LUNG KAM CHIU v. WAH HING STATIONERY MANUFACTORY LTD

HCCW 73/2013

IN THE HIGH COURT OF THE

HONG KONG SPECIAL ADMINISTRATIVE REGION

COURT OF FIRST INSTANCE

COMPANIES WINDING-UP PROCEEDINGS NO. 73 OF 2013

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JUDGMENT

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1.  This is an application by the opposing creditor and contributory, Wu Wei Zei (“Wu”), to strike out the creditor’s petition to wind-up the company known as Wah Hing Stationery Manufactory Limited (“the Company”) taken out by the petitioner, Lung Kam Chiu (“Lung”), and to dismiss the proceedings on the basis that there is a bona fide dispute of the petition debt or a cross-claim on substantial grounds.

2.  After the hearing on 5 December 2013, the parties agreed to conduct further mediation with a view to resolve their dispute.  My decision was therefore deferred pending the mediation. Unfortunately, the mediation was not successful and so I still have to give my judgment on the striking out application.

Background

3.  This is very much a shareholders’ dispute.

4.  Wu, Lung and one Liang Hui Tao (“Liang”) are the only directors and shareholders of the Company.

5.  The petition is made based on a statutory demand served on the Company on 8 February 2013 (“the Statutory Demand”) which was not complied with.  The Statutory Demand is related to a debt of $2,350,568.38 being a director’s loan allegedly due from the Company to Lung (“the Director’s Loan”).

6.  Wu has put forward the following grounds to oppose the petition.  Firstly, it is Wu’s case that the 3 shareholders of the Company had each signed a document known as continuing financial support dated 12 September 2012 (“the CFS”).  According to the terms of the CFS, the respective shareholders agreed to give an undertaking to “provide the necessary funds to finance the operations and to meet all loans and debts obligations of [the Company] for the next twelve months commencing from the date of this letter of [CFS]”.  By reason of the CFS, Wu claims that Lung is not allowed to present a petition to wind-up the Company within 12 months from the signing of the CFS.

7.  Further, according to the resolution of the Board of Directors of the Company dated 10 January 2005 (“the Board’s Resolution”), it was agreed that each shareholder shall take the liabilities in debts and enjoy the rights of the Company in accordance with the number of their shares and the ratio of their shareholdings in the Company.  Hence, Lung has to bear his share of the debts of the Company and cannot demand the Company to repay the Director’s Loan.

8.  Secondly, the Company seeks to recover from Lung the legal expenses paid by the Company to defend the criminal proceedings brought against him.  In the criminal proceedings, DCCC No 1300 of 2009 (“the Criminal Proceedings”), the 3 directors of the Company, Lung, Wu and Liang, together with one Lee Chun were charged with the offence of fraud for making bogus applications to banks for letters of credit.  The 3 directors were convicted after trial and they were sentenced to various terms of imprisonment.  By that time, the 3 directors agreed for the Company to pay their legal expenses, and Lung’s legal expenses amounted to $917,500.  However, the Board of the Company decided to rectify the matter and sought to recover the legal expenses from the various directors of the Company.  Further, I am given to understand that Wu and Liang agree to repay the Company the legal expenses paid by the Company on their behalf.  The Company therefore seeks to set-off the payment of Lung’s legal expenses from the Director’s Loan.

9.  Thirdly, Wu claims that Lung is now holding a sum of $1,893,420.49 (“the Deposit”) in his personal account in Shanghai Commercial Bank (“the Bank”) as trustee for the Company, which is confirmed by a Declaration of Trust signed by Lung dated 12 September 2012 (“the Declaration of Trust”).  Hence, the Company seeks to use the Deposit to set-off the Director’s Loan.

10.  Fourthly, the Company has brought High Court Action No 339 of 2013 (“the High Court Action”) against Lung.  In the High Court Action, the Company claims against Lung for, inter alia:

(i)   the return of the Deposit held by Lung on behalf of the Company;

(ii)   the return of the sum of $1,000,000 being the amount of the mould costs misappropriated by Lung; and

(iii)   an account of profit obtained by Lung in respect of the Company’s businesses diverted by Lung to a company known as Oriental Bind Manufactory Limited (“Oriental Bind”).

