In re HEATER INDUSTRIAL LTD.

1991, No. A5295

IN THE SUPREME COURT OF HONG KONG

HIGH COURT

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J U D G M E N T

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1. 3 Applications lie before me for determination. The 1st is made by the Applicants to strike out the 2nd Petition lodged by the Petitioners for payment of the amount demanded.

2. The 2nd is their application for what has been described as the consolidation of the 1st Petition and the High Court Action which was commenced by the Petitioners but which was struck out by the Applicants as being an abuse of process. The action proceeds by way of the counterclaim and it is common ground that at least some of the background to the issues being ventilated will be common to both the Petition and the action.

3. The 3rd Application is for the validation of legal expenses incurred by the Company in prosecuting the High Court Action.

4. There was at the commencement of the hearing a considerable measure of agreement between Mr. Reyes for the Applicants and Mr. Yuen for the Petitioners. Indeed it is right for me to express my appreciation to them both for the assistance they have given me in crystallising the outstanding issues between the respective parties.

5. On the 1st application Mr. Yuen accepted that there should be a stay of the 2nd Petition but he does not accept that it should be struck out. However, I am satisfied having regard to the provisions contained in Section 182 of The Companies Ordinance, Cap. 32 that it was an abuse of process for the Petitioners to lodge the 2nd Petition as it was clearly not open to the Company to comply with the demand made to them to effect the payment referred to. I therefore order that the 2nd Petition should be struck out.

6. I do not think that there was much difference between the parties on the so-called consolidation. I think that it is now agreed by both parties that the most satisfactory way of proceeding with the litigation is for me to order that the High Court Action and the Petition should be heard by the same Judge - the High Court Action being heard first and the Petition being heard immediately thereafter. I so order.

7. That leaves then the question of validation. Both Mr. Reyes and Mr. Yuen placed reliance upon the judgment of Hoffmann J. in Re Crossmore Electrical & Civil Engineering Ltd. (1989) 5 BCC 37 to determine this issue.

8. His Lordship's judgment is a short one and I propose citing it here in its entirety.

" Hoffmann J.: There are two petitions under the Companies Act pending against Crossmore Electrical and Civil Engineering Ltd.; One is a winding-up petition presented by a creditor, a company called MacFenn Haulage and Plant Co. Ltd.; the petition is based on a claim for money said to be owed as a result of trading transactions between the two companies. The second is a petition under sec. 459 of the Companies Act 1985 presented by Mr. Fenaci who is the holder of 49 per cent of the company's issued share capital and also the controlling director of the petitioning creditor in the creditor's petition. The sec. 459 petition seeks an order that Mr. Fenaci's shares be purchased either by the company or by Mr. McArthur.

Limited relief under sec. 127 was granted in July. Today's application is to extend that relief in the normal form to cover payments made into and out of the bank account in the ordinary course of the company's business over the hearing of the petitions.

Mr. Griffiths, who appears for the petitioning creditor, agrees in principle that such relief should be granted and the evidence of the company's financial state satisfies me that it should. I am however asked to clarify in advance one question which may be a matter of potential dispute as to whether payment of legal costs by the company would be in the ordinary course of its business for the purposes of the order.

The company is nominal party to the sec. 459 petition, but in substance the dispute is between the two shareholders. It is a general principle of company law that the company's money should not be expended on disputes between the shareholders; see Pickering v. Stephenson (1872) L.R. 14 Eq. 322. Consequently it seems to me clear that such expenditure on defending the sec. 459 petition would not be subject to a proviso which states that expressly. It is agreed that in order to cause no difficulty to the bank there should be a further provision that the bank is not to b concerned to enquire whether the money is being so spent or not and that there be liberty to apply to vary that proviso.

The more difficult question is the costs of the company in defending the creditor's petition. The defence is on the basis that the debt is disputed and what is said by Mr. Griffiths is that by virtue of Mr. Fenaci's control as petitioning creditor the dispute is also one which in substance is between the shareholders of the company.

In my view, however, the fact that the petitioning creditor is controlled by a shareholder is an accidental circumstance. The petitioning creditor presents itself in the character of a third party claiming a debt and must therefore be treated in the same way as any other creditor. In the case of an ordinary petition by some wholly unrelated creditor it would I think be in the ordinary course of the company's business for it to pay solicitors to defend itself against such a petition and therefore such payments should fall within the scope of a validation order under sec. 127.

Mr. Griffiths said that it was unjust that the company should be able to spend its money on defending itself against a creditor's petition. thereby potentially diminishing the amount which would be available for distribution to contributories on a winding up if it turned out that there was no substantial ground for the defence In such a case the court might be inclined on the hearing of the petition to make an order such as Brightman J. made in Re Bathampton Properties Ltd. [1976] 1 W.L.R. 168 in which some of the burden of such costs were shifted from the company to the true party interested, who in that case was a director and shareholder, and who had caused the company to expend its money on an unsustainable case.

In my view however the order under sec. 127 would in no way deprive the court of jurisdiction to deal with the costs in such a way on the hearing of the petition. The possibility of a Bathampton order would exist even if the petitioning creditor was an entirely unconnected party. I do not think that in such a case the court would exclude payment of costs from a sec. 127 order. That would in some cases have the effect of depriving the company of the ability to defend itself and thereby pre-empt the question of whether or not the defence was a good one. In principle, therefore, I think the exclusion should be confined to the costs of the sec. 459 petition and the proviso will be so drafted.

I will reserve today's costs to the hearing of the petition."

9. It seems to me that the question which has to be decided is whether the High Court Action relates simply to a dispute between shareholders or whether the action is intended to pursue some other purpose. In the former case validation is not appropriate as it would be wrong for a company to fund such disputes. In the latter case it is appropriate to validate such expenditure.

10. Mr. Reyes accepted that there would inevitably be a considerable amount of overlap in these proceedings. However, he submitted that the main purpose of the action was for the Company to recover from the Petitioners losses sustained as a consequence of the breach of their fiduciary duties to the Company. The fact that they also happened to be shareholders was merely incidental. As against this Mr. Yuen argued that it was necessary to take an overview of the litigation. If one did this it became readily apparent that this was in essence a dispute between shareholders and adopting the principles propounded by Hoffmann J. this expenditure should not be validated.

11. I have considered this matter carefully. I have come to the conclusion that Mr. Reyes is right. Although much of the background is common to both actions essentially this is a case where the Company is endeavouring to protect its own interests. This being the case I propose sanctioning the validation which is sought.

12. I will now hear the parties on costs.