RE KONG WAH HOLDINGS LTD.

HCCW49/2000

IN THE HIGH COURT OF THE

HONG KONG SPECIAL ADMINISTRATIVE REGION

COURT OF FIRST INSTANCE

COMPANIES (WINDING-UP) NO.49 OF 2000

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R E A S O N S

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1. On 13 January 2000, the petitioning creditors who are a syndicate of three banks (Den Danske Bank Aktieselskab, Bank of Scotland and Emirates Bank International) presented petitions to wind-up Kong Wah Holdings Limited ("Kong Wah") and Akai Holdings Limited ("AHL") (collectively "the Companies"). The petitions were supported by Barclays Bank PLC, Singer Company N.V. and The Standard Chartered Bank, and in the case of AHL, also by Graeme Limited and opposed by the Companies and the proposed investor Toyo Holdings Limited ("Toyo"). As the submissions made on behalf of the petitioning creditors were adopted by the supporting creditors, for convenience, references hereafter to the petitioning creditors extend to the supporting creditors unless the context otherwise requires.

2. At the adjourned hearing of the petitions on 23 August 2000, winding-up orders were made. The reasons appear below.

Events prior to 23 August

3. The petitions first came before me on 27 March 2000. Prior to that hearing, as early as 18 January 2000, a preliminary restructuring concept had been formulated and a bank creditors' meeting held on 31 January 2000 when a steering committee of the bank creditors of the Akai Group was formed with HSBC acting as liaison bank. The steering committee had appointed Ferrier Hodgson ("FH") as financial adviser at the end of February 2000. Ten days prior to the March hearing, a proposal was sent by Toyo to Akai and the steering committee for consideration. The steering committee, through its financial adviser, sought an "Information Memorandum" from Messrs Ernst and Young, auditors and financial advisers of Grande Holdings Limited (the parent of Toyo), Toyo and AHL. Because of the matters that had to be covered, the Information Memorandum was not expected to be available until mid-April after which FH would have to conduct a diligence review of the underlying information. At the request of the petitioning creditors, the Companies and Toyo the petitions were adjourned for five weeks to 2 May 2000.

4. As noted above, Toyo, in addition to being an opposing creditor, was also interested in salvaging the Companies as investor. In fact, prior to the presentation of the petitions, it was approached by the Akai Group to inject cash in return for an equity participation. Before reaching a decision, Toyo engaged accountants to conduct a due diligence exercise. Pending that exercise, the Group experienced deep liquidity problems. Toyo agreed to underwrite an issue of convertible bonds to shareholders of up to HK$670 million which issue eventually fell through. It also extended loan facilities to the Group of approximately HK$630 million for funding approved operating working capital requirements. When key personnel of the Companies left in November 1999, certain Toyo/Grande staff were seconded to the Companies.

5. At the adjourned hearing on 2 May 2000, it transpired that the Information Memorandum was only made available on 27 April to the steering committee. Only one of the petitioning creditors was a member of the steering committee. The Companies gave an undertaking to provide the petitioning creditors with a copy of the Information Memorandum and directions were given for the filing of further evidence relating to the proposed restructuring. The petitions were adjourned to 26 June 2000. Meanwhile, on 8 June, FH reported to the steering committee. On 15 June, the steering committee indicated that the proposal was unacceptable and a meeting between the steering committee and Toyo was scheduled for 27 June. In those circumstances, when the petitions were restored for hearing on 26 June, it was accepted by all parties that they had to be further adjourned.

6. By this stage, some three months had elapsed since the original restructuring proposal was first put forward. In granting the further six-week adjournment sought, the court stated in no uncertain terms that unless at the next adjourned hearing (i.e. on 23 August) there was evidence of a restructuring proposal that had the requisite in-principle support of the creditors, no further adjournments would be entertained and specific directions for the filing of evidence to that end were given, viz.

"The Company and the Opposing Creditors do have leave to file and serve Affidavits in support of the restructuring proposal showing the necessary in principle support on or before 14 August 2000."

