FUNG KEI MAN v. IP WAI HUNG AND OTHERS

HCCW 1080 OF 2000

IN THE HIGH COURT OF THE

HONG KONG SPECIAL ADMINISTRATIVE REGION

COURT OF FIRST INSTANCE

COMPANIES (WINDING-UP) NO. 1080 OF 2000

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JUDGMENT

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1. This is a petition for what is commonly known as a "buy-out" order of the Petitioner's shares in Technology Innovation International Ltd ("the Company") on the ground of unfair prejudice under s.168A Companies Ordinance. Although the Petition also sought alternative relief for an order that the Company be wound up on the just and equitable ground, counsel for the Petitioner indicated at the hearing that the primary relief sought was for the purchase of the Petitioner's shares.

Background Facts

2. The background facts are as follows. The Petitioner, the 1st Respondent and the 2nd Respondent are engineers. The 3rd Respondent is the 1st Respondent's wife.

3. The 1st Respondent started working in the 1980's and had a successful career in the electronics industry. By 1992, he had become the Research and Development manager of a company called STD Electronic International Ltd, at which the Petitioner was his subordinate. The 2nd Respondent was an engineer in another company within the STD group.

4. In 1994, the 1st Respondent left STD to join a company called Radica. The Petitioner and the 2nd Respondent joined Radica to continue to work with him.

5. In 1995, the 1st Respondent became a minority shareholder in a company called Eternal Tech Industrial Ltd ("Eternal Tech"). The Petitioner and the 2nd Respondent then left Radica to work in Eternal Tech as its employees.

6. As a result of a disagreement with the majority shareholder of Eternal Tech, the 1st Respondent made plans to start his own company. It is common ground that he invited the Petitioner and the 2nd Respondent to join him.

Incorporation of the Company

7. The 1st Respondent put in train the incorporation of the Company in late 1997. The capital investment was to be $3m. The 1st Respondent invited the Petitioner and the 2nd Respondent to invest $300,000 each, but no commitment was given by either of them.

Allotment of shares

8. Despite that, the 1st Respondent arranged for the allotment of shares in the Company on the basis that the Petitioner and the 2nd Respondent would each hold 10% of the shares. The manner in which the Petitioner was to hold his shares is one of the issues in the present case.

9. Apparently because the Petitioner, the 1st Respondent and the 2nd Respondent had restraint of trade clauses in their contracts with Eternal Tech, their respective shares in the Company were allotted to their respective mothers. However nothing in substance turns on this, because it is common ground that the three mothers were just nominees for the three men.

10. The shares in the Company were thus allotted as to 80% in the name of the 1st Respondent's mother, 10% in the name of the Petitioner's mother and 10% in the name of the 2nd Respondent's mother.

Petitioner's position

11. On 9 April 1998, the Petitioner filled in an Employment Application Form of the Company for the post of Electronic Engineering Manager. In that Form, he filled in 10 April 1998 as the date from which he was available to start working and it is not disputed that he started working in the Company soon thereafter. The 2nd Respondent, on the other hand, did not start working full-time for the Company until July 1999.

12. The directors of the Company were initially the three mothers, joined by the Petitioner, the 1st Respondent and the 3rd Respondent in April 1998. The 2nd Respondent became a director in December 1999, when the three mothers resigned as directors and their shares were transferred to their respective sons.

Running of Company

13. The Company was supported financially by only the 1st Respondent who gave a second legal charge over his residential property. He and his wife also signed guarantees for the Company's liabilities to its bankers.

14. The 1st Respondent was responsible for marketing, management and administration. The Petitioner headed the electronics engineering department and the 2nd Respondent headed the mechanical engineering department.

15. By the end of the financial year 1999, the Company had a retained profit of $680,470. It is not disputed that the 1st Respondent suggested to the Petitioner and the 2nd Respondent that no dividends should be declared for that year, and there was no objection to that suggestion.

Change in relationship

16. According to the Petitioner, and this was not seriously disputed, the three men worked "as with one heart" when the Company was first formed. However, he said, the relationship between himself and the 1st Respondent began to sour in November 1999. He alleged that when the Company was first set up, the 1st Respondent had consulted him on his department's personnel matters and on the technical viability of proposed contracts, but by the end of 1999, he was no longer consulted.

