YAU SIU CHAN v. ITALINA (HOLDINGS) LTD AND OTHERS

HCMP 2410/2007

IN THE HIGH COURT OF THE

HONG KONG SPECIAL ADMINISTRATIVE REGION

COURT OF FIRST INSTANCE

MISCELLANEOUS PROCEEDINGS NO. 2410 OF 2007

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D E C I S I O N

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The application

1.  This originating summons was issued on 30 November 2007 pursuant to sections 111(2), 122 and 124 of the Companies Ordinance, Cap. 32 by Yau Siu Chan, a shareholder of Ita1ina (Holdings) Limited (“the Company”).  The 1^st respondent in the originating summons is the Company.  The 2^nd to 6^th respondents are the present directors of the Company.  I will refer to the 2^nd to 6^th respondents as “the respondents” in this decision.

2.  The applicant seeks an order in these terms:

(1)     an annual general meeting (“AGM”) of the Company be convened by the court for the purpose of transacting the businesses in the schedule to the originating summons;

(2)     directions be given to the manner in which the AGM be called, held and conducted and all ancillary and consequential directions, including:

(a)    the profit and loss accounts and balance sheets of the Company for the years ended 31 March 2005, 31 March 2006 and 31 March 2007 (“the Accounts”) be laid before the AGM; and

(b)   the group accounts (as defined in section 124(1)) dealing with the state of affairs and profit or loss of the Company and its subsidiaries (including but not limited to East Asia Industrial Company Limited 中山市東亞輕工實業有限公司(“East Asia”) and Italina Jewellery Ornaments (Zhongshan) Company Limited伊泰蓮娜首飾精品(中山)有限公司(“Italina Zhongshan”) for the years ended 31 March 2005, 31 March 2006 and 31 March 2007 (“the Group Accounts”) be laid before the AGM.

3.  The businesses to be transacted at the AGM as set out in the schedule are to receive and consider the Accounts, with reports of directors and auditors, the Group Accounts, and to appoint auditors for the Company and fix their remuneration.

4.  After the originating summons was issued, the respondents issued a notice of an AGM for the meeting to be held on 31 December 2007.  The AGM for 2007 was held on 31 December, but no accounts were produced for consideration.  On 8 May 2008, the respondents issued a notice for the 2008 AGM and served it on the applicant on 9 May 2008, with copies of the Accounts and the Group Accounts but only in respect of the year ended 31 March 2007.  This AGM was held on 2 June 2008 and reso1utions to approve the audited Accounts and the audited Group Accounts for the year ended March 2007 were passed by a majority.

5.  On 22 April 2008, the 2^nd respondent filed his first affirmation on behalf of the respondents asserting that the directors are of the view it is impracticable to provide the Group Accounts for the financial years of 2005 and 2006 or that such Group Accounts would be of no real value to members of the Company, as their preparation would involve expense or delay out of proportion to the value to members.

6.  The applicant has restored the originating summons for hearing to resolve the remaining issues: (1) whether the Company should provide Group Accounts for the years ended March 2005 and March 2006 for consideration and approval at an AGM; and (2) the costs of the originating summons.  I will deal with them in that order.

The background

7.  The relevant background matters may be stated as follows.

8.  This application is an ancillary matter arising out of more substantial disputes that are the subject of litigation that is ongoing in HCA Nos. 1255 of 2007 and 1309 of 2007.  The main disputes concern the ownership of 30 odd companies, and arose out of the falling out of siblings in two camps.  They are referred to in the documents filed in court as “the Yau Ngai Siblings” and “the Yau Tak Siblings”.  The applicant belongs to the first-mentioned camp.  Three of the respondents and two of the spouses being the 5^th and 6^th respondents belong to the other camp.

9.  The case of the Yau Ngai Siblings is that there was a group of companies known as the “Italina Group” which have been carrying on the business of manufacturing and sale of imitation jewellery and related products in Hong Kong, Macau and the PRC, and the business of the Italina Group is in effect a family partnership between the seven siblings of the Yau family.  All seven siblings have interests in agreed proportions in the companies in the Italina Group.

