TSANG WAI LUN WAYLAND v. GRAND FIELD GROUP HOLDINGS LTD

HCMP 1059/2008

IN THE HIGH COURT OF THE

HONG KONG SPECIAL ADMINISTRATIVE REGION

COURT OF FIRST INSTANCE

MISCELLANEOUS PROCEEDINGS NO. 1059 OF 2008

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D E C I S I O N

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The application

1.  This is an originating summons issued on 4 June 2008 by Tsang Wai Lun Wayland (“Mr Tsang”) under section 168BC of the Companies Ordinance, Cap 32 and amended on 26 February 2009.  Mr Tsang seeks the following relief:

(1)  leave to bring proceedings on behalf of Grand Field Group Holdings Limited鈞濠集團有限公司(“the Company”) against its directors Chu King Fai (“Mr Chu”), Huang Bing Huang (“Mr Huang”), Au Kwok Chuen Vincent, Hwang Ho Tyan, Zhao Juqun, Yang Biao, Wong Yun Kuen and Mok King Tong;

(2)  an order that an independent auditor be appointed for and on behalf of the Company to investigate and report to the court on its financial position including but not limited to the whereabouts of the $50 million remitted to Yuan Cheng Real Estate (Shenzhen) Limited 遠程置業（深圳）有限公司 (“Yuan Cheng”) by the Company on or about 18 January 2008 and the payments made by Yuan Cheng from funds sources directly or indirectly from the Company, and that all reasonable costs and expenses incurred by the independent auditor for the investigation as ordered shall be borne by the Company; and

(3)  costs of these proceedings be borne by the Company on an indemnity basis.

The background

2.  The Company was incorporated in Bermuda, its shares have been listed on the Main Board of The Stock Exchange of Hong Kong Limited since 1999.  The Company through its subsidiaries carries on the business of development and sale of properties in the PRC.

3.  Mr Tsang, his wife Kwok Wai Man, Nancy and their company Rhenfield Development Corporation together hold about 22% of the issued shares.  The Tsangs were the founders of the Company.

4.  There was a change in the management of the Company in July 2007, when the Tsangs resigned as directors.  They were charged by the Independent Commission Against Corruption in respect of a transaction involving the Company in 2002.  They brought in Mr Huang as a strategic investor in the Company.  The Tsangs became consultants of the Company instead, until Mr Huang and Mr Chu served a notice to terminate their consultancy in March 2008.

5.  Mr Chu has become the chairman and an executive director of the Company.  Mr Huang has been appointed the chief executive officer and an executive director.

6.  Since June 2008, there has been litigation between two camps of shareholders, with the Tsangs on one side and Mr Chu, Mr Huang, and others on the other side.  There is also a dispute regarding the validity of the appointment of directors made by each camp.  I am not concerned with that dispute for present purpose.

7.  Mr Tsang claimed there were breaches of fiduciary duties of the Company’s directors in a number of transactions.  As the Company has not itself brought proceedings against its directors because they are in control of the board, he seeks leave to bring a statutory derivative action on behalf of the Company.

8.  Before I go to the complaints of Mr Tsang that formed the subject of the proposed action, it is convenient I should give a brief introduction of the individuals and entities involved in the complaints.

9.  Mr Chu had been the chairman of Min Tai Group Company Limited深圳閩泰集團since its incorporation in the PRC in 1994.  Min Tai Group Company Limited and its subsidiaries have been carrying on the business of property development, mainly in Shenzhen.

10.  Following his appointment as chairman of the Company in January 2008, Mr Chu resigned as chairman and legal representative of the Min Tai Group Company Limited and his son has become the legal representative in his place.

11.  Mr Chu’s wife, Weng Yulian, is an executive director of Min Tai Development Company Limited閩泰建設有限公司(“Min Tai Development”).  Mrs Chu owns 90% of the shares in this company and her sister Weng Yuqiong owns10%.

