RE PEREGRINE INVESTMENTS HOLDINGS LTD

1998, No.CWU 20

IN THE HIGH COURT OF THE

HONG KONG SPECIAL ADMINISTRATIVE REGION

COURT OF FIRST INSTANCE

COMPANIES WINDING-UP No. 20 of 1998

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J U D G M E N T

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Le Pichon, J.:

1. By summons dated 17 February 1998, the joint and several Provisional Liquidators ("the Provisional Liquidators") of Peregrine Investments Holdings Limited (the "Company") sought the court's sanction to enter into a sale and purchase agreement with Banco Santander S.A. ("Santander") relating to certain assets in some of the Company's subsidiaries as well as the shares of its Singapore subsidiary, Peregrine Singapore Securities Pte Ltd ("PSS"). A draft of the proposed agreement ("the draft Agreement") is exhibited to the 8th affidavit of David Richard Hague, one of the Provisional Liquidators, filed in support of the application.

The hearings

2. A preliminary hearing in chambers took place the following day. The purpose of that hearing was to outline in some detail to leading counsel for the Provisional Liquidators the matters which, upon an initial reading of Mr Hague's 8th affidavit and the accompanying exhibits, appeared to the court to require further elucidation and/or evidence. The application was urgent. This was due to the fact that PSS was technically insolvent and steps might have to be taken to liquidate it which would inevitably have meant the end of the Santander transaction. Accordingly those matters were dealt with that same afternoon by Mr John Mitchell, a director of Price Waterhouse employed by the Provisional Liquidators in relation to the proposed transaction.

3. Mr Mitchell provided the explanations orally in court. He was examined at length by the court and a number of documents not exhibited to Mr Hague's 8th affidavit were produced. Mr Mitchell was not sworn, but the explanations given by Mr Mitchell orally would be summarized in and confirmed by an affidavit and the additional material presented to the court exhibited to that affidavit.

4. Whilst Mr Mitchell was able to answer the matters raised by the court on 18 February, there were additional matters arising from the answers given that on reflection required explanation. A further chambers hearing was accordingly held on 19 February when leading counsel was advised that the application would be adjourned into court in due course for judgment.

5. At the conclusion of the hearing on 19 February which again lasted much of the day, attention focused on a new point. It concerned clause 9.3 of the draft Agreement which provided for an undertaking by, inter alia, the Provisional Liquidators not to bring any claims against the employees of the Peregrine Group in the U.K., Malaysia, Hong Kong and the U.S. whose employment would be transferred to Santander should the transaction be sanctioned ("Transferred Employees") and in particular in relation to bonuses for the employees of the Company's U.K. subsidiary, Peregrine Securities (UK) Ltd. ("PSUK"). The board of PSUK had passed resolutions in late January 1998 to pay bonuses for 1997 to its employees (including the board members) as well as an incentive bonus to most but not all of the employees. Letters to that effect had been issued on 30 January 1998 by the PSUK board.

6. When it became apparent that the draft Agreement containing this particular provision would not be sanctioned, the court was asked to consider the addition of a proviso to clause 9.3 which would preserve future action on the part of the Provisional Liquidators against such of the U.K. Transferred Employees as were directors of PSUK between certain dates. As Santander had entered into contracts with each of the Transferred Employees which were being held in escrow pending the application, deletion of clause 9.3 altogether would result in all the contracts having to be renegotiated which was considered impracticable given the urgency that had arisen.

7. The hearing continued on 20 February. At its conclusion, I indicated that I was prepared to give the sanction sought only if the draft Agreement were to be amended by incorporating a revised form of proviso to clause 9.3 to preserve future action by the Provisional Liquidators against such of the Transferred Employees as were directors of PSUK at any time between 1 January 1997 and the date of the Order.

8. The matter then stood adjourned on the basis that if Santander were prepared to accept two amendments to the draft Agreement including in particular the revised proviso to clause 9.3, the Order could be drawn up and sealed without another hearing but that the application would nonetheless be adjourned into court for delivery of the judgment. (The other amendment is not material for present purposes.)

