CHINA MAGIC ENTERPRISES LTD v. BENEFUN INTERNATIONAL HOLDINGS LTD

HCMP 1132/2009

IN THE HIGH COURT OF THE

HONG KONG SPECIAL ADMINISTRATIVE REGION

COURT OF FIRST INSTANCE

MISCELLANEOUS PROCEEDINGS NO. 1132 OF 2009

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J U D G M E N T

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I.   INTRODUCTION

1.  China Magic seeks a summary Order that Benefun’s directors register the transfer of 468,750,000 fully paid up Benefun Shares to HKSCC.  China Magic executed a share transfer form in HKSCC’s favour in February 2009.  But until now Benefun’s directors have refused to register the transfer on the ground that in a pending High Court action Blackpool claims to be the beneficial owner of the Shares.  In the alternative, Benefun asserts that it has an equitable lien over the Shares. 

2.  Benefun, a Cayman Islands corporation, is a Hong Kong public listed company.  The Shares are registered in China Magic’s name.  This is evidenced by a Share Certificate which Benefun issued to China Magic.  China Magic obtained the Shares by exercising rights under Convertible Notes.  It received those Convertible Notes from Blackpool. 

3.  In its action, Blackpool alleges that it transferred the Convertible Notes to China Magic as a result of a fraudulent misrepresentation by Mr. Sik Siu Wan (currently a director of China Magic).  Blackpool accordingly refers to “the unlawful and wrongful conversion of the Convertible Notes into the Shares”.   It says that “the Shares are void and of no effect and [China Magic] has no title to the Shares”.

4.  I note that the parties controlling Blackpool now have a substantial interest in Benefun.

II.  BACKGROUND

5.  Benefun’s Articles of Association constitute a contract between it and its shareholders.  The following are provisions in those Articles:-

“13.   Except as otherwise expressly provided by these Articles or as required by law or as ordered by a court of competent jurisdiction, no person shall be recognised by the Company as holding any share upon any trust and the Company shall not be bound by or be compelled in any way to recognise (even when having notice thereof) any equitable, contingent, future or partial interest in any shares or any interest in any fractional part of a share or any other rights in respect of any share except an absolute right to the entirety thereof in the registered shareholder.

21. The Company shall have a first and paramount lien on every share (not being a fully paid up share) for all moneys, whether presently payable or not, called or payable at a fixed time in respect of such share; and the Company shall also have a first and paramount lien and charge on all shares (other than fully paid up shares) standing registered in the name of a member (whether solely or jointly with others) for all the debts and liabilities of such members of his estate to the Company and whether the same shall have been incurred before or after notice to the Company of any equitable or other interest of any person other than such member, and whether the period for the payment or discharge of the same shall have actually arrived or not, and notwithstanding that the same are joint debts or liabilities of such member or his estate and any other person, whether such person is a member of the Company or not.

39. The Board may, in its absolute discretion, and without assigning any reason, refuse to register a transfer of any share which is not fully paid up or on which the Company has a lien.

40. If the Board shall refuse to register a transfer of any share, it shall, within two months after the date on which the transfer was lodged with the Company, send to each of the transferor and the transferee notice of such refusal.

41. The Board may also decline to register any transfer of any shares unless:-

(a) the instrument of transfer is lodged with the Company accompanied by the certificate for the shares to which it relates (which shall upon registration of the transfer be cancelled) and such other evidence as the Board may reasonably require to show the right of the transferor to make the transfer;

  ....

(e) the shares concerned are free of any lien in favour of the Company; ....

6.  Rule 8.13 of the Hong Kong Stock Exchange’s Listing Rules requires that a listed company’s shares “be freely transferable”. 

7.  Rule 8.13 is reinforced by Appendix 3, para. 1(2) of the Listing Rules which requires that the Articles of a listed company provide “[t]hat fully paid-paid shares shall be free from any restriction on the right of transfer (except when permitted by the Exchange) and shall also be free from all lien”.

III. DISCUSSION

8.  Mr. Kenneth Chan (appearing for Benefun) submits that Benefun’s directors are not obliged to register the transfer of Shares for the following reasons:-

(1) The Share Certificate (identifying China Magic as registered holder of the Shares) is not conclusive.  In light of Blackpool’s litigation, Benefun’s directors are entitled under Art. 41(a) to demand further evidence to prove that China Magic has the right to transfer the shares.

(2) The shares are subject to an equitable lien in Benefun’s favour.

