WONG MAN YIN v. RICACORP PROPERTIES LTD. AND OTHERS

CACV 3884/2001

IN THE HIGH COURT OF THE

HONG KONG SPECIAL ADMINISTRATIVE REGION

COURT OF APPEAL

CIVIL APPEAL NO. 3884 OF 2001

(ON APPEAL FROM HCMP NO. 1571 OF 2000)

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J U D G M E N T

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Hon Le Pichon JA:

1. This is an appeal from the order dated 17 October 2001 of Deputy High Court Judge Woolley concerning (1) directions given for the valuation of the petitioner's shares in Ricacorp Properties Limited ("the company") which Law Lam Wai ("the 2nd respondent") and Tam Kwong Chuen ("the 3rd respondent") (collectively "the respondents") had been ordered to purchase by an order dated 22 June 2001 made in a section 168A petition ("the main action") and (2) the costs order made in the main action.

Background

2. The company was incorporated in 1981. The respondents were the principal shareholders of the company. On 15 July 1995 they entered into a shareholders' agreement with the petitioner, the major shareholder and director of Capital Property Consultants Limited ("Capital") which was a much smaller estate agency. The parties considered that it would be in their respective interests to enter into an alliance and to cooperate with each other with a view to expansion. The shareholders' agreement provided for a transfer of shares which would result in the petitioner and the respondents holding 91% of the shares of the company equally between them, the other 9% being in the hands of two other minority shareholders, and 75% of the shares of Capital being held in the proportions of 31% to petitioner and 22% for each of the respondents. The petitioner paid $1.474 for each of the shares in the company based on its net asset value together with a premium of $900,000 and was appointed a director. The shareholders' agreement provided that the loans that had been made by the respondents would be shared with the petitioner, in the same proportions as their respective shareholdings. That never happened but all three shareholders made a further loan of $1.5 million each to the company shortly thereafter. The shareholders' agreement further provided, inter alia, for (i) the allotment of shares pursuant to further increases of capital in proportions as would maintain the shareholding ratio of the petitioner and the respondents; (ii) future working capital to be met, upon the Board's unanimous resolution, by means of advances and credit from financial institutions or third parties; and (iii) the repayment of shareholders loans prior to any distribution of profits.

3. On 2 September 1995, a board resolution relating to directors' remuneration was passed. The minutes recorded as follows:

"3. Remuneration of Three Directors

a.	It was resolved that the current salaries of HK$60,000.00 per month for Mr. K.C. Tam (i.e. the 3rd Respondent) and Mr. Barry Law (i.e. the 2nd Respondent) remain unchanged and that of Mr. Denny Wong (i.e. the Petitioner) will be increased to HK$60,000.00 per month with effect on 1st September 1995.
b.	Bonus:
	20% of the Group's net profit before dividend distribution will be equally shared by three Directors."

4. Two EGMs ("the 1st and 2nd EGMs") were convened, on 4 August 1995 and 8 November 1995 respectively, to increase the share capital by a total of 10 million shares. Although the petitioner voted in favour of the resolutions, he demanded repayment of the loan of $1.5 million from the company three days after the 2nd EGM and commenced proceedings in respect of it on 1 December 1995. The company repaid that loan shortly thereafter. The co-operation envisaged by the parties by entering into the shareholders' agreement thus proved to be shortlived. It is fair to say that by December 1995, for practical purposes, it had come to an end.

5. On 14 December 1995, an allotment to the shareholders of the new unissued shares in proportion to their shareholdings was approved. The petitioner and the two minority shareholders were invited to subscribe for the new shares and when they failed or declined to do so, the respondents allotted those offered to themselves. As a result, each of the respondents was allotted 5 million shares ("the 1st allotment"). There followed three further EGMs in 1996, held in March, September and October (respectively "the 3rd, 4th and 5th EGMs") increasing the number of shares by 10 million, 20 million and 20 million respectively to a total of 70 million shares. On 30 April 1996, the 10 million new shares created at the 3rd EGM were allotted to the respondents as to 5 million shares each ("the 2nd allotment") and on 4 October 1996, the 20 million new shares created at the 4th EGM were allotted to the respondents as to 10 million shares each ("the 3rd allotment"). The petitioner was offered a chance to subscribe for the new shares in proportion to his shareholding but he declined to do so. The respondents, on the other hand, took up the allotments. In all, the respondents paid $44.48 million by way of cash injections, $40 million as capital and the balance as premium.

