LIN LESTER CHI KEE v. CHAN LEUK FU AND ANOTHER

HCCW 293/2006

IN THE HIGH COURT OF THE

HONG KONG SPECIAL ADMINISTRATIVE REGION

COURT OF FIRST INSTANCE

COMPANIES (WINDING-UP) NO. 293 OF 2006

____________

____________

______________

J U D G M E N T

______________

1.  This was an application by Mr Chan Leuk Fu (“Mr Chan”), a contributory of Nu-West Natural Products Corp. Limited (“the Company”) for a stay of the winding up of the Company.

2.  Mr Chan is one of the two shareholders of the Company, the other shareholder being Mr Lester Lin Chi Kee (“Mr Lin”).  Each of them holds 50% of its issued shares.  In addition to being shareholders in the Company, Mr Chan and Mr Lin, both of whom live in the United States, are also interested in two American companies incorporated in the state of Washington, called Nu-West Natural Products Corp. (“Nu-West US”) and A-1 International Corp. (“A-1 International”).  Mr Lin has (some time ago) transferred his shares in Nu-West US to his son, but nothing turns on this for present purposes.

3.  The Company was ordered to be wound up by Kwan J (as she then was) on 3 August 2007, following the trial of a petition brought by Mr Lin, in which he sought (among other relief) the winding up of the Company on the just and equitable ground pursuant to section 177(1)(f) of the Companies Ordinance (Cap. 32), on the basis of allegations of wrongful conduct on the part of Mr Chan in respect of the Company which had caused the relationship between Mr Lin and Mr Chan to break down irretrievably.  Mr Darach Haughey and Mr Derek Lai of Messrs. Deloitte were subsequently appointed as its Joint and Several Liquidators (“the Liquidators”).  Prior to its liquidation, the Company’s main business was dealing in health products, principally pain relieving medicated pads sold under the name of “Riaxin”, supplied to it by Nu-West US.

4.  Apart from this petition, there was also litigation between Mr Chan and Mr Lin in the United States relating to Nu-West US and A-1 International.  This litigation continued after the conclusion of the winding up proceedings in Hong Kong.

5.  In November 2008, the parties to the United States proceedings embarked upon a mediation process, which resulted in their entering into a settlement agreement.  The agreement describes itself as having been made between Mr Chan and his “marital community”, Mr Lin, his wife and their “marital community”, Mr Lin’s son (to whom Mr Lin’s shares in Nu-West US had been transferred and his “marital community”, and Nu-West US, A-1 International and the Company.  The meaning of the expression “marital community” was not explained in these proceedings, but nothing appears to turn on it.  Although the agreement expressed itself as having been made by (among others) the Company, which was by then in liquidation, it does not appear that the Liquidators were involved in its negotiation, or approved its terms.  It therefore would not appear to be binding upon the Company or the Liquidators.

6.  The settlement agreement (which was signed by the various parties to it on 8 and 18 November 2008) contained the following main terms:-

(1)    Mr Chan was to pay, or cause any of the Company, Nu-West US or A-1 International, to pay a total of US$759,497 to the Lins.  This was to be paid in four instalments of US$50,000, US$209,497, US$250,000 and US$250,000 respectively (Clause 1).

(2)    Mr Lin and his son’s interests in the Company, Nu-West US and A-1 International were to be deemed to have been transferred to Mr Chan with effect from 1 June 2008, but such transfer was not required until the security referred to in the next paragraph had been provided (Clause 2).

(3)    As security for the full payment of the amounts stated in Clause 1, the parties were to create a mortgage or other charge over two properties in Hong Kong owned by the Company (workshop units in an industrial building in the New Territories) (“the Properties) to secure such payment until payment had been made in full (Clause 3).

(4)    The Lins were to waive any liabilities owed to them by the Company, Nu-West US and A-1 International, and would have no say over whether or not Mr Chan should repay to the Company, Nu-West US and A-1 International any sums which he might owe them (Clause 6).

(5)    The parties were to cooperate in taking such steps as might be necessary to rescind or otherwise nullify the winding up order against the Company (Clause 9).

