FOK LAI LOR NORA v. FOK YING TUNG MING YUAN DEVELOPMENT CO LTD

CACV 88/2020, [2023] HKCA 795

On Appeal From [2020] HKCFI 354 and [2020] HKCFI 1142

IN THE HIGH COURT OF THE

HONG KONG SPECIAL ADMINISTRATIVE REGION

COURT OF APPEAL

CIVIL APPEAL NO 88 OF 2020

(ON APPEAL FROM HCMP NO 974 OF 2017)

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J U D G M E N T

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Hon Yuen JA and Barma JA:

Introduction

1.1.  On 26 April 2017, the plaintiff Fok Lai Lor Nora (“NF”), a shareholder of the defendant company (“the Company”), applied to the Court under s.220 of the Companies Ordinance Cap. 622 (“CO”) for an order cancelling the special resolution (“the SpRes”) passed by the Company at an extraordinary general meeting held on 24 March 2017 (“the 2017 EGM”):

“THAT the share capital of the Company be reduced from HK$3,105,000,000.00 to HK$1,071,000,000.00 and that such reduction of capital be effected by:

(a) cancelling paid-up capital which has been lost or is unrepresented by available assets to the extent of HK$861,000,000.00, i.e. approximately HK$277.29 per share upon each of the 3,105,000 shares which have been issued and fully paid up; and

(b) repaying to the shareholders of the Company paid-up capital to the extent of $1,173,000,000.00, i.e. approximately HK$377.78 per share for each of the 3,105,000 shares which have been issued and fully paid up”.

1.2.  NF’s application was opposed by the Company.  The hearing of the originating summons took place on 23 October 2018.

2.  In a Decision given on 4 March 2020 (“the Main Decision”)¹ the judge dismissed NF’s application and confirmed the SpRes under s.222 of the CO.  He also made a costs order nisi that NF pay the Company’s costs with certificate for two counsel.  NF applied to vary the order nisi, but it was made absolute for reasons given on 11 June 2020 (“the Costs Decision”).

3.  In this appeal, NF has appealed against both the Main Decision and the Costs Decision.  A stay pending appeal was granted by Barma JA and Au JA on 25 September 2020.  

Background

4.  In view of some of the judge’s findings and NF’s arguments on appeal, it is necessary to summarize some factual background.

The Company

5.1.  The Company is a private limited company incorporated in Hong Kong on 10 December 1999.  Originally, there were 10 shareholders holding 10,000 shares in various proportions, with Fok Ying Tung Henry (“HF”), NF’s father, holding 1,600 shares, and Ho Ming Sze (“Mr Ho”) holding 1,400 shares.

5.2.  By 31 March 2006 or on 6 April 2006 (the date is immaterial to this appeal), HF provided sums amounting to approximately $3,520 million, which were recorded in the Company’s books as shareholders’ loans to the Company from Mr Ho. 

5.3.  On 25 October 2006, the balance of these loans was capitalized, and shares were issued culminating in a total of 3,105,000 fully paid-up shares (in 1 class) of $1,000 each, which were issued to a total of 23 persons², resulting in an equal allocation of 135,000 shares to each person. 

5.4.  On the same day (25 October 2006), an Agreement written in Chinese (“the Shareholders Agreement”) was entered into among the 23 persons, which contained (among other things):

(a)  the following recitals:

-  HF has since 1987 been investing in the development of Nansha New Coastal City (“NNCC Development”) with a view to developing it into a modern city;

-  the Company was established to carry out the NNCC Development; 

-  the Company’s scope of business had been “clearly limited to operating and supporting NNCC Development. Aside from that, profit distribution and share transfers of [the Company] are clearly restricted in accordance with the terms and conditions listed in this Agreement herein, in order to

(1)  raise the core staff members’ pro-activeness;

(2)  raise the support of the Fok family members towards investing in NNCC Development; and

(3)  ensure [the Company] can provide the capital required for the plans of NNCC Development”;

(b)  the following clauses:

-  the main business of the Company was “operating and supporting works of” NNCC Development; without the board’s approval, the Company could only participate in such business [clause 1(a) and (b)];

