XU SHENGHENG AND ANOTHER v. CHEUNG KWAN

HCA 291/2009

IN THE HIGH COURT OF THE

HONG KONG SPECIAL ADMINISTRATIVE REGION

COURT OF FIRST INSTANCE

ACTION NO. 291 OF 2009

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BETWEEN

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D E C I S I O N

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1.  This is an application by the 1st plaintiff by counterclaim (“Cheung”) for the continuation of an ex parte interim injunction granted by the Honourable Mr Justice Sakhrani on 3 January 2012 against the 1st defendant by counterclaim (“Xu”). Xu opposes the application.

2.  The original action was started by Xu and his company, Ever Sincere Investment Limited (“Ever Sincere”), as the 1st and 2nd Plaintiffs against Cheung on 6 February 2009.  The original statement of claim was filed on 27 May 2009 and Cheung filed her defence on 14 October 2009.

3.  Cheung re-amended her defence and put in a counterclaim on 16 November 2011.  She also applied for and was granted an ex parte interim injunction against Xu on 3 January 2012 enjoining Xu from dealing with or disposing of 250 million shares in China Ground Source Energy Limited (“the Company”).

4.  The Company is listed in the GEM board of the HKSE.  Its shares were consolidated from four to one on 1 February 2010.  The 250 million shares subject to the injunction are equivalent to 1 billion shares of the Company before the consolidation.  These shares were originally owned by Xu’s company, Ever Sincere.

Background

5.  I would briefly refer to the event that led to Ever Sincere becoming the holder of the 1 billion shares of the Company.  Prior to March 2008 Ever Sincere was the owner of all the shares of Beijing Enterprises Ever Source Limited (“BEES”).  On 21 December 2007, a subsidiary of the Company entered into an agreement with Ever Sincere to purchase all the shares of BEES from Ever Sincere.  The consideration was HK$704 million. 

6.  The sum was made up of HK$200 million in cash payable partly before and partly upon completion, HK$300 million in the form of allotment of 1 billion shares of the Company valued at HK$0.30 per share upon completion and HK$204 million by the issue of convertible notes.  The convertible notes were not to be issued upon completion but were, subject to conditions, to be issued in two lots at two future dates.  The details of the conditions for issuance have been explained in an announcement dated 14 January 2008 issued by the Company to the HKSE.

7.  The relevant part of the announcement is on page 4 which reads:

“(d) as to the remaining balance of HK$204 million,

(i) in the event that the net profits after tax of BEES attributable to the shareholders of BEES for the period of 12 months commencing from Completion Date as reflected in the audited financial statements of BEES prepared in accordance with HKFRS (Hong Kong Financial Reporting Standards) and disclosure requirements of the Companies Ordinance is not less than HK$80,000,000, by the issue of Convertible Notes with the principal amount calculated in accordance with the following formula:

HK$204,000,000 x	The amount of audited net profits after tax of BEES for the aforesaid 12-month period
	HK$200,000,000

within 30 Business Days after the receipt of such audited financial statement (which forms and content must be to the absolute satisfaction of the Purchaser) by the Purchaser; and

(ii) in the event that the net profits after tax of BEES attributable to the shareholders of BEES for the period of 24 months commencing from Completion Date as reflected in the audited financial statements of BEES prepared in accordance with HKFRS and disclosure requirements of the Companies Ordinance is not less than HK$200,000,000, by the issue of the Convertible Notes with the principal amount being the remaining balance of HK$204,000,000 within 30 Business Days after the receipt of such audited financial statement (which forms and content must be to the absolute satisfaction of the Purchaser) by the Purchaser.

For the avoidance of doubt, the aggregate amount of Convertible Notes to be issued will not exceed HK$204 million.”

8.  There is also a profit guarantee, the material part of which reads:

“The Vendor warrants and guarantees to the Purchaser that the net profits after tax of BEES attributable to the shareholders of BEES for the period of 24 months commencing from Completion Date as reflected in the audited consolidated financial statement of BEES prepared in accordance with HKFRS (“24 Month Net Profits”) shall not be less than HK$200 million.

