24.  I do not think the effect of an order for appointing interim receivers would be to establish the right in dispute, as Mr Yuen has apparently contended.  The purpose of interim receivers is to preserve and protect the value of the shares in Group until such time that the dispute of ownership has been resolved.  An example where an appointment of interim receivers was made for this purpose, notwithstanding the beneficial title to the shares in question was in dispute, is Mandarin Resources Corporation Ltd v David Cheng Heng Soon & Others, CACV No. 146 of 1987, 28 April 1988, paragraph 21.

If there is a serious question to be tried in the writ action

25.  Mr Yuen submitted the court should take into account the strength of the case of the Hans on the available evidence.  He contended there are patent absurdities in Mr Hazan’s case.

26.  I do not propose to recite the arguments advanced in paragraphs 15 to 23 of the written submission of Mr Yuen.  Suffice it to say that the evidence is not one way as he has contended.  There are also holes in Ms Han’s affirmation: no mention was made what were the terms of the alleged employment of Mr Hazan in 2002; no explanation was offered how the business and clientele were to be divided among the 2 companies she formed, first to appease Mr Han and later to appease Mr Hazan; there is no apparent basis or documentary support for her contention that Mr Hazan knew when Group was incorporated he was to have no interest in it; there was no attempt on her part to come up with any documentary evidence, notwithstanding she is in control of the companies and should have available documents, to rebut the allegations of misappropriation of funds, if the allegations were wrongly made.

27.  I reject the submission there is no serious question to be tried in the writ action.  I find to the contrary.

If monetary compensation is a sufficient remedy in the writ action

28.  I propose to deal with this point shortly because I do not think there is substance in it.  I have reservations if Mr Yuen is correct that the court would most likely decline to make the declarations sought that Mr Hazan has a beneficial interest in Group and order the share register to be rectified, if Mr Hazan’s allegations were found to be proven at the end of the day.

29.  I assume for the sake of argument that the court would not grant these declarations and orders, and that Mr Hazan would only be granted monetary compensation.  This does not follow at all that that would in itself be a sufficient remedy.  The purpose of the interim receivers is to protect and preserve assets pending the resolution of the disputes.  If books were not properly kept, transactions not properly recorded, assets have been transferred or dissipated before the action is heard, any damages awarded at the end of the day would be difficult to assess and may well not be an adequate remedy.  There is no evidence, one way or other, if Ms Han would be in a position to pay substantial damages, by the time any award would come to be made.

If a buy-out order in the petition proceedings is a sufficient remedy

30.  Mr Yuen made a similar point as regards the buy-out relief sought in the petition concerning Footwears.  The dicta of Harman J quoted earlier would be the answer to this objection.  The present situation is very different from the cases relied on by Mr Yuen in which the courts were concerned with syndicates, a listed company, and joint venture companies in which the other parties were substantial listed companies.  Further, as submitted by Mr Sheppard, a proper basis of valuation of shares was possible in the cases cited.  That may not be the situation here.

If there is a risk of dissipation of assets

31.  It was submitted by Mr Yuen that there was just a bare allegation of Mr Hazan of a risk of dissipation of assets.  I do not agree with this.  Mr Hazan is denied access to the documents, save what records he has been able to obtain before he left.

32.  There is never any clear demarcation of the businesses of the 2 companies set up by Ms Han for the purpose of appeasing her brother and Mr Hazan.  Ms Han is long on denials and assertions and short on backing up what she has deposed to with records of the 2 companies which should be available, if records were indeed kept.

33.  Mr Yuen contended there was the absence of incidents of withdrawals unrelated to business.  I do not think that is correct.  Mr Hazan has produced a schedule from the company records showing transfers from the accounts of Footwears at HSBC.  Of these transfers, US$135,000 was transferred to Ms Han and US$156,000 was transferred to her aunt, Ms Liu Bi Hua.  Ms Han has only managed to produce documents showing disbursements incurred for the company of less than US$3,000.  Up to today, no proper accounts were prepared and disclosed to Mr Hazan of Footwears, of which he is a shareholder and director.  The so-called internal accounting documents he was provided with are not adequate or up-to-date.  There is no proper explanation of the movement of funds in the bank accounts of Footwears, or why customers were asked not to place their orders with Footwears, but with Group.

34.  As mentioned earlier, Ms Han has refused to disclose any information regarding the financial position of Group, whether its financial statements or bank statements.

35.  I find there is a case of risk of dissipation of assets of Footwears and Group.

Adverse impact on the businesses

36.  I bear in mind the adverse impact the appointment of interim receivers might have on the businesses.  This is a factor I should take into account in the exercise of my discretion.

37.  In the present case, both Mr Hazan and Ms Han have informed all the customers or all the important ones of the possibility of the appointment of interim receivers.  Ms Han has exhibited the letters she received.  The reaction of the customers would seem to be similar, even down to the words they used.  Be that as it may, I note that their primary concern is the shipment of the orders they placed, due for delivery in August 2006.  The next concern is that receivers are strangers to this kind of business, they would not be familiar with the production procedures of factories in China and business may suffer in future.  Hence, they all pray that Ms Han should be kept in full control of the businesses.

