HCCW152/2008

HCCW 152/2008

IN THE HIGH COURT OF THE

HONG KONG SPECIAL ADMINISTRATIVE REGION

COURT OF FIRST INSTANCE

COMPANIES WINDING UP PROCEEDINGS NO. 152 OF 2008

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Between

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J U D G M E N T

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INTRODUCTION

1.  In this petition, the Petitioner, Cosmo Solution Limited (“Cosmo”), seeks an order to have the 3^rd Respondent, Hercules Holdings Limited (the “Company”) wound up on just and equitable grounds or that the 1^st Respondent, Wisetrade Far East Limited (“Wisetrade”) and the 2^nd Respondent, Yip Siu Nga (“Yip”) do purchase Cosmo’s shares in the Company pursuant to section 177(1)(f) and section 168A of the Companies Ordinance, Cap 32.  In the course of the trial, Mr Chan, counsel for Cosmo, withdrew the winding-up petition.  The petition proceeded solely on the alternative limb under section 168A for an order for buying out Cosmo’s shares by Wisetrade and Yip.

Dramatis personae

2.  Cosmo is a software company specialized in development of medical service software and had been engaged in information technology (“IT”) business for over twenty years.  Yung Siu Ming (“Yung”) is the majority shareholder and person in charge of the company.  For all intents and purchases, he is the alter ego of Cosmo.  He is assisted by his wife, Mrs Yung.

3.  Wisetrade is a company incorporated in British Virgin Islands.  It is owned and controlled by Cheng On Cheong Leonard Andy (“Cheng”), a radiologist.  It holds 83.07% of the issued shares of the Company.  Cheng is the alter ego of Wisetrade.  

4.  Yip is a trusted friend and business associate of Cheng.  She is the general manager of the Company in which she has a shareholding of 3.38%.  

5.  The Company was incorporated in Hong Kong on 12 January 2006 with a paid up capital of $25,089,000 divided into 83,630 shares of $300 each.  At present, Wisetrade, Yip and Cosmo are its only shareholders, holding 69,470, 2,830 and 11,330 shares respectively.  The objects of the Company were to be the holding company for a medical services company and a set of medical application software for provision of medical services and any services of similar or analogous character.

6.  Hercules Medical Diagnostic & Laboratory Group Limited (“Hercules MDL”) was incorporated in Hong Kong on 19 April 2004 with an authorised and issued share capital of $25,000,000 divided into 25,000,000 shares of $1 each.  Wisetrade was its majority shareholder until 16 February 2006.  Since then, the Company became the majority shareholder holding 12,750,000 shares, i.e. 51% of its issued share capital.  Yip holds 110,000 shares, i.e. 0.44%.  The balance of 12,140,000 shares, i.e. 48.56% are held by twenty-two other shareholders, who are either medical practitioners or their corporate nominees.  Cheng is one of its three directors.

7.  Hercules Group refers to Hercules MDL and a group of medical diagnostic centres established under Hercules MDL towards the end of 2004.

8.  So Yeuk Hon John (“So”) has been the head of the finance and accounting division of Hercules Group, including the Company and Hercules MDL since January 2008.  He was formerly an audit trainee and then an audit supervisor in Dominic Y.C. Ng & Co. CPA, the auditor of the Company. He passed level 2 of the examination for qualifying as a member of the Association of Certified Chartered Accountant. 

9.  Lee Chun Hung (“Lee”) is the technology and development director of Aptom International Limited (“Aptom”), the current IT services provider to Hercules Group.  He graduated from the Liverpool John Moores University in England with a bachelor of science degree in biomedical sciences in 1994 and a master of science degree on information systems from the University of Liverpool in England in 1995.  He acquired membership in a number of professional bodies related to medical laboratory technology and computer science.  In October 2007, Yip invited Aptom to have a test run of Aptom’s IT solutions for Hercules Group.  Subsequently, in March 2008, Hercules Group contracted with Aptom to provide IT solutions to Hercules Group.  Lee was called as an expert in computer and information technology by the Respondents.

Credibility of witnesses

10.  This petition involves both factual and legal disputes.  Credibility of witnesses is of course important.  Yung was the sole witness called by Cosmo.  The Respondents called four witnesses, Cheng, Yip, So and Lee.  In this section, I shall state my overall view of their credibility. I shall deal with specific aspects of their evidence in my fact finding below.

11.  Lee is a director of the IT services provider of Hercules Group.  He was called as an expert and factual witness.  He was a non-interested witness.  His evidence was not in dispute.  He gave evidence in a fair manner.  I accept his evidence as an expert witness in IT.

12.  So is an accountant in charge of the finance and accounting department of Hercules Group since January 2008.  Though not so qualified, he claimed in his witness statement to be a chartered accountant and was presented as a chartered accountant by Cheng and Yip.  He did not even know the names of the professional bodies of which he is an associate member.  The Respondents attempted to tender him as an expert witness.  But his evidence on accounting principles is of doubtful reliability.  I do not accept his evidence as an accounting expert.  But his factual evidence was not controversial.

13.  The evidence of the remaining three witnesses, Yung, Cheng and Yip was controversial.  They were all selective in telling the truth.  Of the three, Cheng was the most incredible.  He is an entrepreneur with vision, a shrewd businessman but a person of rather low commercial morality.  Yip did not have much evidence of important to tell and little to lie about.  Yung was caught exaggerating in parts of his evidence and was hiding Cosmo’s involvement in the interruption to Hercules MDL’s IT system on 1 January 2008.  But he was the least incredible of the three.

The background

14.  Since around 1994, Cheng had been managing Opus     Medical Diagnostic Centre (“Opus”), a radiological/medical diagnostic laboratory/clinic, with the assistance of Yip.  In early 1996, Cheng was looking for an IT solutions for Opus and came to know Yung and Cosmo which subsequently supplied IT solution to Opus.

15.  In November 1999, Opus was sold to a group of investors in the medical diagnostic industry called Vista Healthcare which in turn resold it to a mega medical diagnostic services provider known as British United Provident Association Limited (“BUPA”).  Since then, Cheng and Yip worked under BUPA.  Cosmo also supplied IT solutions to BUPA.

16.  In about the fall of 2004, while still in the employ of BUPA, Cheng was planning to establish a group of medical diagnostic centres under the generic name of “Hercules” which would carry on the same line of business as Opus or BUPA.  His involvement was covert to avoid complications with BUPA.  Yung assisted Cheng in forming Wisetrade and was its shareholder and director.  He executed a declaration of trust declaring that his share in Wisetrade was held for and on behalf of Cheng.  He also assisted Yip in establishing Hercules Group’s domain name in the website.  Wisetrade became a majority shareholder of Hercules MDL. 

17.  Between January and February 2005, an initial arrangement was reached between Cheng and Yung whereby Cosmo would provide to Hercules Group customised IT solution (“Software I”) for $2 million, IT maintenance services at $30,000 per month (“IT services contract”) and management services at $50,000 per month (“management services contract”).  The parties are in dispute as to whether at that stage Cosmo had agreed to invest in the software business of Hercules Group.

18.  In February 2005, Software I was set up and installed in Hercules MDL; but Cheng delayed payment for the reason that he had not yet determined which member of Hercules Group would be the buyer or owner.  In March 2005, Yung was appointed as the chief executive officer (“CEO”) of Hercules Group.  Since then, Cosmo provided management services through Yung acting as the CEO of Hercules Group and the IT maintenance services to Hercules Group.  The management fee of $50,000 and the IT service fee of $30,000 were paid by Hercules MDL to Cosmo.  From 1 March 2005 to 31 October 2006, Mrs Yung worked part time as an in-house software programmer, book keeper and supervisor of the use of Software I.  She was given the title of “Administrator” and the access code “super” for accessing Hercules Group’s accounts and computer system. The parties are in dispute as to whether Mrs Yung or Yip was in charge of accounting matters of Hercules Group at the time.

19.  A number of events occurred in August 2005. First, Cheng caused Yung to be appointed as a director of Hercules MDL, in addition to Yip and another director, Dr Ho.  To Yung’s understanding, his appointment was to protect Cheng’s interest in outvoting Dr Ho as Yip had difficulties dealing with her.

20.  Second, Yung sent a contract in respect of the sale of Software I between Cosmo and Hercules MDL dated 7 August 2005 to Cheng, setting out the terms of that sale.  Cheng did not respond.  Hercules MDL continued to pay the management fee and IT maintenance fee.

21.  Third, Cheng requested Yung to develop and set up a new software (“Software II”) which involved the making of digital imaging and communications in medicine (“DICOM”) images, which are basically detailed and high quality three dimensional images of anatomical parts in three colour tones and accessing of such DICOM images and data in Hercules Group’s network of computers at all its centres through the internet.  Software II was installed by around December 2005.  The parties are in dispute as to whether Cosmo was entitled to charge for Software II. 