6. By late 1996, the petitioner's shareholding was a little over 6% and on 19 December 1996 he ceased to be a director.

7. In June 1997, he commenced HCA 6260 of 1997 for, inter alia, declarations that the three EGMs held in1996 (i.e. the 3rd, 4th and 5th EGMs) were invalid in that they were called on less than 14 days notice and that the 1st, 2nd and 3rd allotments of shares were null and void as he had not been given notice of the relevant board meetings. Short notice as well as the lack of notice of the board meetings were conceded and judgment was given on admissions on 12 January 2000 restoring the authorised capital to 20 million shares and the issued capital to 10 million shares.

8. A 6th EGM was convened on 9 March 2000 at which a resolution was passed to increase the share capital from 20 million to 60 million shares by a rights issue of four shares for each held at a price based on the net asset value per share of the company. The petitioner was given notice and voted against the resolution. He declined to take up the rights issue. The respondents took up 20 million shares each at the directors' meeting on 24 March 2000, the day the petition was presented.

9. The petition was brought under section 168A. The petitioner complained that the following matters constituted unfair prejudice to him as a minority shareholder:

(i) the 1st, 2nd and 3rd allotments conceded by the respondents to be null and void diluted his shareholding and were in breach of the shareholders' agreement;

(ii) the 6th EGM in that the petitioner had not been supplied with any financial information to enable him to decide whether or not he should take up the rights issue;

(iii) excessive directors' remuneration coupled with a failure to declare any dividends;

(iv) failure to observe company and statutory regulations; and

(v) an overstatement of the net asset value of the company when the petitioner purchased his shares in 1995.

The judge upheld complaints (iii) and (iv) and found that those matters constituted conduct which was unfairly prejudicial to the petitioner and ordered that the respondents purchase the petitioner's shares in the company.

10. A further hearing was held on 5 October 2001 to deal, inter alia, with the respondents' applications for directions consequent upon the judgment in the main action and for an order that the petitioner pay one-third of the respondents' costs. The judge gave directions as to the basis upon which the petitioner's shares were to be valued and ordered that:

"...

(5) for the purposes of the valuation of the shares, there shall be added back to the assets of the [company] the sum of HK$30,320,603, being the amount of the excessive directors' remuneration paid to the [respondents];

(6) for the purposes of the valuation of the shares, the allotment of 20,000,000 ordinary shares of HK$1.00 each in the capital of the [company] to each of the [respondents] on 24th March 2000 be disregarded, but the moneys previously put into the [company] by the [respondents] as capital pursuant to the invalid allotments on 14th December 1995, 30th April 1996 and 4th October 1996 respectively be treated as loans to the [company] and the Valuer shall take into account interest which ought to have been paid at a proper market rate on those 'loans';"

Valuation

The petitioner's shareholding

11. The thrust of the respondents' appeal was directed at the valuation being carried out on the basis that the petitioner held 30.33% of the issued shares. The share allotments (i.e. the 1st, 2nd and 3rd allotments) had been one of the petitioner's complaints of unfairly prejudicial conduct. Had that been found to have constituted unfairly prejudicial conduct, direction (6) above would have been unexceptionable. But since the allotments have been held not to constitute unfairly prejudicial conduct, it was submitted that direction (6) was wrong or inappropriate in the circumstances.

12. The judge's findings which led to his conclusion may be summarised as follows. The intention of the parties had been to expand the operations of the company very quickly and this had been done since the number of branches had increased from 20 in 1995 to more than 70 in 1996 and to over 135 in 1997, and turnover had increased from $69 million in 1995 to approximately $625 million in 1998. This rapid expansion could not have come about without a large injection of funds to cover current expenses and investment in fixed assets. Attempts to obtain loans from financial institutions had been unfruitful, leaving as alternatives either massive shareholders' loans or increasing the share capital. Large loans had been made by the respondents which the petitioner should have shared under the terms of the shareholders' agreement but that had never happened and, as noted above, the petitioner had demanded and obtained repayment of his $1.5 million loan some three months after having advanced it.

