CHEUNG HON WAH v. CHEUNG KAM WAH AND ANOTHER

HCMP 2686/2003

IN THE HIGH COURT OF THE

HONG KONG SPECIAL ADMINISTRATIVE REGION

COURT OF FIRST INSTANCE

MISCELLANEOUS PROCEEDINGS NO. 2686 OF 2003

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J U D G M E N T

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1. This is an application by the Petitioner, Mr Cheung Hon Wah, by summons dated 12 August 2003, seeking the appointment of Messrs Stephen Briscoe and Cosimo Borelli of RSM Nelson Wheeler Corporate Advisory Services Ltd as receivers in respect of the 2nd Respondent company, Kammy Town Ltd ("the Company") pending the hearing of the Petition in these proceedings. The 1st Respondent to the Petition is Mr Cheung Kam Wah, the brother of the Petitioner. The summons proposes that the receivers, if appointed, be given wide powers to carry on the business of the Company.

2. The Petition, which is dated 24 June 2003, is presented under section 168A of the Companies Ordinance, Cap. 32 ("the Ordinance"). It seeks an order from the court that the 1st Respondent be ordered to sell his shareholding in the Company to the Petitioner at a price to be determined. According to the Petition, the only shareholders in the Company are the Petitioner and the 1st Respondent, each of whom own 50% of its issued shares, and who are its only directors. So much is not in dispute, although it is the 1st Respondent's case that the Petitioner is not the beneficial owner of the shares of which he is the registered shareholder. However, Mr Chan, appearing for the 1st Respondent accepts that this is a matter which is at least arguable for present purposes, and that I should proceed on the basis that the Petitioner is the beneficial owner of such shares.

3. The business of the Company is the marketing and trading of ready to wear garments, which are manufactured in China. At least until recently, a major (if not the major) customer of the Company was Next plc, a well known retailer of garments in the United Kingdom.

4. According to the Petition, the Company represents the incorporation of a prior partnership between the brothers known as Li Wah Company, and is therefore in the nature of a quasi-partnership. It is said, however, that relations between the Petitioner and the 1st Respondent have now broken down, and that as a result of the breakdown, the Petitioner has been excluded from the day-to-day management of the Company and there is a deadlock at the board level, as the Petitioner and the 1st Respondent are the only directors. It was not seriously disputed that the brothers no longer get along, and that they are no longer able to cooperate with each other. The allegations in, and the tenor of, the evidence that has been filed on both sides speak to the marked deterioration in the relationship between them, with each accusing the other of impropriety and wrongdoing.

5. However, their respective versions of the causes of the breakdown in their relationship are very different. The Petitioner says that he was the person responsible for building up the garment trading business of the Company, and that the 1st Respondent paid little attention to that business, preferring to spend his time looking for investment projects on the Mainland. The Petitioner claims that towards the end of March 2002, the 1st Respondent said that he wanted to realise his investment in the Company, threatening to have it wound up if this could not be achieved. This, says the Petitioner, led to the brothers entering into a "home-made" buyout agreement, which essentially provided for the 1st Respondent to have a cash payment and certain assets of the Company (one of which was described as a property in College Road, Kowloon) as his share, while the Petitioner would be left with the garment trading business. However, the Petitioner says that not long after the agreement was entered into, the 1st Respondent was dissatisfied with the terms of the agreement, and began pushing for a better deal.

6. The Petitioner says that from summer 2002 onwards, things took a turn for the worse, and that the relationship began to deteriorate markedly. He says that Ms Cheung Lai Ming ("Ms Cheung"), their sister, who had been with the Company for many years, and who had for some time been a signatory on its bank accounts (although she was not a director), took sides with the 1st Respondent, and between them they caused serious difficulties for the Company in an attempt to put pressure on the Petitioner to improve the terms on which the 1st Respondent could depart the Company.