22.  On 12 January 2006, the Company was incorporated with Cheng as its sole shareholder and director.  Cheng’s involvement with Hercules Group became overt.  He replaced Yip as director of Hercules MDL, which board consisted of Cheng, Yung and Dr Ho. 

23.  On 28 June 2006, Wisetrade, Yip and Cosmo were respectively allotted 65,169, 2,830 and 11,330 shares in the Company.  It is common ground that the shares allotted to Cosmo was in payment of the price for Software I and Software II in the amount of $3,399,000.  The parties are in dispute as to how the allotments were made. 

24.  While it is common ground that the Company was formed with the principal object of holding Hercules MDL, the parties are also in dispute as to whether the Company was intended to be a partnership vehicle between Cheng, Yung and Yip or their alter egos.  Yung said it was.  Cheng said it was not but a vehicle to enable investors to invest indirectly in Hercules MDL through the Company.

25.  In October 2006, Mrs Yung left the employ of Hercules MDL.  In December 2006, Cheng caused Hercules MDL to terminate the management services contract in order to reduce cost of the operation and to terminate Yung’s appointment as CEO.  In January 2007, Cheng asked Yung to resign as director of Hercules MDL as he was not a shareholder and no longer its CEO.  Yung complied.  As a result, Cosmo was severed from the management of the Company, Hercules MDL or Hercules Group altogether.  Yung requested Cheng to buyout Cosmo’s investment in the Company, but Cheng refused.

26.  In March 2007, the term of two years for the IT services contract expired.  Thereafter, Cosmo continued to provide IT maintenance services on a month to month basis.

27.  On around 20 June 2007, Cosmo received a board resolution of the Company dated 25 May 2007 signed by Cheng to convene an annual general meeting of the Company on 20 June 2007 to consider, inter alia, granting unconditional approval to any loan made or to be made to Cheng or any company controlled by him.  Yung did not attend the meeting as he thought being a minority shareholder of 14% he could not do anything to oppose the passing of the resolution.

28.  The Company defaulted paying the maintenance fees in October 2007.  Then on or about 8 October 2007, Cosmo received an audit confirmation from the Company’ auditor that (1) as at 31 March 2007 Cosmo was owing the Company the sum of $3,399,000 being the unpaid share capital for its 11,330 shares; and (2) the Company was in turn indebted to Cosmo in the amount of $30,000 for maintenance fees.  Yung or Mrs Yung telephoned Yip and raised objection to the audit confirmation.

29.  Later in October 2007, Cosmo received a written complaint from Hercules MDL about the software.  The problem was quickly solved by Cosmo.  Then, on 31 October 2007, Yip faxed a proposal from Aptom with a quotation detailing Aptom’s IT solution and implementation schedule to Cosmo. 

30.  On 24 December 2007, Cosmo received a copy of the auditor’s report of the Company dated 11 October 2007 for the period from 12 January 2006 to 31 March 2007 which reflected that Cosmo had not paid for its 11,330 shares.  This formed the basis of Cosmo’s petition for buyout by the Respondents.  On 27 December 2007, Cosmo sent a written notice to Hercules MDL to terminate its IT services contract on 31 December 2007.   

31.  On 1 January 2008, Hercules MDL experienced interruption in its IT system when using Software I and Software II, which it alleged was caused by Cosmo’s hacking activity.  As a result of the interruption, Hercules MDL instructed Aptom to install its IT solution in Hercules Group’s computer system.  The parties are in dispute as to the circumstances leading to Hercules Group seeking the services from Aptom.

32.  On 11 April 2008, Cosmo’s solicitors wrote to Wisetrade and Yip proposing them to buyout its shares in the Company.  Wisetrade and Yip did not respond.  On 18 April 2008, Cosmo petitioned for winding up of the Company.

The issues

33.  As Cosmo has withdrawn the winding up petition, the sole issue for the Court to determine is whether Cosmo has discharged its burden of proving that the affairs of the Company have been conducted by Wisetrade and Yip in a manner unfairly prejudicial to the interests of Cosmo as a shareholder under section 168A of the Companies Ordinance. 

34.  The basis of Cosmo’s petition is to be found in paragraphs 28 to 30 of the Amended Petition.  In essence, Cosmo alleged that the Company was incorporated as a quasi-partnership between Cosmo and the Respondents but as a result of the Respondents’ conduct, the trust and cooperation between the partners had gone, the quasi-partnership could no longer subsist and the affairs of the Company were being conducted in a manner unfairly prejudicial to Cosmo as a member of the Company.  Though not so pleaded, Cosmo’s case must be premised on the continual use by Hercules Group of the two software as the basis of the quasi-partnership.  The conduct relied on by Cosmo were the Respondents’ ignoring Cosmo’s contribution to the share capital of the Company by way of Software I and Software II as reflected in the Company’s auditor’s report and by Hercules MDL giving up the use of the two software input by Cosmo.  Again, although not so pleaded, Cosmo must be relying on the Respondents’ causing the assertion to be made in the auditor’s report or adopting the auditor’s report.  Mr Chan fairly admitted that the petition could have been better drafted. 

35.  It is common ground that the assertion in the auditor’s report was a mistake and that there was a breakdown in the relationship, trust and confidence between the parties.  The Respondents’ case is primarily that the Company is not a quasi-partnership, that Mrs Yung contributed to the mistake in the auditor’s report, that the mistake had been rectified, that the continual use of the two software was not the substratum of the Company and that in any event Cosmo’s interest as a member of the Company could not have in any way been unfairly prejudiced by the conduct complained of.  The Respondents complained that this petition was brought for the purpose of exerting commercial pressure for buyout of Cosmos’ shares and on better terms.

36.  The issues raised by this petition are:

(1) whether the Company was formed as a quasi-partnership;

(2) whether the continual use of the two software formed the basis of the Company;

(3) in relation to the auditor’s report:

(a) who caused the mistake in the report;

(b) whether the Respondents adopted the mistake;

(c) whether the mistake has been rectified; and

(4) whether Cosmo’s interest as a member of the Company has been unfairly prejudiced by the conduct complained of. 

37.  At the trial, much time was spent on the issue whether Cosmo caused the interruption in Hercules Group’s IT system.  That issue was raised by the Respondents to resist Cosmo’s petition for winding up because by sabotaging Hercules Group’s IT system Cosmo has not come to Court with clean hands.  Now that this petition has been withdrawn, Mr Wong, counsel for Cheng and Yip, submits that the issue ceases to be of direct relevance, as nowhere is this matter featured whatsoever in the Amended Petition setting out the Petitioner’s case.  If indeed the interruption to Hercules Group’s IT system was caused by Cosmo, Cosmo cannot complain of the switch to Aptom’s IT solution.  That was not relied on by the Respondents either.  I shall not deal with this issue.  The inference from Cosmo’s letters dated 3 and 16 January 2008 and Lee’s evidence strongly suggest that Cosmo was responsible for the interruption.

THE FACTS

Incorporation of Hercules MDL

38.  I have set out the non-controversial background in paragraphs 10 to 32 above.  In 2004, while Cheng was still in the employ of BUPA, he planned to engage in a similar business using the name of “Hercules” after leaving BUPA.  Yung assisted him with the setting up of Wisetrade, in which Yung was appointed as a director and held the share as Cheng’s nominee. Yung also assisted Yip in establishing Hercules Group’s domain name in the website. On 19 April 2004, Wisetrade and other medical practitioners or their corporate nominees incorporated Hercules MDL, which in turn set up a number of medical diagnostic centres under the name of Hercules.  To avoid complication with BUPA, Cheng’s participation in Hercules Group had all along remained covert until January 2006, presumably when he was freed of any obligation owed to BUPA. 

39.  Cheng’s case is that back in 2004, he intended to start a side business of developing and licensing software for Hercules MDL for use in the medical diagnostic industry.  He invited Yung to invest in Hercules MDL.  They reached broad understanding that Yung would transfer a medical diagnostic software, which subsequently turned out to be Software I, to a member of Hercules Group which would be treated as his investment.  In return, Yung would be allotted shares in Hercules Group of value of $2 million.  Cheng and Yung would jointly develop the side business.  As a balance against the other shareholders who were in the medical profession, Yung asked for a managerial position in Hercules MDL.  It was pursuant to those broad understanding that Yung was appointed as Hercules Group’s CEO in March 2005 and paid $50,000 per month through Cosmo and later as director of Hercules MDL as well.  However, Cheng’s proposal to allot 2,000,000 shares in Hercules MDL to Yung as payment for Software I met with opposition from some shareholders who preferred cash contribution.  But for such opposition, Yung would have been admitted as a member of Hercules MDL.  The price for Software I was recorded as Cheng’s capital investment to account for Cosmo’s capital contribution to Hercules MDL.  The question of how Yung’s contribution was to be recognised was left unresolved until 2006.  

