RE LUEN CHEONG TAI INTERNATIONAL HOLDINGS LTD

HCCW 584/2002

IN THE HIGH COURT OF THE

HONG KONG SPECIAL ADMINISTRATIVE REGION

COURT OF FIRST INSTANCE

COMPANIES (WINDING-UP) NO. 584 OF 2002

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REASONS FOR DECISION

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1. On 5 September 2002, I made an order to appoint provisional liquidators for Luen Cheong Tai International Holdings Limited ("the Company") on the application of its creditor, the Bank of China (Hong Kong) Limited ("BOC"), and indicated that the reasons for my decision would be given later. The application arose in this manner.

The background

2. The Company was incorporated in the Cayman Islands and registered as an oversea company under Part XI of the Companies Ordinance, Cap. 32, with its principal place of business in Hong Kong. The shares of the Company have been listed on the Hong Kong Stock Exchange since 1999. It carries on business as a holding and investment company. It does not carry out any actual trading and investment activities itself. Its shares in its subsidiaries are its only assets. The Company, through its wholly owned subsidiary, Luen Cheong Tai (BVI) Limited, controls 23 subsidiaries and associated companies (collectively, "the Group"), whose businesses include investment holdings, timber trading and construction.

3. On 1 March 2002, a creditor presented a petition to wind up Luen Cheong Tai Construction Company Limited ("LCT Construction"), a wholly owned and a major subsidiary of the Company. A winding up order was made against LCT Construction on 15 July 2002 and the Official Receiver was appointed as provisional liquidator.

4. On 3 June 2002, a petition to wind up the Company was presented by a creditor, Showa Leasing Company Limited ("the petitioner"). The petition came before a Master on 21 August 2002 and because of the opposition of the Company, it was adjourned to a Judge on 26 August 2002. On 26 August 2002, I acceded to the request of the Company to adjourn the petition for two weeks to 9 September 2002, as the Company had only received a proposal for debt restructuring from a potential investor on 23 August 2002 ("the Company's proposal") and would like to submit this for the consideration of its creditors. I was told by Mr William Wong, who appeared for the Company on the petition and in the application of BOC to appoint provisional liquidators, that if the Company's proposal did not have the support of its creditors, the Company would not be able to resist the petition.

5. On 21 August 2002, BOC made an application ex parte on notice for an order that provisional liquidators be appointed for the Company. The Company duly appeared and indicated to me at the hearing that it would like an opportunity to file evidence in opposition. I therefore adjourned the application to an early date to be fixed and gave directions for evidence to be filed within a short time. Evidence in opposition was filed by the Company with evidence in reply from BOC. I heard the adjourned application on 5 September 2002.

6. BOC is the largest creditor of the Company and its debt is not in dispute. The application to appoint provisional liquidators was made with the support of most of the financial creditors of the Company. Their claims, totalling HK$97,832,020.54, represent 88.5% of the Group's total bank debts of HK$110,530,000.00 as at 30 November 2001; 76.7% of the Company's total bank debts of HK$127,613,000.00 as at 31 May 2001 (on the assumption that all of the bank debts of the subsidiaries have been guaranteed by the Company); and 62% of the Company's total liabilities of HK$162,985,000.00 as at 31 May 2001.

7. Two broad grounds were put forward for the appointment of provisional liquidators. Firstly, it was submitted that this was necessary to protect the assets of the Company, having regard to the drastic deterioration of the financial position of the Company and in view of a number of suspicious circumstances that BOC had learned about and which would require investigation. Secondly, it was contended that provisional liquidators should be appointed to explore a corporate rescue and facilitate a viable debt restructuring proposal as BOC and the supporting financial creditors have lost faith in the ability and integrity of the management of the Company to undertake that exercise. By the time of the adjourned hearing of this application, BOC and the supporting financial creditors had considered the Company's proposal and the revised proposal dated 2 September 2002 ("the revised proposal") and did not find this acceptable at all, for the reasons that I will go into. Hence, it must be recognised that the Company would have few options in this situation, as it is plain that the statutory majority for creditors to approve a scheme of arrangement proposed by the Company under section 166 of Cap. 32 cannot be achieved.

