LIN LESTER CHI KEE v. CHAN LEUK FU AND ANOTHER

HCCW 293/2006

IN THE HIGH COURT OF THE

HONG KONG SPECIAL ADMINISTRATIVE REGION

COURT OF FIRST INSTANCE

COMPANIES (WINDING-UP) NO. 293 OF 2006

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J U D G M E N T

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1.  This is a petition presented by Lin Lester Chi Kee to wind up Nu-West Natural Products Corp. Limited (“the Company”; 中西本草科學中藥有限公司) on the just and equitable ground, pursuant to section 177(1)(f) of the Companies Ordinance, Cap. 32.  Alternatively, the petitioner seeks an order that Chan Leuk Fu, the 1^st respondent herein, should buy out his shares at a fair value to be determined by an independent valuer appointed by the court, pursuant to section 168A of Cap. 32.  The petitioner and the 1^st respondent are the only shareholders of the Company, each holding 50% of the issued shares.  They are also the only directors.

2.  There are two supporting creditors to the petition, Fan Chi Shing and Madam Chan Pik Lin Berry (“Madam Chan”).  Both are former employees of the Company.  Mr. Fan has obtained an award in his favour in the Labour Tribunal.  Madam Chan has a claim for arrears in wages.  They did not take part in the hearing.

3.  The 1^st respondent was legally represented until three weeks before trial, when he filed a notice to act in person.

4.  Other than the petitioner and the 1^st respondent, Madam Leung Lin Wan Winnie (“Madam Leung”) was the only witness who had testified at the trial.  Madam Leung is a former employee and she gave evidence for the petitioner.  The petitioner has filed affirmations of two witnesses who are abroad, Dr. Enyou Yu and Madam Wei Zhang.  As the 1^st respondent had indicated by his former solicitors that he would not wish to cross-examine them, their affirmations were admitted into evidence without the need of calling them.  One other deponent for the petitioner, Gerald Thomason, was required to be called by the 1^st respondent.  Mr. Samuel Chan, who appeared for the petitioner, informed the court that Mr. Thomason, who also resides abroad, would not be called and his affidavit would not be relied on.

The background matters

5.  The Company was incorporated in Hong Kong on 17 May 2000.  The authorised share capital is HK$10,000.00, all of which were issued and paid up.

6.  The name of the Company in English and Chinese closely resembles that of a company set up by the petitioner and the 1^st respondent on 7 October 1998 in the state of Washington in the United States, known as Nu-West Natural Products Corp. (“Nu-West US”; 中西本草股份公司).  The petitioner and the 1^st respondent are residents of Seattle at all material times.

7.  Prior to setting up Nu-West US, the petitioner and the 1^st respondent had engaged in the following co-operative business ventures:

(1)	On 15 June 1995, they incorporated A-1 International Corp. (“A-1 International; 大利國際公司) in the state of Washington, owned by them in equal shares.  For about six months from late 1995 to early 1996, they exported new and used cars from the United States to Hong Kong and Mainland China through this company.  The petitioner was the president of A-1 International and the 1st respondent the vice president.  According to a co-operation agreement in Chinese drawn up by the 1st respondent dated 28 May 1995, the petitioner was responsible for providing capital and managing finance and the 1st respondent was responsible for business operation and management.
(2)	During 1996 to 1997, they participated in a software business venture in Indonesia through A-1 International, with two individuals in Taiwan, Mr. Pan and Mr. Ong.  The petitioner was the managing director of this business venture and the 1st respondent was the assistant to the managing director.
(3)	On 24 August 1997, the petitioner signed a distributorship agreement on behalf of A-1 International with Libest International Corporation (“Libest”), a manufacturer of pain-relieving pads known as “Libest Spur Effect” (百事達骨刺靈).  Libest was established by an individual from Mainland China and was looking for an agent in Seattle for distribution of its pain-relieving pads.  The petitioner invested US$40,000.00 into A-1 International for this distributorship business, which continued for about two years until September 1999.
(4)	On 23 March 1998, the petitioner, the 1st respondent and Dr. Enyou Yu set up CYL International Corp. (“CYL”; 大恩堂草本研究中心) to research, develop, produce and distribute proprietary herbal medicine.  In the co-operation agreement in Chinese drawn up by the 1st respondent of that date, it was provided that the petitioner was the managing director, responsible for finance and personnel management; the 1st respondent was the general manager, responsible for business and marketing; and Dr. Yu was responsible for the research and manufacturing of new medicine.  The petitioner put up the capital for this business.  He held 34% of the shares, the 1st respondent and Dr. Yu each held 33%.  CYL was dissolved by mutual agreement of the petitioner, the 1st respondent and Dr. Yu on 20 September 1999.

8.  In the course of distributing pain-relieving pads for Libest, the petitioner and the 1^st respondent set up Nu-West US in October 1998, to manufacture and market their own brand of pain-relieving pads known by the brand name of “RIAXIN” (骨痛傷腫特效靈).

9.  There is some dispute when RIAXIN was successfully developed and whether the petitioner had played any part in its research and development.  The 1^st respondent claimed that he alone successfully invented the formula for RIAXIN in August 1998 and allowed the petitioner to share in the fruits of his success.  The petitioner accepted initially in the petition that the formula was created in mid 1998.  In his subsequent affirmations, he claimed that RIAXIN was being developed in the summer of 1998, it was a collaborative effort and he had made contributions in doing extensive research on herbal medicine.  He exhibited correspondence and documents to show that RIAXIN was successfully developed some time after August 1999.  He made enquiries with his cousin Madam Wei Zhang in China and she had found for him various sets of encyclopaedia on Chinese herbs, many periodicals and journals and a directory of manufacturers of medicine in China.