The Vendor covenants with the Purchaser that, in the event that the 24 Month Net Profits is less than HK$200 million, the Vendor shall

(a)  pay to the Purchaser an amount in cash (in Hong Kong dollars) equivalent to such shortfall; or

(b)  (at the option of the Vendor) transfer to the Purchaser (for no consideration) the Convertible Notes (then already issued to the Vendor and for which the Vendor has not exercised the conversion right thereof, if any) of such principal amount equivalent to or less than the amount of the shortfall (as the Vendor may elect) free from all encumbrances, and pay to the Purchaser an amount in cash (in Hong Kong dollars) equivalent to the remaining balance of such shortfall,

within 30 Business Days of the date on which the relevant financial statements are made available to the Vendor.”

9.  The agreement to purchase the BEES shares was completed on 31 March 2008.  HK$200 million cash and 1 billion shares of the Company should have been effected to Ever Sincere on that date.  Regarding the convertible notes, the audited financial statement for the purpose of issuance of the first lot of notes should cover 31 March 2009 and these notes should be issued some time after this date if the financial statement should show a profit.

10.  The audited financial statement for the issuance of the second lot of convertible notes should likewise be available sometime after 31  March 2010. 

11.  The convertible notes was non-interest bearing and could be converted into shares of the Company at HK$0.30 per share.  They were transferable subject to prior written consent of the Company.  If the net profit after tax of BEES for the 24 months commencing the completion date should be no less than HK$200 million, Ever Sincere would then be issued with convertible notes at HK$204 million that could be converted to 680 million shares of the Company.

Cheung’s case

12.  Cheung made an affidavit in support of her application for the ex parte injunction.  She said she made a verbal agreement with Xu in about the end of March or early April 2008 to sell Xu 500 million shares of the Company at HK$0.25 cents per share for Xu to become the controlling shareholder of the Company.

13.  The consideration at HK$125 million was payable in two instalments; the first instalment at HK$55 million was payable at the end of June 2008 and the balance of HK$70 million was payable at the end of August 2008.  Xu also pledged to Cheung the 1 billion shares of the Company that were held by Ever Sincere as security for the completion of his purchase from Cheung.  Xu also agreed not to be appointed a director the Company before the purchase was completed. 

14.  If he should fail to complete the purchase, the 1 billion pledged shares would be transferred to Cheung upon the following contingencies.  If the market price of a share should drop by more than half of the agreed price, i.e. to below HK$0.125 per share, Xu would procure Ever Sincere to transfer 500 million of the pledged shares to Cheung. 

15.  The result would be that Cheung would then own 1 billion shares of the Company with a total value of no more than HK$125 million.  That was to put her in more or less the same position as if the agreement had been completed. 

16.  If the market price of the share should go down further to below HK$0.083 per share, Xu would have to procure Ever Sincere to transfer the remaining 500 million of the pledged shares to Cheung.  Cheung would then own 1.5 billion shares of a total value at no more than HK$124.5 million.

17.  For the purpose keeping the purchase price to be paid by Xu in instalments, Cheung and Xu would open a bank account in their joint names.  Xu would pay the purchase money into this account.  When Xu has paid the full sum into the account, the money would be released to Cheung who would also transfer the 500 million shares to Xu.

18.  Cheung also produced some bank statements of this joint account that was opened with DBS Bank, but she misdescribed the statements as bank account opening documents.  She also said that Xu had signed many blank bought and sold notes for transfer of shares which were kept by a solicitor, Mr Aggarwal. 

19.  Mr Aggarwal is the 2nd defendant by counterclaim in this action and is presently incarcerated by the Correctional Services in relation to a large number of alleged crimes of fraud.

20.  In about the end of April or May, Xu purported to pay HK$10 million to Cheung as part payment of the purchase price.  He, however, proposed to put the money into a joint securities account held by him and Cheung for investment in Hang Seng index futures.  Any profit from the investment would be shared between them equally, but Xu alone would be responsible for the loss.  In the end, the HK$10 million was lost and nothing was left to pay Cheung for the purchase of the shares.