12.  An entity known as Dongguan City Min Tai Industry and Investment Limited東莞市閩泰實業投資有限公司(“DCMT”) would also appear to be related to the Min Tai group of companies.  Madam Cheng Lai Yin (“Madam Cheng”) owns 40% of the shares, she is said to be the niece of Mr Chu but this is denied by him.  Madam Cheng’s father, Cheng Yau Chung, is the legal representative of Min Tai Development.

13.  DCMT owns 51% of the shares in Dongguan City Hua Jia Fu Industry and Trading Limited東莞市華嘉富工貿有限公司 (“DHJF”).

14.  Further，Mr Chu used to hold 77.78% of the shares in Shenzhen Hua Ke Nano-Technology Development Company Limited深圳華科納米技術有限公司 (“Hua Ke”).  On 15 January 2008, Mr Chu transferred his shares in Hua Ke to Hui Zhi Hua (“Mr Hui”).  Mr Hui is said to be Mr Chu’s chauffeur, and that has not been denied.  Mr Hui has since become a director and the legal representative of Hua Ke.  Mr Huang has been the supervisor of Hua Ke since September 2006. 

15.  Mr Huang used to hold shares in Shenzhen Zhong Cheng Construction Engineering Company Limited 深圳市中城建設工程有限公司 (“Zhong Cheng”).  In June 2007, after he has been appointed an executive director of the Company, Mr Huang transferred his shareholding in Zhong Cheng to Mr Hui.  Mr Hui held 85% of the shares from January to May 2008, when he transferred some of his shares to a Mr Yam, a personal friend of Mr Chu and who now holds 60% of the shares in Zhong Cheng.

The complaints

16.  The complaints of breaches of directors’ fiduciary duties are contained in a number of affirmations filed by Mr Tsang in these proceedings and may be summarised as follow:

(1)  $50 million was transferred by the Company to Yuan Cheng on or about 18 January 2008.  Yuan Cheng was incorporated as an indirect wholly owned subsidiary of the Company with forged documents and its registration with the Shenzhen City Commerce and Administration Bureau深圳市工商行政管理局was ordered to be revoked by a Shenzhen court in October 2008.

(2)  A project known as the Yi Zheng Economic Development Zone High Technology Industrial Park 儀征經濟開發區高新技術產業園 (“the Yangzhou Project”) was proposed to be acquired from Min Tai Development in June 2008 at $88 million with an up-front payment of $5 million paid out of the funds of Yuan Cheng.

(3)  Certain management service agreements were entered into by Yuan Cheng with DHJF in March 2008, which involved an up-front payment of RMB 8 million by Yuan Cheng.

(4)  Yuan Cheng entered into a Co-operation Framework Agreement with Zhong Cheng in June 2008, which required an up-front payment of RMB 5 million, and made two subsequent payments to satisfy third parties of the credit worthiness of Zhong Cheng, involving total payments of RMB 17 million.

(5)  Loans of RMB 33.1 million were purportedly made by Yuan Cheng to Hua Ke from April 2008 to June 2008.

17.  Mr Johnny Mok, SC submitted on behalf of Mr Tsang there was a modus operandi in that Yuan Cheng was used as a vehicle in the PRC to channel the $50 million transferred by the Company to Yuan Cheng in January 2008.  Large sums were paid to entities connected with Mr Chu, Mr Huang and the Min Tai group of companies, not for a proper commercial purpose, and with no apparent benefit to the Company.  And every time an agreement for a transaction was signed, a substantial up-front payment was made by Yuan Cheng to the other party as “refundable deposit”, interest-free and with no security.  Mr Mok queried if it was proper for the money of a listed company to be managed in this way, and submitted there was breach of fiduciary duty on the part of the directors.  

18.  Mr William Wong for the Company submitted there was no misappropriation of funds by the directors, that every dollar has been accounted for, that no financial loss was suffered by the Company, and there was no evidence of impropriety, merely a difference of opinion as to the commercial decisions made by the board of directors.  He submitted that Mr Tsang has embarked on a guerrilla warfare against the other camp, raising one allegation after another in the voluminous evidence filed in the hope that something would stick with this shotgun approach.