10.  At the outset, the petitioner and the 1^st respondent each held 50% shares in Nu-West US.  They were the incorporators and the first directors.  The general nature of the business, as provided in the articles of association, is the research, manufacturing, marketing, import and export of herb and health food.  All of the petitioner’s shares have been transferred to his son Richard Lin (“Richard”).  The petitioner claimed that the transfer took place soon after the incorporation of the company, as the parties thought it was too risky that the shareholders were identical to A-1 International, in case Libest should sue for misappropriation of trade secrets.  The 1^st respondent asserted that he had no knowledge that Richard is a shareholder until his relationship with the petitioner turned sour in February 2006.  The petitioner, Richard and the 1^st respondent are the directors of Nu-West US.

11.  In late 1999, the petitioner and the 1^st respondent decided to expand the market of RIAXIN pads manufactured by Nu-West US to Asia, including Hong Kong, Taiwan and Mainland China.  In January and March 2000, the petitioner caused Nu-West US to remit a total of US$2,500.00 to Madam Chan, a friend of the 1^st respondent, to cover her expenses in setting up the Company in Hong Kong for selling RIAXIN products.  The Company was incorporated in May 2000.

12.  The sales volume of the Company in 2000 was small.  It operated from the home of Madam Chan at the time.  In March 2001, the petitioner, the 1^st respondent and Richard decided to expand the business of the Company and invest further capital to secure business premises for the Company.  Nu-West US remitted a total of US$25,000.00 for this purpose in March and April 2001.  The 1^st respondent opened a bank account for the Company in Hong Kong and, with the agreement of the petitioner, he and Madam Chan were appointed alternate authorised signatories.

13.  Madam Chan was appointed the general manager of the Company in April 2001.  The 1^st respondent divided his time between the United States and Hong Kong and spent half of his time in Hong Kong to look after the business here.  The petitioner took care of the business of Nu-West US.  The 1^st respondent received a salary from both Nu-West US and the Company.  The petitioner received a salary from Nu-West US only.  It is common ground that the 1^st respondent had reported to the petitioner the sales of the Company on a daily basis and sent him the accounts every month.  All the RIAXIN pads sold by the Company were manufactured in the United States by Nu-West US.  The Company was not engaged in production of the pads.

14.  For the period from incorporation to August 2002, the Company made a profit after tax of HK$1.9 million.  Using the profits earned, in July 2002, the Company purchased Workshop 9 on 8^th Floor, Wah Wai Centre, Nos. 38 to 42 Au Pui Wan Street, Fotan, Shatin, New Territories (“the 8^th Floor property”) for HK$1,200,000.00.  This became the registered office of the Company.  Profit after tax from September 2002 to December 2003 was HK$2.4 million.  In May 2003, part of the profit was used to purchase another property in the same building, Workshop 10 on 9^th Floor (“the 9^th Floor property”), as business premises for the Company, for HK$750,000.00.  In March and April 2004, a third property in the same building, Workshop 10 on 10^th Floor (“the 10^th Floor property”), was purchased for HK$780,000.00.  However, this time, the 10^th Floor property was assigned to the 1^st respondent as the purchaser.  The Company had used the 10^th Floor property as a warehouse for a period; otherwise it was left vacant.  The 1^st respondent did not require the Company to pay for the use of this property.

The breakdown of co-operation and matters leading to the petition

15.  It is common ground that the relationship of co-operation between the petitioner and the 1^st respondent has broken down completely and this came about in February 2006.  The parties’ differences as to how the businesses of the Company and Nu-West US should be run were triggered by the incidents arising out of the Hong Kong Brands and Products Expo held in Hong Kong in December 2005 to early January 2006.  Nu-West US invested about HK$330,000.00 in the Expo, which was attended by the petitioner and Richard.  The petitioner prepared a detailed evaluation of the Expo in January 2006.  The 1^st respondent however regarded the Company’s participation in the Expo as an outright failure.

16.  The salient incidents before and after the breakdown of relationship, based on undisputed evidence or contemporaneous documents, were as follows:

(1)	On 7 February 2006, there was a meeting between the petitioner, Richard and the 1st respondent at the latter’s home in Seattle.  The 1st respondent accused Richard of being keen to spend money on the Expo and claimed it did not generate results.  He expressed discontent with the marketing strategies, personnel and research proposal of the petitioner and Richard.
(2)	On 8 February 2006, the 1st respondent sent a long fax to the petitioner in which he stated that projects of Nu-West US which would involve spending must cease immediately and if money had to be spent, a plan should be submitted for his prior approval. As for the Company, the 1st respondent asked the petitioner not to interfere as this would disturb his strategies and tactics in a critical period.  He sought to draw a clear distinction between shareholders’ power and executive power, and asserted that although the ‘executive shareholder’ should be responsible to all shareholders, the power exercised by the ‘executive shareholder’ was “inviolable”.  He hinted at his preference that the parties should go their separate ways.
(3)	On 27 March 2006, without prior discussion with the petitioner, the 1st respondent caused the Company to place a substantial purchase order with Nu-West US for 500 cartons of RIAXIN pads, with no shipment date or schedule.  The petitioner responded by fax on the same day that the existing production capacity could only supply an initial shipment of 200 cartons by early May 2006, and the balance would have to be postponed.
(4)	In the 1st respondent’s fax on 29 March 2006, he insisted that the Company must have three months’ stock to meet the anticipated boost in business from April 2006.  He stated that if Nu-West US could not act accordingly, he would prepare for production in Hong Kong, which would save time, energy and expenses.
(5)	The 1st respondent reiterated in his fax to the petitioner on 3 April 2006 that the Company must have three months’ stock and accused the petitioner of being irresponsible in not specifying how long the delivery of the balance would be postponed.  The petitioner replied on the same day by a long fax, at the end of which he asked the 1st respondent to consider liquidating the assets and liabilities of the operation in Hong Kong and let him take back his equity of 50% and withdraw from the Company, as the 1st respondent did not appear to trust him any more.
(6)	In his fax to the petitioner dated 9 April 2006, the 1st respondent proposed a division of assets as follows: the petitioner should own Nu-West US and he should own the Company, and they would use 31 March 2006 as the cut-off date.  The net asset value of both companies would be calculated and after setting off the amounts due, they would make arrangements for payment of the balance.  He enclosed his calculation of the net asset value of the Company and requested the petitioner to do likewise for Nu-West US.  They could then discuss other issues in respect of Nu-West US, including the use of trademarks, production technologies, product formula, intellectual property and market distribution.
(7)	As the 1st respondent did not hear from the petitioner on his proposal for splitting up, he chased for a reply on 18 April 2006.
(8)	On 22 April 2006, the petitioner informed the 1st respondent by fax that after consideration, he would not sell his shares in the Company.
(9)	Before the 1st respondent received the petitioner’s reply, he had already given instructions to an information technology company, Friends Marketing Ltd., to design a website with the domain name of www.chanspainpad.com, to promote pain-relieving pads similar to RIAXIN, as evidenced by a fax of one Mr. Chan of Friends Marketing Ltd. dated 21 April 2006.  According to an e-mail of Mr. Chan to Madam Chan dated 8 May 2006, it was requested that all visits to the website of the Company at www.riaxin.com.hk would be re-directed to www.chanspainpad.com.  On or about 25 April 2006, HK$17,600.00 was drawn out of the Company’s bank account to pay the registration fee of the new website and for diverting all web searches for RIAXIN and its name in Chinese to the new website.  Madam Chan engaged Huyi Global Information Resources (Holding) Co. Hong Kong Ltd. to register four Chinese Internet search keywords (中西本草, 骨痛, 傷痛, 特效靈) corresponding to www.chanspainpad.com.
(10)	On 25 April 2006, the 1st respondent instructed his accountant in the United States to use the “fastest method” to set up a new company in the state of Washington by the name of New West Natural Products Corp. (U.S.A.) (“New West US”), with himself as the sole proprietor, to produce and export herbal products.  New West US was incorporated on 26 April 2006 with the 1st respondent as the sole shareholder and president.  He chose the name New West, as this was similar to the names of Nu-West US and the Company.
(11)	At about the same time, the 1st respondent placed orders with various suppliers to purchase ethyl alcohol and bandage adhesive plasters for the production of pain-relieving pads.  In his letter dated 26 April 2006 to Madam Wong Yim of Firstar Healthcare Co. Ltd., a supplier in Guangzhou, China, he asked the materials to be delivered to his new company in Seattle and he would use the name of the Company to place the order and make payment.  He requested Madam Wong to contact Madam Chan for all things and to communicate by telephone or fax for the time being instead of by e-mail, as the website might link up with Nu-West US and was “not advantageous for keeping secret”.  The materials ordered from various suppliers were paid for with the funds of the Company.
(12)	On 28 April 2006, the 1st respondent entered into a formal sale and purchase agreement to sell the 10th Floor property for HK$1,200,000.00.  He assigned the property to the purchaser on 29 May 2006 and kept the net proceeds of sale for his own use.
(13)	Also on 28 April 2006, the 1st respondent unilaterally increased his salary in the Company from HK$40,000.00 a month to HK$100,000.00 and withdrew the said sum from the Company’s bank accounts.
(14)	On 7 May 2006, the 1st respondent instructed Madam Chan to remit US$100,000.00 from the bank account of the Company to his personal account in the United States.  She was instructed to enter the said sum in the accounts of the Company as payment in advance for the goods to be supplied by New West US.  The sum was remitted the following day.  Goods already delivered by Nu-West US to the Company, for which over HK$2.1 million was owed, remained unpaid since April 2006.
(15)	On 17 May 2006, the 1st respondent purchased two sealing machines for New West US at HK$8,392.00 with the funds of the Company.
(16)	The petitioner caused Nu-West US and the Company to bring proceedings in the United States against the 1st respondent and New West US on 18 May 2006 for breach of fiduciary duty, misappropriation of trade secrets, breach of contract, conversion, conspiracy and unfair trade practice.  A temporary restraining order was obtained against the defendants ex parte on 19 May 2006 and was discharged on 1 June 2006.
(17)	The petitioner came to Hong Kong and on 19 May 2006, he terminated the employment of Madam Chan and her daughter summarily and changed the locks of the office afterwards.  A set of the new keys was provided to the 1st respondent on 25 May 2006 when he went to the office with Madam Chan and others and attempted to expel the petitioner.  The police was called on both occasions.  Madam Chan and the 1st respondent refused to provide the petitioner with the password of the Company’s account for Internet banking, and removed all the cheque books on 29 May 2006.  The petitioner was unable to use the funds of the Company to pay wages of its staff or other creditors.
(18)	On 30 May 2006, the 1st respondent terminated the employment of Madam Leung and Miss Ng Yee Ching, who had assisted the petitioner.
(19)	On 1 June 2006, the 1st respondent’s solicitors wrote to the petitioner demanding an undertaking that he should not tamper with, interfere in, or disrupt the business and day to day operation of the Company.
(20)	On 3 June 2006, the 1st respondent caused three notices to be posted up in the office of the Company.  They were headed “Company Announcement”, “Causes of Disputes between Shareholders”, and “Partnership Law – Limited Partnerships”.  He also sent copies of the notices to the petitioner.  The Company Announcement dated 1 June 2006 was issued by the 1st respondent as “executive director”.  In it he stated that the petitioner was just an ‘ordinary shareholder’, not an ‘executive shareholder’ unlike him, who alone was entitled to ‘the right of execution’ in the Company.  He announced to the employees that they could refuse to perform any assignment given by the petitioner; they could refuse the petitioner’s request for the Company’s cheques, seal, accounts and documents; they could refuse to tell the petitioner the passwords to the Company’s computers, bank accounts or electronic gates.
(21)	On 5 June 2006, the 1st respondent changed the locks of the office of the Company and did not provide the petitioner with a set of the new keys.
(22)	In June 2006, funds were drawn from the Company’s bank account to pay for various items for the production of pain-relieving pads by New West US: inner aluminium pouches, another sealing machine, bandage adhesive plasters, computer software design, installation and miscellaneous charges.
(23)	The petitioner’s solicitors wrote to the 1st respondent’s solicitors on 7 June 2006 demanding an account of the monies withdrawn from the Company’s bank accounts and an account of the proceeds of sale of the 10th Floor property.

