TANG CHUEN CHUNG v. KATAL (INTERNATIONAL) KNITTING FACTORY LTD AND OTHERS

HCCW 242/2017

[2018] HKCFI 2828

IN THE HIGH COURT OF THE

HONG KONG SPECIAL ADMINISTRATIVE REGION

COURT OF FIRST INSTANCE

COMPANIES WINDING‑UP PROCEEDINGS NO 242 OF 2017

________________

________________

________________

________________

J U D G M E N T

________________

1.  The Petitioner, Mr Tang Chuen Chung, seeks a winding up of Katal (International) Knitting Factory Limited (“Company”) on the just and equitable grounds. Mr Tang does so on two grounds. First, that the business of the Company has ceased. Secondly, that he has been ousted from the management of the Company. I will explain the apparent inconsistency between these two grounds later.

2.  The Company was formed in 1992.  It carried on business manufacturing and selling garments.  The business had originally been established by the Father of the 2^nd Respondent, Lai Wai-hong and was carried out by an unincorporated company called Hong Ngai Knitting Factory.  Wai-hong died in the 1970s and the business continued under the management of Lai Kwong-wing, Wai-hong’s oldest son.  Mr Tang joined the business and managed its production.

3.  In 1982 a limited company was incorporated to continue the business.  It was called Katal Knitting Factory Limited and was referred to before me as old Katal.  Old Katal quickly began to experience serious financial difficulties, which called into question its viability. Mr Lai asked Mr Tang to continue to work with him to overcome these difficulties, which he did.  By the mid-1980s the business had improved substantially.  Sometime in about mid-1986 Mr Lai and Mr Tang discussed investing in property.  They agreed to do so through a new company. They set up Worldhand Development Limited (“Worldhand”) for this purpose, which was incorporated in September 1986.  Initially they held one share each.  For a period there was a third shareholder, but by 2006 the position reverted to that at the time of Worldhand’s incorporation with each of Mr Lai and Mr Tang having a 50% interest in Worldhand.

4.  In 1996 the Company took over old Katal’s business.  It has throughout its life had three shareholders: Mr Tang, Mr Lai and his younger sister Lai Kam-hung, who is the 2^nd Respondent. All three were directors.  It is clear that Ms Lai had no material role in the management of the Company and at best a very general knowledge of its business or affairs.  Mr Lai and Mr Tang ran the Company.  Mr Tang was responsible for production.  Mr Lai dealt with other matters and appears to have exercised more control over the Company’s affairs than Mr Tang.  Production was carried out by factories in the Mainland, one of which was called New Trend.  The factories were owned or controlled by Mr Tang and Mr Lai although the corporate structure has not been explained to me.

5.  Mr Lai and Mr Tang agreed to cease the Company’s manufacturing business in 2009.  Although I do not have evidence about the details of the cessation, I understand it was complete by the end of the Company’s 2009/2010 financial year which ended on 31 March 2010.  After that date apart from dealing with cessation of the garment manufacturing business, it would appear that the Company’s only activity was holding two flats in the Bellagio in Castle Peak Road (which the evidence suggests may have been converted into one) and a portfolio of shares.

6.  Unfortunately, Mr Lai died on 30 July 2010 and this led to a short series of events, which caused the breakdown of the relationship between Mr Tang and Ms Lai and resulted in what I consider to be an entirely unnecessary piece of litigation. 

7.  The balance sheet of the audited financial statement for the year ending 31 March 2010 was signed by Mr Tang and Ms Lai on about 30 September 2010.  The balance sheet clearly shows a total amount due to directors of $14,725,861.70.  There is no suggestion that any of this was due to Ms Lai or that at any time she thought she was owed anything by the Company.  The balance sheet also records net assets of $29,497,409.97, retained profits of this sum less the Company’s capital of $300, cash in bank of $21,095,346.14 and stock of $500,949.83 (which I note was a reduction from $2,186,398 on 2009, which one might reasonably assume was connected with the 2009 financial problems).

