RE COMPANION BUILDING MATERIAL (HOLDINGS) LTD.

HCMP4909/98

IN THE HIGH COURT OF THE

HONG KONG SPECIAL ADMINISTRATIVE REGION

COURT OF FIRST INSTANCE

MISCELLANEOUS PROCEEDINGS NO.4909 OF 1998

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J U D G M E N T

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1. This is a redomicile application by Companion Building Material (Holdings) Limited ("the Company"), a company incorporated in Hong Kong. The effect of the Scheme, if approved, would allow the Company which is a company incorporated in Hong Kong to be re-domiciled in Bermuda. A subsidiary purpose of the application is to reduce the nominal value of the shares in the holding company, an exempted company incorporated in Bermuda which would be held by shareholders should the redomicile be sanctioned. The shares of the Company have been trading below their nominal value. The Company seeks the sanction of a scheme of arrangement pursuant to section 166 of the Companies Ordinance and confirmation of the reduction of capital.

2. The Company and its subsidiaries (collectively "the Group" ) are principally engaged in investment holding, trading of ceramic tiles, marble and granite products, bathroom accessories, manufacture of ceramic tiles, trading of sundry building materials and provision of installation services for marble and granite products.

3. On 29 September 1998, Barnett J made an order authorizing the Company to convene a meeting of its shareholders to consider and if they saw fit to approve a scheme of arrangement which would effect the redomicile and at the same time reduce the nominal value of the shares to be held by the shareholders. The court convened meeting was held on 5 November 1999. It was attended (in person or by proxy) by 12 persons holding 163,213,564 shares out of 2,251,929,620 shares then in issue, representing 7.25% of the issued capital. Nine of those attending, together holding 99.61%, voted in favour. Only three, holding 0.39%, voted against.

4. In the letter dated 12 October 1998 from the Board to the shareholders which forms part of the Scheme Document, the following reasons were given for the redomicile :

" The Board believes that it is in the best interests of the Company and the Shareholders as a whole that the holding company of the Group be established in an offshore jurisdiction familiar to international investors with a view to enhancing the international standing of the Group. The proposed group structure, with a new holding company in Bermuda, will also allow the Group greater flexibility in formulating any future expansion plans which, if appropriate, may be carried out by overseas subsidiaries of the new holding company.

Bermuda has been chosen as the place of incorporation of the Group's intended holding company in view of its political stability, its common law legal system and its growing importance as an international centre with an increasing number of international companies incorporated there."

It would appear that the Board considered that the move would (1) enhance the international standing of the Group; and (2) allow the Group greater flexibility in formulating future expansion plans. But the Board never sought to explain to the shareholders the basis for its belief. Moreover, it is to be noted that the attributes which the directors considered Bermuda to possess, i.e. political stability, common law legal system, and growing importance as an international centre, are attributes which could equally well be said of Hong Kong.

5. The petition came on for hearing before me on 15 December 1998. At that hearing, the court invited leading counsel's attention to various matters considered in Betty Ho's recently published Public Companies and their Equity Securities in connection with the question of redomicile. As the Petitioner had not had the opportunity of considering those matters, the petition was adjourned sine die with liberty to restore. The Petitioner had indicated that it would address those issues by way of further written submissions which it did on 24 May 1999. Regrettably, due to the court's diary, the adjourned hearing could not take place until 1 November 1999.

6. Prior to making its further submissions, the Petitioner filed further evidence on 13 May 1999 in support of the petition. It would appear from the affirmation of Siu Yuk Chee, a director of the Petitioner, and also of Siu & Leung Enterprises Limited ("Enterprises"), the largest shareholder of the Company, holding approximately 25.64% of its issued capital, that it had apparently been the intention of Enterprises to vote its holding in favour of the Scheme as appears from page 4 of the Scheme Document. However, due to an administrative oversight, those shares were not in fact voted. Mr Siu has further deposed to the fact that the shareholders who attended the meeting and voted in favour of the Scheme are not related to any of the directors of the Company or Enterprises.

