DEACON TE-KEN CHIU v. RONALD LI-KAI CHU AND OTHERS

IN THE SUPREME COURT OF HONG KONG

HIGH COURT

MISCELLANEOUS PROCEEDINGS

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JUDGMENT

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1. This is an application by the respondents to strike out the petition the petitioner has filed under s. 168A of the Companies Ordinance (Cap. 32). The petition alleges unfairly prejudicial conduct on the part of the respondents and prays first, that the respondents be ordered to buy the shares of the petitioner at a fair price to be assessed on his shareholding preceding the diminution of which he complains; second, in the alternative, that the respondents sell their shares to the petitioner on a similar basis; or third, in the alternative, for such other order as may be just and expedient.

2. There is a long and involved history to the matter. Fortunately, it is not necessary to go into all of it in any great detail. The petitioner and the 1st respondent, both originally from Shanghai, have been associated in the business of operating cinema houses in the New Territories since about 1955. They operated them as joint-ventures almost invariably on a 50-50 basis. The petition is concerned here with only one joint-venture, i.e. Fan Ling Theatre Limited ("the company") under which the Fan Ling Theatre was operated and the land and building concerned owned. As the land was originally leased by the 2nd respondent, he was brought into the venture and given 20% of the shares, the remaining shares being split between the petitioner and the 1st respondent each of whom received shares equivalent to 40% of the venture.

3. In the late Nineteen Sixties, relations between the plaintiff and the 1st respondent deteriorated and there was litigation between them concerning the several other theatres in the New Territories. None of the other New Territories theatres continues to be operated as a joint-venture and the Fan Ling Theatre is the sole subsisting joint-venture theatre between the parties. In his petition, the petitioner claims that it was a basic understanding of the several joint-ventures and of the Fan Ling Theatre joint-venture that the snareholding would be divided 50-50 between the petitioner and the 1st respondent and that in relation to the Fan Ling Theatre joint-venture, the effect of the basic understanding was that the exercise of voting rights between them would be exercised in such a manner as not to upset the 50-50 balance.

4. About 1976, the company purchased the Fan Ling Theatre site, and for that purpose its capital was increased from $200,000 to $1m. The 2nd respondent did not take up his proportionate share and the shareholding that resulted was as follows : petitioner 4,800 shares, i.e. 48%; 1st respondent 4,800 shares, i.e. 48%;  2nd respondent 400 shares, i.e. 4%.

5. In 1978 the relationship between the petitioner and the 1st respondent again deteriorated and further litigation resulted. From then onwards, discussions and contacts between them were maintained by correspondence or through their staff or representatives.

6. In may 1988, the petitioner goes on to complain in his petition, the 1st, 2nd and 3rd respondents purported to pass resolutions -

7. The 2nd respondent's shareholding was thus reduced to 300 shares, i.e. 3%, the 3rd respondent acquiring 100 shares, i.e. 1%.

8. The plaintiff's complaint of the conduct of the company's affairs in an unfairly prejudicial manner relates primarily to the increase of share capital from $1m to $2m by the majority vote of the respondents and the denial to the plaintiff of a proportion of the new snares by the improper imposition of a 21 day time limit, thereby reducing his shareholding by effecting the following result: petitioner 31.58%, 1st respondent 63.95%, 2nd respondent 3.95%, 3rd respondent 1.31%.

9. The petitioner claims that he accepted the shares offered to him and conmunicatea his acceptance, although by implication conceding that his payment for those shares may have been made after the expiration of the 21 days, which he submits is irrelevant.  The petitioner's response is that by failing to pay in time the petitioner did not accept the shares; furthermore that he was afforded an opportunity to convene a Board meeting to authorise late acceptance which he declined. I do not think it is necessary to go into all the details of the charges and counter charges and the exchange of correspondence.

10. In his petition, the petitioner also complains about a plan being implemented by the majority vote of the 3 respondents ostensibly to renovate the theatre but in fact to replace it with 2 mini-theatres, which he says does not make good business sense.  He complains also that the share capital was further increased from $2m to $4m; and that no notice of the foregoing matters was given to him and, moreover, his representatives were excluded from the meetings concerned and other meetings.

11. The respondents, of course, have their own explanation and a somewhat different version of the events.

12. In their application to strike out the petition, which they make under 0. 18, r. 19 of the Rules of the Supreme Court and the inherent jurisdiction of the court, the respondents rely upon all 3 grounds in r. 19 i.e.  that the petition discloses no reasonable cause of action, or is frivolous or vexatious, or otherwise an abuse of the process of the court.