40.  In late 2005 or early 2006, Cheng proposed to establish the Company to hold 51% of the shares in Hercules MDL so as to allow investors to invest in Hercules MDL indirectly through the Company.  The reason was that at the time there were many investors who were interested to invest in Hercules MDL, but its members had agreed to cap its authorised capital at $25 million which had already been fully issued. It was then agreed between Cheng and Yung that the price of Software I should be treated as Cosmo’s capital contribution to the Company.  Then 11,300 shares of the Company at the nominal value of $300 each were issued to Cosmo.  At the time, Cheng did not know that included payment for Software II.  I shall deal with those matters in the next subsection. 

41.  Yung’s case is that he refused Cheng’s invitation to join Hercules MDL.  He helped Cheng on a personal basis and took up pro bono appointment as CEO of Hercules Group.  He sent a contract for sale in respect of Software I to Cheng for execution.  Cheng did not pay and did not sign saying that he had not decided which entity under Hercules Group was to hold Software I.  In August 2005, when it became clear to him that Hercules MDL was likely to be the entity to hold Software I, he again sent the contract for sale of Software I to Cheng for execution by Hercules MDL.  Even up to that stage, Yung did not regard Cosmo was an investor in Hercules MDL.  It was only until June 2006 after delivery of Software II and when it became obvious that he could not recover the price from Hercules Group and in view of all the effort he had put into Hercules Group that he agreed to treat the price as Cosmo’s investment in Hercules Group and for Cosmo to become a shareholder of the Company.

42.  The factual disputes are irrelevant and meaningless. Basically, Cheng said that back in 2004 there was broad understanding between him and Yung that Cosmo would inject Software I into Hercules MDL as its investment, but Yung said there was no such understanding.  Mr Wong made very lengthy submissions as to why Cheng’s account should be accepted and Yung’s rejected.  He relied on Yung’s appointment as the CEO of Hercules Group and director of Hercules MDL, negotiated with other entities for co-operation and investing in Hercules Group, applied for approvals from the Radiation Board, etc.  He submits that Yung was so deeply involved in the affairs of Hercules MDL and the Company as to suggest he had intended to be an investor in Hercules MDL.  In my view, in the light of the circumstances of this case, these are neutral events.  Yung’s appointment as CEO was obviously part and parcel of Cosmo’s services to Hercules MDL under the management services contract.  The shareholders of Hercules MDL were medical practitioners who were too busy with their medical practice to attend to these administrative matters, which was why Hercules MDL paid Cosmo $50,000 per month for its management services.  As for Yung’s appointment as director Hercules MDL, Yung’s explanation was that it was to buttress Cheng’s control over Hercules MDL because Yip had difficulties dealing with Dr Ho.  According to Yung, he did all that to assist Cheng.  He admired Cheng’s vision in medical software, in building a patients’ record library and in his ability as a doctor and musician.  The establishment of the patients’ record library coincided with his ideal and would serve the public better.  He was also inspired by a common friend to assist Cheng.  I think there is a lot of truth in Yung’s evidence.  Cheng was the single largest shareholder in Hercules MDL but had to remain covert to avoid complication with BUPA.  It was more likely that he placed Yung in that position to protect his interest in Hercules MDL rather than Yung securing the position because of his interest in investing in Hercules MDL. 

43.  Cheng disputed that Yung’s services as the CEO and a director of Hercules MDL was pro bono. It is obvious that some functions of Hercules MDL or the CEO of Hercules Group have to be performed by a natural person.  Those services must form part of the services to be provided by Cosmo under the management contract.  That Yung was not directly paid for his services was a matter between him and Cosmo.  That did not make his services pro bono.  Even assuming that Yung and Cosmo is one entity, on his own case, all the effort he put into Hercules Group was no more than what an employee or contractor was obliged to do in the performance of his contractual obligation. 

44.  Perhaps, the strongest of Mr Wong’s argument is that if Cosmo had no stake in Hercules MDL in 2004, it would not have risked jeopardising its entire client base including the mega client of BUPA for an one off fee of $2 million and monthly management and maintenance fees of $80,000.  I think this tilts the balance.  I accept Cheng’s account as a more logical and credible account of the antecedent history leading to the formation of the Company and Cosmo’s participation in the Company.  But as I said, this dispute is irrelevant and has no bearing to the ultimate issue I have to decide in this case.

Corporate restructuring and allotment of shares in the Company

45.  In January 2006, when Yung agreed on behalf of Cosmo to join the Company, the shareholding structure of Hercules MDL and the Company had to undergo certain changes.  It is common ground that Cosmo was never paid for Software I which was agreed to be $2 million.  According to Yung, the price for Software II was agreed at $1.5 million after several rounds of discussion.  Then, it was further reduced at Cheng’s request to $1,399,000 when Cosmo agreed to join the Company.  Accordingly, Cosmo was issued 11,330 shares of $300 each in the Company in payment of the two software at the total price of $3,399,000.  Yung said that he had no clue about the restructuring beforehand and was only informed about it afterwards.  

46.  According to Cheng, he was the architect for the restructuring.  He set out the basic objectives and delegated Yung as the CEO of Hercules Group to liaise with Dominic Y.C. Ng & Co. CPA to implement the restructuring.  His objectives were that Wisetrade’s and Yip’s shareholdings in Hercules MDL representing 51% of its issued share capital were to be transferred to the Company in exchange for shares in the Company of like amount to be issued to Wisetrade and Yip and that shares in the Company of $2 million in value be issued to Cosmo as payment for Software I.  He had not in mind to pay for Software II. 

47.  Cheng designed a two stage restructuring process which he instructed Yung to carry out.  Under the first stage, Hercules MDL allotted 3,940,000 new shares of $1 each to the Company.  The shares were to be paid by Cheng to Hercules MDL.  Wisetrade and Yip also respectively transferred their 8,800,000 and 10,000 shares in Hercules MDL to the Company.  It is common ground that these transfers were duly effected.  The Company holds a total of 12,750,000 shares in Hercules MDL.  The second stage was for the Company to allot 12,750,000 of its shares of $1 each to Wisetrade and Yip.  According to Cheng, he instructed Yung to carry out his plan, but Yung did a bad job.  He compared himself as the marshal and Yung as the field lieutenant, who for reasons entirely unknown to him, departed from his plan.

48.  What happened with respect to the second stage is in dispute.  The Company was incorporated on 12 January 2006 with an authorised capital of $10,000 divided into 10,000 shares of $1 each.  One share was issued to Wisetrade.  On 22 February 2006, 299 shares were allotted to Wisetrade.  On 23 February 2006, its share capital was increased to $30,000,000.  This was to dovetail with the amount of capital investment Cheng had in mind for the Company.  According to Cheng, for reasons totally unknown to him, Yung increased the par value of the shares from $1 to $300 by consolidating every 300 shares of $1 each into one share of $300 each and made excessive allotments to Wisetrade and Yip.  On 28 June 2006, Wisetrade, Yip, Cosmo and two others were allotted 65,169, 2,830, 11,330 and 2,800 shares respectively. In respect of his allotment, Cheng said that, unknown to him then, it was unpaid to the extent of $6,800,700, i.e. 65,169 x $300 - $12,750,000.  He said that Yip was entitled to share option in Hercules MDL; but because the number of shareholders of Hercules MDL was very large, he told her that she would have to take her shares in the Company instead.  He instructed Yung accordingly, but Yung allotted Yip more than double the value of shares of $340,000 which Yip was entitled.  Cheng said he did not know about that then either.

49.  All the necessary resolutions and documents of the Company to effect the allotments were executed by Cheng. Cheng said that those documents were prepared by Yung and he signed them believing that they were in order and prepared in accordance with his instructions.  He was not aware of the over allotment to himself, Yip and Cosmo.  Likewise, all the necessary resolutions and documents of Hercules MDL were executed by Yung as director of Hercules MDL.

50.  Mr Wong submits that Cheng’s evidence should be accepted and Yung’s rejected.  He argues that Cheng was a busy medical practitioner who was unfamiliar with company procedures but Yung was familiar with company procedures and had assisted Yip and taught her on such matters.  He argues that as Yung was the CEO of Hercules Group and handled matters of Hercules MDL and the Company, he must as a matter of course have been instructed by Cheng to carry out Cheng’s restructuring plan. 