7. Apart from Mr Siu's affirmation, there is an affidavit of Rosemary Chen Peck Yee the purpose of which was to set out the advantages of Bermuda as an international, financial and business centre. It would appear that Bermuda is a jurisdiction of choice amongst most of the companies listed on the Stock Exchange of Hong Kong : as at the end of 1998, approximately 50% of the companies so listed were incorporated in Bermuda and less than one-third were incorporated in Hong Kong. Quite what significance is to be attached to this is not readily apparent since the reasons for the choice are not known.

8. In support of the submission that Bermuda is an international financial centre, various statistics were provided, for example, the number of exempted companies registered in Bermuda, the fact that Bermuda companies are listed on the major stock exchanges in the world etc. This information whilst material to Bermuda's position as an international financial centre does not make good the assertion that the Group's international standing would be "enhanced" by redomiciling in Bermuda. That feature would only be brought out by drawing a comparison between Bermuda and Hong Kong which that affidavit did not purport to do.

9. It is relevant to mention at this stage that at present the operations of the Group are based in Hong Kong and the PRC. Although the Company holds some foreign assets in the form of interests in subsidiaries and associated companies and carries on foreign business through its buying agent in Malta, such holdings and operations are currently relatively small. Given those facts, I accept that protection against possible expropriation in the future (which was the case in many of the redomicile schemes since 1984) is unlikely to be a purpose much less the predominant purpose of the Scheme. Therefore issues arising in connection with protection against expropriation need not be considered.

10. The second reason advanced for the redomiciling exercise is that it would allow the Group greater flexibility in formulating any future expansion plans. Foreign business would be carried out by overseas subsidiaries of the new holding company and foreign assets held by such subsidiaries. From the fiscal point of view, Bermuda exempted companies are not subject to any income, capital gains, company, profit, withholding or estate tax and there is no stamp duty on share transfers. Under the Exempted Undertakings Tax Protection Act 1966, the Bermuda government, upon application, may provide an assurance to exempted companies that ensures that the favourable tax regime applies to such exempted companies at least until 28 March 2016. Tax exemption assurances are apparently routinely given on application. However, so long as the operations of the Group remain in Hong Kong or the PRC, the Company will not benefit from these fiscal advantages. Equally it has to be said there are no fiscal disadvantages accruing on a redomicile.

11. It was suggested that shareholders could benefit from a saving of stamp duty. The benefit would appear to be more theoretical than real : first, the transfer has to be an off-market transfer; second, the shareholder has to apply to the Company's Hong Kong branch register to move the shares from the Hong Kong register to the Company's principal register in Bermuda and to effect the transfers through the Bermuda register; third, there is an element of uncertainty since it would be entirely a matter for the Company whether or not to approve the application; fourth, the costs involved (which will have to be borne by the transferor) would not make the application worthwhile save for very substantial transactions. For these reasons, redomicile would be tax neutral at least until such time as the operations are conducted offshore. There is no evidence as to when if at all this is likely to occur.

12. Miss Chen's affidavit also sought to extol the merits of the Bermudian Companies legislation in terms of flexibility at least in so far as capital raising is concerned. Court approval is not required for reductions of capital, purchase by a company of its own shares and financial assistance : rather, in lieu of court approval, a declaration of solvency by the directors suffices. Reliance was placed on the consultation document issued in February 1999 by the Company Law Review Steering Group appointed by the Department of Trade and Industry in the United Kingdom as endorsing or supporting the Bermudian approach. That may be an overstatement of the position. On a fair reading of the consultation document, the support appeared tentative. As regards purchase by a company of its own shares, the Steering Group considered it "premature" to make any recommendations on the topic although it would be likely to follow a path equivalent to the one described in the document for the reduction of capital for public companies. As regards financial assistance, whilst acknowledging that changes to the existing law should be made, the Steering Group merely expressed a tentative or provisional view that private companies (as distinct from public companies) be permitted to give assistance if approved, in general meeting, by the members of the company other than those who have a special interest in the outcome and preceded by a declaration of solvency. On the reduction of capital, the Steering Group expressed a provisional view to allow reductions by special resolution coupled with a declaration of solvency but in the case of public companies to allow creditors a reasonable time to object.