7. Thus, it is said that substantial sums were transferred out of the Company's bank account with the Hongkong and Shanghai Banking Corporation Ltd ("the HSBC account"), which the Petitioner says was the Company's main operating bank account, into another bank account of the Company maintained with Nanyang Commercial Bank Ltd ("the Nanyang account"). This, it is said, has resulted in certain debts to suppliers and providers of services not being paid, destroying business relationships which the Company had built up over the years. It is alleged also that there was evidence that Ms Cheung might seek to have the College Road property, which had been charged to the Nanyang Commercial Bank Ltd, released from that charge, which would be likely to trigger a demand from the bank for repayment of loans it had granted to the Company.

8. In addition, it is said that the 1st Respondent has caused difficulties with the Company's staff, resulting in the departure from the Company of some fourteen employees, and that he has instructed the remaining members of its staff not to take instructions from the Petitioner. He is also said to have caused the resignation of the Company's auditors of long standing and refused to sign the Company's audited accounts for the financial year ending on 31 March 2002. It is said that owing to his inefficiency or ineptitude, the Company has had to incur unnecessary expenses, such as airfreight expenses and penalties in relation to inadequate customs documentation. The Petitioner also complains that the 1st Respondent has denied him access to the Company's books and records.

9. Finally, it is said by the Petitioner that the 1st Respondent has unjustifiably taken out legal proceedings by way of a derivative action in HCA 1208 of 2003 ("the derivative action") commenced on 2 April 2003 for the benefit of the Company, accusing the Petitioner of attempting to divert the Company's main customer, Next plc, to another company in which the 1st Respondent wrongly (according to the Petitioner) claims the Petitioner is interested, called Li Wah (Dongguang) Garment Ltd.

10. The 1st Respondent, however, paints a very different picture of the background to the development of the Company's business, and of the breakdown in their relationship. According to the 1st Respondent, it was he, and not the Petitioner, who was primarily responsible for building up the garment marketing and trading business of the Company with the help of his sister, Ms Cheung. The 1st Respondent says that the Petitioner was employed in the business, but that he never applied himself to it. He suggests that in the past, the Petitioner had taken commissions from suppliers, and that more recently, he discovered that the Petitioner was misusing the Company's funds, using them to pay for expenses which had nothing to do with the Company, but which the 1st Respondent suspected were connected with businesses in which the Petitioner had an interest.

11. It is said by the 1st Respondent that it was the discovery of matters of this nature that caused him to transfer the Company's funds out of the HSBC account and into the Nanyang account, so as to ensure that the Petitioner could not effect any substantial payments on his own, without reference to either the 1st Respondent or Ms Cheung, with a view to preventing any further misapplications of the Company's funds by the Petitioner.

12. The 1st Respondent says that this year, the Petitioner volunteered to withdraw from the Company, this being evidenced by a letter from the Petitioner to the 1st Respondent dated 1 April 2003. By this time, the 1st Respondent had come to the view that the Petitioner was guilty of wrongdoing in relation to the Company, by taking steps to divert the business of the Company (particularly that with Next plc) to Li Wah (Dongguang) Garment Ltd, referred to above, and by inducing a number of the Company's employees to join him in this design, leading to the institution of the derivative action to which I have referred, in which injunctive relief was obtained against, among others, the Petitioner. It is said for the 1st Respondent that, having been caught out by the derivative action, the Petitioner has realised that he may not be able to deal with Next plc through other entities, such as Li Wah (Dongguang) Garment Ltd, and that this is the reason for his attempting, by these proceedings, to buy out the 1st Respondent's interest in the Company.

13. So far as the present application for appointment of receivers is concerned, it is clear that the court has jurisdiction to appoint interim receivers under both section 168A of the Ordinance and also under section 21L of the High Court Ordinance, Cap. 4. There was some debate as to the precise principles applicable to such an application in this case. Mr Fung, who appears for the Petitioner, has submitted that in a case such as this, where the shareholding and directorships in the Company are equally split between the Petitioner and 1st Respondent, the effect of a breakdown in the relationship between them is such that a receiver ought to be appointed almost as a matter of course. In support of this argument, he referred me to Re a Company No. 00596 of 1986 (1986) 2 BCC 99,063, where Harman J suggested that the analogy with partnership, where a falling out between the partners often results in the appointment of a receiver pending the dissolution of the partnership, was a good one. Mr Chan, however, suggested that the correct approach was to deal with the matter in a manner similar to an application for an interlocutory injunction, by asking first whether there was a serious issue to be tried, and if so, whether financial compensation would provide an adequate remedy. If not, the court should then go on to consider whether the balance of convenience lay in favour of or against the interim appointment sought. In support of this approach, Mr Chan referred me to Re Full Billion Shipping Ltd [2003] 2 HKLRD 674 and Re Niceline Co. Ltd [2003] 2 HKLRD 725.

