RE GUANGDONG INVESTMENT LTD

HCMP 4867/2003

IN THE HIGH COURT OF THE

HONG KONG SPECIAL ADMINISTRATIVE REGION

COURT OF FIRST INSTANCE

MISCELLANEOUS PROCEEDINGS NO. 4867 OF 2003

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REASONS FOR JUDGMENT

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1. This petition for confirmation of reduction of capital is presented by Guangdong Investment Limited ("the Company"). The proposed reduction of capital is in these respects:

(1)	reduction of the share premium account by HK$3,879,159,478.00; and
(2)	reduction of the capital from US$200,000.00 divided into 200,000 3 1/4 per cent redeemable cumulative convertible preference shares of US$1.00 each ("the preference shares") and HK$4,000,000,000.00 divided into 8,000,000,000 ordinary shares of HK$0.50 each by cancelling all the 200,000 preference shares both issued and unissued on terms that there shall be allotted and credited as fully paid up to the beneficial owner of the 85,949 issued preference shares as cancelled, GDH Limited ("GDH") or its nominee, and in substitution for the cancelled preference shares:
	(i)	HK$497,320,000.00 5.1 per cent five-year bonds; and
	(ii)	HK$497,320,000.00 2.0 per cent five-year convertible bonds.

2. Thus, the proposed cancellation of the preference shares involves a variation or abrogation of the rights attached to the preference shares. But instead of returning to the holders of the preference shares an amount equal to the redemption price on the preference shares with the full amount of fixed cumulative dividends to which the holders are entitled, it is proposed that the Company shall issue to the holders straight bonds and convertible bonds.

3. Special resolutions to give effect to the proposed reduction were passed pursuant to article 44(d) of the articles of association at the extraordinary general meeting of the Company held on 29 September 2003.

The Company and its share structure

4. The Company was incorporated in Hong Kong on 5 January 1973 as a private company and ceased to be such by a special resolution passed on 6 January 1973. Its name was changed to its present name on 12 July 1988. The ordinary shares of the Company are currently listed on The Stock Exchange of Hong Kong Limited.

5. The Company is a widely diversified holding company, which, through its subsidiaries, operates businesses in, inter alia, water distribution, electric power generation, toll roads and bridges, property investment and development, hotel operations and management. Its geographical focus is in the southern part of China and in Hong Kong. Since the onset of the Asian financial crisis, the Company has encountered difficult trading conditions and has suffered significant losses in its various areas of activity.

6. According to the latest audited consolidated accounts, for the year ended 31 December 2002, the Company had accumulated losses of HK$3,744,293,842.00. For the six months ended 30 June 2003, the unaudited management accounts recorded accumulated losses of HK$3,879,159,478.00.

7. As at 16 December 2003, the issued share capital of the Company consists of 5,236,622,672 ordinary shares and 85,949 preference shares, all of which are fully paid up or credited as fully paid up. As at the same date, there is standing to the credit of the share premium account the amount of HK$6,600,018,164.00.

8. The preference shares were issued on 26 May 1998. They are all beneficially owned by GDH, and entitle their holders to receive cumulative fixed dividends, currently fixed at 6.60% per annum calculated on the aggregate of (i) the paid-up value of US$1,000.00; and (ii) the final redemption premium of US$395.64. From 7 April 2004 onwards, the preference shares will carry a fixed dividend of 9.60% per annum. This dividend is payable out of the distributable profits generated by the Company. However, as a result of the accumulated losses, the Company does not have distributable profits to pay the fixed dividends. The unpaid amounts due and outstanding on the preference share therefore accumulate. As at 30 June 2003, the unpaid fixed dividend has accumulated to approximately US$14.42 million, which is equivalent to about HK$112.46 million.

9. Pursuant to the terms of their issue, the preference shares were due to be redeemed on 7 April 2003 at approximately 139.6% of their paid-up value plus any outstanding accumulated but undeclared fixed dividends. As the Company was unable to redeem the preference shares on that day, the terms of the issue of the shares require that if the Company has distributable profits at any time after 7 April 2003, it must apply its distributable profits towards paying down the redemption amount of the preference shares by way of partial redemption until all the preference shares have been redeemed. Hence, the continuation in issue of the preference shares will significantly delay the date on which any dividends may be declared or paid on the ordinary shares.

