LEE PO WANG SAMSON v. EVER RISE ENGINEERING LTD

HCCW 714/2001

IN THE HIGH COURT OF THE

HONG KONG SPECIAL ADMINISTRATIVE REGION

COURT OF FIRST INSTANCE

COMPANIES (WINDING-UP) PROCEEDINGS NO. 714 OF 2001

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J U D G M E N T

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INTRODUCTION

1. This is a petition by a shareholder and creditor that the Company be wound up under section 177(1)(d) of the Companies Ordinance, Cap 32, on the ground that it was unable to pay its debt. The petitioning debt of $1.4 million arose out of two shareholder's loans advanced by the Petitioner to the Company in July 1997 and March 1998 and there is no dispute that it has not been repaid. The dispute is whether it was repayable at the time of service of the statutory demand.

2. The Company has a paid up capital of $1 million. It was acquired by Ms Lui, Mr Yu and Ms Lee in 1995. They held 500,000, 300,000 and 200,000 shares respectively. The main business of the Company was and is to provide building and engineering services in Hong Kong, Macau and China. It was and is effectively run by Ms Lui's husband, Mr Chan. In May 1996, Ms Lee sold her 200,000 shares to Chan who then became a director of the Company.

3. The Petitioner is a building services engineer. He came to know Chan in about 1993 through the introduction of Yu. He learned about Chan's business and the Company in 1995. In June 1996, the Petitioner, Chan and Yu discussed about the Petitioner acquiring 10% of the issued capital of the Company from Yu. Eventually in July 1997, Yu sold 100,000 shares to the Petitioner and assigned his shareholder's loan in the Company in the sum of $600,000 to the Petitioner ("the 1st Loan"). The Petitioner paid Yu $800,000. At the same time, the Petitioner was employed as the Company's project manager. In early March 1998, the Company was in financial difficulties. At the request of Chan, the Petitioner lent the Company $1 million. The Company repaid $200,000 to the Petitioner in December 1998, leaving an outstanding debt of $800,000 ("the 2nd Loan"). In May 1999, Yu sold the remaining of his 200,000 shares and assigned the balance of his shareholder's loan to Lui for a total sum of $1,545,000. The Petitioner was appointed as director in place of Yu. By that time, Chan and Lui together held 90% of the shares of the Company, with the remaining 10% held by the Petitioner.

4. The Company accumulated significant losses over the years but has been kept afloat by substantial loans made to the Company by its shareholders. Apart from the Petitioner, Chan, his wife and Boca International Limited ("Boca") which is a company controlled by them had advanced a total of about $8.3 million. Another business associate, Ms Hu, also lent the Company $2 million. Thus the total indebtedness of the Company from its shareholders amounted to $11.7 million. It had cash flow problems in 2000 and payment of the Petitioner's salary for April and May 2000 were delayed. His salary for November and December 2000 was not paid, while payment of his salary for January 2001 was deferred until the end of March 2001. On 19 May 2001, the Petitioner abruptly resigned as project manager and director of the Company with immediate effect. Three days later, he served a statutory demand on the Company in respect of the $1.4 million debt. He also instituted an action in the Labour Tribunal in respect of his outstanding salaries.

The issues

5. There is no dispute that the debt was owed to Petitioner and that the Company failed to comply with a statutory demand to pay the debt. The Respondent opposes the Petition on the ground that the loans are shareholder's loans and are not repayable on demand. It relies on the oral agreements or promises made between the Petitioner and Chan in June 1997 before the Petitioner acquired the shares in the Company and again in October 2000. It contends that Chan, his wife and Boca would not be calling in the shareholders' loans and in that sense the Company is able to pay its debts in the ordinary course of business. It further contends that the Company is engaged in seven building services and engineering contracts with an estimated total income of $19 million and works in progress worth $9.2 million and that it will be receiving huge amounts of payments within one and half years such that the Company will be able to repay significant portions of the shareholders' loans.