9. The amendments were accepted and the Order sanctioning the Provisional Liquidators to enter into the draft Agreement dated 20 February was sealed on 21 February. On the same day, the court received Mr Mitchell's 16 page affidavit summarizing the matters dealt with by him at the hearings in chambers on 18 and 19 February. The exhibits to this affidavit run to some 180 pages.

10. The reasons for my decision to adjourn the application into court are twofold : first, to explain to the creditors the reasons for sanctioning the Santander transaction; second, to apprise them of certain events that have occurred which impinge on the amount of dividend ultimately distributable in the liquidation.

The bids

11. By way of background, soon after the appointment of the Provisional Liquidators, Santander expressed an interest in acquiring all or part the business of the equity products group in Hong Kong, China, U.K., U.S.A, India, Taiwan and Singapore. Santander terminated its bid after certain key employees of the Greater China Team advised that they did not want to be part of a transaction with Santander. On 27 January 1998, the day before Chinese New Year, the Provisional Liquidators entered into a conditional agreement with BNP for the sale of certain assets, liabilities and shares in various subsidiaries to BNP. That transaction ("the BNP transaction") remains conditional inasmuch as the application for the court's sanction is still pending.

12. Santander continued to be interested in acquiring some parts of the equity products businesses other than the Greater China business such as the London, New York, Singapore businesses as well as certain assets of the Hong Kong business other than assets comprised in the conditional sale to BNP, although by then Santander no longer had any interest in acquiring the businesses in Taiwan or India. By 27 January 1998, BNP and Santander were the only two parties interested in equity products and businesses not covered by the conditional agreement with BNP. Bids were invited.

13. On 29 January 1998, another prospective purchaser expressed an interest in acquiring the U.K. business.

14. On 30 January 1998, BNP made a written offer to acquire certain assets and to assume certain liabilities of the business of PSUK. In summary, the offer was to acquire the trading position (i.e. PSUK's own position) at market value, the fixed assets and some debtors.

15. On 5 February 1998, Santander made a written offer. In respect of the London business, it offered to acquire the fixed assets, counterparty receivables less counterparty payables, both to be ascertained at book value. It did not wish to acquire PSUK's trading position nor any of the debtors which formed the subject matter of the BNP offer. But in addition to the London assets it wished to acquire, Santander's offer extended to two seats on the Hong Kong Stock Exchange, the shares of PSS, some fixed assets in Malaysia and some personnel in Hong Kong and New York :11 in Hong Kong and 17 in New York. Santander also offered a premium of US$1.85 million.

16. On the same day, i.e. 5 February, BNP revised its earlier offer. The only difference between BNP's revised offer and its earlier offer is that PSUK was no longer required to meet any liabilities to staff that were outstanding at the time. As noted above and dealt with in greater detail below, by this date i.e. 5 February, the board of PSUK had issued letters to employees on 30 January 1998 informing them what their bonuses for 1997 would be, which, according to Mr Mitchell, were to be payable in three equal tranches, on 2 February, 16 February and 2 March. So by the date of the Santander offer and the BNP revised offer, one tranche had already been paid. Effectively, BNP, but not Santander, was willing to assume liability for the payment of the second and third tranches. On the other hand, both BNP and Santander were willing to assume liability for the so-called incentive bonus, that being then a liability of PSUK as will become apparent.

17. Time constraints have meant that the third prospective purchaser was not able to enter a bid for the London operations. Nevertheless, it continues to express an interest in purchasing assets not affected by either the Santander or BNP offer and is currently performing due diligence.

18. The Provisional Liquidators continued to negotiate with Santander and BNP after receipt of their offers of 5 February. Those efforts did not result in any significant improvements. Negotiations with Santander on the draft Agreement concluded on 15 February.

Evaluation of the offers

19. A summary of the terms of the Santander offer appears in Appendix I. The premium of US$1.85 million offered by Santander has been reallocated amongst London, Singapore and Hong Kong. On current estimates, the amount of cash consideration to be received at completion is approximately US$6.3 million.

