XCHRX Re Essentially Yours (HK) Ltd.

HCCW 378/2000

IN THE HIGH COURT OF THE

HONG KONG SPECIAL ADMINISTRATIVE REGION

COURT OF FIRST INSTANCE

COMPANIES (WINDING-UP) NO.378 OF 2000

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J U D G M E N T

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1. This is an application made on notice of motion to restrain further proceedings being taken in respect of a winding up petition and for that petition to be dismissed.

2. The petition for winding up was presented in April of this year by a company registered in the British Virgin Islands named Global Faith Investment Limited ('Global Faith'). The petition sought the winding up of a Hong Kong registered company, Essentially Yours (HK) Limited ('the Company').

3. The Company has an authorised share capital of $10,000.00 divided into 10,000 shares with a par value of HK$1.00 each. The paid-up shares are held by three shareholders. They are: Global Faith (holding 475 shares); EYI International Limited ('EYI'), a company incorporated in the Cayman Islands (also holding 475 shares), and a Hong Kong resident by the name of Eliza Fung (holding the balance of 50 shares).

4. Global Faith presented its petition for the winding up of the company on two grounds. First, as a creditor on the basis that, in terms of sections 177 and 178 of the Companies Ordinance, Chapter 32, the company was unable to pay its debts. Second, as a contributory on the basis that, in terms of section 177 of the Ordinance, it was just and equitable that the Company should be wound up. In respect of this second ground, Global Faith has alleged that its representative has been unlawfully excluded from participating in the affairs of the Company and that the remaining two shareholders have colluded to mismanage the company and to prevent disclosure of various books and records.

5. Concerning its alleged indebtedness to Global Faith, the Company seeks to have the petition dismissed on the grounds that, to Global Faith's own knowledge, there is a bona fide dispute concerning that debt, a dispute based on substantial grounds. In addition and/or alternatively it is contended that the company is solvent.

6. Concerning the allegation that - to express it neutrally - there is now deadlock in the management of the company making it just and equitable that it should be wound up, the Company avers that any such deadlock was resolved when an agreement was reached between EYI and Global Faith in terms of which EYI agreed to purchase Global Faith's interest in the Company. Difficulties may have been encountered in respect of that agreement but Global Faith has now instituted action inter alia seeking specific performance. Accordingly, the most appropriate remedy for Global Faith lies not in the winding up of the Company but in seeking a final resolution of the sale of shares dispute, an action which it is now actively pursuing.

A brief history

7. The company was incorporated in July 1999, its main business being the sale and marketing of health products. In that same month, an agreement was entered into between the shareholders and the Company to provide for the management of the company and to regulate the rights and obligations of the shareholders inter se ('the agreement').

8. In terms of article 4.12 of the agreement, Eliza Fung was to be responsible for the daily operation of the company's business and was to be paid a fee for this service. The Managing Director of the company, however, was to be a woman named Geraldine Heyman, a representative of EYI.

9. As for working capital, this was to be provided by the two majority shareholders. In terms of article 5.02 it was agreed that Global Faith would contribute by way of a loan a cash sum of US$500,000.00. EYI agreed, also by way of a loan, to contribute half that amount. However, its contribution of US$250,000.00 was not to be in cash but in kind, consisting of marketing programmes, special software and also the meeting of certain licence fees.

10. Within three months of the signing of the agreement profound disagreement had arisen between the shareholders. This led to a situation where, by letter dated 1 November 1999, the Company, acting through Geraldine Heyman and Eliza Fung, purported to remove Global Faith's representative as a director on the basis of an apparent breach of fiduciary duty. The validity of the dismissal was challenged and a demand was made to inspect the records of the company. It is suggested that obstacles were placed in the way of such inspection. Whichever way the fault lay, it seems to be apparent that by late November 1999 the working relationship between the shareholders had irretrievably broken down.

11. In an effort to resolve the deadlock, EYI made an offer to purchase Global Faith's interest in the company for the sum of US$500,000.00 being the amount of capital which Global Faith had paid to the Company by way of a loan. The offer was accepted and a letter setting out the terms of agreement was signed by both parties. That letter contained clauses to the following effect:

'5. Global and its Shareholders will sign a full and final general release in favor of the Company and EYI International Limited in regard to all claims, save and except for payment of the balance of the Purchase Price.