6. It is well established that a creditor whose debt is not disputed to be due and payable has the right ex debito justitiae to a winding up order: per Godfrey JA in Re Esquire (Electronics) Ltd [1996] 3 HKC 309 at 312. In considering whether to exercise its discretion to wind up a company, the court will have regard to: (1) whether there is any bona fide dispute to the petitioning debt on substantial grounds: Re Shenhua Sheng Yu Coal and Energy Corp. Ltd [2001] 2 HKLRD 452, (2) whether the Company is proved to be unable to pay its debts and (3) whether there are exceptional circumstances which will persuade the court not to make a winding up order on the petition of an unpaid creditor: Re Southard and Co. Ltd [1979] 1 WLR 1198.

7. Thus the issues in this case are: (1) whether the undisputed debt was due and payable, (2) whether the Company is proved to be unable to pay its debt and (3) whether there are exceptional circumstances which will persuade the Court not to make a winding up order.

WHETHER THE DEBT IS DUE AND PAYABLE

The 1st loan

8. According to the Petitioner's affirmation, when he negotiated for the purchase of the shares, Chan and Yu told him that the net worth of the Company was about $7 million. He paid $800,000 on 8 July 1997 for the shares which represented 10% of the net worth of the Company and a compensation of $100,000 for the loss of profits which Yu would otherwise have received if he had not sold the shares. But on 19 July 1997 when Chan asked him to execute the bought and sold notes for the shares, he was told for the first time that the issued capital of the Company was $1 million and hence the consideration for the shares to be transferred by Yu would be $100,000. Chan proposed that as he had already paid $800,000 for the shares, the Company would assign and transfer a loan in the sum of $600,000 advanced by Yu to the Company. As Chan told him that the loan was repayable on demand, he agreed to Chan's proposal.

9. I think what the Petitioner said is incredible to the extreme. If he had agreed with Yu to purchase his shares for $800,000 without any agreement as to assignment of the debt, there was no reason why the Company would on its own initiative transfer Yu's loan to him and no reason why Yu would allow the Company to do so. There must be some agreement as between him and Yu for the assignment of the debt. Look at the situation from another angle, he said he had agreed to purchase the shares for $800,000 and paid Yu $800,000 for 10% of the issued shares of the Company. What turned out was, according to him, he obtained the 10% of the issued shares he bargained for plus a loan repayable on demand. If what he said were true, he could immediately demand repayment and in effect obtain his shares at one quarter of the agreed price. His account, at least to the extent that the loan is repayable on demand, is inherently incredible.

10. On the other hand, according to Chan's affirmation, he, Yu and the Petitioner had discussed on various occasions the business and potential of the Company. Chan made known to the Petitioner that since early 1997, he and his wife and Yu had lent money to the Company because the Company was having more and more projects in hand and he anticipated that all shareholders might be required to continue to lend money to the Company and the Company would make partial repayments from time to time. He told the Petitioner that Yu had lent $1,545,000 to the Company. The Petitioner said he was glad to learn that the Company was having more and more projects and assured him that should he become a shareholder of the Company, he would lend money roughly in proportion to his shareholding in the Company to finance its business. It was upon that assurance, Chan and his wife approved the transfer of Yu's 100,000 shares to the Petitioner at a directors meeting on 16 July 1997. On about the same day, Yu informed Chan that the Petitioner would purchase $600,000 of the debts owing to him by the Company. Chan then effected the necessary entries in the shareholders loan account.

11. I consider Chan's account credible. This is a private company and transfer of shares require approval by the directors. It is incredible that the assignment of the debt had not been discussed. At the time, the shareholders' loan stood at $2,548,000. Shareholders' loan constituted 72% of the Company's working capital. It is incredible that such a significant assignment of debt would not have been discussed between the Petitioner, Yu and the Company represented by Chan. It is even more incredible that Chan would have told the Petitioner that this significant debt assigned could be withdrawn on demand as the Petitioner would have me to believe. Looking at the reality of the situation, not only that he has never made any demand for repayment until 19 May 2001 when he left the Company, he lent the Company another $1 million ten months after he joined the Company. These are consistent with Chan's evidence that the Petitioner joined the Company on the understanding that shareholders would be required to provide working capital for the Company by way of shareholders' loan and inconsistent with the Petitioner's evidence that the debt assigned was repayable on demand.

