XCHRX CHEUNG YIU WING v. KING PACIFIC INTERNATIONAL HOLDINGS LTD. AND ANOTHER

HCA 10063/2000

IN THE HIGH COURT OF THE

HONG KONG SPECIAL ADMINISTRATIVE REGION

COURT OF FIRST INSTANCE

ACTION NO. 10063 OF 2000

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REASONS FOR DECISION

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1. This is an application under section 21L of the High Court Ordinance for the appointment of a receiver. The original summons of 24 November 2000 sought to appointment to collect, get in and receive the proceeds of a placement of new shares in the 1st defendant as announced by its board of directors on 10 November 2000. However, by an amended summons of 10 January 2001, this was extended to all the assets of the 1st defendant ("the company"). On 3 February 2001 I made an order in terms of the application, reserving directions as to the appointment and costs, I now give my reasons for so doing.

2. These proceedings are based on a dispute between the plaintiff, a minority shareholder in the company, and the 2nd defendant, the managing director, who either holds in his own name, or controls, a large portion of the company's shares. In his statement of claim, the plaintiff seeks orders inter alia for a declaration that the 2nd defendant has acted in breach of his fiduciary duties to the company, that he be removed as a director, for an account of profits, and damages. The dispute arises out of a transaction involving a very large investment by the company, at the apparent instigation of the 2nd defendant, in a PRC based joint venture company, Wuhan Ocean Essence Water Factory Company Limited ("the water company"), by means of an eventual 100% interest in Ocean Essence Holdings Ltd, the foreign joint venture partner, the consideration being 207,692,308 new shares in the company issued to a Lang Jin and a Lai Man Yuk (Lang and Lai), but in the name of a nominee, China Fortune Ltd, valued at $135,000,000.00 and then representing 24.75% of the issued share capital of the company.

3. The contention of the plaintiff is that the investment in the water company amounted to little more than a sham, as there was evidence that it was effectively a write-off, and that it was part of a scheme by the 2nd defendant to assist him in obtaining control of the company, having been authorised to vote the new shares in the name of China Fortune Ltd. The plaintiff further complains of the actions of the board of directors, allegedly controlled by the 2nd defendant, in using $11,000,000.00 of the $20,000,000.00 proceeds of a share placement in November 2000 to repay loans to the 2nd defendant.

4. Although the control of the company by the 2nd defendant is a matter to which the plaintiff objects, that in itself cannot be a ground of complaint unless that control is being used to the detriment of the company and, consequently, the other shareholders. As to this, the plaintiff can only point to the water company transaction itself, and says that the 2nd defendant should have taken steps to protect the company, from what is alleged to be a failed transaction, by rescinding it and cancelling the shares issued as consideration.

5. As this matter hinges on the water company transaction, it is necessary to look at the evidence before me surrounding the purchase and its present status.

6. The scheme was first presented to, and approved by, the board of directors in 1998, when the plaintiff, who has throughout been a member of the board, was chairman of the company, as he remained until 8 February 2000. The terms of the transaction were agreed by the board, in discussions in which the plaintiff took part, and the company purchased 60% of Ocean Essence Holdings Ltd on 18 December 1998 and the remaining 40% on 18 May 1999, and the plaintiff was appointed a director of the latter company. It was part of the terms of this agreement that Lang and Lai guaranteed a minimum return on the investment. The water company has so far generated no return for the company at all and attempts to contact Lang and Lai have failed. Concerns about the investment appear to have first arisen in 1999 when representatives of the company were refused access to the premises of the water company, and in early 2000 the plaintiff claimed that enquiries had revealed that it was no longer legally registered, and had ceased to be so registered since September 1998, before its purported sale to the company. The plaintiff accordingly issued a petition for relief under section 168A of the Companies Ordinance in February 2000. However, upon the company agreeing to appoint an independent board committee ("the IBC") to look into the matter of the water company, the petition was withdrawn on 13 March 2000.

