ZHI CHARLES v. KIM YOUNG JUN AND OTHERS

HCA 1821/2015

IN THE HIGH COURT OF THE

HONG KONG SPECIAL ADMINISTRATIVE REGION

COURT OF FIRST INSTANCE

ACTION NO 1821 OF 2015

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D E C I S I O N

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1.  This is the plaintiff’s summons seeking to restrain the 9^th defendant from holding an AGM until further notice.

Background

2.  The plaintiff (“Mr Zhi”) is a minority shareholder of the Company holding 0.06% (290,000 shares out of over 500,000,000).  D1 is said to be the beneficial owner of 43% of the shares in the Company and having control of more than 50% of the voting power of the Company or the board of directors.  D2-7 are the current directors.  D8 is the current auditor. 

3.  D9 (“the Company”) is listed on the main board of the Hong Kong Stock Exchange.  It engages in the business of, amongst others, coal mining, mineral resources and commodities trading.

4.  On 31 October 2008, the Company, acquired stakes in a coal mine in Russia.  Part of the consideration would be satisfied by the issue of the Third Convertible Notes by the Company to the vendor.  A condition precedent for that issue was, amongst others, a technical report on the proved and probable reserves of coal at the mine being not less than 12 Mt.

5.  The Third Convertible Notes (US$443,070,000) were issued to the vendor on 3 April 2013, allegedly based on what was known as the HASS Technical Report which purportedly met the condition precedent.

6.  On 22 April 2013, the Company applied for suspension of trading of its shares. 

7.  There was a wholesale change to the board of directors in February 2014.  D2-7 have been appointed to the board since then.

8.  Subsequently, Mr Zhi and others instituted a number of legal actions and lodged numerous complaints with various regulatory bodies.  There was delay in the finalization of the Company’s audited accounts and announcement of its financial result.  Suspension of trading continued.

9.  On 22 April 2015, the Company announced its audited reports and declared that conditions for resumption had been satisfied (“the Resumption Announcement”).  The announcement referred to Roma Opinions which gave opinions on a Supplementary HASS Technical Report.  The Company stated that its interests in the coal mines and its liability under the Third Convertible Notes were properly reflected in its consolidated financial statements. The Stock Exchange gave approval for the resumption of trading on 24 April 2015. 

10.  On 30 July 2015, the Company gave notice of an AGM to be held on 4 September 2015 (“the AGM”), the purpose of which is to re-elect directors and auditors, to approve the audited consolidated financial statements and the annual reports of 2013, 2014 and 2015, and approve general mandates to directors to issue 20% shares.  Mr Zhi seeks to restrain this AGM from going ahead.

Mr Zhi’s case

11.  Mr Zhi challenged the correctness of the HASS Technical Report and asserted that the condition precedent for issue of the Third Convertible Notes was not met.  The Roma Opinions (not being a technical report) could not salvage the position. 

12.  Mr Zhi further asserts that the current directors and auditors were appointed by the former board of directors at the behest of D1.  They have since “ardently strived to legitimize” the Third Convertible Notes by working with the auditors to provide the delayed audited reports of 2013 and 2014 (collectively “the Audit Reports”) and satisfy the Resumption Conditions.  

13.  Mr Zhi claims that the Audit Reports prepared by D8 were wrong and an “accounting sham”. For example, the 2013 Audit Report included the Third Convertible Notes which were only issued in the following financial year.   He says that this was intentionally done to make the 2014 Audit Report appear better than the 2013 figures.  Since the 2013 Audit Report was wrong, so was the 2014’s.  The 2015 Audit Report omitted the statement of cashflow and of changes in equities.

14.  Further, the company owed debts of of US$300,000,000 and D2 (just an employee living in Korea) had purportedly given HK$400,000,000 loan facilities to the Company.  Mr Zhi said that this was just something that the Company used to fulfill the resumption conditions.  The auditor overlooked these facts.

15.  Mr Zhi asserts that the Company’s directors paid “high fees” to the auditors to procure them to issue an improper audit report. He said that the shares should not have resumed trading and the Resumption Announcement was misleading.  (See §§38-45 of his 1^st affirmation.)