17. In May 2000, the Company was involved in a job for Dreamcast. Part of the project was undertaken by a Korean company. As head of the electronics engineering department, the Petitioner was involved in the project, including travelling to Korea to oversee the Korean work. The job was defectively done, and resulted in the Company having to pay compensation to Dreamcast. Although the 1st Respondent said in Court that he did not blame the Petitioner for this, as it was he who had put the Petitioner in charge, the Petitioner said he felt that the 1st Respondent began to by-pass him to liaise directly with his subordinates, and this caused resentment.

Resignation

18. In any event, it is common ground that on 30 June 2000, the Petitioner handed in a resignation letter to the Company. In this letter, the Petitioner said he regretted to inform the 1st Respondent that he would like to resign from the position of Electronics Engineering Director with effect from 1 August 2000. He went on to say "may I take this opportunity to thank you for your support and co-operation rendered to me in the past few years. I sincerely wish you prosperous business stepping into the new century".

Shareholding

19. On 25 July 2000, the Company instructed solicitors to write to the Petitioner requesting him to resign as a director with immediate effect and to sign transfer documents for his shares, on the grounds that the shares had been allotted to his mother upon the agreement that they were to recognize the Petitioner's contribution to the Company and should be re-purchased by the Company or transferred to any person nominated by the Company at par value in the event of termination of his employment.

20. On 1 August 2000, the Petitioner's solicitors replied denying that any agreement had been made in respect of the shares and alleging that payment for the shares had been waived in consideration of his mother's contribution to the Company. There was a further allegation that the conduct of the Company's affairs and management by the majority shareholders had been oppressive and prejudicial to the Petitioner's interest as a minority shareholder.

Petition

21. This was followed in November 2000 by the Petition. In it, the Petitioner alleged that the affairs of the Company were being conducted in a manner which was unfairly prejudicial to the interests of some part of the members including the Petitioner, in that since in or about November 1999, he was excluded from the management of the Company in that:-

(a) he had not been consulted about management of the Company;

(b) he had not been provided with the Company's audited accounts;

(c) the 1st Respondent had asked him to resign as a director of the Company;

(d) no dividend had been declared, whereas the 1st - 3rd Respondents had received remuneration.

22. It would be noted that the letter in July 2000 alleging the Petitioner's agreement to transfer shares on the termination of his employment with the Company is not part of the Petitioner's case.

23. However, it is the 1st - 3rd Respondents' case (apart from denying unfair prejudice) that there was such an agreement, the effect of which is that the Petitioner was not entitled to the shares any further, and thus has no locus standi to present this petition.

Issues

24. Therefore the issues that the Court has to decide are:

(1) was there an agreement that the Petitioner would transfer his shares to the Company or the 1st Respondent when he ceased to work for the Company?

(2) if there was no such agreement, was there unfair prejudice by:-

(a) failing to consult the Petitioner;

(b) failing to supply him with accounts;

(c) forcing him to resign;

(d) not paying a dividend?

No agreement to transfer shares on termination of employment

25. I shall deal with each issue in turn. On the issue of whether there had been an agreement that the Petitioner would dispose of his shares when he ceased to work for the Company, I find that there had been no express agreement, and that conditions do not exist for any such agreement to be implied.

26. In so deciding, I have taken into account the evidence given by the Petitioner, and the 1st and 2nd Respondents. However, I found the evidence far too vague and uncertain to establish any such agreement.

27. In correspondence before the Petition, it was alleged on behalf of the Respondents that the Petitioner had agreed to transfer his shares back to the Company if the Petitioner left the Company. However in the 1st Respondent's affirmation, he alleged that the agreement was that the shares were to be transferred, not to the Company, but to himself.

28. There is of course a difference in the two allegations because, the 2nd Respondent being a shareholder, the Company is not the 1st Respondent's sole domain. The difference is not merely hypothetical because it would have an effect on what the Company should do with any dividends payable on those shares, which amount to 10% of the Company's issued share capital.

29. The above inconsistency in the Respondents' allegations highlights the uncertain nature of the alleged agreement to transfer the shares.

30. Further, there was uncertainty in the 1st Respondent's evidence as to who was the beneficial owner of the shares during the period when the Petitioner was working for the Company.