51.  Mr Wong submits that Yung’s evidence that he knew nothing about the restructuring is contradicted by a contemporaneous e-mail dated 23 May 2006 issued by him to Dominic Y.C. Ng & Co. CPA setting out the latest shareholding proposal for the Company.  In that e-mail, Yung mentioned Dr Lam’s shareholding in the Company and attached an organisation chart indicating that Chan Pui Wing would hold 2,000 shares and that other shareholders to be identified would hold 13,670 shares, respectively representing 5% and 13.67% of the shareholding in the Company.  Mr Wong also referred to the Annual Review of Hercules MDL dated February 2006 which showed that in addition to Wholesome Group Limited which was in effect Wisetrade, Yip and Cosmo, there were other shareholders including Ng Lok Yee, Chan Pui Wing, Dr Lam and others, holding respectively 14.17%, 2%, 5.67% and 13% of the shares in the Company.  According to Cheng, the Annual Review was prepared by Yung as CEO of Hercules Group, but Yung said that part of the Annual Review was drafted by Cheng including the shareholding structure of the Company as mentioned in the Annual Review which escaped his attention.  On the totality of the evidence, I do not believe Yung had no knowledge of the shareholding structure of the Company in about February 2006.  Clearly, Yung was not telling the truth when he said he knew nothing about the restructuring of the Company. 

52.  But Cheng was not telling the truth either.  There is no dispute that Cheng was the architect and designer of the restructuring.  Since January 2006, presumably when Cheng was no longer bound by any undertaking to BUPA, his involvement in Hercules Group became overt.  He was the sole director of the Company, which was incorporated with him as the sole shareholder.  He was the only person in control of the Company.  While Cheng alleged that Yung was the one arranging the allotment of shares in the Company, the Company’s documents show that 1,200 shares were allotted to Wong Chung Wai and Pang Ching Han on 27 March 2006.  Those allotments were prior to the second stage of the restructuring mentioned by Cheng.  His two stage restructuring is not quite the whole truth.  Those 1,200 shares could not have been allotted by Yung without Cheng’s knowledge.  On 28 June 2006 along with the allotment of shares to Cosmo, two others, namely Chan Pui Wing and Wu George Getting were allotted a total of 2,800 shares.  The shares of those four persons were transferred to Wisetrade on 21 May 2007. Those five additional shareholders had nothing to do with Yung or Cosmo but were clearly associated with Cheng.  Then, another 300 shares were allotted to Wu George Getting and Chau Ying Chau on 9 May 2006.  All those transactions show clearly that Cheng had more control over the Company than he was willing to disclose.  Besides, Cheng is no stranger to company procedures.  He is a director of ten companies, six of which were members of Hercules Group.

53.  Cheng signed the documents allotting the shares to Wisetrade, Yip, Cosmo and the above five persons.  Given the tight control he maintained over the Company, it is impossible for him to sign those documents without ever thinking what those shares were allotted for and the consideration for the allotment.  At the minimum, he could have conveniently checked if the allotment to Wisetrade corresponded to the value of the shares in Hercules MDL it transferred to the Company, i.e. $12,750,000.  If he had no knowledge of the consolidation, he would have been immediately shocked to see Wisetrade being allotted 65,169 shares in the Company instead of 12,750,000 shares.  Also, the odd figure of 65,169 is like a pin in the eye.  It could not have escaped Cheng’s attention. The allotment of 299 shares to Wisetrade on 22 February 2006 showed that consolidation was actually planned well before the allotment of shares to Cosmo and the others.  His evidence that based on his trust in Yung he signed all the documents without reading them, that the consolidation was carried out by Yung without his knowledge and that Yung was the lieutenant who went on a frolic of his own is too simple a concoction to be believed.

54.  Likewise, his evidence that he did not notice the over allotment of shares of a value of $1,399,000 to Cosmo is incapable of belief.  On his evidence, he thought Cosmo was to be issued shares worth $2 million for Software I.  If he had no knowledge of the consolidation, that means when he signed the allotment he should see 2,000,000 shares being allotted to Cosmo.  He could not have signed the allotment without even looking at that figure on the document.  Again, the figure of 11,330 must be another pin in the eye, which he could not have failed to notice and for which he could have failed to raise a query.  It is also impossible for Cheng to say that he did not know about the consolidation or that the allotment of 11,330 shares of the Company to Cosmo included the consideration of $1,399,000 for Software II.

55.  Lastly, the mistake in over allotment to Wisetrade and Yip is very indicative of the identity of the person who actually implemented and not just designed the restructuring.  $6,800,700 worth of shares or 22,669 shares of $300 each were over allotted to Wisetrade and Yip was allotted more than double her entitlement but Cosmo was issued precisely shares equivalent to the value of the two software.  The over allotment was very substantial, about one-third of the issued share capital of the Company. Yung could not have knowingly over allotted to Wisetrade and Yip because that would dilute his interest in the Company resulting in an underpayment for the two software.  Yung was so knowledgeable in company procedures, he could not have committed such a simple arithmetic error in the allotment.  He might have checked and made sure that Cosmo received its correct allotment, but might not have the caution to check if Wisetrade and Yip had not been over allotted. After all, he was not a director of the Company and did not have to sign any documents in respect of Wisetrade’s and Yip’s allotments.  On the other hand, Cheng was the architect who designed the restructuring.  He signed all the documents allotting shares to Wisetrade, Yip and Cosmo.  He, too, could not have committed such simple arithmetic error in the two allotments.  The figures were so odd that he could not have missed them when signing the various documents allotting shares to Wisetrade and Yip.  The over allotment was to his and Yip’s benefit.   

56.  I do not have to go that far as to find that Cheng acted dishonestly or fraudulently, but I am more than satisfied that he was not telling the truth about the allotment.  He was the only director in the Company.  He maintained tight control over the Company.  He designed the restructuring and was the person in charge in implementing it.  In the eventual analysis, I find that Cheng was taking advantage of Yung’s involvement as CEO of Hercules Group and as director of Hercules MDL and his signing documents transferring Wisetrade’s and Yip’s shares in Hercules MDL to the Company to concoct a case of the runaway lieutenant.  I find that both Yung and Cheng were not telling the truth.  In May 2006, at the latest, Yung knew about the presence of other shareholders in the Company.  Cheng knew and even designed the consolidation.  He knew full well the number of shares allotted to Cosmo, which included a payment for Software II and knew full well the number of shares allotted to Wisetrade and Yip and about the over allotment.

Whether there was agreement to pay for Software II

57.  A major factual dispute between the parties is whether there was agreement to pay for Software II.  Yung’s case is that Software II was an entirely different software from Software I, specifically designed to meet Cheng’s requirement and that the price agreed was $1.5 million, but at the behest of Cheng it was reduced to $1,399,000 in June 2006.  Cheng’s case is that as early as 2004 there was an understanding between him and Yung that Cosmo would transfer Software I assessed at a value of $2 million as its capital investment to Hercules Group and the parties would use their respective expertise to develop a minor side business in medical software.  Yung would contribute his expertise in IT while Cheng would contribute his expertise in radiology.  The parties would jointly refine and develop Software II and such other software later acquired or developed with a view to ultimately marketing and licensing such software to other businesses in the medical diagnostic industry.  Software II was developed from Software I by Yung and Cheng on that basis.  In particular, Software II was developed by Cheng in the course of his employment with Hercules Group.  Hence, Cheng took the view that Cosmo was not entitled to charge for Software II, though all along he was misled into the belief that the Company was under an obligation to pay for Software II and erroneously conducted its dealing with Yung on that basis.  Cheng claimed that the Respondents now adopted the position of denying liability to pay on counsel’s advice.  The stance he took was equivocal.  While saying that he was mistaken or misled by Yung, he must impliedly admit he knew about the payment of $1,399,000.  But on his evidence, he said that he knew nothing about it, there was no price agreed for Software II and the payment was arranged by his runaway lieutenant without his knowledge.  Such positions are different to reconcile.

58.  Mr Wong emphasised the total lack of documentary evidence such as an invoice or a contract of sale in support of Yung’s case. He also emphasised that the unusual figure of $3,399,000, i.e. $2,000,000 for Software I for which there is no dispute and the odd figure of $1,399,000 allegedly for Software II, had already been reflected as early as March 2006 in the Annual Review to discredit Yung. 

59.  I shall deal with the second criticism first.  I think the odd figure actually supported Yung’s case rather than discrediting it.  The Annual Review dated February 2006 acknowledged Cosmo’s investment in the amount of $3,399,000.  Cheng could not identify any possible reason for the amount of $1,399,000 to be acknowledged as Cosmo’s capital investment in the Company.  On the contrary, in June 2006 Cheng signed the various documents allotting $3,399,000 worth of shares to Cosmo.  This is credible contemporaneous evidence in support of Yung’s case.  If there is anything wrong with Yung’s evidence, it is the date when he agreed to invest in the Company.  The Annual Review showed that by February 2006 he and Cheng had reached oral agreement for Cosmo’s participation in the Company and not June 2006 which was the date when the shares in the Company were allotted to Cosmo.  It also reflects that the price of $1,399,000 for Software II must have been agreed before February 2006.  Furthermore, after dispute broke out, the Respondents’ solicitors confirmed in January 2008 that Cosmo had fully paid for its 11,330 shares in the Company and the payment included its contribution by way of Software II at a value of $1,399,000 (This is analysed in greater detail below: see paragraphs 61 and 62).   