20. From the creditors' perspective, the value is considerably greater. There has to be added to that figure the approximate amount of liabilities (comprising unpaid remuneration, redundancy costs and guaranteed bonuses) to be assumed by Santander in respect of employees in Malaysia, Hong Kong and Singapore which have an aggregate value of US$2,112,000. There is also an existing subordinated non-interest bearing loan of S$3 million advanced by Peregrine Securities Limited to PSS which is repayable on 10 June 2001. Santander is prepared to be substituted for PSS which will have the effect of giving the subordinated loan a present value of US$1.5 million. Accordingly, taking into account the value of the subordinated loan, the aggregate benefits to accrue for the general body of creditors if the proposed transaction with Santander is sanctioned is of the order of US$10 million.

21. It is relevant to mention that when the documentation was negotiated, it was envisaged that Santander would take 60 of the 97 employees of PSUK. Santander has indicated that another 12 will be taken thereby further reducing the redundancy costs.

The offers compared

23. The Provisional Liquidators have prepared a table which evaluates the Santander offer and the revised BNP offer in summary form. The table (which is in substance reproduced (without the notes) as Appendix II) itemizes the assets involved in each of the Santander and BNP bids. In respect of any item which either offeror was not interested in acquiring, there is a separate column giving its liquidation value. For each of the bids, there is thus a value shown for the value of that bid plus the liquidation value of assets not covered by the bid.

24. In comparing the value of the two bids, there is factored into the calculation BNP's assumption of the second and third tranches of the 1997 bonuses amounting to US$4,237,000. The so-called incentive bonuses described by Mr Mitchell as 'signing on' bonuses were originally PSUK's liability. Both Santander and BNP are willing to assume liability for incentive bonus payments, so the omission of this item from the table is not significant since the values are the same and would cancel each other out.

25. The table shows that the aggregate value of the Santander bid plus liquidation value exceeds the BNP bid plus liquidation value by some US$3.2 million. The difference is accounted for by the fact that the liquidation values of the assets which BNP does not wish to acquire have significantly reduced values or even no value on a liquidation basis. In particular, the counterparty receivables which BNP does not wish to acquire from the London operations have to be discounted by some 40% on liquidation vis-á-vis their book value because, by and large, these receivables are "stale", and cover relatively small amounts distributed amongst a large customer base. The view of the insolvency department of Price Waterhouse in London is that they should be discounted by some 50%. I have no reason to think that for liquidation purposes, the relevant discount applied is not appropriate. The other major difference is the value of the Singapore subsidiary. That subsidiary is technically insolvent. The Provisional Liquidators have been advised by their Singapore liquidation expert that PSS has a nil liquidation value whereas Santander is prepared to acquire PSS at its net asset value at closing which is estimated to be worth US$2.6 million.

26. In addition to the net difference in value stated above, the Provisional Liquidators have identified other values that ought to be added in order for a true view to be obtained. These are guaranteed bonus payments and redundancy costs of US$1.4 million in respect of Hong Kong employees if they were not to be employed by Santander and the assumption of guaranteed bonuses in respect of Singapore and Malaysian employees of US$660,000 and US$50,000 respectively. As noted above, although the present value of the subordinated loan (assuming Santander were to be substituted for PSS) is US$1.5 million, it has no value on liquidation.

27. It should be mentioned that although the New York business is shown as having a nil value because it is insolvent so that no dividend will be received, Santander will hire 17 employees from the New York office and assume liability for contractual bonuses of US$1.53 million. This benefit has not been factored into the calculation.

28. Aggregating the net difference with the value of the first three items (i.e. disregarding New York), the Santander offer plainly has the edge over the BNP offer : in monetary terms, it would yield some US$6.7 million more for the creditors.

Assets remaining in PSUK

29. To the extent that the assets are not being acquired by Santander, they remain with PSUK. They comprise the lease, the trading positions, the debtors, licences and cash. On liquidation, the trading positions and debtors are expected to yield about US$8 million. There is also a substantial cash balance available.