10.  The case of the Yau Tak Siblings is that there have never been a group of companies known as the Italina Group or a family partnership.  They allege that numerous companies were set up over the past 30 years by different combinations of the siblings, some of which belong to all seven siblings, some belong to six siblings only, and some were set up by some of the siblings in co-operation with business partners outside the Yau family.

11.  In July 2005, the applicant and Yau Ngai were ousted from the manufacturing base in Zhongshan Industrial City.  It was alleged by them that the acts of the other camp in 2005 were to exclude them from a substantial part of the core business and assets of the family partnership.

12.  The Company was incorporated in Hong Kong in 1993.  It is not necessary for present purpose to consider why it was formed or the change in shareholdings except to mention that the applicant was and is a shareholder holding 2,500 out of 10,000 issued shares.  The applicant was removed as a director of the Company in June 2005.

13.  The Company was and is an investment holding company.  For present purpose, it is only necessary to note that the Company holds 100% interest in East Asia, 52% interest in Italina Zhongshan.  The business activities are carried out by these subsidiaries.  The Accounts showed that the Company had no turnover for the years ended March 2005 to March 2007.

14.  Since his exclusion from the management of the Company, the applicant claimed he had been kept in the dark about its financial condition and affairs.  Apart from this originating summons, he brought proceedings in HCMP No. 2352 of 2007 against the respondents under section 152FA for inspection of documents and an order was made by Reyes J on 2 October 2008 for the respondents to produce various documents for inspection, including all working documents and schedules used in the preparation of accounts and group accounts of the Company for the year ended March 2007 and for the years ended March 2005 and March 2006 after such group accounts are prepared.  So if the Group Accounts for those two years ought to be prepared, contrary to the respondents’ contention in this application, the documents relating to the preparation of those accounts would also be subject to the order for inspection.

15.  In his affirmation in support filed in the inspection proceedings in March 2008 (which was before the 2^nd respondent filed his affirmation in opposition to this originating summons), the applicant stated that the purposes of inspection of the various records of the Company are for:

(1)     investigating into whether legal proceedings may be appropriate to challenge transactions which adversely affect the applicant’s interest as a shareholder of the Company;

(2)     deciding whether or not his rights as a shareholder may or ought to be exercised; and

(3)    determining the value of the shares of the Company and/or the value of his shareholding.

16.  It is against this background that the assertion of the respondents why Group Accounts for 2005 and 2006 should not be prepared should be viewed.

The statutory provisions

17.  I start with section 124 which relates to the obligation to lay group accounts before a holding company.  Subsection (1) and the relevant exception in (2)(b)(i) provide as follows:

“(1)   Where at the end of its financial year a company has subsidiaries, accounts or statements (in this Ordinance referred to as “group accounts”) dealing as hereinafter mentioned with the state of affairs and profit or loss of the company and the subsidiaries shall, subject to subsection (2), be laid before the company in general meeting when the company’s own balance sheet and profit and loss account are so laid.

(2)          Notwithstanding anything in subsection (1) –

…

(b)     group accounts need not deal with a subsidiary of the company if the company’s directors are of opinion that –

(i)    it is impracticable, or would be of no real value to members of the company, in view of the insignificant amount involved, or would involve expense or delay out of proportion to the value to members of the company; …

and, if the directors are of such an opinion about each of the company’s subsidiaries,  group accounts shall not be required …”

18.  Also of relevance is section 123(2) which provides that a company’s balance sheet and profit and loss account shall comply with the requirements of the 10^th schedule to Cap. 32, so far as applicable thereto.  Part II of the 10^th schedule makes special provisions where the company is a holding or subsidiary company and paragraph 18(4) reads as follow:

“(4)   Where group accounts are not submitted, there shall be annexed to the balance sheet a statement showing –

(a)     the reasons why subsidiaries are not dealt with in group accounts;

(b)     the net aggregate amount, so far as it concerns members of the holding company and is not dealt with in the company’s accounts, of the subsidiaries’ profits after deducting the subsidiaries’ losses(or vice versa) –

(i)    for the respective financial years of the subsidiaries ending with or during the financial year of the company; and

(ii)   for their previous financial years since they respectively became the holding company’s subsidiary;

(c)     the net aggregate amount of the subsidiaries’ profits after deducting the subsidiaries’ losses (or vice versa) –

(i)    for the respective financial years of the subsidiaries ending with or during the financial year of the company; and