14. In my view, the approach suggested by Mr Chan is to be preferred. It seems to me that even where there is alleged to be a deadlock in the management of a company, it is appropriate for the court to consider the evidence as to its effects, weigh those effects against the other factors bearing upon the balance of convenience, and having done so, come to a view as to where the balance of convenience lies in any given case. To do otherwise would be to elevate one factor (that of deadlock or alleged deadlock) to a position where it is given conclusive weight in the balancing exercise - this does not seem to me to be correct, for the effect of such an alleged deadlock may well vary from case to case.

15. I therefore approach the matter in the same way as did the court in the Full Billion and Niceline cases, and will go on to deal with each of the three stages that have been identified.

16. So far as the existence of a serious question to be tried in concerned, I have little difficulty in concluding that this requirement is satisfied. Although Mr Chan made a number of criticisms of the Petitioner's case, and forcefully put forward the 1st Respondent's view of the nature of the Petitioner's strategy in these proceedings, it is neither appropriate nor possible for me to resolve the differences between the parties' respective cases as to the cause of the breakdown at this stage. Only if I were satisfied, on the basis of the available evidence, that the Petitioner's case is wholly lacking in substance, would I consider that there is no serious issue to be tried. In my view, the evidence put forward by the Petitioner would, if accepted at trial, entitle him either to the relief sought in his Petition, or some other relief pursuant to section 168A of the Ordinance, and it does not seem to me to be possible to say that the evidence put forward by the 1st Respondent is such as could persuade me that the matters complained of by the Petitioner are wholly without foundation or entirely lacking in substance. I am therefore satisfied that there is, in this case, a serious question to be tried.

17. As for the second question, which relates to the adequacy of financial compensation as a remedy, this was not a matter which was really gone into by the parties. It would seem to me that, if the Petitioner succeeds in proving his case after trial, in the light of the relief sought in the Petition, questions will arise as to the value of the Company, and ultimately of which party should buy out the other, and at what price. These are matters that are in principle capable of being assessed in monetary terms. If, as the Petitioner suggests, the value of the Company has been diminished during the period up to trial by reason of the acts of the 1st Respondent, this would seem to me to be something that could be addressed in determining the price at which a buy out (if one is to be ordered) should take place. Thus, for example, if the court hearing the matter were satisfied that there has been such a diminution in the value of the Company for which the fault lies with the 1st Respondent, it would be open to the court either to permit the Petitioner to acquire the 1st Respondent's shareholding in the Company at a lower price, or alternatively to require the 1st Respondent to buy out the Petitioner's shareholding on the basis of a valuation that disregards any impairment in the value of the Company due to the 1st Respondent's actions, in particular those after the presentation of the Petition.

18. However, since this aspect of the matter was not, in my view, fully argued before me, and the evidence was not clearly directed to the respective parties' ability to buy out the other, I do not propose to decide the question of whether or not receivers should be appointed on an interim basis by reference to this point. I shall, therefore, go on to consider the question of where the balance of convenience lies in this case.

19. As to this, Mr Fung pointed to four main factors which he submitted pointed strongly in favour of an appointment of interim receivers. These were (1) that there was deadlock in the management of the Company; (2) that there had been clear mismanagement of the Company by the 1st Respondent; (3) that there was evidence of dissipation of assets under the management of the 1st Respondent, so that the assets of the Company should be regarded as being in jeopardy; and (4) that there was an urgent need for control to be exercised over the running of the Company.