7.  The settlement agreement appears to have been entered into without full regard to or appreciation of issues of Hong Kong law.  Thus:-

(1)    It does not seem to have been appreciated that as the Company was already in liquidation, it was no longer open to its shareholders and directors to make decisions in relation to it, and that it would be necessary to involve its liquidators in the settlement if it were to be one that could bind the Company;

(2)    No consideration appears to have been given to whether or not the terms on which the shares in the Company were to be transferred, in particular the provision by the Company of security over the Properties, complied with the provisions of the Companies Ordinance, which prohibit a company from providing financial assistance for the purpose of the acquisition of its own shares (sections 47A to 47G and 48 of the Ordinance).

8.  Some months after the settlement agreement was entered into, Mr Lin instructed his present solicitors.  They appear to have realised that there might be problems with the arrangements under the settlement agreement, particularly in relation to the requirements of section 47A of the Ordinance, and drew this to the attention of Mr Chan’s solicitors.  Although it initially seemed that Mr Chan’s legal advisers accepted that this was an issue that required to be addressed by making amendments to the settlement agreement before seeking to have the winding up of the Company stayed, in the end this did not happen.  Instead, Mr Chan and those advising him began to accuse Mr Lin of being obstructive, and took out the present application seeking a stay of the winding up, essentially on the basis that this had been agreed between the parties as part of the settlement agreement.

9.  At the hearing, Mr Raymond Tsui appeared for Mr Chan, Mr Bernard Man for Mr Lin and Ms Leung appeared for the Liquidators.  Mr Tsui sought an adjournment of the application pending a forthcoming hearing in the United States in relation to the settlement agreement.  The application was opposed, and having considered the arguments, I declined to adjourn the application, for reasons which I gave at the hearing.

10.  So far as the substantive application was concerned, this was opposed by Mr Lin.  Mr Man submitted that there were doubts as to the Company’s solvency, even if the settlement agreement were to be taken into account.  He went on to submit that the settlement agreement should not be taken into account, as it did not appear possible for it to be implemented in accordance with its terms, having regard to the fact that the intended security over the Properties would involve a breach of section 47A of the Ordinance.

11.  The Liquidators’ position was that provided that the Company was able to discharge all of its liabilities, including the costs of the liquidation, and was solvent at such time as the Liquidators might be discharged, they would adopt a neutral position in respect of the application.

12.  Mr Tsui submitted that, having regard to the terms of the settlement agreement, and the latest information as to the financial position of the Company, the Company was solvent, and that a stay of the winding up should be granted.  So far as the settlement agreement was concerned, he submitted that it was valid, and that the perceived problem in respect of section 47A of the Ordinance did not arise, as the situation was one which fell within one or other of two exceptions to the prohibition against the provision by a company of financial assistance to the purchase of its own shares.

13.  The power to order a stay of winding up proceedings arises under section 209(1) of the Ordinance, which provides that:-

“The court may at any time after an order for winding up on the application of … any contributory, and on proof to the satisfaction of the court that all proceedings in relation to the winding up ought to be stayed, make an order staying the proceedings, whether altogether or for a limited time, on such terms and conditions as the court think fit.”

14.  In Five Star Wine Limited (unreported, CFI, HCCW 1208/2002, 1 April 2003), I adopted as correct the approach of Megarry J to the equivalent English provision (section 256(1) of the Companies Act 1948) in Re Calgary & Edmonton Land Company Limited [1975] 1 All ER 1046.  Megarry J held (at pages 1051d to 1052a) that it was usually relevant to have regard to the interests of three groups of persons, namely the company’s creditors, its liquidators (who are entitled to be paid their costs, charges and expenses in priority to other claims) and, where there is likely to be a surplus, its members.  In Five Star Wine, the position was that the company’s realisable assets were less than its debts, but on the applicant for a stay undertaking to pay to the petitioner its outstanding debt and to pay to the liquidators an amount sufficient to cover their estimated costs, charges and expenses, I granted a stay conditional upon such payments being made, with the stay to take effect only after payment was made.

15.  It therefore seems to me that in considering the present application, the key question is whether or not the Company can be regarded as solvent.