16.  According to Mr Zhi, the Third Convertible Notes constituted the bulk of the US$300,000,000 debt of the Company, in which D1 has much vested beneficial interest.  A conversion price set at $48 is already an insurmountable burden which would eventually lead the Company into permanent insolvency.  Resetting the conversion price would dilute the interests of independent shareholders, including Mr Zhi. The Company’s shares have been suspended for 2 years and the Company failed to provide proper audit reports until very recently.  The resumption in trading was only to allow D1 to dump over 50 million shares and trade away the Third Convertible Notes. 

17.  The generally endorsed writ seeks, against the Company,

(a) A declaration that the audit reports prepared by D8 are not appropriate for presentation at the AGM;

(b) An order not to convene any general meeting to approve the audited reports prepared by D8, to elect D2-7 as directors, and to allow for general mandates for conversion of any debt in the shares of the Company or for resetting of the conversion price of the Third Convertible Notes, until the validity of the Third Convertible Notes is determined by the court;

(c) Equitable damages.

18.  In relation to the present summons, Mr Zhi claims that the directors were not properly elected in the past and so it was a misnomer to have them re-elected.  Approval at an AGM will help legitimize the Third Convertible Notes and the Audit Reports.  A delay of the AGM for a few weeks will not prejudice the Company but the passing of a detrimental resolution without due process would permanently prejudice the Company. If misconduct is found, the reality is that any enforcement of sanctions and remedial measures would likely become ineffective.  Mr Zhi thus seeks this injunction to prevent unfairly prejudicial consequences for independent shareholders. 

Procedural irregularity

19.  Mr Zhi’s summons was issued on 11 August 2015 and served on the Company on the 12^th.  There was less than 2 clear days’ notice in contravention of Order 32, r 3(1).  Mr Kwok, counsel for the Company, is however content to argue for the dismissal of the summons without the Company’s affirmation in opposition.  In the premises the court only has before it the 3 affirmations of Mr Zhi, the last of which was filed and copied to the Company on the day of this hearing.

Legal principles for the grant of the injunction

20.  It can readily be seen that the relief sought in the summons is one of the final reliefs sought in the writ. 

21.  Where the grant of an injunction would in effect summarily decide the litigation in favour of the plaintiff and possibly conclude the litigation altogether, the court would not apply American Cyanamid principles, but examine the merits of the claim more closely and would take account of the parties’ respective prospects of success so as to avoid injustice to the defendant. In particular, the court would be reluctant to grant injunctive relief where the evidence before it “did not present any overwhelming balance on the merits in the plaintiff’s favour, or any other overriding ground for an immediate injunction without trial”: see Cayne v Global Natural Resources plc [1984] 1 All ER 225 at 236b-f per Kerr LJ.

22.  Likewise, the authorities in the Hong Kong courts show that the plaintiff in such a situation has to show that he is “very likely to succeed at trial”: Liao Zhiqiang & ors v Cheung Sin Ling Vicki & ors, HCA 1886/2013 (unrep., 16 April 2014) at §28 per DHCJ Wilson Chan; or has “a good prospect of success”: Chinaplus Wines Ltd v Berry Bros & Rudd Ltd & ors, HCA 1818/2012 (unrep., 13 December 2012) at §§32-33 per Anthony Chan J;  Hong Kong Civil Procedure 2015, Vol 1, §29/1/18.

Likelihood of success

23.  The interim relief sought by Mr Zhi may dispose of part of the action against the Company.  Mr Zhi has to show that he is very likely to succeed at the trial.

24.  From the evidence, one can see an intricate web of relationship among D1-7 and their related entities.  There are allegations against D1 of embezzlement and illegal channeling of funds to the Company. There had been a change of 3 firms of auditors within a span of 12 months.

25.  The Company’s attempt to hold a board meeting to announce delayed annual and interim reports has been thwarted because of 2 High Court actions taken out by the shareholders of the Company (eventually discontinued) and another one taken out by Mr Zhi (which is subject to an application for striking-out due to be heard in a month’s time). 

26.  The crux of the disputes in those actions was, like the present case, whether or not the condition precedent for the issue of the Third Convertible Notes had been fulfilled, ie whether the Company had obtained the technical report required.

27.  The Third Convertible Notes were issued after advice of 2 senior counsel was obtained by the Company but Mr Zhi has produced little evidence in proof of his case.  The documents he exhibited are mainly documents in the public domain (principally company announcements) or letters of complaint to regulatory authorities. 