11.  The Company also seeks to set-off the amount due from Lung under the High Court Action against the Director’s Loan.

Legal principles

12.  A petition for winding-up may be presented by a creditor.  If there is no debt, it follows that there is no creditor and the presenter does not have the locus standi and the petition must fail (see: Mann v Goldstein [1968] 1 WLR 1091 p 1095-1096).

13.  Where a debt is disputed on substantial grounds, even if the company appears insolvent, the court will restrain the prosecution of a petition of winding-up (see: Mann v Goldstein, supra, p 1099F).

14.  In determining whether there is bona fide dispute of substance, the relevant principles were summarised by Kwan J (as she then was) in Re Hong Kong Construction (Works) Ltd, unreported, HCCW 670/2002 (7 January 2003) at §6:

“(1) The burden is on the company to establish that there is a genuine dispute of the debt on substantial grounds. In this context, ‘substantial’ means having substance and not frivolous. An honest belief in an insubstantial ground of defence is not sufficient to avoid a winding-up order.

(2) The court should look at the company’s evidence against so much of the background and evidence that is not disputed and not capable of being disputed in good faith; in other words, the evidence is not to be approached with a wholly uncritical eye.

(3) The court would caution itself against unsubstantiated and unparticularised assertions, especially where particulars and information have been sought by the other side. It is incumbent on the company to put forward ‘sufficiently precise factual evidence’ to substantiate its allegations.

(4) The court does not try the dispute on affidavit but is to determine whether a substantial dispute exists. In so doing, the court necessarily has to take a view on the evidence, to see if the company is merely ‘raising a cloud of objections on affidavits’ or whether there really is substance in the dispute raised by the company. Even where the company has obtained unconditional leave to defend in an application for summary judgment, the Companies Court is not precluded from examining the evidence and taking a view on whether the debt is disputed on substantial grounds. … … …

(5) If there is a debt which in part above the statutory minimum is indisputable, a petition can validly be presented even if the debt as claimed in the petition is for a larger sum, part of which is bona fide disputed. The court would not as a general rule strike out a petition or restrain its advertisement even though the petition also refers to sums claimed by the petitioner in relation to which there is a dispute … … …

 (6)       Where a company does not or cannot dispute the petitioning debt, but puts forward a counterclaim which is disputed, on an application to strike out the petition or to restrain its advertisement, it could not be said that the petition  is an abuse of the process of the court, even though the existence of the cross-claim may be relevant to the exercise of the court’s discretion on the hearing of the petition … …”

15.  In Re Grandfield Pacific Hotel Ltd, unrep, HCCW 29/2001 (3 January 2002), Kwan J also said the following at §11:

“To resist a petition, the company must show that it has a bona fide defence, not a fair probability of one. It is possible that a company might on an Order 14 application convince the court that it has a fair probability of a defence but at the petition stage it might not be able to establish it has a bona fide defence … … … if a winding-up order is made, the company’s claim against the petition may still be pursued by the liquidator as he thinks proper, so there is no injustice in adopting a higher threshold for the company requiring it to show that it has a bona fide defence, quite apart from the public policy considerations in a winding-up.”

16.  In the case that the company is relying on a cross-claim to oppose the petition, Kwan J said the following in Re Sinom (Hong Kong) Ltd [2009] 5 HKLRD 487 at §§11 & 12:

“11. As with a petition where there is a bona fide dispute of the debt on substantial grounds (a disputed debt petition), where the company has a genuine and serious cross-claim against the petitioner greater than or equal to the petitioner’s debt (a cross-claim petition), such a petition may be restrained from proceeding (Re Pan Interiors Ltd [2005] EWHC 3241, paras. 34-39). It is an abuse of the process of the court to make a statutory demand or present a winding-up petition based on a claim to which there is a triable defence (Re Company [1992] 1 WLR 351). A cross-claim petition is regarded in the same way (Southern Cross Group Plc v Deka Immobilien Investment GmbH [2005] BPIR 1010, paras. 29-30; Re Pan Interiors Ltd, para. 35).