8. The petitioner, which is one of the supporting financial creditors, indicated that in view of the perceived benefit to creditors if provisional liquidators should be appointed, it would not press for a winding up order at the adjourned hearing of the petition if this application were granted.

9. The Company's stance to the appointment of provisional liquidators was as follows. It was acknowledged by the Company that it has a liquidity problem and if the Group's financial creditors were to call in their facilities, the Group would not be able to make immediate and full payment. If the creditors would not press for a winding up so that a debt restructuring proposal could be explored, the Company would wish to conduct its own rescue proposal instead of having this undertaken by provisional liquidators. If, however, the financial creditors should insist on winding up the Company, then the Company would not resist the appointment of provisional liquidators as it would regard a winding up order as inevitable. In that instance, the Company would only oppose the choice of the persons to be appointed as proposed by BOC, on the ground that these persons do not appear to be independent and impartial.

10. Having heard submissions from Mr Wong and Mr Bartlett, who appeared for BOC, I am persuaded that it would be appropriate in the circumstances to appoint provisional liquidators on the two grounds put forward by BOC.

Protecting the assets of the Company

11. It was not alleged by BOC that there was misappropriation of assets of the Company. It was alleged that the board of directors had behaved irresponsibly with respect to the creditors' interests and that there were suspicious circumstances requiring investigation. Mr Bartlett has referred me to two Australian decisions, Riviana (Aust.) Pty. Ltd v Laospac Trading Pty. Ltd (1986) 10 ACLR 865 and Australian Securities Commission v Solomon (1996) 19 ACSR 73. It was submitted on the basis of these two decisions that suspicious circumstances, which may not amount to misappropriation of assets, may be sufficient reason to appoint provisional liquidators in an appropriate case to protect the interests of the creditors and shareholders, where, for instance, there is a need to preserve the status quo to ensure the least possible harm to all concerned pending the hearing of the petition, or there is a need for an independent investigation of the affairs of the company without delay.

12. I agree jeopardy to assets should not be limited to misappropriation of assets. As in the case of Riviana, this is not an application made ex parte in which the court would need to proceed very cautiously. Here, the Company has appeared and has filed evidence in opposition. In a contested application, the onus on the applicant is not as heavy as in an application made ex parte, "in the sense that the court takes into account the fact that the company is present, so that the company has an opportunity of putting before the court any relevant factors as to why a provisional liquidator should not be appointed", and "if the [applicant's] affidavits raise matters to which a court would expect there to be some answer and there is no answer provided then that in itself raises a matter of suspicion that it may well be in the public interest to put in a provisional liquidator", even though the suspicious circumstances may not amount to putting the company's assets in jeopardy (Riviana, per Young J). I must, however, emphasise, as the Federal Court of Australia had stated in Australian Securities Commission, that the power to appoint provisional liquidator is a broad one and the affairs of companies will vary greatly, so it will be inappropriate to limit the power by restricting its exercise to fixed categories or classes of circumstances or fact. Statements made in other cases should only be treated as guidance of broad principles, whether and how the principles should be applied in another fact situation would depend on all the relevant circumstances.

13. I turn to the evidence relied on by BOC in support of its contention that it would be appropriate to appoint provisional liquidators to protect the assets of the Company.

14. Much of the information relied on by BOC was elicited from the annual report of the Company for the financial year ended 31 May 2001. Under the listing rules of the Stock Exchange, the Company was required to release its annual results for that financial year by 30 September 2001 and its interim results for the six-month period ended 30 November 2001 by 28 February 2002. The 2001 annual report was released only on 12 June 2002, almost nine months late. The interim results were released on 10 July 2002, almost five months late. According to the announcements of the Company, the 2001 annual report was delayed due to the resignation of its auditor and the interim results were delayed because the annual results were delayed. Owing to these delays, the creditors have been deprived of timely financial information of the Group.

