MORNING RAY INVESTMENT CO LTD v. JINHUI INTERNATIONAL ENTERPRISE LTD

HCMP 1155/2021

[2022] HKCFI 926

IN THE HIGH COURT OF THE

HONG KONG SPECIAL ADMINISTRATIVE REGION

COURT OF FIRST INSTANCE

MISCELLANEOUS PROCEEDINGS NO 1155 OF 2021

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D E C I S I O N

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Introduction

1.  On 13 August 2021 Morning Ray Investment Co. Ltd (“Morning Ray”) issued an originating summons pursuant to section 740 of the Companies Ordinance, Cap. 622, seeking disclosure of 14 categories of documents concerning the financial affairs of Jinhui International Enterprise Limited (“Company”) between June 2013 and the date of the court making an order.  There is no dispute that Morning Ray holds 30% of the Company’s issued capital and meets the shareholding threshold (2.5%) required to make an application under section 740.  The documents that are sought are very extensive and may amount to nearly all the Company’s documents, certainly all its financial records, for almost nine years. Morning Ray seeks them because it is concerned at the way the Company has dealt with its sole asset, namely, what was originally its 61.5% shareholding in Guangdong Create Century Intelligent Equipment Group Corporation Limited (“Listco”), which has an A share listing on the Shenzhen Stock Exchange.  The Company is a holding company and its interest in Listco, its dividends and the proceeds of the sale of shares in Listco represent its sole assets and activities.  It is Morning Ray’s case that it is concerned the Company has sold shares and dealt with proceeds of sale and dividends improperly and for the benefit of the other two shareholders in the Company.  In Morning Ray’s skeleton Mr Ho breaks down Morning Ray’s complaints, which it suggests needs investigation into three parts:  First, missing proceeds of the sale of shares in Listco and dividends.  Secondly, the need to investigate the use of proceeds of sale of shares and dividends, which Morning Ray suggests were distributed to the Company’s other two shareholders as unauthorised loans to them by the Company.  Thirdly, the failure of the directors to produce audited financial statements 2018/19 for years onwards.

2.  The Company’s other two shareholders are Wang Chiu Chuan (50%) and Wang Ming Chiang (20%) (“Chiu Chuan” and “Ming Chiang”).  Morning Ray’s application is supported by the affirmations of Wang Jian (“Jian”).  Jian is related to Chiu Chuan and Ming Chiang.  The Wang family established Listco and Jian and his Wife own Morning Ray, although these matters are not explained, as they should have been, in his supporting affirmation.

3.  Section 740 gives the court a discretionary power to order inspection of a company’s records or documents if it is satisfied that the application is made in good faith and for a proper purpose.  The latter will commonly be satisfied by demonstrating that the shareholder’s reason for seeking inspection concerns the shareholder’s economic interest in the company.  However, before considering section 740 in more detail there is another issue that arises for consideration as Morning Ray has had a representative director on the Board at all material times and there is an overlap between a director’s rights to inspect a company’s documents and a shareholder’s rights under section 740.

Director’s right to inspect documents

4.  A director of a company has extensive common law and statutory rights to inspect and obtain copies of a company’s documents.  These are summarised by Fok JA (as he then was) in [26] of Tsai Shao Chung v Asia Television Ltd[1]:

“26. It is helpful to begin the analysis by a restatement of the relevant principles which were helpfully set out in the judgment of Kwan J (as she then was) in Ng Yee Wah v Lam Chun Wah, unrep., HCMP 4616/2001, 28.6.05, at §29, namely:

‘(1) The right of a company director to inspect the company’s documents is well established at common law (Burn v London and South Wales Coal Company and Risca Investment Company (1890-91) 7 TLR at 118-119; Edman v Ross [1922] 22 SR (NSW) 351 at 360-361; Conway v Petronious Clothing Company [1977] 1 WLR 73 at 89-90; Berlei Hestia (NZ) Limited v Fernyhough [1980] 2 NZLR 150 at 163-164; Molomby v Whitehead & Australian Broadcasting Corp [1985] 7 FCR 541 at 550-552; Wuu Khek Chiang George v ECRC Land Pte Limited [1999] 3 SLR 65 at paragraphs 25, 27, 31-34; Law Wai Duen v Boldwin Construction Limited [2001] 4 HKC 403 at 408-409).