-  within the first 10 years after the signing of the Agreement (i.e. up to October 2016), 40% of the Company’s net profits shall be distributed as follows: 10% as bonuses to 10 named persons; 30% as dividends to the shareholders; and the balance to be retained for purposes of investment and development of the Company [clause 3(a)];      

-  after the first 10 years (i.e. after October 2016), the net profits shall be distributed as follows: bonuses to core staff members in accordance with the decisions of the board at the material times; retention for purposes of investment and development of the Company in accordance with the decisions of the board at the material times; and distribution of the balance as dividends to the shareholders [clause 3(b)];

-  a resolution passed by at least 9 directors is required before the shareholders maybe asked to consider (among other things) cessation, dissolution and liquidation of the Company, transfer or increase of the Company’s authorized capital, or amendment or adjustment to the profit distribution referred to in clauses 3(a) and 3(b) [clause 4(i)];     

-  within the first 10 years, no shareholder may sell, mortgage or deal with his shares [clause 5(a)], and if any shareholder dies, his shares would be “automatically gifted” to the Ming Yuan Nansha Foundation [clause 5(b)]; 

-  after the first 10 years, each shareholder shall have the “full right” to own his shares, which may be inherited by his “statutory or specified heir”, but his shares may not be sold etc without the written consent of shareholders holding at least 75% of the shares of the Company [clause 5(c)];

-  the shareholders agreement shall be of full effect until the company is liquidated or ceases to be an independent legal entity [clause 6(b)];

-  the shareholders agreement shall prevail over the articles of association [clause 6(c)];

-  the shareholders agreement shall not be amended except with the written approval of all the signatories to the agreement [clause 6(e)].    

The business of the Company

6.1.  The principal business of the Company is investment holding.  It holds interests in subsidiaries, associated companies and joint ventures (“investee companies”) involved in the development of projects in Nansha, which has been designated a free-trade zone for the Pearl River Delta. 

6.2.  In NF’s 1^st affirmation (Fok I), she said the major activity of the company was to “provide funding” to the investee companies. 

6.3.  However, in the 1^st affirmation of the General Manager and director of the Company filed on 21 June 2017 (“Lam I”), Lam Sik Lau said “the company is not in the business of providing funding to”³ the investee companies (emphasis added).  Rather, when these investee companies required funding, their management would make proposals to their respective stakeholders, which would decide whether or not to provide funding, and if so, how.  The Company’s board would from time to time make decisions on the proposals based on their merits. Mr Lam said:

“Whether or not the Company makes further investments in the 4 major development projects⁴ (or other projects) is a commercial and management decision for its board of directors, taking into account a wide range of factors, including the prospects and viability of the projects in question, and not just the projects’ funding needs (which can be satisfied by bank borrowing, for example)”⁵. (Emphasis added).

7.  According to NF, at that time, the projects were not yet completed.  This does not appear to have been challenged in the affirmations filed on behalf of the Company, but since 2013, the board has stated that

“in view of the Proposal⁶ and that the Company did not have a specific plan in respect of the development of the [NNCC], and also upon reviewing the Company’s shareholding structure, business developments and plans in 2014”⁷ (emphasis added).

its capital exceeded its needs and a reduction of capital was viable.  

8.  Before discussing this, we will first set out the statutory procedures by which a reduction of capital may be achieved.

Statutory provisions for reduction of capital

9.  Since 3 March 2014, the CO has provided 2 pathways by which the capital of a company may be reduced. 

Sub-Division 3 (s.226 - 232)

10.1.  This is the traditional pathway (previously s.58-61 CO Cap.32) which involves a petition to the court for confirmation of reduction. It is well-established in the case law discussing such petitions that confirmation may be given if the proposal complies with principles set out in Re Thorn EMI plc⁸(“the Thorn principles”), i.e.:

(1)  all the shareholders are treated equitably;

(2)  the reduction proposal had been properly explained to the shareholders so that they could form an informed judgment on it;

(3)  the creditors are safeguarded; and

(4)  the reduction is for a discernible purpose.

10.2.  It is noted that when this pathway is adopted, the company must apply to the court for a confirming order, and only creditors are entitled to object to the reduction [s.59 CO Cap.32, now s.227 CO Cap.622].