38.  If these are the concerns of the customers, there is no reason why the concerns could not be allayed.  The independent professionals appointed as interim receivers will not do anything that would jeopardize the fulfillment of the existing orders, indeed they have a positive duty to see to it that orders are fulfilled within time.  As for the existing management, the key personnel, and that must apply to Ms Han, are unlikely to be replaced, if they are important to the success and smooth operation of the businesses.  I reiterate the function of the interim receivers is to protect and preserve assets, pending the resolution of the disputes.  They are there to assist and to ensure that the businesses are run properly.

39.  As for the expenses of appointing receivers, that would be borne out of the assets of the companies in the first instance and they are subject to the approval of the court.  It does not appear to me in this situation the expenses would have a crippling effect on the businesses or would be wholly disproportionate.

Undertaking as to damages and fortification of the undertaking

40.  I accept that an undertaking as to damages is an essential condition to the appointment of interim receivers (National Australia Bank Ltd v Bond Brewing Holdings Ltd (1990) 1 ACSR 445 at 486 and (1990) 1 ACSR 722 at 724 to 725).  Mr Hazan is prepared to give an undertaking in these terms in the draft order submitted to the court:

“(i)    to be answerable to the court for that property the receivers (hereinafter appointed) shall receive in the proper performance of their duties or become properly liable to pay in the proper performance of their duties and which the assets of the company (as defined) are insufficient to meet;

(ii)     to obey any order which this court may make as to damages, if it should consider that the 1^st respondent shall have sustained any by reason of this order and which the petitioner ought to pay;”

41.  I would accept the terms of the proposed undertakings.  As for the question of fortifying the undertaking as to damages, Mr Sheppard informed the court that Mr Hazan is prepared to offer fortification in this manner.  Firstly, there is due to him from the company or companies US$200,000 being the balance of what Mr Hazan should receive as his share of profits for the latest season. Mr Hazan is content for that to remain with the company or companies pending the resolution of the disputes as a form of security for his undertaking as to damages.  Secondly, he has undertaken to provide within 7 days a banker’s guarantee for an additional US$200,000.

42.  Mr Yuen submitted that notwithstanding the fortification now offered by Mr Hazan, the amount is inadequate.  Ms Han has stated in her affirmation that an appropriate amount for security should be RMB 45 million.  Mr Yuen has not gone as far as that.  I understand Ms Han’s figure is on the basis that Group makes a profit of about RMB 15 million a year.  I am not prepared to order fortification to be provided on this projected basis, when Ms Han has not seen fit to produce proper accounts relating to the businesses she operates.  Besides, it is the wrong basis.  It is unlikely, if interim receivers are wrongly appointed, the companies would suffer losses to the extent that their profitability is reduced to nil.

43.  The court has to make an estimate of a likely amount of the loss which may be suffered if the order for appointment of interim receivers should be wrongly made.  I think a more reliable guide is the amount of profits received by Mr Hazan.  In 2002, the amount he received was US$185,000; in 2003, the amount was US$350,000 (of which US$60,000 was set aside for the operations of businesses); for the latest season, the amount was US$450,000 (of which he received only US$250,000) and as mentioned earlier, he is owed US$200,000.

44.  These figures are not refuted by Ms Han, nor has she put forward any explanation how they were arrived at.  In addition to the fortification offered by Mr Hazan, I note that he is a 50% owner of the shares in Footwears.  In my view, the fortification offered by him would provide reasonable security for his undertaking as to damages in the event that the orders for appointment are wrongly made.  If there should be any material change in circumstances, there is no obstacle to the respondents or defendants to apply to court for further fortification to be provided by Mr Hazan.

The alleged misconduct of Mr Hazan

45.  Next, Mr Yuen submitted that Mr Hazan is in the course of forming a joint venture with Hongmin and has taken steps of incorporating a new company and has engaged lawyers to draw up a shareholder’s agreement.  This move was taken after Mr Hazan was ousted from management and has ceased to be actively involved in the business of Footwears or Group.  I am unable to see how that could be regarded as misconduct to disentitle Mr Hazan from relief.

If there is an adequate alternative protective regime

46.  Lastly, the Hans offered an undertaking to the court and this they say would be sufficient to protect Mr Hazan’s interest pending trial.  The undertaking is in these terms:

(a)     to keep proper books and accounts of Group and Footwears; and

(b)    not to dispose of the companies’ funds and assets otherwise than in the ordinary course of business without giving advance notice to Mr Hazan, say 7 days.

47.  I do not think the undertakings are sufficient.  Next to nothing is known about the financial position of Group.  Even if there is an undertaking to keep proper books and accounts in future, nothing is known of the transactions in the past, if proper records have been kept.  The affairs of both companies require investigation, that should be carried out without delay.  The transfers of monies from the accounts of Footwears have remained largely unexplained.  There is no apparent demarcation of the business operations or assets of the 2 companies.  Interim receivers should look into all these matters.  I consider more comprehensive powers are needed for the protection and preservation of assets.

48.  Mr Yuen has said everything that can be said.  I am not persuaded that there is any valid objection to the appointment.  I am satisfied the balance of convenience lies in favour of appointing interim receivers.

49.  I would grant the relief sought.  I will hear the parties on the terms of the appointment and on costs.