WONGS INVESTMENT DEVELOPMENT HOLDINGS GROUP LTD (In Liquidation) v. CHINA KINGSTONE MINING HOLDINGS LTD AND ANOTHER

HCMP 1472/2015

IN THE HIGH COURT OF THE

HONG KONG SPECIAL ADMINISTRATIVE REGION

COURT OF FIRST INSTANCE

MISCELLANEOUS PROCEEDINGS NO 1472 OF 2015

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REASONS FOR DECISION
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1.  These are the reasons for my decision on 3 July 2015 to continue an urgent injunction I granted on 28 June 2015 against China Kingstone Mining Holdings Ltd (“China Kingstone”) and the underwriter Royal Moon International Ltd (“Royal Moon”), requiring in essence that the relevant shares in the open offer be allotted to the petitioner rather than to Royal Moon.

2.  The open offer of shares was proceeded with and closed following my rejection of an earlier application by the petitioner for an injunction to restrain the open offer on 19 June 2015, Friday.  The background to the open offer of shares is dealt with in the reasons for that decision which will be handed down at the same time as these reasons, and will not be repeated here.

3.  After it failed to obtain an injunction to put a stop to the open offer, the petitioner (acting by its liquidators) decided to subscribe for the new shares in full pursuant to the open offer and, on 22 June 2015 Monday, with the sanction given by the court in the petitioner’s liquidation (HCCW 332/2012), obtained a loan from a third party syndicate represented by Asian Capital (Resources) Limited (“Asian Capital”) for that purpose.  Prior to the deadline for acceptance (4 pm, 22 June 2015), the petitioner duly completed and sent to China Kingstone the form of application for the offer shares together with a cashier’s order for $61,346,313.80 to subscribe for 613,463,138 shares at $0.10 each.

4.  On 22 June 2015, however, a company called Red Victory Group Limited began to complain to the liquidators about their actions in obtaining the loan from Asian Capital to subscribe for shares.  On 23 June, Red Victory asked the liquidators to convene a creditors’ meeting to consider a resolution for their removal from office.

5.  Red Victory is a company that was keen to acquire a controlling interest in China Kingstone.  For that purpose, in April 2013 it took an assignment from a major creditor of the petitioner, namely, Bank of Communications, of the claims that the bank had against the petitioner.  As security, Red Victory made a reverse assignment to the bank, as a result of which Red Victory was at the material times an equitable assignee of certain debts owed by the petitioner to the bank.  In May 2013, Red Victory supported the appointment of the present liquidators in the liquidation of the petitioner.

6.  There was apparently some communication on the morning of 19 June 2015 regarding possible financing from Red Victory for the petitioner to subscribe for shares should it fail to obtain an injunction to stop the open offer, though no detailed terms of any offer had emerged from Red Victory at that stage.  The hearing of the application for injunction lasted until about 5 pm on 19 June with the result that the injunction sought to restrain the open offer was refused at the end.  On 20 June, Saturday, at 4 pm, the petitioner’s liquidators sent a letter to all known creditors and claimants of the petitioner inviting firm offers to fund the subscription for shares, with a deadline set on 9am 22 June, Monday.  Red Victory sent a letter by email to Bank of Communications copied to the liquidators at 8:31am on 22 June, in which Red Victory offered a loan with interest at 0.01% p.a. less than the rate of any loan obtainable by the liquidators from the market.  However, the liquidators said it did not come to their attention until around 10:30am after they had made an application to the court for sanction of their proposal to borrow from Asian Capital.  In fact, under s 199(2)(e) of the Companies (Winding Up and Miscellaneous Provisions) Ordinance (Cap 32), the liquidators had, without any need for the sanction of the court, the power to raise money on the security of the assets of the petitioner, including the shares it held in China Kingstone.  In any event, the liquidators considered that the terms offered by Red Victory, including the requirement that the petitioner must obtain Red Victory’s written consent before exercising its voting rights in respect of the shares, were unsatisfactory and unacceptable. 

7.  On 25 June, Red Victory took out a summons in the liquidation proceedings of the petitioner (ie HCCW 332/2012) pursuant to s 200(5) of the Companies (Winding Up and Miscellaneous Provisions) Ordinance, returnable on 4 August 2015 (with an estimate of 30 minutes), for, inter alia, a declaration that the liquidators’ actions were not in the best interests of the company (ie the petitioner), an order that the liquidators’ act or decision be reversed or modified as the court deems fit, an order that the liquidators’ act or decision in causing the petitioner to enter into the loan agreement with Asian Capital be reversed, an order that China Kingstone be restrained from issuing shares pursuant to the open offer to the petitioner, alternatively a declaration under s 276 of the same Ordinance that the liquidators are liable to make good the loss caused to the company by their misfeasance.

