RE HONG KONG PHARMACEUTICAL HOLDINGS LTD

2.  The provisional liquidators seek an order that they have the sanction of the court to enter into a settlement agreement (“the Settlement Agreement”) between the Company, its wholly owned subsidiary, HK Pharmaceutical (PRC) Distribution Limited (“HKPD”), and various individuals known as “the Noteholders” in the Settlement Agreement.

3.  The application was initially opposed by the petitioning creditor, Goldon Investment Limited, and the Official Receiver.  The petitioning creditor has withdrawn its opposition on 12 September 2005 but the Official Receiver maintains his stance.

4.  I will first summarise the transaction contemplated in the Settlement Agreement.  On or about 13 August 2001, the Company entered into a share transfer agreement (“the Share Transfer Agreement”) with the Noteholders by which their 51% interest in Guizhou Ensure Chain Pharmacy Company Limited (“Ensure”), held through Joinbest Investment Limited (“Joinbest”), was transferred to the Company for HK$15,254,400.00, to be paid by the Company by a cash consideration of HK$3 million, and the issue of convertible notes with an aggregate principal amount of HK$12,254,400.00.

5.  Ensure is a company incorporated in the People’s Republic of China and formed as a sino-foreign joint venture.  Its main business is the retail of Chinese and western medicine in Guizhou province in the Mainland.

6.  Joinbest is a company incorporated in the British Virgin Islands.

7.  Pursuant to the Share Transfer Agreement, HKPD became the legal and beneficial owner of all the issued shares of Joinbest, and the convertible notes were issued by the Company to the Noteholders.

8.  Each convertible note is convertible at HK$1.38 per share into a total of 8.88 million ordinary shares of the Company, and they have matured on 30 March 2005.  The principal amount owing under the convertible notes to the Noteholders is HK$12.2 million odd.  The Company does not have the financial resources to meet this obligation.

9.  By the Settlement Agreement, it is proposed that the Company’s liability under the convertible notes is to be dealt with as follows:

(1)	the Company will return all of its 51% interest in Ensure to the Noteholders by HKPD transferring all the Joinbest shares to the Noteholders or their nominees;
(2)	in return, the Noteholders will pay a cash consideration of HK$3 million to the Company; and
(3)	the Noteholders will provide a release of all their claims against the Company, including any claim for repayment of the outstanding principal of HK$12.2 million under the convertible notes.

In short, the above steps would result in an “unwinding” of the Share Transfer Agreement and place the respective parties in the position as if the original transaction had never occurred.

10.  The provisional liquidators are of the view that the Settlement Agreement will be in the best interests of the Company and its creditors, whether looked at on a purely financial basis, or from a risk or operational perspective.  They have given reasons why it seems unlikely there would be any purchaser of the Company’s 51% interest in Ensure, apart from the Noteholders.  I have no reason to question the provisional liquidators’ assessment that it is unlikely there would be any other purchaser for this asset.

11.  The provisional liquidators have the support of the 3 main creditors of the Company, whose debts make up approximately 95% of the total liabilities of the Company.  They are Umbrella Finance Company Limited, the petitioning creditor, and, for obvious reasons, the Noteholders.

12.  I should also mention that on 25 August 2005, the Stock Exchange of Hong Kong Limited gave conditional approval of the resumption of trading in the shares of the Company, upon completion of the restructuring as detailed in the resumption proposal submitted to the Listing Division.  On 7 September 2005, the provisional liquidators signed the Debt Restructuring Agreement with an investor (“the Investor”), by which the Investor is to obtain majority control of the shares in the Company upon the consideration stated, and subject to the satisfaction of certain conditions precedent.  The winding-up petition of the Company has been adjourned to a date in January 2006 for the Company to take necessary steps to implement the restructuring by a scheme of arrangement.

13.  The principal operations of the Company and its subsidiaries comprise 3 business units:

(1)	the retail and wholesale of pharmaceutical and traditional Chinese medicine in Hong Kong through Nam Pei Hong Sum Yung Drugs Company Limited;
(2)	the retail of pharmaceutical and Chinese medicine in Guizhou province through Ensure, in which the Company holds a 51% interest; and
(3)	the manufacture and distribution of biotechnological products in Shanghai through Shanghai Hua Xin Biotechnology Company Limited, in which the Company holds a 57% interest.

14.  The restructuring by the scheme of arrangement will not include the businesses of Ensure and Hua Xin.  The Investor is not interested in taking over the Company’s interest in Ensure.  It is the understanding of the provisional liquidators that the Investor will be negotiating with Ensure to enter into a supply arrangement to sell the products of the Company through the pharmacy network of Ensure.

15.  The Official Receiver is opposed to this application for sanction for two main reasons:

(1)	The Settlement Agreement amounts to a compromise or arrangement between a class of creditors and the Company.  This compromise should be approved by a scheme of arrangement under section 166.  It is inappropriate for the provisional liquidators to bypass the requirements of section 166 to implement a scheme of arrangement.  Reliance was placed on the decision of Le Pichon J (as she then was) in Re SinoAmerican Telecom Inc, HCCW No. 329 of 1998, 3 July 1998, which was upheld by the Court of Appeal in [1998] 3 HKC 514.
(2)	There is no independent valuation of the Company’s interest in Ensure, there is risk that the disposition in the Settlement Agreement might be at an undervalue and thereby prejudice the interest of unsecured creditors.