8.  On 25 October 2010 a meeting was held at Mr Tang’s suggestion to discuss the Company and its assets, which in addition to those I have already mentioned included four cars.  Mr Tang mentioned at the meeting that he was owed approximately $7.3ml by the Company. It appears clear from the Respondents’ own evidence that they did not dispute this, although neither did they approve Mr Tang withdrawing this amount from the Company.  The following day Mr Tang caused a cheque to be drawn for $7,374,055.09 on the Company’s account.  This was possible because Ms Lai, who was a co-signatory to the bank account, had signed a number of blank cheques, which were held by the accounts manager a Mr Leung. Mr Tang had used one of these to effect the payment.  Mr Leung mentioned this to Ms Lai on 27 October 2010, although there is no suggestion that he did so because he thought there was anything suspicions about it; he was simply informing her.  However, it appears that Ms Lai thought otherwise.  In her first witness statement Ms Lai says this in [66]: “After the incident of the 26.10.2010 Company Cheque, and the Petitioner failing to provide any justification for the payment, I became anxious about the status of the Company and whether the Petitioner and Mr. Leung were acting in the best interests of the Company.”  Given the contents of the financial statement Ms Lai had signed four weeks earlier there was in my view no justification for immediately assuming that there was something fishy about Mr Tang taking payment of the amount the accounts showed due to him when the Company had more than enough money to pay him and it had ceased its garment business.  However, on 29 October 2010 she collected all the blank cheques she had signed.

9.  On 4 November 2010 Ms Lai attended the office of the Company with Mr Au Gary Chung Lok, the 3^rd Respondent, who along with Mr Leung was one of Mr Lai’s executors.  Ms Lai was accompanied by her solicitor and representatives of her accountant and, to use her own language in her witness statement, demanded to see the documents of the Company.  Ms Lai does not explain why she so quickly moved to an overtly confrontational position, but in my view unsurprisingly Mr Leung who was in the office reacted badly and refused to hand them over.  He then called the police.  After some discussion Ms Lai removed 33 box files of documents and her accounting representatives downloaded data from the computers.  The next day Ms Lai attended the office again with her solicitor and removed two external hard disks from the office computers.  Her explanation for this behaviour in [68] of her first witness statement is this: “I am keeping the 33 Boxes of Documents in the best interests of the Company, as the Petitioner can no longer be trusted to act in the best interests of the Company after the incident concerning the 26.10.2010 Company Cheque.”

10.  On the basis of the evidence before me, during the following eight years Ms Lai has demonstrated no wish to discuss constructively with Mr Tang sorting out the affairs of the Company and, as common sense clearly suggests is desirable, liquidating the Company and distributing its assets.  Ms Lai seems, for example, to have made no effort herself to procure the production of financial statements for the years subsequent to 2010 or engage with Mr Tang in order that this can be done or other issues addressed like the payment of management charges for the Bellagio. As a result the Company has been subject to prosecution for not filing tax returns and a claim by the management of the Bellagio in the Small Claims Tribunal.

11.  Sometime after 25 April 2017 Mr Au, the 3^rd Respondent, was registered as a shareholder of the Company as executor of Mr Lai’s estate. On 24 July 2017 at an extraordinary general meeting of the Company, the board of the Company was re-constituted.  Following the extraordinary general meeting the directors became Madam Lai, Mr Au, and Chan Kim‑hung, who was unknown to Mr Tang and apparently is a relative of Mr Lai.

12.  On 7 August 2017 Mr Tang issued a winding-up petition.  As I mentioned he relies on two grounds.  The first is that the Company has been dormant for six years.  The second is that Mr Tang has been unfairly ousted from the management of the Company in which he had a reasonable expectation to be permitted to be involved.

13.  It seems to me that both grounds are clearly made out.  The Company was set up to manufacture garments, which it did through factories in the Mainland.  The business was profitable and it would appear that a significant amount of that profit was transferred from the Company to Worldhand, which was owned by Mr Lai and Mr Tang, to invest in property.  Although it is correct that the Company bought a flat or flats at the Bellagio and for a period held public companies’ shares, which as is demonstrated in [7] represent a small proportion of the Company’s assets, this was not its business, and in large part because of Ms Lai’s conduct the Company has done nothing but passively holds these assets for in excess of six years.  It seems clear to me that in substance the Company is dormant and should be wound up.  This is enough to dispose of the petition, but I shall say something about the second ground.