31. If the shares were only to be transferred when the Petitioner ceased to work for the Company, that would mean that the shares nevertheless belonged to the Petitioner beneficially during the time when he was working for the Company. However, the 1st Respondent said in evidence that the Petitioner was in effect, merely his trustee, because he said dividends should in principle go to himself (the 1st Respondent) but depending on the Petitioner's performance, he (the 1st Respondent) would decide whether to give the Petitioner the dividends, similar to staff bonuses.

32. Again, the above uncertainty as to the nature of the alleged agreement shows that it had not been properly thought out.

33. Further, it is important to note that, even according to the 1st Respondent's evidence, the shares were in fact allotted to the Petitioner's mother before the alleged agreement. I find it highly unlikely that the 1st Respondent would have arranged matters in this way. Once the shares were allotted, if the Petitioner had refused to go along with the alleged agreement asked of him, the 1st Respondent would have had to "unscramble" the allotment, leading to unnecessary waste of time and expense at a time when the 1st Respondent was keen to set up the Company.

34. Moreover, if there had been any express agreement as alleged by the 1st Respondent, one would have expected the 1st Respondent, an experienced administrator who had just had an unpleasant experience with his co-shareholder at Eternal Tech and who would have been sensitive to the risk that relationships between co-shareholders might deteriorate, to have made a written record of it. None was made.

35. Neither the Petitioner's mother (nor later, the Petitioner) was asked to sign any transfer forms for the shares in escrow, nor were any similar devices used, which would have been consistent with such an agreement.

36. I find that the 1st Respondent caused shares to be allotted to the Petitioner, without condition, because the 1st Respondent was anxious to secure his services.

37. Of the 8-10 people who moved from Eternal Tech to the Company, shares were allotted only to the Petitioner and the 2nd Respondent. The two of them were obviously highly-valued individuals whom the 1st Respondent was particularly keen to entice to the new Company.

38. The 1st Respondent caused shares to be allotted to them (in the names of their respective mothers), even before they left Eternal Tech, and even before they decided whether to make a capital investment, so as to encourage them to join the Company and to identify with it.

39. Eternal Tech had given the Petitioner regular increments and a substantial raise in salary to $36,000 p.m. The starting salary at the Company was lower. In the 1st Respondent's own words, the reason why he caused shares to be allotted to the Petitioner was to instill in him a "sense of belonging" in the Company. That may well have been so, but that is not equivalent to evidence that there was an agreement, binding in law upon the Petitioner, that he would have to transfer the shares at par (whether to the Company or to the 1st Respondent) if he ceased to work for the Company. Nor can I see any conditions for any implied agreement, and that has not in any event been suggested by the 1st - 3rd Respondents.

40. The facts that the Petitioner had to fill out application forms for employment, or had to apply for leave, or that he filled out his revenue returns as an employee do not detract from my finding that there had been no agreement that he held the shares beneficially. Those facts merely showed that for certain work-related purposes, the Petitioner was an employee of the Company. Employment by a company is not necessarily inconsistent with a beneficial shareholding in it.

41. As for the 2nd Respondent's evidence, he did not suggest that he had been present on any occasion at which the 1st Respondent and the Petitioner discussed the alleged agreement.

42. As for himself, he said that the 1st Respondent had such an agreement with him, but even so, the evidence was uncertain. In his oral evidence he said the 1st Respondent had told him that he (the 1st Respondent) would give him the shares "as a gift", although he later added that in Chinese, "gift" meant that when he left the Company, he would have to return the shares to the 1st Respondent. I find that evidence difficult to reconcile.

43. Once a gift is made, it is no longer open to the donor to retrieve it when property had passed. It matters not that he had set up the Company, or had financed it, or had paid the subscription price for the shares, or had caused the Company to waive it. Here, the 1st Respondent had caused the shares to be allotted (through the mothers) to the Petitioner and the 2nd Respondent, and he intended them to have the shares for themselves, so that they felt they were part of the Company and were not just employees, and because they were risking their careers at Eternal Tech to join him in this new venture.

44. Even if the 1st Respondent might have genuinely thought that he could ask for the shares back when he wanted to because they had "come from him" in the first place, and whatever might have been the more honourable thing for the Petitioner to have done, the issue is whether the Petitioner had made any legally-binding agreement to that effect, and in the circumstances I have found above, I find that no agreement had been made by the Petitioner to transfer the shares (whether to the Company or to the 1st Respondent) when he ceased working for the Company.

No failure to consult

45. The Petitioner therefore has locus standi to present this petition but I find however that he has failed to show that there has been any unfair prejudice such as to warrant a buy-out order.