(ii)   for their other financial years since they respectively became the holding company’s subsidiary;

so far as those profits are dealt with, or provision is made for those losses, in the company’s accounts;

(d)     any qualifications contained in the report of the auditors of the subsidiaries on their accounts for their respective financial years ending as aforesaid, and any note or saving contained in those accounts to call attention to a matter which, apart from the note or saving, would properly have been referred to in such a qualification, in so far as the matter which is the subject of the qualification or note is not covered by the company’s own accounts and is material from the point of view of its members;

or, in so far as the information required by this sub-paragraph is not obtainable, a statement that it is not obtainable:

         Provided that the Financial Secretary may, on the application or with the consent of the company’s directors, direct that in relation to any subsidiary this sub-paragraph shall not apply or shall apply only to such extent as may be provided by the direction.”

19.  No statement in compliance with paragraph 18(4) was annexed to the balance sheet of the Accountsfor the years ended March 2005 and March 2006.

20.  Lastly, section 125(1) provides that subject to subsection (2), the group accounts laid before a holding company shall be consolidated accounts comprising a consolidated balance sheet and profit and loss account.  Subsection (2) provides as follows:

“If the company’s directors are of the opinion that it is better for the purpose –

(a)     of presenting the same or equivalent information about the state of affairs and profit or loss of the company and those subsidiaries; and

(b)     of so presenting it that it may be readily appreciated by the company’s members,

the group accounts may be prepared in a form other than that required by subsection (1), and in particular may consist of more than one set of consolidated accounts dealing respectively with the company and one group of subsidiaries and with other groups of subsidiaries, or of separate accounts dealing with each of the subsidiaries, or of statements expanding the information about the subsidiaries in the company’s own accounts, or any combination of those forms.”

21.  The relevant exception in section 124(2)(b)(i) does not appear to have been considered in any reported decision in Hong Kong.

22.  Mr Jose Maurellet appearing for the respondents contrasted the local statutory provision with section 229(3) of the Companies Act 1985 in the UK.  The latter provision reads:

“(3)   In addition, a subsidiary undertaking may be excluded from consolidation in Companies Act group accounts where –

(a)     severe long-term restrictions substantially hinder the exercise of the rights of the parent company over the assets or management of that undertaking, or

(b)     the information necessary for the preparation of group accounts cannot be obtained without disproportionate expense or undue delay, or

(c)     the interest of the parent company is held exclusively with a view to subsequent resale and the undertaking has not previously been included in consolidated group accounts prepared by the parent company …”

23.  Mr Maurellet made the point that unlike the UK provision, section 124(2) specifically stipulates it is “if the company’s directors are of the opinion” of certain matters that group accounts shall not be required.  He submitted that under the UK provision, the matters to be weighed in considering if group accounts shall be required are to be looked at objectively. But in Hong Kong, because of the wording of section 124(2), the weighing decision is primarily one for the board of directors. It was argued that whilst the court retains a supervisory jurisdiction, the court should not substitute its own views for the views of the directors or interfere with a management decision of the directors, unless it could be shown that no reasonable directors would have formed such an opinion or that the opinion could not have been formed bona fide.

24.  Mr Maurellet prayed in aid the cases involving the exercise of powers vested in the board of directors by the articles of association, such as the power to issue shares, in which the established principle of judicial non-interference with bona fide management decisions has been applied (Howard Smith Limited v Ampol Petroleum Limited and Others [1974] AC 821 at 832; Kwok Shun On v Wong Sai Wing and Others [2001] 3 HKLRD 811 at 825J to 826D, para 73).  He submitted that unless it is shown that the opinion of the respondents not to prepare Group Accountsfor years 2005 and 2006 was held in bad faith or out of the range which reasonable directors may hold, this application must fail.

25.  Mr John Yan, SC submitted on behalf of the applicant that the requirement to prepare group accounts is a corporate governance issue and the legislative provision is to ensure transparency of the affairs and accounts of the companies. It is not simply a management decision.  The issue must be whether the view taken by the directors not to prepare group accounts is correct and reasonable in all the circumstances, not simply whether the opinion of the directors is held in bad faith.