The legal principles

19.  There are three requirements to be satisfied for leave to be granted to bring a statutory derivative action.  They are set out in section 168BC(3):

(1)  it appears to be prima facie in the interest of the Company that leave should be granted to Mr Tsang to bring proceedings on its behalf;

(2)  there is a serious question to be tried and the Company has not itself brought the proceedings against the intended defendants; and

(3)  the applicant has served a notice on the Company in accordance with section 168BD.

20.  The Company has not indicated it would bring proceedings against the intended defendants.  And Mr Tsang has complied with the third requirement.

21.  For the first requirement, it is only necessary to establish it appears to be prima facie in the interest of the Company to sue.  It is not necessary or appropriate to establish this to a particularly high standard and the court should not attempt to resolve the underlying dispute.  It would suffice if an arguable case is disclosed and, on the face of it, it would be in the interest of the Company to bring proceedings.  The second requirement is likewise of a relatively low threshold (Re F & S Express Limited [2005] 4 HKLRD 743 at 746E to 747D, paras l7 to 21; Re Lucky Money Limited, HCMP No. 505/06, 18 July 2006, Kwan J, paras 40 to 42; Re Myway Limited[2008] 3 HKLRD 614 at 622 to 624, paras 28 to 31).

22.  I turn to consider each of the complaints if the above requirements are satisfied.  I will first look at the complaints to see if an arguable case is disclosed.  I will then look at the matter in the round if it appears to be prima facie in the interest of the Company to sue.

Yuan Cheng

23.  As mentioned earlier, it was held by a Shenzhen court that Yuan Cheng was formed by forged documents, and its business registration has since been revoked.

24.  The gravamen of this complaint is that the directors had approved the remittance of the very substantial sum of $50 million to Yuan Cheng at the board meeting on 14 January 2008, despite questions were raised specifically over the legality of the formation of this company, and that the very substantial sum of $50 million remitted by the Company to Yuan Cheng has been put under the control of an unauthorised and unlawful entity.

25.  I have been informed by Mr Wong that the judgment of the Shenzhen court is now under appeal.  I have also noted the Company’s contention that any irregularities in the formation of Yuan Cheng could be rectified by the board of directors.

26.  I am satisfied there is a serious question to be tried if the directors had acted in breach of their fiduciary duties to the Company in this matter.

Min Tai Development and the Yangzhou Project

27.  The Yangzhou Project was the sole asset of Min Tai Development at the material time.  A letter of intent was signed by Metro China Investment Limited, a wholly owned subsidiary of the Company, with Min Tai Development on 23 June 2008 to acquire the Yangzhou Project at a consideration of $88 million in stock and cash. The proposed acquisition is by the purchase of the entire share capital of Min Tai Development.  Min Tai Development had a negative asset value of $7.7 million as at June 2007 according to the draft auditors’ report obtained on the instruction of Mr Chu.  Further, Min Tai Development owed a debt of $90 million to Mr Chu.  Upon the signing of the letter of intent, $5 million was paid out of the funds of Yuan Cheng to Min Tai Development as earnest money.  Further, in order to finance the proposed acquisition, the Company entered into a placing agreement in July 2008 with the objective of raising $15.4 million from the placing of new shares.

28.  The proposed acquisition of the Yangzhou Project fell through.  In a belated affirmation made by one of the directors yesterday, it was stated that $5 million had been repaid to the Company, and the documentary evidence in support of this repayment is being located and will be produced in a further affirmation within the next three days.  Mr Wong submitted the Company has suffered no financial loss.

29.  The complaint is that if the transaction had been proceeded with, the effect of this would be to use the Company’s money to repay the loan of $90 million purportedly owed by Min Tai Development to Mr Chu.