Sub-Division 2 (s.215-225)

11.1.  This is a new pathway sometimes called the “court-free” pathway.  Under this pathway,

-  where all directors of the company make a solvency statement that complies with ss.204-207 (“the solvency statement”),

-  a company may reduce its share capital by a special resolution passed within 15 days after the date of the solvency statement, but

-  a member or creditor of the company may, within 5 weeks of the date of the special resolution, apply to the court for cancellation of the resolution. The court then must make an order confirming or cancelling the special resolution, and may do so on such terms and conditions as it thinks fit.

11.2.  The solvency statement is set out in s.206 CO (where material) as follows:

“(1) A solvency statement in relation to a transaction is a statement that each of the directors making it has formed the opinion that the company satisfies the solvency test in relation to the transaction.

(2) In forming an opinion for the purpose of making a solvency statement, a director must—

(a) inquire into the company’s state of affairs and prospects; and

(b) take into account all the liabilities of the company (including contingent and prospective liabilities).

(3) A solvency statement—

(a) must be in the specified form;

(b) must state—

(i) the date on which it is made; and

(ii) the name of each director making it; and

(c) must be signed by each director making it”.

11.3.  The solvency test referred to in the solvency statement is satisfied under s.205 CO if:

(a)  immediately after the transaction there will be no ground on which the company could be found to be unable to pay its debts; and

(b)  either—

(i)   if it is intended to commence the winding up of the company within 12 months after the date of the transaction, the company will be able to pay its debts in full within 12 months after the commencement of the winding up; or

(ii)  in any other case, the company will be able to pay its debts as they become due during the period of 12 months immediately following the date of the transaction.

11.4.  Section 207 CO provides that a director who makes a solvency statement without having reasonable grounds for the opinion expressed in it commits an offence which may include a term of imprisonment of up to 2 years.             

Company’s petition for reduction in 2014 under the Sub-Division 3 pathway

12.1.  Coming back to the facts of this case, on 4 August 2014, the Company passed a special resolution to reduce its capital from $3,105 million to $1,953.045 million (i.e. cancellation of capital to the extent of about $1,152 million) based on the ground that its capital was in excess of its needs.  

12.2.  The Company filed a petition with the court in September 2014 under the Sub-Division 3 pathway.  NF opposed the petition^9, and the matter came before the judge.

The 2016 Decision

13.1.  The judge dismissed the petition in Re Fok Ying Tung Ming Yuan Development Co Ltd ¹⁰ (“the 2016 Decision”) on the grounds that:

(a)  the special resolution was defective, in that as the balance sheet ending 31.12.2013 shows the sum of only $748 million as the Company’s accumulated loss which could be used to reduce its share capital, this was the amount by which the  share capital could be reduced [§§17 and 19];

(b)  for that reason, the wording of the special resolution may be misleading to future creditors [§22]; and

(c)  the audited financial statements placed before the court contained disclaimers (said to be due to the lack of cooperation of the investee companies [§§27, 30, 32, 33]), and thus they did not comply with the requirement in s.380 CO for financial statements to give a true and fair view of the financial position of the company, which the directors are required to prepare under s.379 CO [§35].

13.2.  It is notable however, that the judge rejected NF’s submissions that:

-  support of the reduction would be in breach of the Shareholders Agreement [§35], and

-  the Company should retain sufficient capital to embark on new projects, the judge finding that (i) the board and all the current shareholders, except her, do not intend that the Company should embark on new projects, and (ii) there was no basis for concluding that the retained capital would be insufficient for the existing projects [§37].        

13.3.  There was no appeal from the 2016 Decision. 

13.4.  It would be noted that in the 2016 Decision, the judge remarked that “the directors had the alternative of making solvency declarations and effecting a capital reduction that way” [§33], clearly a reference to the Sub-Division 2 pathway. 

13.5.  From this, and other references to the protection of past and future creditors in that 2016 Decision [§§19 - 20], it is clear that the petition was rejected under the 3^rd principle in Thorn, ie. safeguarding the Company’s creditors.

Company‘s proposal for reduction in 2017 under the Sub-Division 2 pathway

14.1.  About a year after the 2016 Decision, the Company proceeded to seek to effect a reduction under the Sub-Division 2 pathway.

14.2.  On 16 February 2017, the Company circulated a notice to shareholders to convene the 2017 EGM for the purpose of considering the SpRes for the reduction of the Company’s share capital.  Solvency statements were signed by all the directors, and it has not been suggested by NF that any were invalid or incorrect.