7. The IBC reported on 14 April 2000 in respect of the allegations made by the plaintiff about the water company and, in a letter to the Listing Division of the Stock Exchange of that date, stated that the water company was still in existence and in normal operation and that the company effectively owned, through Ocean Essence Holdings Ltd, 90% of it. There are reservations by the plaintiff as to both the composition and the findings of the IBC. Mr Swaine, however, on behalf of the plaintiff, says that it is the events after the middle of 2000 which are relevant here, and has drawn my attention to documents exhibited to the plaintiff's affidavits. The first of these is a notice from the Wuhan City Bureau Administration of Industry and Commerce dated 26 May 2000 to the effect that a list of companies, including the water company, had failed to participate in the annual review for 1999 and, unless they applied within 15 days for a hearing, their business licence would be revoked. The second, dated 19 June 2000, is a notice revoking that licence, the company having failed to apply for a review or hearing, and that an objection may be raised at the next level up of Administration of Industry and Commerce. One point which is immediately clear from these is that, in order to be at risk of having their licence revoked, up to these dates there must have been one, which casts some doubt on the plaintiff's allegation that the company had not been registered. The next document is an opinion from a PRC lawyer, Cheng Dong Ping, dated 13 November 2000 who, having recited the above documents, says that the water company did not appeal within the statutory period of 60 days from 19 June. However, he then goes on to say that they did so on 3 August 2000, which would have been within this period, but it had been rejected as being out of time, and the licence was accordingly revoked. There is also a suggestion that the local representative of the joint venture company has been arrested. There is certainly no dispute that the water company has failed to produce any accounts, indeed, access to the books and records appears to have been denied both to the directors and the accountants. The plaintiff says that the water company venture is therefore clearly a write off, and steps should be taken to extricate the company from the venture, which the 2nd defendant and the board are not doing.

8. The defendants do not accept that this is the situation. While it is conceded that the licence at present stands revoked, and for the purposes of this hearing it is accepted that the gentleman referred to has been arrested, steps are being taken, not only to appeal the revocation, as is apparent from a public announcement made on 12 January 2001, but to find a buyer for the project. It is also apparent from that announcement that the plaintiff's legal opinion from the PRC lawyer is wrong, in that the appeal in August 2000 was not rejected because it was out of time, but because it was made by the wrong entity. It is now, they say, proceeding to arbitration in the PRC.

9. However, there is no documentary evidence produced by the defendants in respect of either the arbitration or their attempts to find a buyer, in particular their discussions with a company called Z.Com with whom it is stated in a public announcement made on 30 January 2001 they hope to conclude a sale shortly. In the same announcement, which gives the audited results for the year ended 31 March 2000, and which are disclaimed by the auditors, the latter go on to say that they were unable to obtain information and explanations as to doubts cast on the validity of the water company. Similarly, there is no explanation of the value placed on the water company, some $13,000,000.00 more than the purchase price some two years ago of a company which has produced no profit and may not even still be operative. I would add that the auditors also express misgivings as to whether the 1st defendant could even be valued as a going concern.

10. Where then does that leave the evidence as to the situation of the water company, upon which this application largely relies? The early allegations of the plaintiff are, on the face of it, rebutted by the report of the IBC in April 2000, which does not appear to be seriously challenged at this stage. As to the events after that, while there is no doubt that the water company's licence has been revoked, it is possible that this is not yet the end of the matter, but there is no evidence that steps are being taken to put things in order, and, if they are not, the investment may be a write-off. It was not in hindsight a wise investment, it has produced no returns for the company, and does not appear to have been well managed by those in charge in Wuhan, not least by allowing the licence to lapse.

11. It is the plaintiff's case that everything that has happened in relation to the water company was designed to increase the number of shares controlled by the 2nd defendant and effectively give him control of company. Further concern is expressed about what has happened to those shares since. The original agreement provided that Lang and Lai would not dispose of those shares for a period of two years, yet the IBC report noted that they had been mortgaged in favour of ICEA Financial Services Ltd to secure a loan to Intelligent Trico Investment Holdings Ltd, which was the vehicle used by the 2nd defendant in a general offer for the 1st defendant in May 1999. There is equally no evidence from the defendants as to the present status of those shares, and some that 83,000,000 of them have been gifted to a relation of the 2nd defendant. I would add that the 2nd defendant himself has seen fit not to put before me any evidence at all in respect of this application.

12. I have two questions now before me: first, whether the facts put forward are sufficient to found an application for a receiver; and second, whether, even if they are, the plaintiff has locus standi under the exception to the rule in Foss v Harbottle (1843) 2 Hare 461 to bring such proceedings at all.

