XCHRX EXCEL NOBLE DEVELOPMENT LTD. AND ANOTHER v. WAH NAM GROUP LTD.

HCCW 130/2000

IN THE HIGH COURT OF THE

HONG KONG SPECIAL ADMINISTRATIVE REGION

COURT OF FIRST INSTANCE

COMPANIES (WINDING-UP) NO. 130 OF 2000

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D E C I S I O N

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1. This is an application for validation orders under s. 182 of the Companies Ordinance. The summons was issued on 4 March. As now amended, the summons seeks an order that in the event of an order to wind-up the Company being made on the petitions which were presented to this court, no payments and transactions as set out in the schedule attached to the amended summons in the ordinary course of business of the Respondent (Company) shall be avoided. For ease of reference, I will attach a copy of the schedule to the transcript of this decision.

2. Before going into the details of the application, it is important to bear in mind the principles which guide the exercise of the Court's discretion when considering applications for validation.

3. In Burton v. Deakin Ltd [1977] 1 All ER 631, it was held that where a petition for winding-up has been presented on the basis of a company's alleged insolvency, and where the transactions sought to be validated are not in the ordinary course of the business of the company, the court has to be affirmatively satisfied on the evidence before it that the transaction is beneficial to the company.

4. In Gray's Inn Construction Co. Ltd [1981] WLR 711 at 718, the Court of Appeal held that the policy of the law is to procure so far as practicable rateable payments of the unsecured creditors' claims. It is clear that the court should not validate any transaction which might result in one or more pre-liquidation creditors being paid in full at the expense of other creditors, who will only receive a dividend, in the absence of special circumstances making such a course desirable in the interests of the unsecured creditors as a body.

5. Where a third party proposes to enter into a transaction with a company which is liable to be invalidated under the companies legislation, the third party can decline to do so until the company has obtained a validating order, or it might itself seek a validating order, or it can enter into the transaction in anticipation of the court making a retroactive validating order at a later date. A third party who does that takes the risk of the court refusing to make the order.

6. Having said that, it may not always be feasible for a validating order to be sought before the transaction in question is carried out. The need for speedy action may be such as to preclude an anticipatory application; or the beneficial character of the transaction may be so obvious that there is no real prospect of a liquidator seeking to set it aside, but in any case in which the transaction is carried out without an anticipatory validating order, the disponee is at risk of the court declining to validate the transaction.

7. I should also note that in respect of post-liquidation transactions, for those which cannot harm the creditors as they do not reduce the value of the assets, the court would be inclined to ratify any transactions. Clearly if a transaction increases or would increase the value of the company's assets, or would preserve the value of the company's assets from harm, the court would give effect to those transactions.

8. I find that the present case is one where the circumstances set out in Burton v. Deakin above apply.

9. First, both petitions here have been presented on the basis of the Company's alleged insolvency. In fact the Company faces two petitions presented on that basis. One has been presented by two companies called Excel Noble and Unbeatable Assets Ltd and the other is presented by two companies called HCK China Investments Limited and Investment Austasia Limited.

10. Excel Noble and Unbeatable Assets' petition is based on the Company's alleged failure to pay on certain convertible loan notes; HCK's and IAL's petition is based on the Company's alleged failure to pay certain promissory notes.

11. In respect of Excel Noble and Unbeatable Assets' petition, this was pursuant to an action in which Beeson J had made various orders on 17 December 1999. One order required the Company to pay Excel Noble $6m. as interim payment by 31 December 1999. There was no appeal from this order but no payment was made on 31 December 1999 or before.

12. Another order made on the same day required the Company to make payment into court of $24m. by 7 January 2000. This order is under appeal. No stay of execution of this order was granted pending appeal. However, the Company has failed to make payment into court by 7 January 2000.

13. On 3 January 2000, Excel Noble obtained a garnishee order against the Company's banks, and on 27 January 2000, a writ of FiFa was issued against the Company, which was not discharged by payment to the bailiff until about a month later.

14. Further the audited accounts which the Company has produced in evidence before me for the year ended 31 December 1998 are qualified and the auditors have there expressed uncertainty as to whether the Company can continue on a going concern basis.

15. Taking all those matters into account, there is at least a question as to the Company's ability to pay its debts as they fall due; certainly this is not a case where the Company is demonstrably solvent.

16. Secondly, the transactions referred to under items 1 and 2 of the schedule are not transactions in the ordinary course of business of the Company.

17. As for item 3 Mr Kenneth Chan, counsel for the Company, has in his closing submissions asked the court to adjourn further hearing of this item. I see no prejudice to the other parties in so doing, subject to any argument as to costs, and I would therefore adjourn the application with regard to item 3. I shall say no more about item 3 or the submissions made by the parties before me with regard thereto.

18. The real issue in this matter is whether the transactions in items 1 and 2 are to the benefit of the Company and not unfair to the general class of unsecured creditors as a whole.

