SIN CHUNG YIN RONALD AND OTHERS v. SINODENTAL INVESTMENTS LTD AND ANOTHER

HCCW 404/2011

IN THE HIGH COURT OF THE

HONG KONG SPECIAL ADMINISTRATIVE REGION

COURT OF FIRST INSTANCE

COMPANIES (WINDING-UP) PROCEEDINGS NO. 404 OF 2011

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BETWEEN

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D E C I S I O N

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1.  The petitioners are dentists. In May 1998 they formed a chain of dental clinics using a company called Health & Care Dental Clinic Limited (“the clinic”).

2.  The various clinics that they operated proved successful.  They grew, but by 2001 needed capital for further development.  In May 2001, the petitioners were approached by the 1st respondent, which is a venture capital company which was interested in investing.

3.  On 17 August 2001, the petitioners incorporated the company, the 2nd respondent.  The 1st respondent agreed to subscribe for 490,000 preference shares for a consideration of HK$20 million.  The parties executed a subscription agreement on 23 August 2001.  The clinic and its various operating companies became subsidiaries of the company.

4.  The parties then proceeded to execute a comprehensive shareholders’ agreement on 21 September 2001.  This was amended by a supplemental agreement on 31 March 2006.  This was as a result of the 1st respondent’s decision to convert its preference shares into ordinary shares, which gave it more than 50 per cent of the issued ordinary shares in the company.  A further agreement was signed on 1 October 2006 amending the provisions of the shareholders’ agreement dealing with board representation and managerial issues.

5.  All the agreements were drafted by lawyers.  The original shareholders’ agreement contained an entire agreement clause.  The parties appear to have been dealing with one another on a considered arm’s length basis, and carefully recorded their agreements and understandings in writing.

6.  The petitioners all entered into employment contracts or consultancy agreements with one of the clinic’s operating subsidiaries after the company had been established.  The only reference to any understandings between the parties not incorporated in a formal written agreement is in paragraphs 23 and 24 of the petition, which reads as follows:  

“23. When proposing such modifications, the 1st respondent assure the petitioners that there would be no fundamental changes to the existing operations and/or operational mode of the Company and the modifications were merely necessary to meet HKRI’s requirements on paper only. The changes were to allow more involvement of the 1st respondent in participation in the management of the Company as the 1st Respondent and the Petitioners were in effect quasi partners.”

“24. On reliance of the assurance and based on the friendly relationship between the parties at that time, the petitioners entered into a Further Supplemental Agreement with the 1st respondent on 1 October 2006...”

7.  The company apparently operated satisfactorily, although financially it was not particularly successful.  By early 2010 its financial position had improved and, so the petitioners allege, substantial profits were anticipated.

8.  From April 2010 onwards, the parties’ relationship began to deteriorate.  The petitioners’ complaints about the 1st respondent’s conduct are contained in paragraphs 29 to 51 of the amended petition.  I do not need to summarise them in this judgment.

9.  An open offer was made by the petitioners to sell their shares to the 1st respondent in a letter of 27 October 2011 at a price calculated by reference to pre-tax profits and at a PE ratio of 10, but this was not acceptable to the 1st respondents.

10.  The petition was issued on 13 December 2011.  The petitioners seek an order pursuant to section 168A of the Companies Ordinance that their shares are purchased by the 1st respondent, and in the alternative, they seek a winding-up of the company.

11.  The 1st respondent has applied to strike out the prayer for a winding-up order.  It has done so on the grounds that there is no realistic prospect of any such order being made and no reason has been advanced for including this relief in the petition.

12.  There is no dispute about the principles by reference to which the court should consider applications of this sort.  I summarised those principles as follows in paragraph 21 of my judgment in the New China Hong Kong Highway Limited HCCW550 of 2009 unreported 23 February 2010:

“The 2nd respondent accepts that in assessing this application, I should assume that all the allegations in the petition and the supporting evidence are true, and on this assumption I should consider whether or not there is any real possibility or prospect of a winding-up order being made having regard to section 180(1)(a) of the Companies Ordinance: Re Wong To Yick Lok Ointment Limited [2001] 2 HKC 618 per Yuen J (as she then was) at 623H-624B approved by the Court of Appeal at [2003] 1 HKC 404 per Le Pichon JA at 487H. Section 180(1)(a) provides that:

‘The court shall not refuse to make a winding-up order on the grounds that some other remedy is available unless it is of the opinion that the petitioner is acting unreasonably in seeking to have the company wound up instead.’

It follows that I should strike out the petition if I consider that there is no real prospect of the court making a winding-up order.  In assessing whether or not this is the case, I should, as with an application to strike out a pleading (which the petition is technically not), bear in mind that it is only in a plain and obvious case that a petition or part of it should be struck out.”

