CHOI SHING WAH v. EXCEL SPACE DEVELOPMENT LTD.

IN THE HIGH COURT OF THE

HONG KONG SPECIAL ADMINISTRATIVE REGION

COURT OF FIRST INSTANCE

COMPANIES WINDING UP NO. 478 OF 1994

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JUDGMENT

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1. In this petition, the Petitioner has asked primarily for an order that his shares in a company be purchased by the other shareholders. Before I deal with the issues that have arisen in this petition, it is necessary to understand the background.

Background

2. In 1989 and the early 1990's, the Petitioner Raymond Choi Shing Wah ("Choi") and James Leung King Yin ("Leung") had a successful computer software business. They had 2 companies, called Kent Sonic Ltd and Fieldson Ltd. Kent Sonic was the more active company. Mr Choi held 49% and Mr Leung, 51% of Kent Sonic.

3. Mr Choi was a skilled computer programmer who was in charge of the technical side, and Mr Leung, who was himself an electronics engineer, was in charge of the business side, obtaining contracts from customers and acting as liaison between the customers and Kent Sonic's engineering personnel.

Acquisition of property

4. As their businesses became more successful, they ran out of space at the rented premises which they occupied, the lease of which was also expiring. By 1992, they had accumulated some profits, so they decided to buy premises.

5. At that time, Kodak House II in North Point, a new development, was available for sale at $3,000 per sq. ft. However the smallest unit then available was 1,919 sq. ft. The total purchase price would cost $5,757,000.

6. In view of the excess capacity, they looked for someone to share the burden of acquiring the extra space. Mr Leung's room-mate at university, Joe Shek Shing Kuen ("Shek") had started a computer business called Comtech Computer Co. with 2 other associates, and they were also looking for premises. The other 2 associates were Robert Luk Chi Yan and Roden Tang Kim Shing. Mr Tang was also known to Mr Leung as they attended the same church. It seemed a perfect solution for these 2 businesses to occupy separate parts of the new premises.

7. There was a factual dispute as to who first saw the property and who initiated the idea of acquiring it together. In my view, that is not relevant to the issues in the present case. It is common ground that the property was acquired as described below.

Shareholders Agreement

8. Because the parties knew each other, there was no formal agreement. It was decided at an informal meeting at a teahouse in November 1992 that Unit 1204 of Kodak House would be acquired. That was because the layout of that unit was such that it could be conveniently partitioned into 2 sections, a larger section of 1,200 sq. ft at one side for the use of Kent Sonic and a smaller section of about 719 sq. ft at the other side for the use of Comtech. There was also a small hallway at the entrance which would be shared.

9. Although both Kent Sonic and Comtech were looking for premises to operate from, it was agreed that these companies would not be owner-occupiers. Instead it was orally agreed that a new company made up of the 5 individuals (instead of their existing companies) would be formed to hold the property. The reasons for this are important because they provide a key as to the parties' intention.

10. Apparently there were 2 reasons for this. First, it was thought that there would be tax advantages to the computer companies to have to pay rent which they could offset against their profits. Secondly, Comtech was a new company, having been set up only a year ago, and its viability was uncertain. If Comtech failed financially, creditors would look to its interest in the property, and Mr Choi and Mr Leung did not want their property to be co-owned with strangers. If Comtech was merely a tenant, its failure would not affect ownership of the property, only its occupation. Apparently they did not mind an entity other than Comtech occupying the other section.

11. It was therefore agreed that the 5 individuals would form a property-holding company, which would then let the premises to the respective businesses (i.e. the 1,200 sq. ft section to Kent Sonic and the 719 sq. ft section to Comtech). They intended that the rent received from the computer companies would be used to pay the mortgage instalments.

12. There was some dispute at the hearing as to whether there was an agreement between the individuals that they would not sell their shares in the property-holding company for 2 years, or whether the agreement was that the company would not sell the property for 2 years. Mr Leung said quite frankly that no-one had really thought too deeply whether there was any difference. I find that there was an understanding that in the normal course of events, they would not sell the property within 2 years, the normal period of a commercial lease. That was because quite a sizeable amount of money in partitioning and decorating the property would have to be spent.

13. By acquiring the property using a different company and not through Kent Sonic and Comtech, they were no doubt attempting to insulate the property from their computer companies which might succeed or fail.