13. In any event, the views of the Steering Group however characterized are not conclusive. As to the merits of the solvency test replacing court approval, it should not be overlooked that while creditors would have reasonable protection from the risk of insolvency, there would not appear to be any protection for shareholders from selective reductions. Reductions which discriminate between shareholders would amount to a change of class rights requiring separate class meetings. Whether or not class meetings are required is often a difficult and contentious issue. Inasmuch as court scrutiny and/or adjudication on this issue is dispensed with, shareholder exposure would be that much greater. Whilst it is a matter for the shareholders whether or not they wish to assume that risk, it must first be drawn to their attention. That was not done. In short, the legal advantages said to accrue do not appear to be obvious.

14. No doubt from management's point of view, the Bermudian regime is much less restrictive of its powers and thus more flexible. The ease, for example, with which the domicile, residence, place of incorporation or corporate seats may be altered and capital raised may readily appeal to management. From the shareholders' perspective, it may not necessarily be an advantage given that far-reaching ramifications may flow from such changes (such as a reduction in the extent of regulatory protection), bearing in mind that the changes can be effected without their consent or despite their objection. Again, these consequence ought to have been disclosed and specifically drawn to the shareholders' attention. They were not.

15. Disclosure and fairness are the twin requirements in the just and equitable treatment of shareholders which is one of the criteria for court approval. See Ho on Public Companies and their Equity Securities 1998 Ed. at 15.3.4. Whilst I do not consider that the additional evidence substantiates the reasons for redomiciling given in the Board's letter, in particular, as regards 'enhancement', a shareholder may perhaps take a different view. However not only was the additional evidence not put before the shareholders for their consideration, there is also the fact that it was deficient in the respects mentioned above. Arguably, the consent given by the passing of the resolution at the court convened meeting was not informed consent, the disclosure made being insufficient.

16. In the circumstances, the options open to the court are :

(1) to dismiss the application altogether; or

(2) to exercise the court's discretion in favour of the Company notwithstanding the deficiencies.

17. Leading counsel for the Company submitted that even if there were deficiencies, they were not so serious as to warrant a dismissal or what would virtually be the equivalent if the Company had to start afresh by reconvening a shareholders' meeting. Costs of approximately $3 million have apparently already been expended.

18. As noted above, due to an oversight, the major shareholder did not attend or vote at the meeting which was only attended by shareholders holding 7.25% of the issued capital. The turnout was disappointingly low. The apathy to the issue of redomiciling is self-evident. It is reasonable to infer that the shareholders (other than the majority shareholder who did not attend) holding some 67% of the issued shares did not care about the outcome or they would have attended or voted. However those shareholders who did vote in favour of the resolution accepted the conclusory statements made in the Board's letter at face value. They raised no queries although the conclusory statements were unsubstantiated.

19. It is trite law that petitioners who fail to provide a full and adequate explanation to shareholders run the risk of having their applications dismissed. But dismissal is not automatic : the court still retains a discretion. How is that discretion to be exercised?

20. On one view of the matter, if shareholders were prepared to vote in favour of a resolution notwithstanding the absence of the factual basis for it, it is unlikely that the result would be any different were they now to be provided with the additional evidence and the risks referred to above drawn to their attention. In that sense, no harm appears to have been done. If the Company is to start afresh, another round of costs will have to be incurred which will fall on none other than the members themselves.

21. If the meeting were reconvened, the resolution is almost bound to be carried since it is reasonable to assume that the majority shareholder will not overlook attending and voting in favour of the resolution. Even if all or some of the shareholders who voted in favour on the last occasion were to change their minds in view of the disclosures made, it would not affect the outcome : they would be outvoted. There is also the fact that there is a valid subsidiary purpose (viz. to reduce the par value of the shares) to be achieved.

22. On these special facts, and not without considerable hesitation, I have reluctantly reached the conclusion that I should exercise my discretion to sanction the Scheme notwithstanding the deficiencies considered above and to confirm the reduction of capital.