8.  Before that summons was served on the liquidators, on 26 June Friday at 6:08am, China Kingstone issued an announcement about that summons.

9.  At noon on 26 June, a board meeting of China Kingstone was held.  The minutes recorded that various documents including Red Victory’s letters of complaint and its summons were placed before the board and that the board considered that:

“if an order was made in favour of Red Victory according to the Summons, the liquidator’s act or decision in causing [the petitioner] to participate in the Open Offer shall be reversed or modified as the court deems fit and as a result thereof, the subscription of Offer Shares by [the petitioner] under the Open Offer may be reversed and the subscription money paid by [the petitioner] to the Company may be required to be returned to [the petitioner].”

10.  Later on the same day, at 10:54 pm, China Kingstone issued an announcement setting out the results of the open offer of shares.  In essence, it was stated:

(1) the board of China Kingstone had resolved to declare the petitioner’s application for offer shares invalid; and

(2) the shares which the petitioner had applied for had therefore been allotted to Royal Moon, as a result of which Royal Moon had become a substantial shareholder of China Kingstone;

(3) share certificates would be despatched by ordinary post on or before Monday, 29 June; and

(4) dealings in the offer shares, in the fully-paid form, were expected to commence on the Stock Exchange at 9:00 am on Tuesday, 30 June.

11.  The reasons stated in the announcement for declaring the petitioner’s application for shares invalid were that China Kingstone had received complaint from Red Victory and, in particular:

(1) Red Victory had asserted that the liquidators “might not have the power to subscribe for the relevant Offer Shares” and “through its solicitors requested the Board [of China Kingstone] not to allot and issue the relevant Offer Shares to [the petitioner]”.

(2) The Board considered that if an order were made in favour of Red Victory, the liquidators’ decision to participate in the Open Offer could be reversed.

(3) For that reason, the board resolved that the petitioner’s application was “invalid by the discretionary decision of the Board”.

12.  Remarkably, neither Red Victory nor China Kingstone sought any comment from the petitioner with regard to these matters. Nor did the board of China Kingstone seek any legal advice before deciding to do what they did.

13.  It was in those circumstances that the petitioner sought an urgent appointment with the court for an application for injunction to restrain China Kingstone from allotting to Royal Moon the new shares for which the petitioner had applied pursuant to the open offer.  I heard the application in the afternoon of 28 June, Sunday, on an ex parte on notice basis.  China Kingstone appeared by counsel who submitted a skeleton argument and a draft affirmation to oppose the application and so did Red Victory, although it was not clear it had any standing in these proceedings.  Despite having been served or notified, Royal Moon did not appear on 28 June.

14.  On 3 July, the return date, Mr Kenneth Chan, and with him Mr Billy Ma, appeared again on behalf of China Kingstone in opposition to the inter partes summons since taken out by the petitioner for the continuation of the injunction.  Red Victory had by letter sought to be excused from attending the hearing as it “has no direct interest in the unfair prejudice proceedings in HCMP 1472/2015”.  Royal Moon again did not appear.

15.  For the purposes of the interim application, the simple point seemed to me to be that there was at least a strongly arguable case that there was an offer of shares by China Kingstone and there was an acceptance by the petitioner.  There is no suggestion that there was any defect in the form of acceptance.  Prima facie, therefore, a binding contract had come into existence for the issue and allotment of the shares to the petitioner.  Mr Chan argued that the prospectus for the open offer was no more than an invitation to treat, and the shareholders’ application for shares pursuant to the open offer was in truth an offer, and that therefore no binding contract came into existence until the company decided to accept a shareholder’s application. 

16.  It seems to me that the legal nature of the open offer depends on the proper construction of its terms in the context of the relevant background.  The case of Alliance Holdings Ltd v Federal Commissioner of Taxation (1981) 37 ALR 430 relied upon by Mr Chan was quite a different case, concerning a company that had borrowed money from the public secured by debentures issued following invitations contained in prospectuses. There Woodward J took the view that the prospectus of itself was nothing more than an invitation to treat.  There was nothing in that case to suggest that there was a right for the recipients of the prospectuses to elect to take the debentures.

17.  The facts of the present case are in my view very different from Alliance Holdings Ltd.  It is not necessary for me to come to a final determination at this stage but it seems to me probable, as a matter of construction, that a binding contract arose upon acceptance of the open offer by the shareholders by submitting a valid application for shares.

18.  First, the prospectus defined the open offer to mean a proposed offer on the terms and subject to the conditions set out in the underwriting agreement and the prospectus documents.  It set a time as the “Latest Time for Acceptance” defined as the latest time for application for the offer shares.  It recognised that qualifying shareholders had “rights to subscribe” for shares under the open offer and informed them of the procedures to be followed if they wished to accept their “assured entitlement”.

