CHU CHUNG MING AND ANOTHER v. LAM WAI DAN AND OTHERS

HCCW 377/2011

[2022] HKCFI 3609

IN THE HIGH COURT OF THE

HONG KONG SPECIAL ADMINISTRATIVE REGION

COURT OF FIRST INSTANCE

COMPANIES (WINDING-UP) NO. 377 OF 2011

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J U D G M E N T

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1.  This is the ruling of the Court on para 1 of the Petitioners’ summons dated 5 August 2022. Para 1 of the summons reads:

“For purpose of compiling the valuation report pursuant to the Order dated 8^th October, 2015, the Valuer shall not apply any marketability discount when valuing the shares of the 3^rd Respondent.”

2.  In gist, the Petitioners are asking the Court to intervene and overrule the Valuer’s professional opinion in adopting the marketability discount for the purpose of valuation.

3.  The summons is supported by the 12^th affirmation of the 1^st Petitioner Chu Chung Ming (“Chu 12”).

4.  A brief history of the proceedings, for the present purpose, is as follows.

5.  On 22 December 2014, this Court ordered the Respondents to buy out the Petitioners’ 50% interest in the 3^rd Respondent ie the Company in question under the then s 168A of Companies Ordinance, Cap 32.

6.  On 8 October 2015, this Court ordered the appointment of a joint independent professional valuer, being a certified public accountant, to value the fair market price of the Petitioners’ shares in the Company with consequential directions, including inter alia that “there shall not be any minority shareholding discount”. The disallowance of minority shareholding discount in the context of a buy-out Order in relation to a quasi-partnership company is well-established: Re Yung Kee Holdings Ltd unrep, HCCW154 of 2010, Harris J, 31 October 2012 at [165].

7.  Subsequently, the parties have jointly appointed KPMG who issued a revised draft valuation report on 18 November 2021 (“Draft”).

8.  At p 13 of the Draft, KPMG set out the valuation summary of the Company as at 31 March 2015. In this Court’s Order dated 8 October 2015, the date of the valuation should be the date of the Order, which is the prima facie starting point: Re New Century Iatrical Inv Management Ltd [2020] 3 HKLRD 464 at [32]. This aspect of the valuation is not the subject of the present application but, unless the parties consider there is no material difference between the valuations as at the 2 different dates, they or their advisers should consider whether or not to point that out to KPMG before finalizing the Draft.

9.  At p 18 of the Draft, KPMG clearly recognized and followed this Court’s direction that there should be no minority shareholding discount. However, they opined that “when valuing private companies, it is important to take into account a marketability discount to reflect the fact that there is no ready market for them.”

10.  At p 25 of the Draft, KPMG further elaborated on the concept of marketability discount.

11.  Ultimately, KPMG selected a discount of 10% for the lack of marketability of the Petitioners’ equity interest.

12.  The issue of marketability discount has been the subject of discussion in correspondence between the Petitioners and KPMG: see items 55 to 59 of the Agreed Chronology. In an email dated 26 May 2022 from KPMG to the Petitioners’ solicitors, KPMG elaborated on the reasons for adopting the marketability discount in this case. The reasons included (i) the Company being a private one, its shares would not be openly traded and certain time and cost are required to process the transaction; (ii) even when the underlying assets of the Company ie a plot of farmland and a shop, as opposed to the Company’s shares, are being marketed for sale, the same concept applies as if the Company’s shares are being marketed for sale; (iii) since the plot of farmland is not as frequently traded as compared to residential or commercial properties, a discount should also be applied by reason of the lack of marketability of this type of assets.

13.  In Chu 12, Mr Chu has stated his or his adviser’s grounds of opposition to the marketability discount. Regrettably, Chu 12 contains mostly bare assertions, misreading of the Draft and other misstatements.

14.  First, at paras 14 to 17, Mr Chu said:

“14. The practical outcome of the aforesaid judicial resolution of the parties’ disputes is that the Respondents would enjoy the entirety of the Company and its assets.

15. There is no basis to apply a discount to reflect any liquidity issues that the Respondents may face in future should they subsequently elect to sell those shares.