6. Global and its Shareholders will provide three (3) year non-competition covenant in favor of the Company confirming that they will not compete with the business of the Company for three (3) years after Closing.'

12. Global Faith had a number of shareholders. One of those shareholders was a company called Landmark Investments Trading Limited ('Landmark'). The majority shareholder of that company and the person in effective control of it was Eliza Fung. This lady had not been present when the sale of shares agreement had been reached but apparently had been 'connected' to the negotiations by means of a conference line. Landmark, however, would not agree to sign the necessary release forms unless it received a share of the US$500,000.00. The other shareholders would not agree as, in their eyes, the funds represented no more than the repayment of their original loan. After a period of impasse, however, Landmark agreed to sign the necessary release forms and did so on 28 January of this year. Then a few days later, by letter dated 3 February, Landmark's solicitors advised Global Faith's lawyers that Landmark was 'revoking and and withdrawing' those releases. A demand was made for the return of the documents. It is not certain what exactly transpired but what is known is that on 10 February Global Faith despatched the release forms to EYI and, on the basis that it had now met its obligations, demanded completion of the agreement. Although funds were held in escrow, EYI refused to complete. It did so, as I understand it, on the basis that Global Faith had not yet provided valid releases.

13. Thereafter, on 9 March of this year, Global Faith instituted action against EYI in this Court. Its claim was based on the sale of shares agreement and sought inter alia :

'(i) The sum of US$500,000.00;

(ii) Alternatively, an order for specific performance of the Sale Agreement and/or the Escrow Agreement;

(iii) A declaration that the sum of US$500,000.00 is held by the Escrow Agent and/or by Messrs Clarke & Kong on trust for the Plaintiff and that the Plaintiff is solely entitled thereto;

(iv) An injunction to restrain the Defendant by itself or by its servants or agents from dealing with the sum of US$500,000.00 held by the Escrow Agent and/or by Messrs Clarke & Kong;

(v) Damages;'

14. EYI has defended that action. But, as an indication of Global Faith's determination to pursue the action, shortly after the issue of the writ it sought and obtained an injunction to prevent EYI disposing of its Hong Kong assets. That injunction remains in force.

15. Approximately six weeks later, on 27 April, Global Faith presented its petition for the winding up of the Company.

16. The allegation that the Company is unable to pay its debts.

17. The debt referred to in the petition is the sum of US$500,000.00 'being the outstanding principal loans lent to the Company in July 1999'. The petition alleges that on 13 January of this year Global Faith served a demand on the Company requiring repayment of that money but the company has neglected and/or refused to pay.

18. As earlier indicated, the Company denies that the sum of US$500,000.00 is due and payable to Global Faith. It is the Company's contention that winding up petitions ought not to be used as an alternative to an application for summary judgment under O.14 of the Rules of the High Court and it is an abuse of the process of the Companies Court for a creditor to present a petition for the winding up of a company which is solvent and which has raised a bona fide triable defence to the creditor's claim. As to the principle, see Re a Company (No. 0012209 of 1991) [1992] 1 W.L.R. 351 in which Hoffmann J (as he then was) said:

'....if, as in this case, it appears that the defence has a prospect of success and the company is solvent, then I think that the court should give the company the benefit of the doubt and not do anything which would encourage the use of the Companies Court as an alternative to the R.S.C., Ord. 14 procedure.

For those reasons the injunction will go. The basis upon which the injunction is granted is that presentation of the petition is an abuse of the process of the court. I think that it should be made clear that abuse of the petition procedure in these circumstances is a high risk strategy, and consequently I think the appropriate order is that the petitioner should pay the company's costs on an indemnity basis.'

19. To consider the substance of the Company's defence it is necessary to go to the agreement entered into between the Company and its three shareholders in July 1999.

20. In respect of the working capital required by the company, article 5.02 of the agreement reads:

'Funds required to start up the Company and to maintain the working capital of the Company shall be contributed by the Shareholders as Loans as follows:

(a) EYI International shall contribute the sum of US$250,000.00 by means of License fees, renewal fees, customized software and marketing programs and the like; and

(b) Global shall contribute the sum of US$500,000.00 in cash or equivalent (any "equivalent" contribution shall be subject to approval by EYI International).'