13.  Before addressing the question of whether or not there is a real prospect of a winding-up order being made, I would say this.  The inclusion of the prayer for a winding-up order assumes that the petition reveals any ground for invoking the court’s jurisdiction under section 177(1)(f) of the Companies Ordinance.  As with a large number of the petitions concerning shareholder disputes that come before the Hong Kong Companies Court, it seems to have been assumed that this is a “quasi partnership” case and that the equitable considerations are to be imposed on the exercise of the 1st respondent’s legal rights.

14.  Not all private companies attract the application of these principles.  As Lord Wilberforce explained in Ebrahimi v Westbourne Gallieries Ltd. [1973] AC 360 at 379:

“Certainly the fact that a company is a small one, or a private company, is not enough. There are very many of these where the association is a purely commercial one, of which it can safely be said that the basis of association is adequately and exhaustively laid down in the articles. 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 confidences - this element will often be found where a pre-existing partnership has been converted into a limited company;

(ii) an agreement, or understanding, that all, or some (for there may be ‘sleeping’ members), of the shareholders shall participate in the conduct of the business;

(iii) restriction upon the transfer of the member’s 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.”

15.  It is unclear what the petitioner intends by paragraph 23 of the petition.  I note that there is nothing to suggest that the 1st respondent was agreeing not to exercise its rights under the shareholders’ agreement or that change in accordance with the terms of the shareholders’ agreement was not to take place.  It is difficult to read paragraph 23 as saying anything more than something along these lines: “We intend things to continue much as they are at the moment” during a conversation about the second supplemental agreement.  Even assuming, as I must at this stage, that this is what was said, I have difficulty accepting that it is sufficient to impose equitable restraints on the 1st respondent’s exercise of its legal rights.

16.  As I understand it, Mr Leung, who appeared for the petitioners, accepted that paragraphs 23 and 24 could only be fairly read as meaning that in relation to the matters dealt with by the second supplemental agreement there would be no fundamental change.  It follows that the only complaints relevant to the just and equitable ground are those concerning professional and ethical matters, which is what the relevant parts of the second supplemental agreement dealt with.  These complaints are explained in paragraphs 46 to 51 of the amended petition.  The scope of these complaints is narrow, and even if proven at trial, do not seem to me to be such as to be likely to justify a winding-up order.

17.  As I have already mentioned, the main thrust of the 1st respondent’s attack on the inclusion of the prayer for a winding‑up order is that there is no prospect of a winding-up order being ordered because of the inclusion of a claim for principal relief under section 168A in the form of a buyout order.  It is only in the alternative that a winding‑up order is sought.  Neither the petition nor the petitioner’s evidence explain why the prayer has been included.  The 1st respondent is the subsidiary of a listed company and the company forms part of its Health Care Division, GenRx Healthcare.  The petitioner does not suggest that the group cannot afford to buy out their shares or any reason for thinking that the petitioner would be better off if the company were to be wound up.

18.  I asked Mr Leung why the prayer for a winding‑up order had been included.  His answer amounted to this:  “The 1st respondent might refuse to complete any order to purchase the shares the court might make.”  In other words, the petitioners do not have any present intention to seek a winding-up order.  Mr Leung seemed to envisage the possibility of the petitioners returning to court after they had unsuccessfully attempted to enforce an order for the sale of their shares, and in those circumstances, seek a winding-up order.

19.  I rather doubt if this is possible, but neither counsel were able to provide sufficient assistance in this regard for me to make a definite decision as to whether it is possible for a petitioner to return to court to seek an alternative remedy in these circumstances.  However, what does seem to me to be quite clear is that there is no realistic prospect of the court making a winding-up order, and I strike out the second prayer in the petition.

20.  I would also have struck out the prayer on the ground that even if the matters alleged in the petition were proved at trial, they would not justify a winding-up order being made on a just and equitable ground.

21.  I think it is appropriate to end with the salutary reminder of Madam Justice Yuen in Re Wong To Yick Wood Lock Ointment Limited [2001] 2 HKC 618 at 623F.  There is a Practice Direction in England, (No. 1 of 1990) [1990] 1 WLR 490 reminding practitioners of the undesirability of including as a matter of course a prayer for winding up as an alternative to an order under section 459 of the Companies Act (1985) (equivalent to section 168A of the Companies Ordinance) that:

“It should be included only if that is the relief that the petitioner prefers or if it is considered that it may be the only relief to which he is entitled.”

22.  It is clear that the prayer for a winding-up order has been included in this case without sufficient thought as to whether or not it is necessary.  Practitioners should not automatically include as an alternative relief in a petition presented primarily for relief under section 168A of a prayer for winding up.  They should only do so if there is reason to believe that this may be the relief that will be sought at trial, and the facts relied on in forming this view should be set out in the petition and amplified as necessary in the petitioner’s evidence filed in support of that petition.

23.  I order that the costs of the 1st respondent’s application to strike out and the summons to amend that summons be paid by the petitioners to the 1st respondent forthwith, such costs to be taxed if not agreed.