LAM KWOK KAI v. ORIENT VENTURE INVESTMENT LTD AND ANOTHER

HCCW 419/2019

[2020] HKCFI 576

IN THE HIGH COURT OF THE

HONG KONG SPECIAL ADMINISTRATIVE REGION

COURT OF FIRST INSTANCE

COMPANIES WINDING-UP NO. 419 OF 2019

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R E A S O N S   F O R   D E C I S I O N

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A.   INTRODUCTION

A1.  The application

1.  By a summons of 17 March 2020 (“the Summons”), Orient Venture Investment Limited (“the Company”) has applied for a validation order under section 182 of the Companies (Winding Up and Miscellaneous Provisions) Ordinance, Cap.32 (“CO”).

2.  At the hearing on 30 March 2020, I made an order in terms of the Petitioner’s draft, with certain amendments. I now give my reasons for so doing.

A2.  The background

3.  The petition to wind up the Company on the “just and equitable” ground was presented on 31 December 2019 (“the Petition”). It concerns a shareholders’ dispute between the Petitioner (the President of the Company and a minority shareholder) and the 2nd Respondent.

4.  The Company is in the business of trading multi-layer ceramic capacitators (“MLCCs”). It owns a joint venture with Guangdong Fenghua Advanced Technology Holding Co Ltd (“Fenghua”) in Forward Electronics Technology Ltd (“Forward China”), which manufactured MLCCs (or at least it did until 2018, according to the Petitioner). The Petitioner says that prior to 2018, the Company managed the Forward China joint venture with Fenghua, sold MLCCs supplied by Forward China through Fenghua, and sold and distributed MLCCs supplied by the Johanson Group, a group of companies ultimately owned by members of the Johanson family, to various customers.

5.  The Petitioner complains of unfairly prejudicial conduct, alleging (inter alia) that the board of directors has transferred US$2.9m of the Company’s funds to Johanson Hong Kong Limited (“JHK”), a company controlled by Kurt William Johanson (“Johanson”), the sole director of the Company’s board, and Johanson’s families and relatives.

A3.  The scope of the validation order sought; the parties’ stances

6.  The Company sought a validation order in respect of:

6.1  expenses incurred in the ordinary course of business of the Company consisting of the categories set out in paragraph 1 of the Summons, with the proviso that the total of such payments or dispositions should not exceed HK6.5m in each calendar month (save for the expenses under paragraph 2 of the Summons);

6.2  the accounts payable of the Company as set out in KWJ-5, which includes amounts which have been paid by JHK on the Company’s behalf after the presentation of the Petition, and accounts payable incurred during the Company’s ordinary trade which have fallen due or will shortly fall due (see paragraph 2 of the Summons);

6.3  all reasonable legal expenses incurred by the Company in these proceedings and to comply with any validation order made (see paragraph 5 of the Summons).

7.  The Company offered to provide a regular schedule (“Monthly Schedule”) recording each payment made under paragraphs 1, 2 and 5 of the Summons, and the right to inspect supporting documents in respect of such payments within 5 clear working days from the receipt of the Monthly Schedule.

8.  By the time of the hearing, the parties’ differences had narrowed down such that the Petitioner accepted that the Company is currently solvent and did not oppose the grant of a validation order in, save that:

8.1  expenses under paragraph 1 of the Summons should be limited to HK$4m per calendar month, and insofar as the expenses were payable to JHK, they were first to be set off against the balance of the loans / prepayments made to JHK by the Company;

8.2  payments under paragraph 2 of the Summons should be set off against from the balance of the loans / prepayments made to JHK by the Company, and not from the Company’s bank accounts listed in paragraph 3 of the Summons;

8.3  payments under paragraph 5 of the Summons for legal expenses should be limited to HK$100,000 in total;

8.4  the time allowed for the Company to provide its Monthly Schedule should be reduced to 7 days from the end of each month;

8.5  the time for inspection of documents supporting the Monthly Schedule should not be limited, and the right to inspect should include the inspection of documents relating to the sales order(s) if any corresponding to the purchase orders from which the payments arise.