16.  At the hearing, I was provided with a handwritten table that all parties agreed represented the current financial position of the Company.  This showed that there was cash on hand of some HK$1,572.943.41.  According to the Liquidators, no further significant recoveries were expected.  This was because remaining accounts receivable were likely to prove irrecoverable, and on the assumption that the settlement agreement would be put into effect, no value should be ascribed to the Properties, as they would stand charged to secure the payment of the agreed price for Mr Lin and his family’s shareholding in the Company and the two US companies, and similarly, no value should be ascribed to debts due from Mr Chan to the Company of some HK$3,165,938.47, as these were to be waived under the terms of the settlement.  Against this, the Company was liable to external creditors for some HK456,234.90 in respect of proofs of debt which had been accepted by the Liquidators, and the Liquidators costs and charges since their appointment were estimated at about HK$1 million, and were continuing to accrue.  In addition, there was a claim by Mr Chan, which had been admitted, in the amount of HK$210,000, but this could be left out if the settlement agreement were effective.  There were also debts of HK$63,000 to Mr Lin and HK$2,436,485.19 to Nu-West US, in respect of which proofs had been lodged, but which had not yet been adjudicated by the Liquidators.  Mr Tsui submitted that these, too, could be left out of account, assuming the settlement to be effective.

17.  Mr Man did not agree that the debt owing to Nu-West US should be left out of account, as the settlement agreement did not in terms call for a waiver of debts between the various companies inter se, but only as between the individuals (Mr Chan and Mr Lin) and the various companies.  To this submission, Mr Tsui responded that once the settlement was completed, Mr Chan would be in control of Nu-West US, and could therefore ensure that it waived the debt owed to it by the Company.

18.  Even assuming (without deciding) that the settlement agreement is valid and effective, and that all of the debts of Mr Chan, Mr Lin, the Company and Nu-West US can be ignored, the position at the hearing was that the Company had available cash of HK$1,572,000 odd, and debts and liquidation costs of about HK$1,456,000 odd.  Given that the amount of the liquidation costs was an estimate, and that additional costs would be incurred over time, I do not think that the court can be satisfied that the Company was in a position to meet all of its debts and liquidation costs so as to justify the exercise of the court’s discretion to grant a stay of the winding up proceedings.

19.  Further, in February 2010, after the conclusion of the hearing, Mr Chan’s solicitors wrote to the court to indicate that it was hoped that the matter could shortly be settled amicably.  This resulted in the Liquidators reiterating their position, and providing updated financial information, which indicated that the cash on hand was (which was more or less unchanged) now insufficient to meet the Company’s external debts (which remained at about HK$456,000) and the liquidation costs (which were estimated to have risen to some HK$1,600,000 odd, as a result of continued work done by the Liquidators and additional expenses which had been incurred).  Even allowing for the possibility that not all of the Liquidators’ costs would be recoverable on taxation of their bills, it would appear that the concern which I have mentioned in the previous paragraph has proven to be justified.

20.  Thus, even if the settlement agreement were valid and effective, and Mr Chan were to undertake that he would cause Nu-West US to waive its claims against the Company, the Company would now clearly not be able to meet all of its debts and liquidation costs.  Thus, in the absence of any arrangements being made to ensure that it will be able to do so, it would not be appropriate to order any stay of the winding up.

21.  It is therefore not strictly necessary to consider whether the provisions of the settlement agreement are valid and effective.  However, since Mr Tsui contended that it was, and the matter was argued, I shall briefly indicate my views on the matter.

22.  It seems to me that there is at the outset a difficulty in relation to the settlement agreement that arises from the fact that the Company is in liquidation.  For so long as that remains the case (i.e. until a stay of the winding up is granted), it would seem impossible for the security over the Properties called for under clause 3 of the settlement agreement to be granted without the agreement of the Liquidators.  Given the Company’s financial position, it is not easy to see how such agreement would be forthcoming.  In those circumstances, the obligation on Mr Lin and his family’s part to transfer their interests in the Company and the two United States companies would also remain in abeyance, and it would not seem possible for the arrangements under the settlement agreement to be completed.

23.  Further, so far as the question of section 47A of the Ordinance is concerned, that section prohibits the giving of direct or indirect financial assistance by a company for the purpose of the acquisition of shares in itself.  In the context of the settlement agreement, the provision by the Company of security over the Properties to secure the payment of the purchase price in respect of its (and the United States companies’) shares would clearly amount to the provision of financial assistance to Mr Chan to enable him to acquire such shares (see e.g.Heald v O’Connor [1971] 1 WLR 497).  This was not disputed by Mr Tsui.