The second loan

12. According to the Petitioner, on or about 9 March 1998, Chan told him that the Company was in financial difficulties and requested him to lend money to the Company at an interest rate of 1% per month. Chan assured him that the loan would be repaid within a very short time, in any event, not more than two months. He lent the Company $1 million by drawing on his overdraft facility with Po Sang Bank Ltd. When the loan was not repaid after two months, he demanded repayment. Chan suggested that in view of the financial difficulties of the Company, all shareholders should advance loans to the Company in proportion to their shareholdings. He rejected Chan's suggestion outright. Upon repeated demands, the Company repaid him $200,000.

13. Chan disputed that this second loan was made in circumstances as alleged by the Petitioner. He said that it was made pursuant to the agreement and mutual understanding or promise reached between the Petitioner and himself that shareholders are required to lend money to the Company to provide for its working capital. At the time when the Petitioner lent the Company this $1 million, Chan and his wife had also lent the Company almost $2 million. Between then and 22 December 1998, Chan granted further loans to the Company totalling $4,138,187 but was repaid $378,037. Yu also advanced another $300,000. All these are consistent with their agreement that the shareholders would lend money to the Company roughly in proportion to their shareholdings.

14. Chan denied that the repayment of $200,000 to the Petitioner was made as a result of the Petitioner's repeated demands but because the Company received a substantial payment before Christmas and hence it repaid part of the loan to the Petitioner as well as to Chan. Indeed the Company's shareholders' loan account shows that on the same day, the Company repaid Chan $760,000 when it repaid the Petitioner $200,000. Again, this is consistent with the arrangement as alleged by Chan. On the other hand, there was a total lack of contemporaneous documents from the Petitioner for a period of more than three years in support of any demand for repayment of what the Petitioner alleged to be a short term loan.

Nature of the loans

15. From the above analysis, it is highly credible that the Petitioner and Chan had an agreement or understanding that the shareholders are required to lend money to the Company to provide for its working capital. Indeed in the case of Yu's loan, it was not fully repaid until he sold the balance of his shares to Chan's wife, when his outstanding loan was assigned to her.

16. Miss Chan refers to French, Applications to Wind up Companies, para. 6.3.1 and submits that debts due to members of the company must be taken into account in considering whether the company is proved to be unable to pay its debts. I have no doubt that this is a correct proposition of the law. However, the point now in issue is not merely that the debt is a shareholder's loan but that because of the terms of the loan it is not repayable on demand, i.e. it is not due and payable.

17. Looking at the reality of the situation, the Company is a three members company with a paid up capital of $1 million. Its turnover in 1998, 1999 and 2000 were $37.5 million, $20.2 million and $14.7 million respectively. Given the nature and size of its operation as a building services and engineering company, its paid up capital is unrealistic. It can readily be inferred that shareholders' loan must form a significant part of its working capital. These are not ordinary loans but are in reality working capital for the Company. Working capital is not liquid cash and would usually be tied down as assets in various forms. In the case of the Company, it may be tied down as work in progress or as security deposits paid under engineering contracts. Even in the absence of express agreement, it can readily be inferred that loans advanced as working capital are not repayable on demand. Hence, Chan's evidence that when the Petitioner acquired the shares and was assigned the loan of $600,000, he knew and agreed with Chan that the loan was to provide working capital for the Company and was not repayable on demand but as and when the Company was able to pay is highly credible and accords with business sense. It is also credible that he agreed to provide similar loans. In my view there is a bona fide dispute on substantial grounds as to whether the debt is not due and payable at the time of service of the statutory demand.