20. In opposition to such an order, Mr Chan, apart from responding to the matters raised by Mr Fung, made the following points: (1) that the effect of an appointment of receivers would be likely to be extremely damaging to the Company; (2) that the cost of such an appointment would be prohibitive, and could not be justified having regard to the Company's financial circumstances; and (3) that having regard to the nature of the Company's business, a receiver, even if given powers of management such as those sought here, was not well placed to run such a business. In connection with this last point, Mr Chan made it clear also that the 1st Respondent did not accept that the receivers proposed by the Petitioner were well qualified to run the Company's business on an ongoing basis.

21. I shall deal with each of these points in turn. So far as the evidence is concerned, apart from the evidence filed in accordance with the directions for filing of evidence which had been given (which included a number of affirmations apparently made in these proceedings which were exhibited to the affirmations made by the principal protagonists), there were a number of late affirmations which were put before me. Shortly before the hearing, additional affirmations by the 1st Respondent and Ms Cheung were filed. These were objected to by Mr Fung. However, having considered their contents, I ruled that while the affirmation of Ms Cheung should not be used (since it seemed to me to contain little of probative value for the purposes of this application), the affirmation of the 1st Respondent could be used and referred to. Further, in the course of the proceedings short further affirmations were made for both parties, to which I have had regard, as notwithstanding formal objection being voiced to their introduction on both sides, they were dealt with substantially on their merits in the course of the argument before me.

22. I deal first with the question of deadlock. As to this, it seems to be common ground that for present purposes I should proceed on the basis of an equal split between the Petitioner and the 1st Respondent in terms of shareholdings and directorship on the board of the Company, Mr Chan having accepted that there was at least an arguable case in this respect. Mr Fung suggested that in these circumstances, the Company was in a state of paralysis, as the board and shareholders could not agree on anything. He submitted that any acts done by the 1st Respondent without the benefit of a board resolution or shareholder's resolution would be ultra vires the Company.

23. Mr Chan, however, submitted that the Company was able to and was carrying on its business. In this regard, he pointed to evidence in the later affirmations in which the Company's recent draft management accounts were disclosed, and in which there were also disclosed, although somewhat belatedly, evidence of reasonably substantial orders for the supply of garments to a number of different buyers. Although the quality of this evidence was the subject of attack by Mr Fung for the Petitioner, it seems to me that the material does show that the Company has continued to function since March this year, notwithstanding the problems that have arisen as between the Petitioner and the 1st Respondent. Although it is fair to say that the level of business appears to be somewhat lower than in the recent past, I do not think that the difference is such as to show that the Company is no longer capable of operating effectively. The disagreement between the parties does not, therefore, appear to have paralysed the Company so far as its day to day operations are concerned.

24. So far as the argument that the business now being carried on by the Company is ultra vires is concerned, it does not seem to me that the court, if it were to permit the existing state of affairs to continue (as it has done for some months between the alleged exclusion of the Petitioner at about the beginning of April 2003, and the making of the present application in August 2003), would in any sense be condoning such acts, if indeed they are ultra vires the Company. Rather, it seems to me that the court in such a case would simply be coming, as it must, to a view as to where the balance of convenience lies, taking account of the extent of the impact of the disagreement between the shareholders on the operations of the Company. Where such disagreements leave the Company entirely unable to operate, the element of deadlock will be of much greater weight than it might be in cases in which the Company is continuing in business. In this case, while the element of deadlock is a factor that is to be taken into account, I do not regard it as conclusive, or virtually so, in favour of the appointment of receivers, given that the Company appears, on the evidence before me, to be able to operate and continue in business.

25. So far as the second point raised by Mr Fung is concerned, this is that there has been serious mismanagement by the 1st Respondent of the Company's business, principally by neglecting to pay a number of suppliers of services and by causing the Company to effectively lose the use of its manufacturing base in China by the manner in which he has dealt with that entity. The Petitioner contends that as a result of this, there has been a serious impact on the Company, since its strategic relationships which have been built up over many years have been largely destroyed. Mr Fung pointed to a number of complaints from suppliers and other parties as to delays in rendering payment for their services, and to legal proceedings in China which have apparently had the effect of the Company being evicted from the factory in China which has hitherto carried on production for it in January 2003.