Clause 9.3

30. I now turn to clause 9.3 of the draft Agreement which was inserted at Santander's request. It reads as follows :

"Subject to Clauses 9.4 and 9.5, each of the Vendors and the Liquidators undertake to the Purchaser (for itself and for the benefit of the Singapore Companies, the Transferred Employees and the employees of the Singapore Companies), that they will not themselves bring, and will endeavour to procure that other Peregrine Group companies will not bring, any claims against any of the Singapore Companies, the Transferred Employees or the employees of any of the Singapore Companies (including, subject to paragraph 1 of Schedule IX, for any money owed) and that, in particular, they will not bring any claims against any of the UK Transferred Employees in relation to the decision to pay, or the payment of, any bonus to any employees prior to the date hereof." (emphasis added)

The concluding sentence of clause 9.3 apparently reflects a specific request made to Santander by the board of PSUK. The exception contained in clause 9.4 is confined to claims relating to any actual or alleged fraud whilst clause 9.5 reads :

"The Liquidators and the Vendors are only required to comply with Clause 9.3 to the extent that they are able to do so while also complying with relevant requirements and duties applicable to them under relevant laws."

31. The reasons for the court's refusal to sanction clause 9.3 as originally drafted appear below.

sLondon bonuses

33. As at 13 January 1998, the day the Provisional Liquidators were appointed, PSUK had 97 employees. Late on 29 January 1998, the board of PSUK informed the Provisional Liquidators' representatives in London that they intended to issue letters to employees the following day telling them what their bonus for 1997 would be. Despite being instructed not to do this by the Provisional Liquidators' representatives in London and similarly so instructed earlier on 30 January 1998 by the Provisional Liquidators' representatives in Hong Kong, the letters were issued. As appears from Mr Mitchell's affidavit, the end of year bonuses referred to in these letters were, in the main, discretionary bonuses. He refers to their being payable under the bonus letters in three equal tranches on 2 February, 16 February and 2 March respectively. However, according to the pro forma examples of the types of letters issued by the PSUK board exhibited to Mr Mitchell's affidavit, the payment dates are 2 February, 17 February and 27 February. Be that as it may, two of three instalments have already been paid and the third is either due today or early next week.

34. It would appear that two types of bonus letters were issued to employees by PSUK : the first type informed the recipient of the amount of bonus and that it would be payable on 3 February, 17 February and 27 February unless that employee's employment is terminated prior to any of the payment dates, in which event the recipient would not be entitled to receive any further bonus payment. The second type which was sent out to the majority of the employees contained an additional provision entitling the recipient to receive a further sum (i.e. the incentive bonus) upon the occurrence of a Triggering Event, that is to say upon the successful conclusion of a sale of PSUK's share capital or business. Each of the letters referred to the board's wish "to reward those who remain with [PSUK] over the next few weeks."

35. A schedule of the 1997 bonuses showing the amount of each payment as well as the amount of the incentive bonus, if any, was before the court. Each of the three payments constituting the 1997 bonus is of an equal amount. The incentive bonus, where payable, is also in respect of an identical amount as each of the three payments except in the case of four of the directors.

36. The Provisional Liquidators stress that they were throughout opposed to the payment of bonuses other than contractual or guaranteed bonuses. In particular, they strenuously deny the suggestion that the resolutions of the board of PSUK had "the full support of the Provisional Liquidators" as stated in a board minute of PSUK.

37. There does not appear to be any standard form of contract of employment for the employees of PSUK. Three broad categories have so far been identified, namely,

(1) those that provide for a guaranteed year end bonus with no provision for any other bonus payment;

(2) those that provide for an annual bonus to be paid at the discretion of PSUK with no provision for any other bonus payment;

(3) senior executive contracts that provide for a minimum guaranteed bonus in the first financial year of service together with an entitlement to participate in a bonus pool calculated by reference to net revenues generated from the area of business in which the employee is involved, such bonus pool to be divided between named key executives and other executives, with final allocations being determined by representatives of Peregrine Securities Limited.

The resolutions passed by the PSUK board were designed to 'crystallize' the discretionary bonuses. So far as the Provisional Liquidators are aware, only a small proportion of the bonuses can properly be described as contractual or guaranteed bonuses.

