WONG WAI TUNG v. LAM CHUN FUNG AND ANOTHER

HCCW 150/2018

[2019] HKCFI 801

IN THE HIGH COURT OF THE

HONG KONG SPECIAL ADMINISTRATIVE REGION

COURT OF FIRST INSTANCE

COMPANIES (WINDING UP) PROCEEDINGS NO 150 OF 2018

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DECISION

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Introduction

1.  On 12 June 2018, Wong Wai Tung, the petitioner (“P”), presented a contributory’s petition (“the Petition”) seeking an order that his shares in Meanmax Limited (“the Company”) be bought by Lam Chun Fung,the 1^st respondent (“R1”), alternatively a winding-up order, on the basis of unfairly prejudicial conduct by R1.  There is no dispute that the Company is solvent.

2.  On 2 August 2018, R1 issued an inter partes summons seeking a validation order (“the Summons”) supported by his 1^st affirmation.  The Summons was returnable on 5 November 2018.

3.  Despite correspondence in respect of the Summons, no agreement was reached.  On 29 October 2018, P filed an affirmation (P’s 2^ndaffirmation) consenting to a validation order in principle, but not the ordersought in the Summons, and suggested variations.  In particular, P challenged the quantum of the proposed cap on payments allowed to be made by the Company towards ordinary business expenses, and disputed that commission payments to directors should be permitted.  R1 filed a 2^nd affirmation on the same day.

4.  On 5 November 2018, the Summons came before Ng J.  To the extent that agreement had been reached, a validation order was made by consent albeit not in identical terms to the order sought by the Summons.

5.  The Summons came back before me today for resolution of at least the costs of the Summons. P argues that a further issue properly before me today is whether or not the Order should be varied to contain the words “For avoidance of doubt, no ‘commission’ should be allowed to be paid to any directors or shareholders of the Company” (“the Commission Exception”).  R1 disputed that this issue remains live until this hearing but now at this hearing accepts the issue is indeed live.

6.  R1 filed a skeleton dated 13 March 2019 which only addresses costs.  P filed a skeleton dated 14 March 2019 addressing the Commission Exception issue and costs.  R1 filed a supplemental skeleton also dated 13 March 2019, addressing the Commission Exception issue but P appears not have had sight of that when responding to R1’s first skeleton.  On 15 March 2019, the parties obtained the audio recording of the hearing of 5 November 2018.  On 18 March 2019, P filed a skeleton addressing the Commission Exception issue having regard to the audio recording.  At my request, a transcription of the audio recording was provided to the Court on the eve of this hearing.  The transcription was prepared by P, and R1 has agreed the transcription so far as material.  It is this transcription which makes it clear that Ng J adjourned the Commission Exception issue to today’s hearing.

Should the Order be varied to include the Commission Exception?

7.  Paragraph 3 of the Order is concerned with the validation of payments out of the Company’s property of ordinary business expenses.  Generally, in practice, a validation order would not attempt to set out what does and does not constitute an ordinary business expense of the company — that is a matter left to the directors, and they are responsible for getting it right.  Where a petitioner is being kept informed of the payments being made out of the company’s property after the making of a validation order, the petitioner may challenge whether a payment made was an ordinary business expense.  Here, P sought a declaration in advance that no commissions to directors or shareholders are to be paid.  Ng J agreed that the issue should be argued today.

8.  R1’s 1^st affirmation (at paragraphs 16 – 23) sets out what R1 claims are the Company’s expenses, exhibiting three documents LCF-8,LCF-9 and LCF-10. Other than a bare assertion that the Company’s expenses include commissions, there is no explanation of the documents to demonstrate that commission payments to directors or shareholders are an ordinary business expense of the Company, or that their payment is necessary and expedient in the interests of the Company.

9.  P’s 2^nd affirmation at paragraph 38 asserts:

   (a)   The profit and loss estimation for the period April–August 2018 provided by R1 to P under cover of a letter dated 4 October 2018 does not show any payment of commission to R1.

   (b)   One of P’s complaints about R1’s conduct in the Petition is that in June 2018 the majority directors resolved to cease paying salary to directors and instead to pay directors commission of 15% based on his/her team’s monthly sales, which was in breach of the oral shareholder agreements of 2008 and 2009 and deprived P of his monthly income as well as adversely impacting on P’s right to 50% of the Company’s profits (this complaint is made at paragraphs 45 – 48 of the Petition).

   (c)   There is no urgency in respect of payment of any commissions.  

10.  It seems to me that, in theory, where it is uncontested that directors working on behalf of a company should be remunerated by way ofcommission, then that is capable of being an ordinary expense of the company.  (See eg Re Everglory Energy LtdHCCW 198/2016 (unreported, 20 July 2016), Anthony Chan J, para 16.)

11.  However, here it is claimed by P that the Company has been established by the two shareholders P and R1 on the basis of remuneration for directors by fixed salary, and an equal division of profits between the shareholders.  P claims there has been a variation of the compensation structure by the directors without both shareholders’ consent, and in breach of the shareholder agreement.  P claims this is unfairly prejudicial conduct and that P has suffered consequential loss in his Petition.  As I understand R1’s Points of Defence, R1 accepts that the original shareholder agreement was for the payment of fixed salary to directors, not commissions, but R1 disputes any wrongdoing.

12.  Mr Mak for R1 accepts that there has been a change in the remuneration structure for directors agreed in the original shareholder agreement.  He submits (as I understood it) that under the previous structure,P received a salary of HK$90,000, and under the new structure he would get15% of his team’s income so there can be no unfair prejudice.  I simply cannot accept such a bare submission.  Whether or not the change in remuneration structure is unfairly prejudicial to P is a matter for the Petition on proper evidence.

13.  In these circumstances, it seems to me that there is a substantive issue between the parties as to the legitimacy of commission payments by the Company to its directors.

14.  A validation order is concerned with enabling the payment of debts of the company in order that the company may continue in business pending the determination of a winding-up petition.  I am most concerned atthe suggestion that the Court should validate the payment of a disputed debt. This is especially so when the disputed debts are between a company and itsdirectors, a fortiori directors on the petitioner’s side, and there is no evidence before the Court from R1 as to why the commission payments need to be made before determination of the Petition.

15.  Mr Mak cited Re Burton & Deakin Ltd[1977] 1 WLR 390 at 397A–F for the proposition that a court will not generally interfere with thedirectors’ management discretion.  However, at 397G–H, Slade J points out that to validate a particular disposition, there must be evidence before the court showing that the directors consider the disposition, falling within their powers under the company’s constitution, is necessary or expedient in the interests of the company (inter alia).

16.  R1 sought and obtained a validation order for the payment of ordinary business expenses, subject to a reservation of the argument as to whether commission payments should be validated.  It seems to me R1 has to establish at least prima facie that the commission payments are necessary or expedient in the interests of the company and must be made prior to the determination of the Petition in order for the Company to continue in business.  There is no such evidence from R1.  I do not accept that a copy of the resolution to change the remuneration structure to commissions is prima facie evidence to satisfy R1’s burden.  The resolution was not put in evidence by R1 with any explanation of why it was in the Company’s interests.  Rather, it was put in evidence by P in order to demonstrate why he has a complaint of unfair prejudice in the Petition based on the resolutionto change the remuneration structure.  The resolution is challenged as being in breach of the shareholder agreements.

17.  I therefore order a variation to the Order to include the Commission Exception sentence to paragraph 3.

Costs in respect of obtaining the Order on 5 November 2018

18.  Where a company is solvent, it is trite that the general rule is that a validation order ought to be granted to enable the continuation of its business pending determination of a winding-up petition, unless there is compelling evidence that a disposition is likely to injure the company.  See Re Emagist Entertainment Ltd[2012] 5 HKLRD 703, paragraphs 5 – 7.

19.  Further, generally, the costs order in respect of a validation order should reflect the possibility that the petitioner’s complaints will be upheld and that the petitioner will be able to credibly argue that he should not be penalized by having to pay legal costs incurred in dealing with the validation order: Re Jessop & Baird (Hong Kong) Ltd[2017] 1 HKLRD 78 at paragraph 7.  This is the reason for the normal costs order to be costs in the cause of the petition.  However, as stated in paragraphs 6 – 7 of Re Jessop & Baird, there may be a departure from the normal costs order where there has been inappropriate opposition to the validation order which has led to increased costs.

20.  Whilst a petitioner is required to respond cooperatively to an application for a validation order for post-petition expenses of a solvent company, one must not ignore the obvious starting-point that the applicant for the validation order should give sufficient information in support of the application in the circumstances of the company in question.

21.  R1 issued the Summons on 2 August 2018.  The Order as made is not in the same terms as the Summons but, materially:

   (a)   contains separate provisions as to validation of past expenses, and a validation order for ongoing expenses;

   (b)   sets the cap for monthly payments of ordinary business expenses at a much lower amount than that proposed by R1;

   (c)   includes provisions (as well as undertakings from R1) for reporting to P in respect of the payment of ordinary business expenses along with supporting documents; and

   (d)   contains undertakings by P as to no competitive use of the information provided pursuant to the Order.

22.  That inclines me to think that whereas R1 was entitled to a validation order, a certain amount of opposition and/or suggested amendment to its terms by P was reasonable.

23.  I have read the inter-solicitor correspondence between 6 August 2018 and 11 October 2018.  I do not propose to set it all out.  In summary, my view is that:

   (a)   Where R1’s Summons sought a validation order with a cap at HK$2.5 million per month, and the supporting evidence statedthat the Company’s bank accounts held HK$9.6 million odd and RMB 1.4 million odd in cash, then the proposed cap was high enough to justify some questions from P about the quantum of ordinary business expenses of the Company each month.

   (b)   A breakdown between actual past expenses and likely future expenses was appropriate.

24.  Accordingly, I do not think that P’s responses to R1’s request to consent to a validation order were unreasonable and uncooperative.

25.  I therefore consider that, in respect of the costs of and incidental to the Summons, save costs relating to the Commission Exception issue and today’s hearing, the normal order of costs in the cause of the Petition is appropriate.

Remaining costs

26.  Had R1 agreed to the inclusion of the Commission Exception issue in the Order at the hearing before Ng J, and had R1 accepted that the appropriate costs order at that time was costs in the cause of the Petition,then today’s hearing would have been unnecessary.  Accordingly, the costs of and incidental to the Summons since 6 November 2018 are to P in any event, with certificate for counsel, to be taxed if not agreed.