DONEUR H.K. LTD v. FOUR TWENTY CO LTD AND ANOTHER

HCCW 278/2004

IN THE HIGH COURT OF THE

HONG KONG SPECIAL ADMINISTRATIVE REGION

COURT OF FIRST INSTANCE

COMPANIES (WINDING-UP) NO. 278 OF 2004

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D E C I S I O N

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The applications

1.  There are two applications before me.  The first application is an application of the 2^nd respondent to strike out paragraphs 14 & 18 of the amended petition and paragraph (1) of the prayer for relief.  The other application is an application of the petitioner to re-amend the petition.

2.  The 2^nd respondent has opposed the amendments made to paragraphs 11A, 15, 15C, 15D and 15E of the draft re-amended petition.

3.  In the petition, the petitioner seeks to wind up Four Twenty Company Limited (“the Company”), the 1^st respondent herein, on the just and equitable ground.  Alternatively, the petitioner seeks relief under section 168A of the Companies Ordinance, Cap. 32, that the 2^nd respondent may be ordered to buy out the shares of the petitioner in the Company at the value to be assessed on the basis that the affairs of the Company had been conducted in a manner unfairly prejudicial to its interest.  The same allegations are relied on in the amended petition to found relief for winding up and under section 168A.

4.  The main ground for the striking out application is that there is no real prospect of the court making a winding-up order and that the petitioner is acting unreasonably in insisting to wind up the Company which is solvent, instead of pursuing the available alternative remedy for the purchase of its shares.

5.  There is no dispute as to the approach and principles to be adopted in the strike out application and they may be summarised as follows:

(1)	It is assumed that the particulars and allegations in the petition and the supporting affidavits of the petitioner would be established and the conflicts resolved in favour of the petitioner (Re Forecast Nominee Limited [1996] 4 HKC 12 at 18C; Re Prudential Enterprise Limited [2001] 2 HKC 687 at 692D-E).
(2)	The application should be approached with the greatest circumspection and it is only in a plain and obvious case that the court should exercise its discretion to strike out the petition for winding up or the parts complained of (Re Wong To Yick Wood Lock Ointment Limited [2001] 2 HKC 618 at 623I).
(3)	The burden is on the applicant to show that it is plain and obvious that the petition for winding up would fail on the ground there is an alternative remedy available to the petitioner and that the petitioner is acting unreasonably in seeking to have the company wound up instead of pursuing that other remedy (section 180 (1A) of Cap. 32; Re Wong To Yick Wood Lock Ointment Limited, supra.at 622I to 623F and 623H and on appeal at [2003] 1 HKC 484 at 487H to 488B).
(4)	Where proposed amendments are put forward in an application to strike out, the court should have regard not only to the allegations in the existing petition but also to matters in the proposed amendments (Re Prudential Enterprise Limited, supra. at 692D).

The background facts

6.  Doneur H.K. Limited, the petitioner herein, is a company incorporated in Hong Kong in June 1999.  All except one of the shares in the petitioner are held by Hiroyuki Kawase (“Mr HK”).  The remaining share is held by his wife, Mrs Ayako Kawase (“Mrs AK”).

7.  The 2^nd respondent, Yoshiteru Kawase is a son of Mr HK.

8.  The Company was incorporated in Hong Kong on 9 May 2001.  At all times, the petitioner holds 30% of the issued shares and the 2^nd respondent holds the remaining 70%.

9.  The 2^nd respondent is a fashion designer.  He established a company in Japan in March 2000 called fakedelic company limited (“fakedelic”).  There is dispute if fakedelic is owned entirely by him.  The petitioner’s case is that 30% of the shares in fakedelic is owned by the 2^nd respondent’s mother, Mrs AK, and only 70% of the shares is owned by him.

10.  The 2^nd respondent has always been a director of the Company.  He has also appointed management staff of fakedelic as directors of the Company.  The petitioner and Mr HK have not been directors.

11.  Another company relevant to the proceedings is a company incorporated in Japan known as EXIV Company Limited (“EXIV”).  EXIV would appear to be wholly owned by Mr HK although he holds only 60% of the registered shares.

The Petitioner’s allegations

12.  The petitioner’s case is that the Company was established by Mr HK and the 2^nd respondent as a vehicle for the specific purpose to save tax payable by EXIV and fakedelic in Japan, where the rate of profits tax of companies is much higher than in Hong Kong.  The plan was for EXIV and fakedelic to remit their profits from Japan to a new entity in Hong Kong as royalty income and it was agreed between Mr HK on behalf of the petitioner and the 2^nd respondent that the Hong Kong entity would pay dividends every year out of the royalty income received from EXIV and fakedelic.  In this way, Mr HK and the 2^nd respondent would share the profits of EXIV and fakedelic in Hong Kong out of the dividends paid by the Hong Kong entity.  It was further agreed that the Hong Kong entity would only do business with EXIV and fakedelic.