26.  I have reservations if the hurdle to challenge the decision of the board not to prepare group accounts is as high as contended by Mr Maurellet.  I am more inclined to agree with Mr Yan.  In my view, it would suffice if it can be shown that the opinion held by the directors is not on reasonable grounds.  I do not think it has to be shown that no reasonable directors would have formed such an opinion, or that the opinion is outside the range that reasonable directors may hold.  Notwithstanding the difference in wording between our section 124(2) and the UK provision, I do not think there should be a material difference in the approach of the court in considering if the criteria are met to exempt a holding company from the requirement to prepare group accounts.  In the UK, as in Hong Kong, the responsibility is with the board of directors of the holding company to consider if group accounts should be prepared, having regard to the criteria laid down in the statutory provision.  In the event of dispute, the court would consider if the criteria laid down in the statutory provision are met, on an objective assessment.

The opinion of the directors

27.  The opinion of the directors was set out in paragraph 53 of the 2^nd respondent’s 1^st affirmation and contained in the last two sentences of this paragraph which read as follows:

“Given that the group accounts of 31 March 2007 would reflect the financial status of the subsidiaries of Italina (Holdings), I and the other directors of Italina (Holdings) are of the view that it is impracticable to provide the group accounts for the financial years of 2005 and 2006.  Such impracticability would also render the extra expense or delay out of proportion to value to the members of the company as extra information and documents would need to be retrieved from the mainland.”

28.  As mentioned earlier, no statement in compliance with paragraph 18(4) of the 10^th Schedule to Cap. 32 has been annexed to the balance sheet of the Accountsfor the years ended March 2005 and March 2006.  Had such a statement been made, the reasons given why subsidiaries are not dealt with in Group Accounts would of course be considered by the court.  But there is no such statement.  I do not think I should consider any other reason advanced by the respondents’ counsel to support or explain the opinion they held, as those reasons were not the respondents’ reasons in forming the opinion they held, on the evidence they have adduced to this court. I should concern myself with assessing the opinion of the Company’s directors by looking at their own grounds, not an opinion as rationalised ex post facto by their counsel.

29.  The respondents opined it is impracticable to prepare Group Accounts for the financial years of 2005 and 2006, given that Group Accounts of March 2007 would reflect the financial status of the subsidiaries of the Company.  I cannot possibly see how that opinion could be upheld on any view.

30.  As stated in paragraph 39 of the Framework for the Preparation and Presentation of Financial Statements issued by the Hong Kong Institute of Certified Public Accountants (“HKICPA”):

“Users must be able to compare the financial statements of an enterprise through time in order to identify trends in its financial position and performance.  Users must also be able to compare the financial statements of different enterprises in order to evaluate their relative financial position, performance and changes in financial position.”

31.  The disclosure of comparative figures of the immediately preceding year in the accounts is a requirement under Cap. 32 (10^th Schedule, paragraphs 12(16) and 17(5)) and of the Hong Kong Accounting Standards (“HKAS”) 1 “Presentation of Financial Statements” issued by HKICPA.  The 2007 Group Accounts do not contain any comparative figures, and do not comply with the above requirements.  Without the Group Accounts of the previous years, it is not possible to obtain a proper understanding of the financial performance and position of the Company and its subsidiaries in the previous years or the trends in performance over the years.

32.  The other reason advanced by the respondents in the affirmation is that the impracticability to prepare Group Accounts for 2005 and 2006 would render the extra expense or delay out of proportion to the value to members as extra information and documents would need to be retrieved from the Mainland.

33.  I also fail to see how these could be regarded as reasonable grounds.

34.  There is no evidence of the time or expense likely to be involved in the preparation of the Group Accounts for the two previous years.  There is only a bare assertion that the time and expense would be out of proportion to the value of the information to members.  That is simply not good enough.

35.  On the evidence, 15 weeks after the present auditors were appointed, the Accountsfor 2005 to 2007 were signed by the directors and the auditors on 18 April 2008.  Eleven days later, the 2007 Group Accounts were signed by the directors and the auditors on 29 April 2008.  The auditors’ remuneration disclosed in the 2007 Group Accounts was $49,133.