24.  Mr Tsui suggested, however, that the situation came within the exception to section 47A provided by section 47C(1)(a), which states that financial assistance is not prohibited if the company’s principal purpose in giving that assistance is not to give it for the purpose of any such acquisition, or the giving of the assistance is but an incidental part of some larger purpose of the company.  Mr Tsui submitted that in this case, as the provision of the security was part of the arrangements to settle overall the disputes between Mr Chan and Mr Lin, the giving of the assistance in the form of the security was but an incidental part of some larger purpose of the Company.

25.  However, in Brady v Brady [1989] AC 755, the House of Lords held that a distinction must be drawn between the purpose for which a company gives financial assistance and the reason or motive for doing so.  As Lord Oliver put it (at 779E to 780H):-

“… if the [prohibition] is not, effectively, to be deprived of any useful application, it is important to distinguish between a purpose and the reason why a purpose is formed. The ultimate reason for forming the purpose of financing an acquisition may, and in most cases probably will, be more important to those making the decision than the immediate transaction itself. But “larger” is not the same thing as “more important” nor is “reason” the same as “purpose”. … The purpose and the only purpose of the financial assistance is and remains that of enabling the shares to be acquired and the financial or commercial advantages flowing from the acquisition, whilst they may form the reason for forming the purpose of providing financial assistance, are a by-product of it rather than an independent purpose of which the assistance can properly be considered to be an incident.

… the only purpose that can be discerned in the redemption of loan stock is the payment in tangible form of the price payable to enable the Brady shares to be acquired … to say that the “larger purpose” of Brady’s financial assistance is to be found in the scheme of reorganisation itself is to say only that the larger purpose was the acquisition of the Brady shares on its behalf. … The acquisition was not a mere incident of the scheme devised to break the deadlock. It was the essence of the scheme itself and the object which the scheme set out to achieve.”

26.  I agree with Mr Man that this case is not relevantly distinguishable from the situation in Brady v Brady, as the purpose of providing the financial assistance here, in the form of the security to be granted, was to enable Mr Chan to acquire (inter alia) the shares in the Company.  Without such security, Mr Lin might well not be willing to part with his shares in the Company in advance of full payment of the price, as was envisaged by the settlement agreement.  The desire to settle the disputes between the parties was the reason why the parties wished to have Mr Lin sell his interests in the Company and the two United States companies to Mr Chan, but the purpose of the financial assistance was to enable that sale to take place.

27.  Mr Tsui suggested that the situation in this case was distinguishable, because here, the Company was already in liquidation.  However, I am unable to see that this provides a relevant distinction either – in Brady v Brady, it was desired to prevent the companies concerned from being wound up, whereas here, it is desired to remove the Company from liquidation and return it to a situation in which it can resume business.  In both situations the objective is to avoid a situation in which the company is (or remains) in liquidation, so that it can carry on business.

28.  Mr Tsui suggested in the alternative that it might be possible to come within the relaxation of section 47A available to unlisted companies under section 47E(1), which provides that financial assistance is not prohibited if the provisions of the rest of that section, and sections 47F to 48 are complied with.  One of the requirements is that contained in section 47E(6), which requires that a majority of the directors of the company proposing to give the financial assistance should have a statement complying with section 47F before the financial assistance is given.  Section 47F requires that the directors giving the statement state (among other things) that they have formed the opinion that, as regards the company’s initial situation immediately following the date on which assistance is proposed to be given, that there will be no ground on which it could then be found to be unable to pay its debts and that it will be able to pay its debts as they fall due during the year immediately following that date.

29.  Mr Man submits that it Mr Lin would be acting entirely reasonably in declining to make such a statement, having regard to the Company’s present financial position, particularly as the making of such a statement without reasonable grounds for doing so would expose him to the risk of committing an offence under section 47(5), which would be punishable by a fine or imprisonment.  Given the Company’s financial position as I have set it out above, I think that this must be right.

30.  Accordingly, it would not seem that the Company would be able to bring itself within any of the available exceptions so as to render the giving of the financial assistance lawful, and it would not therefore seem possible for the settlement agreement to be implemented according to its terms as things stand.  That being so, the reason for the stay application would appear to fall away, and it was not, I think, suggested by Mr Tsui that the application could succeed in those circumstances.

31.  Thus, for the reasons which I have given, I have come to the view that the application must be dismissed.  So far as the costs of the application are concerned, I shall make an order nisi that Mr Lin’s and the Liquidators’ costs of the application should be paid by Mr Chan, to be taxed on the party and party basis if not agreed.