The Company

14. Accordingly, in November 1992, Excel Space Development Ltd ("the Company") was acquired as the property-holding company. All 5 persons became directors. The nominal capital of the Company was increased.

15. The allocation of the 19,190 shares reflected the intended use of the space in Unit 1204. Thus, Mr Leung and Mr Choi were together allotted 12,020 shares, and Mr Shek, Mr Luk and Mr Tang were altogether allotted 7,170 shares. The latter group held their shares equally. As between Mr Leung and Mr Choi, they more or less held an equal number of shares, Mr Leung holding 6,020 shares and Mr Choi holding 6,000 shares.

16. On 1 December 1992, the Company entered into an Agreement to purchase the property. The Occupation Permit was granted on 31 December 1992.

Guarantee to mortgagee bank

17. A bank had agreed to grant the Company a mortgage. By a resolution dated 19 January 1993, all 5 persons as directors of the Company resolved to acquire the premises and to mortgage the premises to the Bank on an "all monies" mortgage. The mortgage instalments were about $35,000 a month.

18. The Bank required a guarantee and on 28 January 1993, all 5 persons signed a Deed of Guarantee to jointly and severally guarantee repayment by the Company of "all moneys" that might be owed by the Company to the Bank.

Breakdown in relationship between Mr Choi and Mr Leung

19. After partitioning and decoration works had been carried out, the computer companies moved into the premises in March 1993. The monthly rent payable by Kent Sonic for its section was $26,650 and that payable by Comtech for its section was $15,968, making a total of $42,618 receivable by the Company monthly. As far as the Company was concerned, that covered the mortgage instalments of about $35,000 a month, with about $7,000 extra for utilities, management fees, cleaners' charges, rates and other expenses connected with property-holding.

20. Unfortunately, in the months between January and September 1993, the economy suffered a downturn and Kent Sonic's business deteriorated. With that came a deterioration in the relationship between Mr Choi and Mr Leung.

21. Mr Choi complained that Mr Leung was not getting enough orders and that he spent too much time with his friends in the Comtech section. There is no or insufficient evidence that Mr Leung drove out Mr Choi because he wanted to go into high-technology products which required more capital than Mr Choi was unwilling to invest.

22. Mr Leung complained that Mr Choi did not keep normal office hours and it was thus difficult to service customers when they called the office with technical inquiries. There was also a time when Mr Choi was inaccessible.

23. Having seen and heard both persons, I find that as far as these types of complaints were concerned, there was no intention by either Mr Choi or Mr Leung to harm the business or each other. It is an unfortunate fact of life that when times are rough, faults that would have been overlooked or tolerated in smoother times tend to be amplified.

24. For some months before September 1993, Kent Sonic's business was so bad that trade receipts were inadequate to pay the rent. Mr Leung and Mr Choi waived their salaries to enable Kent Sonic to pay the rent to the Company. This was in accordance with the agreement that Kent Sonic had to pay rent for its occupation of the property.

25. Matters came to a head in October 1993 with Mr Choi and Mr Leung going their own ways, and both in effect abandoning Kent Sonic as an on-going business. On 1 October 1993, Mr Leung commenced a sole proprietorship in the name of Kent Sonic Research Company ("KSR"). On 15 October 1993, Mr Choi became a 40% shareholder in a company called Borison Electronics Ltd and he became a director of this Company on 18 October 1993.

26. Mr Leung ran KSR from the section previously occupied by Kent Sonic. However he said KSR was not making enough profit to pay the rent and he was only trying to salvage the situation after Mr Choi walked out on Kent Sonic. Mr Choi moved out because he said it would be impossible for him to share the conference room and research department with KSR. Mr Choi considered that he had no obligation to support the Company financially because it was permitting KSR to occupy the section. There were discussions between the parties which did not result in any compromise.

Petition

27. Subsequently certain matters occurred regarding the conduct of the Company's business and its use of the property which are the subject of complaint by Mr Choi in this Petition issued in October 1994.

28. The main complaint was that in August 1994, a resolution was passed by the directors of the Company (except Mr Choi himself) resolving that from October 1993 (i.e. when Mr Choi left Kent Sonic), KSR and Comtech were or would not be required to pay rent for their occupation of the property, and that payments made into the Company's account for the mortgage instalments would be treated as having come from shareholders' loans for which interest would be charged.