12. To successfully resist a cross-claim petition, the company has the onus of establishing that its cross-claim is genuine, serious and of substance.  There must be supporting relevant details to demonstrate that the cross-claim is based on substantial ground.  The test is very much the same as the test for a disputed debt petition for deciding whether a debt is disputed in good faith and on substantial grounds (Application to Wind Up Companies (2^nd ed., 2008) paras. 6.10.7.2 and 6.10.7.3 and the cases there cited).”

17.  There is no dispute between the parties about the aforesaid legal principles.

The Statutory Demand and the Director’s Loan

18.  The petition is made based on the amount due under the Director’s Loan.  According to the Audit Confirmation issued by the Company dated 10 April 2012, the Company owed a sum of $2,350,568.36 to Lung as at 31 December 2010, which debt was unsecured, interest free and repayable on demand.  After being served with the Statutory Demand, the solicitors for the Company issued a letter to Lung’s solicitors dated 20 February 2013, confirming that, in accordance with the Company’s 2011 audited accounts, the Company owed a debt of $2,230,198 to Lung as director.  By way of a certificate dated 20 February 2013, the auditors of the Company certified that as at 31 December 2011, the Company owed a debt of $2,230,198 to Lung.

19.  It is common ground that, although the actual amount of the debt ($2,230,198) is less than the amount of the debt stated in the Statutory Demand ($2,350,568.36), it would not invalidate the petition itself (see: Re Tweeds Garages Ltd [1962] 1 Ch 406 at 414 and Re Hong Kong Construction (Works) Ltd, unreported, supra, at §6).

20.  Wu does not seek to dispute the amount due to Lung under the Director’s Loan, and so there is no triable defence to the underlying debt.  The only issues here are: (i) whether Lung is precluded from presenting the petition by reason of the CFS or the Board’s Resolution; and (ii) whether there are genuine and serious cross-claims based on substantial grounds against the petitioner greater or equal to the petitioner’s debt.  I therefore have to assess critically the 4 grounds put forward by Wu to oppose the petition.

The effect of the CFS and the Board’s Resolution

21.  First, Wu claims that Lung is precluded from lodging the petition by reason of the CFS and the Board’s Resolution.

22.  It is common ground that each of the shareholders of the Company had signed a CFS.  According to the terms of the CFS, each shareholder agreed to give an undertaking to “provide the necessary funds to finance the operations and to meet all loans and debts obligations of [the Company] for the next twelve months commencing from the date of this letter of [CFS]”.

23.  It is Lung’s case that the CFS was prepared by the auditors of the Company who informed him that the same was needed for “auditing purposes”, and he therefore signed it without any question.  In any event, Lung revoked and withdrew the undertaking in the CFS on 22 February 2013, and so he should not be disallowed to present the petition because of such document. Further, the undertaking would have expired on 11 September 2013 in any event, and up to now the Company has still not repaid the Director’s Loan to Lung.

24.  In my judgment, the circumstances under which the 3 shareholders of the Company had signed the CFS are far from clear. The court does not know what caused the 3 shareholders to sign the CFS, or whether there was any consideration to support the provision of the undertakings in the CFS.  The obligations of the shareholders under the CFS are also vague and uncertain, and so the court should not prohibit the presentation of the petition simply because of such vague document.

25.  For the Board’s Resolution, I cannot see how the shareholders’ agreement to bear the responsibility for the debts of the Company in accordance with the ratio of their shareholdings would prohibit a director from enforcing a loan advanced by him to the company.  If Wu’s argument is correct, there is no way for a director to get back his loan which simply cannot be right.

26.  By reason of the aforesaid, I do not accept that the CFS or the Board’s Resolution would have the effect of barring Lung from presenting the petition to wind-up the Company based on the outstanding Director’s Loan.

The set-off of the payment of legal fees

27.  There is no dispute that the Company had paid for the legal expenses of all the 3 directors and Lee Chun in defending the Criminal Proceedings.