17.  This petition was presented on 13 June 2006.  The 1^st respondent issued a summons on 19 June 2006 seeking a validation order in respect of payments made into or out of the bank accounts of the Company in the ordinary course of business and dispositions of the property in the ordinary course of business for proper value.  I dismissed his application on 28 June 2006.

The broad issues in dispute

18.  The broad issues in dispute may be stated as follows:

(1)	whether the Company was set up as a marketing arm of Nu-West US in Asia on the basis of mutual trust and confidence similar to Nu-West US and other business ventures previously set up by the petitioner and the 1st respondent, or whether it was set up as an entirely separate company free to pursue its own interest without regard to Nu-West US (“the quasi-partnership issue”);
(2)	whether the petitioner has been unjustifiably excluded from the management of the Company by the 1st respondent since about February 2006 (“the expulsion issue”);
(3)	whether the 1st respondent has misappropriated the funds of the Company for the purpose of setting up a rival company in the United States owned or controlled by him, New West US, after the split-up negotiations between the petitioner and the 1st respondent had fallen through in April 2006, or whether the 1st respondent was justified in setting up New West US (“the misappropriation issue”);
(4)	whether the 10th Floor property and the sales proceeds thereof upon its sale in May 2006 were held by the 1st respondent on trust for the Company (“the 10th Floor property issue”), or whether the 10th Floor property was purchased with the 1st respondent’s own funds for his own benefit; and
(5)	if the petitioner should succeed in establishing his case, what is the appropriate relief that should be granted (“the relief issue”).

19.  Other matters of dispute were raised in evidence.  I do not consider them relevant and it is not necessary for present purpose to resolve them.

The witnesses

20.  The principal witnesses are the two protagonists, who, between them, have filed a total of nine affirmations in these proceedings.  From the above findings of salient matters resulting in the breakdown of relationship, based on matters largely not in dispute, the 1^st respondent would need to explain and justify his actions, namely, his exclusion of the petitioner from the management of the Company, his setting up of New West US in a secretive manner to produce pain-relieving pads similar to the RIAXIN pads produced by Nu-West US, and his use of the Company’s moneys to fund the operations of New West US.

21.  The 1^st respondent’s cross-examination of the petitioner was relatively brief, centred mostly on peripheral matters of little relevance to the real issues in dispute.  The petitioner’s counsel cross-examined the 1^st respondent extensively and I have had ample opportunity to assess his credibility.

22.  The 1^st respondent is seventy years old.  As is apparent from the letters, the petitioner had for a long time looked up to the 1^st respondent, as the older of the two men, with greater experience and learning.  The 1^st respondent’s name in Chinese is陳畧呼 (Chan Leuk Fu).  He is usually known by the name of陳大夫 (Chan Dai Fu), “dai fu” meaning a practitioner in Chinese medicine.  He is not conversant in English.

23.  The impression I have of the 1^st respondent is that he is a crafty, opportunistic and manipulative person.  He is capable of dubious and underhand practice, as is evident from a letter dated 10 September 1997 he wrote to Mr. Pan and Mr. Ong, less than a month of the appointment of A1-International as a distributor of Libest Spur Effect, informing these business partners from Taiwan that he had solved the skin allergy problem caused by the Libest pads and proposed to launch his own brand of pain-relieving pads.  He suggested that before he was able to develop the new medicine, they could build up the new brand in Taiwan by using the Libest pads and re-packaging the pads with the new brand name, to open up the market and accumulate enough capital for the new business venture.  The plan was to be carried out in the names of the Taiwan partners so that Libest would not suspect A-1 International’s involvement and stop the supply under the distributorship agreement.  The petitioner deposed in his affirmation that this plan was rejected by him and the Taiwan partners as “devious” and was not implemented.  The 1^st respondent retorted in his affirmation this was an attempt to smear his character but his letter speaks for itself.

24.  The petitioner is a more straightforward person.  I am inclined to accept his evidence on most matters.

The quasi-partnership issue

25.  The petitioner’s case is that the Company was set up as a continuation of the previous quasi-partnership between him and the 1^st respondent in Nu-West US, arising out of their decision to expand the business of RIAXIN pads into the Asian markets.

