RE KOF MEDIA CORP. LTD

HCCW 544/2008

IN THE HIGH COURT OF THE

HONG KONG SPECIAL ADMINISTRATIVE REGION

COURT OF FIRST INSTANCE

COMPANIES (WINDING-UP) NO. 544 OF 2008

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J U D G M E N T

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1.  This creditor’s petition to wind up KOF Media Corp. Limited (“the Company”) was presented by China Opportunity S.A. SICAR of Luxembourg.

2.  On 18 July 2008, the petitioner by its solicitors in Hong Kong served a statutory demand on the Company for US$750,000 plus interest of US$55,068.64, being sums due and payable pursuant to a breach of clause 6 of the Option and Shareholders’ Agreement dated 15 October 2007 (“the Option Agreement”) and clauses 5.3, 8.1(a) and 8.2 of the Convertible Loan Agreement also dated 15 October 2007 (“the Loan Agreement”).

3.  No payment was made by the Company pursuant to the statutory demand.  The winding-up petition was presented on 12 November 2008.

4.  The Company appeared by its director Fung Kwok On William.  Leave was given to him to represent the Company in these proceedings on 19 January 2009.

5.  Mr Fung filed a total of 4 affirmations in these proceedings.  The petitioner by its chairman and director Niccolo Magnoni filed 2 affirmations and its solicitor filed 2 affidavits.

6.  It is the Company’s contention it has a bona fide dispute of the petitioning debt on substantial grounds.  The petitioner should first establish its entitlement to the sums claimed by a writ action and this petition should be dismissed.

7.  Two broad grounds in opposition were raised by the Company.

8.  Firstly, it is alleged that the US$750,000 was not a loan to the Company but an investment in the Company and that the money was spent in accordance with the instructions of the petitioner.

9.  Secondly, it is denied that the Company was in breach of the Option Agreement and the Loan Agreement as alleged.

The background

10.  I will first set out the relevant background matters.

11.  In May 2005, KOF (Group) Development Limited (“KOF (Group)”) entered into a sub-licence agreement with the publisher of a magazine called “Airport Magazine” published in Shenzhen for a ten-year period commencing July 2005, which gave KOF (Group) effective control over the production of the magazine.  Airport Magazine was a free monthly tourism magazine distributed in the two international airports in Shenzhen and Guangzhou.

12.  In July 2007, KOF (Group) entered into a sub-licence agreement with Shanghai Guojin Culture Distribution Limited (“Guojin”), which gave KOF (Group) effective control over the production of a national financial newspaper published in Shanghai known as “International Finance News” (“IFN”).  This sub-licence agreement did not have a set term.  Under this agreement, KOF (Group) was required to pay a fee of RMB 6.8 million a year to Guojin.

13.  Print media was and is a regulated industry in the PRC.  KOF (Group) did not own the publications.

14.  As funds were required to establish the IFN operations, KOF (Group) sought an investor.  In August 2007, the petitioner expressed interested in investing in KOF (Group).  Due diligence was carried out for the petitioner by KPMG and Hong Kong solicitors.

15.  The petitioner’s solicitors advised on restrictions in foreign investment in media in the PRC.  They opined that KOF (Group) through various structures “currently does more than is permitted under PRC law, in that it directly or indirectly produces, edits, issues and acts as general distributor to the IFN and the Airport Magazine”.  They recommended that before any investment was made by the petitioner, arrangements must be put in place to restructure the business so that KOF (Group) “is only doing some or all of the permitted activities”.  This would mean “new contracts will need to be entered into with both the Airport Magazine Publisher and the INF Publisher”.

16.  On legal advice, the petitioner decided that it would be best to invest directly into a new Hong Kong company rather than into KOF (Group).

17.  Accordingly, the Company was incorporated in Hong Kong on 27 September 2007, with an authorised share capital of HK$10,000, divided into 10,000 shares of HK$1 each.  Mr Fung and Andy Fung each subscribed to 1 share in the Company.

18.  A number of agreements were prepared by the petitioner’s solicitors and they were executed on 15 October 2007.

The Option Agreement

19.  The Option Agreement was made between the petitioner, Mr Fung, Andy Fung and the Company.  By this agreement, the Company was to allot in cash at par 2 shares to the petitioner, 8 shares to Mr Fung and 8 shares to Andy Fung at completion, which was 15 October 2007 (clause 3).  Under clause 4, the petitioner had the option to subscribe for further shares of the Company of 750 shares at US$1,000 per share and 3,000 shares at US$500 per share at any time during the period starting on the date of the Option Agreement.  The period for the exercise of the option to subscribe for the 750 shares would end on the day 6 months after the “Reorganisation Completion Date” (i.e. 15 April 2008), and the option to subscribe for the 3,000 shares would end 12 months after the Reorganisation Completion Date.  The Company would be used as a joint venture to engage in the business of acting as the holding company of KOF (Group) which shall in turn carry on the business of procuring advertising sales for, and the distribution of, the Airport Magazine and IFN (recital (A) and clause 9).

