GENG HUA ZHONG AND ANOTHER v. LI SHU HON AND ANOTHER

HCCW 403/2017

[2019] HKCFI 1374

IN THE HIGH COURT OF THE

HONG KONG SPECIAL ADMINISTRATIVE REGION

COURT OF FIRST INSTANCE

COMPANIES (WINDING-UP) PROCEEDINGS NO 403 OF 2017

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D E C I S I O N

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1.  This was an application by Li Shu Hon (“the 1^st respondent”) by summons dated 1 February 2019 to strike out the winding up relief in the Amended Petition dated 15 March 2018 (“the petition”). At the conclusion of the hearing, the Decision was reserved which I now give.

BACKGROUND FACTS

2.  The facts set out below are gleaned from the petition and the affidavits filed in support. In an application (such as the present) for the striking out of winding up relief from the petition, it is well-settled that the court proceeds on the basis that the particulars and allegations of the petition would be established.

3.  The 2^nd respondent (“the Company”) was incorporated in 2001 as a quasi-partnership between Li Jin Wen (“Vito”) and the 1^st respondent and would be operated as such.  Vito held 60% of the issued shares and the 1^st respondent remaining 40%.

4.  The Company trades in medical devices and electronic components through its PRC subsidiaries (“the PRC subsidiaries”) which amongst others included T-Hero Industrial Co Limited SZ (“T-Hero SZ”), and T-Bon Medical Technologies Co Limited (“T-Bon”).

5.  By about 28/29 March 2007, Vito and the 1^st respondent agreed to treat their respective shareholdings in the company as 40.5% and 39.5% respectively so as to accommodate the participation in the business of Geng Hua Zhong (“the 1^st petitioner”) and Li Jin Hu (“the 2^nd petitioner”) (collectively “the petitioners”)  (employees involved in the management and operation of the PRC subsidiaries) as shareholders, such that the 1^stpetitionerand the 2^ndpetitioner respectively would have 15% and 5% beneficial interest in Company.

6.  It was agreed and understood by Vito, the petitioners and the 1^st respondent (collectively “the Shareholders”) that, inter alia, (a) the petitioners (and Vito) would be responsible for the day-to-day management of the PRC subsidiaries and the 1^st respondent would be responsible for the day-to-day management of the Company; (b) all information (including financial information) related to the Company and the PRC subsidiaries should be disclosed to all the Shareholders; (c) any transfer by a Shareholder to a third party required the prior unanimous consent of all the Shareholders; and (d) the Company would establish an office in Hong Kong (“the Shareholders’Agreement”). 

7.  There was an “Implied Understanding and Agreement” between the Shareholders and forming its substratum that (i) the Company which was incorporated as a quasi-partnership between the 1^st respondent and Vito  would be operated as such; (ii) the modus operandi and underlying ownership of the Company and the PRC subsidiaries (collectively “the Group”) would remain unchanged, with all the Shareholders being entitled (a) to participate in the management and affairs of the Group and consulted in advance of all major decisions, and (b) to all information of the Company and the PRC subsidiaries.

8.  For present purposes, the expression “the 2007 Understanding and Agreement” is a collective reference to all the matters set out in §§6 – 7 above.

9.  Vito acted as chairman of the Group; the 1^st respondent was appointed managing director of the Group as well as a director of the Company;the 1^st petitioner served as CEO of the Group’s electronic devices business carried on through some of the PRC subsidiaries whilst the 2^nd petitioner served as CEO of the medical devices business carried on through T-Bon. 

10.  Subsequent to the Shareholders’ Agreement, the parties were advised that under relevant PRC law and regulations, shareholders residing in the PRC, namely, Vito and the petitioners could not be seen to be involved in the management of T-Hero SZ (an entity to be acquired by the Company) and the Company (the entity acquiring T-Hero SZ) at the same time.  As a result, Vito resigned from the Company and transferred his shares in the Company to the 1^st respondent’s wife to be held on trust for him absolutely.  The petitioners did likewise on 28 February 2011.  