21. As to any repayment of loans made to the company by its shareholders, article 5.04 provides as follows:

'To the extent that a Shareholder makes Loans to the Company in excess of his pro rata share, then such Loans shall be made on a demand basis, and such Shareholder may require the Company at any time to repay his Loan to the point where his Loan does not exceed his pro rata share. If each Shareholder advances his pro rata share of all Loans requested, then no Shareholder shall, so long as he remains a Shareholder, demand repayment of his Loans without the prior written consent of all Shareholders. Except as hereinbefore provided, if the Company repays the Loans in whole or in part, it shall do so pro rata in proportion to each Shareholder's contributions by way of Loan.'

22. There has, however, been disagreement as to the true meaning of that article.

23. Mr Sussex, for the Company, contends that the pro rata shares of the loans made by Global Faith and EYI are detailed in article 5.02; namely, US$500,000.00 by Global Faith (in cash) and US$250,000.00 by EYI (in kind). Those, he says, are the pro rata shares and, in terms of article 5.04, no demand for repayment of those loans can be made without the prior written consent of all shareholders. Mr Sussex submits that the first sentence of article 5.04 - 'to the extent that a shareholder makes loans to the company in excess of his pro rata share, then such loans shall be made on a demand basis....' - only applies to loans made by Global Faith in excess of the US$500,000.00 already loaned and to loans made by EYI in excess of its US$250,000.00. There has, however, been no further loans made by Global Faith in excess of its original US$500,000.00 and accordingly no loan moneys are subject to repayment on demand.

24. That seems to me, when read in context, to be the plain meaning and intent of article 5.04. It is understandable that in July 1999, at the beginning of the enterprise, the parties would not have wanted those providing working capital to be able to remove it on demand. That would constitute a most precarious beginning. But, of course, the working capital was not provided in equal shares. That, it seems to me, explains the use of the phrase 'pro rata'. It further seems to me to be understandable that if any shareholder was called upon to provide the company with extra funds - above and beyond that already agreed - then the shareholder should be able to recover those extra funds on demand; after all, they fall outside the agreement reached by the company and its shareholders.

25. Mr Harris, for the Petitioner, contends for a different meaning. As I understand his submission, it is that Global Faith and EYI had equal shares in the Company and accordingly their respective provision of working capital is presumed to be the same. Their pro rata shares were, therefore, US$250,000.00 each. But Global Faith paid in excess of that and was therefore entitled to repayment on demand of that excess; namely, US$250,000.00. But that meaning, it seems to me, works on the premise that equal shareholdings equate to equal loan accounts and I do not see that there is any such implied nexus. Certainly, I can find nothing in the agreement to suggest it. Shareholders may well (and often do) lend differing amounts to their company. Loan accounts quite commonly vary. Shareholders may also agree, when a company is first registered, to provide differing amounts to that company. If each shareholder honours his agreement, he pays in his pro rata share.

26. In my view, Mr Harris' interpretation strains the language of the article and, as I have earlier indicated, seems unlikely to have been what the parties intended at the time of making the agreement. I come to these conclusions with the assistance of Lord Hoffmann NPJ's dicta in the Court of Final Appeal decision of Jumbo King Ltd v. Faithful Properties Ltd & Others (1999) 2 HKCFAR 279, at page 296:

'The construction of a document is not a game with words. It is an attempt to discover what a reasonable person would have understood the parties to mean. And this involves having regard, not merely to the individual words they have used, but to the agreement as a whole, the factual and legal background against which it was concluded and the practical objects which it was intended to achieve. Quite often this exercise will lead to the conclusion that although there is no reasonable doubt about what the parties meant, they have not expressed themselves very well.'

27. Being satisfied, therefore, that Global Faith had no right, in the absence of the agreement of the other shareholders, to demand repayment of its loan (or any part of it), it follows that, in my view, Global Faith is unable to make an allegation that the Company is unable to pay its debts. At the very least, there must be a bona fide and triable issue on the point.

28. The allegation that it is just and equitable to wind up the Company.

29. Mr Sussex submits that Global Faith has instituted two sets of proceedings, the one being in conflict with the other. He points to the fact that if Global Faith is successful in having the Company wound up on the grounds that it is just and equitable to do so, it will effectively be destroying the subject matter of its other cause of action; namely, the Company's shares. This, he contends, cannot be right, more especially as Global Faith, if it is successful in both actions, will have obtained specific performance of the sale of shares agreement, thus securing its US$500,000.00, and will at the same time have engineered the death of the Company making the shares for which it is receiving the US$500,000.00 worthless.