21.  In about the end of August 2008 the price of the shares started to fall.  Cheung repeatedly asked Xu to pay the sale price and complete the purchase.  Xu, however, only told her that the share price would be supported by an institutional investor.  Cheung believed Xu because the managing director and fund manager of the institution was one of their friends.

22.  At the beginning of September, Cheung said she wanted to sell the 500 million shares in the market to reduce her loss.  Xu asked her to wait until December 2008 and promised to ask Aggarwal to complete the transfer documents for the 1 billion pledged shares to her.  In addition, there were other promises by the 2nd to 4th defendants herein given to Cheung for Cheung not to sell the 500 million shares of the Company at that time.

23.  Cheung then asked Aggarwal to arrange for the transfer of the pledged shares to her.  She understood that this was to be achieved by way of transfer to her of the entire shareholding of Ever Sincere as the pledged shares were registered in the name of Ever Sincere.  However, Aggarwal asked her to find a Mainland nominee to hold the shares of Ever Sincere for her.  She was only able to find one Wang in around 20 January 2009.

24.  Aggarwal then prepared the documentation for transfer to Wang of the Ever Sincere shares.  However, the transfer was not completed as Aggarwal had reported to the police that the company kit of Ever Sincere was lost.  Xu also reported the loss of the company kit to the share registrar of Ever Sincere and instructed the registrar not to process any transfer of the shares of Ever Sincere.

25.  Cheung also discovered that Xu had transferred the billion pledged shares from Ever Sincere to himself on 22 January 2009. Hence, even if the shares of Ever Sincere should have been transferred to Wang a few days after 20 January 2009, Cheung would still be unable to get hold of the pledged shares.  She was then served with the writ in this action when she attended the AGM of the Company on 6 February 2009.

26.  As I have referred to above, Cheung re-amended her defence and put in a counterclaim on 16 November 2011 to claim various sums from the defendants by counterclaim and the pledged shares from Xu.  She also put in a stop notice to prevent Xu from disposing of the pledged shares.  Xu’s solicitors then gave notice to her solicitors that Xu intended to sell the pledged shares.  She then applied for and obtained the interim injunction enjoining Xu from disposing of the shares. 

Xu’s case and analyses

27.  Xu made an affirmation in opposition.  Regarding the joint bank account alleged by Cheung and for which Cheung produced some bank statements, Xu in his defence had made an absolute denial of the same and put Cheung to strict proof of the same.  However, he in his affirmation did not say a word about the account or the bank statements exhibited by Cheung.

28.  He, however, referred to a number of disclosure of interest notices (“DI notice”) filed by him and Cheung with the HKSE disclosing their notifiable interest in the shares of the Company.

29.  A notifiable interest in listed shares is defined in section 311(3) of the Securities and Futures Ordinance, Cap 571 as follows:

“(3) A person has a notifiable interest at any time when he is interested in shares comprised in the relevant share capital of the listed corporation concerned of an aggregate nominal value equal to or more than the nominal value of the percentage of the listed equity share capital which is the notifiable percentage level for the time being.”

30.  He said Cheung in March 2008 did not have 500 million shares of the Company for sale to him.  He referred to a DI notice by Cheung, dated 8 April 2008 which shows that Cheung was only interested in 265,004,000 shares as at 28 March 2008.  Xu’s solicitors later filed an affirmation exhibiting all DI notices filed by Cheung in respect of her interest in the shares of the Company.

31.  I list below the dates and the number of shares of the Company she was interested in from 28 March 2008 to 6 February 2009 when this action was started:

32.  Xu then said that the DI notices filed by him and Ever Sincere show that on 28 March 2008 he was interested in 1,680,000,000 shares in the Company.  After 1 billion of these shares were transferred to him on 22 January 2009, Ever Sincere still was interested in 680 million shares of the Company.  Hence he said that Cheung was lying when she alleged that she had agreed to sell him 500 million shares of the Company and he had agreed to transfer all the shares of Ever Sincere to her so as to let her have the 1 billion pledged shares of the Company.  He said the alleged transfer was inconceivable as Ever Sincere was then interested in 1,680,000,000 shares of the Company rather than just 1 billion shares. 