11.  The 1^st respondent’s misconduct about which the petitioners complain commenced in early 2011, several years after Vito’s resignation. Their complaints are pleaded in detail in section D of the petition (§§32 to 82).  In summary, the complaints concern conduct on the part of the 1^st respondent in the management and operation of the Group that showed a serious lack of probity and/or was in flagrant breach of the 2007 Understanding and Agreement.

12.  Specifically, the 1^st respondent:

(i)  used duress to cause an allotment to be made in 2012 that gave him control of the Company;

(ii)  grossly mismanaged the Company by (a) refusing to borrow for the Group when it required financing during the downturn in the manufacture of electronic devices at the end of 2010/early 2011;(b) refusing to allow the petitioners and Vito access to financial information of the Company; and (c) unreasonably refusing a Group financial management committee proposal in early 2012;

(iii)  unreasonably caused a strike at the Hong Kong office in August 2012;

(iv)  excluded Vito from the management of the Group;

(v)  unreasonably obstructed the audit of the financial statements of the PRC subsidiaries post-2013;

(vi)  excluded the 1^stpetitioner from the management of the Group in February 2015;

(vii)  unreasonably delayed the Company’s EGM in 2015; and

(viii)  refused to and/or delayed in returning the shares of Vito, and the petitioners in the Company to them respectively.

13.  The 1^st respondent’s refusal to honour the 2007 Understanding and Agreement resulted in complete deadlock in the business and affairs of the Group.

14.  The petitioners seek the following relief: (1) an order setting aside the allotment; (2) a winding up order on the just and equitable ground within section 177(1)(f) of the Companies (Winding Up and Miscellaneous Provisions) Ordinance, Cap 32; and (3) alternatively, that the 1^st respondent buyout the 15% shareholding and 5% shareholding of the 1^st petitioner and the 2^nd petitioner in the Company respectively; and (4) such other relief as the court sees fit.

THE APPLICABLE LEGAL PRINCIPLES

15.  The principles are well-settled and it is common ground that they are conveniently stated in Re Raising Engineering Ltd [2015] 5 HKLRD 22 at §§6 – 7.  In summary:

(a)  In assessing an application to strike out winding up relief as an alternative: 

(i)  it is assumed that the petitioner’s allegations are made out;  

(ii)  it is only in plain and obvious cases that the court should strike out the winding up relief sought; and

(iii)  the burden is on the applicant to show that it is plain and obvious that petition for winding up would fail because the petitioner is acting unreasonably in not pursuing that other remedy.

(b)  The court will only grant a winding up order rather than buyout relief if there is good reason to do so.  Accordingly, the petitioner must be able to point to particular matters that might make a winding up order the appropriate relief and state in the petition the grounds supporting such relief.

THE SUMMONS TO STRIKE OUT

16.  Mr Maurellet SC who appeared for the 1^st respondent submitted that this is a clear case for the court to strike out the winding up relief sought because all that the petitioners are after is nothing more than a buyout.  He referred to the pre-action letter from the petitioners’ solicitors (“SH”) dated 22 December 2016, submitting that it supported such a reading and drawing attention to the fact that there was no suggestion made in the letter of misappropriation by the 1^st respondent or that anything needed to be investigated which could justify a winding up order.   

17.  There is also the fact that the petitioners acknowledged in §88 of the petition that the Company is solvent and trading.  The allegations made are essentially about unfairly prejudicial conduct on the part of the 1^st respondent in the management and conduct of the Company’s affairs. It was submitted that the petitioners should have sought section 724 relief instead.  

18.  In the petition, the only reason advanced for a winding up order was limited to a query as to whether the 1^st respondent had sufficient means to buy-out the petitioners’ shareholding.  It was said that no other reason or justification for claiming winding up relief was pleaded.

19.  In summary, it would appear that the grounds for the present strike-out summons appear to be the following: the only relief the petitioners are genuinely after is a buyout; the complaints if made out constitute unfairly prejudicial conduct that warrant relief under section 724 and not a winding up order; in any event, the petitioners have failed to identify the particular reason for seeking a winding up order in the alternative.