14.3.  The 2017 EGM Notice enclosed:

-  the Circular in respect of the proposed reduction, stating (among other things) that the Company had no new investment projects or plans and that $1,071 million would be sufficient to meet the Company’s needs in the foreseeable future [§18] 

-  Reports and Financial Statements of the Company and its subsidiaries for the period from 1.1.2016 to 31.8.3016 (“the August 2016 Accounts”)unqualified by the auditors (unlike the financial statements presented for the 2014 petition) showing impairment losses of approximately $1,042 million; and

-  a letter from Hopkins Consulting Limited dated 14 February 2017 (“the Hopkins Letter”).

14.4.  This resulted in a number of letters from NF’s solicitors to the Company’s solicitors.

14.5.  On 21 March 2017, NF’s advisers inspected the documents referred to in the Hopkins Letter.

15.1.  At the 2017 EGM, NF’s solicitors’ letters were tabled and the contents read to the meeting, after which she requested an adjournment, which request was put to the vote.  Of the 20 shareholders who voted, 16 voted for the 2017 EGM to proceed. 

15.2.  After the Company’s professional advisers addressed the meeting on the matters raised in the letters from NF’s solicitors, the SpRes was passed by a majority of 19 shareholders voting in favour of the SpRes, with 2 abstaining, and NF being the only shareholder voting against it. 

16.1.  NF then applied to the court under s.220 CO to cancel the SpRes.  This section provides (where material):

“(1) ... [A] member or creditor of the company may apply to the Court, within 5 weeks after the date of the special resolution for reduction of share capital, for cancellation of the resolution.

...

(4) If an application is made under this section—

(a) the applicant must, as soon as possible, serve the application on the company; and

(b) the company must give the Registrar notice in the specified form of the application within 7 days after the day on which the application is served on the company”.

16.2.  Upon an application being made under s.220 CO, the powers of the court are set out in s.222 (where material):

“(1) On an application under section 220, the Court must make an order confirming or cancelling the special resolution for reduction of share capital, and may do so on any terms and conditions it thinks fit”.

16.3.  The statute makes provision in s.225 for registration of the SpRes where there is an application to the court for cancellation, as follows (where material):

“(1) If -

(a) an application is made under section 220 in respect of the special resolution for reduction of share capital;

(b) ...

(i) the Court makes an order under section 222 confirming the special resolution;

... and

(c) the company delivers to the Registrar a return ...

(i) within 15 days after the making of the order, or within any longer period ordered by the Court; ...

the Registrar must register the return.

Note—

Under section 215(2), the special resolution and the reduction of share capital take effect when the return is registered by the Registrar”.

The Main Decision

17.1.  NF’s application was dismissed by the judge who confirmed the SpRes for reasons which may be summarized below:

-  the Sub-Division 2 pathway was intended to be “quicker, cheaper and less technical” (emphasis added) than the Sub-Division 3 pathway [§20], although the Thorn principles still applied [§21];

-  the protection of creditors is the “primary concern” and the production of the solvency statement was central to the Sub-Division 2 pathway [§21];

-  as for shareholders, the “most likely legitimate concern” was information about the Company’s debt at the time of the SpRes [§21], and in this regard, the “historical” requirement (in petitions to the court) of evidence to identify permanent losses, and to explain why they are said to be permanent, is not required [§30];

-  the Company’s proposed undertaking (attached to the Main Decision) (“the Undertaking”) “cured” NF’s concerns about the nature of the impairment losses which she said had not been proven to be permanent losses [§35]. 

17.2.  The judge therefore held that, even though:

(a)  there has been a longer than desirable time lag between the August 2016 Accounts and the date of the 2017 EGM (7 months); and

(b)  NF has raised some questions as to whether impairment losses¹¹ are permanent in nature,

these did not represent a threat to creditors’ interests given the Undertaking.

17.3.  The judge also noted that the integrity of the decision made by the large majority of shareholders, who clearly wanted the capital reduced, was not called into question.

17.4.  The judge accordingly confirmed the SpRes under s.222 CO.

18.  On 24 March 2020, NF filed a Notice of Appeal.  She filed an application for a stay which was granted by this court (Barma and Au JJA) for reasons set out in a judgment given on 25 September 2020.