9.  The Official Receiver took a neutral stance in relation to the application, and helpfully referred to the principles in Re Emagist Entertainment Ltd [2012] 5 HKLRD 703 and Re Raising Engineering Ltd, unreported, HCCW 318/2014, 21 May 2015, Au-Yeung J.

B.   THE RELEVANT PRINCIPLES

10.  The principles set out in Re Burton & Deakin Ltd [1977] 1 WLR 390 at 397A to 398B have been applied and explained in Hong Kong in Emagist (supra), Re Raising Engineering Ltd (supra), Re Wah Ying Cheong Company Ltd, unreported, HCCW 225/1996, 14 March 2003, Kwan J (as she then was), Chan Mei Chun v K & A International Company Ltd, unreported, HCCW 317/2013, 27 November 2013, Anthony Chan J. For present purposes, the relevant principles are as follows.

10.1  The weight to be attached to the opposition of a contributory to an application for a validation order in the case of a solvent company is very different from the situation where a petition is presented on the ground of insolvency.

10.2  For a solvent company, the responsibility of managing the business of the company is entrusted by its articles of association to its directors. The court does not generally, save in the case of proven bad faith or other exceptional circumstances, interfere with the exercise of the discretion conferred on the directors by the articles of association at the instance of a shareholder. This does not change simply because a winding up petition has been presented. See Burton at 397A-C.

10.3  If on an application for a validation order for a particular disposition relating to a solvent company, (a) evidence is placed before the court showing that the directors consider that that particular disposition, falling within their powers under the company’s constitution, is necessary or expedient in the interests of the company, and (b) the reasons given for this opinion are reasons which the court considers that an intelligent and honest man could reasonably hold, it will in the exercise of its discretion normally sanction the disposition, notwithstanding the opposition of a contributory, unless the contributory adduces compelling evidence proving that the disposition is in fact likely to injure the company. See Burton at 397G-H.

10.4  It follows that one would normally expect a company to obtain without difficulty a validation order in respect of payment of expenses made in the ordinary course of business, once the court is satisfied that the company is solvent and has an active and ongoing business. The court would not be concerned to check with precision the nature and amount of the expenses. See Emagist at [5] to [6].

10.5  A practical way of alleviating any concerns of a petitioning shareholder may be to provide a regular summary to the petitioner of the expenses that are being paid by the company. See Emagist at [7].

10.6  The court will not allow the dispute and / or mistrust between the shareholders to prevail over the interest of the company or its creditors, or to allow the application for a validation order to be developed into satellite litigation. See Chan Mei Chun at [6].

11.  As for validation of legal expenses, where a company is a nominal party to a petition, but in substance the proceedings involve a dispute between shareholders, the company’s money should not be spent on disputes between shareholders save for proper costs incurred, for example, on giving discovery, on an application for a validation order, and such further costs as may be expedient and necessary in the interest of the company as a whole. See Re Wah Ying Cheong at [16].

12.  It should be borne in mind that the purpose of the court’s jurisdiction to grant validation orders is to preserve the value of assets of a company for the benefit of the people interested in the assets, notwithstanding the pendency of winding up proceedings, in order that the company might not be unduly hampered in carrying out transactions which might be for the benefit of those interested in the value of its assets. Thus where, for example, a company is not trading profitably, the court will have regard to whether the continued operation of the company’s bank account would be for the benefit of those interested in the value of the company’s assets. See Re A Company [1987] BCLC 200 at 202f-h, 205b-c; Harbour Front Limited v Money Facts Limited and others, unreported, HCCW 116/2015, 14 February 2017, Harris J.

13.  Mr Nicholas Oh (for the Petitioner) submitted, and Mr James Man (for the Company) did not disagree, that the veracity of the stated intentions or business plans of the directors of a company needs to be assessed against the objective evidence.

