RE MUSIC TRADING ON-LINE (HK) LTD

HCMP 1541/2008

IN THE HIGH COURT OF THE

HONG KONG SPECIAL ADMINISTRATIVE REGION

COURT OF FIRST INSTANCE

MISCELLANEOUS PROCEEDINGS NO. 1541 OF 2008

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REASONS  FOR  JUDGMENT

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1.  This petition presented on 4 November 2008 was brought by Music Trading On-line (HK) Limited (“the Company”) acting through its receivers. The Company seeks sanction of the court under section 166 of the Companies Ordinance, Cap. 32 for a scheme of arrangement with its creditors under the scheme (“the Scheme Creditors”).

2.  The Company was incorporated in Hong Kong on 4 December 1999 and commenced trading in February 2000. Prior to 31 August 2007, the Company owned and operated a business under the name of “CD WOW!”, which involved the sale to consumers of CDs, DVDs, computer games and other products over the internet. As mentioned below, on 31 August 2007, most of the Company’s assets were sold to Stomp Pty Limited (“the Purchaser”), an international retailer and wholesaler of DVDs, CDs and games from Australia.

3.  On 20 March 2007, the High Court of Justice Chancery Division in the United Kingdom handed down a judgment on liability against the Company (“the UK Proceedings”). On 23 May 2007, damages of £41,136,417.50 were awarded against the Company in favour of all the plaintiffs in the UK Proceedings, namely, Independiente Limited; EMI Records Limited; XL Recordings Limited; Wildstar Records Limited; Mercury Records Limited; Sony Music Entertainment (UK) Limited, on behalf of themselves and for all other members of the British Phonographic Industry Limited and Phonographic Performance Limited; and Sony Music Entertainment Inc. Also on 23 May 2007, these parties brought an action against the Company in Hong Kong in HCA No. 1090 of 2007 to enforce the judgment in the UK Proceedings and obtained an ex parte Mareva injunction on the same day to restrain dissipation of assets of the Company. As a result of these events, on 25 May 2007, the receivers were appointed pursuant to a fixed and floating charge granted by the Company in favour of Asia Sino Holdings Limited (“Asia Sino”). The receivers immediately took steps to protect the business and assets of the Company.

4.  The ex parte Mareva injunction granted on 23 May 2007 restricted any kind of business being conducted by the Company other than as necessary to complete existing orders. At the inter partes hearings of the injunction on 1 and 14 June 2007, it was varied to allow the Company to trade subject to undertakings given by the receivers, which included not to sell the business or any part of it, not to make any distribution to Asia Sino or to its order, and to take steps to ensure that any business carried out by the Company was not in breach of the undertakings given in the UK Proceedings, namely, not to parallel import into the United Kingdom. Pursuant to the above undertakings, the receivers conducted the business until 31 August 2007 when it was sold with the approval of the court.

5.  On 25 June 2007, the plaintiffs in the UK Proceedings presented a creditor’s petition to wind up the Company in HCCW No. 282 of 2007. The winding-up petition has been adjourned by the court on several occasions to provide the Company with an opportunity to formulate a scheme of arrangement.

6.  On 24 August 2007, the receivers entered into a sale and purchase agreement (“the S&P Agreement”) with the Purchaser, whereby they agreed to sell the assets of the Company to the Purchaser conditional upon the approval of the sale by the court. These assets included the rights, interests and benefits of the Company in the consumer list, chattels, website and books and records of the Company (“the MTOL Assets”). The sale was approved by the court on 29 August 2007 free of the Mareva injunction and completion of the sale in relation to the MTOL Assets took place on 11 April 2008.

7.  The receivers undertook work to secure the value of the remaining assets of the Company, which included the accounts receivable due from payment service providers and the remaining inventory of the Company with a retail value of $32,312,603.00 (“the Inventory”). The S&P Agreement did not include the Inventory but provided for a mechanism pursuant to which the Purchaser would sell the Inventory on behalf of the receivers. It was provided in the S&P Agreement that the sale proceeds of the Inventory sold with the Purchaser’s assistance would be allocated between the Company and the Purchaser in the respective proportions of 65% and 35%.

8.  The receivers considered that the Purchaser might not be able to realise the full retail value of the Inventory and as a result, for the purpose of the scheme of arrangement, the receivers had adopted two scenarios to estimate the future sale proceeds that might be realised. Scenario 1 estimated the sale of the remaining Inventory at full retail value less the 35% payable to the Purchaser pursuant to the S&P Agreement, this would realise net proceeds of $13.4 million. Scenario 2 adopted a more cautious approach and estimated the value of the remaining Inventory at 50% of its estimated retail value, less 35% payable to the Purchaser, and the likely realisation would be $6.7 million.

9.  As at the date of the winding-up petition, according to the information available to the receivers, the total claims against the Company amounted to $738.6 million odd. The claims of the petitioning creditors, whose debts are unsecured, amounted to $629 million and the aggregate claims of other unsecured creditors came up to $47 million. Asia Sino is the only secured creditor the receivers are aware of and its claim was $21 million. The claims of the petitioning creditors and Asia Sino accounted for 93% in value of the total claims against the Company.