14.  In his opening Mr Cheung accepted that the Respondents were not asserting that Mr Tang misappropriated the $7.3ml, although at points the witness statements appear to suggest it.  Their case was that the payment was sufficiently suspicious to justify Ms Lai’s reaction and that subsequent breakdown in their relationship, and Mr Tang’s removal from the board was not their responsibility and arose from Mr Tang’s unwillingness to justify the payment.  I understood Mr Cheung to accept that because the breakdown in communication had occurred by November 2010, we are concerned with events in the period October and November 2010 to see whether or not Mr Tang’s conduct justified Ms Lai’s behaviour.

15.  Any prospect of succeeding with this defence evaporated after the Respondents called their 3^rd witness, Ms Jenny Hui.  Ms Hui had worked as an accounts clerk for the Company for the 12 years prior to January 2010.  She was asked by Mr Leung to work for a few days in September 2010 to input data into the account software package as part of the process of finalising the financial statements for the year ending 31 March 2010.  Ms Hui was a straightforward witness who, unlike either Mr Tang, Ms Lai or Mr Au, was able to explain the Company’s ledgers and the entries that went to produce the balance in Mr Lai and Mr Tang’s favour in the directors accounts.  I understood Mr Cheung to accept in his oral closing submissions that given Ms Hui’s evidence, there was no basis for the Respondents to suggest that the balance in Mr Tang’s favour and thus the cheque drawn on 26 October 2010 were suspicious.  What in my view is clear is that Ms Lai knew little about the Company’s financial affairs or its accounts.  She jumped to the conclusion that the payment was suspicious because she did not know why Mr Tang was owed this money, but this was because she knew very little about the Company’s affairs having, it is my impression, been given a share and appointed a director by her older brother simply to give him control at shareholder and board level.  Her attitude of mind was, it seems to me reasonable to infer, hinted at in the evidence that Mr Au was keen to give at the beginning of his cross‑examination—the business of the company was a family business and the Family decided to take back control.  Ms Lai saw the Company as belonging to the Family and was not happy that Mr Tang felt able to pay himself a substantial sum without her agreement or approval.  Ms Lai in her cross-examination showed no appreciation of the fact that Mr Tang owned one third of the Company, and received more than one third of the profit as a consequence of the arrangement established by her brother that the surpluses be paid to Worldhand, which was owned 50/50 by him and Mr Tang.  It seems to me fairly obvious that once Mr Lai had died, one would expect Mr Tang, who was the only other shareholder that had been actively involved in running the business, to have a substantial role to play in the Company’s management, but the tenor of both Ms Lai and Mr Au’s evidence indicated that this was not how they saw matters.

16.  There is no evidence that Ms Lai ever suggested to Mr Tang that she would like to work with him to understand the affairs of the Company.  There is no evidence that after 27 October 2010 she or Mr Au suggested that they have a meeting to discuss financial issues in order that they could understand the sums owed to the directors and decide how the Company’s assets should be dealt with.  Instead they attended the Company’s office on 4 November with a solicitor and accountants and demanded to take away the accounting records.  This seems to me to have been an unjustified and aggressive action.  It was all the more misconceived because the head of the accounts department was Mr Leung, who Mr Lai trusted enough to appoint as one of his executors.

17.  This case is an example of the unsatisfactory way in which shareholders disputes are frequently conducted in the Companies Court.  As I regularly point out to counsel and solicitors, it is important that at the outset they understand the business and the accounts of the company in order that they can assess the merits of their client’s case and, indeed the veracity of the various allegations clients make to them, and ensure that a case develops properly.  It is quite clear to me that this has not happened in the present case.  Ms Hui’s witness statement was significantly inconsistent with her oral evidence.  If lawyers had sat down with her and taken the opportunity to use her knowledge of the Company’s financial affairs and its accounts to understand them, they would have discovered that Ms Lai’s concerns were probably baseless or at least so weak that they did not justify her refusal to deal with Mr Tang.  What they appear to have done is to produce a script, which advanced their client’s case.  Although I appreciate that solicitors and counsel who are unfamiliar with company work, which is common in my experience in the case of lawyers who are instructed on small shareholders disputes, may have difficulty understanding their often unsophisticated client’s case and managing the client’s expectations, this is not an excuse for simply pandering to the client’s wishes and whims and helping manufacture supporting evidence.