(A)   Whether a buyout order is the real objective of the petition

20.  The thrust of the submission is that it is clear from the tenor of the pre-action letter (see §16 above) that what the petitioners were genuinely after was a buyout offer.  The fact that the petitioners asked for a buyout meant that they considered it feasible.  There was no suggestion that anything needed to be investigated. 

21.  A year after the pre-action letter, the petition was filed for winding up on the just and equitable ground.  The 1^st respondent highlighted the fact that the petitioners have not explained the change in circumstances during that year rendering a winding up order necessary.

22.  Mr John Hui who appeared for the petitioners proffered a different reading of the 8-page pre-action letter that at the outset stated two principal grounds relied on for relief: namely, (1) a total breakdown in mutual trust and confidence between Vito and the petitioners on the one hand and the 1^st respondent on the other, and (2) the affairs of the Company have been conducted by the 1^st respondent in a manner that was unfairly prejudicial to Vito and the petitioners. 

23.  The pre-action letter went on to describe the matters underpinning those allegations in some detail.  Winding-up relief was specifically sought although the opportunity for the 1^st respondent to make a reasonable offer to buy out was offered to avoid litigation that would otherwise ensue.  For the purpose of assessing a reasonable price, a request was made for the 1^st respondent to provide financial information including consolidated audited financial reports of the Company as well as the consolidated management accounts for the previous four years.

24.  In my view, the pre-action letter is inconclusive as it is capable of being read either way. To surmise or infer the petitioners’ real intention from that letter is not a useful exercise.  

25.  On the question of change of circumstances between the date of the pre-action letter and the presentation of the petition, it is to be noted that SH received a substantive reply (of no less than 17 pages) in mid-February 2017.  While it was accepted that trust and confidence between the two camps of shareholders had completely broken down, the 1^st respondent rejected the allegation that he was responsible for such breakdown. Rather, he countered by alleging (with considerable detail) that it was caused by breaches of fiduciary duties and illegal conduct on the part of the petitioners and Vito.  The reply undoubtedly generated much hostility, but no buyout offer was forthcoming.  Nor was the requested financial information provided.

26.  In those circumstances, the “no change in circumstances” characterisation in the intervening 12 months between the pre-action letter and the petition would not appear to be accurate.  For one thing, the 1^st respondent made clear that it was certainly not taking up the buyout offer unless compelled to do so by the court.

27.  It would be convenient at this point to consider the financial ability ground that is accepted was pleaded in the petition before turning to the need for investigation issue.

(B)   The 1^st respondent’s financial ability for a buy-out

28.  According to the latest audited reports[1] of the Company and the PRC subsidiaries, the combined net asset value of the Group is approximately HK$110 million.  For the purposes of the buyout, the parties proceeded on the basis that the combined shareholding of the petitioners and Vito amount to 60.5%.  On that basis, the potential price payable by the 1^st petitioner would be HK$66.55 million.

29.  The 1^st respondent disclosed the following assets as regards his financial means: (i) three flats (which he jointly owns with his wife) with a combined net value (after deducting outstanding mortgage amounts and outstanding charges) of HK$44 million; (ii) a fixed deposit of US$170,000 (or approximately HK$1.3 million); and (iii) overdraft facilities from the Standard Chartered Bank (“SCB”) of up to HK$23 million.

30.  The 1^st respondent’s wife is apparently agreeable not only to a sale of the flats but also to the application of her share of the proceeds towards the buyout.  In those circumstances, it was said that the aggregate value of available assets for the buyout exceeded the sum of HK$66.55 million.

31.  The petitioners invited a closer attention to the line of credit of HK$23 million said to be available to the 1^st respondent.  The SCB letter dated 27 April 2019 (“the facility”) is exhibit LSH-17 to the 1^st respondent’s 3^rd affirmation.

32.  The facility was given in relation to an overdraft account.  HK$23 million is the maximum line limit or overdraft amount permitted under the facility.  It is to be noted that the amount “is determined by the Bank from time to time”.