10.  On 11 February 2008, the receivers, the directors of the Company and the petitioning creditors agreed the key terms of a proposal which they believe would provide the best possible return to the Scheme Creditors (including the petitioning creditors) and Asia Sino in the most efficient time frame. The key term was for the Company and its Scheme Creditors to enter into a scheme of arrangement pursuant to which the Scheme Creditors would compromise their claims against the Company, and the winding-up petition, the UK Proceedings and the High Court Action would be dismissed. The proposal would depend on whether scenario 1 or scenario 2 was adopted and requires the realisation of the remaining excluded assets (being the accounts receivable and the Inventory, as defined in the S&P Agreement). The total realisations from these assets would comprise the scheme funds from which the scheme administrators would make payments in this order:

(1)     to pay preferential claims, if any, in full;

(2)     to pay all Scheme Creditors including the petitioning creditors and Asia Sino on a pari passu basis, with such limitation on the dividend due to the petitioning creditors and a cap on the return to Asia Sino, subject to whether scenario 1 or 2 was adopted.

11.  Asia Sino has agreed to waive its entitlement to security (the validity of which was disputed by the petitioning creditors) in return for the treatment of its claims pursuant to the terms of the proposed scheme. The scheme provides for a mechanism whereby the sum to be received by Asia Sino is only released once distribution to the creditors as a whole have reached an agreed minimum.

12.  The costs of the scheme will be met by the directors and subject to the scheme being successful will not be payable from the realisations described in the scheme document.

13.  On 2 September 2008, leave was given to the Company to convene a meeting of the Scheme Creditors to consider the proposed scheme of arrangement.

14.  On 26 September 2008, a letter was sent to the Scheme Creditors proposing a modification to the scheme in that the distribution to Scheme Creditors as described in clause 7 of the scheme be in accordance with the steps for scenario 2 and on the basis of the total estimated realisations of $30.9 million. This would provide the petitioning creditors with a dividend of $22.8 million, Asia Sino with $5.3 million and other creditors with $2.9 million.  The modification was proposed as, since the dispatch of the explanatory statement, all inventory of the Company had been sold and most of the accounts receivable had been collected.  The realisations from, inter alia, the Company's inventory and receivables, comprise the scheme funds to be distributed to creditors and the receivers were able to more accurately estimate the return to creditors prior to the scheme meeting.

15.  On 30 September 2008, a meeting was summoned for one class of creditors. The receivers took the view that although the petitioning creditors’ debt is disproportionately larger than the other creditors, their legal rights (rather than their interests) are the same as the other creditors. As for Asia Sino, it is treated within the scheme as an unsecured creditor. It would relinquish its security in return for receiving distributions under the scheme in the short term of a much lesser amount.

16.  Twenty-two Scheme Creditors filing notices of claim attended the scheme meeting in person or by proxy, representing aggregate claims of $679 million.  They were fully apprised at the meeting of the effect upon the distributions which they would receive, if the claim by the Commissioner for Inland Revenue for profits tax of $8,030,356.00 should be found to be a valid preferential claim. The chairman advised that if the entire claim were treated as preferential, the first $8,030,356.00 of proceeds available to the scheme administrators would be payable to the Commissioner and the total distribution to the Scheme Creditors would be reduced to $22.9 million.  The Scheme Creditors attending and voting passed unanimously a resolution approving the Scheme, as modified by the circular of 26 September 2008.  Thus, the scheme was approved, as modified, by the required majority under the statute, being a majority in number of the Scheme Creditors attending and voting representing greater than 75% by value of the debt held by such creditors and admitted to vote.

17.  The receivers have sought legal advice on the claims of the Commissioner for Inland Revenue.  Should this claim not be resolved prior to the time when the scheme administrators will pay the first dividend to the Scheme Creditors, $8,030,056.00 will be set aside pending the adjudication of this claim.

18.  I am satisfied that the class of Scheme Creditors was properly constituted. The scheme provided that preferential claims are to be paid in full to the claims of the Scheme Creditors and there are sufficient funds to do so. The rights of preferential creditors are not compromised in any way under the scheme. As for the petitioning creditors, their legal rights against the Company are the same as other unsecured creditors. Asia Sino is to relinquish its security and would be treated as an unsecured creditor under the scheme.

19.  The meeting was convened in compliance with the directions of the court. The Scheme Creditors were given sufficient information and explanation of the scheme and its effects to enable them to make a reasonable judgment how to vote.

20.  The receivers and the directors of the Company are of the view that the scheme is the best available proposal for creditors, by which they would obtain in the short term an increased and more certain return than would be obtained in liquidation.

21.  Without a scheme as proposed, distributions to creditors other than the petitioning creditors and Asia Sino would be negligible, as the claims of the petitioning creditors represented 90% of all known claims. Under the scheme, the petitioning creditors agreed to cap the distributions they are to receive at $22.8 million and Asia Sino agreed to give up its security in return for receiving out of the assets of the Company a sum of about $5.3 million. In this way, creditors other than the petitioning creditors and Asia Sino should receive a dividend, which, although small, is likely to be greater than that on liquidation. The scheme is the combination of considerable efforts and negotiation between the salient parties over a lengthy period. I am satisfied this arrangement is such that an intelligent and honest member of the class concerned and acting in respect of his interest might reasonably approve.

22.  I have therefore sanctioned the scheme and made an order in terms of the draft submitted as amended.