Appeal

19.  On appeal, NF’s grounds may be summarized as follows:

(A)  the Judge was wrong to adopt the approach that the court should not be “overly technical” when reviewing reductions under the Sub-division 2 pathway, because the quantum and nature of the losses must be proved by cogent evidence;

(B)  the Company has failed to prove the losses, and the nature of those losses (i.e. whether permanent or not) could not be analysed. 

(C)  As the financial information relied upon was 7 months out of date, and there had been a material increase in the Company’s losses between the dates of the August 2016 Accounts and the 2017 EGM, the amount stated in the SpRes was wrong, and it was therefore defective;

(D)  there was inadequate explanation of the nature and cause of the Company’s losses;

(E)  the Judge was wrong to take into account NF’s motives for challenging the SpRes.

Discussion     

20.  It would be convenient for us here to set out simply our understanding of the rationale for reduction of capital. 

- Rationale for reduction of capital

21.1.  The traditional “capital maintenance” rule or doctrine was that companies limited by shares must not reduce their issued share capital except as the law permits.  As far as creditors were concerned, it was thought that a creditor gives credit to a company on the faith of the representation that the capital shall be applied only for the purposes of the business, and that gives him a right to oppose the return of capital to the shareholders.

21.2.  However, as noted in the Rewrite of the Companies Ordinance (“CO Rewrite”), Consultation Paper on Share Capital, The Capital Maintenance Regime, Statutory Amalgamation Procedure, the premise of the capital maintenance doctrine has been questioned, as there are doubts whether creditors rely on the share capital significantly in practice [§3.5], and the doctrine has become “less relevant” [§3.6].  The capital maintenance rules are also considered to be “unduly complex” [§3.7].  Hence, the new pathway discussed later in this Judgment.

21.3.  Where shareholders are concerned, protection is afforded (if there are different classes affected) by the 1^st Thorn principle, and generally by the provision of adequate information under the 2^nd Thorn principle.  Nevertheless, it is well-established that “the rules governing the raising and maintenance of capital are designed primarily for the benefit of those dealing with the company as creditors”¹²(emphasis added).

22.1.  An important consideration for shareholders, however, is that where permanent losses are not written-off, the capital would be “tied up”, to the detriment of those shareholders who wish to receive ready funds.  This is because under s.297 CO, a company may not make a distribution except out of “profits available for distribution”.  Such “distributable profits” mean the company’s accumulated profits less its accumulated losses.  These profits and losses include those of a capital nature.  Therefore, if a company has accumulated losses which are greater than its accumulated profits, it would not be lawful for it to make a distribution, eg by paying a dividend.  Hence, to put it simply, before a distribution could be made, the company would have to recoup or write-off its accumulated losses first.  Recouping such losses would depend on generating profits, which might or might not be achievable.  Alternatively, writing off accumulated losses by a reduction of capital would enable dividends to be paid to the shareholders out of future profits, to the benefit of those who wish to receive ready funds as well as continue to hold their shares.

22.2.  So far as creditors are concerned, they are regarded as taking the risk that a company may not operate profitably, and may lose its capital as a result of operating losses.  Where capital is reduced for the purpose of writing off permanent losses, creditors have no cause for complaint.  However, it is necessary to be satisfied that losses written off are indeed permanent in nature, and thus are irrecoverable.  Where this is not so, as in the case of losses arising from impairment provisions in respect of assets, the losses may be recovered in future if there is a recovery in the value of the asset in question.  This might give rise to profits which would then be available to distribution following the earlier reduction of capital based upon such losses.  If this were to happen, shareholders could obtain a return of capital at the expense of creditors where the losses relied upon for a capital reduction are not permanent in nature.  This problem can (and has) been addressed by the courts through the exacting of suitable undertakings to protect the creditors’ interests.   

23.  It would thus be seen, as illustrated by the Thorn principles, that where a reduction of capital is concerned, the focal elements are:

-  the provision of protection to creditors by ensuring that losses written off are permanent in nature or that suitable safeguards by way of undertaking are put in place, and

-  the provision of adequate information to shareholders so they could decide for themselves whether to vote for reduction.