28.  There is a set of transcript of conversation between him and the CEO of the Roma Group Ltd on 21 May 2015 (Exhibit CZ-9).  There was one statement purportedly coming from one Kelvin Luk (of Roma) that “their audit report has lots of problems”.  Mr Zhi claims that the transcript shows that :

(a) ROMA strongly believed that there were numerous problems in the Resumption Announcement and the Audit Reports;

(b) ROMA was in a position to know or address the Company’s reports because both the Announcement and the Audit Reports relied heavily on the opinions of ROMA.

(c) Kelvin Luk affirms that some of the statements made by the Company pertaining to the ROMA assessment on the Russian coal mine were inaccurate;

(d) That the Company, the auditor and the current directors should all be liable for the accounting scam and misleading announcement.

29.  The transcript was said to show irrefutable evidence of the “accounting scam and the misleading announcement to defraud the Hong Kong financial regulatory establishment and innocent investors”. 

30.  However, it was not clear what the proper context was in which the representations were made.  They were made by Roma, not the Company or the auditor.  The allegations of Mr Zhi are highly contested.  Even if the Audit Reports were problematic, there was no evidence, let alone expert evidence, as to how any alleged problems related to the issue of the Third Convertible Notes.

31.  The allegations against the directors is that they paid “high fees” to the auditors to procure them to issue an improper audit report (§3.2 and 3.4 of the writ).  Mr Zhi confirms in his oral submission that he is alleging fraud against the directors and auditors and is expecting the Company to dispute it.  Mr Zhi’s affirmations have not given details of the fraud.  The statement of claim is yet to be filed.

32.  Mr Zhi also confirms in oral submission that this is a derivative action taken out by him on behalf of the Company. However, as pointed out by Mr Kwok, this is quite inconsistent with Mr Zhi’s stance in seeking relief against (instead of for) the Company in the writ, namely, equitable damages.

33.  Taking the 3 affirmations at their highest, I am not satisfied that Mr Zhi has shown high likelihood of success of his claim.  It is not appropriate to grant an interim injunction on the basis of unsubstantiated allegations.

Balance of convenience

34.  Assuming I am wrong in applying a higher standard than American Cyanamid in this case, there are certainly serious issues to be tried on Mr Zhi’s allegations.  Where then does the balance of convenience lie?

35.  Mr Zhi’s affirmations suggest that the AGM should be adjourned until

(a) A one day hearing of this case; or

(b) Completion of the SFC’s investigation of D1’s misconduct or Stock Exchange’s investigation on whether there is any violation or misconduct.   

36.  With regard to (a), trial of this case will much exceed one day.  Given that even the statement of claim is not yet filed, the trial will take place beyond 4 September 2015.

37.  With regard to (b), investigation by a statutory body is of a different nature from the application now before the court.  The time taken for investigation is also out of control of the court.  It is undesirable, in my view, to adjourn an AGM indefinitely.

38.  The Company has not held an AGM for 3 accounting years, in breach of the Companies Ordinance.  Its ability to function properly will be affected.  Its listed status will be in jeopardy.

39.  The directors and auditors were appointed after the Third Convertible Notes were issued and the re-election is to maintain the status quo.  There was no suggestion that any of them was related to the vendor of the mine.  It is unclear why the current directors would want to “legitimize” the Third Convertible Notes if they were issued under dubious circumstances by the previous directors.

40.  I do not agree with Mr Kwok that the other resolutions are uncontroversial as they touch upon the validity of the Third Convertible Notes. 

41.  Mr Kwok informs the court that Mr Zhi is unlikely to meet any undertaking as to damages because he has failed to settle a number of cost orders in different actions.  However, there is no evidence before the court on this aspect.  There is also no application by the Company for Mr Zhi to fortify the undertaking as to damages.  For present purposes, I make no finding against Mr Zhi on this aspect.

42.  On the other hand, the loss which Mr Zhi will suffer is, even on his suggestion, most likely a dilution of his interest which is compensable by damages.  The Company appears to have taken out a lot of loans but there is no suggestion that the Company is not able to meet the damages.

Conclusion

43.  Mr Zhi fails to pass the first hurdle of showing that he is very likely to succeed at the trial to justify the injunction sought.  The balance of convenience is against the grant of an injunction.  Accordingly, I dismiss the summons.

44.  There shall be an order, nisi, that Mr Zhi shall pay the Company’s costs, summarily assessed at $70,000.

45.  I thank Mr Kwok for his assistance.