RE FOUNDER (HONG KONG) LTD.

HCMP 6226/1999

IN THE HIGH COURT OF THE

HONG KONG SPECIAL ADMINISTRATIVE REGION

COURT OF FIRST INSTANCE

MISCELLANEOUS PROCEEDINGS

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J U D G M E N T

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1. There is before me an application by Originating Summons for the Court to convene a meeting under section 166 of the Companies Ordinance.

2. It is the intention of the Applicant, Founder (Hong Kong) Limited, to put forward a Scheme of Arrangement for the Court's sanction, part of which involves a proposed reduction of capital by the cancellation of existing shares and also the cancellation of a share premium account. One of the stated objectives is for the company to become the wholly owned subsidiary of a newly incorporated Bermudan company (called Founder Holdings Limited) and for its existing shareholders to become instead, shareholders in such Bermudan company.

3. However, in support of the application, the Court has only been provided with an Affirmation of a Mr. Cheung Shuen Lung which describes in the most general terms the structure of the proposed Scheme. Although I appreciate that cancellation of the share premium account (standing at $866,242,644) is strictly a matter to be considered in the context of the anticipated application for confirmation of a reduction of capital, it appears to be an important part of the Scheme overall. Thus, while the intention, subject to what I say below, appears to be that after cancellation of the company's existing shares, the shareholders are to be allotted and issued with shares in the Bermudan company, nothing is said in the documents before the Court as to the intended treatment of the credit arising upon cancellation of the share premium account.

4. The Court has also been supplied with a draft Scheme which, as I read it, is riddled with inaccuracies and unsatisfactory features. Thus, in Recital (F), provision appears to be made for the Applicant to allot and issue to the Bermudan company "Founder Holdings New Shares". This appears clearly to be erroneous as such shares will in fact be issued by the Bermudan company and are not shares which the Applicant can allot or issue. Clause 3 of the document suggests that it was intended to refer to the issue of "new Founder Shares". This however is a concept which, although used in the document, is missing from the definitions clause.

5. In Clauses 3, the wrong consideration for cancellation of the existing shares has apparently been identified. Thus, by Clause 2, on the Effective Date, the Applicant's capital and share premium account are proposed to be cancelled and replaced by new Founder shares. These new Founder shares are, on the same day, to be allotted, issued and credited as fully paid, to the Bermudan company or its nominees. Forthwith on the Scheme becoming effective, the Bermudan company is to increase its capital from HK$100,000 to HK$160 million. The object is apparently for the Bermudan company to allot and issue all shares in its capital as so increased, in consideration for the cancellation of the Scheme shares and the allotment and issue to itself of the new Founder shares. However, by Clause 3, the consideration is said to be the transfer by the Bermudan company, not of the new Founder Holdings shares, but of the "Founder Holdings Existing shares". These are defined as the existing 1 million $0.10 shares before the abovementioned increase in capital. This seems a clear error. The Scheme therefore crucially fails to identify the "Founder Holdings New Shares" as part of the consideration to move from the Bermudan company.

6. Moreover, it appears to me that on the present draft of Clause 3, the proportion of shares to be transferred by the Bermudan company (even assuming they are not confined to Founder Holdings Existing Shares) has been misidentified. The document wrongly says that the proportion is "one Founder Share for every Scheme Share". These are the wrong shares as they are both shares in the Applicant company. Presumably the intended exchange is between new Founder Shares and Founder Holdings New Shares.

7. Further examples of the unsatisfactory features of the draft, apparent from considering Clauses 2, 3 and 5 together, are as follows. While the existing shareholders are to have their shares cancelled and the intended consideration is said to be for them to become holders of the Bermudan shares, the draft Scheme provides (i) that the Bermudan company is to allot and issue shares to the Applicant company or at its direction, rather than to the existing shareholders who have had their shares cancelled; (ii) the number of shares being dealt with is left at large, referred to as "such number ....... as Founder Holdings may agree"; and (iii) a gap of up to 7 days can arise during which time the shareholders of the Applicant will have had their shares cancelled without becoming holders of any shares in the Bermudan company.