Events between 13 and 30 January 1998

39. The events as they unfolded leading up to the board resolutions are described below.

40. The Provisional Liquidators were appointed on 13 January 1998. The PSUK board acted with considerable alacrity in seeking and obtaining written advice from a leading city firm in relation to proposed payment of bonuses in relation to the year ended 30 November 1997. PSUK's solicitors were asked to identify the factors that the PSUK board "may properly take into account in resolving to make such payments in any event". The written advice was apparently distributed in draft to the board on 15 January. The directors were advised to consult a separate law firm regarding their own personal positions which was accepted and acted upon by the PSUK directors.

41. A meeting of the PSUK board was then convened for 23 January 1998 to discuss the issue of bonus payments. There is an unsigned copy of the minutes of this meeting from which it appears that in normal circumstances, bonuses would have been decided by early December. In fact the minutes refer to Mark Elswood, the Chairman of PSUK having recommended bonuses ("figure A+") for staff and directors in November. After discussion with Mr Jamieson, the Chief Executive Officer of Peregrine Brokerage Ltd., these were adjusted and a revised lower figure ("figure A") put forward to Mr Jamieson. In early December, Mr Jamieson suggested a lower figure ("figure B") to Mr Elswood for consideration. No consensus or final decision was ever reached, no doubt because of the predicament in which the Peregrine Group found itself at the end of 1997. 1997 was anything but a normal year for Peregrine and senior management could not have been oblivious of the looming disaster. The minutes state that all issues relating to bonus payments had been discussed with Price Waterhouse in London and in Hong Kong and that it was the board's view that the proposed bonus payments had the full support of the Provisional Liquidators. As noted above, the Provisional Liquidators take issue with this statement.

42. The PSUK board met again on 29 January 1998. The copy of the minutes of that meeting exhibited to Mr Mitchell's affidavit is unsigned and refers to extensive discussions on 28 and 29 January between Mr Elswood with PSUK's solicitor as to the proposed payment of bonuses and the 'sensitivity' in making those bonus payments. It also referred to the fact that the payments of bonuses to PSUK's staff and directors which had been agreed in principle on 23 January, entailed that overall payments amounted to approximately US$8 million (i.e. figure A) and not the amount of US$6.1 million (i.e. figure B) which was the amount of the bonus provision in the PSUK balance sheet. It was noted that the US$6.1 million was the balance sheet figure at the time of the provisional liquidation of the Company and that the figure had remained in the balance sheet in the financial information sent by PSUK to Hong Kong. The Chairman then proposed a bonus payment mechanism which was adopted by the meeting.

43. The purpose of the mechanism proposed was to create the impression that the bonus payments were in line with the figure in the accounts (viz. US$6.1 million) by withholding a quarter of the bonus otherwise payable to staff other than directors until the successful conclusion of a sale of the business or assets provided the employees/directors were still being employed at PSUK at that time. This mechanism thus 'reduced' the 1997 bonuses to US$6.354 million and was the genesis of the incentive bonuses. For the directors, the incentive bonus figure represented the difference, if any, between figure A and figure B. It was resolved unanimously, inter alia, that "in principle it would be in the best interests of [PSUK] to make the bonus payments" set out in the schedule to the unsigned minutes.

44. It is plain from these minutes that at the time the resolutions were passed, liability for the incentive bonus was that of PSUK and not of any prospective purchaser although, subsequently, in negotiations with Santander and BNP, both were willing to assume this liability.

Bonuses and profits

46. The aggregate amount of 1997 year end bonus the PSUK board saw fit to resolve to pay amounts to ￡3,962,451 (or US$6.354 million applying an exchange rate of USD1.6 = GPB1) whilst the aggregate incentive bonuses amount to ￡945,939 (or US$1,513,502). The total amount of bonuses resolved to be paid was therefore US$7.85 million. Although under the terms of the transaction Santander is assuming the liability for the incentive bonuses, in considering the propriety of the resolutions, the relevant amount must be the aggregate of the 1997 bonuses as well as the incentive bonuses in respect of which PSUK had rendered itself liable.

47. The relevant bonus payment board meetings were attended by the eight members of the board, each being a recipient of bonus payments. The aggregate bonus payments for directors including incentive bonuses amount to ￡2.338 million or US$3.74 million. This represents almost 50% of the total bonuses of US$7.85 million declared.