36.  The auditors qualified their opinion for the Accountsin that the Company has not prepared consolidated financial statements for 2005 and 2006 in accordance with HKAS 27 “Consolidated and Separate Financial Statements” issued by HKICPA.  They also qualified their opinion for the 2007 Group Accounts as they were unable to satisfy themselves as to the quantity of inventory recorded in the substantial sum of $111 million. The business activities of the Company were conducted through its subsidiaries and the assets and liabilities of the subsidiaries are very substantial, as can be seen from the Group Accounts for 2007.  The revenue of the subsidiaries amounted to $75 million, non-current assets were $62.9 million, current assets were $133.4 million, and total liabilities $167 million.

37.  No other ground for impracticability was put forward by the respondents.  The 2^nd respondent did not say in his affirmation that it would be impracticable in view of the insignificant amount involved.  The respondents could not have taken that view, given the size of the subsidiaries’ businesses.

38.  On an objective view, I do not think it can be said that the associated costs would be disproportionate to the value of the information to be gained.

39.  The respondents have adduced a report from an accounting expert.  Their expert was asked to comment on the potential value of the “2005 and 2006 Consolidated Accounts”.  The inference drawn by this expert from the fact that no consolidated accounts were prepared from 1998 to 2004 is irrelevant and misplaced.  His opinion is that provided the conditions in section l25(2)(a) and (b) are met, the group accounts may be prepared in a form other than a consolidated balance sheet and profit and loss account, by providing separate audited accounts of the Company and of each subsidiary and supplemented by additional appropriate information.  He did not say it would be impracticable to prepare Group Accounts for 2005 and 2006, nor did he express agreement with the respondents that the preparation of such accounts would involve delay or expense out of proportion to the value to members.

40.  Even if the correct approach were the higher requirement as submitted by Mr Maurellet, I would have held that the decision not to prepare Group Accounts for 2005 and 2006 was not made in good faith.

41.  Since late November 2007, the respondents have been in possession of all the relevant documents for the preparation of such accounts.  The real value of the Group Accounts to a member to have a complete understanding of the financial performance and trends in performance over the 3-year period would clearly outweigh the expense or time to be taken in preparing them.

42.  The respondents were aware all along of the applicant’s demand for Group Accounts to be provided, and the parties were in hostile litigation.  No evidence was adduced of any board meeting in which the directors considered the question if Group Accounts for any year should or should not be prepared.  In making the decision not to prepare Group Accounts for the two earlier years, it did not appear that the respondents had given any thought to the provision of a paragraph 18(4) statement, as the Company is obliged to do, or the alternate form of providing group accounts instead of a single consolidated financial statement.  I am inclined to agree with Mr Yan that the respondents had not applied their minds to the obligation to furnish Group Accounts or the alternative thereto.

43.  I make an order that the 2005 and 2006 Group Accounts are to be prepared and laid before an AGM of the Company for consideration and approval, and such AGM is to be convened withina reasonable time to be stipulated.  The respondents have proposed a period of four months, with liberty to extend time.  I would order 60 days from today.  There is no indication on the evidence before me that a much longer period is needed.

Costs

44.  I do not propose to recite the history canvassed in the affirmations filed.  In my view, the applicant was justified in issuing the originating summonsand proceeding with it.  I reject the contention of the respondents that the application was premature or unnecessary.

45.  The response of the respondents throughout, from the first letter of the applicant’s solicitors dated 16 November 2007,to the demand to convene an AGM and to prepare accounts was non-committal and hardly re-assuring.  There is no reason why the respondents could not have informed the applicant when an AGM would be held, before the originating summons was issued on 30 November 2007.  I see no reason why an estimated timetable could not have been given to the applicant when the Accounts would be ready to be tabled before another AGM, before the applicant filed a substantial affirmation in support of this application.  I note it was only when the 2^nd respondent filed an affirmation in opposition on 22 April 2008 that the respondents indicated for the first time the Group Accounts for the financial years of 2005 and 2006 would not be prepared.

46.  I award the costs of this originating summons to the applicant.

47.  The applicant seeks a certificate for two counsel.  Having regard to the factors highlighted by Mr Yan there is no reported decision on the statutory provision in issue, the value of the property involved, the importance of the Group Accounts to the applicant, and the general importance of this application to other litigation between the parties, I am persuaded that it is reasonable and proper to engage two counsel in this application, so a certificate for two counsel will be made.