30. In my judgment, there is strength in this argument. A contributory's petition based on 'just and equitable' grounds is not normally hostile litigation against the company itself, the protagonists invariably being the shareholders and/or directors. Yes, there is conflict between the original shareholders but, no matter where the fault may properly have lain, it seems that one of those shareholders, Global Faith, reached a decision to sell out its interest in the Company in order to extracate itself from that conflict. Global Faith asserts that the agreement reached pursuant to that decision remains valid. Indeed, as I understand it so does EYI, its only objection being that Global Faith has not yet complied with its undertakings under the agreement. That being the case, Global Faith can assert no more than bare ownership of its shares on the basis that it remains listed as the holder of the shares. That is an assertion evidenced by its action against EYI seeking inter alia specific performance of the agreement, an action which it instituted before it presented its petition for winding up. It seems to me, therefore, that Global Faith has sought and is still pursuing an alternative remedy to resolve the management deadlock.

31. In his book, Applications to Wind up Companies, Derek French writes (at page 79) that in any proceedings to prevent its compulsory winding up, the company must prove that the petition would constitute an abuse of process. This can be done, he writes, by showing that the petitioner is unreasonably seeking to wind up the company instead of pursuing an alternative and more appropriate remedy. A fortiori this must be so where the petitioner is actually pursuing such alternative proceedings.

32. In Re a Company (No. 003028 of 1987) [1988] BC LC 282, a director, Mr A, who had lent money to the company, been appointed a director and entered into a service agreement with it, was removed from his office and his employment on the ground of misconduct. Mr A then commenced action for damages in the Queen's Bench Division alleging a repudiatory breach of his contract of service which he accepted. Mr A then presented a petition for the winding up of the company on grounds that it was just and equitable to do so. Scott J (at page 296 of the judgment) said:

'....what then, I must ask myself, is the point of the petition? Counsel for the company would answer that the point of the petition from Mr A's point of view was to bring unreasonable and improper pressure on the company, and through the company on the Es. It may be that that is a motive of Mr A's; I know not. But I must ask myself what other legitimate purpose the petition can serve. If Mr A succeeds in the Queen's Bench action, it can serve none. If he fails in the Queen's Bench action I think his petition is bound to fail; and for reasons which I have given, I cannot at the moment see any viable intermediate position.

This is an unusual application to strike out in that, on the view I take, if it had not been for the Queen's Bench action I think counsel for the company would have been in great difficulty in asserting that the petition was one which was bound to fail. I think that a person in Mr A's position, part contingent creditor, part contingent shareholder, in substance co-venturer with risk capital at stake, is entitled to invoke the court's jurisdiction under the just and equitable ground if he has been wrongfully excluded from the management that he was intended to have. If it had not been for the Queen's Bench action, I think an application to strike out would have been doomed to failure. But there is the Queen's Bench action. Mr A started it, and is prosecuting it. He is entitled to do that. But he has in a real sense, I think, made an election in favour of the relief sought in that action. The implications of this election render improper the presentation and prosecution of the petition.' [My emphasis]

33. What then are the implications of Global Faith's election to sue EYI? If it is successful, it will be compensated and have no further interest in the Company. But, as Mr Sussex has pointed out, if this petition for winding up is successful, the shares which EYI will then be forced to acquire will be worthless. If the Company is wound up, the subject matter of Global Faith's action against EYI will be destroyed before that action comes to trial. The implications for both Global Faith and EYI will be profound. If, however, Global Faith is unsuccessful, because there appear to be several bases on which that could happen, the implications are not so easy to divine. But if Global Faith remains a shareholder and there remains a management deadlock of the kind asserted then it seems to me that it may then be appropriate for Global Faith to present a petition for winding up. I do not see that it is proper for it to do so now before the collateral litigation is decided.

Conclusion

34. I have come to the conclusion that, in the circumstances of this case, the petition ought not to be allowed to stand. The petition will, therefore, be dismissed.

35. As for costs, I see no reason why costs should not follow the event and there will be an order nisi to that effect.