The petitions

7. These came on for hearing on 23 August 2000. From the evidence filed, it appeared that the petitioning creditors were seeking a winding-up order and the appointment of provisional liquidators simultaneously. Since the debts underlying these petitions were not disputed, much of the evidence filed was essentially in support of the application for the appointment of provisional liquidators. Procedurally there was an inconsistency in this dual approach : if a winding-up order were made, the Official Receiver would become provisional liquidator by virtue of section 194 of Cap.32 and no question of appointing provisional liquidators would arise. Alternatively, the petitioning creditors could proceed with their section 193 application either on the basis that the petitions were to be further adjourned or if no winding-up orders were made at that hearing. The two could not proceed in tandem.

8. Upon that intimation from the court, the petitioning creditors decided to proceed with the winding-up petition rather than with their application for the appointment of provisional liquidators. They did not pursue the contention (foreshadowed in their supporting affidavits) that to obviate the need for the Official Receiver to become provisional liquidator pursuant to section 194(1)(a), it was open to the court to appoint provisional liquidators pursuant to section 193 immediately prior to making a winding-up order without, as it were, hearing a substantive application for the appointment of provisional liquidators. The purpose of such an exercise would be nothing less than to 'circumvent' the application of section 194(1)(a). Had it been necessary to decide that question, which would have involved construing sections 193 and 194(1)(a), I have no doubt that I would have ruled against the petitioning creditors. The device proposed was artificial and contrary to the spirit and intendment of those provisions.

The Companies' application for an adjournment

9. At the hearing, the Companies (supported by Toyo) applied for a four-week adjournment. Whilst accepting that they were not in a position to demonstrate the in-principle support required, the Companies submitted that the restructuring proposal was proceeding in a "positive fashion". A document described as "Revised Restructuring Proposal" dated 16 August 2000 ("the Revised Restructuring Proposal") had been circulated to all bank creditors who together held 54% of the overall indebtedness of the Companies. It was submitted, inter alia, that because the Akai group of companies is a global conglomerate, the proposal restructuring was necessarily complex and more time was therefore required.

10. There was a conflict of evidence as to the number of proposals preceding the Revised Restructuring Proposal, whether the earlier proposals had been rejected outright as unacceptable and/or whether counter-proposals had been made such that negotiations had never broken down. For present purposes, it is unnecessary to resolve those differences.

11. As to the Revised Restructuring Proposal itself, the petitioning creditors maintained that that had been rejected by the steering committee. The Companies and Toyo disagreed.

12. It is common ground that on 16 August, an all-banks meeting was held. Whilst it was accepted that there was no consensus as to the terms of the Revised Restructuring Proposal as at the date of the hearing, the position of the Companies and Toyo was that the Revised Restructuring Proposal was still alive and under active consideration and that HSBC had informed the Companies that they considered that there was "evidence of a continuing willingness on all parties to seek a deal that would be satisfactory". A further meeting had in fact been set up for the afternoon of the day of the hearing itself. The Companies maintained that the purpose was to continue discussions with a view to 'finalizing' the terms of the Revised Restructuring Proposal.

13. HSBC and the Bank of Nova Scotia filed affidavits in support of the adjournment sought. The contents were substantially similar. The deponents being the relevant bank officers involved in the negotiations concerning the Revised Restructuring Proposal stated that :

"...the proposed restructuring of the Akai group is proceeding in a positive fashion. The Revised Restructuring Proposal gives me confidence that, ultimately, a restructuring of the indebtedness of the Company will result in the creditors of the Company receiving more than they would in an immediate winding up of the Company."

Pausing there, whatever the status of the Revised Restructuring Proposal, it is clear that negotiations as to its terms had not come to an end but were still ongoing as at the date of the hearing.