29. After the issue of the petition, the parties tried to settle the matter but they were unsuccessful. No applications were made to the Court by the Company for validation of any proposal to sell the property at any price. The hearing of the Petition took place 5 years after it was filed.

Use of premises

30. After Mr Choi's departure in October 1993 the property was used by KSR and Comtech rent-free until June 1995 when it was let to a third party for a 2-year term from June 1995 to June 1997. The rent received was adequate to cover the mortgage instalments.

31. The tenancy was initially renewed for another term of 2 years from June 1997 but the tenant terminated the lease prematurely in December 1998. In relation to this renewed lease, the rents received were not enough to meet the mortgage instalments and the balance was met by the shareholders of the Company except for Mr Choi.

32. From December 1998 to April 1999, the property was left vacant.

33. Since April 1999 the property has been to another tenant at a substantially lower rent, with the shortfall in the mortgage instalments being met by the shareholders except for Mr Choi.

34. It would appear that the market value of the premises, having risen at one stage, has dropped substantially from the original purchase price of $3,000 per sq. ft to less than half. The Company now owes more to the bank than the value of the property.

Grounds of Petition

35. It should be noted that in the present proceedings, the court is not determining the question who was responsible for the break-up of Kent Sonic and who may have been in breach of duties to that company or to the other shareholder of that company. The company which is the subject-matter of this petition is Excel Space, the property-holding company, and the question is whether Mr Choi has made out his case that after Kent Sonic broke up, the other shareholders of Excel Space had treated him in a way that can be said to be unfairly prejudicial to him as a 31% shareholder of that Company.

36. The conduct that Mr Choi submits was unfairly prejudicial to him were as follows:-

(1) in March 1994, Mr Leung asked Mr Choi to sign minutes dated 2 February 1994 of a directors' meeting of the Company and a minute dated 2 March 1994 of the AGM of the Company when no prior notice of those meetings had been received by him;

(2) on 20 May 1994, the other directors of the Company changed the bank mandate of the Company excluding Mr Choi as a signatory;

(3) on the same day, 20 May 1994, there was filed at the Companies Registry a Notice signed by Mr Leung notifying the Registry that Mr Choi had resigned as a director of the Company effective on 16 April 1994, when no resignation had taken place;

(4) Mr Leung had diverted Kent Sonic's business to Kent Sonic Research since October 1993, and had used the section of Unit 4 which had been let to Kent Sonic without payment of rent or licence fee;

(5) on 6 August 1994, the directors of the Company resolved that the Company would not charge any rents or licence fees for the occupation of the property with retrospective effect from October 1993. The mortgage instalments were treated as having been lent to the Company by its shareholders (except Mr Choi) who charged interest at about 20% p.a.

37. I shall deal with issues (1), (2) and (3) first as, in my judgment, they are relatively minor matters.

38. First, as to the minutes. I find this was an entirely innocuous episode. The company secretary had reminded the directors that the statutory meetings had not been held, so to comply with the Companies Ordinance, a meeting of the directors of 2 February 1994 was minuted, as was an AGM of 2 March 1994. Nothing of importance was involved and there was nothing sinister in Mr Leung's request to Mr Choi to sign those minutes.

39. Secondly, as to the bank mandate. Originally 3 signatures were required to operate the bank account of the Company, viz. Mr Leung, Mr Choi and Mr Shek. After Mr Choi left Kent Sonic, he refused to sign cheques because he said he did not know whether the expenditure was genuinely required for the Company. This was so even though some of the expenses were clearly for the Company, such as secretarial fees.

40. I find that Mr Choi's refusal to sign cheques arose from distrust as well as an objection to KSR's use of the former Kent Sonic section of the property. Therefore the Company was justified in resolving to change the bank mandate in these circumstances, simply to ensure the normal operation of business. As it turned out, the effective date of the change in the bank mandate was much later when it was no longer a matter of dispute. If Mr Choi's petition had been based solely on the change in bank mandate, then it should have been dismissed.

41. Thirdly, I come to the filing of a notice in the Companies Registry that Mr Choi had resigned as a director when in fact he had not. Mr Leung said that the auditor's firm who were also the company secretary had suggested that Mr Choi should resign and had prepared a notice to be filed if Mr Choi agreed to resign at a meeting called for 16 April 1994. Mr Leung had signed the notice, he says in draft and undated.