19. I deal first with the transactions at item 1. Mr Chan says that the Company is seeking validation of items 1(a)-(c) as an "all or nothing" application. In other words, he is applying for validation of (a), (b) and (c), and if the court were to decline to validate any part of (a), (b) or (c), then the Company is not applying for validation for any other part.

20. The facts are briefly as follows.

21. As stated above, Beeson J had ordered on 17 December that the Company pay Excel Noble $6m. by 31 December. By 31 December the Company had failed to pay any part, and in January it was subject to garnishee proceedings and FiFa. On 10 February 2000, Excel Noble presented the present petition.

22. On 18 February 2000, that is after the presentation of the petition, the Company borrowed $6m. from a company called Pioneer Dragon Ltd which amount was drawndown on 19 February 2000. This loan was unsecured. There were no terms governing the Company's use of the money borrowed from Pioneer Dragon.

23. As it was, the Company paid the $6m. to the bailiff to discharge the FiFa order and the funds are now being dealt with, as I am given to understand, under s. 270 of the Companies Ordinance. So, the upshot of that is that Pioneer Dragon became an unsecured creditor of the Company for $6m.

24. It was not until 24 February 2000 that the Company and Pioneer Dragon entered into a Subscription Agreement. The terms of the Agreement were briefly that Pioneer Dragon would subscribe for 60m. shares of the company at 10 cents each, and under clause 4.2(c), at completion forthwith after the Company has received the full amount of the subscription money, the Company shall apply the whole of the subscription money so received or (as the case may be) so much thereof as may be sufficient to repay and satisfy the total amount of the loan then outstanding.

25. In other words, the $6m. which Pioneer Dragon would have to pay the Company for the 60m. new shares would have to be immediately applied to repay Pioneer Dragon the $6m. unsecured debt. In the schedule to the present amended summons, this has been referred to as a set off.

26. Under clause 2.1 of the Subscription Agreement, completion of the Subscription Agreement was conditional upon the winding-up proceedings having been wholly and finally terminated and the Company being able to validly allot and issue the new shares in accordance with the terms of this Agreement free from any restriction or prohibition in law or the allotment and issue of new shares in accordance with the terms of this Agreement having been validated and approved by the court pursuant to s. 182 of the Companies Ordinance.

27. In other words, if the court did not validate the allotment of the new shares in accordance with the terms of the Agreement, including clause 4.2(c), then the Subscription Agreement would not be completed.

28. It is clear that the Subscription Agreement turns Pioneer Dragon from an unsecured creditor for $6m. to a shareholder of 60m. shares which shares can be freely traded on the market. The average closing price of shares of this company for 10 trading days up to and including 18 February was 9.4 cents, and the closing price on 18 February was nearly 12 cents.

29. In my view, it would be unfair to the other unsecured creditors for Pioneer Dragon to be preferred in this way. Pioneer Dragon chose to make an unconditional, unsecured loan to the Company after presentation of the petition without having first obtained a validation order. No evidence has been placed before me to indicate that Pioneer Dragon was not aware of the presentation of the petition against the Company. In making such a loan, Pioneer Dragon became an unsecured creditor, who would only be entitled to a dividend ranking pari passu with other creditors on a liquidation.

30. I see no reason why the court should now validate the Subscription Agreement so that this particular unsecured creditor could steal a march on other unsecured creditors by recouping the loan by trading the shares on the market.

31. Accordingly, I would decline to validate that part of the transaction which involves the application of the proceeds of the subscription to repayment of the unsecured loan. Mr Chan having indicated that this application in respect of item 1 is an "all or nothing" application, the application under item 1 fails.

32. I shall now deal with the transaction at item 2. For this item, Mr Chan has indicated that the transactions set out therein may be severed for the purposes of the application for validation. Briefly the facts appear to be as follows.

33. On 16 February 2000, after presentation of the petitions, Mr Chim Hiu Fei acquired 200m. shares of the Company from Mr William Chan. Previous to this, Mr Chim Hiu Fei had no shares in the Company. As a transfer of shares, validation under s. 182 of the Companies Ordinance would appear to be required. Mr Chan has not been able to refer me to any statute or authorities to suggest otherwise. No validation appears to have been sought.

34. On 28 February 2000, Mr Chim Hiu Fei agreed to place 100m. of his shares with 36 placees, with Mr Chan's securities company Wah Hing Securities Company as placing agent, and as part and parcel of the same Agreement, the Company agreed to issue 100m. new shares to Mr Chim Hiu Fei, the price of the shares in both transactions being 10 cents each.

