RE CHINA STRATEGIC HOLDINGS LTD

HCMP 440/2006

IN THE HIGH COURT OF THE

HONG KONG SPECIAL ADMINISTRATIVE REGION

COURT OF FIRST INSTANCE

MISCELLANEOUS PROCEEDINGS NO. 440 OF 2006

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REASONS   FOR   JUDGMENT

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1.  This is a petition presented by China Strategic Holdings Limited (“the Company”) for confirmation of reduction of its share capital and special capital reserve account, and for cancellation of its share premium account, under sections 58(1), 58(1A) and 59 of the Companies Ordinance, Cap. 32.

2.  The Company was incorporated on 22 September 1972 under its former name. It is an investment holding company with widely diversified investments. Through its subsidiaries, it is engaged in the business of manufacturing and trading of battery products, property development and investment in the People’s Republic of China (“the PRC”) and in vessels for sand mining. Through its associates, it is engaged in the manufacturing and marketing of tires in the PRC and other countries, and the business of providing package tours, travel and other related services, and hotel operation business.

3.  The present authorised capital of the Company is HK$800 million, divided into 8,000,000,000 ordinary shares of HK$0.10 each, of which 881,595,087 shares are in issue and fully paid or credited as fully paid. The total issued share capital is HK$88,159,508.70.

4.  Since December 1972, the shares of the Company have been listed on the Main Board of The Stock Exchange of Hong Kong Limited (“the Stock Exchange”).

5.  As at 31 December 2005, there is standing to the credit of the Company’s special capital reserve account the sum of HK$414,881,000.00 and there is standing to the credit of the share premium account the sum of HK$1,900,916,000.00.

6.  There is provision in the articles of association that the Company may by special resolution reduce its share capital, any capital redemption reserve fund or any share premium account in any manner authorised and subject to any conditions prescribed by law.

7.  By a special resolution passed at the extraordinary general meeting on 6 October 2005, it was resolved that the Company would undergo a reorganisation of its share capital (“the Capital Reorganisation”) in this manner:

(1) the nominal value of each share of HK$0.10 each in the capital of the Company is to be reduced by cancelling the paid-up capital to the extent of HK$0.05 on each of the shares to the effect that each issued share in the capital will be treated as one fully paid-up ordinary share of HK$0.05 each in the capital (“the Capital Reduction”);

(2) each of the authorised but unissued shares of HK$0.10 each in the capital is to be subdivided into 2 shares of HK$0.05 each (“the Subdivision”);

(3) the entire amount standing to the credit of the share premium account of the Company as at the date on which the Capital Reorganisation becomes effective is to be reduced to zero (“the Reduction of Share Premium”);

(4) the credit arising from the Capital Reduction and the Reduction of Share Premium is to be transferred to the special capital reserve account of the Company and the directors are to be authorised, to the extent permitted by the court and subject to any conditions which the court may impose, to apply an amount standing to the credit of the special reserve account towards the elimination of the accumulated deficit of the Company; and

(5) subject to and forthwith upon the Capital Reduction and the Subdivision having become effective, every 2 shares of HK$0.05 each in the capital of the Company, whether issued or unissued, are to be consolidated into a share of HK$0.10 each (“the Consolidated Shares”).

8.  Prior to the extraordinary general meeting, the Company had issued a public announcement on 19 April 2005 and a circular to all the shareholders on 10 September 2005, giving an explanation of the proposal for reduction of capital. The reason for the proposed reduction is to eliminate the accumulated losses of the Company. The Company will then be in a position to consider payment of future dividends. Further, a sufficient balance will remain in the special capital reserve account with which to facilitate the distribution in specie to shareholders, in accordance with the terms of the group reorganisation mentioned below.

9.  The credit arising from the proposed reduction of capital will be HK$2,359,876,754.00. The Company proposes to apply the credit towards the elimination of the accumulated losses, which were approximately HK$1,230,448,000.00 as at 31 December 2005 (“the Accumulated Losses”). The balance of the credit arising of HK$1,129,428,754.00 will be transferred to the special capital reserve account of the Company and is to be applied for the purpose of the issue of shares in the group reorganisation to be implemented in this manner.

10.  Upon the proposed reduction of capital taking effect, the Company will continue to be listed on the Main Board of the Stock Exchange, engaging in the business of manufacturing of battery products, investments in securities and property and investment in unlisted investments. All other subsidiaries of the Company carrying on property development and investment holding business and in vessels for sand mining, and all other associates of the Company and its subsidiaries (“the China Strategic Group”) carrying on the manufacturing and marketing of tires and the business of providing package tour, travel and other related services will be grouped under Group Dragon Investments Limited (“GDI”) and its subsidiaries (“the GDI Group”).

11.  GDI will acquire the subsidiaries and associated companies from the Company. GDI will pay for such acquisition by issuing such number of its shares (“the GDI Shares”) to the Company, which will result in the number of GDI shares to be in issue being equal to the number of the Consolidated Shares.

12.  Shares in the capital of GDI will, following the injection, be distributed in specie to the shareholders of the Company on the basis of one GDI Share for one Consolidated Share. Such distribution will be effected by distribution from the special capital reserve account of the Company, which in excess of the wants of the Company, of an amount equivalent to the carrying value of GDI. Shareholders may choose either to retain the GDI Shares or realise their interests by accepting the “Offer for the GDI Shares”, which is an offer of cash plus shares or of bonds in Hanny Holdings Limited (one of the 2 substantial shareholders in the Company, which are themselves publicly listed companies in Hong Kong).