14. The deponents further opined that an immediate liquidation of the Companies would not be in the best interests of the creditors. As regards the benefits which would result from a restructuring, counsel for the Companies referred to the estimate of liquidation recoveries under a liquidation scenario contained in the Information Memorandum made by FH, predicated on the recovery of over US$100 million from pledged assets outside Hong Kong as well as to the Revised Restructuring Proposal which set out initial and potential recoveries calculated by reference to the relative share price of Akai Electric Company Limited ("AEL"). It was contemplated that creditors would be issued AEL shares as part of the restructuring exercise. If the AEL shares were to reach the base share price of 20 yen shown for the initial recovery only and not the higher share price, the initial recovery still compared favourably with the anticipated liquidation recovery. The petitioning creditors were sceptical of the anticipated recovery rate under the Revised Restructuring Proposal since it was predicated upon enlarging the shareholding of AEL from 425 million shares to 1698 million shares. Suffice to say that the court cannot realistically form a view as to which of these is to be preferred without the assistance of experts and it would be presumptuous for it to do so.

15. HSBC and the Bank of Nova Scotia together hold approximately 25% of the overall indebtedness. Although initially it was submitted on Toyo's behalf that it held 17% of the overall indebtedness, counsel for Toyo later accepted that 12% would be more accurate. On that basis, taken together, creditors holding some 37% of the overall indebtedness supported the adjournment. It was urged that the court ought to have regard to the wishes of the majority. In this context, the petitioning creditors and the supporting creditors together hold only about 5.4% of the overall indebtedness.

16. But the matter was not as simple as that. The percentages mentioned above were referable to the overall indebtedness rather than unsecured indebtedness. Most of the bank creditors were partially secured. Obviously the rate of recovery under a restructuring would vary greatly depending on the extent of that security. Appendix A to the Revised Restructuring Proposal showed that the initial recovery rate (including the secured portion) for bank creditors ranged from 4% to 100%. For this reason, the percentages of overall indebtedness relied on were not of particular assistance. No one saw fit to approach the question from the perspective of unsecured indebtedness.

17. The petitioning creditors were also critical of the failure of the Companies and/or Toyo to address in any meaningful way the numerous areas of concern elaborated at great length in the several affidavits filed by the petitioning creditors relating to the absence of any sufficient explanation for the huge operation loss of US$1.82 billion suffered by the Group for the year to 31 January 2000, the lack of information regarding the Companies' financial position for the period from February to July 2000, and 'loss' of assets since the presentation of the petitions. Implicit in all of this were allegations of serious misconduct on the part of the Companies and/or Toyo and/or those who control them. As noted earlier, the evidence filed by the petitioning creditors served a dual purpose, the "areas of concern" being of particular relevance to the issue of the appointment of provisional liquidators. The evidence filed by the Companies and Toyo did not address those allegations substantively which may have been due to time constraints since the section 193 summons was only taken four days prior to the hearing and the issue in the earlier hearings was confined to restructuring. Had the section 193 application been the substantive application, it would have been surprising if leave would not have been sought to adduce evidence in opposition. As that issue was not before the court, it serves no purpose to dwell further on those allegations or to express any views about their merits.

18. In the course of his reply during the afternoon of the hearing, counsel for the Companies produced a schedule to illustrate the extent of support for an adjournment. If the Revised Restructuring Proposal were implemented, certain debts including inter-company debts would be waived, such that of the overall indebtedness of US$856 million, the scheme debts would be of the order of US$633 million. Counsel for the Companies contended that the adjournment had the support of creditors holding in the aggregate 66.5% of the scheme debts :

The notes to the Schedule identified those in support and in opposition to the adjournment. At first blush, the percentages shown bore little relation to the evidence that had been adduced. Then, inexplicably belatedly and out of the blue, letters from five creditors allegedly supporting an adjournment were produced for the first time.