16. To penalize the Petitioners for difficulties the Respondents might face in future when they decide to sell those shares (due to the fact that they are private company shares) is unreasonable and unjustified.

17. I have been advised and I verily believe that the Order ought not be interpreted to have such effect.”

15.  In this court’s view, para 14 is self-evident but is irrelevant to the issue at hand. In every case when there is a buy-out Order under s 168A, the same outcome will result from the execution of the Order. The purpose of the buy-out Order is not to reward the Respondents or to penalize the Petitioners but to provide a fair compensation to the Petitioners for selling their shares in the Company so as to effect a clean break. In this context, the overriding consideration is fairness as between the parties: Re New Century Iatrical Inv Management Ltd at [29] - [30].

16.  Paras 15 to 17 are all bare assertions of the Petitioners’ or their legal adviser and they do not at all follow from para 14. In particular, there is no question that the adoption of the marketability discount being a penalty to the Petitioners - the rationale of it has been stated clearly in the Draft and in the email from KPMG dated 26 May 2022.

17.  Second, at paras 18 to 19, 22 to 24, Mr Chu said:

“18. The Court in the Order directed, inter alia, that a surveyor be appointed to make a valuation of the Land and the Shop of the Company.

19. It is clear that the basis of the valuation of the shares would be premised upon the net value of the underlying assets ie upon an asset-based valuation.

…

22. The net asset value of the Land and Shop owned by the Company was duly determined by the surveyor in a report compiled by them (“the GCA Report”).

23. After taking into account the GCA Report and making adjustments pursuant to the Order to reach a valuation, there is NO basis to apply a discount to REFLECT THE FACT THAT THE SUBJECT SHARES are shares in a private company (as distinguished from shares in a listed company) and hence “there is no ready market” for them…

24. That the subject shares are shareholdings of a private company has always been crystal clear to the parties and to the Court at all material times.”

18.  Para 19 is misleading. While it is clear, and is accepted by the Petitioners, that KPMG has rightly taken into account the value of the Company’s underlying assets, that is not the same as a valuation premised only upon the value of the underlying assets ie the farmland and a shop. Otherwise, there would be no need for KPMG to conduct a valuation - all that the parties need would be the GCA Report.

19.  Para 23 is a bare assertion - the basis of applying the marketability discount has been made clear to the Petitioners. Para 24 is neither here nor there.

20.  Third, at para 25, Mr Chu said:

“25. If a “marketability discount” is applicable (which is not admitted), it would in any event have been off-set by a “control premium”. See page 25 of the Revised Draft Valuation Report.”

21.  That statement is incorrect. In fact, what KPMG actually stated at p 25 of the Draft is that “minority discount”, not “marketability discount”, is a mirror image of control premium which is an amount that a buyer is usually willing to pay over the current market price of a company in order to acquire a controlling share in that company.

22.  Fourth, at paras 27 to 29 and 31, Mr Chu said:

“27. The Valuer recognized at page 27 of the Revised Draft Valuation Report that the studies of marketability discount may not be relevant for our present case. See 3^rd paragraph at the right column under the heading “Implication”.

28. The 5^th paragraph at the right column under the heading “Implication” stated that “The selected discount for lack of marketability of 10% mainly reflect the time and transaction cost required for the shareholders to realise the assets in the market.

29. There is no issue of selling the underlying assets of the Company to third parties in our present case. Applying a discount to “reflect” on any future time and/or transaction cost is unreasonable and unjustified.

…

31. Conveyance of the Land and the Shop of the Company (should the Respondents wish to sell them off in future) ought not be hugely costly or time-consuming. In any event, they do not concern the Petitioners. They are irrelevant for purposes of the valuation under the Order.”

23.  Para 27 is a mis-description of what KPMG stated in the Draft at p 27. What KPMG actually said was that “the above studies of marketability discount may not be relevant in this case.” The above studies were concerned with the differences between the prices of shares prior to IPOs and the actual IPO prices. Of course, the studies may not be relevant to this case which has nothing to do with any proposed IPO of the Company’s shares.