(2) The right of inspection flows from the director’s duties to the company and a director does not have to explain why the inspection is sought or demonstrate any particular ground or ‘need to know’ as a basis (Law Wai Duen, supra at 405 and 409; Molomby, supra at 550; Wuu Khek Chiang George, supra at paragraph 27). Thus, the inaction on the part of the director after grounds for suspicion concerning the company’s affairs have arisen is irrelevant; likewise, the intention of the director to discover misfeasance with the view to seeking relief, or that the desire to find evidence is motivated by vindictiveness (Law Wai Duen, supra at 409).

(3) It is only where it can be proved that the director intends to abuse the confidence in relation to the company’s affairs and to injure the company in a material way that the director’s right of inspection can be interfered with, and such interference can only be effected in circumstances where a restriction on a director’s right can be imposed because of misuse of confidential information leading to damage (Law Wai Duen, supra at 408).

(4) In view of the proposition in (3), the exercise of a director’s right of inspection is, ‘generally speaking, not a matter of discretion with the Court’ (Edman v Ross, supra at 361; Berlei, supra at 163; Wuu Khek Chiang George, supra at paragraphs 32 and 33; Law Wai Duen, supra at 408).

(5) The onus of establishing that the right of inspection will be exercised for improper purpose lies on the person who asserts it and ‘clear proof’ is required to satisfy the court ‘affirmatively’ that the grant of the right of inspection would be detrimental to the interests of the company (Wuu Khek Chiang George, supra at paragraph 34).

(6) The scope of inspection can potentially be very wide, covering any ‘documents belonging to the company’ (Burn v London and South Wales Coal Company, supra at 118; Edman v Ross, supra at 360), ‘corporate material’ (Molomby, supra at 550), ‘corporate records and accounts’ or ‘corporate information’ (Berlei, supra at 163), ‘accounting and other records of the company’ (Wuu Khek Chiang George, supra at paragraph 25).

(7) It is perfectly proper for a director to engage an accountant to conduct the inspection in exercise of his right. A director may certainly exercise his right through his agent (Edman v Ross, supra at 361; Law Wai Duen, supra at 409). A director is also entitled to take copies of the documents during inspection (Burn v London and South Wales Coal Company, supra at 118; Edman v Ross, supra at 361).

(8) Whilst there may be some dispute in the authorities if the statutory provision (our statutory provision is section 121(3) of Cap. 32) adds a statutory right of inspection to an existing common law right, it is abundantly clear that the statutory provision is consistent with and does not detract from the common law right (Conway v Petronious, supra at 85 and 89; Berlei, supra at 163; Wuu Khek Chiang George, supra at paragraphs 25 and 31).’”

5.  The relevant sections of the current Companies Ordinance, Cap. 622, are:  financial records section 373(2) & (3); minutes of directors meeting section 481 and company records sections 654 & 655.

Should section 740 be used if the shareholder is a director?

6.  The upshot of this is that Morning Ray did not need to bring an application under section 740 in order to obtain the information it seeks because it had and has a director on the Board, who has a clear right to inspect and copy all the documents sought by the originating summons.  Jian does not explain why he had not insisted that his rights as a director be respected or demonstrated that he had ever made a meaningful attempt to exercise them by, for example, attempting to inspect documents.  Jian does not even tell the court where he thinks the bulk of the documents are located.  This was not a matter that Mr Ho, on behalf of the Jian, was able to assist with as he was only instructed to appear at the hearing not prepare the evidence.

7.  Although the Defendant had suggested in its skeleton argument that the fact that Jian is a director is relevant, it was not suggested that it as significant as in my view it arguably at least is, and I asked counsel to address me on the propriety of a shareholder making an application under section 740 if he (or in the case of a corporate shareholder his representative director) had the right to inspect the documents and, if this is prevented, make the much more straightforward application for an order that he be permitted to inspect documents.  The debate before me identified a number of issues that are relevant to this question.

8.  The first is a practical matter.  It is commonly for applications for inspection by a director to be countered by the director’s removal from the board thus removing his right to inspect.  In the present case this has not happened.  There is no evidence before me from Jian, which suggests that this is what he expected and this is the reason the application was made under section 740.  It seems to me that if this is anticipated the director/shareholder can formulate the application in the originating summons as primarily sought by the director with an alternative application by the shareholder, which can be explained in the evidence is included in the event that the director is removed.  If the director is not removed the application will be more straightforward.  If the director is removed the application will be pursued under section 740.