A.  Alleged Reason 1: Right to demand further evidence under Art. 41(a)

9.  In my view, this is not a valid ground for refusing registration.

10.  The directors’ right to request additional evidence under Art. 41(a) is not unfettered.  It is restricted to such evidence as may be reasonably required to show the transferor’s right.

11.  Here all Blackpool has done is to make allegations against China Magic in a High Court action.  In practical terms, it is hard to see what “evidence” (apart from the Share Certificate) China Magic can produce in order to rebut Blackpool’s allegations that China Magic deceived Blackpool and that, as a result, the law treats China Magic’s acquisition of the Shares as void.  All those are matters for the Court (not Benefun’s Board) to determine, essentially after considering oral evidence as to what was said (or not said) at the time of the alleged representations.  Benefun’s directors are not a sort of tribunal before whom China Magic has to disprove Blackpool’s allegations on some balance of probability.

12.  The burden is on Blackpool as a plaintiff in proceedings to establish its title (if any) to the Shares and to take appropriate measures (such as taking out an interim injunction) to protect the same.  But, apart from filing a Statement of Claim in March 2009, Blackpool has done little to advance its litigation despite the lapse of several months.

13.  In those circumstances, I do not think that Benefun’s Board can reasonably require China Magic to produce anything else by way of proof.

14.  I am fortified in this conclusion by Art. 13.

15.  By that provision, Benefun makes it clear to the world (and contractually promises its shareholders) that it will not have regard to equitable interests (actual or alleged) when considering whether a person is entitled to a share.  In Art. 13, Benefun states that it will simply treat a registered holder of shares as having “the absolute right to the entirety thereof”.  This leaves it up to a person (such as Blackpool) claiming some equitable interest in Benefun shares to take steps to protect whatever rights one may have.  It is not for Benefun to concern itself with the validity or otherwise of a third party’s alleged entitlement to shares.

16.  There are good reasons for such an approach to the trading of shares in a listed company like Benefun. Mr. Kent Yee (appearing for China Magic) rightly submits that, save for the imposition of purely formal requirements (for instance, a need to trade in particular numbers or lots of shares), the free transferability of listed shares is important to the credibility of a public exchange.  Few will buy or sell shares on an exchange, if directors of listed companies may readily query transfers and decline to register them on account of alleged hidden interests in shares.  That, it seems to me, is an obvious underlying policy consideration to the stipulations in Rule 8.13 and Appendix 3, para.1 (2) mentioned above.

17.  In support of his contention, Mr. Chan has cited Sim v. Anglo-American Telegraph Company (1879) 5 QBD 188.  But I have not found that case to be of much help.  It concerned a share registration which was based on a forged transfer form.  There is no suggestion here that the Share Certificate or the share transfer form are forged.  More pertinently, Sim concerned a private company.  The case was decided in a wholly different context.  As far as I can see from the report, there were no equivalents to the Art. 13 or to the Listing Rules to constrain the Court’s analysis in Sim.

B.  Alleged Reason 2: Existence of an equitable lien

18.  Benefun alleges that it engaged Mr. Sik as agent to introduce investment opportunities.  Mr. Sik is said to have introduced Blackpool to Benefun with the result that Benefun entered into a deal with Blackpool for the purchase of a Mainland plantation. 

19.  Part of the consideration for the deal was the issue of Convertible Notes to a principal amount of $400 million.  Upon exercise, the Convertible Notes could be converted into Benefun shares in accordance with a formula.  It is as a result of the issue of these Convertible Notes that Blackpool has obtained a substantial interest in Benefun.

20.  According to Benefun, if Blackpool gave Mr. Sik some of the Convertible Notes as commission for arranging the deal, Mr. Sik obtained a secret commission which Benefun had in no way authorised.  Insofar as Mr. Sik through China Magic exercised the rights under his Convertible Notes to acquire the Shares which he now seeks to transfer to HKSCC, Benefun (the argument runs) must have an equitable lien over the Shares in the amount of the secret commission.

21.  Benefun thus reasons that it is entitled to refuse registration of the Shares under Arts. 39 and 41(e), because it enjoys a lien over the Shares sought to be transferred.

22.  China Magic denies Benefun’s allegations.  In particular, Mr. Sik denies any agency for Benefun.  Mr. Sik also points out that he did not join China Magic until a much later time. 

23.  But Benefun claims that it has evidence (including e-mails from Mr. Sik supposedly acknowledging existence of an agency) which supports its case.  Benefun submits that I cannot decide the merits of its claim on a summary basis in these proceedings, without recourse to a trial.