13.  The Company was incorporated for the above reason.  Shortly after incorporation, the Company entered into Business Trust Contracts with EXIV and fakedelic, pursuant to which EXIV and fakedelic paid royalty to the Company, in the percentages approximately equivalent to their respective shareholdings in the Company.  The articles of association of the Company provided that the Company shall in each year hold a general meeting and that the payment of dividends will be determined in the general meeting.

14.  Since its incorporation in May 2001, no annual general meeting had been held and no financial statements or audited reports were provided and approved in the general meeting.  No dividends were declared by the Company, contrary to the agreement between the petitioner and the 2^nd respondent.

15.  The petitioner’s solicitors wrote to the board of directors on 18 June 2003 complaining that no annual general meeting was held and that the provisions in Cap. 32 regarding the laying before the company at the annual general meeting of the accounts with a director’s report and an auditor’s report had not been complied with.  The board was asked to hold an annual general meeting within 21 days, failing which an application would be made to the court.  This was met with no response.  A second letter dated 27 August 2003 was sent by the petitioner’s solicitors, giving final notice that if the demand for an annual general meeting was not met, a petition would be presented to wind up the Company or to seek relief under section 168A.

16.  On 18 December 2003, the petitioner’s solicitors wrote to the 2^nd respondent marked “subject to contract” referring to complaints in the two earlier letters and stating that without prejudice to other rights the petitioner may seek to claim against the Company, the petitioner was prepared to “consider the proposal to sell off its shares and interests in the Company” to the 2^nd respondent or his nominees at the current market value to be assessed by an independent auditor.  The petitioner’s solicitors gave notice that if no written confirmation was forthcoming from the 2^nd respondent that he would agree to the proposal, the petitioner would seek other relief without further notice.  It does not appear from the available evidence there was any negotiation on the petitioner’s proposal to sell its shares and Mr Remedios for the 2^nd respondent has confirmed that no offer has been made by the 2^nd respondent.

17.  The petition was presented on 3 March 2004, and the amended petition was filed on 28 April 2004.

18.  It was only in the 2^nd respondent’s affirmation in opposition filed on 12 June 2004 that he disclosed the audited financial statements of the Company, for the years ended December 2001, 2002 and 2003.  According to the latest audited accounts as at 31 December 2003, the Company had accumulated profits in the sum of HK$11,502,462.00.  Also according to the latest audited accounts, substantial sums had been borrowed from the Company by the 2^nd respondent as interest-free unsecured loans, repayable on demand.  The amount due from the 2^nd respondent as at 31 December 2003 was HK$13.5 million odd.  The petitioner had no knowledge of this loan until the audited accounts were disclosed in the 2^nd respondent’s affirmation.  No reason was given why the loan was made.

19.  Also, in the 2^nd respondent’s affirmation, he stated that the Company ceased trading activities from May 2003 and has remained dormant since.  It was also mentioned in the director’s  report for the year ended 31 December 2003 that during the year the principal activities of the Company were garment trading and provision of fashion design services for earning royalty income and that the Company was dormant from 1 June 2003.  The reason that the Company had ceased trading activities, according to the 2^nd respondent, was because he and Mr HK and their respective companies have been engaged in litigation in Japan and Hong Kong.  He therefore terminated the Business Trust Contract between the Company and fakedelic in January 2003.  He further stated that the cessation of business of the Company was meant to be temporary, and that he intended to resume business once litigation with the petitioner and Mr HK has been resolved.

20.  After the petition was presented and on 12 July 2004, the first annual general meeting of the Company was held.  The accounts for the year ended 2001 to 2003 were adopted by the Company, on the majority votes of the 2^nd respondent, notwithstanding the queries and objection of the petitioner.  No resolution was passed to declare dividends at that meeting.

21.  In summary, the petitioner’s complaints are as follows:

(1)	the 2nd respondent had failed to abide by the agreement to share profits in the form of royalty paid to the Company by EXIV and fakedelic by causing the Company to declare dividends each year and that the purpose for which the Company was set up has gone;
(2)	the Company was improperly managed in that more than HK$13 million was lent to the 2nd respondent for no apparent reason and the loan was outstanding as at 31 December 2003;
(3)	contrary to the agreement that the Company should do business only with EXIV and fakedelic, the Company had business transactions with other companies and as a result had incurred expenses in considerable sums.

The strike out application

22.  I am not persuaded that it is plain and obvious the relief to wind up the Company would be denied to the petitioner in this situation.  I am mindful that the petitioner has not explained on affidavit if it has any preference for winding up relief and on the evidence, it must be taken that the petitioner has no objection to the buying out of its shares, although it wishes to pursue winding up relief as an alternative remedy.

23.  The profits accumulated by the Company are, on the petitioner’s case, profits of EXIV and fakedelic and which the Company should have caused dividends to be declared for the shareholders to share in such profits.  As a result of the dispute between the 2^nd respondent and the petitioner and Mr HK, the 2^nd respondent had caused the Business Trust Contract entered into by fakedelic with the Company to be terminated, thereby cutting off a major source of income of the Company.  Moreover, the Company has remained dormant for 18 months and there are no plans to resume trading activities until the litigation in Hong Kong and Japan has been resolved, which may well take some time.  The present situation is different from the situation where a company is solvent and has accumulated profits due to its own trading activities and is still actively trading.