16.  Under the order I made on the appointment of provisional liquidators, it was provided in paragraph 4 that the provisional liquidators would have, inter alia, these powers:

“	(g)	to enter into discussions with potential purchasers for the sale of any of the Company’s Assets, and to enter into confidentiality or exclusivity agreements relating to any proposed sale;
	(h)	to formulate and carry out a restructuring of the business of the Company or its Affiliates and/or enter into a compromise or arrangement, including without limitation under section 166 of the Companies Ordinance (Cap. 32), on the Company’s behalf with the creditors of the Company …, provided that any such compromise or arrangement shall not be binding on the Company’s creditors until approved by this Court.”

17.  Under paragraph 4(g), the provisional liquidators would only have power to enter into a discussion for sale of any of the assets of the Company and to enter into a non-binding agreement.  Under paragraph 4(h), the provisional liquidators are empowered to enter into a compromise or arrangement, including a compromise or arrangement under section 166, provided that any such compromise or arrangement is not to be binding on the creditors until approved by the court.

18.  Under section 193(3), the court may limit and restrict the powers of the provisional liquidators by the order appointing them.  In paragraph 7 of the order on appointment, the provisional liquidators are given liberty to apply generally.

19.  I turn to the first ground of opposition raised by the Official Receiver.  Should the provisional liquidators be required to implement the Settlement Agreement by a scheme of arrangement and comply with the requirement under section 166?

20.  The Official Receiver submitted that the Settlement Agreement involves a compromise with a class of creditors, namely the Noteholders, and thus fall within the wording of section 166.  Hence, the compromise should be implemented by a scheme of arrangement under the procedure provided in that section.

21.  Section 166(1) provides as follows:

“Where a compromise or arrangement is proposed between a company and its creditors or any class of them, or between the company and its members or any class of them, the court may, on the application in a summary way of the company or of any creditor or member of the company, or, in the case of the company being woud up, of the liquidator, order a meeting of the creditors or class of creditors, or of the members of the company or class of members, as the case may be, to be summoned in such manner as the court directs.”

22.  I am satisfied that the Settlement Agreement does involve a compromise or arrangement within the meaning of section 166.  Under normal circumstances, the principles enunciated by Plowman J in Re Trix Ltd [1970] 1 WLR 1421 should apply and they may be stated as follows: the proper way to distribute the assets of a company other than strictly in accordance with creditors’ rights is by a scheme of arrangement under section 166 which binds all creditors, and not by an agreement of compromise under section 199(1)(e), which would deprive non-assenting creditors of the court’s protection and prevent them from expressing their views.  See Re Bank of Credit and Commerce International SA (No. 2) [1992] BCC 715 at 731B to G, and Re SinoAmerican, supra at 522D to H.

23.  If I am concerned here with liquidators and not provisional liquidators, I have no doubt that this would be within the letter of section 199(1)(e) for the court to approve the compromise in the Settlement Agreement by the powers in that provision (see Bank of Hindustan, China & Japan Ltd v Eastern Financial Association Ltd (1869) LR 2 PC 489; Re Commercial Bank Corporation of India and the East (1869) LR 8 Eq 241).  Whether the court should do so under the compromise provision in section 199(1)(e), instead of under section 166, is another matter.

24.  It is not in dispute that where special circumstances are shown, the court has a residual discretion to sanction compromise and not insist on the procedure in section 166 to be followed.  In Re Bank of Credit and Commerce, this discretion was exercised as it was not practicable to hold creditors’ meetings, let alone class meetings, to ascertain the wishes of creditors, due to the sheer number of creditors worldwide and that a substantial portion of them had given no or incomplete addresses.  Similarly, in the case of Taylor, Noter [1992] BCC 440, cited in the Bank of Credit and Commerce, it was not practicable for a creditors’ meeting to be held, as assets of the companies and of the sequestered estate were so confused that it was not possible to identify the assets of each and it was practically impossible to determine who the true debtors were.

25.  In the present case, it is not impracticable to hold a creditors’ meeting.  Nevertheless, it was submitted by the provisional liquidators that special circumstances do exist and that the court should not insist on the adoption of the procedure in section 166.

26.  Firstly, there is an overwhelming majority of creditors in favour of the Settlement Agreement.  Their debts make up 95% of the total indebtedness.  I should say this in itself is not a compelling factor, as in Re SinoAmerican,it was also represented to the court that 95% of the creditors supported the proposed transaction.  The court must be satisfied that the consent of the creditors is informed or true consent, and that they were “properly, accurately and fairly informed prior to taking a decision” (at 523A).

27.  Secondly, the Settlement Agreement was not a wholesale disposal of the Company’s assets, unlike the situation in Re SinoAmerican.  It involves merely a single asset of the Company and the compromise is with just one group of creditors.

28.  Thirdly, in the event that the 51% interest of the Company in Ensure is not disposed of by way of the Settlement Agreement, it would be dealt with as part of the main scheme of arrangement for the Company.  HKPD would be liquidated by the scheme administrators and the interest of Ensure transferred to the scheme fund to be distributed to the general body of creditors.  However, as it is unlikely there would be any buyer interested other than the Noteholders, the 51% interest in Ensure is unlikely to be sold, or if sold, would be for a substantially lower price.  The end result might be that the scheme administrators would have to sell the 51% interest in Ensure back to the Noteholders, and the same result as what is contemplated in the Settlement Agreement would be achieved, although there would be significant delay, there would be no assurance the same terms as offered in the Settlement Agreement would be obtained by the scheme administrators, and there would be no reduction in the liabilities of the Company by HK$12.2 million being the claims of the Noteholders.  To insist on following the procedure under section 166 would only lead to unnecessary costs, significant delay, and a probably less advantageous outcome for the unsecured creditors.  The provisional liquidators are concerned that if the offer in the Settlement Agreement is not taken, they might not have a comparable offer again.