15. The auditor's report stated that the auditors are unable to form an opinion as to whether the accounts give a true and fair view of the state of affairs of the Group and of the Company as at 31 May 2001 or of the loss and cash flows of the Group and as to whether the accounts have been properly prepared in accordance with the disclosure requirements of the Companies Ordinance. This was due to various reasons, including the following:

(1) insufficient evidence on the value of the beneficial land use rights of a forest concession in Suriname, South America, acquired by a subsidiary of the Company on 31 August 2000 for a purchase price of HK$125 million and valued at HK$105,256,000.00 ("the Concession Rights");

(2) insufficient evidence of whether further provision is required for the diminution in value in the interests in subsidiaries;

(3) insufficient evidence on the accuracy of provision for tax;

(4) insufficient documentation to ascertain the receivable/payable on the Group's construction contracts;

(5) the appropriateness of going concern basis; and

(6) the recovery of the loans receivable in the sum of HK$78,397,000.00 ("the Loans Receivable") under the assignments to a company in Suriname as described below was doubtful.

16. As pointed out by BOC, a review of the 2001 annual report and the interim accounts as at 30 November 2001 shows that during the 18 months from 31 May 2000 to 30 November 2001, the financial position of the Company has deteriorated drastically in that:

(1) the cash position of the Company and/or the Group decreased from HK$42 million to HK$3 million;

(2) the retained earnings of the Company and/or the Group decreased from HK$91,182,000.00 to accumulated losses of HK$83,528,000.00;

(3) the net asset value of the Company and/or the Group decreased from HK$256 million to HK$118 million;

(4) the Company's and/or the Group's current liabilities increased by HK$26 million;

(5) amounts due from the Company and/or the Group to related companies in the Group increased by almost HK$22 million; and

(6) losses were HK$154,083,000.00 and HK$20,627,000.00 for the year ended 31 May 2001 and for the six months ended 30 November 2001 respectively.

17. The Company and/or the Group is the owner of machinery and equipment valued at approximately HK$52,410,000.00 of which HK$36,084,000.00 is held by way of financial lease. The Company entered into a lease agreement with Jilin Jitai Industrial Company Limited ("Jilin") in 1998 whereby the Company leased all, or a substantial proportion, of this machinery to Jilin. The two directors of the Company, Mr Chan Man Chuen and Mr Vong Pak Cheong, have a 45.9% interest in Jilin. Rental income in respect of the lease of machinery to Jilin for the financial years ended 1998, 1999 and 2000 were to be HK$8,710,000.00, HK$17 million and HK$17 million respectively. As at 31 May 2000, there were outstanding rental receivables owing from Jilin to the Company of approximately HK$25.3 million. There would appear to have been little payment by Jilin to the Company during the financial year of 2000 and no attempt by the Company to enforce any remedies to recover the machinery.

18. According to the 2001 annual report, on 1 May 2000, the Company assigned loans receivable of HK$47 million from a debtor, who was not identified, to a company incorporated in Suriname and engaged in the forestry business ("the assignee"). On 1 June 2000, the Company gave a further assignment to the assignee of the rent receivables from Jilin of HK$25.3 million referred to above. Pursuant to these assignments, the unidentified debtor and Jilin were released from their obligations to settle the Loans Receivable being HK$78,397,000.00 in total (made up of the two debts assigned and interest of HK$6,097,000.00). In consideration of what was assigned, the assignee undertook to either repay the Loans Receivable to the Company and/or the Group or supply timber stocks to the Company and/or the Group for five years. No security was provided by the assignee with respect to the assignments. What was provided was a letter of comfort by which the assignee agreed to transfer an equivalent amount of land use rights under certain forestry concessions in lieu of cash settlements to the Company and/or the Group. As at 12 June 2002, the assignee has failed to make any repayment of the Loans Receivable or provide any timber stocks to the Company and/or the Group. Further, it has yet to fulfil its obligations under the letter of comfort to transfer any land use rights under its forestry concessions to the Company. No provision for the Loans Receivables was made in the annual accounts for 2001. It would appear from the evidence filed by the Company that the operations in Suriname are at a "standstill". It was submitted on behalf of BOC that these transactions raise justifiable suspicions and should be immediately and independently investigated.