10. In view of this, the Company has proposed the cancellation of all the preference shares, both issued and unissued. The sole beneficial owner, GDH, has consented to the cancellation. As mentioned, it will receive in place of the cancelled shares two different types of bonds, the aggregate principal amount of which will be HK$994,640,000.00. This is less than the amount which GDH would have been entitled to receive upon a full redemption of the preference shares. Under a letter agreement dated 21 August 2003, GDH has agreed to waive the difference between the redemption amount and the aggregate principal amount due under the two types of bonds.

The purposes for reduction of capital

11. The financial position of the Company has not changed materially since 30 June 2003, which is the date to which the latest management accounts were prepared. The paid- up capital of the Company including capital in the form of the share premium account to the extent of HK$3,879,159,478.00 has been lost or is unrepresented by available assets. Under section 79B, the Company is not permitted to pay any dividend while there remain any accumulated losses. The purpose for the reduction of the share premium account is to eliminate the accumulated deficit of HK$3,879,159,478.00 on the Company's profit and loss account as at 30 June 2003, so as to bring forward the time when the Company may be in a position to pay dividends on the ordinary shares and to bring the Company's capital more into line with its available assets.

12. The purpose for the cancellation of the preference shares to be replaced with the straight bonds and convertible bonds is to accelerate further the resumption of the payment of dividends to the holders of the ordinary shares.

The extraordinary general meeting

13. On 4 September 2003, the Company sent a circular to all its shareholders containing the following documents:

(1)	a letter from the board of directors to the shareholders;
(2)	letter from the independent board committee to the independent shareholders;
(3)	a letter from the independent financial adviser to the independent board committee;
(4)	notice dated 4 September 2003 convening an extraordinary general meeting of the holders of the ordinary shares and the holders of the preference shares; and
(5)	form of proxy for voting at the extraordinary general meeting.

14. The circular sets out in detail the reasons for the proposed reduction of the share premium account and the cancellation of the preference shares. On the basis of the advice received from the independent financial adviser, the independent board committee has advised the independent shareholders that the terms and conditions of the proposed cancellation of the preference shares are fair and reasonable so far as the independent shareholders are concerned.

15. As I have mentioned, the special resolutions to give effect to the proposed reduction were passed at the extraordinary general meeting held on 29 September 2003. The holders of the ordinary shares present in person or by proxy voted unanimously in favour of the special resolutions. The two holders of the preference shares have signed a resolution on 16 and 17 September 2003 consenting to the alteration or abrogation of the special rights attached to the preference shares effected by the implementation of the special resolutions set out in the notice convening the extraordinary general meeting. They have also voted unanimously in favour of the special resolutions.

The legal principles

16. The legal principles upon which the court will sanction a reduction of the share premium account are similar in all respects to those upon which the court will sanction the reduction of share capital (Re Ratners Group plc (1988) 4 BCC 293 at 295). They are as follows:

(1)	all the shareholders should be treated equitably in the reduction;
(2)	the proposals for reduction should have been explained to the shareholders properly for them to exercise an informed decision how to vote on the proposed reduction;
(3)	the reduction is for a discernible purpose; and
(4)	the interests of the creditors are safeguarded.

17. I am satisfied that the shareholders are treated equitably here. As stated by Harman J in Re Ratners Group plc, supra, the principle here is that the shareholders are treated equitably. "That usually means that they are treated equally, but may mean that they are treated equally save as to some who have consented to their being treated unequally ...". As stated earlier, all the holders of the preference shares unanimously consented in writing to the alteration or abrogation of their rights attached to the preference shares and all the holders of the ordinary shares and the holders of the preference shares present in person or by proxy have voted unanimously in favour of the special resolutions. There is no question that they are not treated equitably.

18. I have considered the circular sent by the Company to all the shareholders and am satisfied that the shareholders have been given a sufficient explanation for them to exercise an informed judgment as to how to vote at the meeting.