30.  I am of the view that there is also an arguable case for this complaint.

Management service agreements with DHJF

31.  I have earlier related the apparent connection of DCMT and DHJF with the Min Tai Group of companies.  The financial documents of Yuan Cheng, including cheque books, chops and seals, bank cards, keys to safe deposit boxes were delivered to Madam Cheng on 7 April 2008.  Mr Chu however claimed that Madam Cheng had never participated in the management of Yuan Cheng.

32.  On 28 March 2008, the Company caused Yuan Cheng to pay RMB 8 million to DHJF pursuant to two management service agreements, under which Yuan Cheng agreed to provide management services to a shopping plaza of DHJF for two years at an annual fee of RMB 1.45 million.  RMB 8 million was paid over by Yuan Cheng as a refundable security deposit within three days of the agreement, notwithstanding the facilities of the property under management had not been completed, as shown by photographs taken in April 2008.

33.  Mr Tsang’s complaint is that this transaction is blatantly disadvantageous to the Company.  Yuan Cheng was required to put up RMB 8 million up-front, in return for receiving RMB 1.45 million a year for two years.  This was not a transaction on normal commercial terms, and was brought about because of the connection of DHJF with the Min Tai group of companies.  Although the obligation of DHJF to refund RMB 8 million after two years was guaranteed by DCMT, this was not a sufficient security to Yuan Cheng and the Company.

34.  On behalf of the Company, it was submitted that it was the commercial decision of the board to enter into the management service agreements in order to diversify its business, and the mere fact that Mr Tsang holds a different opinion does not constitute a sufficient reason to sue.

35.  The threshold I am to apply is relatively low.  I hold there is an arguable case in respect of this complaint.

Transactions involving Zhong Cheng

36.  On 17 June 2008, a Co-operation Framework Agreement was entered into between Grand Field Group Limited (“Grand Field HK”), a direct subsidiary of the Company, Yuan Cheng and Zhong Cheng, by which Zhong Cheng was appointed as main contractor of Grand Field HK at an annual fee of RMB 500,000.  A security deposit of RMB 5 million was required to be paid by Grand Field HK to Zhong Cheng within seven business days of signing of this agreement, even before any work was begun.  The amount was paid by Yuan Cheng.  According to this agreement, Yuan Cheng would receive 90% of net profits from construction projects carried out under the construction licence of Zhong Cheng.

37.  Mr Tsang complained this was another patently disadvantageous transaction for the Company.  Zhong Cheng was paid ten times its annual fee even before any work was started.  A substantial block of shares in Zhong Cheng was transferred by Mr Hui to Mr Yam and Mr Hui resigned as a director of Zhong Cheng, just several days before the board of directors of the Company voted in favour of signing the Co-operation Framework Agreement.  Zhong Cheng would appear to be a company controlled by Mr Chu as well.  Mr Tsang also queried whether it would be legal under PRC law for Zhong Cheng to pass on a substantial part of the profits derived from the exploitation of its construction licence to Yuan Cheng.

38.  On 15 July 2008 and 29 August 2008, Yuan Cheng paid further sums of RMB 10 million and 7 million to Zhong Cheng, for the purpose of satisfying third parties of Zhong Cheng’s credit worthiness in construction projects that Zhong Cheng was invited to participate.

39.  Mr Tsang complained these payments were also improper.  He produced a report from lawyers in the PRC stating that the construction project for the payment in July 2008 did not appear to exist.

40.  On the part of the Company, it was submitted that it was a management decision to enter into the Co-operation Framework Agreement with Zhong Cheng.  As for the two sums totalling RMB l7 million paid to Zhong Cheng, it was asserted that both sums were repaid to Yuan Cheng when the construction projects fell through, although no documentary evidence was produced in respect of the repayment of RMB 10 million.