26.  In cross-examination, the 1^st respondent accepted that the Company and all the other business ventures were formed on the basis of mutual trust and confidence between him and the petitioner.  Further, in his long fax to the petitioner on 8 February 2006, he stated that the Hong Kong and American companies “are one body”.  This understanding was also reflected in a business analysis prepared by the 1^st respondent and faxed to the petitioner in about July 2001, in which reference was made to the consolidated profit and loss position of Nu-West US and the Company.

27.  I have no difficulty in finding that both Nu-West US and the Company were in the nature of quasi-partnerships formed on the basis of mutual trust and confidence between the petitioner and the 1^st respondent.  There was close collaboration between them in setting up these entities.  The participation of both in the development of the formula for RIAXIN was the genesis of their quasi-partnership in Nu-West US and the Company.  For present purpose, it is not necessary to decide who invented the formula.  At the very least, I find on the evidence adduced by the petitioner and of Madam Wei Zhang that he had played some part in the development and research of the formula.  The extent of his involvement was mentioned in his letter to the 1^st respondent dated 18 March 2006, and was not disputed by the 1^st respondent in the correspondence exchanged at the time.

28.  I reject the 1^st respondent’s evidence that the petitioner only became involved in the development of the formula in March 2000, when he asked the petitioner to order the ingredient Glycerin.  This was not borne out by the documents adduced by the petitioner, which showed that he had a greater involvement and it was earlier than March 2000.  The 1^st respondent’s assertion that he alone was responsible for developing the formula with his own financial resources and that he had allowed the petitioner to share in the fruits of his hard work is not credible.

29.  I find also on the evidence that the petitioner had taken an active part in the major decisions, strategy and operation of the Company, although he came to Hong Kong infrequently and it was the 1^st respondent who had supervised and monitored the day-to-day administration by Madam Chan.

30.  I find that the Company was set up as a marketing arm of Nu-West US in Asia.  I reject the 1^st respondent’s contention that the Company was entirely separate and was free to pursue its own interest without regard to Nu-West US.  Each company had relied on the support of the other in furthering their business objectives.  The shareholders had considered the profits and losses of both companies as a whole, as evident from the business analysis prepared by the 1^st respondent in 2001.  70% of the business of Nu-West US was derived from the sales of the Company.

31.  It is undeniable that the Company was established with the financial backing of Nu-West US.  As late as the Expo in late 2005, Nu-West US was assisting the Company and investing substantial sums in its operations.  It was with the permission of Nu-West US that the Company registered the trademark of RIAXIN in Hong Kong.  All the products sold by the Company were supplied by Nu-West US.  But for the fact that both entities were formed on the basis of mutual trust and confidence between the petitioner and the 1^st respondent, an agreement would have been drawn up to provide for the terms on which the Company was to market and distribute the RIAXIN pads manufactured by Nu-West US.

32.  The 1^st respondent’s answer to a hypothetical question put to him in cross-examination was telling.  He was asked to suppose that the petitioner had set up a new company in Hong Kong to be the new marketing arm of Nu-West US as the sales performance of the Company was unsatisfactory and whether he would find this acceptable.  He said he would object to this because this would seriously affect the business of the Company and it would be unfair to him.  This disposes of the contention that each company was free to pursue its own interest without regard to the other.

The expulsion issue

33.  The 1^st respondent had advanced these grounds to justify the exclusion of the petitioner from the management of the Company since February 2006.

34.  It was claimed in the letter of the 1^st respondent’s solicitors to the petitioner dated 1 June 2006 that there was an oral agreement between the parties in mid 2000 that the petitioner would manage Nu-West US and the 1^st respondent would manage and be in control of all affairs of the Company, and pursuant to the alleged agreement the petitioner had never been involved in the management or decision making of the Company since incorporation.  This assertion was repeated in the notices posted by the 1^st respondent in the Company on 3 June 2006, that pursuant to the oral agreement, the petitioner was an ordinary shareholder, not an ‘executive shareholder’, and that the petitioner’s only right was to inquire about the operating results and prospects from ‘the executive shareholder’.

35.  I reject all the above contentions, which were not supported by evidence.  The petitioner was entitled to and did participate in the management of the Company, prior to February 2006.  He had communicated with the 1^st respondent on a daily basis regarding the business of the Company.  He had been involved in and was consulted on major decisions and strategies although not the day-to-day administration.  The distinction between an ordinary shareholder and ‘executive shareholder’ was misconceived, so was the 1^st respondent’s reliance on an extract relating to limited partnerships in partnership law.  There was no justification to exclude the petitioner, a 50% shareholder, from the management of the Company.

The misappropriation issue

36.  The petitioner claimed that the 1^st respondent had improperly withdrawn from the Company amounts totalling US$106,819.60, HK$250,178.05 and HK$170,519.90.  The 1^st respondent claimed that after his application for a validation order was dismissed on 28 June 2006 and since 12 August 2006, he had been using his own money to finance the operations of the Company, until the Company became dormant in October 2006.

37.  The 1^st respondent admitted that he started to plan for the setting up of a new company in the United States in early April 2006, before he had any reply from the petitioner if the latter was agreeable to splitting up their interests in the two companies in the manner proposed in his fax dated 9 April 2006.  He asserted that New West US was set up in a secretive manner for the benefit of the Company, and advanced two grounds to explain and justify his actions to set up a new company to produce pain-relieving pads:

(1)	to ensure that the pads would be free from bacteria; and
(2)	to ensure that the Company’s demands to have sufficient stock of the pads would be met.