“Impairment losses”

24.1.  It is obvious that once a loss is realised (eg by sale of the loss-making asset), that loss would be permanent.  The question in this case is whether losses set out in the Company’s balance sheet as “impairment losses” should be treated as permanent.  As Harman J said in In re Jupiter House Investments (Cambridge) Ltd¹³:

“When I use the word ‘permanent’, I mean, of course, permanent so far as is presently foreseeable; I do not suggest that the evidence should prove permanence for ever and ever ...”.

24.2.  Hong Kong Accounting Standard 36 contained an explanation of when an asset is described as “impaired”, so as to be shown as such in a company’s balance sheet.  An “impairment loss” should be recognised by the company if an asset’s carrying amount exceeds the amount to be recovered through the use or sale of the asset. 

25.  However, although the asset or loss is impaired, the loss may or may not be permanent. It was not disputed that the concept of “permanent” versus “non-permanent” losses is not an accounting concept.  The equivalent accounting concept is the distinction between losses which have been recognized in the profit and loss account but which could be reversed in the future if circumstances change (i.e. non-permanent losses), and losses which have been recognized in the profit and loss account and because of their nature cannot be reversed in the future (i.e. permanent losses).  

26.1.  NF referred to the impairment losses shown in the balance sheet in the August 2016 Accounts.  They have been listed in the report of NF’s expert Nicholas Allen in §9.3.  The total amount of these impairment losses is $1,042,039,796 (for convenience, referred to hereafter as “$1,042 million”).  NF contended that the Company has failed to show that out of this figure, $861 million are permanent losses so as to enable the Company to pass the SpRes referred to in §1.1 above.

26.2.  NF pointed to a letter dated 19 January 2015¹⁴, where the Company’s then solicitors said:

“We are instructed by the Company’s board that the accumulated losses shown in the financial statements for the year ended 31 December 2013 are not or are not likely to be permanent losses. The board is hopeful that those losses can be recovered when Guangzhou Nansha Development and Construction Limited can transfer the land use right to Nansha Grand Hotel and other fixed assets of the Company’s investment are re-valued in the future - the fixed assets including but not limited to various buildings in the Nansha Information Technology Park project in Mainland China”. (Emphasis added).

26.3.  Pausing here, the issue is not whether the “accumulated losses” per se were or were not permanent, but whether the losses set out in the balance sheet as “impairment losses”, which went to make up the accumulated losses, were or were not permanent.  If they were not, the accumulated losses might ultimately be recovered (in whole or in part) as a result of subsequent increases in the value of impaired assest, and creditors might thus be disadvantaged.

27.  However by 2017, the situation had changed.  As Mr Lam stated in Lam I [§48]:

“The Company’s board of directors take the firm view that practically all of the impairment losses shown in its audited financial statements are permanent in the sense that it is not foreseeable from [the] point of view of the directors that those losses can be recovered”. (Emphasis added).

28.  This view was however reversed 16 months later when in Lam II (filed 15 October 2018), the Company recognised that since the date of the 2017 EGM, its financial position had changed for the better according to professional appraisals of landed properties. 

29.  Be that as it may, some 1½ years had elapsed between the time of the 2017 EGM and the hearing before the judge.  We take the view that the most relevant consideration when the court decides whether to confirm or cancel the SpRes is the audited report and financial statements for the year ended 31.12.2016¹⁵ (which shows the Company’s financial position at the closest date before the 2017 EGM, although they were not available until 22 August 2017, after the meeting).  These audited financial statements showed total impairment losses of $1,040,957,734¹⁶ (slightly less than the $1,042 million figure).

The Undertaking       

30.1.  As at the hearing before the judge, due to the increase in property values as set out in the appraisals, $794.7 million of the $1,042 million impairment losses had been reversed.   

30.2.  However, as the total of the impairment losses according to the August 2016 Accounts (which were the only accounts available at the 2017 EGM) was $1,042 million, the Company offered an Undertaking under which, to safeguard existing creditors, all recoveries in respect of the impairment losses up to that amount (i.e. $1,042 million) would be paid into a Special Capital Reserve (“the Reserve”), from which no distribution to the shareholders would be made by the Company, the Reserve to be reduced by fresh capital, or upon impairment losses becoming permanent (e.g. by the sale of the Company’s interests in an impaired investee company or other impaired asset)¹⁷. This was affirmed by a resolution of the shareholders at an EGM on 15 October 2018 (“the 2018 EGM”).