26. As to these matters, I note that the complaints to which reference was initially made all related to matters arising at the end of 2002 and early 2003. The 1st Respondent's case is that these are matters in relation to which it is believed that the Petitioner was seeking to use the Company's funds to meet obligations which had nothing to do with the Company's business, but which were in fact in connection with his own interests. There is evidence from the Company's accountant that a number of claims and demands for payment could not be reconciled with orders placed by the Company, and that following this being pointed out to the suppliers in question, no more has been heard about these matters.

27. Given that these matters appear to relate to a time frame that is some time in the past, I do not attach too much weight to them for present purposes, as they do not appear to be matters which are ongoing. Mr Fung referred also to more recent evidence of demands for payment by suppliers, and to recent District Court proceedings taken out against the Company as evidence of mismanagement by the 1st Respondent. The 1st Respondent's response was that in relation to at least one case, the matter had actually been settled by agreement, so that the claim was without merit. Reference was also made by the 1st Respondent to difficulties in locating documentation that might shed light on whether or not the claim had any proper foundation.

28. Complaint was also made that the 1st Respondent had effectively driven away the key members of the Company's staff. A number of affirmations by ex-employees of the Company were included in the evidence before me. However, it seems to me that the issue of loss of staff is a matter that is very much bound up with the underlying dispute between the parties, with the Petitioner asserting that such staff have been forced out, whereas the 1st Respondent claims that they have been enticed away by the Petitioner as part of his plans to divert the main business of the Company to entities controlled by him. It seems clear from the business that is still being carried on that the Company is, notwithstanding the loss of some of its staff, able to continue in operation.

29. So far as the alleged inefficiency or ineptitude of the 1st Respondent is concerned, Mr Chan submitted that complaints such as this were of relatively minor significance. In my view, these appear to be matters which may well occur from time to time in any business, and I do not therefore attach great weight to them.

30. It is also fair to say that not every one of the welter of complaints levelled against the 1st Respondent has been specifically responded to. However, it seems to me that it is necessary to look at the complaints overall, and having given them the weight that they merit, consider how they affect the balance of convenience in the light of other factors that might militate against the appointment of receivers.

31. In these circumstances, while there may be some substance in some of the complaints that are levelled against the 1st Respondent's running of the Company over the last few months, it seems to me that the majority of the complaints are very much tied up with the overall dispute between the parties, and I do not consider it possible to say, at this stage, that they are of such substance that they amount to compelling reasons for the appointment of receivers in respect of the Company's business and operations, particularly when there are, in my view, other factors that point in the opposite direction.

32. So far as the question of dissipation of assets is concerned, it seems to me that the complaint in relation to transfers out of the HSBC account is one that is of little substance, and does not really go beyond the complaints of mismanagement. The Petitioner has put forward the transfers out of the HSBC account into the Nanyang account as examples of dissipation. The 1st Respondent's position is that the transfers were made in order to prevent improper payments being made by the Petitioner under his sole signature, as was possible in respect of the HSBC account. This again is very much connected with the underlying dispute between the parties. However, it seems to me that at the end of the day the money is still in the Company, and has not been removed from it. Although Mr Fung argued that there was a risk to the Company's assets because its funds were not being used to pay debts which it should be settling, that seems to me to be essentially the argument based on mismanagement in a different guise, and not in any real sense something which adds to those allegations.

33. The other alleged dissipation relates to a suggestion by the Petitioner that Ms Cheung might take steps to have the College Road property released from its charge to the Nanyang Commercial Bank Ltd, so that it can be refinanced for purposes allegedly unconnected with the business of the Company. The 1st Respondent and Ms Cheung suggest that the property is actually owned beneficially by Ms Cheung, although this is disputed. Mr Chan drew my attention to a document which indicated that the Company and the parties had undertaken to compensate Ms Cheung in respect of any loss she might suffer as a result of the pledge of the property to the Company's bankers, and suggested that this was evidence that the property was beneficially owned by Ms Cheung. While the document might support that inference, I do not think it can be regarded as in any way conclusive, as it is possible that Ms Cheung might be put to expense by reason of the use of the property as security even if she were only a trustee of the property for the Company. I therefore proceed on the assumption, for present purposes, that there is at least an arguable case that Ms Cheung is not the beneficial owner of the property.