19. As for there being a discernible purpose for the reduction, this requirement is also met. In this context, "discernible" means "something which is demonstrated by evidence to the court and is something sufficiently solid and near in expectation to be a real prospect" (Re Thorn EMI plc (1988) 4 BCC 698 at 701). The court takes a fairly broad view of what amounts to a discernible purpose and once it is established there is a discernible purpose for the reduction, the court will not judge the motive of the company in pursuing that purpose (Buckley on the Companies Act, 2000 ed, paras. [135.36] and [135.37]).

20. What needs to be considered in greater detail in this instance is the means by which the Company proposes to safeguard the interest of creditors.

The protection for the creditors

21. The position of the creditors and the means by which they are to be protected were addressed at the hearing of the summons for directions. In summary, the Company has taken or has proposed to take the following steps:

(1)	The Company has undertaken an extensive creditor ascertainment and quantification exercise as described in paragraphs 513 to 523 of the 1st affidavit of its executive director and chief financial officer, Wang Man Kwan Paul ("Mr Wang"). I am satisfied that the Company has in place internal record-keeping systems so that it would have identified and quantified on a prudent basis all of its creditors who would exist at the notional effective date of 31 December 2003.
(2)	The Company has obtained consents from a number of its creditors to the proposed reduction and they have been conveniently set out in a schedule with all the non-consenting creditors. The aggregate claims of the consenting creditors are HK$2,410,812,751.00 and the total claims of the non-consenting ones are HK$33,901,977.00.
(3)	The total debts of or claims against the Company, other than those of the consenting creditors, which would be admissible to proof in a notional winding up of the Company commencing on the notional effective date, as estimated by the Company in the region of HK$34 million as stated above, was made on a conservative basis, as credit has been given for the value of the full claims whether or not a dispute exists as to liability or quantum of such claims.
(4)	In relation to the non-consenting creditors, they are to be protected by the establishment of a trust account into which would be deposited the amount of HK$34 million, being the total amount of their claims as estimated, on the terms of a trust deed as described below.
(5)	To safeguard the interest of all existing creditors, the Company undertakes to create a special reserve upon the reduction. Before I go to the terms of this undertaking, it is necessary to explain how the accumulated losses have been classified as permanent and non-permanent losses.

The losses

22. The losses which the Company is seeking to write off against the credit arising on the reduction of its share premium account by an amount of HK$3,879,159,478.00 are in part permanent and in part non-permanent in nature. For this purpose, permanent loss is not necessarily irretrievable but must not be temporary or balanced in whole or in part by gains on other assets. Protection is required for the existing creditors in respect of non-permanent losses to be written off in the reduction of capital, for otherwise the reduction or cancellation of such capital would prejudice their interests (Boyle & Marshall, Practice and Procedure of the Companies Court, 1997 ed., at para. 4.9.4).

23. In the 1st affidavit of Mr Wang, he has set out in considerable detail between paragraphs 28 and 506 the circumstances in which the accumulated losses have arisen and grown since the financial year ended 31 December 1998 by reference to the "Provisions Schedules". The Provisions Schedules were prepared by the staff under the direction of Mr Wang and reviewed by the Company's auditors. The supporting evidence exhibited to Mr Wang's affidavit has filled up 20 lever arch files. The accounts of the subsidiaries and associates of the Company were gone into to establish the diminution in value and provision for interests in a considerable number of subsidiaries and associates. I have no doubt that this is a thorough exercise.

24. Certain of the accumulated losses are shown in the balance sheet of the Company as at 30 June 2003 by provisions which amounted to HK$2,997,627,603.00. HK$2 million of these provisions were written back in October 2003 and the rest of the provisions in the aggregate of HK$2,995,627,603.00 are described by Mr Wang as "unlikely ever to be recovered although they may at present be regarded as non-permanent in nature". By a process of elimination, the balance of the accumulated loss (i.e. HK$3,879,159,478.00 - HK$2,995,627,603.00 = HK$883,531,875.00) is regarded as permanent loss.

25. An alternative way of quantifying the permanent loss would be to identify and add up the amount of each item of permanent loss that the Company incurred for each of the financial years, including those in respect of its many subsidiaries and associates, since its incorporation in 1975 to 2003. This would appear to be a formidable and impossible exercise. This is because in the process of calculating the operating profit of the Company for the various financial years, it is necessary to net off items of expenses, some of which are themselves permanent losses and some of which arise out of the writing off or writing back of old provisions, which might have been made years before. The figure for accumulated losses is the result of the netting off exercise. The profits and losses of each of the financial years since 1975 would have to be analysed to identify each and every item of the permanent loss that had been netted off against the revenue of the Company over the years. One other practical difficulty is the problem of locating financial documents for the years prior to 1996, as financial documents are retained by the Company for seven years pursuant to the requirements of the Inland Revenue Ordinance.