30.3.  As mentioned earlier, the judge was satisfied with the Undertaking.  He dismissed NF’s application for cancellation of the SpRes and confirmed it under s.222 CO.

31.  We now turn to NF’s grounds of appeal.     

(A) “Overly technical” approach in Sub-Division 2 reductions?

32.  As mentioned earlier, there are now 2 pathways to reduction of capital:

-  the traditional pathway (formerly s.58 - 63 CO Cap.32, now the Sub-Division 3 pathway)

          and

-  the new, “court-free” pathway (the Sub-Division 2 pathway).

33.  The Sub-Division 2 pathway finds its origin in the UK Companies Act 2006.  It would be noted that under the UK procedure, there is no provision allowing a shareholder (cf a creditor), to apply to court for cancellation of the special resolution for reduction.  This is because in the usual case, shareholders would only be concerned with rights between classes (if any).  This is another pointer that where the court is involved in a reduction of capital, its primary task is to ensure that the creditors are safeguarded (i.e. the 3^rd Thorn principle).    

34.1.  In the Main Decision, the judge described the Sub-Division 2 pathway as “intended to be quicker, cheaper and less technical” than the Sub-Division 3 pathway [§20].  There can be no doubt that the Sub-Division 2 pathway is quicker and cheaper.  What NF appeals from is the judge’s view that it was also intended to be “less technical”.

34.2.  There are obvious differences between the Sub-Division 2 pathway and the Sub-Division 3 pathway but we do not think the judge meant to say that in a s.220 application under the Sub-Division 2 pathway, the court would only be “ticking the boxes” to see if a solvency statement has been signed by all the directors.  If that were the case, the judge would not have held that the Thorn principles still applied [§21], and in applying them, he held that “the protection of creditors is the primary concern” (i.e. the 3^rd Thorn principle), while “in the case of a shareholder, the most likely legitimate concern” is to have enough information (i.e. the 2^nd Thorn principle) to conclude that the amount of the proposed distribution is viable in light of the Company’s financial position.

34.3.  Clearly, the judge had considered the August 2016 Accounts, which showed total impairment losses of $1,042 million and considered the Undertaking of that amount to be placed in a Special Capital Reserve to be sufficient safeguard for the creditors, which after all, are the parties to be protected. 

35.  As for NF’s argument that the Undertaking had not been proffered at the EGM, there were in existence then the audited August 2016 Accounts, and the board’s judgment that “practically all” the impairment losses were permanent.  Of course it would have been better if the board had also provided professional appraisals if they had been available then.  But the onus was on NF who was seeking to contend that the impairment losses were not permanent, or to suggest an undertaking, which was not done.    By the time of the hearing, the Company quite properly recognized that the impairment losses might not in fact be permanent in nature, and addressed this by way of the Undertaking which was proffered to, and accepted by, the Court.

(B) and (C) The Company’s losses

36.1.  These two grounds may be discussed together.  As mentioned earlier, the issue is not the Company’s accumulated losses (which may include realised losses), but the quantum of the “impairment losses” as at the date of the 2017 EGM, which may ultimately prove not to be permanent.  

36.2.  There was indeed a time lag of 7 months between the end date of the August 2016 Accounts and the date of the EGM (24.3.2017).  However, as we have noted above [§29], having calculated ourselves the total of the impairment losses according to the audited accounts for the year ended 31 December 2016 (being realistically, the latest date for audited accounts to be available for the EGM in March 2017), the difference is relatively small: $1,042 million (as at 31.8.2016) and nearly $1,041 million (as at 31.12.2016).  If there had been a great discrepancy between the August 2016 Accounts (on which the Circular was based accurately) and the 31.12.2016 accounts (by which time the Circular would have become inaccurate) which could have influenced reasonable shareholders at the time they were called upon to act at the EGM, the result may well be different^18.  But in the present case, as we have said, the difference between the impairment losses in the August 2016 Accounts and those in the 31.12.2016 accounts was small.  The August 2016 Accounts had been audited without qualification and the board had taken the “firm” view in 2017 that “practically all of the impairment losses shown in its audited financial statements are permanent in the sense that it is not foreseeable from [the] point of view of the directors that those losses can be recovered” (Lam I, §48).  The board, whose integrity has not been impugned, is in the best position to make a judgment on business matters like these.  In any event, as we have noted, a suitable undertaking was proffered, which the Judge was entitled to regard as sufficient to protect the creditors’ legitimate interests in the event that the board’s view should prove incorrect as a result of subsequent events. 