60.  On the first criticism, Yung’s explanation was that at the time Hercules Group was short of funds.  If the date of the oral agreement for Cosmo’s participation in the Company is pushed back to January 2006, everything falls into place.  Most probably, Yung and Cheng had been negotiating for payment of Software II by shares in or before December 2005. On Yung’s case, at the time Cheng had not paid for Software I or signed the sales contract for Software I.  Software II was only installed around December 2005 or January 2006.  At the time, Yung and Cheng were negotiating for Cosmo’s participation in the Company.  In the circumstances and in view of the twelve years’ personal and business relationship he had with Cheng, his position as the CEO of Hercules Group, Cosmo’s receipt of substantial contract fees from Hercules MDL, Yung’s more relaxed attitude in not issuing invoice or a contract of sale could be understood.

61.  Mr Wong referred to schedule 3 of the contract for sale of Software I and argues that Software II was developed pursuant to schedule 3 and Cosmo was not entitled to be paid.  He also referred to Cheng’s evidence that Software II was only some kind of modification work on the DICOM software of insignificant value and fell within schedule 3 of the agreement.  I do not wish to go unnecessarily into this realm of expert evidence.  According to Yung, Software II was developed and tailor-made for Hercules Group at the specific request and instructions of Cheng.  It is a medical imaging and reporting system which consisted of multiple DICOM servers, PACS servers, web servers for sites, customer web DICOM imaging and diagnostic report viewer that supposedly should be supported by Hercules’ hardware as the central web service server.  In short, it is comparable to the system used in hospitals and not in clinics as envisaged in schedule 3.  His evidence is supported in certain respects by the Respondents’ expert, Lee.  I have all the more reasons to accept Yung’s evidence and reject Cheng’s.

62.  Very fatally for Cheng, the story he was telling in Court is precisely the opposite of what his solicitors wrote to Cosmo on 11 January 2008.  In that letter, his solicitors gave the same account as Yung’s, except that they attributed what was allegedly said and done by Cheng to the other director of Hercules MDL, Dr Ho. Peculiarly, they mentioned in paragraph 8 of their letter Yung’s agreement to “continue to refine and update Software I and later also Software II”, in paragraph 12 that Software II was a new software and in paragraph 13 that the price for Software II was agreed at $1,399,000 and paid by shares of the Company, which Dr Ho considered excessive.  His solicitors wrote as follows:

“8. (4) in his information technology capacity, Mr Yung would continue to refine and update Software I and later also Software II (as defined further below) for the Hercules Group in the light of feedbacks given and deficiencies identified by Ms Yip, Dr Ho and other staff in connection with their use of the software;

…

12. In late 2005, in the light of the need of the joint venture business, Mr Yung and/or Cosmo developed a new computer software for DICOM images (“Software II”). Software I and Software II are collectively referred to as the “Software” here. The parties had not agreed on the proper valuation of Software II but Mr Yung had caused Software II as well as the intellectual property rights therein to be transferred to Hercules Holdings when it was eventually established.

13. In return and as per the agreement as mentioned in    paragraph 6 above, Mr Yung caused 11,330 shares in Hercules Holdings at the value of HK$300 each (or at the collective value of HK$3,399,000) to be allotted and issued to Cosmo in full and final settlement of the price of the Software.  We are instructed that our clients have always considered your valuation of Software II at HK$1,399,000 [HK$3,399,000 - HK$2,000,000 (the agreed price for Software I)] to be excessive.  But in any event, contrary to the allegation in Cosmos’s letter dated 3 January 2008, the Software had been paid for (more than sufficiently) by the shares.”

63.  What his solicitors described was precisely Cosmo’s case as presented by Yung and was contrary to what Cheng said in Court.  His solicitors also said that there was no prior agreement as to the price of Software II; that after some negotiation the price of $1,399,000 was agreed and was paid by shares in the Company.  Cheng was serious enough to instruct solicitors to write to Cosmo.  He took care to misrepresent to his solicitors that it was Dr Ho who negotiated with Yung.  Whatever was the reason for so masquerading himself, he must have given clear thoughts about his case before giving instructions to his solicitors.  I find Yung’s evidence utterly incredible.

64.  Yung now claimed that he adopted the new position upon counsel’s advice to explain his equivocal position.  In my view, he was trying to concoct an additional defence and to hide behind his counsel if he is disbelieved so as to preserve his image as an unimpeachable witness.  I have no doubt about counsel’s integrity.  The advice Yung obtained from counsel must be based on his instructions on the facts.  I reject his evidence on the facts.  He must have misrepresented to his counsel.  I find him an opportunist and an utterly dishonest witness.

65.  Accordingly, I find that Yung and Cheng reached agreement for the sale and purchase of Software II at a price of $1.5 million between August and December 2005.  Software II was installed between December 2005 and January 2006.  At about the same time, the parties negotiated for payment of Software II by shares in the Company and Yung agreed to a further reduction of price to $1,399,000.  As reflected in the Annual Review, an oral agreement had been reached in about February 2006 for Cosmo’s participation in the Company.  The oral agreement was implemented on 28 June 2006 when 11,330 shares in the Company was allotted to Cosmo.

Whether the Company is a quasi-partnership company

66.  Cosmo’s case is based on the breakdown of trust and confidence in a quasi-partnership company.  However, Mr Wong submits that such issues which only relate to the question of whether it is just and equitable that the Company be wound up under section 177(1)(f) are no longer relevant, save as to valuation of the Company’s shares in the event that the Court makes a buyout order against the Respondents.  But he accepts that the terms of a quasi-partnership may have an impact on whether or not certain acts of a quasi-partner are unfair or prejudicial.  He quoted the House of Lords decision in O’Neill v Phillips [1999] 1 WLR 1092 at 1104 in support of his proposition.

67.  I agree with Mr Wong’s submission.  In that case, Lord Hoffmann dismissed counsel’s argument that breakdown of trust and confidence among members in a quasi-partnership company justifies a buyout order.  The existence or otherwise of a quasi-partnership is not a relevant consideration in a buyout petition except for the purpose valuation, but is relevant as part of the factual circumstances for the purpose of determining whether the act of the majority complained of is unjust and prejudicial.  In the event of a buyout of shares of a quasi-partnership company, the shares of the minority shall be valued on the basis of the shares of a company as a going concern without any discount.  In the case of a non quasi-partnership company, the usual minority discount applies.  Accordingly, I shall investigate if the Company was formed as a quasi-partnership company and if it was, the terms of that quasi-partnership agreement.

68.  A company is an incorporation with separate corporate personality.  A quasi-partnership company is difficult to define.  As pointed out by Lord Wilberforce in Ebrahimi and Westbourne Galleries [1973] AC 360 at 379, the expression is confusing.  It is a shorthand expression for a company in which the exercise of membership rights by members of a company may, by reason of its particular circumstances, be subjected to equitable considerations of a personal character arising between the individual members which might make it inequitable for them to insist on their legal rights or to exercise them in a particular way.  Such circumstances are usually associated with small private companies, but the fact that the company is a small one, or a private company, is not enough.  The superimposition of equitable considerations requires something more, which typically may include one or probably more of the following elements: (i) an association formed or continued on the basis of a personal relationship involving mutual confidence; (ii) an agreement or understanding, that all, or some, of the shareholders, shall participate in the conduct of the business; (iii) restriction on the transfer of the members’ interest in the company - so that if confidence is lost, or one member is removed from management, he cannot take out his stake and go elsewhere.

69.  The sole basis on which Yung claimed that the Company was a quasi-partnership is that to his understanding, the Company shall be comprised of Cosmo, Wisetrade and Yip only.  Then, upon discovering there were other shareholders in the Company he raised objection and Cheng bought out those other shareholders.  Mr Wong submits that Yung’s case is not to be believed.  He compared paragraph 18 of the Petition, which reads:

“The Company was formed in January 2006 with shareholders including the 1^st Respondent, the 2^nd Respondent, Wong Chung Wai, Pang Ching Han, Chan Pui Wing, Wu George Getting, Chau Ying Chau and the Petitioner. The Company in turn held 51% of the issued shares of Hercules MDL. It only came to notice of the Petitioner from a recent inspection of the record at the Companies Registry in early 2008 that the shares held by Wong Chung Wai, Pang Ching Han, Chan Pui Wing, Wu George Getting and Chau Ying Chau for a total of 4,300 shares were transferred to the 1^st Respondent on 21^st May 2007.”

with paragraph 18 of the subsequently Amended Petition, which reads:

“By September 2006, the Company had eight shareholders including the 1^st Respondent, the 2^nd Respondent, Wong Chung Wai, Pang Ching Han, Chan Pui Wing, Wu George Getting, Chau Ying Chau and the Petitioner. The Company in turn held 51% or so of the issued shares of Hercules MDL. It only came to notice of the Petitioner from a recent inspection of the record at the Companies Registry in early 2008 that there were shares held by Wong Chung Wai, Pang Ching Han, Chan Pui Wing, Wu George Getting and Chau Ying Chau, and that their total of 4,300 shares were transferred to the 1^st Respondent on 21^st May 2007.”