28.  According to Lung, the legal fees were paid by the Company in 2008 to 2010.  By that time, Lung, Wu and Liang agreed that their legal fees, together with those of Lee Chun, were all to be borne by the Company.  In the previous accounts of the Company, the auditors had not expressed any adverse opinion on the treatment of these legal fees as the expenses of the Company, and so Wu and Liang cannot just simply adjust the previous accounts of the Company without the consent of Lung.  Further, Lung relied on such agreement between the directors and extended a loan in the sum of $1,220,000 to the Company in June 2012 to ease the cash flow problem of the Company.  In such circumstances, Wu and Liang cannot unwind the agreement.

29.  Although the 3 directors of the Company had previously agreed for the Company to pay for these expenses, it does not disturb the fact that these expenses remained the personal expenses of the persons being charged in the Criminal Proceedings and not the Company’s expenses.   In fact, a director owes a fiduciary duty to the company, and it may not be appropriate for the board to pass a resolution for the company to pay for the personal expenses of the directors.  At the very least, there is nothing to prevent the board to pass a resolution to adjust the previous accounts of the company to reflect that these are the personal expenses of the directors, provided that all the other directors of the company are prepared to repay their share of the expenses.  In my judgment, there is a serious dispute as to whether the Company is allowed to recover the legal expenses from Lung, and so Wu has managed to establish a genuine and serious cross-claim in this regard.

The Deposit and the Declaration of Trust

30.  The next cross-claim relates to the Deposit kept by Lung in his personal account.

31.  There is no dispute that Lung had signed the Declaration of Trust acknowledging that he was holding the Deposit as trustee for the Company.  However, he disputes the contents in such document and denies that he is in fact holding the Deposit as trustee.  According to Lung, he signed the Declaration of Trust only upon the instruction of the auditors of the Company.  In any event, the Deposit is a security offered to the Bank for the granting of the credit facilities to the Company.  As the Company has failed to repay the loans advanced under these credit facilities, the Bank does not allow Lung to withdraw the Deposit from the account.  In such circumstances, Lung claims that no set-off can be made by the Company based on the Deposit.

32.  For the purpose of the present striking out application, since Lung had personally signed the Declaration of Trust, I have to put Wu’s case at the highest and accept that Lung is in fact holding the Deposit as trustee for the Company.  The problem here is Lung’s allegation that the Bank does not allow him to withdraw the Deposit.  If the Director’s Loan is repayable on demand and Lung does not have immediate access to the fund because it is being used as a security for the loans advanced by the Bank to the Company, then no valid set-off can be made against the Director’s Loan.

33.  In support of his contention, Lung has produced a Deed of Charge on Account and Set Off dated 18 January 2002 to show that the Deposit had been pledged as a security for the loans advanced to the Company.

34.  Unfortunately, Wu has not produced any evidence to rebut Lung’s allegation in this regard.  In the absence of any evidence from the Company or Wu to show that Lung can have immediate access to the Deposit, I do not accept that the Company or Wu can use the Deposit to set-off the Director’s Loan. 

Misappropriation of the Company’s asset and diversion of the Company’s businesses

35.  Finally I come to the cross-claims made by the Company in the High Court Action (apart from the claim for the return of the Deposit).  In the High Court Action, the Company, Wu and Liang claim against Lung for the return of the mould costs paid by the Company’s client which had been misappropriated by Lung.  Further, they claim for the account of profit made by Lung in diverting the Company’s businesses to Oriental Bind.

36.  In reply to these allegations, Ms Fong, counsel for Lung, submits that the Company and Wu have made these serious allegations without substantive particulars or proof, and so the court should disregard these allegations for the purpose of the striking out application.

37.  In my judgment, the court should not just look at the allegations in the pleadings in the High Court Action in determining whether the Company would have a cross-claim on substantial grounds against Lung. Instead, the court should focus on the quality of the evidence that can be put forward by the Company and Wu in substantiating these allegations.

38.  In this regard, Wu is able to produce the following documents to substantiate the allegations:

(i)   an unsigned letter dated 13 August 2007 (“the Lihit Letter”) sent in the name of Lung to the Company’s client known as “Lihit Lab”, introducing one Perfect Keen Ltd (“Perfect Keen”), which was wholly owned by Lung, as a related company of the Company, and that the factory of Perfect Keen would conduct future business with Lihit Lab;

(ii)   various emails (“the Emails”) between Lung and at least 3 entities, namely Bantex, Hamelin Brands and Farook International Stationery, about various purchase orders apparently diverted from the Company to Oriental Bind.