19.  Secondly, the application form stated that a qualifying shareholder was “entitled” to apply for any number of offer shares equal to or less than his “assured allotment”.  It stated that valid applications for such number of offer shares below or equal to an applicant’s assured entitlement “will be given effect in full”.  China Kingstone expressly reserved the right to refuse an application that did not comply with the application procedures.  In contrast there was no general reservation of any power for the directors to refuse an application in their discretion.

20.  Thirdly, there is no dispute that this was not just any invitation to subscribe for securities but an “open offer” of shares. “Open offer” in this context is a term of art, which is dealt with in Rules 7.23 to 7.27 of the Listing Rules of the Stock Exchange.  In particular, Rule 7.23 states:

“An open offer is an offer to existing holders of securities to subscribe securities, whether or not in proportion to their existing holdings, which are not allotted to them on renounceable documents.” (emphasis added)

Rule 7.25 provides:

“Offers of securities by way of an open offer must remain open for acceptance for a minimum period of 10 business days.” (emphasis added)

21.  On this basis it seems to me strongly arguable that the open offer was an offer capable, upon acceptance, of giving rise to a binding contract, and that a shareholder’s entitlement under an open offer is a matter of legal right, not a benefit that might or might not be conferred on him depending on the directors’ discretion. 

22.  Mr Chan further argued that the entitlement of the petitioner as a shareholder to be allotted new shares pursuant to the open offer was subject to the articles of association of the company, in particular, Art. 12(1), which provides:

“Subject to the Law, these Articles, any direction that may be given by the Company in general meeting and, where applicable, the rules of any Designated Stock Exchange and without prejudice to any special rights or restrictions for the time being attached to any shares or any class of shares, the unissued shares of the Company (whether forming part of the original or any increased capital) shall be at the disposal of the Board, which may offer, allot, grant options over or otherwise dispose of them to such persons, at such times and for such consideration and upon such terms and conditions as the Board may in its absolute discretion determine but so that no shares shall be issued at a discount. Neither the Company nor the Board shall be obliged, when making or granting any allotment of, offer of, option over or disposal of shares, to make, or make available, any such allotment, offer, option or shares to Members or others with registered addresses in any particular territory or territories being a territory or territories where, in the absence of a registration statement or other specia1 formalities, this would or might, in the opinion of the Board, be unlawful or impracticable. Members affected as a result of the foregoing sentence shall not be, or be deemed to be, a separate class of members for any purpose whatsoever.”

He argued that pursuant to this article the board of directors of China Kingstone had a discretion, which they exercised, to refuse to allot shares to the petitioner.

23.  It is again unnecessary to come to a final conclusion on this but in my view it is difficult to see how Art. 12 was relevant. First, that article appears to be about other territories than Hong Kong where “in the absence of a registration statement or other specia1 formalities”, the allotment would or might, in the opinion of the board, be unlawful or impracticable. There is no suggestion that any difficulty had arisen for that reason.  The board had not demonstrated how an allotment of shares to the petitioner would be “impracticable” (Mr Chan had disclaimed reliance on illegality).  Finally and in any event, there is nothing to suggest that the board of directors in fact acted pursuant to and exercised any power under that article.  Mr Chan frankly admitted that he was not aware of the article until very recently.

24.  In my view, therefore, the court should proceed here on the basis that there was prima facie a contract in existence requiring China Kingstone to issue and allot 613,463,138 shares to the petitioner.  Those shares represented approximately 16.85% of the enlarged issued share capital of the company after the open offer.  As such, the contract was probably specifically enforceable, given the parcel of shares was “of such a size or nature that to acquire it elsewhere would involve undue difficulty or uncertain expenditure”: Spry, ‘The Principles of Equitable Remedies’, 9^th edition, 2014, p. 66; Able Success Asia Ltd v China Packaging Group Co Ltd & ors (HCA 1120/2014; 27 June 2014), §§30-32.  The shares in question accordingly arguably represented the property of the petitioner in equity.  Further, Mr Joffe submitted, and Mr Chan did not dispute, that given the petitioner’s status as a major shareholder holding over 30% of the capital of China Kingstone, it cannot acquire shares on the market representing more than 2% of the capital without triggering an obligation to make a general offer under the Takeover Code.  Irreparable loss could therefore be caused to the petitioner if the injunction was refused, which at least potentially could not be adequately compensated for in damages: Employees for whom Zhang Caikui held shares in China Shanshui Investment Co Ltd v Zhang Caikui (HCA 1661/2014; 20 May 2015), §31.