18.  It is quite clear to me that Mr Tang is entitled to a just and equitable winding-up order, and if the Respondents had been sensible and properly advised this litigation could have been avoided either by agreeing to a winding up or the Respondents offering to buy out Mr Tang at a price representing his interests in the assets of the Company.

19.  I will, therefore, make a winding-up order and hear counsel on costs.

(Submission on Costs)

20.  There is no dispute that costs should follow the event and that the 2^nd and 3^rd Respondents should pay the Petitioner’s costs of the petition. Mr Chain, however, seeks an order that the costs be taxed on an indemnity basis.  He does so on the grounds that, as he says is demonstrated by the inter partes correspondence, the Respondents have never engaged seriously with the Petitioner’s attempts to settle these proceedings; proceedings which I have already indicated in my view should have been recognised as unnecessary.  In addition, he points to the unsatisfactory contents of Ms Hui’s witness statement which I have explained earlier in my reasons as indicating a failure to prepare evidence which fairly put a case for contesting the petition proceedings.

21.  Order 62, rule 5 sets out the matters to be taken into account in exercising the court’s discretion.  Sub-rule 5(1)(e) refers to the conduct of the parties; the conduct that is relevant is described in sub‑rule 5(2):

“For the purpose of paragraph (1)(e), the conduct of the parties includes—

(a) whether it was reasonable for a party to raise, pursue or contest a particular allegation or issue;

(b) the manner in which a party has pursued or defended his case or a particular allegation or issue;

(c) whether a claimant who has succeeded in his claim, in whole or in part, exaggerated his claim; and

(d) conduct before, as well as during, the proceedings.”

22.  At its outset, sub-rule 5(1) explains in sub para (aa) that the court should have reference to the underlying objectives set out in Order 1A, rule 1.  As is clear from Order 1A, the underlying objectives of the Rules are to encourage a prompt and cost effective resolution of disputes that come before the court, to promote a sense of reasonable proportion in the conduct of proceedings, and generally to ensure fairness.  It seems to me to be consistent with the principles explained in these two Orders that the court can properly take into account in deciding whether or not to order that costs are paid on an indemnity basis, whether the proceedings have been unnecessary, whether attempts to settle the proceedings have been dealt with constructively, and generally, whether the way in which the case has been prepared and presented has been fair rather than disingenuous and inclined to prolong and complicate litigation rather than advance the resolution of the dispute. 

23.  More generally, the circumstances in which the court will order indemnity costs are summarised in [62/App/12] of the Rules of the Supreme Court in which the Court of Appeal’s decision in Choy Yee Chun v Bond Star Development Limited [1]is referred to.  In that decision, the Court of Appeal describes circumstances which the authorities demonstrate are occasions on which the court may be inclined to order indemnity costs, although, importantly, the court observes that the discretion which the Rules give a judge are not fettered or circumscribed to these categories.  The overriding principle being that an order on the higher basis is appropriate. 

24.  As will be apparent from my reasons, it seems to me that the way in which the Respondents have dealt with Mr Tang’s claims, and his attempts to either have the Company wound up or alternatively have his own interests in it purchased, has been unsatisfactory.  I would note that I have conducted the various case management conferences in these proceedings at which on a number of occasions Mr Chain on behalf of Mr Tang has indicated a willingness to settle and outline a basis for progressing discussions.  These have over time not been responded to constructively. It also in my view is unsatisfactory that despite the fact that well before trial it is obvious that the Respondents had access to the relevant documents and, in the case of Ms Hui, somebody who could help explain the ledgers, that the Respondents have continued to make serious allegations against Mr Tang without taking the trouble themselves to understand the affairs of the Company and its accounts with a view to assessing fairly what the true position is, and how the parties’ interests can fairly be resolved. 

25.  As I have already indicated, it is far too common in the Companies Court for small shareholders disputes to be conducted in this way, and for the disputes between owners of businesses which it should be possible to resolve relatively easily to be allowed to deteriorate into rather childish squabbles, which serve no commercial purpose other than to incur legal costs which reduces the value of the assets available to shareholders.

26.  I am satisfied that this is an appropriate case in which to order that the 2^nd and 3^rd Respondents pay the Petitioner’s costs of the proceedings on an indemnity basis.