39.  Further, Wu claims that he has contacted Lihit Lab and learns that Lung had instructed Lihit Lab to pay the mould costs due to the Company to Perfect Keen.  Further, the person-in-charge of Oriental Bind appeared in the Emails, Gary, is the son of Lung, and this supports the Company’s allegation that Lung had been diverting the Company’s businesses to his related company.

40.  Facing these allegations, Lung denies that he has ever sent the Lihit Letter to Lihit Lab.  But quite surprisingly, Lung has not made any substantial reply about the Emails, and he has not made an express denial that he had not diverted any businesses of the Company to Oriental Bind. In her submission, Ms Fong submits that her client had not managed to divert any businesses to Oriental Bind.  However, counsel is not supposed to give evidence from the Bar table and so I would ignore her submission in this regard.

41.  It is clear that Lung, being a director of the Company, owed a fiduciary duty to the Company and should not have diverted the Company’s business orders to other companies.  By looking at the contents of the Emails, there is some substance in the Company’s allegation about the diversion of businesses.  Without any creditable explanation by Lung, it is very difficult to explain why Lung had written the Emails discussing orders to be placed by these entities with Oriental Bind.  Obviously, it would not be possible for the Company to know before discovery the extent of the businesses diverted from the Company to Oriental Bind, but the Emails, in my judgment, are documents which support that the Company does have a genuine and serious cross-claim based on substantial grounds.

42.  On the other hand, the Lihit Letter was unsigned, and so there is some doubt as to whether Lung had actually misappropriated the mould costs due to the Company.  However, as there is some evidence to substantiate the Company’s claim for diversion of businesses, the complaint about misappropriation of mould costs should also deserve serious investigation by the court.  Hence, I am satisfied that these are genuine and serious cross-claims.

Conclusion

43.  In Lung’s affirmations, he also complains that he has been unfairly excluded from the management of the Company.  However, these allegations would not be relevant for the court in determining whether there is any substantial dispute between the parties about the underlying debt and the cross-claims.  Lung can seek to wind-up the Company based on the ground of unfair prejudice in the conduct of the Company’s affairs under s 168A of the Companies Ordinance (Cap 32), but these allegations would not be relevant for the court in determining the present petition which is one based on the non-payment of debt.

44.  For the above reasons, I am satisfied that there are genuine and serious cross-claims in respect of the reimbursement of the legal expenses and the claims for misappropriation of the Company’s asset and diversion of the Company’s businesses.  So far as the quantum of the cross-claims is concerned, the claims for the reimbursement of legal expenses and misappropriation of the Company’s asset amount to $917,500 and $1,000,000 respectively.  The quantum of the claim for the account of profit relating to diversion of businesses is unclear at this stage, but taking into account the liquidated claims for the earlier items, I am satisfied that there are genuine and serious cross-claims the quantum of which is equal or greater than the amount of the Director’s Loan.  In such circumstances, the petition should not be allowed to proceed.

45.  There is also a serious dispute between the parties as to whether the Company is solvent at this stage.  As I have found that there are genuine and serious cross-claims on substantial grounds, it is quite unnecessary for me to determine this particular issue.  In any event, as the present case is very much a shareholders’ dispute focusing on the financial condition of the Company, the court has to seriously investigate the financial accounts of the Company in determining the various issues relating to the cross-claims.  In my judgment, this is not an appropriate case for the Companies court to exercise the jurisdiction to wind-up the Company, and the petition should therefore be struck out.  I make the order accordingly.

46.  In accordance with the directions given by Harris J, the petition will be adjourned to the first Monday after the handing down of this Judgment, i.e. 17 February 2014, for the final disposal of the petition.

47.  I also make an order nisi that the costs of the summons be paid by the petitioner to the opposing creditor and contributory, the Company and the Official Receiver, which shall be made absolute 14 days after the date of the handing down of this Judgment.