26. Mr Wang has identified in his 2nd affidavit the major types of permanent losses incurred by the Company. They consist of administrative expenses and finance costs, realised losses on disposal of subsidiaries and other assets, loss on interest rate swap, fixed assets written off, and payment of withholding tax in China.

27. I will accept the quantification of the permanent losses by the process of elimination as described above. It is proposed by the undertaking of the Company to create a special reserve up to the limit of the non-permanent losses.

28. I should mention that there has been further realised losses as explained in the 3rd affidavit of Mr Wang in that the Company has paid an agreed arbitration award in the sum equivalent to HK$10,673,580.00 on 15 December 2003. A provision of HK$10,951,086.00 has previously been made in respect of the arbitration claim. This amount should be deducted from the non-permanent losses. The limit of the special reserve is to be reduced from HK$2,995,627,603.00 by HK$10,951,086.00 to HK$2,984,676,517.00. There is an overprovision which is the difference between HK$10,951,086.00 and HK$10,673,580.00 in the amount of HK$277,506.00. The overprovision will be written back by the Company and credited to the special reserve pursuant to the undertaking I now come to.

The special reserve and the undertakings

29. For ease of reference, I annex to this judgment a schedule setting out the terms of the final form of the undertakings in relation to the special reserve and the trust account as contained in the order that I made on the petition.

30. The special reserve proposed to be created is to be credited with the following:

(1)	any amount arising by reason of a release of any provision which had previously been taken into account in establishing the accumulated deficit on the profit and loss account of the Company shown in the balance sheet of the management accounts of the Company for the six months ended 30 June 2003; and
(2)	any amount received by the Company as profit by way of distribution from a corporation which was a subsidiary of the Company at the effective date which is made by such subsidiary out of profits available for distribution prior to the effective date or any dividend paid to the Company in respect of any liquidation of such subsidiary commencing prior to the effective date.

31. No specific amount has been ear-marked to this special reserve, as it is designed to protect creditors in circumstances where there is any recovery of loss by way of write-backs of provisions where there is hidden value of the Company in the form of distributable profits available in subsidiaries or distributions from subsidiaries.

32. The special reserve has the following features:

(1)	It is to subsist for as long as there shall remain outstanding any debts or claims against the Company which would be admissible to proof in a notional winding up of the Company commencing on the effective date (Boyle and Marshall, op cit at para. 4.9.5; Re Grosvenor Press plc [1985] 1 WLR 980).
(2)	The limit to the special reserve, as mentioned earlier, is set by the amount of those losses which are non-permanent in nature, along similar lines of a form of undertaking which I have accepted in Re Goldbond Group Holdings Limited, HCMP No. 1891 of 2003, 27 June 2003 (see also Re Swank International Manufacturing Co. Ltd, HCMP No. 2580 of 2003, Dep J Poon, 4 August 2003). This form of undertaking was not canvassed in Re Capital Asia Ltd [1999] 2 HKC 854. The limit on the special reserve is founded on the premise that items of permanent loss should be eliminated first from the amount of accumulated loss to be written off, hence the only possible reduction of the losses eliminated by the credit arising from the capital reduction will arise from any recovery of the non-permanent losses in respect of such assets.
(3)	Applying the above rationale, the limit of the special reserve will be reduced automatically upon the liquidation, disposal or other realisation, after the effective date, of a subsidiary, resulting in the provision made in relation to such subsidiary becoming a permanent loss.
(4)	The amount standing to the credit of the special reserve may, and the limit of the special reserve will automatically, be reduced by any increase in the paid-up share capital or share premium account of the Company resulting from the issue of shares, other than for the purposes of any redemption or purchase by the Company of its own shares, for cash or other consideration or by way of the capitalisation of distributable profits or reserves.

33. So long as the undertaking shall remain effective, it will be recorded by note or otherwise in a summary form in the audited financial statements of the Company or in any of its published accounts or prospectuses.