24.  Paras 29 and 31 are just bare assertions.

25.  Lastly, at paras 32 to 35 under the sub-heading “No Discount for non-controlling interest”, Mr Chu said:

“32. The Valuer stated in para 8 at page 15 of the Revised Draft Valuation Report that ‘when valuing non-controlling interests in private companies, it is important to take into account a marketability discount to reflect that there is no ready market for them.’

33. It is also stated in the said para 8 that ‘…a marketability discount, ie discount for lack of control, of 10% is applied on the FMP of 50%...’.

34. The Court is aware that the subject shares constituted 50% of the capital of the Company and hence NOT a controlling interest.

35. Therefore, in light of the above First to Fifth Points and the fact that the Court knew that the subject shares are 50% of the capital of a private company, the Order should be interpreted to mean that NO discount ought to be applied to cover lack of marketability.”

26.  In this court’s view, a fair reading of the Draft as a whole shows that KPMG is keenly aware of this Court’s Order that there should be no minority shareholding discount or discount for non-controlling interest. How that can be translated to mean no discount ought to be applied to cover lack of marketability is wholly unclear.

27.  With respect, the skeleton arguments of the Petitioners are not much better. They are largely a repetition of the grounds stated in Chu 12.

28.  In particular, for the 2^nd Ground set out in the skeleton arguments, this court cannot see how it can undermine the rationale of the marketability discount explained by KPMG and made known to the Petitioners. It is true that the Respondents can elect to sell all 100% of the shares in the Company in future, but the issue here is what was the value of the Petitioners’ 50% shareholding in the Company as at the valuation date.

29.  Para 13 under the 2^nd Ground is just another bare assertion and is contrary to the opinion of KPMG that even when the underlying assets of the Company are being marketed for sale, the same concept applies as if the Company’s shares are being marketed for sale.

30.  As for the 7^th Ground in which Mr Lo simply cites a paragraph from Re Yung Kee Holdings Ltd, the short answer is that the paragraph was dealing with minority discount, not marketability discount, as rightly pointed out by Mr Yuen.

31.  To conclude, this court has directed the parties to jointly appoint a single independent professional valuer to value the fair market price of the Petitioners’ shares in the Company. It is up to KPMG to apply their professional expertise to conduct the valuation. What the present application boils down to is that the Petitioners are dissatisfied with the methodology of KPMG in applying a marketability discount and asks this court to disallow KPMG from doing so. Mr Lo is unable to refer this Court to any authorities which support the present application save for the general principles stated by Kwan VP in Re New Century Iatrical Inv Management Ltd at [29] - [30] which emphasize that the overriding consideration is fairness as between the parties. Given that KPMG is jointly appointed by the parties and they therefore should be taken to accept that the firm have the requisite expertise to conduct the valuation, this court cannot see any unfairness as between the parties in deferring to KPMG’s chosen methodology.

32.  In Chan Luen Yan and Ors v Chan Tin Chai and Ors, unrep, HCCW 211 of 2007, 3 July 2013, Ng J at para 23, this Court laid down the principle governing challenges to the valuation of a single joint valuer as follows:

“…I would hold that, on a matter of opinion (as opposed to fact or law), unless patent errors can be demonstrated on the face of the report, the court should be very slow to intervene with the chosen expert’s determination solely on the ground that one party has subsequently found and engaged another expert who holds a different opinion…”

33.  The opinion referred to in that passage refers to the opinion of the chosen valuer. The principle, which is not disputed by Mr Lo, applies to a case where the challenge is backed up by the opinion of another expert. It should apply a fortiori to the present case where the Petitioners’ challenge is not so backed up. Applying that principle to the present case, this Court cannot find any patent errors on the face of the Draft, and for that reason also, this Court is not minded to grant the present application.

34.  Lastly, at the hearing, Mr Lo submits his main point is that in terms of fairness, KPMG should not apply the marketability discount. For reasons stated above, this Court cannot accept Mr Lo’s submissions.

35.  In the circumstances, this Court is of the view that the present application is unmeritorious and should be dismissed. There shall be an Order that para 1 of the Petitioners’ summons dated 5 August 2022 be dismissed.