33.  However, as I have mentioned above by reference to the announcement by the Company dated 14 January 2008, if BEES could turn in some net profits after tax, Ever Sincere would be issued some convertible notes by the Company.  The value of the convertible notes could be up to HK$204 million which could be converted into 680 million shares of the Company. However, the issuance of the notes, if any, and the amount of such notes to be issued would depend on the amount of the net profit after tax of BEES. 

34.  If there should be no profit then no convertible notes would be issued.  Furthermore, the first lot of notes would only be issued sometime after 31 March 2009 when the audited financial statements covering this date would be available.  Hence, no convertible notes would have been issued as at 22 January 2009 or the earlier date of 28 March 2008.  It was also not known on these two dates whether any and, if so, how much convertible notes would be issued to Ever Sincere.

35.  Mr Mak, counsel for Xu, submitted that even if no profit should be made by BEES, Xu could have paid up under the profit guarantee and could still have obtained the HK$204 million convertible notes. However, I think in any case Ever Sincere would not have been issued the convertible notes on or before 22 January 2009.  During the period between 28 March 2008 and 22 January 2009, I do not think Xu had a notifiable interest within the meaning of section 311(3) of the Securities and Futures Ordinance in any of the shares that could be converted from the unissued convertible notes. The notes also had a maturity period of five years and the conversion could take place at any time during this period. 

36.  Before the actual conversion, Ever Sincere could not have exercised any voting right on the strength of the unconverted convertible notes.  Therefore, the DI notices by Ever Sincere, saying to the extent that it was interested in 680 million shares of the Company by way of derivatives from 28 March 2008 to 22 January 2009, were all premature, inaccurate and misleading.  The notices misled the shareholders of the Company and the investing public to think that Ever Sincere was during this period already interested in 1,680,000,000 shares. 

37.  The investing public was misled to think that Xu through Ever Sincere and his wife was the biggest shareholder of the Company holding 29.77% of the voting rights when he only had 17.74% which was 0.05% more than the next biggest shareholder.  Unfortunately, the same inaccurate information also appeared in a tri-quarterly report of the Company dated 13 August 2008.

38.  In fact, a notice of the Company dated 14 September 2010 shows that Ever Sincere in the end only obtained 121,847,500 consolidated shares of the Company by exercising the convertible notes (or 487,390,000 shares before the consolidation).  But for the consolidation on 1 February 2010 of four shares into one, Ever Sincere would have obtained 487,390,000 shares by exercising HK$146,217,000 convertible notes which is about 71.68% of the 680 million shares.

39.  For the period from 28 March 2008 to 22 January 2009, Ever Sincere only had 1 billion shares of the Company and Cheung alleged that these had been pledged to her.  The transfer of these shares by Ever Sincere to Xu on 22 January 2009, which left nothing behind in Ever Sincere, may also operate as a corroboration of Cheung’s case that Aggarwal had purportedly transferred the shares of Ever Sincere to Cheung’s nominee on 20 January 2009.

40.  If Cheung is truthful, the transfer of the 1 billion shares of the Company to Xu on 22 January could have been a further act by Xu to prevent Cheung from obtaining these pledged shares.  Cheung has already alleged the reporting of the loss of the company kit of Ever Sincere by Aggarwal and the instruction by Xu to the share registrar not to transfer the shares of Ever Sincere.  These allegations, which are disputed, prevented Cheung from obtaining the shares of Ever Sincere.  If the 1 billion shares of the Company were transferred out of Ever Sincere, even if Cheung could have obtained the shares of Ever Sincere, she would still be unable to obtain the 1 billion shares of the Company. 

41.  Xu further challenged Cheung for not having filed any DI notice for the alleged sale of 500 million shares to Xu as that exceeded 5% of the issued shares of the Company.  He said if there was such an agreement, all parties to it should have filed a DI notice disclosing the same.  He made the same point in respect of the alleged pledge of the 1 billion shares by Ever Sincere.