9.  As is apparent from the Court of Appeal’s judgment in Re Lehman Brown Ltd[2] the fact that a shareholder’s representative (nominee as it is referred to in the judgment) had right of access to the books and records of the Company is relevant to an assessment of whether good faith or proper purpose had been shown.  It is not clear from the judgment whether by this the Court of Appeal were referring to the director’s legal right of access or that as a matter of fact access was available, or a combination of the two, but it seems most likely that it was the former.  What is clear is that the Court of Appeal were not faced with the argument that I explain in the next paragraph.

10.  Before me the argument focused on whether or not an application could be for a proper purpose if a shareholder already had access as a director or whether the existence of the director’s right goes to the exercise of the discretion.  The question is whether (A) if the application would be for a proper purpose if the shareholder was not a director does (B) the fact that the shareholder or its nominee is a director and has a legal right to inspect the documents prevent (C) the application being for a proper purpose.  I note at this juncture that it seems to me that this issue will generally be relevant to proper purpose rather than bona fides (although there may be cases in which it touches on both, for example, if the application is made for tactical purposes) as if assumption (A) is made it tends to suggest that the shareholder’s intentions are genuine.

11.  It might be suggested that in practice little ultimately turns on this issue because if the court takes the view that a shareholder should use the director’s right of access the court can in the exercise of its discretion dismiss the application.  That having been said it seems to me that the better argument is that it is not a proper purpose for a shareholder, who is a director (and I include a nominee director in this category) to use section 740 because this is to undermine proper corporate governance.  It is a director’s function and duty to monitor the performance of a company.  Section 740 exists to enable a shareholder to do so if the shareholder believes that the directors are in some respect, relevant to the shareholder’s interest in the Company, failing to do so.  If the shareholder is a director the course consistent with the structure of responsibility established by the Ordinance and generally accepted principles of corporate governance is for the director to take action.  In these circumstances it cannot be a proper purpose for the shareholder to seek to do what the director can do.  In my view to do so would come close to endorsing a failure by a director to carry out the director’s duties imposed by section 465 of the Ordinance.  It is undesirable for an additional reason: an application by a director for an order facilitating access to a company’s books is far more straightforward than an application under section 740.  Economy and proportionality point in favour of requiring the application to be made by a director rather than under section 740 where this is possible.  Even if the alternative analysis is preferred, namely, that these considerations go to discretion, the conclusion in my view is the same.

12.  In the present case there is no explanation for why Jian has not exercised his powers as a director.  It seems to me that for the reasons that I have explained the application is not, therefore, made for a proper purpose and, if I am wrong about that, in any event it would be wrong to make an order, because in my view the court should decline to do unless a good reason has been shown for the director not insisting on his rights and, if needs be, taking action to enforce them.  This is enough to dispose of the application.

Bona fides and proper purpose

13.  I explain the relevant principles, which guide the court in determining applications under section 740, over which there is no disagreement other than in respect of the issue discussed in the previous section, in [24]–[26] of Re Bank of East Asia Limited[3].

“24. Section 740 gives the court a discretion on the application of 5 or more shareholders, or members representing 2.5% in value of the voting rights, to order inspection of a company’s records or documents if it is satisfied that:

(1) the application is made in good faith; and

(2) the inspection is for a proper purpose.

25. The expression ‘proper purpose’ is not defined in the section, but its meaning and how the 2 requirements are to be understood and applied has been considered in a number of cases in relation to section 740 and its predecessor sections 152FA and 152FB of the former Companies Ordinance, Cap. 32, which are in all material respects the same. In Wong Kar Gee Mimi v Hung Kin Sang Raymond [4] I considered in detail the characteristics of the 2 requirements. I will not repeat the discussion here. In summary those which are relevant to the present case are as follows:

(1) The ‘good faith’ and ‘proper purpose’ requirements constitute two separate and independent tests. The applicant must first, establish that he is acting in good faith and second, the court must believe the circumstances are such that the inspection sought is for a proper purpose: §§14-16.

(2) The burden of proof is borne entirely by the applicant: §42.

(3) The fact that an applicant has only recently acquired a small holding in the company may be strong evidence that the application is either not made in good faith or not made for a proper purpose: §23.

(4) Section 740 is not an opportunity for shareholders to challenge the commercial decisions of the company's management: §36.

(5) In order to satisfy the ‘proper purpose’ criteria it is not necessary to satisfy the court that the applicant has a specific or personal right that can only be protected through the inspection of records. A wish to inspect documents to investigate a genuine and credible belief that there has been corporate mismanagement is capable of constituting a proper purpose[5]. Generally, where the court is satisfied that the ‘purpose’ is germane to a shareholder’s economic interest in the company a ‘proper purpose’ will have been satisfied[6].