13. The judge took into consideration the fact that the petitioner (i) had voted in favour of the resolutions to create new shares at the 1st and 2nd EGMs; and (ii) knew of the 1st, 2nd and 3rd allotments but had decided not to accept the offers. At [16] of his judgment in the main action, the judge had this to say:

"While there were therefore irregularities in the later EGM's, in that a miscalculation by [the respondents] had meant short notice of a day or two being given, and a lack of notice of the board meetings at which the allotments were decided, and while these are clearly breaches of company and statutory regulations, I cannot agree that, in so far as the share allotments are concerned, any prejudice or unfairness resulted towards the petitioner ... There was no attempt here by the other shareholders to conceal what they were doing, and he had ample opportunity to subscribe for the shares, and thus retain his proportional holding, or to seek to have the decisions annulled, which did not happen until the High Court proceedings were commenced in 1997. Even then, no prejudice was alleged, only annulment of the allotments on the basis of lack of notice of the meetings and breach of clauses 1.3 and 3.2 of the agreement."

In light of those matters, he reached the following conclusions (at [19-20]):

"19. ... I am satisfied that [the petitioner] was well aware of the intention to increase the capital by the issue and allotment of new shares, and had initially agreed to it. He was kept informed, although perhaps not as timeously as could have been done, but with no prejudice to him, and he decided that he was not going to subscribe to the new shares, in the certain knowledge that the effect would be to reduce his proportion of the total shares.

20. Was the conduct of the respondents unfairly prejudicial in the context of these allotments? It certainly caused prejudice in that the petitioner's proportional shareholding was reduced, but this was, as I have already found, from his own choice. Was it unfair? I am not satisfied that it was. Breach of their obligations under the company's articles, or under statute, may well be evidence of unfair dealing, but it is by no means conclusive. As Hoffmann LJ observed in Re Saul D Harrison & Sons plc [1995] 1 BCLC 14, conduct may be technically unlawful without being unfair, and vice versa. While the respondents did breach regulations, all they were doing was continuing on the path of expansion of the company which had been the original intention of all the parties, and with which the petitioner concurred. The fact that he later, either for personal reasons, or reasons connected with the interests of his own company, decided not to support that expansion financially, does not make the respondents' pursuing it, while offering him a share in it, unfair for the purposes of section 168A."

14. It could not have been clearer that the buyout order was not made as a result of the respondents' conduct with regard to the share allotments. The buyout order was made to address other grievances which the petitioner was able to establish, viz. excessive directors' remuneration coupled with a failure to declare dividends and the failure to observe company and statutory regulations. As regards the latter grievance, apart from the lack or any proper notice of EGMs and board meetings conceded by the respondents, it concerned the respondents' failure to prepare accounts or convene annual general meetings to consider the accounts as required by statutory and company regulations, to hold the AGM at all in 1998, and to send the 1998 accounts to the petitioner at all or in proper time rather than any alleged dilution of the petitioner's shareholding.

15. Mr Huggins SC for the petitioner submitted that the court should not make any order which would have the effect of treating the earlier allotments as effective to dilute the petitioner's shareholding. Any valuation should reflect the true legal position as to the relative shareholdings of the parties as it stood at 24 March 2000 and in view of the respondents' admissions which resulted in the judgment entered against them in January 2000, the effect which was "to nullify the shares issued under the resolutions of those EGMs, and to reduce the share capital." In short, Mr Huggins invited the court to adopt a strictly legalistic approach and to ignore the reality which was that the expansion of the company and its consequential profitability could not have occurred without the massive injection of capital on the part of the respondents.

