ZHONG ZHIRONG v. BOLD PACIFIC LTD

HCMP 548/2013

IN THE HIGH COURT OF THE

HONG KONG SPECIAL ADMINISTRATIVE REGION

COURT OF FIRST INSTANCE

MISCELLANEOUS PROCEEDINGS NO 548 OF 2013

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J U D G M E N T

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1.  This is an application by the applicant (“Zhong”) as a minority shareholder of the respondent, Bold Pacific Limited (“Company”), for leave pursuant to section 168BC of the Companies Ordinance, Cap 32 (“Ordinance”) to bring a derivative action on behalf of the Company against its directors Chan Chi Man (“Chan”), Zeng Guozhong (“Zeng”) and Yuen Yan Yan (“Yuen”).

2.  In the draft statement of claim (“SOC”) for the proposed derivative action, Chan, Zeng and Yuen will be the 2^nd to 4^th defendants in those proceedings with the Company as the 1^st defendant.

Background

3.  The Company was incorporated in Hong Kong on 6 September 2000.  It has issued share capital of HK$10,000 divided into 10,000 shares of HK$1 each. Chan holds 7,000 of those shares and the remainder is held by Zhong. 

4.  The directors of the Company were Chan and Zhong until 2010.  On 16 December 2010, Chan was replaced by Zeng as a director.  On 8 November 2012, Yuen was appointed as the third director.  In an adjourned AGM held on 1 March 2013, Zhong was replaced by Yuen as a director.  Since then, Zeng and Yuen are the only directors of the Company. 

5.  The Company is an investment holding company.  It is holding 100% of the shares in a Mainland Company called Bi Yi.  Bi Yi manufactures and sells mineral water, wine and juice products.  The mineral water produced by Bi Yi is sold under trademarks owned by the Company which are registered in the Mainland.  These trademarks have been owned by the Company since 2005.

Zhong’s complaints

6.  Unsurprisingly, this application was precipitated by disagreement between the shareholders of the Company.  According to Zhong, shortly before the originating summons herein was issued on 20 March 2013, he became aware that Yuen was holding herself out as a director of the Company and she had caused the government authorities in Shenzhen to seize the mineral water products bearing the trademark “Bi Yi”, which are owned by the Company, from his factory there.

7.  At the same time, Zhong became increasingly concerned that both Chan and Zeng had failed to properly account for income received from the sale or use of the Company’s assets.

8.  According to Zhong, Chan had sold large quantities of mineral water and alcoholic products owned by the Company without accounting for the proceeds of these sales.  His evidence is that, based on certain record obtained from a Mainland factory owned by Chan (Sunshine Plastics Factory), Chan had received no less than RMB 4 million from the sale of the Company’s products from 2000 to 2003 and a further RMB 4 million for the period from 2003 to 2009, none of which has been paid to the Company.

9.  Zhong also complains that Zeng has not been acting in the best interest of the Company, but has been serving the personal interests of Chan.  He says that he has been kept in the dark by Chan and Zeng over the finances of the Company.

10.  In respect of the appointment of Yuen, Zhong says that when he received a notice from Zeng of his intention to convene a general meeting of the Company on 1 November 2012 to pass a resolution that Yuen be made a director of the Company, he instructed his solicitor to write to Zeng and inform him that he would not attend the proposed meeting which would make it impossible for a quorum to be formed under articles 8 and 22 of the Company’s Articles of Association (“Articles”).

11.  Despite his non-attendance at the said meeting, and in the absence of a quorum, on 8 November 2012 Zhong was informed that Yuen had been made a director of the Company pursuant to an EGM held on that day in his absence. Zhong contends that the resolution which underpins Yuen’s appointment is invalid by reason of the absence of quorum. 

12.  Zhong says that the Company must be enabled to bring proceedings against Chan and Zeng to account for missing sales revenue, to have the purported resolution appointing Yuen as a director declared to be of no effect and to restrain Yuen from holding herself out as a director of the Company.

The Company’s position

13.  Zhong’s complaints are vigorously denied by the Company acting under the instructions of Zeng and Yuen.  The Company contends that no leave should be granted to Zhong to commence the derivative action because:

(1)  His claims do not disclose any serious issue to be tried as they are either unviable as a matter of law or unsupported by the evidence;

(2)  Alternatively, Zhong can seek redress by alternative means without requiring the Company to incur costs to pursue the claims;

(3)  The board of directors of the Company (“Board”) opposes the bringing of the derivative action; and

(4)  Given the modest financial circumstances of the Company, it should not be compelled to incur costs to pursue the claims.

14.  I shall cover the details of Company’s case when I deal with the individual complaint below.

Applicable legal principles

15.  I have been referred by Ms Ho, who appeared for the Company, to a number of applicable legal principles.  They are not in dispute and are as follows. 

16.  The requirement for leave under s 168BC of the Ordinance is a determination of the applicant’s standing to bring a derivative action. Therefore, the burden falls squarely on the applicant to convince the court that he should be allowed to bring the derivative action, rather than putting the burden on the company to persuade the court otherwise: The Annotated Ordinance of Hong Kong, Companies Ordinance, § 168BC.03.

17.  Before the court would grant leave for the applicant to commence a derivative action under s 168BC, it has to be satisfied that:

(1)  It appears to be prima facie in the interest of the company that leave should be granted to the applicant (s 168BC(3)(a));

(2)  There is a serious issue to be tried and the company has not itself brought the claim (s 168BC(3)(b)); and

(3)  The applicant has to serve a written notice on the company pursuant to s 168BD of the Ordinance at least 14 days before he takes out the leave application, unless the court grants leave to dispense with the service of such notice.

18.  In considering whether it is in the interest of the company to bring the derivative action:

(1)  Where the proposed claim is not against the directors, the board’s view of what is in the commercial best interest of the company should generally be given considerable weight: Re Li Chung Sing Tong (Holdings) Ltd [2011] 5 HKLRD 274 at §§ 28-29;

(2)  The court would consider whether the substance of the redress which the applicant seeks to achieve is available by means which does not require the company to be brought into litigation against its will: The Annotated Ordinance of Hong Kong, Companies Ordinance, § 168BC.04.

19.  In addition to the above, Mr Sherry, who appeared for Zhong, has submitted that as regards the first two requirements set out in para 17 above, the threshold is low.  He relies upon Tsang Way Lun Wayland v Grand Field Group Holdings Ltd, unrep, HCMP 1059/08, 26 February 2009 at § 21: 

“For the first requirement, it is only necessary to establish (sic) 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).”

20.  With these principles in mind, I turn to the various issues before the court.

The appointment of Yuen

21.  This is a key issue which underpins many of Zhong’s complaints.  The Company maintains that the appointment of Yuen as director was validly made pursuant to article 22 and regulation 56 of the Articles.

22.  Article 22 provides that:

“For all purposes, the quorum for all general meetings shall be two members personally present or by proxy and no business shall be transacted at any general meeting unless the requisite quorum be present at the commencement of the business.”

23.  Regulation 56 of Table A of the First Schedule of the Ordinance, which was adopted without any change pursuant to articles 1 and 2 of the Articles, provides that:

“If within half an hour from the time appointed for the meeting a quorum is not present, the meeting [if not convened upon the requisition of members] shall stand adjourned to the same day in the next week, at the same time and place or to such other day and at such other time and place as the directors may determine, and if at the adjourned meeting a quorum is not present within half an hour from the time appointed for the meeting, the members present shall be a quorum.”

24.  The undisputed evidence is that by a notice dated 11 October 2012, the Board informed Zhong that an EGM would be held on 1 November 2012 to consider the appointment of Yuen as a director. Zhong made a deliberate decision not to attend the EGM to render it inquorate (see letter from his solicitors dated 27 October 2012).

25.  As the quorum was not present at the 1 November 2012 EGM, pursuant to regulation 56, the meeting was adjourned to 8 November 2012.  At the resumed EGM, as Zhong did not attend within half an hour from the time scheduled for the meeting, pursuant to regulation 56, Chan, being the only shareholder present, formed the quorum.  The resolution appointing Yuen as director was duly passed at the EGM (see attendance list and minutes of the EGM).

26.  Valiantly, Mr Sherry argued that the words“For all purposes”contained in article 22 preclude the application of regulation 56 or the inclusion of it as part of the Articles.  He drew a comparison with regulation 55[1] which does not contain such words but the words “save as herein otherwise provided” and submitted that the differently formulated article 22 does not permit the application of regulation 56.  I agree with Ms Ho that this cannot be the case.

27.  Firstly, article 1 of the Articles clearly provides that: “Subject as hereinafter provided, the regulations contained in Table ‘A’ in the First Schedule to the Companies Ordinance (Chapter 32) shall apply to this Company, and be deemed to be incorporated with these Presents”.  Article 2 lists out the regulations which are not adopted or are modified.  Regulation 56 is not included in the list, nor is it modified by any provision in the Articles.  The suggestion that regulation 56 does not form part of the Articles is untenable.

28.  Secondly, I am unable to see any conflict between regulation 56 and article 22.  It is a matter of common sense that the business of the Company should not be frustrated by the lack of quorum.  Regulation 56 caters for situations like the present when a member sought to obstruct the operation of the Company by rendering the EGM inquorate.  In other words, an exception has been made by regulation 56 in respect of the operation of article 22.  I am unable to see that the difference in formulation between article 22 and regulation 55 precludes any exception as contended by Zhong. 

29.  Thirdly, the above analysis is consistent with two recent authorities – To Chun Wa & Anr v Goldsort Co Ltd & Ors, unrep, HCMP 563/11, 22 September 2011, §§ 7, 10-13 and Re: China Star Enterprise Hong Kong Ltd [2012] 5 HKLRD 290, §§ 5 and 12.  I am told by Mr Sherry that the judgment in China Star Enterprise is under appeal.  However, without even having sight of the grounds of appeal, I have no reason to doubt the correctness of that judgment. 

30.  Accordingly, I hold that Yuen was properly appointed. 

31.  For completeness, it is not disputed that Zhong has a personal entitlement to bring proceedings to challenge the appointment of Yuen.  I agree with Ms Ho that this militates against granting leave to bring derivative action under this complaint.

The complaints against Chan

32.  The complaints cover two causes of action.  Firstly, it is alleged that Chan had sold mineral water and alcoholic products produced by Bi Yi without accounting for the proceeds: §§ 11-15 and 26(a) of SOC.  Secondly, there is a claimfor payment of fees under an agreement between Bi Yi and Chan whereby Chan was allowed to import into the Mainland and sell alcoholic products under two trademarks owned by the Company (“Alcohol Sub-contract”): §§ 16-17 and 26(b) of SOC.

33.  First and foremost, there is ambiguity in Zhong’s evidence as to whether the trademarks under the Alcohol Sub-contract are owned by the Company.  They were originally owned by Bi Yi.  It is unclear whether they had been transferred to the Company at a later stage (see Zhong’s 2^nd affirmation, §§ 10-12, Chan’s affirmation, § 17(2) and Zeng’s affirmation, § 7(2)-(3)). 

34.  As Ms Ho has rightly pointed out, the losses suffered under these two causes of action belong to Bi Yi because the products allegedly sold by Chan were the properties of Bi Yi and the fees payable under the Alcohol Sub-contract were due to the same.  Hence, a claim by the Company for the proceeds of sale and fees in question will be barred by the reflective loss principle (see Landune Intl Ltd v Cheung Chung Leung, CA, [2006] 1 HKLRD 39, §§ 24-35 for a succinct summary of that principle). 

35.  In simple terms, although Bi Yi is wholly owned by the Company, they are separate legal entities and the Company does not own the properties belonging to Bi Yi.  Ms Ho has referred me to a court of appeal authority of Oriental Peer Co Ltd v Terrian Ltd & Ors [1987] 2 HKC 61 where it was stated at 72E:

“This is trite law but it is too often overlooked and, as Lord Russell of Killowen observed in EBM Co Ltd v Dominion Bank [1937] 3 All ER 555 (PC) at p 564 it is ‘of supreme importance that the distinction should be clearly marked, observed and maintained between an incorporated company's legal entity and its actions, assets, rights and liabilities on the one hand, and the individual shareholders and their actions, assets, rights and liabilities on the other hand’.”

36.  Mr Sherry did not argue against the reflective loss principle.  He recognised the force in Ms Ho’s submissions in this regard.  However, Mr Sherry submitted that the difficulty may be overcome with a double derivative action – Zhong bringing an action on behalf of Bi Yi.  Ms Ho objected to the shifting of Zhong’s case.  It was rightly pointed out that the SOC is the second attempt by Zhong to marshal his case in support of this application.  It was highly undesirable for this new argument to be made without proper formulation in a draft statement of claim, elaboration in a skeleton argument and proper notice to the other side.  The double derivative action argument was therefore disallowed.

37.  By reason of the reflective loss principle alone, the complaints against Chan have no leg to stand on.

38.  Further, Chan denies that he had sold any of Bi Yi’s products without accounting for their proceeds.  It is not disputed that Bi Yi was at all material times and still is under the control of Zhong.  Despite Chan’s denial, Zhong has not produced any record to support his complaints, including those he allegedly found at Chan’s factory (see para 8 above)[2].

39.  As regards the claim for trademark fees under the Alcohol Sub-contract, it is likewise based solely upon Zhong’s allegations, which are denied by Chan.

40.  Mr Sherry was at pains to point out that the threshold which Zhong has to satisfy for the purpose of this application is low.  However, it cannot be right that the court should then act upon any unsupported allegation regardless of its quality.  That would be an abdication of its responsibilities.  Given the fact that Zhong is in control of Bi Yi and his failure to adduce any documentary evidence in support of his allegations, I am not satisfied that there are serious issues to be tried in the complaints against Chan.

41.  In light of the above analysis concerning the appointment of Yuen and the complaints against Chan, all the complaints against Zeng and Yuen fall away with one exception, to which I now turn.

The seizure by Shenzhen authorities[3]

42.  Zhong alleges that Zeng was in breach of his fiduciary duties to the Company for allowing Yuen to lodge a false complaint to the Shenzhen authorities on behalf of the Company against him for infringement of the former’s intellectual property rights: § 22 of SOC.  Without any particulars, Zhong claims that as a result of the complaint, “[he] is now unable to produce and sell mineral water products for Bi Yi which has resulted in an immediate loss of income to [the Company]” (emphasis added): see §23 of SOC.

43.  As against Yuen, it is alleged that she had wrongfully held herself out as the Company’s director and wrongfully made the complaint to the Shenzhen authorities as a director of the Company: see § 24 of SOC.

44.  According to the Company, Zhong had a contract with Bi Yi where the latter subcontracted to the former its business in producing and selling mineral water products in return for an annual fee.  Under that contract, Zhong was allowed to use the relevant trademarks which belonged to Bi Yi at the time (they were subsequently transferred to the Company).  However, despite the expiration of the contract at the end of March 2012, Zhong continued to produce and sell mineral water products in Bi Yi’s name with those trademarks. 

45.  A board meeting of the Company was called to take place on 17 December 2012 to discuss the matter.  Zhong was notified of the meeting but failed to attend the same.  It was resolved at the meeting that Zeng and a Mainland law firm were to take action against infringement of the Company’s intellectual property rights.  The minutes of the meeting were sent to Zhong.

46.  In due course, complaint was made by the Company’s Mainland lawyers to the Shenzhen authorities resulting in the seizure of mineral water products bearing one of the trademarks in March 2013.  The matter is being investigated by the authorities. 

47.  The only dispute to the Company’s case raised by Zhong is that after the expiration of his contract with Bi Yi, the production of mineral water products was resumed by Bi Yi itself (this is inconsistent with § 23 of the SOC (see para 42 above)) and that all the proceeds of sale of those products had been paid into Bi Yi’s bank account.  If that is the case, it is quite unfortunate that Zhong had failed to attend the meeting in December 2012 to explain the situation to the Board.

48.  However, if Zhong is right, the matter will no doubt be clarified in the course of the investigation by the Shenzhen authorities.  I am unable to see the justification for a derivative action. 

49.  I agree with Ms Ho that it is a matter for the Board as to the appropriate action to be taken to protect the Company’s intellectual property rights.  The Board was acting with the benefit of the advice of Mainland lawyers, and I see no impropriety on the evidence. 

50.  Further, I am not satisfied that the Company has suffered any loss under this complaint.  The goods currently seized by the Shenzhen authorities must belong to Bi Yi and they should be released after investigation.  As to any stoppage in Bi Yi’s production (as indicated above, Zhong’s evidence is quite opaque), that again would be the loss of Bi Yi.  There is no evidence that Bi Yi has to pay the Company for the use of its trademarks. 

51.  In the premises, I do not believe that there is any serious issue to be tried or that it is in the interest of the Company that leave be given for the institution of derivative proceedings under this complaint.

The Company’s financial position

52.  For completeness, Ms Ho has argued that the Company has limited funds in hand and therefore it would not be in its interest to become involved in a derivative action.  There is no evidence before the court that the Company is unable, if it so desires, to raise funds on the strength of its ownership of Bi Yi.  I would not decline this application on this point alone.

Conclusions

53.  By reason of the aforesaid, this application is dismissed with costs to the Company to be taxed if not agreed.

54.  Last but not least, I am grateful to counsel for their assistance in these matters.