20.  Clause 6 is a material provision.  It relates to reorganisation of the business.  By this clause, Mr Fung and Andy Fung agreed to take all reasonable steps to ensure that the reorganisation obligations as specified were to be completed to the satisfaction of the petitioner, unless such obligations were otherwise waived by the petitioner, in each case on or before the Reorganisation Completion Date (i.e. 15 April 2008).

21.  The reorganisation obligations included the following.

22.  In respect of the Airport Magazine,

(1) a company or a branch of a company was to be acquired or established in Shenzhen (“the Shenzhen Company”);

(2) the Shenzhen Company was to enter into an advertising and distribution agreement with the publisher of the magazine, in form and substance satisfactory to the petitioner and which conforms with all applicable decrees and regulations in the PRC; and

(3) the Shenzhen Company was to obtain all necessary approvals and permits to enter into the agreement in (2)

(clauses 6.1.2, 6.1.3 and Schedule 2).

23.  For IFN,

(1) a company was to be established in Shanghai (“the Shanghai JV”);

(2) the Shanghai JV was to enter into an advertising and distribution agreement with Guojin in form and substance satisfactory to the petitioner and which conforms with all applicable decrees and regulations in the PRC; and

(3) the Shanghai JV was to obtain all necessary approvals and permits to enter into the agreement in (2)

(clauses 6.1.4, 6.1.5, 6.1.6 and Schedule 3).

24.  By clause 13.1, the shareholders, being the petitioner, Mr Fung and Andy Fung agreed it was their intention the financing requirements of the Company should be met by a combination of the proceeds of the subscription of shares under the Option Agreement, the proceeds received under the loan facility in the Loan Agreement and/or dividends generated through the carrying on of the business referred to above or other business approved by the Company.

25.  By clause 20.9, the parties agreed that in relation to their respective obligations under the Option Agreement, time shall be of the essence.

26.  It is not in dispute the Shenzhen Company and the Shanghai JV were never established by 15 April 2008 or subsequently, and no advertising and distribution agreement was ever entered into by the Shenzhen Company or the Shanghai JV in relation to the Airport Magazine and IFN.

The Loan Agreement

27.  The Loan Agreement was made between the petitioner as the lender, the Company as the borrower, Mr Fung as the guarantor, and Andy Fung.  By clause 3, the petitioner agreed to make available to the Company a loan of US$750,000 (“the Loan”) from the date of the agreement on 15 October 2007 and the Company agreed to apply the Loan solely for the purposes of establishing the Shanghai JV, terminating the sub-licence agreement between KOF (Group) and Guojin made in July 2007, and entering into the new advertising and distribution agreement with Guojin.

28.  Under clause 5, the petitioner had the right, but not the obligation, to convert the whole or any part of the Loan into fully paid shares of the Company (“Conversion Right”) during the period starting on 15 October 2007 and ending on 6 months after the Reorganisation Completion Date (i.e. 15 April 2008).

29.  Clause 5.3 is a material provision.  This reads as follows:

“If the Conversion Right is not exercised:

(a) before expiry of the Conversion Period, it shall be extinguished on such expiry; or

(b)    in the sole and absolute discretion of the Lender, whether such non-exercise of the Conversion Right is prior to or after the expiry of the Conversion Period, the Lender shall have the right to demand repayment of the Loan (“Repayment Demand”) within thirty (30) days of sending the Repayment Demand, in writing, to the address of the Borrower pursuant to clause 18.2.”

30.  The petitioner says by the statutory demand dated 18 July 2008, a repayment demand under clause 5.3(b) was served on the Company and the Company was obliged to pay within 30 days thereof.  As mentioned earlier, this petition was presented on 12 November 2008, close to 4 months after the statutory demand was served.

31.  Clause 8.1(a) provided that if the reorganisation was not completed in accordance with clause 6 of the Option Agreement, this would constitute an event of default.  By clause 8.2, on occurrence of an event of default the petitioner may, by written notice to the Company, declare the Loan to be immediately due and payable.

32.  On 25 October 2007, the petitioner made available to the Company the Loan.  On 23 May 2008, the petitioner’s solicitors sent a notice to the Company notifying the latter the reorganisation obligations had not been complied with.  The notice declaring the Loan immediately due and payable was sent to the Company on 2 June 2008.