19. According to the interim accounts as at 30 November 2001, the consolidated assets of the Group were HK$359,769,000.00 and the consolidated liabilities of the Group were HK$241,703,000.00. If the net asset value of the Group is to be adjusted by taking into account the Concession Rights and the Loans Receivable which the auditors regarded as doubtful, the Group would have a net deficit of HK$54,500,000.00. I note from the unaudited consolidated balance sheet of the Group for the year ended 31 May 2002 that the net current liabilities stood at HK$121 million.

20. It was also pointed out by BOC that in the 2001 annual report, it was recorded that in April 2001, the Group acquired three internet companies with net asset values of HK$3.35 million at a cost of HK$64,070,000.00. The consideration paid consisted of an assignment of trade receivables of HK$59.7 million and new shares valued at HK$4.4 million. The principal assets of these companies were website development. As at 31 May 2001, just a month after the acquisition, the Group wrote off all the goodwill in relation to these websites at HK$60,720,000.00. This transaction again caused BOC to have concerns about the integrity and competence of the management of the Company.

21. Further, as late as 22 July 2002, the Company announced that the Group had acquired a 100% interest in Sky Glory Holdings Limited for HK$14 million and on 24 July 2002, it announced that one of the subsidiaries had agreed to purchase Fortuna Group Limited for HK$20.04 million. These acquisitions, made at a time when the Group was faced with considerable difficulties in meeting its debt obligations, caused BOC to have further doubts about the competence of the Company's management.

22. As I have mentioned above, all these matters are taken from the 2001 annual report, the interim accounts and various announcements of the Company, so the facts cannot be disputed. The only question is whether it is justifiable for BOC and the supporting financial creditors to infer suspicious circumstances and questionable conduct of the management. On behalf of the Company, it was submitted that these matters would at most show that the management had made bad business decisions. I do not agree, looking at the magnitude of the transactions and their cumulative effect.

Facilitating a rescue proposal

23. I turn to the other ground for which the appointment of provisional liquidators is sought.

24. Trading in the Company's shares was suspended on 5 June 2002, 15 and 24 July 2002 and as from 23 August 2002. The listed status of the Company is a valuable asset. It is recognised by all that if a restructuring without winding up could be brought about, this would be more beneficial to the creditors.

25. In or around August 2001, BOC had become concerned about the Company's ability to repay its debts and requested the Company to appoint Ernst & Young to conduct a limited scope financial review. Apart from engaging Ernst & Young to conduct the review, the Company also appointed them on 6 September 2001 to assist the Company and the Group in presenting a restructuring proposal to the financial creditors. A draft restructuring proposal was presented by Ernst & Young to the Company's management on 17 September 2001. The following day, the appointment of Ernst & Young to formulate a restructuring proposal was terminated due to "costs reasons". The limited scope financial review was issued by Ernst & Young in October 2001. Thereafter, and not until BOC had applied for the appointment of provisional liquidators on 21 August 2002, the Company's management have not put forward any global restructuring plan to its major creditors except for a repayment proposal to two of the financial creditors dated 2 January 2002, which proposal was not adhered to by the Company or the Group.

26. By the revised proposal of 2 September 2002, the potential investor, Ever Capital Development Limited ("Ever Capital"), would make a capital injection of HK$30 million, out of which HK$25 million would be used to repay financial creditors and HK$5 million would be employed as working capital, and a deferred cash repayment to financial and other creditors of HK$10 million over three years derived from rental income from Ever Capital's property in the mainland. If the proposal were accepted, this would result in a return of approximately 30% to the financial creditors on their debts. Further, according to the Company's unaudited consolidated management accounts for the year ended 31 May 2002 tabled at a meeting between the Company and some of the financial creditors on 3 September 2002, the Group has assets worth HK$337 million. On that basis, Ever Capital is proposing to acquire a controlling stake in a company with assets worth HK$337 million (without taking into account the listed status of the Company) for a consideration of HK$40 million. The financial creditors have requested the management of the Company to supply information on the financial standing of Ever Capital, a company incorporated in the British Virgin Islands, and its relationship, if any, to the Company's management. No information on this was provided.