38.  The first ground may be disposed of shortly.  The 1^st respondent produced a test report from a laboratory dated 2 February 2006 stating that the samples of RIAXIN pads submitted in January 2006 failed to comply with the microbial limit in topical traditional Chinese medicines stipulated in the guidelines sanctioned by the government in Macau.  He had informed the petitioner of the test report at the time and they had discussed what should be done in the production procedures to reduce the risk of contamination.  The petitioner testified that the samples submitted within a month of this test report had passed the test and, after that, the Company continued to export RIAXIN pads to Macau for sale without any problem.  The 1^st respondent admitted this in cross-examination.  He also accepted that failing the laboratory test in February 2006 was an isolated incident and did not consider there was any need to taken any action on account of this.

39.  The 1^st respondent alleged in his affirmation that he had told the petitioner if bacteria-free goods could not be provided to meet the demands of the Company, he would do something on his own to ensure that the future business of the Company would not be affected.  He claimed that the petitioner raised no objection and even made a proposal that the petitioner should take over Nu-West US and the 1^st respondent should take over the Company.  In cross-examination, he was unable to give even an approximate date of this important conversation.  He could not remember if what he deposed to was said in one telephone conversation.  I am not inclined to believe him.  I accept the petitioner’s evidence there was no such conversation.

40.  The first ground could provide no justification for setting up a new company in early April 2006 to produce the pads.

41.  For the second ground, it is necessary to consider the order of 500 cartons placed by the 1^st respondent on 27 March 2006, whether the Company did have sufficient stock at the time, what was the anticipated future demand, and whether Nu-West US was able to meet the demands of the Company.

42.  On 23 January 2006, the Company placed a purchase order with Nu-West US for 602 cartons, to be delivered on or before 5 March 2006.  On 1 March 2006, Nu-West shipped 159 cartons under this order.  At the time the order for 500 cartons was placed on 27 March 2006, Nu-West US had not indicated that the balance of 443 cartons under the previous order would not be fulfilled and in fact on 31 March 2006, a further 196 cartons were shipped under the previous order.  Adding the 196 cartons of a value of about HK$990,000.00 to the closing inventory in March 2006 of HK$670,000.00, the level of stock would be in the region of HK$1.6 million, which was not far short of three months’ stock insisted upon by the 1^st respondent as discussed below.  Further, in the petitioner’s response on 27 March 2006, he had offered to supply 200 cartons by early May 2006.

43.  The 1^st respondent admitted in cross-examination he was aware that the normal production capacity of Nu-West US was 150 to 200 cartons a month.  The rate at which Nu-West US had been supplying the Company in March 2006 would seem to accord with the normal production capacity.

44.  The 1^st respondent explained in his affirmation why the Company would need at least three months’ stock.  It was to meet the increasing demands in Macau, China and the Mannings Store in Hong Kong and the boost in business due to a VIP membership system to be put in place by the Company in April 2006.  In cross-examination, he clarified that the demands in China he mentioned was actually not the market in Mainland China, as the Company had not been able to export RIAXIN products to China due to the strict implementation of Good Manufacturing Practice on drugs production (GMP requirements) in China since 2004.  What he meant was just sales to Mainland tourists visiting Hong Kong.  As for the sales in Macau, he accepted that the monthly turnover in February and March 2006 was only in the region of HK$50,000.00 or HK$60,000.00.  He did not elaborate on the anticipated demand due to the VIP membership system in his affirmations or oral testimony.  So essentially, the 1^st respondent was left with the anticipated demand from Mannings.

45.  The 1^st respondent gave a breakdown of the anticipated increase in demands in the earlier part of his cross-examination.  He claimed that the anticipated total demand for three months was in the region of HK$4 to 5 million, made up of projected monthly sales of HK$1 to 1.2 million to Mannings, and additional monthly sales of HK$500,000.00 for Macau, Mainland tourists, and Hong Kong other than the Mannings Store.  The anticipated increase in demand from Mannings was based on his conversation with the person in charge of Mannings who allegedly said the sales could double.  The conversation was not mentioned in any of the affirmations of the 1^st respondent.

46.  When the 1^st respondent was asked to go through the financial statements of the Company and explain further his calculations, he changed his evidence.  He said he calculated the whole sum and did not divide up the sales or demands from various sources.  Thus, the sales volume for January to March 2006 was in the total sum of HK$3.8 million, or HK$1.2 million odd per month on average.  He worked out the inventory.  The closing inventory for March 2006 was HK$670,000.00 odd.  If he wanted three months’ stock, it should be over HK$2 million.  As the inventory in March 2006 was not enough for three months, he placed the purchase order for 500 cartons.

47.  Mr. Chan submitted that the 1^st respondent would appear to have in mind the value of the purchase order for 500 cartons (HK$2.4 million odd) when he testified that three months’ stock should be worth over HK$2 million.  I am inclined to agree.  I am left with the distinct impression that the 1^st respondent was tailoring his evidence to justify his claim that three months’ stock was needed.  I am very sceptical if the total anticipated demands would indeed require three months’ stock.

48.  There was no cogent explanation why the Company should need to order 500 cartons at the end of March 2006 at one go.  The 1^st respondent’s prompt response on 29 March 2006 that if Nu-West US could not supply the Company, he would prepare for production in Hong Kong, was telling.  His discontent with the proposed partial delivery of 200 cartons by early May 2006 was unreasonable.  The petitioner had played into the 1^st respondent’s hands when he intimidated at the end of his long fax on 3 April 2006 his desire to withdraw from the Company as the 1^st respondent did not appear to trust him.