33.  I turn to consider the two broad grounds of opposition of the Company.

Whether the amount claimed was a loan

34.  This ground may be disposed of quickly.  The legal effect of the various agreements executed by the Company is clear.  Even though the parties had agreed the amount of US$750,000 made available by the petitioner to the Company was to be applied in a certain way, there are clear provisions in the Loan Agreement in clauses 5 and 8 setting out the circumstances under which the petitioner may demand repayment of this sum or of such sum that had not been converted into shares in the Company.

35.  There is nothing unfair or unjust about requiring the Company to comply with its legal obligation in making payment to the petitioner.

Whether there was breach of the reorganisation obligations

36.  The Company alleged it would be able to rely on the defences of common mistake, frustration and force majeure, on the basis that because of certain PRC legislation, it was not possible for the Company to fulfil the reorganisation obligations by 15 April 2008 or even by July 2008.

37.  It was contended by the Company that

(1) by reason of Regulation No. 8 promulgated by the PRC State Administration for Industry and Commerce being the Provisions on the Administration of Foreign-funded Advertising Enterprises (“the Provisions”), a Hong Kong company could only set up an advertising joint venture in the PRC if it had obtained an HKSS (i.e. Hong Kong Service Supplier) Certificate under the Mainland and Hong Kong Closer Economic Partnership Arrangement (“CEPA”);

(2) an HKSS Certificate could only be obtained in respect of advertising business if the applicant company had at least 3 years’ track record in advertising by the time of the application;

(3) at the material time in mid April 2008, the Company or even KOF (Group) had less than 3 years’ advertising track record;

(4) hence, it was legally impossible for the Company to set up a separate advertising company in Shanghai or Shenzhen (i.e. the Shanghai JV and the Shenzhen Company) by 15 April 2008.

38.  The Company merely produced an extract of the Provisions and did not adduce expert evidence on PRC law by a qualified expert.

39.  The petitioner obtained a legal opinion from a qualified expert on PRC law.  According to this expert opinion, during the relevant period from 15 October 2007 to 18 July 2008 (i.e. the date of the statutory demand), it was not a must for a Hong Kong company seeking to set up a joint venture (“JV”) or a wholly-owned foreign enterprise (“WOFE”) in the PRC to engage in advertising business to obtain an HKSS Certificate.  The expert opined that a Hong Kong company could, pursuant to the Provisions, do so either under CEPA (which would require an HKSS Certificate) or under the arrangements applicable to foreign investors in general under the Provisions (which would not require an HKSS Certificate).

40.  For the establishment of a JV or WOFE during the relevant period, the Provisions were applicable to Hong Kong companies, whether or not they had an HKSS Certificate.  Of the requirements set out by the petitioner’s expert, they included the following:

(1) for a JV, all partners should have existed and engaged in advertising business for over 2 years since establishment;

(2) for a WOFE, the investor has existed and engaged in advertising business for over 3 years.

41.  On the evidence of the petitioner’s legal expert, it is not a must for the Company to obtain an HKSS Certificate.  Mr Fung claimed in one of his affirmations the legal opinion of the petitioner’s expert that it is not mandatory for a Hong Kong company to obtain an HKSS Certificate is not accurate, but the Company has not adduced any expert evidence of its own.  I see no reason not to accept the opinion of the petitioner’s expert.

42.  Under the Option Agreement, the reorganisation obligations could have been complied with by acquiring or establishing a JV or WOFE for the businesses in Shenzhen and Shanghai.  It was not legally impossible for KOF (Group) to establish a JV, as KOF (Group) had engaged in advertising business for over 2 years by 15 October 2007.  According to the due diligence report of KPMG, KOF (Group) commenced managing the Airport Magazine in September 2005.

43.  I hold that there is no bona fide dispute that the Company was in breach of the reorganisation obligations under clause 6 of the Option Agreement.  As an event of default had occurred, the petitioner was entitled to demand immediate payment of the Loan and demand was duly made on 2 June 2008.

Whether there was a separate right to demand payment

44.  In addition, the petitioner also relied on its separate and independent right to demand repayment of the Loan within 30 days of the demand sent to the Company under clause 5.3(b) of the Loan Agreement.

45.  As submitted by the petitioner’s counsel, the only condition to the exercise of that right was that the petitioner must not have exercised the Conversion Right at the time of the demand.  A demand was served in this respect by the statutory demand.

46.  I hold also that the petitioner is entitled to payment under clause 5.3(b).  The Company has not raised any or any defence of substance to the exercise of the right under this provision.

47.  To conclude, there is no bona fide dispute of the petition debt on substantial grounds.

48.  I make an order to wind up the Company.  The petitioner’s costs are to be paid out of the Company’s assets.