CHIU JOSEPH v. LEE WAI HUNG

HCA 2232/2011

IN THE HIGH COURT OF THE

HONG KONG SPECIAL ADMINISTRATIVE REGION

COURT OF FIRST INSTANCE

ACTION NO. 2232 OF 2011

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REASONS FOR DECISION

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1.  This was an Order 14 summons by the applicant for summary judgment against the defendant under a Shares Transfer Agreement dated 11 October 2010 made between the applicant and the defendant in Chinese (“the agreement”). At the conclusion of the hearing, unconditional leave to defend was granted with an order that costs be in the cause.

Undisputed background facts

2.  Since July 1995 the applicant and the defendant have been the sole directors and shareholders of Aarone Engineering Products Company Ltd (“the company”).  Prior to 11 October 2010, the applicant and defendant held 35% and 65% of the issued share capital respectively.

3.  Both the applicant and the defendant played an active role in the affairs of the company which they jointly operated, each being responsible for different areas of the business.  The company was profitable as will be apparent from the value ascribed to the applicant’s shareholding.  The sale of the applicant’s shares meant that a successful business association of some 15 years was to come to an end.

The applicant’s claim

4.  The agreement provided for the sale of 30% of the issued share capital by the applicant to the defendant for $15 million payable in 4 instalments in the amounts and on the dates set out in clause 1 of the agreement.  It is the applicant's case that the defendant defaulted on the third instalment of $3 million.  Further, the applicant has duly exercised his right under the agreement to sell the remaining 5% of his shareholding for $2.5 million, payable in three instalments at half yearly intervals.  However, the defendant was in breach by failing to pay the first instalment of $833,333.33.

5.  The applicant sought summary judgment for the unpaid instalments with interest, a declaration that the defendant was in breach of the agreement, specific performance, damages in addition to specific performance and costs.

The defence

6.  The defendant's case is that in August/September 2009 the applicant informed the defendant that he wished to retire and sell all his shares in the company.  Effectively, there was to be a parting of the ways of a long-standing business partnership and arrangements had to be put in place to ensure an orderly transition.

7.  Mr Ah-weng, counsel for the defendant, described the parting as a ‘corporate divorce’.  The negotiations culminated in two agreements: an oral agreement between the defendant, acting on behalf of the company, and the applicant (“the consultancy agreement”) which was partly evidenced by clause 2 of the agreement and an agreement for the sale of the shares by the applicant to the defendant (“the shares agreement”).  The shares agreement was said to be made partly orally and partly in writing as per the agreement.  In short, the defendant’s case is that both the consultancy agreement and the shares agreement are partly evidenced by the agreement.

8.  It is common ground that the agreement is a home-made document.  According to the defendant, it represented their joint efforts as laymen to record the consultancy agreement (being arrangements to facilitate the applicant’s retirement from the company) and the shares agreement (for the sale of the applicant’s shares) which agreements, it was submitted, were inextricably linked.  For his part, the applicant denies any participation in the drafting of the agreement.  

9.  Mr Shum who appeared for the applicant accepted that the agreement is not a conventional or typical agreement for the sale of shares.  Indeed, most of the clauses had nothing to do with the sale of the applicant’s shares.  Clauses 2, 4 and 6 and part of clause 3 appear to be concerned with the period of transition of two years (the consultancy period) and the manner in which the accounts of the company would be settled between the applicant and the defendant, with 31 March 2010 being the cut-off date.  Even then, there are obscurities such as the meaning and effect of clause 5 and how the bonus in clause 6 would be calculated.

10.  According to the defendant, one of the oral terms of the consultancy agreement was that in keeping with the applicant’s past loan repayment practice with the company over the years, the applicant agreed not to take a monthly salary but would instead accept monthly advancements to be treated by a company as interest free loans and repaid by applying against them any dividend/additional bonuses from new clients during the period of transition.

11.  Further, it is also the defendant’s case that one of the oral terms of the shares agreement was an agreed contractual mechanism which the defendant could elect to exercise to reduce payments due to the applicant by the corresponding liabilities owed by the applicant to the company.  

12.  The defendant did so elect in respect of the third instalment (due 15 November 2011) and the first of the three payments in the remaining 5% shares (due 20 September 2011).  The defendant’s case is that on 20 September 2011 the overall liability owed by the applicant exceeded the aggregate amount of the third instalment and the first of the three payments for the remaining shares.

13.  As regards the applicant's liabilities said to be owing to the company, suffice it to say that defendant has produced documentation in support and proffered explanations for discrepancies.

14.  Since unconditional leave has been granted, it would not be appropriate to go into further detail.  On any view, the defence raised cannot be said to be ‘moonshine’.  Given the factual matrix, it is a defence that is reasonably arguable.

Section 47A of the Companies Ordinance (“the Ordinance”)

15.  The thrust of Mr Shum’s submissions was that the mechanism described in § 11 above, if a contractual term, would fall foul of section 47A which prohibits a company from providing ‘financial assistance’ for the acquisition of its own shares.  (In passing, it is to be noted that in the UK, the law on financial assistance no longer applies in relation to the acquisition of shares in private companies.)  The section 47A point was raised for the first time in Mr Shum’s written submissions dated 18 October 2012.

16.  Mr Shum submitted that the only point in the present case is whether section 47C applies.  That section sets out transactions that are not prohibited and include what is called the principal or larger purpose exception.  It requires the determination of the principal purpose for which assistance was given but in each case it must be given in good faith in the interests of the company.  Mixed motives will give rise to difficulties in practice: Belmont Finance Corp Ltd v Williams Furniture Ltd (No 2) [1980] 1 All E R 393 at 402.

17.  Pausing there, unless and until the factual disputes have been resolved and the terms of the consultancy agreement and the shares agreement have been determined, it would not be possible for the court properly to ascertain the ‘principal purpose’ and to determine whether the exception in section 47C applies.

18.  It is well established that Order 14 is for clear cases; that is, cases in which there is no serious material factual dispute and, if a legal issue, then no more than a crisp legal question as well decided summarily as otherwise: see per Bingham LJ in Crown House Engineering v Amec Projects Ltd (1990) 6 Const. LJ 141 at 154.

19.  Leaving aside for the moment the question of a serious material factual dispute, what of the legal issue?

20.  Mr Shum relied on Re Nu-West Natural Products Corp Ltd [2010] 4 HKLRD 208 which appeared to adopt the Brady v Brady [1989] AC 755 (HL) approach in drawing a distinction between the purpose for which a company gives financial assistance for the acquisition of shares in itself and the reason or motive for doing so.  It was said that the reason or motive which induced the company to give assistance cannot be a separate purpose justifying the assistance; that a ‘larger purpose’ is not the same as a ‘more important reason’.  Therefore, it is important to distinguish between ‘a purpose and the reason why a purpose is formed’.

21.  It has been noted that such an approach has “a very restrictive effect on the scope of section 47C and has been criticised by several commentators”: Butterworths Hong Kong Company Law Handbook (13^th Edn), [47C.03].

22.  I do not consider that the legal issue that arises is a ‘crisp legal question’ suitable for summary disposal.  The principal purpose is undoubtedly fact-sensitive and, in my view, it would be wrong to decide that question in the abstract as it were, without the benefit of the whole factual matrix.  Moreover, the legal issue is clearly one of some complexity and, on the facts of this case, it is unsuitable for summary disposal.