46. The Petitioner's first complaint was that he was not consulted on management matters. It is apparent from his cross-examination however that the Company's operations were clearly demarcated so as to allow each of the three shareholders to develop their own individual skills. The 1st Respondent's skills and experience were in management, marketing and administration, the Petitioner's skills were in electronic engineering and the 2nd Respondent's skills were in mechanical engineering. I find that there had been no expectation or agreement that all three (or at least, the Petitioner) would share in management decisions.

47. In cross-examination, the Petitioner said that he had taken part in decisions on the structure of the Company and on deployment of personnel. However that was at the early stages of the Company when his input was required for how he wanted his department to be set up and what personnel were required. Once the Company's internal structure had been set up, his input would not have been required and I find that it was intended that he should deploy his skills at electronic engineering and the 1st Respondent's skills, at management.

48. The Petitioner also said that he had taken part in meetings regarding the technical aspects of contracts. He agreed however that he did not attend meetings for any other purpose. Thus, for repeat orders, or for common-place orders which the Company could clearly perform, it would not have been necessary for him to have been consulted, and it has not been suggested that there were any situations other than these.

No failure to provide audited accounts

49. The Petitioner's second complaint, as stated in paragraph 16 of his affirmation supporting the Petition, was that he had not been provided with the audited accounts of the Company.

50. This can be dealt with briefly. It was common ground that the Petitioner had in fact been provided with the audited financial statements of the Company for the year ending 31 March 1999. He had not been provided with the audited financial statements for the financial year ending 31 March 2000, but prior to his resignation from the Company, those financial statements were not yet available from the auditors. The Petitioner did not dispute that, and the fact that the provision of audited financial statements does not figure significantly can be seen from the dearth of correspondence from him in this regard.

Request to resign not unfair prejudice

51. I deal then with the Petitioner's third complaint, which was that the 1st Respondent had asked him to resign as a director of the Company. The Petition pleaded that this was "in or about June 2000". The Petitioner's affirmation in support of the Petition referred to a letter dated 25 July 2000.

52. Be that as it may, I find that even if the complaint referred to the letter dated 25 July 2000, this was not an act of unfair prejudice because the Petitioner had himself sent a resignation letter dated 30 June 2000 indicating that he wished to resign as Electronic Engineering Director. Further, it was clear from the terms of that letter that he had no complaints about his role in the Company or the fact that he had not yet been provided with the audited financial statements.

53. Moreover, if he was leaving the Company because he was dissatisfied with his treatment as shareholder, one would hardly have expected him to tell the 1st Respondent a story that he was leaving to join a business set up by his cousin. The Petitioner said in evidence that he came up with that story because he thought that would make it easier for both sides to face each other. That would be unlikely conduct for someone who considered himself hard done by.

No dividend

54. The Petitioner's last complaint was that no dividend had been declared. Although there was a hint in the Petition of secret profits, it was clear from the evidence that there was no evidence that there had been any breach of fiduciary duty on the part of any of the 1st to 3rd Respondents.

55. As far as the financial year ended 31 March 1999 was concerned, it was not disputed that there had been consultation among the 1st Respondent, the Petitioner and the 2nd Respondent and that the consensus was that the profits should be retained.

56. The Petitioner said that his complaint was about the 2nd financial year. However I accept that the Company's financial position was such that it cannot be said that the failure to declare dividends was an act of unfair prejudice. Although the audited financial statements show that the Company did make a profit for that year, it had current liabilities of about $9m and its current assets comprised for the most part of inventories and trade and other receivables. For a company with only 1 year's trading goodwill, it was reasonable for the remaining directors to have regarded it as commercially prudent to keep cash flow within the Company for operating expenses.

Order

57. I find therefore that none of the Petitioner's allegations in the Petition (whether singly or together) amount to unfair prejudice such as to warrant a buy-out order, nor a winding-up of the Company on the just and equitable ground. Accordingly, I would dismiss the Petition.

58. As for costs, I would make an order nisi that the Petitioner should bear half of the costs of the Petition, so as to reflect the fact that although the Petitioner failed in his petition, at least half of the time of the hearing was spent on the 1st to 3rd Respondents' unsuccessful allegation that the Petitioner had no locus standi to present the petition because of the alleged agreement for the transfer of shares.