13. I turn then to consider the 1st ground i.e.  that no reasonable cause of action is disclosed. In practical terms the respondents mean that no unfair or prejudicial conduct is averred on the face of the petition. It must be said that while this ground was not abandoned, it was rightly not very seriously pursued by Mr. Alan Yau for the respondents.   I am able to say at once that on the face of the petition (which is of not inconsiderable length, the particulars relied upon stretching alone to no less than 16 pages) there are clearly averments that do disclose a reasonable cause of action i.e.   conduct unfairly prejudicial to the petitioner. Some of these I have already outlined. That the way in which the averments are formulated may be open to some of the criticism leveled by Mr. Yau in no way undermines that conclusion.

14. I proceed then to consider the second and third grounds which can conveniently be dealt with together, as Mr. Yau, and Mr. Daniel Fung Q.C. have done in their submissions, in the context of the following 3 issues :

15. Beginning with the first issue, ofcourse the respondents deny that they have been guilty of conduct unfairly prejudicial to the petitioner in the affairs of the company.   They contend that the petitioner having failed to take up shares on the 2 increases of share capital, those shares were properly taken up by the respondents; that the mini-theatres proposed are a sound business proposition; that in any case, business efficiency is not an appropriate matter for the court to determine; and that the petitioner's representatives were rightly excluded from the meetings of the company complained of. I have already stated my view that the averments in the petition do disclose conduct unfairly prejudicial. I do not propose to recount the considerable evidence for and against such conduct nor my analysis of it.  suffice it to say that having carefully examined it all, I have no hesitation in finding that it is very far from plain and obvious that those averments are unsustainable.

16. More specifically, I find myself unable to say that the understanding pleaded by the petitioner between him and the 1st respondent, that their respective shareholdings would be 50:50, is obviously unsustainable. The concept of unfair prejudice enables the court to take into consideration such legitimate expectations arising from agreements and understandings of the members of a company inter se (Re : Posgate & Denby (1987) BCLC 8). Likewise I find myself unable to dismiss the petitioner's other complaints as unsustainable, i.e.   the increase of authorised share capital from $1m to $2m, then from $2m to $4m, the passing of the related resolutions, the time limit of 21 days within which to take up the new shares, which time limit did not appear to have been duly sanctioned by a resolution of the board or company embarking upon the construction of 2 mini-theatres under the guise of renovation, and improper exclusion of the petitioners proxies from board and company general meetings.

17. I have carefully considered the respondents submissions in reply, in the context of whether their conduct in the foregoing respects was unfairly prejudicial to the petitioner.   Notwithstanding that a considerable amount of the evidence is in the form of company documents and correspondence between the parties, and that clearly the petitioner for his part can hardly be said to have always been reasonable, again I am not able to conclude that it is plain and obvious that the conduct of the respondents in question was not unfair.  Finally at least in reducing the petitioner's shareholding in the company and therefore in the valuable theatre site, it was clearly prejudicial.

18. Turning then to the second and third issues, which can conveniently be examined together, Mr. Fung raised the preliminary point that the motion itself is an abuse of process as it would not lead to resolution of the practical difficulty facing the parties, but, if the respondents were successful, would exacerbate it. The point is the failure of the parties to agree the basis of valuation. It turns upon the fact that the major asset of the company is the land upon which the Fan Ling Theatre stands, which is said to have been valued on the petitioner's behalf at a sum $10m. A valuation on the basis of the profits of the company, would, it is suggested, not reflect that value. Mr. Fung pointed to the judgment of Nourse J. (as he then was) In re Bird Precision Bellows Ltd. (1984) 1 Ch 419 at 430D - E, where he said in relation to a minority shareholder that :-

"On the assumption that the unfair prejudice has made it no longer tolerable for him to retain his interest in the company, a sale of his shares will invariably be his only practical way out short of a winding up. In that kind of case it seems to me that it would not merely not be fair, but most unfair, that he should be bought out on the fictional basis applicable to a free election to sell his shares in accordance with the company's articles of association, or indeed on any other basis which involved a discounted price. In my judgment the correct course would be to fix the price pro rata according to the value of the shares as a whole and without any discount as being the only fair method of compensating an unwilling vendor of the equivalent of a partnership share."

This was affirmed by the Court of Appeal; (1986) 1 Ch 658 at 667B - 669F and 675E - F per Oliver LJ and at page 677F per Purchas LJ.