The plain meaning conveyed by paragraph 18 of the original pleading is that the Company was formed by Cosmo, Cheng, Yip and five others and it only came to Cosmo’s notice in early 2008 that the five others had their shares transferred to Cheng on 21 May 2007.  The petition as it then stood contained no reference to quasi-partnership.  The plea of quasi-partnership was introduced into paragraph 16 of the Amended Petition together with the amendments in paragraph 18 quoted above half a year later. While a party is free to change his pleading, it is open to the other side to use the amendment as a basis for attacking credibility where the circumstances so justify.

70.  As analysed above, Yung’s e-mail to Dominic Y.C. Ng & Co. CPA dated 23 May 2006 and the Annual Review of Hercules MDL showed clearly that at least between February and June 2006, i.e. at around the time when Cosmo agreed to join the Company, Yung knew there were other shareholders in the Company.  Those shareholders also held substantial amount of shares compared with his shareholding.  That state of mind is consistent with the pleading in paragraph 18 of the Petition, i.e. the Company was formed by Cosmo, Cheng, Yip and five others and it only came to Cosmo’s notice in early 2008 that the five others had their shares transferred to Cheng on 21 May 2007.  It is apparent that Yung was indifferent as to whether there were other shareholders or who those shareholders were.  It is unlikely that there was an agreement that the Company shall comprise of only the three of them and that upon discovery of the additional shareholders he raised objection to Cheng who then rectified the situation pursuant to their agreement.  That the Company ended up with Wisetrade, Yip and Cosmo as the sole shareholders is but a fortuitous and neutral event.  I find Cosmo’s case as pleaded under paragraphs 16, 17 and 18 of the Amended Petition is an afterthought and concoction.

71.  On Yung’s case, despite the personal relationship he had with Cheng and the assistance he gave him, all along he refused to invest in Hercules MDL or the Company.  On Cheng’s case, Yung was desirous for Cosmo to invest in Hercules MDL or the Company and had worked for Hercules Group on the basis that Cosmo would become a member.  Ironically, on Cheng’s scenario, Cosmo would have a better case to argue for a quasi-partnership.  However, even on that scenario, all the work that Yung did for Hercules Group or the Company was no more than the services which Cosmo had contracted to provide under the management contract.  Hence, it cannot be said that the Company was formed or continued on the basis of a personal relationship involving mutual confidence. 

72.  The terms of the shareholders’ agreement have not been pleaded, though it was pleaded in paragraph 28 of the Amended Petition that the whole foundation for cooperation and/or quasi-partnership had gone upon Hercules MDL giving up the use of the two software.  Mr Chan openly admitted that the pleading was unsatisfactory but referred to Yung’s evidence of the terms of the agreement.  According to Yung, the essential terms of his quasi-partnership agreement with Cheng were as follows:

(a)  the projected capital of the Company would be $25 million;

(b) the Company would continue to hold and maintain at all times not less than 51% of the shareholding of Hercules MDL as a long term investment;

(c) the right of the two software would be sold by Cosmo to the Company at the price of $3,399,000 which would be paid and satisfied by way of an allotment and issue of equivalent value of ordinary shares of the Company;

(d) the Company would grant Hercules MDL and its associated companies the licence to use the two software at a fee to be agreed; and

(e) the Company would explore the possibility of marketing the two software to other medical diagnostic companies.

Items (a), (b) and (d) above are not disputed by the Respondents.  Item (c) is disputed as to whether the price of Software II in the amount of $1,399,000 was agreed.  I have found in favour of Cosmo.  Item (e) was not seriously disputed and it would make good sense to have made that as a term of the partnership agreement.  In his evidence, Yung admits that one of the principal objects of the Company was to be the holding company of Hercules MDL and to carry on licensing software as a side business. I have no difficulties in accepting Yung’s evidence that these were the terms on which he agreed to invest in the Company.

73.  On my finding, there was no agreement that the Company shall comprise of Wisetrade, Yip and Cosmo only.  I find that the terms of the shareholders’ agreement between Cosmo, Wisetrade and Yip are as stated by Yung above and that to be the holding company of Hercules MDL is one of its principal objects of the Company.  But, even on the basis of these terms, I am unable to find the Company was a quasi-partnership company.

CONDUCT OF THE MAJORITY COMPLAINED OF

74.  Having made the above factual findings, I now turn to consider the conduct of the majority complained of, which formed the basis of Cosmo’s claim that the affairs of the Company are being conducted in a manner unfairly prejudicial to Cosmo as a member of the Company.  Cosmo raised two complaints in paragraph 28 of the Amended Petition: (i) the elimination of Cosmo’s interest by ignoring its input of the two software and claiming that no capital investment had ever been received from Cosmo (i.e. a complaint about the auditor’s report); and (ii) Hercules MDL giving up the use of the two software.  In the course of his evidence, Yung complained of a further conduct, namely that he was being forced out of the Company.  This is an unpleaded point.

First complaint: the auditor’s report

75.  Cosmo attributed the auditor’s mistake in asserting that Cosmo had not paid for its 11,330 shares in the Company to Cheng and Yip and relied upon that as conduct which justified an order to buyout.  The parties raised many factual disputes: such as how the mistake was caused, who caused the mistake, whether Mrs Yung was in charge of the finance and accounts of the Company and Yip’s response to Yung’s complaint about the mistake.  Regardless of these factual disputes, this ground is bound to fail as the mistake has been rectified before the issue of the petition.  I shall nevertheless deal with these disputes.

76.  Until this trial, it was common ground between the parties that the two software at a price of $3,399,000 were to be paid by way of shares in the Company.  11,330 fully paid shares of $300 each were allotted to Cosmo on 28 June 2006.  Cosmo was issued with the share certificate to that effect.  These shares together with those allotted to Wisetrade and Yip were recorded in the 2007 accounts of the Company, the annual return and return of allotments as fully paid.  It is common ground that the assertion to the contrary in the auditor’s report was a mistake.

77.  Mr Wong submits that the mistake was made by the auditor, that neither Cheng nor Yip was responsible for the mistake and that Mrs Yung was the source of the mistake.  It is common ground that in about October 2005, there was an agreement between Cheng and Yung that Software I was to be injected into the Hercules MDL under Cheng’s name and treated as Cheng’s investment in Hercules MDL.  It would then be a matter as between Cheng and Yung as to how Cosmo would be repaid by Cheng.  But as far as Hercules MDL was concerned, it was Cheng who injected Software I in the value of $2 million into Hercules MDL.  Mrs Yung made a voucher recording Cheng’s injection of Software I into Hercules MDL, correctly reflecting this agreement between Cheng and Yung.  In June 2006, in connection with the restructuring, Mrs Yung made another voucher recording a transfer of Software I from Hercules MDL to the Company.  Both vouchers were made with the knowledge of Yung who was then the CEO of Hercules Group in addition to his capacity as representative of Cosmo as shareholder of the Company.  Yung has no quarrel with the correctness of those vouchers and accepted in cross-examination that the effect of those two vouchers to an outsider is that Software I was injected into the Company by Hercules MDL and that Cosmo had not injected cash or assets to the Company for its allotment of the $2 million worth of shares.  As for the injection of Software II, there was simply no document recording its injection into the Company.  It is therefore reasonable for an outsider to come to the conclusion that Cosmo’s share in the Company had not been paid for.

78.  The mistake was further compounded by Mrs Yung’s successor, Grace Lam who joined Hercules Group in November 2006.  Grace Lam created a voucher which wrote off the total of $3,399,000 as unpaid share capital due from Cosmo.  She also wrote off $19,541,000 supposedly due from Wisetrade and Yip.  Unpaid share capital is a term which is inconsistent with shares issued as fully paid.  What Grace Lam did was clearly an accounting mistake. 

79.  The parties dispute as to who was the head of the accounting and finance department of Hercules Group at the time.  After some dispute, Mr Chan accepts that Mrs Yung supervised Yip and the other accounting staff, especially on the making of book keeping entries.  In my view, whoever was in charge did not matter.  The vouchers were prepared by Mrs Yung, but the write off was made at a time after she had left the employment of Hercules Group.  It is inconceivable that Grace Lam, whether as a mere accounts clerk or supervisor in charge of the accounting section, could have made such an enormous write off without consulting her senior.  The person she would most likely have consulted would be Yip as Mrs Yung had resigned and Yip was the general manager and presumably the third person in command in the Company or Hercules Group after Cheng and Yung.