42. The meeting was held but resignation was not discussed. Mr Leung says the company secretary had by mistake dated the notice and had it filed in the Companies Registry. This is supported by a letter from Chan Yeung & Lai to the Companies Registry dated 16 March 1995. In the light of this letter, I accept that there had been a mistake on their part and I am not prepared to find that there was anything sinister in the filing of the notice.

43. Fourthly, Mr Choi complains of the diversion of Kent Sonic's business to KSR and the use by KSR of the Kent Sonic section of the property. In my view, these are 2 different matters which should be treated differently.

44. As far as the alleged diversion of business is concerned, this has nothing to do with the Company and Mr Choi's interests in it as a shareholder. If Mr Leung were in breach of his fiduciary duties as a director of Kent Sonic, then Mr Choi should have instituted proceedings (in a derivative action) on behalf of Kent Sonic. By the same token, if Mr Choi had been in breach of his duties to Kent Sonic by "walking out", then Mr Leung should have caused Kent Sonic to sue him. These allegations and counter-allegations regarding Kent Sonic should not be confused with their rights in and obligations towards Excel Space, the property-holding company.

45. As far as the use of the former Kent Sonic section is concerned however, that is a different matter, which should now be appropriately discussed with the fifth issue.

46. Mr Leung claimed that after Mr Choi left, KSR occupied the Kent Sonic section because Mr Choi refused to pay his part of the mortgage instalments. That is also the rationale offered for the decision in August 1994 that KSR and Comtech were to occupy the property rent-free, with all payments made into the Company's account to be treated as shareholders' loans bearing interest.

47. Mr Leung sought to justify that position by saying that it was the personal obligation of each shareholder to pay the mortgage instalments. However, when one analyses the intention of the parties as deduced from all the circumstances, that is not correct.

48. The obligation of the 5 individuals was only their obligation as guarantors if the Company failed to pay the mortgage instalments, but it was intended that the Company would pay the mortgage instalments from the rent it received from letting out the property.

49. In this connection it would not matter if the property were let to entities other than Kent Sonic and Comtech. Although the property was originally intended to be let to these companies, it was not agreed that the property could only be occupied by these companies. I find that to be the intention of the parties because the possibility of Comtech's failure was present right at the start - it was the very reason why the property was not acquired by the computer companies but by a separate property-holding company.

50. Since the parties had contemplated that Comtech might at some stage not be able to occupy that section, so that the section would have to be occupied by another entity, why should not the same consideration apply to Kent Sonic? And why would it be necessary for the sections to be occupied only by Kent Sonic and Comtech? After all, the very reason for choosing Unit 1204 was because its layout permitted 2 distinct sections to be partitioned out into mutually exclusive areas.

51. Accordingly, I find that when Kent Sonic (whether because of Mr Leung's fault or Mr Choi's fault) no longer operated from their section of the property and no longer paid rent, the Company should have taken steps to obtain rent for the use of the section from KSR which was the company occupying the area. If KSR could not afford to pay the rent because it was not making a profit, as Mr Leung says, then the Company should have let the section out to a fee-paying outsider. If the returns were inadequate to meet the mortgage instalments, then no doubt the shareholders of the Company would either have to borrow from outsiders, or to meet the shortfall by way of shareholders' loans or injection of additional capital. But the other shareholders never went down that road - they simply took over the property for themselves and acquired priority over Mr Choi to any surplus by becoming creditors of the Company, the contributories being only entitled to any surplus after secured and unsecured creditors.

52. Therefore I find that the other shareholders were acting in an unfair and prejudicial way to Mr Choi when they caused the Company to resolve that from August 1994 onwards, the entire property should be used by KSR and Comtech rent-free and all payments into the Company's account be treated as shareholders' loans at 20% interest. That triggered the petition and Mr Choi's request to wind up the Company or to have his shares bought by the other shareholders.

53. Mr Leung sought to explain the rate of interest, which was substantially higher than the commercial loan rate, by saying that he and his fellow shareholders had to borrow from credit card companies in order to meet the mortgage instalments. But the point is that having agreed that the property-holding Company should be separated from the fortunes (good or bad) of the computer companies, if their computer companies could no longer afford the agreed rent, they should have let the property to outsiders and it would only be if the market rent would still not meet the mortgage instalments that these individuals should have dug into their own pockets.