C.   THE ISSUES FOR DETERMINATION

C1.  Limit on monthly expenses

14.  The Company proposed that the validation of monthly expenses incurred in the ordinary course of business be capped at HK$6.5m, having regard to average monthly expenses of HK$4.26m in January and February 2020 and allowing for a degree of variance in the expenses.

15.  The Petitioner asked that the cap should be reduced to HK$4m, given that the Company’s calculation of average monthly expenses had wrongly included salary for Eric Johanson and John Johanson who were not in fact employees, and given the Company’s decrease in business subsequent to the termination of the Company’s right to distribute products of the Johanson Group, leaving JHK as the main or sole customer of the Company. The Petitioner further said that the claimed intention to build up the Company’s business in selling Forward China’s MLCCs to JHK is questionable, given that (a) Forward China is in fact no longer manufacturing MLCCs, (b) JHK could simply bypass the Company and place its orders directly with Fenghua, (c) the sales to JHK are at cost price (or near cost price), such sales are loss-making for the Company, and there has been no evidence put forward as to future orders which would require the Company to spend an additional HK$2.3m per month, (d) Forward China has in fact been wound up.[1]

16.  Even if the corrected figure for average monthly expenses is corrected to take out the wrongly-included salaries, this would not reduce the figure to below HK$4m. The principle reason for the dispute over the amount of the cap therefore related to the anticipated business volume for the Company.

17.  The Company said there is inevitably a certain degree of variance in expenses from month to month, and that it plans to continue to build up the business of selling Forward’s products to the Johanson Group. In response to the doubts raised by the Petitioner, it said that (a) Forward China is a certified manufacturer in China, and it is this certification which is recognised by the Company’s customers and JHK, regardless of whether the MLCCs are actually manufactured by Forward China, (b) it is not possible for JHK to order directly from Fenghua so as to bypass the Company altogether, as the Company is a majority owner of Forward China and would not allow Forward’s name or goodwill to be lent to such products, (c) whilst business volume dropped in February 2020, this was attributable to the outbreak of COVID-19, and the Company is restructuring its business, during which time there will be fluctuations in its purchasing and sales expenses, (d) the Forward China has not been wound up – the audit report relied on by the Petitioner does not refer to any winding up of Forward China.

18.  I did not agree that the monthly cap on the Company’s expenses should be set at HK$4m a month.

18.1  It is not disputed that the Company’s average monthly expenses incurred in the ordinary course of business in January and February 2020 exceeds HK$4m.

18.2  This is not a case where the Company is asking for validation of actual expenditure of HK$6.5m for any particular month, of which the Petitioner says that only HK$4m is justified. Rather, the Company is asking for validation of payment of expenses in the ordinary course of business, and accepts a monthly cap of HK$6.5m (but says that a cap of HK$4m would be insufficient). Whether the cap is HK$6.5m or HK4m should not affect the answer to the question of whether a particular item of expenditure has been properly incurred in the ordinary course of its business.

18.3  It is the view of the Company’s sole director that in order to cater for possible fluctuations in the Company’s expenditure, the cap on spending should be set at HK$6.5m. The director further states an intention to expand the Company’s business. Whilst the Petitioner has sought to cast doubt on the veracity or feasibility of the Company’s stated business plans (and hence the cap proposed by the Company), in my view, it cannot be said that the points put forward, when viewed in the light of the Company’s answers, provide compelling evidence that any proposed expenditure would likely injure the Company, or that there is bad faith on the part of the Company’s director. Nor is the court in a position to determine that the Company’s business is bound to shrink, such that its monthly expenditure will fall further to below HK$4m.

18.4  Unlike the situation in Re A Company, the Petitioner in the present case accepts that the Company should continue trading and should be paying expenses in the ordinary course of doing so; he is not saying that since the Company appears to be unprofitable it should cease operations altogether. There is an inherent contradiction in the Petitioner’s submission that the Company’s proposed business is not viable but that the Company should continue the business (provided that it does not spend more than HK$4m a month).