80.  Upon receipt of the audit confirmation on or about 8 October 2007 suggesting that Cosmo had not fully paid for the shares, Yung or Mrs Yung telephoned Yip.  Yip told the caller that the audit confirmation was wrong and told the caller to ignore it. Yip said the caller was Mrs Yung, but Yung said that it was he who made the call.  Whoever called Yip was not material.  But I find it more like that it was Mrs Yung who called and that Yung was trying to economise on the evidence by saving the trouble of calling Mrs Yung as he did in not calling Danny Siu in relation to another issue in dispute.

81.  Yung further alleged that he complained to a staff of Dominic Y.C. Ng & Co. CPA who told him that in the absence of documentary proof of payment it was their normal practice to issue an audit confirmation to verify any questionable sum.  Yung told the staff that the shares had been paid for by the two software.  The staff replied that he would sort the matter out with Cheng. 

82.  Yung said that he telephoned Yip again and suggested the preparation of a retrospective shareholders’ agreement as an answer to the audit confirmation.  Yip told him to leave the matter to Cheng and herself and that in due course the audit report with appropriate changes would be prepared. 

83.  After that, Yung alleged that he asked for a copy of the auditor’s report.  Yung was not specific as to when he asked for the auditor’s report.  Again, Yip said that the request was made by Mrs Yung on 24 December 2007.  In view of the assurance by Yip, Yung might not feel the need to make an immediate demand for the auditor’s report but did so after two months.  For similar reason as above, I prefer Yip’s evidence. 

84.  Upon reading the report, Yung discovered that the Company reported a loss after tax in the sum of $15,451,675.07 and made a provision for bad debt due from shareholders in the sum of $11,039,000.  The provision for bad debt was made up of a loan of $6,791,000 to Cheng, unpaid share capital due from Yip in the amount of $849,000 and unpaid capital due from Cosmo in the amount of $3,399,000 for the entirety of the 11,330 shares.  The mistake had not been rectified.  He protested to Yip saying that he did not agree with the way she handled the matter and asked her to tell Cheng to clarify.  But Yip replied that she and Cheng decided to adopt the auditor’s report.  Yip denied such conversation had ever taken place. 

85.  Mr Wong submits that Yung’s evidence should not believed as this telephone conversation was not pleaded in the Petition and that except for saying that his protest was ignored Yip’s alleged reply was not mentioned in his affidavit.  With respect, I do not think such evidence need to be pleaded in the Petition.  Yung’s evidence and Yip’s evidence are so conflicting that I can only accept or reject either of their evidence in its entirety and cannot put part of one’s evidence to the other.  It is common ground that all along Yip’s stance was that the auditor’s report was incorrect and she would cause the mistake to be rectified.  Thus, it would be surprising if Yung did not protest immediately upon reading the auditor’s report.  I have to reject Yip’s evidence that no such telephone conversation ever took place.  The odds, then, were in favour of Yip standing by the report and telling Yung that she and Cheng adopted the auditor’s report.  On this issue, I accept Yung’s evidence.

86.  A few days later, Cosmo terminated its IT service contract with Hercules MDL and then the interruption to Hercules MDL’s IT system occurred.  Yung alleged that when Yip telephoned Cosmo’s manager, Danny Siu, she demanded return of the shares in the Company.  Danny Siu was not called.  There was no explanation from Cosmo.  On the other hand, Yip’s evidence was that she telephoned Danny Siu about the interruption and had a dispute with him on the ownership of the two software. It was in the context of that dispute that she said if Cosmo had not sold ownership of the software to Hercules MDL, it should return the 11,330 shares in the Company.  Yung’s allegation is a very serious one.  In the absence of any explanation why the maker of the statement was not called, I could only draw the inference that his evidence would not support the allegation as put by Cosmo.  Besides, Yip’s reply made good sense in the light of the context in which the argument allegedly arose.  I think Yung was exaggerating the evidence by only quoting part of the conversation.

87.  Then in the course of the communication between Cosmo and the Respondents’ solicitors that followed, the Respondents’ solicitors replied via their letter dated 11 January 2008 in unequivocal terms that Cosmo’s 11,330 shares in the Company were fully paid by the price of Software I and Software II.

88.  On 31 March 2008, Wisetrade and Yip paid the Company respectively $6,791,000 and $849,000 in respect of the portions of their unpaid shares in the Company.  In the auditor’s report for the period ending 31 March 2008, Cosmo’s complaint about the non-payment of its shares in the Company was rectified.

89.  On 11 April 2008, Cosmo through its solicitors offered to sell its shares in the Company to the Respondents.  The offer was not accepted and Cosmo issued the Petition on 18 April 2008.

90.  There is no dispute that the mistake in the auditor’s report was caused by the two vouchers prepared by Mrs Yung and the write off by Grace Lam.  Except for the occasion on or about 24 December 2007, Yip had consistently said the audit confirmation was a mistake and told Yung to ignore it.  But, put at the highest, even if Yip approved the write off and together with Cheng adopted the auditor’s report, she and Cheng resiled from that position within two weeks through their solicitors’ letter dated 11 January 2008.  They paid up their unpaid shares on 31 March 2008.  The mistake was rectified as stated in the auditor’s report for the period ending 31 March 2008.  By the time the petition was issued, there was really no cause to complain on this ground.  There is no reason to suggest that the conduct will be repeated.  No unfair prejudice could possibly have been suffered by Cosmo as a member.

Second complaint: Hercules MDL giving up the use of the two software

91.  In paragraph 28 of the Petition, Cosmo relied on Hercules MDL giving up the use of the two software as evidence that the basis or foundation for Cosmo’s cooperation with the Respondents had gone.  What was the basis or substratum was not pleaded. Cosmo never pleaded that the Company will secure the continual use of the two software by Hercules MDL as the substratum of its cooperation with the Respondents.  The terms of the shareholders’ agreement were not pleaded, though they were mentioned in Yung’s affidavit: see paragraph 72 above.  But none of those terms referred to the substratum now alleged.  Indeed, Yung’s evidence did not go that far as to allege that there was such substratum. 

92.  On the contrary, Cosmo’s pleaded case is that it agreed to take on shares of the Company as a holding company of Hercules MDL in payment for the two software.  In paragraphs 16 and 17 of the Amended Petition, Cosmo pleaded:

“16. Despite repeated requests and demand, Hercules MDL and Dr Cheng refused and/or failed to settle the said sum of HK$3,500,000.00 with the Petitioner. In around January 2006, Dr Cheng proposed that the Petitioner might take the HK$3,500,000.00 worth of IT solutions as investment in a holding company that would hold the shares of Hercules MDL. …

17.   In around June 2006, Mr Yung thought that since the Petitioner had been so much involved in the operation of Hercules MDL and that with the personal participation of Dr Cheng in the operation of Hercules MDL starting in 2006 there ought to be more business, Mr Yung eventually agreed on behalf of the Petitioner to the proposal of accepting shares of the holding company of Hercules MDL to settle the outstanding sum of HK$3,500,000.00, and to enter into such quasi partnership.  Pursuant to this quasi partnership agreement, the Company earlier incorporated in January 2006 was therefore set up as the holding company to hold 51% or so of all issued shares of Hercules MDL and to hold the exclusive right to use and market (or licence out) the two IT solutions.  …”

(emphasis added)

As pleaded, Cosmo accepted the shares in the Company in payment of the outstanding price of the two software.  The only substratum pleaded was that the Company shall be a holding company of Hercules MDL holding 51% or so of its issued shares and to hold the exclusive right to use and market the two software. This substratum corresponded with some of the terms of the shareholders’ agreement as stated by Yung.  On the pleading as well as on the evidence, the substratum now relied on by Cosmo never formed the basis of Cosmo’s cooperation with Wisetrade and Yip.

93.  According to Yung’s affidavit, by November 2006, all the six medical diagnostic centres of Hercules MDL had been set up and become fully operational.  Then in December 2006, Cheng revealed to Yung that he was desperately trying to cut cost of the operation.  They agreed that Cosmo’s management services contract should be terminated with effect from 31 December 2006 and that Yung should pull out from his services as CEO of Hercules Group and director of Hercules MDL following the termination of the management services contract.  He said that he was being forced out of the Company.  Despite the termination of the management services contract, Cosmo’s IT services contract continued.