33.  In pertinent part, the facility provided as follows:

“ The Current Line Limit of the Facility shall be adjusted according to the market value of and the respective Lending ratio relating to the eligible collateral …

The Bank reserves the right to at any time review, reduce or otherwise vary the Maximum Line Limit, the Current Line Limit, the Lending ratios …

1) The Bank requires a charge on assets in the accounts below as security for the Facility

Investment Fund Account …

Deposit Accounts …

2) Other security as described in the Memorandum of Charge On Assets”

34.  In view of those provisions, the petitioners submitted that the facility has the hallmarks of a margin loan facility.  Whether and to what extent the 1^st respondent can borrow from SCB would thus depend on the market value of eligible collateral and the applicable lending ratio.  Thus, the facility is not evidence of a credit line of HK$23 million being available to the 1^st respondent absent evidence of any collateral (and the relevant applicable lending ratio) already provided or offered by him to SCB enabling it to draw down.

35.  The logic of the petitioners’ analysis is difficult to fault and, indeed, the 1^st respondent did not seek to submit an alternative analysis of the facility.  Rather, the 1^st respondent proceeded to distinguish one of the authorities cited by the petitioners on the issue of relevance of a purchasing party’s financial ability to pay for the shares to be acquired.

36.  In Re Nu-West Natural Products Corp Ltd, HCCW 293/2006 (unreported, 3 August 2007) Kwan J (as she then was) in considering the appropriate relief to be granted (namely, winding up or buyout), considered as “highly relevant to the exercise of the discretion” the purchasing party’s financial ability to buy out: §71.

37.  The 1^st respondent sought to distinguish that decision on the ground that those observations were made in the context of a decision after trial that had proceeded on the basis that there were two options open to the court when granting relief, viz a winding up order or a buyout. It was submitted that those observations are not applicable should winding up relief be struck out at this stage because in that scenario the court would no longer have an option and would be compelled to order a buyout.

38.  Assuming that the complaints would otherwise support winding up on the just and equitable ground, I am not persuaded that the distinction sought to be drawn is a valid one.  The approach advocated by the 1^st respondent flies in the face of one of the basic tenets for striking out winding up relief − that it should only be ordered where it is “clear and obvious” that the petition would fail on the ground that there is an alternative remedy available to the petitioner and the petitioner is acting unreasonably in pursuing a winding up order instead of that other remedy.

39.  Courts may be prepared to order winding up despite the possibility of a buyout, for example, where there is no evidence of the respondents’ financial ability to buyout the petitioners’ shares. In Re Perfect Trade Limited, HCCW 1147/1999 (unreported, 1 June 2001), Chu J (as she then was) considered (at §59) that there is no room for making a buyout order in the absence of evidence as to the respondents’ financial ability.

40.  West v Blanchet [2000] 1 BCLC 795 concerned an unfair prejudice petition where a buyout order was sought.  The practicality of the offer has to be considered in order to judge whether it is ‘reasonable’.  Peter Leaver QC observed (at 803c–d) that:

“ It would … be too easy for a party to make an offer … which it had little or no realistic possibility of satisfying. In order to be a reasonable offer, there must be a realistic prospect, a reasonable likelihood, that the offeror will be able to pay the price likely to be decided upon by the independent expert appointed to value the shareholding.”

41.  Thus, an offer is not reasonable if the offeror cannot finance it: see French, Applications to Wind Up Companies, 3^rd Edition at §8.234.  Where a prima facie case has been shown that the ability of the 1^strespondent to finance any buyout is seriously in doubt, it is hardly “plain and obvious” that winding up relief should be struck out at this stage or that the petitioners are acting unreasonably in seeking winding up.  

42.  In Re M Kirpalani (HK) Ltd, HCCW 618/2009 (unreported, 23 June 2010), Barma J (as he then was) considered that any uncertainty regarding the question whether or not the respondents would be able to comply with a buy out order depended on the evidence.  In the present case, the evidence renders it doubtful whether or not that a buyout, if ordered, could be complied with: see Kirpalani at §§37 – 38. 