13. The power of the Court to appoint a receiver given by section 21L of the ordinance is stated in very wide terms, and may be invoked to protect assets where there is some obvious danger to them pending determination of the main proceedings, or where the management is disrupted by disputes within the governing body preventing them from acting together for the benefit of the company. The latter case cannot apply here. While there is clearly a dispute between the plaintiff and the 2nd defendant, it is the plaintiff's case that the 2nd defendant has the support of the board, indeed "controls" it, so such a dispute does not amount to any let or hindrance in the normal management of the company: the plaintiff just does not agree with what the 2nd defendant and the rest of the board wish to do.

14. Are the assets in danger? The assets I take the plaintiff to mean are those represented by the $135,000,000.00 investment in the water company, and possibly the $20,000,000.00 being the proceeds of the November 2000 share placement, although the application is in respect of all the assets of the company. Mr Swaine has added in support the fact that the shares of the company are presently suspended from trading, and it has failed to hold an AGM in 2000. These, in my view, are not matters which affect this application. The principal complaint is clearly that the 2nd defendant, through his shareholding and those he is authorised to vote, is able to control the management of the company to the exclusion of the plaintiff, and has taken decisions with which the plaintiff disagrees. That is equally of no concern to the Court, unless such decisions have placed the assets of the company in such jeopardy that a receiver is essential to protect them.

15. As to the water company investment, it has been urged by the plaintiff for some time that steps should be taken to rescind the agreement. There is grave concern as to the original agreement with Lang and Lai, who are in breach of it, and have apparently disappeared. There is no evidence before me as to the possibility of the water company being relicensed to do business at all, nor the genuineness of negotiations to dispose of it. Clearly some steps need to be taken to either make it a profitable investment, or to extricate the company from it. There is no evidence of any such steps being taken, and the investment of $135,000,000.00, which had the effect of diluting the company's shareholding by some 25%, to the obvious detriment of the other shareholders, is very much at risk.

16. It follows that, in respect of this part of the company's assets at least, there are ample grounds for a receiver to be appointed to protect them. In respect of the $20,000,000.00 proceeds of the share placement, while there is some suspicion arising from payment of $11,100,000.00 to the 2nd defendant, while other debts are owed to third parties, the evidence does not show such a degree of wrongdoing that would lead me to make an order on that alone.

17. I do not believe that the making of an order in the terms sought by the plaintiff will affect the company so adversely as to place the balance of convenience against it. It is essentially a holding company, so that the appointment of a receiver to manage its assets need not disturb its day to day running. Its shares are presently suspended from trading, so there can be no major damage to the price of them, and I have been given no evidence of any other arrangements by the company which will be adversely affected. It is clear that this is a company already in severe difficulties which is controlled by a shareholder who may well not be doing sufficient to protect its assets, and it seems to me to be to the benefit of the company and the other shareholders that an independent third party takes at least temporary control.

18. There is one other matter which has been pointed out to me by Mr Yeung for the 1st defendant, and that is that the Securities and Futures Commission has finally taken an interest in this, having previously left it to the shareholders, by requiring production of a number of documents and records relating to the water company agreement. This does not affect my decision. The interests of the SFC and the shareholders are not necessarily the same, and their investigation will in my view be assisted rather than hindered by the appointment of a receiver.

19. Although this is sufficient to dispose of the matter, before I leave it I will deal briefly with the second question before me, namely whether the plaintiff has locus standi under the exception to the rule in Foss v Harbottle.

20. The plaintiff can only bring himself within the exception to the rule, that the company itself is the only proper plaintiff, where authority for such proceedings cannot be obtained, which is clearly the case here, and

".....the act complained of is of a fraudulent character or oppressive or is ultra vires the company, or is criminal; or where the wrongdoers control the majority of votes.... [Halsburys Laws, 4th Ed., vol. 7(1) para. 1012]"

21. Mr Yeung for the 1st defendant has made much of the fact that no fraud is pleaded in the statement of claim. However, fraud itself is not a requirement. It has to be conduct of a fraudulent nature, which may not amount to fraud but may be otherwise questionable. The allegation here is that the 2nd defendant has used the water company deal, and the shares passing into his control as a result of it, to take control of the company itself, and then fail to take steps which might extricate the company from a large and unwise investment, and at the same time reduce the number of shares he is presently able to vote. Such behaviour, if proved at trial, must be at least questionable, and falling within the scope of being of a fraudulent nature. I am not therefore prepared to say at this stage that he does not have locus standi to bring these proceedings.

22. For these reasons I am satisfied that the balance of convenience requires an order for an interim receiver to be appointed pending trial of this action or further order of the Court.