27. For these reasons, BOC and the supporting financial creditors have rejected the revised proposal.

28. What is proposed by BOC and the supporting financial creditors is that provisional liquidators should be appointed to make an assessment of the financial position of the Company with a view to facilitating a restructuring of the Company and its subsidiaries, as they have lost faith in the management of the Company to put forward a viable proposal. It is hoped that the listed status of the Company may be realised in the absence of a winding up order as the financial and regulatory requirements of the Stock Exchange for such a relisting are less onerous than for a relisting by way of introduction where a company has been wound up. Hence, the listed status would be far more attractive to potential investors and could fetch a much higher value than in the situation after a winding up order is made, judging from the price generated for the listed status in Re Keview Technology (BVI) Ltd [2002] 2 HKLRD 290 at 296B. Thus, it is proposed that in the event that provisional liquidators are to be appointed, the petitioner would seek an adjournment of the petition at the hearing on 9 September 2002 for the provisional liquidators to explore restructuring proposals.

29. Is this a legitimate reason to seek the appointment of provisional liquidator? For a provisional liquidator to be appointed, an applicant is required to show a good prima facie case that a winding up order will be made. It may seem paradoxical that in this situation, the objective is not to wind up the company but to adjourn the petition so that a rescue proposal might be explored. In Keview, it was held by Yuen J (as she then was) that there is no jurisprudential objection in extending the powers of provisional liquidators appointed under section 193 of Cap. 32 to carry out a corporate rescue role. It seems to me a logical extension of Keview that if provisional liquidators may be empowered by the court to facilitate a restructuring proposal, this recognised function of the provisional liquidators could provide the rationale for appointing them in the first place.

30. The statutory provisions, namely section 193(3) of Cap. 32 and rule 28(1) of the Companies (Winding-up) Rules, are wide enough to accommodate such a ground for appointment. The English courts have recognised that the avoidance of a scramble by creditors for assets and the protection of assets pending the putting forward of a scheme of arrangement may be good reasons for the appointment of provisional liquidators in the case of insurance companies, where the administration order scheme is not available (see Keview, supra. at 293G to H; Re English & American Insurance Co. Ltd [1994] 1BCLC 649 at 650b to d; and Lightman and Moss, The Law of Receivers and Administrators of Companies, 3rd ed., para. 2-045). I was also referred by Mr Bartlett to an Australian decision, Cope Allman (Marrickville) Pty. Ltd v The Marrickville Businessman's Club Ltd (1983) 1 ACLC 1003, in which the court appointed a provisional liquidator for the purpose of ascertaining whether the company's business could be carried on effectively and possibly of ascertaining whether some arrangement or compromise could be reached with the creditors.

31. In Keview, it was held that it is not an abuse of the process for a petitioner to present a petition for the purpose of effecting a freeze on actions against the company, so that a scheme of arrangement can be worked out, adopting the dicta of Harman J in Re Esal (Commodities) Ltd [1985] BCLC 450 at 459 to 460. I respectfully agree. So long as it is intended by the applicant that a winding up order will be sought in the event that a scheme of arrangement cannot be achieved and that it is likely that a winding up order would be granted if it were sought, it does not appear to me there is any abuse of the process of the court.

32. For the above reasons, I accept this is also a proper ground for appointing provisional liquidators in this instance.

The choice of the provisional liquidators

33. BOC and the supporting financial creditors have proposed to appoint Mr Stephen Liu Yiu Keung and Mr Yeo Boon Ann of Ernst & Young as provisional liquidators. The Company has objected to these individuals on the ground that Ernst & Young had acted for the Company in formulating a draft restructuring proposal in September 2001 and that it had carried out a limited scope financial review which was issued in October 2001. It was submitted by Mr Wong that because of this past involvement of Ernst & Young, these individuals have put themselves into an apparent position of conflict.

34. I do not regard this as sufficient reason for not appointing these individuals. It has not been alleged or shown in the evidence filed by the Company that the information made available to Ernst & Young or the work they carried out in relation to their previous assignments were such that it would be improper for them to act as provisional liquidators. I also bear in mind that the review conducted by Ernst & Young was a limited scope financial review.

Orders

35. For the above reasons, I have made an order appointing Mr Liu and Mr Yeo the provisional liquidators of the Company in terms of the draft order submitted by BOC. I have ordered that the costs of the application including those of the Official Receiver be taxed and paid out of the assets of the Company in the first instance.