54. Having found therefore that the other shareholders' conduct was unfair and prejudicial to Mr Choi, the question is what is the appropriate relief.

Relief

55. Mr Choi has asked for an order that the other shareholders purchase his shares. Although the original petition asked for a winding up of the Company, he is not seeking this relief now for the obvious reason that the Company no longer has no value. Of course the Court on an application under s.168A Companies Ordinance has a wide discretion to give relief, which includes an order to wind up the company if it is considered right, but given that the only asset of this Company is the property, and the value of this property is less than the outstanding secured debt, it is clear that there is no point ordering this company to be wound up now.

56. The question then is, if the appropriate relief is a buy-out, at what point in time should be the shares be valued. That makes a large difference in the present case because the property value has gone up and then down over the many years during which this petition was pending.

57. Obviously it would be of benefit to the petitioner for the shares to be valued as at the date of presentation of the petition. That is because at that time, the property value had increased since its acquisition, leading to a growth in the value of the shares in the Company. The Company had bought the property at $3,000 per sq. ft. In September 1994, when the parties attempted to resolve the matter by selling the property, the agreed price was $5,500. As it turned out, the Company was unable to sell the property at this price, but that is an obvious indication that there was some value in the shares as at the date of the presentation of the petition.

58. On the other side of the coin, the remaining shareholders would obviously prefer the shares to be valued as at the date of the order for buy-out. No doubt they would say that to require them to buy the petitioner's shares now, when the Company is not worth anything, would be tantamount to a fine for their misconduct.

59. It is a difficult decision, but in the light of the authorities, I take the view that even taking into account present circumstances, it would be fair and proper for the shares to be valued as at the date of presentation of the petition.

60. In Re Cumana Ltd [1986] BCLC 430, a case which was quoted in Re Tai Lap Investment Co. Ltd [1998] 4 HKC 438, the rationale for the use of the date of the presentation of the petition was that that was the date on which the petitioner elects to treat the unfair conduct of the majority as in effect destroying the basis on which he agreed to continue to be a shareholder, i.e. when he elects the remedy of a buy-out. It is true that in re London School of Electronics Ltd [1986] 1 Ch 211, 224, Nourse J referred to his view that if there be a general rule, he would personally think that the date of the order or the valuation would be more appropriate when the company is a going concern. However that would not be appropriate where the buy-out was sought at a time when the Company was solvent and valuable but, due to the respondents' delay in recognizing the weakness of their position, they did not buy the petitioner's shares until ordered by the Court at the end of the litigation.

61. When property values may vary considerably as they do in Hong Kong, it would not be right for a petitioner, who has offered to sell his shares at the time the petition was presented, to bear the consequences of the respondents' refusal to concede to a buy-out until sometime later. By ordering a buy-out, the Court is vindicating the petitioner's offer to sell his shares at the time the petition is presented because the other shareholders have acted unfairly and prejudicially towards him. The respondents, who of course knew what they had done, should therefore have bought his shares when the petition was presented. If they choose not to do so until a later date, they have to take the risk that their decision not to concede the petition when it was presented might lead to a loss if the market falls. It should be noted that it was always open to the shareholders or the directors to apply to Court for leave to sell the property at any time if they had considered that the market was appropriate. They chose not to do so.

62. Re Tai Lap Investment Co Ltd, referred to above, was another case where there were substantially different values between the date of the presentation of the petition and the date the buy-out was ordered. The Court of Appeal held that the trial judge had exercised her discretion properly in valuing the shares at the date of the presentation of the petition and Rogers JA held that he would have done the same. He said that the appropriate date is the date where the wrongful conduct has unequivocally been declared by the petitioner to be unacceptable. If the respondents had acted properly after the presentation of the petition, they would not have defended the matter but would have conceded. Godfrey JA said that once the petitioner has sought a buy-out in his petition, the risk of any fall in the value of the shares since that date is thrown on the respondents and there was nothing unfair in that.

63. In the circumstances, I would order that the Petitioner's shares in the Company be purchased by the other shareholders, the shares to be valued as at the date of presentation of the petition. I will give an order nisi that the respondents bear the costs of the petition, and will give liberty to the parties to apply for any ancillary orders or as to the working out of the order.