(6) ‘As I have already explained, in my view the court should incline to a liberal interpretation of “proper purpose” with a view to advancing the protection of shareholder rights and interest and the maintenance of appropriate standards of corporate governance. This is particularly true in the case of publicly listed companies ……… the court should be more willing to grant inspection orders to protect the interests of members in publicly listed companies’[7]. This view was endorsed by Deputy Judge (as he then was) L Chan in Choi Chi Wai v Hong Kong Agriculture Special Zone Limited [8] as being ‘more in line with the prevailing disposition of the community on corporate governance’.

(7) As part of establishing a proper purpose, the applicant has to show that there is a sufficiently reasonable ‘case for investigation’ as regards past or future wrongful or other undesirable conduct. The shareholder may fail to obtain inspection where he fails to make out on his own material some kind of case for investigation, or where the corporation is able by leading evidence to dispel whatever suspicion has reasonably been aroused: §39.

(8) Once the court is satisfied that the applicant has established a ‘proper purpose’ the company should be required to be transparent[9].

26. The court is not required, and should not endeavour, on an application under section 740 to reach conclusions about the merits of the matters relied on as constituting a ‘proper purpose’. The court needs to be satisfied that a proper purpose has been established and that in the exercise of the court’s discretion it is a proper case in which to make an order for inspection. Recorder Anderson Chow gave a useful summary of what this process involve in paragraph 25 of his judgment in Leung Chung Pun v Masterwise International Ltd [10]:

‘Where, as in the present case, the application for inspection of a company’s records is for the purpose of enabling the plaintiff to carry out investigation into alleged misconduct or maladministration, it would not be possible or appropriate for the court to reach a firm conclusion on each complaint raised because, amongst other things, the evidence would likely not be complete, it is unlikely that disputes of fact can be resolved on affidavit evidence alone, and the complaint may well be raised again in subsequent proceedings for adjudication.  Accordingly, what I consider the court should do is to assess, on the basis of the available evidence, whether the plaintiff has made out a proper case for investigation taking into account such explanations as may be offered by the defendant.  If the plaintiff is able to make out a proper case for investigation, the court should move on to consider whether, in the exercise of its discretion, the inspection sought ought nevertheless to be refused.  The statute does not lay down any restriction as regards the matters which the court may take into account when exercising its discretion.  Thus, the court is entitled to take into account a wide spectrum of matters. However, as cautioned by Harris J in Wong Kar Gee Mimi v Hung Kin Sang Raymond (supra), [34]-[37], the court should strike a proper balance between (i) requiring the company to be transparent and (ii) not permitting the statutory jurisdiction to be used by a shareholder to challenge managerial or commercial decisions made by the board of directors of the company.  How this balance should be struck in any given case can only be determined on a case by case basis.’”

14.  The Company argues that regardless of the view taken in respect of the issue I have previously discussed the application should be dismissed, because it is not necessary and not made in good faith.  It points to the fact that the Morning Ray had been able to exhibit supporting documents, which demonstrate that Jian must have had access to many of the documents he seeks and further that he had a material role in the Company’s financial affairs.

15.  It is difficult to determine where the truth lies in the dispute between the parties about how much involvement each had in the Company’s financial affairs.  Ultimately, three factual issues are determinative in my view.  First, that the principle complaint is that the Company advanced a loan to Chiu Chuan and Ming Chiang for RMB1.3 billion without board approval and in breach of section 157H of the previous Companies Ordinance Cap.32 and they will not engage in a proper consideration at Board level of the obvious concern that Morning Ray has about this.  Chiu Chuan and Ming Chiang have not in their evidence in my view given an adequate explanation for either matter.  The second, which I have already explained, is that it is unclear from the evidence, who had or has what documents, although the auditors must have had most that are sought at least for the period ending 31 December 2018 (the end of the last financial year for which audited financial statements have been produced).  Thirdly, that there are no audited financial statements for the following years and as Chiu Chuan and Ming Chiang are the majority on the Board they should have taken steps to ensure the progress of the audit and it would appear that they have failed to do so at least effectively.  If Jian were not a director, I would have found that Morning Ray had established a proper purpose and that the application was made in good faith.  I would not, however, have made an order in the unnecessarily wide terms in which it is sought.  I would have limited the scope of the order to the financial records of the Company, documents relating to the receipt of the proceeds of sale of shares in Listco and dividends and advances made to shareholders.

16.  I dismiss the application and make an order nisi that Morning Ray pays the Company’s costs such costs to be taxed if not agreed.