16. The unfairly prejudicial conduct which resulted in the making of a buyout order under section 168A is highly relevant since the buyout order was meant to provide redress for such conduct. As Lord Hoffmann stated in O'Neill v Phillips [1999] 1 WLR 1092 (at 1098D-E):

"In section 459 Parliament has chosen fairness as the criterion by which the court must decide whether it has jurisdiction to grant relief. It is clear from the legislative history (which I discussed in In re Saul D. Harrison & Sons Plc. [1995] 1 B.C.L.C. 14, 17-20) that it chose this concept to free the court from technical considerations of legal right and to confer a wide power to do what appeared just and equitable. But this does not mean that the court can do whatever the individual judge happens to think fair. The concept of fairness must be applied judicially and the content which it is given by the courts must be based upon rational principles."

Given the fact that the judge found that the allotments were bona fide in the sense that they were necessary and in the interest of the company, they did not constitute unfairly prejudicial conduct. In respect of the allotments, there was therefore nothing to be put right by way of a buyout. That being so, there can be no intrinsic objection to treating the sums paid by the respondents for what they were in reality i.e. as capital rather than as a loan. Were it otherwise, it would work a serious injustice to the respondents who have put up the working capital without which profits could not have been reaped. It has to be borne in mind that a capital injection is to be distinguished from a loan: the expectations are entirely different. In the former, the investor takes the risk of losing his investment in whole or in part but also stands to reap a substantial benefit should the investment prove profitable. In the latter, all the investor expects is a return in the form of interest payments on the amount advanced. To treat the subscription monies for the 1st, 2nd and 3rd allotments as a loan would effectively penalize the respondents for conduct which has been found not to be unfairly prejudicial. That cannot be right.

17. In re Saul D. Harrison & Sons Plc. [1995] 1 BCLC 14, Hoffmann LJ observed (at 18g-19a):

"... a finding that conduct was not in accordance with the articles does not necessarily mean that it was unfair, still less that the court will exercise its discretion to grant relief. There is often sound sense in the rule in Foss v Harbottle (1843) 2 Hare 461. In choosing the term 'unfairly prejudicial', the Jenkins Committee (para 204) equated it with Lord Cooper's understanding of 'oppression' in Elder v Elder and Watson 1952 SC 49:

'a visible departure from the standards of fair dealing and a violation of the conditions of fair play on which every shareholder who entrusts his money to a company is entitled to rely'.

So trivial or technical infringements of the articles were not intended to give rise to petitions under s 459.

Not only may conduct be technically unlawful without being unfair: it can also be unfair without being unlawful."

Insofar as the buyout can be said to have been granted in respect of lack of any or proper notice of board meetings, it was plainly within the category of technical infringements referred to in Saul D. Harrison. This is because, as noted above, the shortness of the notices formed but an insignificant aspect of the respondents' failure to observe regulations. Having regard to these considerations, the judge's direction which has the effect of treating the petitioner as owning 30.33% of the issued shares was wrong in principle and cannot be justified. In my judgment, fairness would require in the petitioner's shareholding to be valued by reference to an issued capital consisting of 50 million shares.

Directors' remuneration and dividends

18. In arriving at the amount of $30,320,603 which the judge directed ought to be added back to the assets of the company for the purposes of valuation, the judge used the agreement reached between the parties as to remuneration as reflected in the board minutes of 2 September 1995 as the starting point. That amount represented the difference between the total amount of remuneration paid to the respondents as directors less salaries payable to each of them of $60,000 a month and a bonus equal to one-third of 20% of the group's net profit for dividend distribution. There is a respondent's notice filed by the petitioner to the effect that this amount should carry interest at 1% above prime to which there is no objection from the respondents.

19. Two matters arise out of that direction. First, the judge proceeded on the basis that the appropriate allowance for bonus for each of the respondents was one-third of 20% of the profit before dividend distribution. It is tolerably clear from the board minutes that the parties considered and agreed that 20% of the group's net profit before dividend distribution was the appropriate bonus. Whilst at the date of the September agreement there were three working directors, so the 20% fell to be shared between them, the amount set aside for bonus was not dependant on the number of working directors. Rather, the bonus should go to those collectively responsible for generating the profits of the company. In other words, the same percentage should be maintained as bonus irrespective of the number of working directors. Second, the judge considered that the amount of overpayment should be added back to the assets of the company for the purposes of valuation. However, the September agreement contemplated that the balance after providing for the remuneration of the directors should be available for dividend distribution. That was the parties' clear intention. Accordingly, a direction that the assets be distributed as dividends to the shareholders would be more consonant with the parties' intention than writing the excess back as assets of the company for the purposes of valuation of the petitioner's shareholding.