49.  I find that the second ground put forward by the 1^st respondent did not justify his action in setting up New West US to produce the pads.  He had clearly acted in bad faith.  The actions taken by him in this respect, as summarised in the earlier part of this judgment, were unfairly prejudicial to the petitioner on an objective test; whether the 1^st respondent had genuinely believed that he did so in the best interest of the Company is irrelevant.

50.  On 9 November 2006, the 1^st respondent purportedly transferred all his shares in New West US to the Company.  I note his express instruction to his accountant in April 2006 that he was to be the sole proprietor of the new company.  He gave no credible explanation for the transfer.  This would appear to be a tactical move, to give credence to his allegation that all the subterfuges he resorted to in setting up New West US and using the Company to fund its operations, was not for his personal benefit but for the benefit of the Company.  I would attach no significance to it.

51.  Contrary to the 1^st respondent’s denials, the real reason why New West US was set up was because the 1^st respondent was expecting a split up with the petitioner.  He envisaged the petitioner would have Nu-West US and he would have the Company.  The pain-relieving pads would need to be produced in the United States to fetch a higher price.  As the Company would no longer obtain its supply from Nu-West US, he would need to set up his own company in the United States to produce the pads.  He did so with the funds of the Company in a surreptitious manner, without the consent of the petitioner.  This was a serious matter, not a mere question of not following “the necessary corporate formalities in some of [his] actions involving the Company and New West”, as he has sought to put a harmless explanation to this in his latest affirmation.

52.  Mr. Samuel Chan submitted that the 1^st respondent had acted precipitously in setting up New West US before he had any reply from the petitioner to his proposal on 9 April 2006 to split up their interests in the two companies.  In short, the 1^st respondent had jumped the gun.  The situation is similar to Allmark v. Burnham [2006] 2 BCLC 437 cited by Mr. Chan, where it was held that the actions taken by the first respondent, who had conducted himself as though he owned all the shares of the company and treated the petitioner as a ‘has been’ so far as the business was concerned, pending the conclusion of a proposed exit agreement with the petitioner, were unjustifiable in law and unfairly prejudicial to the petitioner.

The 10^th Floor property issue

53.  It is the petitioner’s case there was a clear agreement or understanding between him and the 1^st respondent that the 10^th Floor property was to be held by the 1^st respondent on trust for the Company.  Further, as the purchase price was provided by the Company, the 1^st respondent held the property on a resulting trust for the Company.

54.  The 1^st respondent denies there was any agreement or understanding as alleged by the petitioner.  His case is that he purchased the 10^th Floor property with part of the dividend declared by the Company and distributed to him.  He had used his own funds and the property was his beneficially.

55.  According to the petitioner, prior to 2004, the Company was considering an expansion to the market in China and was studying measures to comply with the GMP requirements in order to export to China.  The 10^th Floor property was intended as a packing workshop for the expansion to the China market.  The 1^st respondent represented to him that it might not be a good idea for the Company to hold too many properties in its name, and suggested that this new property should be held by a shareholder on trust for the Company, and a ‘dividend’ would be paid to that shareholder to enable him to pay the purchase price.  The 1^st respondent proposed initially that the petitioner should be the purchaser, but the petitioner declined and asked the 1^st respondent to take up the purchase on behalf of the Company.  The 1^st respondent was paid a dividend of HK$910,000.00 in early 2004 for him to purchase the property.

56.  It is not in dispute that the dividend purportedly paid to the 1^st respondent was not declared by the Company in general meeting, in accordance with regulation 115 of Table A adopted as part of the articles of association of the Company.  It is common ground that to date, the petitioner has not been paid any dividend.

57.  The plan to use the property as a packing workshop that would comply with GMP requirements did not materialise.  The Company used the property as storage for some time at no charge.  The 1^st respondent settled all outgoings of the property from the amount paid to him as dividend.

58.  The 1^st respondent gave different accounts of how the purchase came to be made.  I find his version incredible.

59.  In his 2^nd affirmation, the 1^st respondent did not refer to any discussion between him and the petitioner concerning the property.  He merely stated that he decided to pay himself a dividend of HK$910,000.00 in early 2004 (in his oral evidence, he said he only took HK$900,000.00 and the petitioner took HK$10,000.00), as the Company had made a profit, that the petitioner had never shown any objection to the 1^st respondent paying himself a dividend, and what he did with his dividend was entirely his own business.  He accepted though that the petitioner is also entitled to a dividend payment of HK$910,000.00.

60.  In his 3^rd affirmation, he mentioned that he had discussed with the petitioner and the latter agreed to his withdrawing HK$910,000.00 as dividend.  He alleged that the petitioner was entitled to a dividend in the same amount but the petitioner chose not to take it at the time, probably due to tax reasons.  This could not be right, as the Company did not have enough cash to pay another dividend of HK$910,000.00 to the petitioner.  According to the balance sheet for the year ended 31 December 2004, the cash and bank balance stood at HK$830,400.00.  The 1^st respondent acknowledged in cross-examination that in March 2004, it was not practicable for the Company to distribute dividends of HK$1.8 million to the shareholders.

61.  It was in cross-examination that the 1^st respondent mentioned for the first time a discussion he had with the petitioner regarding the purchase of the 10^th Floor property.  He raised the idea of purchasing this property, as the price was very low.  The petitioner asked him to use the Company to buy.  He told the petitioner as the Company already owned the 8^th Floor property and the 9^th Floor property, it would be better for the shareholders to buy the property jointly, with dividends distributed by the Company.  The petitioner did not think it advisable to buy the property in their joint names, and suggested the 1^st respondent should buy it.  The 1^st respondent declined and asked the petitioner to be the purchaser, but as the petitioner persisted, in the end the 1^st respondent bought the property.