43.  In my view, it would be invidious to pre-emptively exclude the option of a winding up order that would otherwise be available in the circumstances of this case.

44.  That aside, it is worth highlighting that one of the three properties owned jointly by the 1^st respondent and his wife is actually the matrimonial home.  That is not normally an asset one would expect a party making a buyout offer would wish to realise except as a last resort.

45.  It was contended on the 1^st respondent’s behalf that the Company’s shares which undoubtedly have a value could be charged should any shortfall arise.  However, no evidence concerning the feasibility of such potential charge was adduced.

46.  In my view, at the very least, the petitioners have shown one particular reason for seeking a winding-up order.  

(C)   Need for investigation

47.  Essentially, the petitioners’ case is that they have been denied access to any relevant financial information since their exclusion from management.  It was said that various attempts to have the accounts independently audited have been thwarted by the 1^st respondent’s refusal to implement any such decision.  In April 2016 the Company’s auditors expressed an adverse opinion on the Company’ financial statements becausethey did not contain consolidated financial statements of the PRC subsidiaries.

48.  But it was only after the date of the petition when the 1^st respondent filed affidavit evidence in February and May 2019 that the Company’s accounts for the year ended 31 December 2016 and audit reports for the years 2013 and 2014 were made available.  They were exhibits to the affirmations filed on behalf of the 1^st respondent.  There are allegations and counter allegations of misconduct in relation to the assets/affairs of the Group arising from those accounts. The allegations made by both camps, when resolved, may well have an impact on the financial state of the Group.  Suffice it to say that it is unlikely that its true financial state can be ascertained without those disputes being resolved.

49.  The 1^st respondent submitted that the need for an investigation has not been sufficiently particularised and properly pleaded in the petition to warrant the retention of winding up as an alternative relief.  But what is clear from the petition and the evidence filed is that the Group accounts need to be sorted out.  Whether that is likely to be a long drawn out process or not is difficult to say on the present state of the evidence.  Nor is it possible to divine what (if any) problems they may present in the context of a valuation exercise. The possibility that winding up may be the preferable outcome after trial cannot sensibly be ruled out at this stage.

50.  In any event, for present purposes, I do not consider that it makes a practical difference given the concerns raised regarding the 1^st respondent’s financial ability to make a buyout.

(D)   Whether the complaints made in the petition would justify a winding up order on the just and equitable ground

51.  As I understand it, the gravamen of the 1^st respondent’s contention is that while the complaints made would make out a case of unfair prejudice, they are insufficient to warrant a winding up order when the Company is actively trading and solvent.  That winding up is a remedy of last resort is well-settled.  Hence, the reluctance to grant winding up where the company is successful and profitable. 

52.  The winding up and unfair prejudice jurisdictions are parallel, not coterminous.  In many cases, conduct of a company’s affairs may justify relief under both jurisdictions.  The fact that the allegations would justify an order under both jurisdictions does not of itself render winding up relief sought in the alternative otiose, warranting a strike out.  It has to be shown that the petitioner is acting unreasonably in seeking a winding up order.

53.  The 1^st respondent placed considerable reliance on Kirpalani and sought to draw parallels between the complaints made in that case and the present case, emphasising their similarities and the judge’s conclusions. That was not a particularly useful exercise since different sets of facts may invite different conclusions.

54.  It is clear from §33 of that case that if the offer made may not provide the petitioner with all that he could reasonably expect at the end of the day, it would only mean that it is proper for him to continue to seek a buyout, but not that it would be proper for him to seek a winding up order if it were plain and obvious that he would be acting unreasonably in doing so.

55.  Where there are serious reservations as to the 1^st respondent’s financial ability to pay, in my view, it would not be improper for the petitioners to seek a winding up order because in those circumstances they could not be considered as acting unreasonably.

CONCLUSION

56.  For the reasons set out above, the 1^st respondent’s application to strike out the winding up is dismissed.  There is to be an order nisi of costs in favour of the petitioners to be taxed if not agreed with certificate for two counsel.