94.  Then on 31 October 2007, Yung received a telephone call from Yip informing him that Hercules MDL was about to switch to another IT solution and a test run was underway.  Yung replied immediately that Cosmo would have to discontinue the IT services contract if Hercules Group did so.  Yip did not respond but faxed a copy of Aptom’s quotation to Yung later that day showing a schedule of implementation.  The package offered by Aptom was $482,000 which included a three year annual maintenance fee of $150,000.  On 29 November 2007, Yip signed the quotation indicating that Hercules MDL wished to have a test run of Aptom’s IT solution.  The test run was scheduled to take place in January or February 2008.  Much of the above evidence is not in dispute except that Cheng and Yip said that Hercules MDL had not decided to switch to another IT solution but was only exploring with Cosmo the possibility of switching to another computer software developed by other software engineers and a reduction of the monthly IT service fee but Cosmo over-reacted with almost immediate termination of the IT services contract.  I do not accept Cheng’s and Yip’s explanation. Even on Yip’s evidence, there was no discussion about reduction of IT service fee.  She was unilaterally informing Cosmo of the test run of Aptom’s IT solution.  Given the substantially lower service fee charged by Aptom, it was only to be expected that Cosmo’s IT solution would be replaced by Aptom’s, though Cosmo’s termination of the IT services contract was premature.  I accept Yung’s evidence that Yip informed him that there would be a switch to another IT solution.  In any event, this dispute has no bearing to the petition.

95.  On 1 January 2008, Hercules Group’s IT system experienced interruption.  Since Software I and Software II could no longer function, Hercules MDL contracted with Aptom to install its IT solutions.

96.  On the evidence, there was no agreement that the Company will secure the continual use of the two software by Hercules MDL.  Hercules Group was free to switch to other IT solutions.  Hercules MDL was reducing its operational cost.  It terminated Cosmo’s management contract.  It looked for cheaper IT solutions in the market.  Aptom’s offer was significantly cheaper than Cosmo’s.  In sixteen months, savings on Cosmo’s IT service fees would be sufficient to pay off Aptom’s package including three years’ maintenance service.  That is clearly to the benefit of Hercules MDL and the holding Company.  The Company’s affairs could not be said, by reason of the switch, to be conducted in a manner unfairly prejudicial to the interest of Cosmo as a member.  This is so even if the interruption was not caused by Cosmo.  As explained in paragraph 37, it unnecessary to burden this judgment with investigating who was responsible for the interruption in Hercules Group’s IT system.

97.  Furthermore, on Yung’s evidence, he admitted that the or a principal business of the Company was to hold a majority interest in Hercules MDL.  Despite the switch to Aptom’s IT solution, the Company is still holding a majority interest in Hercules MDL. Hence, Mr Wong submits that even if the continual use of the two software was the substratum for Cosmo’s cooperation, in the light of Yung’s evidence, the substratum cannot be said to have been gone.  Mr Wong is obviously right.

Yung being forced out of the Company

98.  I now return to Yung’s complaint about being forced out of the Company towards the end of December 2006.  After the termination of his appointment as CEO of Hercules Group and director of Hercules MDL, Cheng convened the first annual general meeting of the Company in June 2007 and passed a resolution granting unconditional approval to any loan made to Cheng or to his companies.  Yung was unhappy about that but did not object as he was in the minority.  In October 2007 Cosmo received the audit confirmation which led to his telephone conversation with Yip on or about 24 December 2007 when, on my finding, Yip said that she and Cheng adopted the auditor’s report. 

99.  Presumably, Yung raised this complaint as a ground of unfair prejudice based on exclusion from management.  This conduct has not been pleaded in the Amended Petition.  He said that during the discussion with Cheng about cutting cost, he told Cheng that he did not agree to terminate his directorship in Hercules MDL and proposed to Cheng to buy all of Cosmo’s shares in the Company, but Cheng refused.  Then on 19 January 2007, he received a resignation notice and was told to sign.  He signed reluctantly.  He said that if he had retained his directorship, he could still check on the Company.  His evidence in Court is quite inconsistent with paragraph 70 of his second affidavit filed on 23 October 2008.  There, he said:

“In December 2006, Dr Cheng revealed to me that he was desperately trying to cut cost in the operation. Dr Cheng and I also thought that the [management service] was no longer required. It was therefore agreed between Dr Cheng on behalf of Hercules MDL and I on behalf of the Petitioner that the [management service contract] should cease, effective on 31^st December 2006, and that I should also be pulled out from all my pro bono favours (taking up appointment as CEO, director, setting up Centres) to Hercules MDL following the cessation of the [management service contract].

Earlier in his affidavit, he said that his appointment as CEO and director of Hercules MDL was a pro bono favour or a burden which he had hesitation to accept.  The picture he was trying to paint by the passage quoted above is that he was neutral about the termination of his pro bono favour if not that he felt being relieved of a burden which he took on with hesitation.  There was not the slightest hint that he had any objection to the termination. 

100.  As for his claim that by retaining his directorship in Hercules MDL, he could monitor what was going on with the Company, I fail to see how his directorship in a subsidiary could entitle him to monitor what was going on with the holding Company.  Be that as it may, Yung was not a shareholder of Hercules MDL.  He cannot validly complain about the termination of his directorship in Hercules MDL.  Likewise, neither Yung nor Cosmo could complain about the termination of Yung’s appointment as CEO of Hercules Group or the termination of Cosmo’s management services contract with Hercules MDL as the appointment and management services contract were not Cosmo’s rights as member of the Company.  His appointment as CEO of Hercules Group or director of Hercules MDL or the management services contract were not secured by the shareholders’ agreement or articles of association of the Company. 

101.  Yung’s allegation has to be rejected.  Not only that what he now said in Court was not pleaded, it is so inconsistent with his affidavit as to suggest it was an afterthought or an impromptu concoction in the witness box.

CONCLUSION

102.  Yung, Cheng and Yip were all selective in telling the truth.  My finding of fact is based primarily on Yung’s evidence, who as I have said was the least incredible of the three. He started with all good intention to assist Cheng in setting up Hercules Group and providing him with a cover while Cheng was under some obligation owed to BUPA not to engage in a similar business.  He desired to participate in Hercules MDL and its medical software business.  He was talked into injecting the two software into Hercules Group as Cosmo’s investment.  Through Cosmo, he obtained some benefit by way of the IT services contract and management services contract.  On the other hand, Cheng obtained the two software practically for free during the inception of Hercules Group when capital was much need. Initially, he delayed payment of $2 million for Software I and then he persuaded Yung to treat the price of the two software as Cosmo’s contribution to the share capital of the Company.  In the meantime, Hercules MDL had the use of the two software without paying.  Came 2006, Cheng’s operation of Hercules Group went overt.  Yung became redundant.  So, Cheng blew his cover, terminated Cosmo’s management services contract and Yung’s appointment as CEO of Hercules Group and director of Hercules MDL.  He caused Hercules Group to switch to Aptom’s IT solution.  Naturally, Cosmo was forced to terminate the IT service contract.  Cosmo’s collateral benefits in the cooperation evaporated.  Cosmo’s investment became tied down in the Company for nothing.  The Company suffered massive losses.  Had Yung been able to show that the Company was a quasi-partnership company or that the continual use of the two software formed the basis of Cosmo’s cooperation with Wisetrade and Yip, I would have no hesitation in ordering a buyout against Wisetrade and Yip.  But he failed. Yung made a bad investment for Cosmo.  Cosmo’s petition could only be dismissed.

103.  Usually, costs should follow the event.  However, the present petition is basically a partnership dispute between Yung on the one part and Cheng and Yip on the other.  They comprise of all the members of the Company.  Many unnecessary factual disputes were raised.  Cheng and to some extent Yip were found lying on most of the factual issues, but they succeeded in the action.  But for the above consideration, they should be entitled to costs from Cosmo.  Even if no costs order is made in their favour, they would be able to have their costs reimbursed by the Company.  Having regard to all the circumstances in this petition, I consider it appropriate that all costs should be paid by the Company except for a nominal fraction, equivalent to Cosmos’s 13.55% shareholding in the Company, which should be paid by Cosmo to reflect their failure in the petition.  Accordingly, I make a costs order nisi that there be no order as to costs except that the 1^st and 2^nd Respondents’ costs and 86.45% of the Petitioner’s costs shall be paid by the 3^rd Respondent.

104.  Cosmo’s only hope is that its indirect investment in Hercules MDL through the Company would pay off.  If Hercules MDL makes profit, part of the profit would go to the Company through its 51% shareholding.  Cosmo would have to see to it that these profits are not unfairly dissipated by the majority.  If it is, Cosmo may launch a better prepared action on a more proper cause.  Of course, it would be in the interest for all parties to resolve the dispute with goodwill and reach agreement for a voluntary buyout on reasonable terms than to use their resources on wasteful litigation.  It is for that reason that I made detailed finding on various issues in dispute, which would otherwise have been quite unnecessary.

105.  Accordingly, the petition is dismissed with a cost order nisi that the 3^rd Respondent shall pay all of the 1^st and 2^nd Respondents’ costs and 86.45% of the Petitioner’s costs.  Such costs are to be taxed, if not agreed.