19. Some of these letters were proforma responses attached to letters sent from AHL duly completed and returned by the relevant recipient as to whether or not it supported an adjournment. It would appear that at least two letters had been sent by AHL, one dated 19 August and the other 21 August seeking support for an adjournment. The petitioning and supporting creditors did not know anything about the AHL letters and the scope of circulation is an unknown factor. Neither letter was mentioned in any of the affidavits filed on behalf of AHL and no reference was made to such letters at the outset of the hearing which I find incredible.

20. Be that as it may, there were proforma replies from the Bank of Tokyo-Mitsubishi Limited, Hang Seng Bank Limited and Ing Bank N.V., which appeared to support an adjournment. The fourth was a letter from Bank of America but its support for an adjournment was qualified :

"... If your Company and the White Knight are prepared to aggressively pursue with sincerity from now on unlike before, we are prepared to support a further adjournment of the winding-up petition for not more than one month subject to a meaningful restructuring proposal in place."

Finally, there was also a letter from a non-bank creditor, Sansui Electric Company Limited ("Sansui"), giving in-principle conditional support subject to acceptable legal documentation. All the responses other than the one from Sansui were dated 22 August. Plainly the Companies were in a position to disclose those letters prior to the commencement of the hearing but they must have made a conscious decision not to do so. What was even more surprising was the fact that neither of the AHL's letters dated 19 and 21 August was available in court.

21. As regards Sansui's reply, that was dated 23 August, the date of the hearing itself. Hitherto, restructuring negotiations had not involved creditors other than bank creditors. Sansui's letter was thus a total surprise. It then emerged that Akai owned 42% of Sansui and Toyo and Sansui had a common chairman.

22. What is the court to make of all this? The Companies' approach to the hearing is, to say the least, incomprehensible given the specific directions made on 26 June 2000 set out above. The surreptitious manner in which "additional support" for an adjournment was presented to the court in the course of the Companies' reply and the unavailability of the Companies' circular letters dated 19 and 21 August in court are considerations which affect the court's assessment of the Companies' sincerity and good faith, and in particular, whether they have made a full and frank disclosure to the court of circumstances relevant to the exercise of the court's discretion.

23. Leaving aside the court's serious reservations, and assuming in favour of the Companies and Toyo that creditors holding 66.5% of the scheme debts support an adjournment, that of itself would not be sufficient reason for the discretion to be exercised in favour of the Companies. It is not the case that the Revised Restructuring Proposal was acceptable in principle to 66.5% of the scheme creditors; rather, that Proposal had not even been finalized, being subject to further negotiations. Whether or not those would culminate in an agreement which could then form the basis for seeking in-principle support is entirely speculative. It would have been different had there been an agreement as to the terms of the restructuring which had the support of 66.5% of the scheme creditors. Had that been the case, a short adjournment might have been justified to enable the Companies to obtain the support of creditors holding another 10% or so of scheme debts.

24. Further, the evidence filed on behalf of HSBC and the Bank of Nova Scotia was couched in guarded terms. That negotiations were proceeding in a "positive" fashion could mean any number of things. The word used was too elastic and imprecise. How close the parties were to a consensus remained a matter for speculation. If the meeting fixed for the afternoon of the date of the hearing was for "finalization" of the Revised Restructuring Proposal as was the Companies' position, (the implication being that the parties, or at least the Companies, Toyo and the steering committee were very close to reaching a consensus,) I would have expected HSBC and the Bank of Nova Scotia to have said so. They did not. Further, the absence of any explanation as to why the meeting scheduled for the afternoon of the date of the hearing could not have taken place earlier smacked of a ploy to gain further time.

25. The court has already been more than indulgent in terms of adjournments granted, with full regard to the complexity of the restructuring exercise. Much more than the conventional four week period has been given to enable the Companies to come up with a restructuring proposal acceptable to the majority of the creditors. At least four months have come and gone without any consensus being reached as to its basic terms. In the circumstances, the case for a further adjournment has not been made out and it would not be right to exercise my discretion in favour of the Companies' application.

Conclusion

26. As the debts were undisputed, winding-up orders must necessarily follow the refusal of the application for an adjournment.