42.  However, I doubt if the alleged agreement of sale and purchase of 500 million shares would result in the need to file a DI notice.  Any right acquired in the agreement may not amount to an interest in the shares and hence a notifiable interest in the shares.  The same applies to the alleged pledge of the 1 billion shares.  The pledge was only a security and no right including voting right in the shares had allegedly changed hands.

43.  Regarding the documents for transfer of the Ever Sincere shares to Cheung’s nominee, Xu simply asserted in his affirmation that the documents were forged without any elaboration.  His counsel, Mr Mak, however, explained that the allegation of fraud merely went to the contents of the documents and not Xu’s signatures thereon.  There was some intimation of theft of documents by counsel.

44.  Finally, Xu alleged that Cheung had lied to Sakhrani J that she still had 500 million (or 125 million after consolidation in February 2010) shares that she had agreed to sell Xu.  Xu referred to Cheung’s DI notices and said that Cheung’s shareholding was reduced to 157.4 million before consolidation or 39.35 million after consolidation from 8 September 2010 onwards.

Cheung’s reply

45.  Cheung made a second affidavit to reply to Xu’s allegations regarding the inadequacy of her shares of the Company in March 2008 to meet her sale obligation under the alleged agreement.  She said the material times for her to transfer the shares were June and August 2008 when Xu should have paid HK$55 million and HK$70 million on those dates respectively.  She and her company, the 2nd plaintiff by counterclaim, had 395.9 million shares by 27 June 2008 (as proved by the DI notices produced).  She also said that Xu knew that she and her friends together had more than 500 million of the shares and one of her friends (whose name she did not disclose) had also agreed to provide her with more than 100 million shares to make up the 500 million to be sold to Xu.

46.  Cheung also said Ever Sincere had interest in only 1 billion shares of the Company because the 680 million shares to be converted from convertible notes to be issued were subject to contingencies. She also said that Xu in disclosing an interest in the 680 million shares in his DI notices, when such interest had not materialised and was subject to contingencies, was trying to mislead the investors and the public.

47.  She also said it was unnecessary for her to file any DI notice on her agreement to sell 500 million shares to Xu because the agreement was subject to future payment.  For a DI notice in relation to the 1 billion shares, she said when she found a nominee in Wang to hold the Ever Sincere shares for her, the 1 billion shares was then divested from Ever Sincere and she had no basis to make disclosure of these shares.

48.  Regarding her holding of the shares when she made the ex parte application on 3 January 2012, she referred to her DI notice showing that she had 683,116,000 shares before consolidation or 170,779,000 after consolidation shares on 8 September 2010.  Of these shares, 525,716,000 before consolidation or 131,429,000 after consolidation shares were used for restructuring and merger of various interests and assets on 8 September 2010. However, in the beginning of November 2011, the restructuring and merger was undone and reversed so that her holding reverted to 683,116,000 shares before consolidation.  However, no DI notice was filed because of the oversight of the consultant company.  She said she would procure a DI notice to be filed in respect of the reversion of the restructuring as soon as possible to reflect her actual holding.  Therefore, when she made the ex parte application to Sakhrani J on 3 January 2012, she indeed had more than 500 million shares of the Company.

A serious question to be tried

49.  Xu says that Cheung’s alleged agreement of sale and purchase is completely bogus.  Cheung says that the joint bank account she had with Xu was for Xu to make payment for the 500 million shares.  Xu made an absolute denial of the same in his defence and put Cheung to strict proof. When Cheung produced some bank statements of the joint account in her affidavit, Xu did not give a word of explanation. 

50.  Cheung produced the share transfer documents for the Ever Sincere shares which were to transfer to her indirectly the 1 billion pledged shares of the Company dated 20 January 2009.  Xu merely said that these transfer documents were forged and did not give a word of explanation.  If the transfer documents should be given effect, Cheung through her nominee, Wang, would shortly have control over the 1 billion shares of the Company.  However, that 1 billion shares were transferred out from Ever Sincere to Xu on 22 January 2009. 

