CHINACULTURE.COM LTD v. LAM TING BALL, PAUL AND OTHERS

HCA 2902/2017

[2020] HKCFI 1698

IN THE HIGH COURT OF THE

HONG KONG SPECIAL ADMINISTRATIVE REGION

COURT OF FIRST INSTANCE

ACTION NO 2902 OF 2017

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D E C I S I O N

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1.  On 2 July 2020 I heard a case management conference in this statutory derivative action, the trial of which is fixed to commence on 9 November 2020 for 25 days. At risk of oversimplification, the principal issue in the case is whether the paint business of the 4^th Defendant (“Company”) which was spun-off into a separate listed company, CPM Group Limited (“CPM”), at an undervalue. The undervalue primarily arising because the IPO share price of CPM failed to reflect the value of a parcel of land owned by the paint business in Shajing, Shenzhen (“Property”).

2.  Two matters raised at the CMC require determination.  Both concern expert evidence.  The first relates to the value of the Property.  The second relates to the valuation of the paint business more generally and has been called the corporate finance issue.

3.  On 2 February 2018 I made an order for expert evidence concerning the market value of the Property at 9 July 2017 and the redevelopment value of the Property at the same date.  Reports and supplemental reports have been prepared by Mr CK Lau for the Plaintiff and Mr Gary Man for the 1^st to 3^rd Defendants. Both discuss the redevelopment potential of the Property and the value of land taking into account its redevelopment potential.  The 1^st to 3^rd Defendants now, however, propose that additional expert evidence is required concerning the applicable Mainland town planning regulations and the prospect in July 2018 of converting the use of the Property to non-industrial or other industrial use.

4.  Mr Jat argues that both experts are Hong Kong based valuers and do not have the expertise to opine on the prospects of a change in the use of the Property.  As I have already noted in fact both experts do express opinions on this issue.  Neither says that they consider this a relevant issue, but one on which they are not qualified to express a view.

5.  Whether or not further expert evidence is required turns on what precisely is in issue.  The issue is not whether the use of the property could have been converted; the issue is whether, on the assumption that at the time the spin-off was under consideration a valuation of the Property had been sought, it is likely that the valuation would have taken into account the prospect of converting the land use to one that was more valuable and what impact this would have had on the IPO share price.  On the assumption that the Company had decided to obtain a valuation in addition to that which had been obtained for the purposes of preparation of its financial statements (which in turn assumes that the approach to valuation for the purposes of complying with accounting standards might not have required conversion of the land use rights to be taken into account) it seems to me rather more likely that the Company would have proceeded to get a valuation from professionals such as Mr Lau or Mr Man without the kind of additional opinion that the 1^st to 3^rd Defendants now suggest is required. The fact that it is only at this stage of the proceedings that the Company has formed the view that something additional is required tends to suggest that it is artificial to proceed on the basis that the Board’s decisions would ever have been informed by input from a Shenzhen professional familiar with converting land use.

6.  It seems to me that the additional expert evidence that it is now sought to adduce would add nothing of value given the nature of the issue.  It would be more likely to unhelpfully complicate the matter by introducing additional hypothetical questions, which would not assist the determination of the issue.  I note that it is not being suggested that Mr Man’s report is in some way wrong or incomplete or that the valuation issue formulated in the original order is wrongly formulated or that it has not been properly addressed by the experts.  This being the case I am not prepared to allow additional opinion evidence relating to the prospects of converting the use of the Property.

7.  The position in respect of the corporate finance expert evidence is different.  A problem with the case has been that from the outset the parties have had difficulty understanding each other’s complaints about the way the spin-off was conducted and the offer price arrived at.  It is, however, agreed that expert evidence is required from individuals familiar with how a listed company would be expected to approach the spin-off of part of its business and, in particular, how it would be valued.

8.  The parties have proposed two alternative formulation of the issues to be put to the experts.  The Company proposes that the experts are asked to opine on two short matters.  First, what is the market practice in pricing an IPO like the companies spin-off of CPM.  Secondly, is the price range in the prospectus reasonable on the facts?  The Plaintiff suggests an alternative approach.  They identify a number of specific issues that the corporate finance experts should be asked to address.  They are as follows:

(1)     Whether it would have been prudent for CNT to obtain a proper valuation of its Shajing Land/Property on a market value basis and/or redevelopment basis as at 9 July 2017 before determining or agreeing upon the price of CPM’s shares on the Spin-off?

(2)(i)  Assuming that the value of the Shajing Land/Property as at 9 July 2017 was to the order of RMB666,000,000 on a market value basis and/or the order of RMB840,000,000 on a redevelopment basis, or alternatively, that on a proper revaluation of the Shajing Land/Property, the NAV of the Paint Business pre Spin-off would have far exceeded HKD860,000,000, as a properly instructed financial adviser of CNT with a mandate to advise CNT in the Spin-off, what advice would you have given CNT?

(2)(ii)  In the scenario under paragraph (2)(i), would you consider that it was practicable for CNT to have retained the Shajing Land/Property and yet proceeded with the Spin-off of the Paint business?  What other actions could CNT have taken to safeguard its interests and maximise its value in the Spin-off if it still wished to proceed to spin off its Paint Business?

(2)(iii)  Assume that the value of the Shajing Land/Property was to the order of RMB666,000,000 on a market value basis and/or RMB840,000,000 on a redevelopment basis, what was the loss to CNT in having proceeded with the Spin-off by deemed disposing its Paint Business with the Shajing Land/Property at a combined valuation of HKD860,000,000?

9.  Particularly given the problematic way the corporate finance issues have emerged I do not think it is helpful to formulate the issues in the way that the Plaintiff proposes.  For example, the first issue, is not put in any kind of context and does not define “proper”.  I told the parties at the end of the hearing that I proposed to draft the issues for the experts and invite their comments on them.  The following is the draft:

(1)  How would an IPO in the form of a spin-off of a business of the type conducted by CPM commonly be priced?

(2)  Would consideration be given to whether or not the value of real property as shown in the company’s audited financial statements is the correct value to be used for the purposes of determining the share price for the IPO?  What advice and recommendations might be given to a board in this regard?

(3)  How, if at all, would the value of real property owned by a company to be spun-off be taken into account when determining the share price for the IPO?  In particular:

(i)  would the approach to determining price be effected if land represents a sizable proportion of a company’s net asset value?

(ii)  If the land value is to be taken into account in calculating the share price for an IPO of a manufacturing company would this commonly be at a discount to net asset value?

(4)  On the basis of the information available at the time the share price for the IPO of CPM was calculated was the share price within the range of share prices that might have been expected applying normal commercial and financial considerations?

10.  The parties should provide me with their comments within seven clear calendar days.  If necessary a short hearing can be arranged to finalise the issues.