13.  The takeover of the Company and general offer to its shareholders is conditional upon the Capital Reorganisation and the group reorganisation, but the Capital Reorganisation and the group reorganisation are intended in any event. The proposal for reduction of capital and reorganisation here has some similarity with the arrangement in Westburn Sugar Refineries Ltd. [1951] AC 625.

14.  As at 31 December 2005, the net asset value of GDI was approximately HK$1,204,800,000.00, which is approximately HK$75.4 million greater than the expected balance of HK$1,129,428,754.00 in the Company’s special capital reserve account. To implement the distribution in specie of GDI Shares, the Company proposes that approximately HK$76 million of receivables due from third parties to GDI and/or its subsidiaries will be transferred to the Company and/or its subsidiaries before completion of the group reorganisation and the intra-group loan due to GDI and/or its subsidiaries arising from such transfer will be waived. Following completion of such transfer, the net asset value of GDI will be reduced to approximately HK$1,128,800,000.00, which is less than the expected balance of HK$1,129,428,754.00 in the Company’s special capital reserve account.

15.  The proposed reduction of capital does not involve the diminution of any liability in respect of unpaid capital, but there would be a partial repayment of capital in that there would be some payment to shareholders of the sum standing to the credit of the special capital reserve, through the distribution in specie of the GDI shares. There would be a remaining balance in the special capital reserve of about HK$628,754.00 after the distribution (the expected balance of HK$1,129,428,754.00 less the expected net asset value of GDI of HK$1,128,800,000.00).

16.  The Accumulated Losses are mainly attributable to substantial investment, operating and trading losses and writing off bad debts. Detailed information has been provided of the losses from the financial year of 1998 to the financial year of 2005 and the extent to which they cannot be recovered and are thus permanent in nature. The Company considers that all of the Accumulated Losses represent realised permanent losses.

17.  At the hearing of the summons for directions on 28 March 2006, I made an order dispensing with the settlement of a list of creditors pursuant to section 59(2) of Cap. 32, notwithstanding that the Company has not at that stage finalised the terms of its undertaking to be offered for the benefit of its creditors, insofar as any losses considered by the Company as permanent may not be accepted as such by the court. I did so as almost all of the Company’s creditors have consented to the proposed reduction of capital and cancellation of the share premium account and reduction of the special capital reserve account of the Company.

18.  As at 31 December 2005, the Company owed HK$931,065,379.64 to 55 creditors. As at 20 February 2006, 42 creditors amounting to over 99% of the total debt owed by the Company in dollar value have given written consents to the capital reduction. Only 13 creditors representing HK$911,408.03 of the debt in aggregate have not consented in writing and the Company has as at 20 February 2006 a combined cash balance of around HK$3.8 million in 2 of its bank accounts. As the proposed return of capital to shareholders is to be wholly financed from the special reserve account, it would appear that are more than sufficient liquid assets to pay any non-consenting creditors and still leave a margin of approximately 0.31% of remaining liabilities of the consenting creditors. In any event, cash cover need not be shown for creditors who consent to the proposed reduction (Practice and Procedure of the Companies Court, by Boyle and Marshall, 1997 ed., para. 4.9.11).

19.  There are also produced the audited consolidated financial statements of the group for the year ended 31 December 2005, showing that current liabilities had amounted to HK$282 million odd. This decrease in current liabilities was the result of the elimination of amounts owing by the group to its subsidiaries and had the effect of reducing the amount of debt owed by the Company to its creditors. I note also that the bank balances and cash in the consolidated balance sheet stood at HK$115.8 million odd.

20.  The directions for advertisement of the notice of presentation of the petition have been complied with. No creditors have indicated that they wish to appear and none have appeared at the hearing of the petition.

21.  At the hearing of the petition, the Company offered an undertaking for the protection of its creditors, insofar as any losses may prove to be non-permanent, in the sense that there is recovery of bad debts written off after the proposed reduction has taken effect. The undertaking is along the lines of an undertaking accepted in Re Goldbond Group Holdings Ltd., HCMP. No. 1891 of 2003, 27 June 2003. The Company will undertake to place any identified amounts recovered into a special capital reserve account, which will be maintained so long as pre-capital reduction creditors remain unpaid and do not consent to distribution.

22.  The Company has identified and listed in a schedule to the undertaking those advances, loans and investments which might arguably be non-permanent in nature, the aggregate of which is HK$2,177,208,081.00 (“the overall aggregate limit”). The undertaking will capture all such recoveries, if any, as may be made in future so that such sums will be preserved in the special capital reserve account subject to the stated terms. The overall aggregate limit in the special capital reserve account may be lowered in relation to fresh capital coming in and on disposal of the fixed assets and realisation of the advances, if any. There is the usual proviso that would permit the release of amounts standing to the credit of the special capital reserve account in specified circumstances where the creditors’ interests will have been otherwise safeguarded. The Company further undertakes to publish in its audited financial statements and in any prospectus a summary of the undertaking aforesaid for so long as the same shall remain effective.

23.  I have accepted the undertaking offered by the Company with some slight amendments.

24.  I am satisfied that the shareholders are treated equitably, the reduction proposals have been properly explained, the reduction is for a discernible purpose and that the creditors are sufficiently safeguarded.

25.  I have therefore made an order confirming the reduction of capital.