48. The minutes of the board meetings held on 23 and 29 January as well as the legal advice obtained on 15 January went to enormous lengths to 'justify' the bonus payments generally and, in particular, as regards each director individually, possibly with a view to discouraging any challenge to the legality or propriety of the board's actions. It is to be noted that in the case of one of the directors, the bonuses did not achieve their stated purpose. He resigned, presumably so as to head for greener pastures, after receiving the first tranche. So much for rewarding those remaining with PSUK over the few weeks of uncertainty.

49. The total profits of PSUK before bonus payments for the year ended 1997 are in the region of US$10 million. The year end and incentive bonuses taken together of US$7.85 million wipe out approximately 80% of those profits although, admittedly, US$1.5 million of that amount is only payable upon the successful conclusion of a sale of the business or assets. This might well be considered an improvement from the previous year when PSUK saw fit to declare bonuses of US$4.3 million out of total profits of US$4.8 million. So in 1996, almost 90% of the profits was creamed off for bonus payments when staff salaries were not in any sense nominal : they were US$6.5 million in 1996 and the annualized salary of PSUK staff for 1997 was US$8.3 million. What is certain is that the amount of bonuses declared (less the amount of guaranteed bonuses) must, correspondingly, diminish the amount ultimately available for distribution to the creditors.

The bonus resolutions

51. Directors are fiduciaries and owe a duty to the shareholders of the company to act bona fide in their best interests. But when a company is insolvent, it is the creditors' interests that are paramount. See West Mercia Safetyware Ltd. v. Dodd [1988] BCLC 250 at 252-253.

52. As PSUK is a wholly owned subsidiary of the Company, its shareholder is its parent i.e. the Company. Although PSUK is itself not insolvent, it is a wholly owned subsidiary of a parent that became insolvent. To follow the logic through, the insolvency of the parent must cast a whole new dimension on how the fiduciary duties of the PSUK board fall to be discharged since the relevant shareholders in that situation must mean the creditors. Certainly, the directors may not carry on as usual, as if nothing had befallen the parent company. As explained earlier, monies expended in the payment of bonuses other than contractual bonuses must necessarily be at the expense of the creditors.

53. The matters set out above (which are not findings of fact) appear to have the makings of a prima facie case of wrongdoing on the part of the directors of PSUK. Despite the carefully drawn minutes of the two board meetings of 23 and 29 January, they are certainly not conclusive of the bona fides of the directors of PSUK in declaring the bonuses. In that regard, I make two observations : first, the resolutions were wholly unnecessary so far as the payment of guaranteed bonuses is concerned; second, the very fact that the concluding part of clause 9.3 was added at the behest of the PSUK board is telling and betrays an underlying uneasiness which does not sit comfortably with a clear conscience.

The amendment to clause 9.3

55. Clause 9.3 as originally drawn is designed to tie the hands of the Provisional Liquidators and forestall any misfeasance proceedings that the facts, once fully investigated, may warrant. Put differently, this court is indirectly being asked to 'bless' conduct on the part of the directors of PSUK which, justifiably, may be considered outrageous. The request is as unmeritorious as it is bold : it is little short of an affront to the court and deserves to be rejected out of hand.

56. The revised form of proviso will enable the Provisional Liquidators to enquire further into the matter. They should seriously consider whether misfeasance proceedings are warranted.

57. As noted earlier, for the years 1996 and 1997, bonuses absorb as much as 90% and 80% respectively of the profits of PSUK for those years leaving precious little for the shareholders. These stark figures give the impression that PSUK's raison d'être is to generate profits in order to fund bonus payments to its employees. It is a remarkable state of affairs that substantially all of PSUK's profits (which are not insubstantial) should be applied in this fashion. The bonus issue may well merit further consideration by the Provisional Liquidators. They may also need to consider the duties of the main board of the Group. As the Company is a public company, its senior management are accountable to investors who, in the present case, are members of the public.

APPENDIX I

APPENDIX II

Comparison of Santander vs BNP Offers