62.  His account of the discussion on the purchase of the property was not far different from the petitioner’s account, save that he still maintained when he purchased the property with a ‘dividend’ distributed only to him specially for that purpose, he did so for his own benefit and not for and on behalf of the Company.

63.  When he was cross-examined about the discussion they had on the dividend, the 1^st respondent said he had told the petitioner he needed HK$900,000.00 for the purchase of the property (the purchase price was HK$780,000.00, the balance was intended for initial and future renovation expenses) and the petitioner might also get a dividend.  He did not however mention what amount of dividend might be paid to the petitioner.  His thinking at the time, which was not disclosed to the petitioner, was that if the petitioner had wanted a dividend, they would share the sum of HK$900,000.00 equally.  I find this evidence implausible.

64.  To bolster his claim that the property was not intended for the Company as a packing workshop to comply with the GMP requirements, the 1^st respondent alleged that he learned about the GMP requirements and brought it to the petitioner’s attention in May 2004, whereas the sale and purchase agreement of the 10^th Floor property was entered into on 23 March 2004.  This was not the case, as it would appear from contemporaneous documents in 2002 and 2003 adduced by the petitioner that the parties had been looking into the issue of complying with the GMP requirements for quite some time before the purchase of the property.

65.  On 5 March 2002, a quotation was obtained by the Company for an automated packing machine costing HK$135,000.00 and other machines for printing and packaging.  The 1^st respondent initially admitted in cross-examination that the machines were for the purpose of setting up a packing workshop for the Company in Hong Kong to comply with the GMP requirements.  He retracted this admission and claimed that the quotation for machines, although obtained by the Company, was meant for Nu-West US.  He did not dispute that a detailed consultancy proposal dated 9 September 2004 was submitted to the Company by Formal Win Consultants Ltd., on measures to be taken by the Company to comply with the GMP requirements.

66.  The 1^st respondent was evasive and contradictory.  I accept the petitioner’s evidence on this issue.  I find that the 1^st respondent held the 10^th Floor property on a constructive trust for the Company, based on the clear understanding and agreement that the Company should have the beneficial interest in the property, notwithstanding that the purchase was made in the 1^st respondent’s name.  In reliance on the common intention aforesaid, the Company had acted to its detriment in providing the money for the purchase.

67.  The property was also held on a resulting trust for the Company in that it was purchased with the funds of the Company.  The amount of HK$910,000.00 or HK$900,000.00 paid to the 1^st respondent was not in truth and in substance a dividend, but merely a device to enable a shareholder of the Company to purchase a property for the benefit of the Company.  In the balance sheet of the Company as at 31 March 2006 enclosed in the letter of the 1^st respondent to the petitioner on 9 April 2006, there was an entry under “current assets” of account receivable being a loan to the 1^st respondent of HK$900,000.00 for the purchase of the 10^th Floor property.  This was not the correct treatment either, but it showed that the 1^st respondent did not appear to have regarded the payment as a dividend to him.

68.  The 1^st respondent had sold the 10^th Floor property in May 2006.  According to him, the net proceeds amounted to HK$1,198,860.47.  The net proceeds are held on trust for the Company.  He had no right to dispose of the property on his own or retain the net proceeds for his own benefit.  This was unfairly prejudicial conduct in the affairs of the Company, and would also provide justification for winding up on the just and equitable ground.

The relief issue

69.  The primary relief sought by the petitioner is winding up rather than to have his shares bought out by the 1^st respondent.

70.  Mr. Chan submitted that a buy-out order is not a practical or an effective remedy in this situation for the following reasons.

71.  Firstly, the 1^st respondent has admitted he does not have the financial means to buy out the petitioner’s shares.  He has adduced no evidence on his financial ability.  He said he would need to borrow from his friends and from banks in Hong Kong and the United States to pay the purchase price.  This is of course highly relevant to the exercise of my discretion.

72.  Secondly, the Company has been dormant since about October 2006.  All the staff had left.  The solvency of the Company is in doubt, its largest creditor being Nu-West US.  It is uncertain if the Company would have the means or incentive to settle the overdue amounts of close to US$300,000.00 to Nu-West US once a buy-out order is made.

73.  Thirdly, a buy-out order would require resolution of a multitude of matters in relation to the affairs of the Company where solvency is in doubt, or would involve the court embarking on a laborious and expensive process requiring a degree of co-operation between the parties which had hitherto been lacking.  The questions of the future business relationship between the Company and Nu-West US, and the ownership of the RIAXIN and other trademarks registered by the two companies, would render the valuation of the petitioner’s shares very difficult.  The liquidator would be in a better position to carry out investigation into the relevant matters and arrive at a proper return due to the creditors and the contributories (Antoniades v. Wong [1997] 2 BCLC 419 at 427a to c).

74.  I agree with the above submissions.  It would be more appropriate to wind up the Company in these circumstances.

Orders

75.  I order the Company to be wound up.  It is not necessary to make any other order for an account against the 1^st respondent as sought in the petition.  The liquidator would have vested in him all necessary powers to realise and recover assets of the Company, and to deal with claims lodged by any creditor, including Nu-West US, the 1^st respondent and the supporting creditors.

76.  As costs should follow the event, I make an order nisi that the 1^st respondent is to pay the petitioner’s costs in these proceedings.