35. Item 2(a) of the schedule asks the court to validate the placing by Mr Chim Hiu Fei through Wah Hing as placing agent of 100m. existing shares of 10 cents each to 36 independent placees at the placing price of 10 cents per share. I am concerned with this because since the transfer of the shares from Mr William Chan to Mr Chim Hiu Fei has not been validated, it may be the case that Mr Chim Hiu Fei does not have the 100m. shares to place with the 36 placees. The burden is on the Company to satisfy the court on the present application that validation would be right and proper. I find that it has failed to do so in relation to item 2(a).

36. As for item 2(c), since the commission payable to Wah Hing is only in respect of the placing, and I have declined to validate the placing for reasons set out above, it follows that I decline to validate the payment of the commission.

37. As for item 2(b), this involves Mr Chim Hiu Fei subscribing for 100m. new shares at 10 cents each, which money is to be applied for payment into court under Beeson J's order for payment into court of $24m. The Company apparently hopes to raise the balance of the funds separately.

38. Assuming as I must for present purposes that it would be to the benefit of the Company to make payment into court under the court order, it would obviously be of benefit to the Company for $10m. in cash to be raised, and I see no detriment to the general class of unsecured creditors for new shares to be allotted to Mr Chim Hiu Fei in consideration for that.

39. Accordingly, I would make an order that in the event of an order to wind-up the Company being made on the petitions, no payments and transactions as set out in item 2(b) shall be avoided, namely the issue by the company of 100m. new shares of 10 cents each in the Company at the issue price of 10 cents per share payable in cash to Mr Chim Hiu Fei and the payment of the proceeds thereof, namely HK$10m. into court pursuant to the order of Beeson J made on 17 December 1999 under HCA 12439 of 1999.

40. In making that order, I would out of an abundance of caution order that the validation upon the payment into court be under Order 29 Rule 13 such that the money paid in would not become the property of the Plaintiffs in that action.

41. As for item 2(d), there has been no breakdown of the expenses incidental to the transactions set out in items 2(a), (b) and (c) up to HK$250,000. In fact, no evidence at all has been placed before the court as to this estimate. Clearly there would be some expenses e.g. solicitors' charges for drafting the Subscription Agreement referred to in item 2(b), but in the absence of any evidence, I am unable to give a blanket validation or to assume any sort of breakdown as between the placing and the subscription.

42. Accordingly, I would make no order in respect to item 2(d) today but I would be prepared to give liberty to the Company to apply to restore this part of the application.

SCHEDULE

1. Under the Agreement for Subscription of New shares in Wah Nam Group Ltd. ("WNG") dated 24th February 2000 made between WNG and Pioneer Dragon Ltd. ("PD") -

a) The issue by WNG of 60 million new shares of HK$0.10 each in WNG at the issue price of HK$0.10 per share (payable in cash) to PD ("PD Issue");

b) The application of the proceeds of the PD Issue in the sum of HK$6,000,000 for payment of the load in the sum of HK$6,000,000 advanced by PD to WNG on 19th February 2000 by setting of against each other;

c) The payment by WNG of the expenses incidental to the transactions set out in paragraph 1(a) & (b) hereinabove up to HK$50,000;

2. Under the Placing and Subscription Agreement dated 28th February 2000 made between Chim Hiu Fe and WNG and Wah Hing Securities Ltd. ("Wah Hing") -

a) The placing by Chim Hiu Fei through Wah Hing as placing agent of 100 million existing shares of HK$0.10 each to 36 independent placees at the placing price of HK$0.10 per share;

b) The issue by WNG of 100 million new shares of HK$0.10 each in WNG at the issue price of HK$0.10 per share (payable in cash) to Chim Hui Fei and the payment of the proceeds thereof (HK$10,000,000) into Court pursuant to the Order of Beeson J. made on 17th December 1999 under HCA12439/99;

c) The payment by WNG to Wah Hing a commission equal to 3% of the placing price, equivalent to HK$300,000;

d) The payment by WNG of the expenses incidental to transactions set out in 2(a), (b) and (c) above up to HK$250,000.

3. Under the Share Sale and Purchase Agreement dated 28th February 2000 made between Opulent Associate Ltd. Early Way Enterprises Ltd., Liu Chiu Kwan, Wong Miu Wan (collectively referred to as the "Vendors") and WNG -

a) The payment by WNG of HK$ 8,500,000 to the Vendors being a deposit and in part payment of the consideration for acquisition by WNG of the entire issued share capital of Beauty Asia Enterprises Ltd. ("Beauty Asia");

b) The issue by WNG 815 million new shares of HK$0.10 each to the Vendors credited as fully paid n satisfactions of the remaining balance of the purchase consideration;

c) The payment by WNG of expenses incidental to the transactions set out in 3 (a) and (b) hereinabove up to HK$1,500,000, including -

i) Costs for preparing accountant's report - HK$400,000;

ii) Costs for preparing a circular to the member - HK$500,000;

iii) Printing costs - HK$180,000;

iv) Professional valuation report fee - HK$100,000;

v) Legal costs - HK$300,000.