19. Mr. Fung referred also to the following passage in Re A Company No. 007623 of 1984 (1986) 2 BCC 99,191 at 99,197 where Hoffman, J. in holding that a discount should be made in the circumstances of that case to reflect the lower value of a minority shareholding said :-

"A fair value must in my judgment reflect the potential value of the shares to both vendor and purchaser. It was common ground that an outsider would not be willing to pay more than a nominal sum for the petitioner's shares. It was also clear that he would not, on a winding up, obtain his proportionate part of anything like the value of the company calculated on the basis of its previous earnings."

20. However no difficulty arises from any possibility of a discounted minority shareholding following Mr. Yau's concession made in the course of submissions, that the valuation may be made upon the basis of the value of the shares as a whole and without any discount.   But Mr. Fung contends that the fair value of the shares should be assessed by reference to the potential or development value of the land. This the respondents do not feel able to concede as they not unreasonably consider that there is no guarantee that they will be permitted to develop, nor as to what amount of premium they might be required to pay to the Government and so forth. They say the valuer should have a free hand in determining the fair price. The matters raised seem to me precisely the sort to which an expert valuer would best be able to give due weight in the assessment of fair value. It is suggested on behalf of the plaintiff that the valuer should be required to assess or specifically take into account the development value of the land. I do not consider that necessary or appropriate; an expert valuer should I think be free to take into account all the factors he considers relevant including potential value, subject ofcourse to subsequent correction by the courts in the normal way where a mistake or error of principle can be shown. In that context Mr. Fung has expressed concern that a non-speaking valuation may limit the scope for intervention by the courts. I do not think that warrants a direction by this court possibly requiring a departure from the provision in article 32(iii) agreed by the parties themselves. Nor is there any reason to suppose that a valuer will not take due account of the development value. To direct that one single factor to be taken into account may unbalance the weighing of other relevant factors that an expert valuer no doubt carries out. In reaching that conclusion I have found reassurance in the views of Hoffman, J. in his similar dismissal of the submission that a valuation by an independent valuer was not likely to be a speaking valuation in Re a Company No. 006834 of 1988 (1989) 5 BCC 218 at 222 H, 223 A. In my judgment, therefore, there is no reasonable objection to the form and manner of valuation offered by the respondents. It follows that the respondents' motion cannot be regarded as an abuse of process.

21. I revert then to the second and third issues mentioned, i.e.  whether the petition is premature because the petitioner ought first to have availed of the buy out mechanism in article 32, and whether he has unreasonably rejected a reasonable offer and ought therefore not to be permitted to persist with his petition. In XYZ Ltd. (No. 004377 of 1986) (1986) 2 BCC 99,520, 99,527 Hoffman, J. in circumstances not dissimilar in principle said this:

"In these circumstances it seems to me that if the articles provide a method for determining the fair value of a party's shares, a member seeking to sell his shares on a breakdown of relations with other shareholders should not ordinarily be entitled to complain of unfair conduct if he has made no attempt to use the machinery provided by the articles.  I say nothing about cases in which there has been bad faith or plain impropriety in the conduct of the respondents or about cases in which the articles provide for some arbitrary or artificial method of valuation. But a provision that the auditors (or some other independent person) shall fix a fair value' for the shares gives the auditors precisely the function which a court would have to perform under sec. 459.  The auditors will be free to have regard, if they think it fair to do so, to any of the matters mentioned by Nourse J. in Re Bird Precision Bellows Ltd [1984] Ch. 419; (1984) 1 BCC 98,992 or by me in Re a Company (No. 007623 of 1984 (1986) 2 BCC 99, 191.   The only difference is that the court's valuation will take longer and be far more expensive. I therefore do not consider that in the normal case of the breakdown of a corporate quasi-partnership there should ordinarily be any 'legitimate expectation' that a member wishing to have his shares purchased should be entitled to have them valued by the court rather than the auditors pursuant to the articles ..."

I would adopt what Hoffman, J. says. In my view it follows from that and what I have just said in relation to Mr. Fung's preliminary point concerning the basis of valuation, that insofar as the value of his shareholding is concerned, the petitioner ought to have availed of the buy out mechanism in article 32(iii) before filing his petition; and likewise that his rejection of the final offer made by Mr. Yau on behalf of the respondents during the hearing was an unreasonable rejection of a reasonable offer.