24.  I am not persuaded that Benefun’s allegation of a lien is a valid ground for refusing registration.

25.  Take Benefun’s claim of an agency with Mr. Sik at face value.  Assume that the allegation is arguable.

26.  Where an agent accepts a secret commission, a principal has two available remedies. The principal may sue the agent personally to account for the commission.  Alternatively, the principal may assert a constructive trust over the property or funds which constitute the commission.  Where the principal opts for the latter remedy, the principal may trace into whatever other property the commission might have been converted to and may lay claim to the converted property.  It is the second remedy of a constructive trust which (if rightly invoked) gives rise to a proprietary interest.

27.  An “equitable lien” is a vague concept.  The terminology may have been chosen to try to fit into the wording of Arts. 39 and 41(e).  But it does not appear to me to be an accurate description of the right being asserted by Benefun here.

28.  What Benefun is in effect saying is that China Magic holds the Shares on constructive trust for Benefun.  According to Benefun, this is because the secret commission of Convertible Notes (which China Magic acquired through Mr. Sik) was converted into the Shares and Benefun is therefore entitled to trace into the Shares.  

29.  I shall assume (in Benefun’s favour) that the constructive trust being asserted is one which the law treats as having arisen immediately upon the handing over of the Convertible Notes to China Magic or Mr. Sik. There is another type of constructive trust which only arises when, for remedial purposes, the Court imposes a constructive trust and makes a declaration to that effect after a trial.  That second type of constructive trust would not assist Benefun’s case since it arises only upon the Court making a declaration and there has been no such.  

30.  On analysis, Benefun’s position is analogous to that of Blackpool.  Both are making claims of an equitable interest in the Shares.  Despite the time that has elapsed since China Magic sought to register its transfer, neither Blackpool nor Benefun has applied for interim relief to stop the transfer of the Shares.  Both have been content to leave their claims of an equitable interest at the stage of mere allegations.

31.  In those premises, just as Benefun’s directors are bound by Art. 13 to disregard Blackpool’s allegations, they must be obliged to disregard Benefun’s own claim to an equitable interest in the Shares when considering China Magic’s share transfer.  By Art. 13, Benefun agreed with its registered shareholders that it will not have regard to alleged equitable interests in Benefun shares.

32.  There is a further difficulty with Benefun’s argument.

33.  Mr. Yee rightly points out that the Articles must be construed in light of (and within the factual matrix of) the Listing Rules (including Appendix 3 para. 1(2)).  It would be odd if Benefun and its registered shareholders intended the Articles to be construed in a way which was inconsistent with the Listing Rules.  This is because Benefun would not have been allowed to list (and could not have gone public) unless its Articles conformed with the Listing Rules.

34.  Given Appendix 3 para. 1(2), Art. 39 should be construed as meaning that, where a share is fully-paid up, the share must be treated as free of all lien.  Recall that Art. 39 states that Benefun’s directors may refuse registration of any share “which is not fully paid up or on which the Company has a lien”.  The underscored words should be read as only having possible application or relevance where shares are not fully paid up.  Otherwise, Art. 39 would fall foul of the condition in Appendix 3 para. 1(2). There is no evidence that the Exchange has authorised Benefun to deviate from the plain meaning of Appendix 3 para.  1(2).

35.  Identical considerations hold in relation to Art. 41(e).  Where that provision refers to “any lien in favour of the Company,” the restriction on registration can only operate when one deals with shares which are not fully paid up.

36.  Consequently, however one looks at the matter, Arts. 39 and 41(e) cannot apply to the situation posited by Benefun.  On the one hand, if Benefun is in reality claiming a constructive trust, then by Art. 13 it cannot use the alleged equitable interest as justification for non-registration.  On the other hand, if Benefun has some sort of “equitable lien” (whatever that term might mean), then since the Shares are fully paid up, the interest asserted would not in any event fall within Arts. 39 and 41(e) read in conjunction with Appendix 3 para. 1(2).

IV. CONCLUSION

37.  Benefun is not entitled to refuse registration of the transfer of the Shares from China Magic to HKSCC.  China Magic’s claim succeeds.  I shall hear the parties on costs and consequential orders.

38.  I add by way of footnote that, in coming to my decision, I have had the benefit of the recent judgment of Deputy High Court Judge Louis Chan in the similar (and related) case of Hero Rich International Ltd. v. Benefun International Holdings Ltd. and others High Court Action No. 1433 of 2009, 9 December 2009.  I gratefully acknowledge the assistance that I have derived from Judge Chan’s reasoning in Hero.