41.  I am also of the view that an arguable case is made out for the complaints in relation to Zhong Cheng.

Payments to Hua Ke

42.  From 30 April 2008 to 23 June 2008, total sums of RMB 33.1 million were channelled between Yuan Cheng and Hua Ke.  These transfers were booked as loans in the accounts of Yuan Cheng.  The Company had belatedly made a public announcement in October 2008 disclosing these transfers as they constituted discloseable and connected transactions under the Listing Rules of the Stock Exchange in that Hua Ke was a “connected person” of the Company under the Rules.

43.  The Company stated that the sums transferred to Hua Ke had all been repaid to Yuan Cheng within a relatively short time and the Company has suffered no loss.  Yuan Cheng made the transfers so as to appear to the State Administration for Foreign Exchange it was actively using the money in its bank accounts so that the authority would not reject its application to obtain foreign exchange in future.

44.  Mr Tsang’s complaint is that these transfers were fictitious transactions, to make misrepresentation to the authorities that the money of Yuan Cheng was not lying idle in the banks.  The amounts transferred to Hua Ke were booked as loans, with no security and interest.  Moreover, of the sums transferred by Yuan Cheng to Hua Ke, RMB 27 million was borrowed by Yuan Cheng from a bank at a commercial rate of interest with security put up by Yuan Cheng.  Mr Mok submitted the reason advanced by the Company for these transfers is bizarre and contrived.  The Company was put in serious jeopardy of possible default by Hua Ke of not repaying the substantial funds transferred.

45.  I am inclined to agree with Mr Mok an arguable case is established for the payments made to Hua Ke.

If it appears to be prima facie in the interest of the Company to sue

46.  On the case presented by Mr Tsang, there is an arguable case that the Company had, through Yuan Cheng, entered into various disadvantageous transactions.  Yuan Cheng was required to put up substantial deposits with no interest or security, and was exposed to the risk of non-payment if the other party should default.  The entities that received substantial fund transfers from Yuan Cheng had the benefit of the use of the money at no cost and with no security, whereas Yuan Cheng had to incur the expense of interest in borrowing RMB 27 million from a bank with security.  There was doubt as to the legality of some of the transactions.  If these allegations were established, I am inclined to think that the Company had suffered financial loss and ought to be compensated in damages by those directors who had acted in breach of their fiduciary duty.

47.  On the face of it, it would appear to be in the interest of the Company to bring legal proceedings against the intended defendants.

Orders

48.  I will grant leave to Mr Tsang to bring a statutory derivative action on behalf of the Company in the terms as sought in paragraph 1 of the amended originating summons.

49.  I decline to make an order to appoint an independent auditor to investigate the financial position of the Company.  If the Company wishes to engage such an auditor, it is at liberty to do so, without any order from the court.  As for Mr Tsang, it seems to me that the information presently available to him is prima facie sufficient to bring proceedings.  I do not see the need for investigation by an independent auditor to be appointed by the court at this stage.  The appointment of an independent auditor in Re Lucky Money Limited was made on the special facts of that case, and it does not mean an appointment is called for whenever there is a sharp conflict in the evidence filed.

50.  I decline to make an order as to the costs of the statutory derivative action to be brought.  This should be deferred until a later stage when the outcome of the statutory derivative action is known or when the position is clearer.

51.  Mr Mok seeks an order as to the costs of this application to be indemnified by the Company, including four sets of costs reserved in respect of an application for an interim injunction under section 168BG(1) to restrain the Company from proceeding with the placement of new shares in July 2008 for one of the transactions complained of.

52.  He submitted that costs should follow the event, and the requirements in section 168BI(3) for awarding costs are satisfied, including the requirement as to indemnity, namely that the member was acting in good faith in, and had reasonable grounds for, making the application.

53.  Mr Wong submitted that costs of the application should be deferred for consideration in the same way as the costs of the statutory derivative action.

54.  I am persuaded it would be more appropriate to defer costs in these circumstances.  It would be better to look at the whole picture in exercising the discretion to award costs in this complex dispute, so as not to fetter the court’s discretion in any way, particularly as this involves awarding costs on an indemnity basis.

55.  I order the costs of the application are also to be deferred, with liberty to apply.