25.  It is true that the decision and exercise of power of the petitioner’s liquidators has since been challenged by Red Victory. The summons taken out by Red Victory on 25 June remains to be heard.  Still I cannot see how that could afford an excuse for China Kingstone not to allot shares to the petitioner.  Mr Chan urged that I should not grant the injunction, lest that Red Victory’s application under s 200(5) became nugatory.  It does not seem to me that the injunction would have that effect: Red Victory would still be free to pursue its application, including its prayer for a monetary restitutionary order.  Moreover, Red Victory had by letter on 30 June indicated to the petitioner that it was willing to lend money for the petitioner to repay the loan from Asian Capital. The effect of that would, presumably, be for Red Victory to be substituted as the lender and chargee of the shares.  It did not appear to me from Red Victory’s letter that it was at all against the petitioner’s subscription for shares as such.  Indeed I could not see any commercial reason why it  should be against it.  Nor could counsel (Mr Roland Lau and Mr P K Fung) who appeared for Red Victory on 28 June sensibly explain why their client (as a beneficial creditor of the petitioner) would want the petitioner’s shareholding in China Kingstone to be reduced from above 50% to around 33%.  Why Red Victory opposed the injunction application on 28 June remains a mystery.

26.  It is likewise a mystery why the board did not consult the petitioner before deciding to announce and make the open offer of shares (when they had consulted other substantial shareholders), and why they had now acted simply on Red Victory’s complaints without even asking the petitioner for comment before rejecting its application for shares.  To my mind, these matters which Mr Chan was unable to explain at all raise a real question as to whether the directors of China Kingstone were acting with a view to procuring the dilution of the shareholding of the petitioner.

27.  Further, the petitioner has given an undertaking not to dispose of or further encumber the new shares subscribed for pending the final determination of the petition.  Whether or not Red Victory’s application would ultimately succeed is not a matter for me in this application.  Suffice it for present purposes to note that there is a high threshold for a challenge of a bona fide exercise of power by a liquidator: Re Wickson Holdings Ltd [2011] 2 HKLRD 373, §19(d).  Conversely, to refuse the injunction would virtually mean proceeding on the assumption that, first, Red Victory would ask the court to undo the subscription for shares by the petitioner and, secondly, that such application would succeed.  If the injunction was refused and the shares were placed with Royal Moon, there was a real risk that the shares would be disposed of in the market, which it would be realistically impossible for the petitioner to recover.

28.  Mr Chan also submitted that as Royal Moon had been notified to underwrite the shares in question and had paid the full amount, granting the injunction would disturb the status quo.  I was unable to accept this argument.  According to China Kingstone, it was not the purpose of the open offer to dilute the petitioner’s shareholding.  The petitioner accepted the offer for the shares on 22 June.  Maintaining the status quo would mean allotting shares to the petitioner so that the proportionate shareholdings in China Kingstone were as little disturbed as possible.  The underwriting agreement required Royal Moon to take up shares not accepted by 4 pm on 22 June, but shares were regarded as having been “accepted” where the application form had been lodged together with the requisite remittance (see clauses 6.1 & 6.2).  Given the petitioner did send in a valid application form and a cashier’s order for the shares, it would appear that Royal Moon did not come under an obligation or acquire an entitlement to subscribe for the shares instead.

29.  Mr Chan also criticised the petitioner’s conduct in relation to its earlier application for injunction on 19 June.  In particular he alleged that the petitioner had improperly failed to disclose its plan to raise funds to subscribe for the shares and had instead simply asserted that the petitioner would be unable to take up the shares offered if the open offer was permitted to proceed.  The short answer, in my view, is that the petitioner had lost that application for injunction.  Its conduct there should not in my view affect the relief it now sought which must be judged on the merits of the present application.

30.  It is relevant to inquire, conversely, if the injunction was granted, what damage would be suffered by the respondents and whether such damage could be recompensed in damages: American Cyanamid Co v Ethicon Ltd [1975] AC 396, 408. Irrespective of whether the shares were allotted to the petitioner or to Royal Moon, China Kingstone would obtain the subscription monies.  The only damage that could be caused to China Kingstone, Mr Chan argued, was its potential liability to Royal Moon.  But, first, as stated above, the underwriting agreement did not entitle Royal Moon to take up any shares unless they were not “accepted” (in the sense defined) by the latest time for acceptance.  Secondly, there is no suggestion that China Kingstone’s potential exposure to Royal Moon could not be made good by money.  As for Royal Moon, despite having been served, it had not taken any step to oppose the application for injunction.

31.  Finally Mr Chan argued that since the shares held by the petitioner in China Kingstone had been pledged to Asian Capital, the petitioner would not be able to honour any cross-undertaking as to damages.  With respect, the argument was flawed.  The shares were pledged for a loan of $67.5 million.  That did not mean there was no remaining value in the equity.

32.  For the above reasons I made an order on 3 July continuing the injunctions granted on 28 June.

33.  I make an order nisi that China Kingstone do pay the petitioner forthwith the costs of and occasioned by the petitioner’s ex parte application and inter partes summons dated 30 June 2015 with a certificate for two counsel.