18.5  The Petitioner will be able to scrutinise the Company’s expenditure as the Company has agreed to give a Monthly Schedule setting out each payment, including information relating to the sales order, if any, corresponding to the purchase order giving rise to a payment, and the opportunity to inspect and take copies of supporting documents.

C2.  Set-off against loans or prepayments made by Company to JHK

19.  The Petitioner sought to impose a requirement that insofar as any amounts were payable to JHK (for example, for reimbursement of amounts which JHK has paid on the Company’s behalf after the presentation of the Petition), there should first be a set-off against amounts owed by JHK to the Company, so that only the net amount due to JHK should be validated. There was no suggestion that any such amounts should not be validated as not being properly due (other than by reason of the set-off claimed).

20.  The amounts which the Petitioner relied on as being owed by JHK to the Company include the US$2.9m which is the subject of the Petition. The Company said that certain amounts were lent to JHK on the understanding that they were long-term loans, and that the board of JHK, consisting of Johanson and two other persons, would not agree to a set-off.

21.  The Petitioner did not identify the legal basis on which the court should order that payments to JHK (of amounts which were not disputed as being properly due) should be made in this manner. It was proposed that the Company should be restricted from making any payment to JHK for debts owed to it, unless such payments represented an amount in excess of the amounts owed by JHK to the Company; if JHK wished to recover debts owed to it, it could sue the Company for them, at which point the Company could invoke a defence of set-off. It cannot be right for the court to make a validation order so as to effectively invite the Company’s creditor, with whom the Company has ongoing business dealings, to issue proceedings against the Company for failure to pay debts.

C3.  Legal expenses

22.  There was no dispute that the Company should be given a validation order in relation to costs of the validation order itself, or on giving discovery.[2] However, the Petitioner proposed a cap on such costs at HK$100,000.

23.  The Company’s stance was that the cap was unreasonable, given that the application for the validation order had already given rise to substantial costs, and there would be ongoing legal costs in complying with the validation order and with giving discovery.

24.  I considered it inappropriate to impose a cap as proposed, having regard to the principleas explained in Re Wah Ying Cheong at [16].

25.  Rather than seek to carry out some form of mini-taxation at this stage, I ordered the validation of payment of the Company’s reasonable legal expenses incurred in applying for and complying with the validation order and any order for discovery in these proceedings, following the principle in Re Wah Ying Cheong at [16].

C4.  Contents and timing of Monthly Schedules; inspection of supporting documents

26.  By the time of the hearing, the Company had agreed that the Monthly Schedules which it would provide to the Petitioner would include a record of the sales order(s) if any corresponding to the purchase orders giving rise to the Company’s payments.

27.  The Company had originally proposed that it be given 14 clear working days after the end of each calendar month for the preparation of the Monthly Schedule. The Petitioner asked that this be reduced to 7 days. The Company explained that 7 days was not realistic, that it would need to check its records against bank statements issued at the end of each month, that Johanson was stationed overseas and would need to review the schedule, and that at least 10 working days would be needed to compile the schedule each month.

28.  The Petitioner suggested that if there were mistakes in the Monthly Schedules discovered after checking against bank statements, these could always be corrected after delivery of the schedule.

29.  I see no reason to impose a time limit which is unrealistic and which may lead to the need to issue revised schedules, creating additional work and expense. The Company should provide its Monthly Schedules within 10 working days after the end of each month.

30.  As to the provision of the Monthly Schedules covering the period from 1 January 2020 to 31 March 2020, the Petitioner asked for this to be produced within 14 days from the date of the order. In view of the upcoming public holidays, the Company should provide the schedule within 14 working days.

31.  At the hearing, the Company agreed that the Petitioner could inspect and take copies of supporting documents upon receipt of the schedules.

C5.  Costs

32.  The parties agreed that I should order that the Company’s costs of the application for the validation order should be in the cause of the Petition.