18. Much has been said by Miss Chan that the agreement, if there was one, was made between the Petitioner and Chan as shareholder and the Company cannot acquire any right or be subject to any liability arising under a contract to which it is not a party. Mr Tam refers to Snelling v John G Snelling Ltd and Others [1973] 1 QB 87 where it was held that though the company was a stranger to the contract and was not entitled to rely on the terms thereof in their defence to an action by the plaintiff, nevertheless, where all the parties to the contract, including the company, were before the court, the proper order to make in the action by the plaintiff against the company was not to stay the plaintiff's proceedings against the company, but to dismiss his claim, for the reality of the matter was that the plaintiff's claim had failed and the order of the court ought to reflect that fact. Miss Chan ably distinguishes Snelling v John G Snelling Ltd and Others from the present case in that Chan, a party to the contract, has not opposed the petition and therefore not all the parties to the contract are now before the court. I think she is right. This is not an appropriate case to apply the principle in Snelling.

19. However, neither Miss Chan nor Mr Tam seized the significance that Chan was a director of the Company and was liaising with the Petitioner about the transfer of Yu's shares to the Petitioner in his representative capacity as a director of the Company. The Company is a private company in which the right to transfer shares is restricted. As Chan said in his affirmation, it was on the basis of the Petitioner's assurance that he would lend money to the Company so as to finance its business that he and his wife approved the transfer of shares. Chan and his wife must have approved the transfer in their capacity as directors of the Company and not in their personal capacity as shareholders. Thus it could be reasonably argued that the agreement is not an agreement between shareholders, but an agreement between the Petitioner and the Company.

20. On the evidence of Chan, I am satisfied that the Company has a credible defence and a bona fide dispute on substantial grounds as to whether the debt is due and payable on the date of service of the statutory demand.

Other issues

21. In view of my above conclusion, I do not think it necessary to consider if the Company was solvent. Even if it were not, the general rule is that a bona fide disputed debt may not be the basis of a creditor's petition: Re S Zhong Shan International Investments Co Ltd [1990] 1 HKC 90. There are no special circumstances to justify a departure from this general rule. Indeed all the circumstances point in favour of refusing the petition. The debt is a shareholder's loan of the nature of working capital of the Company. The majority shareholders have been advancing a much more significant amount in keeping the Company afloat and will not be calling in the loan. The Company is about to receive substantial payments from its various projects which will pay off the debts of its ordinary creditors. Not only that the ordinary creditors will not be prejudiced, but in fact they will be benefited by the Company continuing with its business. There is also no prejudice to the Petitioner as shareholders' loans are deferred loans whose repayment ranks after the repayment to other creditors, even unsecured creditors. Such working capital would have been spent in discharging its liabilities in the usual course of business of the company or transformed into assets of different forms, such as work-in-progress or receivables. Funds may not be readily available to meet repayment on demand. Thus even in the absence of any agreement as alleged by Chan as regards deferred repayment, the Court's discretion would be exercised against granting of a winding up order.

22. There is a dispute about an agreement in respect of the deferring payment of salaries due to the Petitioner. That is irrelevant as the petitioning debt relates solely to the $1.4 million advanced by the Petitioner to the Company.

CONCLUSION

23. There is no dispute that the Company owed the Petitioner a debt of $1.4 million. The debt is a shareholder's loan and on the facts of the case is of the nature of working capital. The Petitioner abruptly resigned as project manager and director of the Company without notice on 19 May 2001. Instead of formally demanding repayment or instituting proceedings for recovery of the debt, the Petitioner issued a statutory demand. He was informed that the Company disputed as to whether the debt was due and payable at the time the statutory demand was served on the Company. In fact Chan has instituted an action under HCA3769 of 2001 against the Petitioner seeking specific performance of the loan agreement. Having come to the conclusion that the Company has a credible defence and bona fide dispute to the petitioning debt on substantial grounds, the petition must be dismissed with costs.