24.  In the event that a buy-out order is made of the petitioner’s shares, no value would be attributed to the shares on the basis on the Company being sold as a going concern.

25.  It is not obvious to me that the price for the shares of the petitioner fixed by the court, on the basis of net assets value of the Company, if a buy-out order is made, would have exceeded the capital sum that would be distributed on a winding up.

26.  The 2^nd respondent has not advanced any basis or mechanism for fixing the price of the petitioner’s shares in the event that a buy-out order is made, although in the oral submission of Mr Remedios, he contended that the effect of a winding up order and a buy-out order would probably be the same, as the Company has no assets other than the profits accumulated being the royalty received.

27.  It does not appear to me that the petitioner is acting unreasonably in pursuing winding up relief in the alternative.  It may be simpler to pursue winding up relief, to avoid any dispute on the prescribed basis to determine the price of the petitioner’s shares, or the discount, if any, to be given to reflect the fact that the petitioner’s shares constituted a minority shareholding.  Further, the retention of the winding up prayer in this situation is not likely to cause damage to the Company, as there are no plans to resume business until the dispute has been resolved.

28.  As to the allegations of mismanagement in paragraph 15 of the proposed re-amended petition, they are made merely for the purpose of establishing unfairly prejudicial conduct and/or that it is just and equitable to wind up the Company.  The petitioner does not seek any recovery in these proceedings of the loans advanced to the director or the directors or the expenses alleged to be unreasonably incurred.  I see nothing wrong about that.

29.  As to paragraph 14 in the amended petition, which the 2^nd respondent seeks to strike out, I see nothing objectionable in this paragraph either.  I do not find the allegation lacking in particulars as contended, particularly when this paragraph is read with the proposed amendments in paragraphs 11, 12, 13 and 13B.  Nor do I think it irrelevant or embarrassing as contended, I note that the failure to provide audited accounts had persisted until after the petition was presented.

30.  For the above reasons, I decline to exercise my discretion to strike out parts of the petition.  It does not appear to me inevitable that the court would not order the Company to be wound up.  I therefore dismiss the strike out application.

The amendment application

31.  Objections were made to various paragraphs mainly for the reason that the proposed amendments are lacking in particularity.  This defect can be cured, by giving leave to amend on terms, that sufficient particulars be provided so that the 2^nd respondent be informed of the case he has to meet.  This is particularly so where the petitioner has served an affirmation disclosing to some extent the matters relied on in support of some of the allegations in the proposed amendments.

32.  I turn to consider the individual paragraphs objected to by the 2^nd respondent.

Paragraph 11A

33.  I do not think the allegation that the petitioner had provided financial and other assistance to the 2^nd respondent and the Company around the time of establishing the Company is irrelevant.  This may go to show the relationship of co-operation on which mutual trust and confidence was founded to form the Company as a vehicle for tax saving.

34.  I would allow the amendment on condition that the petitioner is to particularise the “financial and other assistance” it had made to the 2^nd respondent and the Company, as the petitioner has done in paragraphs 11 and 12 of the 2^nd affirmation of Mr HK.

Paragraph 15

35.  I would only allow at this stage the proposed amendment in the first sentence relating to the loan of more than HK$12 million borrowed by the director or directors of the Company.  The rest of the proposed amendment relates to an allegation that the Company had been doing business with companies other than EXIV and fakedelic and had incurred “many items of expenses in considerable sum” without reasonable cause.  I propose to adjourn the application to amend this part of paragraph 15 to give the Company a further opportunity to come up with properly formulated amendments.  As I have indicated to Mr Hui, who appeared for the petitioner, the Company should at least provide the basis on which it is alleged that the Company had been doing business with other companies apart from providing services to EXIV and fakedelic, even though the petitioner is not aware of the identities of these third party companies at this stage.  Further, the Company would need to particularise properly what were the “many items of expenses in considerable sum” that have been incurred as a result of such dealings with third party entities.  I am not minded to give leave to amend until the petitioner has come up with properly formulated amendments dealing with these two aspects.

Paragraphs 15C, 15D and 15E

36.  As I have indicated to Mr Remedios, there is nothing to the objection taken in respect of paragraphs 15C and 15D.

37.  I will disallow the amendment in paragraph 15E which seems to me unnecessary and otiose.

38.  Subject to the correction of some clerical errors, which I will mention, and subject to the condition imposed in respect of paragraph 11A, I allow the amendments to the draft re-amended petition with the exception of paragraph 15E.  The application to amend the subsequent part of paragraph 15 is adjourned sine die with liberty to restore upon the provision of revised amendments.

39.  I will hear the parties on the costs of the two applications.