8. There is no explanation as to why, if the existing shareholders have their shares cancelled, they should not have them immediately replaced by the proposed new shares in the Bermudan company. No explanation is given for providing that the Bermudan shares go to the Applicant rather than the shareholders who have had their shares cancelled. While the Scheme states that the Applicant has informed the Bermudan company that it intends to direct that the shares go to its shareholders, it may be questionable whether the shareholders themselves would be able to enforce compliance with that indication. No explanation is given as to why there should be a gap of up to 7 days when the shareholders have had their shares cancelled and have merely an unsecured expectation of shares in the Bermudan company being allotted and issued to them at the Applicant's direction.

9. I am therefore wholly unsatisfied that a Scheme in the form provided to the Court could ever secure the Court's sanction. To put it most charitably, it is clear that the present application is extremely premature, with the documents not ready to see the light of day. Indeed, many of them have not seen the light of day, even in a defective state.

10. The only other document I was provided with is a draft Explanatory Statement. This is a document which cannot be properly understood in isolation. For example, it refers to an accompanying letter from the Board which, it says, gives reasons for the Scheme. That letter is not before me. A composite document of which the Explanatory Statement forms a part is intended. That too is not before me. It is presumably for this reason that certain terms used in the Explanatory Statement are not defined, such definitions, I assume, being elsewhere in the intended composite document. However, without those definitions, the Explanatory Statement cannot be fully understood.

11. In Re South China Strategic Ltd [1996] 4 HKC 182, the Court dismissed a similar application at the stage of the summons for directions prior to the hearing of the petition for confirmation of a reduction of capital. Mr. Justice Rogers stressed that since part of the Scheme involved a reduction of capital, the reduction proposals had to be properly explained, that the creditors were seen to be safeguarded and that the reduction was for a discernible purpose that is something demonstrated by evidence, applying Re Thorn EMI plc [1989] BCLC 612.

12. The Court (at p. 188) also stressed the importance of the accuracy of the scheme document and the need for the Scheme to be sufficiently explained to permit an intelligent and honest man as a member of the relevant class to decide whether it should be approved. If it did not accurately portray the underlying facts, the shareholders and their advisers would be misled. Because the Court was of the view that the explanations of the proposals were inadequate, in particular as to the potential impact of the Scheme on creditors, it dismissed the application for directions.

13. In Re China Light & Power Co Ltd and CLP Holdings Ltd [1998] 1 HKC 170 at 182-4, Mrs. Justice Le Pichon, similarly stressed the need for transparency and full disclosure of material information to the shareholders, although in that case, her Ladyship held that the deficiency was not fatal to the application.

14. In the present case, given the inaccuracies in and unacceptable features of the draft documentation provided to the Court, I consider it desirable, at this early stage in the procedure, to make the Court's objections known and not, for instance, to allow the application for sanction and confirmation to progress beyond the court and company meetings before returning to the Court for disapproval. If, as in the present case, it is obvious that the Scheme is defective and would not, in its present form, be sanctioned, to direct a court meeting to be conducted on the basis of such flawed documentation would not only involve wasted expenses, it could mislead and cause confusion among the Applicant's shareholders.

15. I outlined my concerns to Mr. Clifford Smith who appeared for the Applicant and he applied for the matter to be stood down to permit his client to re-consider its documentation. I decided to grant the application and will therefore adjourn this matter sine die.

16. I ought also to mention one matter which I thought it right to disclose in the course of the hearing. The Affirmation filed in support of the present application was filed by a Mr. Cheung Shuen Lung. By sheer coincidence, I am scheduled to hear a winding-up petition (HCCW 391/1999) tomorrow in respect of a company called Goldcone Properties Limited, currently in voluntary liquidation. In those proceedings, the principal contest is between permitting the voluntary liquidation to continue or to order that there be instead a compulsory winding-up of the company. However, in the evidence which has been filed in the Petition, certain allegations have been made against a person also called Mr. Cheung Shuen Lung. Such allegations include alleged misfeasance as a director. Mr. Smith has been unable to ascertain whether the same gentleman is involved in both sets of proceedings. However, I indicated to Mr. Smith that these allegations do not fall to be dealt with tomorrow and they have obviously not had any influence upon the views I have reached this morning. I have however considered it desirable in the interests of transparency that the Applicant be made aware of this coincidence. It is also my intention tomorrow to make a similar disclosure to the parties involved.