37.  We do not think that much, if any, weight should be given to the accounts after the year ended 2016.  The relevant date for consideration is the date of the EGM when the SpRes for reduction of capital was passed (although it takes effect on registration of the return by the Registrar).  A post-EGM increase or decrease in losses does not by itself show that the figures on which the directors were working as at the EGM were incorrect.  This is clear as the statute does not call for a further or updated solvency statement when an application has been made under s.220 CO and the matter then has to be considered by the court.  Under the Sub-Division 2 pathway, what the court confirms is the special resolution passed at the EGM (although it takes effect upon registration of the return with the Registrar).  This is in contradistinction with the Sub-Division 3 pathway, where it is the court’s order that “alters” the Company’s share capital [s.230(2) CO]. 

38.  The judge was entitled on the state of the Company’s financial position as at the 2017 EGM to confirm the reduction of capital of $861 million.  As for the issue whether the Company had “proved” which of the impairment losses were permanent, and which might not have been, the judge accepted the Undertaking so that the creditors would be sufficiently safeguarded under the 3^rd Thorn principle (notwithstanding the solvency statement).  There is nothing in the Sub-Division 2 pathway that supports NF’s argument that the shareholders were entitled to primary evidence before the EGM to verify each loss and its nature, although in the present case, the August 2016 Accounts were provided.

(D) Inadequate explanation to shareholders?

39.  The judge was entitled on the evidence to find that the Circular contained sufficient information, accompanied by audited (August 2016) Accounts which as mentioned above was not required under the Sub-Division 2 pathway.

40.  It is notable that at the EGM, NF’s request for an adjournment was put to the vote.  Of the 20 shareholders who voted, 16 voted for the 2017 EGM to proceed. After the Company’s professional advisers addressed the meeting on the matters raised in the letters from NF’s solicitors, the SpRes was passed by a majority of 19 shareholders voting in favour of the SpRes, with 2 abstaining, and NF being the only shareholder voting against it. It is notable that NF’s application under s.220 CO is not a representative application under s.220(3) CO and that none of the other shareholders of the Company has joined in these proceedings in her support. 

41.  It is therefore clear that the shareholders considered that they had adequate information with which to proceed to a vote.

(E) NF’s motives

42.  NF has included as a ground of appeal that the judge has unjustifiably taken her motives into account.  The judge was clearly addressing the point in NF II, where she had said [§8]:

“... I voted against the Proposed Reductions of Share Capital not for my personal interest but because they are, among other things, clearly contrary to the wishes of my late father for the capital of the Company to be used for the development of Nansha. He did not give the vast sum of HK$3.52 billion to the Company and expected that a large portion of it would be returned to the shareholders after his death. This is contrary to his dream of developing his home town Nansha into a prosperous city comparable to Shenzhen”.

43.  However laudable from the point of view of a daughter desiring to perpetuate her late father’s wishes, it is well-established that business decisions are properly within the province of the board, and the judge may well have had in mind his own 2016 Decision, where NF had argued that a reduction of capital would breach the Shareholders Agreement.

(F) Costs Decision

44.  Finally, as to costs, we note that the Undertaking was only offered about a week before the hearing before the judge.  However, in the Costs Decision, the judge decided that it would have made no difference to NF’s case anyway.  That was a decision that the judge was entitled to take on the evidence, especially the passage in NF II in §42 above.  Accordingly, we do not consider that we should interfere with the judge’s exercise of discretion.

Order

45.  This appeal should be dismissed.  It is not necessary to deal with the Respondent’s Notice.  We would make a costs order nisi that the costs of the appeal should be paid by the appellant to the respondent with certificate for two counsel.  We would also direct that the stay is lifted with immediate effect.

Hon Au JA:

46.  I agree with the Judgment of Yuen JA and Barma JA.