34. I am satisfied that the form of undertaking given in respect of the special reserve should afford sufficient protection to the existing creditors.

The trust account

35. It is accepted by the Company that there is in a technical sense a return of capital to the shareholders as the preference shares are being cancelled and replaced by bonds to be issued to GDH or its nominees. As regards creditors, there is an important distinction to be drawn between cases where no return of capital is involved in the reduction and cases where there will be a return of capital. The distinction is drawn by sections 59(2) and (3). The latter provision states that "where a proposed reduction of share capital involves either the diminution of any liability in respect of unpaid share capital or the payment to any shareholder of any paid-up share capital, the court may, if having regard to any special circumstances of the case it thinks proper so to do, direct that subsection (2) [which relates to settlement of a list of creditors] shall not apply as regards any class or any classes of creditors".

36. At the hearing of the summons for directions on 13 November 2003, I have accepted the submissions of Mr Scott, SC that in view of the undertakings given by the Company as to the setting up of a trust account, this would constitute "special circumstances" so that the court may dispense with the need to settle a formal list of the Company's creditors under section 59(2). I was referred to a number of accepted methods of safeguarding the interests of creditors in this situation, including obtaining the consent of creditors to the proposed reduction, adducing evidence that the company has cash and other liquid assets sufficient to meet all its liabilities, and the payment of money into a trust account to meet the claims of relevant creditors (Boyle and Marshall, op cit at paras. 4.9.8 and 4.9.13). I was given to understand by Mr Scott that a similar undertaking to set up a trust account was accepted by Dep J Woolley in Re CLP Holdings Ltd, HCMP No. 1708 of 2002, although no reasoned judgment was given.

37. In this instance, the Company proposes to give an undertaking to set up a separate trust fund in the amount of HK$34 million, out of which the claims of the non-consenting creditors can be met. The trust fund is to be set up with Guangdong Investment (Nominees) Limited, which is a bank and a wholly owned subsidiary of the Company, in the terms of a trust deed exhibited to the 1st affidavit of Mr Wang. The principal features of the trust deed may be stated as follows:

(1)	The "qualifying beneficiaries" are defined as all persons who at the effective date are owed debts by the Company and who have not consented to the reduction.
(2)	A "qualifying claim" is any debt owed by the Company to a qualifying beneficiary as at the effective date.
(3)	The duration of the trust is six years, sufficiently long for all relevant claims to have crystallised and have been dealt with within the ordinary limitation period.
(4)	The trust property is reduced if the debt is paid, the contingency period in respect of a contingent liability expires or the relevant creditor later consents.
(5)	Payment out of the trust property is triggered by a letter from the Company in the form annexed to the trust deed or if the trustee is otherwise satisfied that the claim is valid.

38. The creation of this type of trust would have the effect of creating a fund of assets immune to the claims of a liquidator or of the Company's other creditors on any insolvency occurring after the effective date (Corporate Insolvency: Law and Practice, by Bailey, Groves and Smith, 2nd ed, para. 8.66). The funds settled pursuant to the trust deed will be free of any right of set off or recourse by the trustee holding the account in respect of any other claim against the Company or its subsidiaries or associates.

39. I accept that the undertakings given in relation to the trust account would provide sufficient safeguard to the interests of the non-consenting creditors.

Orders

40. For the reasons given above, I have made an order confirming the reduction of capital in terms of the draft submitted and approved the minute to be delivered to the Registrar of Companies.

Schedule of Undertakings

AND the Company by its Leading Counsel obtaining leave to revise its undertaking given on 13 November 2003 in the following terms:

(1)	that for so long as there shall remain outstanding any debt of or claim against the Company which, if the date on which the proposed reduction of the share premium account of the Company and the cancellation of the Preference Shares takes effect (the "Effective Date") were the commencement of the winding-up of the Company, would be admissible to proof in such winding-up and the person entitled to the benefit thereof shall not have consented to the said reduction of capital or agreed otherwise, the Company shall credit to a special reserve in the books of the Company (the "Special Reserve"):
	(a)	any amount arising by reason of a release of any provision taken into account in establishing the accumulated deficit on the profit and loss account of the Company shown in the balance sheet of the management accounts of the Company for the six months ended 30 June 2003; or
	(b)	any amount received by the Company as profit by way of distribution from a corporation which was a subsidiary of the Company at the Effective Date (a "subsidiary") which is made by such subsidiary out of profits available for distribution prior to the Effective Date or any dividend paid to the Company in respect of any liquidation of a subsidiary commencing prior to the Effective Date; and
(2)	the Special Reserve:
	(c)	shall not be treated as realised profits of the Company; and
	(d)	shall, for so long as the Company shall remain a limited company, be treated as an undistributable reserve of the Company for the purposes of the Companies Ordinance (Chapter 32 of the Laws of the Hong Kong Special Administrative Region of the People's Republic of China) or any statutory modification or re-enactment thereof

PROVIDED ALWAYS THAT:

	(i)	the Special Reserve may be applied for the same purposes as a share premium account may lawfully be applied;
	(ii)	the amount standing to the credit of the Special Reserve may be reduced by an amount equal to any increase, after the Effective Date, in the paid-up share capital or share premium account of the Company which results from an issue of shares (other than for the purposes of any redemption or purchase by the Company of its own shares) for cash or other consideration or by way of the capitalisation of distributable profits or reserves, and the Company shall be at liberty to transfer the amount so reduced to the general reserves of the Company and the same shall become available for distribution;
	(iii)	the amount credited to the Special Reserve in accordance with the foregoing provisions of this undertaking shall not at any time exceed HK$2,984,676,517 (the "Limit");
	(iv)	the Limit may be reduced by the amount of any increase, after the Effective Date, in the paid-up share capital or share premium account of the Company which results from an issue of shares (other than for the purposes of any redemption or purchase by the Company of its own shares for cash or other consideration or by way of the capitalisation of distributable profits or reserves;
	(v)	the Limit may be reduced upon the liquidation, disposal or other realisation, after the Effective Date, of a subsidiary by the amount of the provision made in relation to such subsidiary as at 30 June 2003 less such amount (if any) as is credited to the Special Reserve as a result of such liquidation, disposal or realisation; and
	(vi)	in the event that the amount standing to the credit of the Special Reserve at any time exceeds the Limit after any reduction of the Limit pursuant to provisos (iv) and/or (v) above, the Company shall be at liberty to transfer the amount of any such excess to the general reserves of the Company and the same shall become available for distribution

AND the Company by its Leading Counsel further undertaking that so long as the aforesaid undertaking shall remain effective, such undertaking will be recorded by way of note or otherwise in a summary form in the audited financial statements of the Company or in any of its published accounts or prospectuses

AND the Company by its Leading Counsel giving an additional further undertaking that all profits and write-backs of provisions made by the Company between 1 July 2003 and the Effective Date will be subject to an undertaking in terms similar to the aforesaid undertaking and further undertaking

AND the Company by its Leading Counsel obtaining leave to revise its undertaking given on 13 November 2003 in the following terms:

(1)	that the Company will, on or before the Effective Date, deposit in a separate bank account with a first class bank in the name of Guangdong Investment (Nominees) Limited as trustee and designated the "Guangdong Investment Limited Capital Reduction Trust Account" (the "Trust Account") the sum of HK$34,000,000, being an amount equal to the projected liabilities of the Company owed to those creditors who would be entitled to prove in a notional winding-up of the Company were one to commence on the Effective Date and who have not given their consent to the proposed reduction of the share premium account and the cancellation of the Preference Shares of the Company rounded up to the nearest million, in the terms of a trust deed in the form of the draft trust deed marked "WMKP-544-392" (the "Trust Deed") as referred to in the Affidavit of Wang Man Kwan, Paul filed herein on 5 November 2003;
(2)	that unless and until all amounts due to such creditors of the Company shall have been paid or satisfied or otherwise extinguished, or such creditors shall subsequently give their consent, or any period of limitation shall have expired, the Company shall, upon and subject to the terms of the Trust Deed, retain to the credit of the Trust Account a sum in cash equal to the amount due to such non-consenting creditors for the time being unpaid; and
(3)	that the Company shall maintain the Trust Account for a period of six years from the Effective Date or such other date as the Court shall direct, or such shorter period as provided under the Trust Deed