51.  Xu also did not say a word on why he had chosen to make the transfer of the 1 billion shares on that day if not to defeat the transfer of the same to Cheung of these alleged pledged shares.

52.  In the light of these matters, I find that there is a serious question to be tried on Cheung’s alleged sale and purchase agreement, the related pledge agreement and the alleged subsequent transfer agreement pursuant to the pledge agreement.

Material non-disclosure

53.  Xu also alleged that Cheung was guilty of material non-disclosure when she applied for the ex parte injunction.  The first material non-disclosure is the fact that she did not have 500 million shares in March to April 2008 when the alleged sale and purchase agreement was made.  This matter goes to the issue of the serious question to be tried.

54.  Cheung in her affidavit in support of the ex parte application already disclosed the statement of the joint bank account and the transfer documents for the shares of Ever Sincere.  I do not think the disclosure to Sakhrani J that she in March/April 2008 had not had in her name or her control 500 million shares would have affected the exercise of the discretion in granting the injunction.  I do not think this was a material consideration in the light of what Cheung had said in her affidavit and the documents exhibited by her.  The table above of the shares held by Cheung from time to time also shows that she was able to acquire further shares from time to time and she also had more than 500 million shares when she made the ex parte application.

55.  The next allegation of material non-disclosure is Cheung’s failure to tell Sakhrani J that Ever Sincere, in fact, had interests over 1,680,000,000 shares.  This was material in that Cheung alleged the transfer of the Ever Sincere shares to her nominee was for transfer to her indirectly the 1 billion pledged shares, but Ever Sincere in fact had 1,680,000,000 shares, hence the transfer of the shares of Ever Sincere to her nominee would mean the transfer to her nominee the 1,680,000,000 shares of the Company or the interest therein.

56.  In the light of my observation above that Ever Sincere only had 1 billion shares and its DI notices were inaccurate and misleading to the extent of its alleged interest in the 680 million shares, this allegation of material non-disclosure is a non-point.

57.  The next allegation is Cheung’s failure to disclose that she had not filed any DI notice on the sale and purchase and pledge agreements.  However, I have in the discussion above already doubted the need for DI notices for these agreements.  This is again a non-point.

58.  Xu further attacked Cheung for having lied to Sakhrani J on her shareholding at the ex parte application.  I accept Cheung’s statement in her second affidavit that she in fact had shares that were equal to more than 500 million before consolidation as at the date of the ex parte application.  I therefore hold that she had not lied to Sakhrani J.

Adequacy of damages

59.  Cheung’s remedy is the 1 billion shares or damages for breach of contract.  However, the shares of the Company are traded in very small quantities in the GEM Board.  It is very difficult to quantify the value of the 1 billion shares as it may take years to sell such a quantity at the market without serious damping on the market price.  It is also doubtful if Xu has the means to pay Cheung for the loss.  Damages are therefore an inadequate remedy.

60.  Xu says he wants to sell the shares and his loss may be very substantial if he is prevented from doing so.  However, Cheung says that the shares of the Company are sold in very small quantities in the market.  If Xu should receive any offer for private sale of these shares, Cheung would like to have the right of first refusal, or alternatively, Xu can go ahead with the sale but pay the proceeds into court pending trial of the counterclaim on the alleged agreement.

61.  I think Cheung’s proposal is reasonable and can prevent Xu from being prejudiced by the injunction.  I therefore continue the ex parte injunction in the same terms until trial or further order.

62.  Xu has indicated that if the exemption should be continued, he would like to argue on the scope of the injunction and fortification of Cheung’s undertaking.  There is no objection by Cheung to this request.  I therefore direct the parties to fix another hearing with an estimate of two hours for argument on these two matters.

63.  I also make a costs order nisi that the costs of the ex parte application and the application to continue be in the cause of the counterclaim of the alleged sale and purchase agreement, save that the costs for arguing the application to continue be paid by Xu to Cheung.

64.  I also direct the parties to fix a 9.30 am appointment outside the next 14 days for summary assessment of the amount of costs payable.