34. That said, it seems to me that the evidence of likelihood of dissipation is not particularly strong, consisting as it does largely of a telephone conversation which the Petitioner says he had with a Mr Lau, who informed him that there was a possibility that steps might be taken to refinance the College Road, apparently to enable the 1st Respondent to obtain funds with which to settle his indebtedness to Mr Lau. Be that as it may, Ms Cheung has offered (through Mr Chan and in writing) to undertake not in any way to dispose of the property for any purpose other than those of the Company, and it seems to me that even if receivers are not appointed, this would provide some measure of protection in respect of the College Road property, and I therefore accept this undertaking.

35. So far as Mr Fung's fourth point, relating to urgency of the situation, is concerned, I do not think that this adds greatly to the other points which have been advanced, and which I have dealt with. The matters relied on appear to be limited to three or four instances in respect of which it is said that creditors have not been paid in recent months. However, having regard to the level of business that is disclosed in the management accounts and the orders which have been provided, it is not my view that these are matters which demonstrate an imminent risk that the Company will be wound up or otherwise irreparably damaged unless the 1st Respondent is removed from the position of control which he currently occupies. The picture that Mr Fung has painted is of a company that is sinking fast, with mounting unpaid debts, and a shrinking or dying business. However, as I have indicated, there is evidence that the Company is still operating, and apparently doing so at a profit. While there may be concerns on the part of the Petitioner that the Company may not be as profitable as in the past, it is not clear to me that the appointment of a receiver would be likely to improve the situation greatly, particularly as Mr Fung accepts that the role of the receiver was not likely to be more that of a business operator who would actively be seeking to obtain additional business for the Company.

36. So far as the disadvantages of an appointment of receivers to the Company are concerned, it seems to me that there are clearly likely to be significant disadvantages in such an appointment. It is well recognised that the appointment of receivers is a drastic step, and not one which should be lightly undertaken. The appointment of receivers is inherently likely to have an adverse effect on a company and its business. The appointment is liable to be misunderstood by suppliers and customers, and is likely to make them less willing to deal with the company in receivership. Although it is of course possible for the receivers to explain the situation to those who deal with the company, this may or may not have the desired effect. There is therefore likely, in my view, to be damage to the goodwill of the Company which will be difficult to quantify (see e.g. Bond Brewing Holding Ltd v National Australia Bank Ltd (1990) 1 ACSR 445; Jaber v Science and Information Technology Ltd [1992] BCLC 764; Re Full Billion Ltd (supra); and Re Niceline Ltd (supra)). The appointment of receivers is also likely, I think, to be disruptive of the Company's business.

37. Moreover, it seems to me that it is inevitable that the costs involved in the appointment of receivers will be substantial. These costs are unlikely, to my mind, to be offset by the receivers being in a position to generate any significant additional business for the Company. It therefore seems to me that the cost of receivership is likely to outweigh any advantages that it might have.

38. I would also add that although I have been supplied with some information as to the proposed receivers' experience which indicates that one of them has been involved as a provisional liquidator of garment trading companies on a number of past occasions, there is, with one exception, little information as to the nature of his involvement in such cases. In the one case in which details are given, the nature of the role was more that of orderly disposition of remaining orders and collection of debts, rather than the active running of an ongoing basis. I think, therefore that Mr Chan's contention that the receivers would not be best placed to run this company's business is deserving of some weight.

39. In all the circumstances, having regard to my reservations as to the complaints which have been made about the 1st Respondent's management of the business of the Company, and in the light of the serious consequences that I am satisfied would be caused if receivers were appointed, I am of the view that the balance of convenience in this case comes down against the appointment of receivers. As I have noted above, I accept the undertaking which has been proffered on behalf of Ms Cheung.

40. I therefore dismiss this application. So far as costs are concerned, I shall make a costs order nisi that the 1st Respondent shall have the costs of and occasioned by this application, to be taxed on the party and party basis if not agreed, with certificate for two counsel.