22. However both those grounds necessarily involve the assumption that he, the petitioner and not the respondents, should go. This being an application to strike out, Mr. Fung submits, rightly in my view, that neither ground would operate against the petitioner unless it was plain and obvious that he should go.

23. I should, first of all, say that it is common ground that relations between the parties have irretrievably broken gown. There is authority which I adopt that where this happens, the only solution is for them to part company (see Re a Company No. 007623 of 1984 (1986) 2 BCC 99,191 at 99,194, per Hoffman, J. and Re a Company No. 003096 of 1987 (1988) 4 BCC 80, 91 per Peter Gibson, J.).  That proposition is in any case not disputed by the parties. But each says the other should go.  For the respondents, Mr. Yau points to powerful and cogent reasons and considerations that it is the petitioner who should go: that the respondents are and have been actively concerned in the management of the company since 1986; that the petitioner has shown little interest in the affairs of the company and did not attend board meetings between July 1986 and August 1988, nor company meeting except through proxies since the end of 1988; that it is the respondents who have been and continue to be interested in the cinema business of the company and planning for the future; that the petitioner takes the view that "the Fan Ling Theatre site is ripe for intensive redevelopment into a high rise composite commercial and residential building" and has obtained a $10m development valuation; that the petitioner is willing to be bought out and has been prepared to put the venture up for sale; and that it is the respondents who hold the majority shareholding. Mr. Au also referred to the following passage from the judgment of Hoffman, J. in Re a Company (No. 006834 of 1988) ex parte Kremer (1989) BCLC 365 at 367 H:

"I think it must be very unusual for the court to order a majority shareholder actively concerned in the management of the company to sell his shares to a minority shareholder when he is willing and able to buy out the minority shareholder at a fair price ...."

24. It must be said in the context of the non-attendance of the petitioner at meetings, that the breakdown of relations between him and the 1st respondent which presumably made meetings an unpleasant matter, may in some degree account for that. And, in that regard it seems clear to me that the matters before me are only a skirmish in the long drawn out war between the two. Also I would add while the petitioner was the minority shareholding, it was nonetheless a substantial 48% prior to the disputed matters. Finally the respondent's offer made during the hearing was to purchase the petitioner's shareholding on a pro-rata basis valued as a whole, without any discount or minority discount, on the pre-existing basis at 10th March 1989 (i.e. 48%), the valuation to be carried out by an independent valuer who was to have a free hand in determining fair value.

25. For the petitioner, Mr. Fung submitted that the situation arises from the unfairly prejudicial conduct of the respondents; that the petitioner was a pioneer and has had a continuous interest in the operation of theatres in the New Territories; that he wanted and secured 50 : 50 participation from the outset and maintained it through the worst; that he was keen to maintain his participation and insisted upon allotment of his proportion of shares; that even after filing his petition, he made it clear that he remained keen to acquire the respondents' shareholding.

26. I feel bound to say that I find it difficult to accept the thrust of that submission given such evidence and indications as I have before me. But the petitioner relies also upon his claims of bad faith and impropriety in their conduct of the affairs of the company against the respondents in the several respects I have mentioned. In my view those are clearly matters that have to be taken into account in deciding who should go (see also Re a Company No. 003096 of 1987 (1988) 4 BCC 80, 93). They could have a significant effect. I am unable to sufficiently resolve the nature of the bad faith and impropriety simply upon the affidavit and documentary evidence before me to the point that I could safely come to a conclusion that it is plain and obvious that it is the petitioner who should go. Indeed I have had difficulty in resolving to the requisite standard some of the other points taken by Mr. Yau and Mr. Fung (and also the existence of unfairly prejudicial conduct from which section 168A jurisdiction flows) without the benefit of a hearing of the petition. For those reasons and notwithstanding the powerful submissions made by Mr. Yau,the cogent reasons he pointed to and my reservations about Mr. Fung's submissions about the petitioner's motives (which, on the evidence, seem to be the realization of the maximum potential value of his shareholding) I am unable to reach the conclusion that it is plain and obvious that it is the petitioner who should go. It follows therefore that on this account (thought not upon the assessment of fair value), I am unable also to reach the conclusion that it was unreasonable for the petitioner to bring his petition and to persist with it. The respondents' application to strike out therefore fails and is refused.

27. I nave given my reasons at length in the hope that they may assist the parties to yet come to terms upon the matter of fair value and spare themselves and the courts yet further ventures in their forensic saga.

28. I will now hear counsel upon costs.