20. As appears at [24] of his judgment, the profits of the company and the emoluments paid to the respondents during the relevant period were as follows:

In my judgment, in determining what constituted excess remuneration, each of the respondents should be allowed a salary of $60,000 per month and 10% of the profit (if any) for the relevant period. By way of illustration, for the period ended 31.3.99, the excess remuneration falls to be calculated as follows:

1.Profit before providing for directors' remuneration	$20,224,701
2.Directors' salaries ($60,000 x 12 x 2)	$1,440,000
3.Profit after providing for directors' salaries	$18,784,701
4.20% of (3)	$3,756,940
5.Net profit available for distribution after bonus and salaries	$15,027,761

The excess is to be distributed by way of dividend to the shareholders pro rata according to their respective shareholdings and, for that purpose, notwithstanding the technical invalidity of the 1st, 2nd and 3rd allotments, the respondents are to be deemed to have been allotted new shares upon the payment of the requisite subscription monies.

Costs

21. The respondents' summons on costs was for an order that the petitioner be ordered to pay one-third of their costs. That was on the basis that the petitioner had been successful on only two of the five issues raised at trial and only on two of the prayers of the petition and insofar as the matters on which the petitioner had failed, they had occupied a significant proportion of the hearing. It was also the respondents' case that the petitioner had raised issues that were both unreasonable and improper: the respondents submitted that the petitioner's allegation that the earlier allotments had been made without his knowledge or consent was based on an elaborate story putting the blame on his maid (in that she had put the letters in a drawer) which episode took up half a day of the hearing and, further, the petitioner himself had brought about the share dilution by declining to take up the shares offered.

22. The applicable principles are encapsulated in the following passage from the judgment of Nourse LJ in Re Elgindata Ltd (No 2) [1993]1 All ER 232 at 237f-g:

"The principles are these. (1) Costs are in the discretion of the court. (2) They should follow the event, except when it appears to the court that in the circumstances of the case some other order should be made. (3) The general rule does not cease to apply simply because the successful party raises issues or makes allegations on which he fails, but where that has caused a significant increase in the length or cost of the proceedings he may be deprived of the whole or a part of his costs. (4) Where the successful party raises issues or makes allegations improperly or unreasonably, the court may not only deprive him of his costs but order him to pay the whole or a part of the unsuccessful party's costs."

The respondents' application was plainly based on the third and fourth principles set out above.

23. The judge dismissed the respondents' summons. He did so on the basis that the petitioner had succeeded in obtaining a buyout order which was the result he principally sought. He was still a successful party although he did not succeed in all of his complaints. The judge went on to say this:

"It is trite law that any party who recovers more than nominal damages, or at least a substantial part of what he seeks, should have his costs as against the other party in the absence of very unusual circumstances or evidence that he has deliberately wasted time and costs by raising a large number of issues which had no hope of success. This is not such a case, and I see no reason why the usual order should not apply."

24. The respondents took issue, correctly, in my view, with that statement of the law inasmuch as the judge was not applying the Elgindata test. First, whether or not the issues or allegations unsuccessfully raised by the petitioner had caused a significant increase in the length or cost of the proceedings was purely a factual issue. Since the issues as to which the petitioner was unsuccessful were substantive rather than peripheral, that alone would have justified depriving the petitioner of at least a proportion of his costs. Intent was irrelevant. Second, the episode relating to the maid plainly fell within the fourth principle and, on the facts, an order requiring the petitioner to pay part of the respondents' costs could conceivably have been justified. Looking at matters in the round and taking a broad view of the proceedings as a whole, in my judgment, it would be appropriate to deprive the petitioner of one-half of his costs and I would so order.

25. I would also make an order nisi that the costs of this appeal be to the respondents and the costs of the cross-appeal be to the petitioner.

Hon Sakhrani J:

26. I agree.

Hon Rogers VP:

27. I agree with the judgment of Le Pichon JA. There will therefore be an order as proposed.

Remarks: