In re SINOAMERICAN TELECOM INC.

HCCW329/98

IN THE HIGH COURT OF THE

HONG KONG SPECIAL ADMINISTRATIVE REGION

COURT OF FIRST INSTANCE

COMPANIES (WINDING UP) NO.329 OF 1998

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D E C I S I O N

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1. This is an ex parte application by the Provisional Liquidators under section 182 of the Companies Ordinance that they may be permitted to accept the offer of Phoenix Telecommunications Limited ("Phoenix"), the terms of which are contained in a document attached to the summons issued herein, to purchase by way of private treaty the interest of Sinoamerican Telecom Inc. ("the Company") in all the shares of and its loans to its subsidiaries Remoco (HK) Limited ("RHKL") and Goldremart (Holdings) Limited ("Goldremart") and its loan to Rightone Telecom (HK) Limited ("Rightone"), and for an order that the Provisional Liquidators be permitted to accept the offer of Phoenix to purchase the sundry assets of the Company. Allan Yuen Shek Sang ("Mr Yuen") a director and major shareholder and also a minor creditor of the Company was given notice and appeared in person.

Background

2. The background to this application is that the Company, which is a BVI company has two wholly-owned subsidiaries, namely, RHKL and Goldremart. RHKL is a joint venture partner in Shenzhen Ligao Telecom Technology Company Limited. The PRC joint venture partner is Shenzhen Wanlitong Industrial Development Company Limited ("WLT"). The business is in telecommunications.

3. Mr Yuen and his associates, including his brother and wife, owned just shy of 85% of the issued share capital of the Company. Investors from outside Hong Kong, mainly the United States, have invested considerable sums amounting to some US$11.5 million in the Company whose core business is in the telecommunications industry in the PRC. One of the investors, Dragon Investment Company II LLC ("Dragon II"), a Cayman Island Company, filed a petition to wind up the Company on 14 May 1998 based on the Company's inability to pay its debts. On the same day, an application was made by Dragon II to appoint John Robert Lees and Desmond Chung Seng Chiong as joint and several Provisional Liquidators.

4. Paragraph 4 of the Order appointing the Provisional Liquidators authorized them to :

"sell or dispose of any of the assets by way of private treaty, tender or auction and upon such terms and conditions as the Provisional Liquidators may deem appropriate and subject to their first obtaining leave to do so from the court."

5. Asian Capital Links ("ACL") focuses on investments in Asia. Mr James Desmond Collins-Taylor is a director of one of its subsidiaries, ACL Asia Limited. He is also a director of the petitioning creditor Dragon II. Dragon II's principal shareholders are ACL's strategic partners. Dragon II was ACL's investment entity. It is apparent from Mr Collins-Taylor's first affidavit filed in support of the appointment of the Provisional Liquidators that the investors have fallen out with the Yuen group. Serious allegations have been made against Mr Yuen but the court is not concerned today with the merits of those allegations.

6. The Provisional Liquidators state that the only valuable asset of the Company is its interest through RHKL in the joint venture. Since their appointment, the Provisional Liquidators have endeavoured to find ways of realizing this asset. On 5 June, the Provisional Liquidators obtained an order from Madam Justice Beeson, inter alia,

"to invite offers by way of private treaty from each and all of the shareholders and each and all noteholders of the Company as appearing in the Company's Registers of Shareholders and Noteholders on 22 April 1996 and Star Telecom Overseas Limited for all the Company's interest in all shares in and loans to its subsidiary RHKL and Goldremart, and the Company's loans to Rightone."

7. It is said that the value of the Company's investment in the joint venture is at serious risk because of alleged breaches by RHKL under the joint venture agreement. There is a letter dated 4 June 1998 from Chu Qing Hai, a director of WLT to that effect. It would appear that Mr Chu, like the investors, has also fallen out with Mr Yuen. It is alleged that funds need to be injected on a very urgent basis into the joint venture so that the suppliers can be paid, otherwise the paging network which is part of the joint venture business will suffer and the joint venture may in fact come to an end if WLT were to take steps to terminate the licence, assuming it were able to establish breaches of the joint venture on the part of RHKL. It was urged upon the court that it was critical for the order to be made forthwith if disaster is to be averted.

8. So this is the back-drop to the present application. The Company has debts of some US$17 million of which apparently US$10 is due to Dragon II although the Petition only alleges a debt of some US$2.5 million.

9. On 23 June, the Provisional Liquidators received a bid from Phoenix which is the alter ego of the noteholders of the Company. It is a special purpose vehicle created for the proposed transaction. It has no assets of its own. The rationale for their bid through the medium of Phoenix is that the value of their earlier investments would not be eliminated. It is the only bid that the Provisional Liquidators have received but other than Star Telecom (who has not expressed any interest), no third party has been approached. The proposed transaction is therefore 'internal', a feature which not unnaturally attracts vigilance on the part of the court.

Phoenix's bid

10. The essential features are set out in Schedule 3 to the Proposed Sale and Purchase Agreement which contains particulars of the consideration. The bid as originally proposed was that all known liabilities of the Company would be assumed by Phoenix and that each creditor would have the option of having the amounts due to them paid in full over time as well as the right to receive shares in Phoenix equivalent to 10% of the outstanding shares in Phoenix on a fully diluted basis. In addition, each creditor would be given the right to elect to convert the amounts due by Phoenix to equity in Phoenix. If a creditor was to decide not to accept this primary option, Phoenix proposed that it would still assume each known creditor's liability and in the case of noteholders, repay amounts in full over a 36 month period conditional upon a successful private placement and/or public listing fees during that time period. In the case of other creditors, if they chose not the accept the primary option, 15% of their primary liability would be paid in cash immediately, with the balance being paid over a three year period. This summary is taken from paragraph 67 of Mr Lees' third affidavit.

The hearing

11. The application was made and heard on an urgent basis on 30 June. As a result of observations made and questions raised by the court, the hearing was adjourned for further evidence to be filed. The adjourned hearing took place on 3 July. Mr Lees filed a fourth affidavit to explain that a scheme of arrangement under section 166 of the Companies Ordinance was not practicable as it would not only take several months but is an expensive process, and there are no funds with which to undertake that particular exercise. In addition, the Provisional Liquidators also say that there is a lack of information due to their inability to obtain certain records of the Company which makes it difficult to conduct any public auction. In this context, I should say that the books and records of the Company were removed from the Hong Kong offices of the Company because the landlords were repossessing the premises, and sent by Mr Yuen to the subsidiaries' offices located in China. When the Provisional Liquidators required the records to be returned, a proportion of those records were apparently detained on the PRC side of the border by the PRC Customs.

12. I cannot go into the merits or otherwise, or the reasons for the inability of the Provisional Liquidators to obtain possession of all the records. Although there was a private examination under section 221 of Mr Yuen last week, it is not appropriate for the court to come to any conclusion or to draw any inferences from the examination that was conducted. Suffice to say that according to the Provisional Liquidators, they do not have sufficient financial information because these were contained in computers and hard-disks which, according to Mr Yuen, have been detained in China.

13. The further evidence filed contains a revised Schedule 3, the relevant part of which is attached as an Appendix for ease of reference. The provision that is revised is subparagraph (iii) of paragraph 1.2. It now reads as follows :

"(iii) In the case of trade creditors, if they do not accept the equity option, they may accept 15% of their Liabilities in cash immediately following adjudication of their claims by the liquidator(s) of the Company (once appointed) and the balance of their Liabilities will be paid in full within a period of 36 months (the 'trade creditor cash alternative'). For the avoidance of doubt, the balance of the monies due to the trade creditors under this option will be paid as and when the business of the Purchaser enables payment to be made i.e. it is not proposed that the sums due be payable in monthly instalments."

At the earlier hearing on 30 June, the court had asked what was meant by the provision that "liabilities will be paid in full within a period of 36 months". In particular, the court had enquired whether this meant that they were to be spread over 36 months and repaid in equal monthly instalments. The revised schedule shows that that is not the intention. The revised proposal nevertheless states that "the balance of the 85% will be paid in full". However, it is apparent that the balance will only be met if the Company is in a financial position to do so at any time during the 36 months. There is certainly no guarantee that the balance will be paid. But why there should be a cut-off point at 36 months is not readily apparent.

14. So far as communication of the present proposal to creditors are concerned, this is dealt with in the second affidavit of Mr Collins-Taylor at paragraphs 11 and 12. In brief, as most of the creditors are based in the U.S., it fell to Ms Rose Marie Fox rather than Mr Collins-Taylor to advise them of the proposed offer and Ms Fox was principally responsible for dealing with those creditors and explaining what the offer meant for them as creditors. Ms Fox has not filed any affidavit regarding her role in all of this.

15. The bid proposal that was dispatched to each of the creditors of the Company is exhibited as JDCT-3 to Mr Collins-Taylor's second affidavit. It is to be noted that it was never dispatched to a number of creditors including Mr Yuen and those thought to be associated to him, amounting to approximately 6% of the known creditors save that several of them were contacted just before or even after the hearing had begun.

16. This bid proposal came into being on 22 June and the bid structure proposal includes the following :

"Any trade creditor not participating will receive cash equal to 20% of principal with repayment of remaining principal in 18 months. Any note-holder or convertible note-holder who received or was to receive equity or warrants in Sino and who does not participate will receive their principal over 36 months."

The bid proposal was revised apparently on 23 June and the 20% cash alternative was reduced to 15%. Mr Collins-Taylor explained that this was as a result of the Provisional Liquidators subsequently identifying further creditors of the Company. He deposed to the fact that those trade creditors who have been contacted are aware of this reduction in percentage. In addition to the dispatch of the bid proposal, he was informed by Ms Fox and believes that she has followed up the bid proposal by speaking to the "vast majority of the creditors concerned or their representative" who have, since their original investment, been kept informed of the status of the Company by either Mr Collins-Taylor or Ms Fox insofar as information regarding its affairs was available.

17. When it was pointed out that there was no reference here to the change from '18 months' to '36 months', Mr Carey stated that there would be no difficulty in undertaking to file an affidavit, if the court so required, to the effect that in fact all trade creditors contacted had been informed of the change. It was urged upon the court in emphatic language that commercial reality requires the court to make an order in terms forthwith sanctioning this transaction. According to the third affidavit of Mr Collins-Taylor which was submitted to the court this morning, 83% of the trade creditors have now accepted either the equity option or the trade creditor cash alternative. It is further stated that the proposal has the support of over 95% of the creditors.

Effect of the proposals

18. The effect of the proposals can be summarized very briefly. In essence, it removes the Yuen group and the original outside shareholders from the picture altogether by transferring the Company's only valuable asset to Phoenix. They will not be shareholders of Phoenix and they will have no interest in Phoenix other than by taking up the equity option if they happen to be creditors. This transaction is effectively a scheme of arrangement but one which short-circuits or by-passes the statutory requirements. It is said that the urgency of the matter so requires and in fact, ever since I first dealt with the matter in mid-May, urgency has been put in the forefront of every single application of which there have been a number, (including applications that I have not referred to because they are not really pertinent to today's application) although often-times the 'urgent' application has been long in coming.

19. The court finds itself in a difficult position. On the one hand, it is said that 95% of the creditors support the proposal and that, therefore, regardless of what the other 5% might or might not do, their views can be ignored or overridden. It was submitted that any sensible person would in fact take up this offer because it would be better to have 15% repaid than nothing at all which, it is said, is likely to be the case if the court were not to sanction the transaction. On the other hand, if the court were to sanction this proposal, it will effectively drive a coach and four through the statutory requirements for a section 166 scheme.

20. The statutory requirements are there for very good reasons. If all the proper procedures are observed for a scheme of arrangement, there will not be any uncertainty as to the meaning of certain of the provisions. For one thing, the scheme would be properly explained. For example, notwithstanding the contention to the contrary, I confess that if a were a trade creditor, I would somehow be led into thinking that after receiving 15% up-front, I will receive the remaining 85% within the following 36 months. But, plainly, that is not the case. In my judgment, the statement that the balance (i.e. 85%) will be repaid is misleading. If so, the trade creditors' consent is not, in any real sense, informed or true consent.

21. On further reflection, whether it is appropriate for there to be more than one class of creditors is an open question. Plainly the interest of noteholders is different from those of trade creditors. Moreover, it is not clear that the shareholders ought not to be a separate class given the effect of the transaction. In a section 166 application, the applicant has the responsibility for determining the appropriate classes of shareholders and creditors and any issue regarding the correct composition of the classes will generally be determined on the hearing of the petition to sanction the scheme. The court finds itself handicapped by the truncated procedure adopted in the present application.

22. In essence, what is proposed is a scheme of arrangement. In considering whether or not I should exercise my discretion to sanction this transaction, I have come to the conclusion that it would not be a proper exercise of my discretion to sanction a transaction that would in effect by-pass the statutory requirements for a scheme of arrangement. It cannot be right to allow the transaction through the back door, as it were. The haste with which the present proposal is being rushed through, seemingly without proper and mature reflection, is a further reason for the court to approach the application with circumspection. There is also the fact that Phoenix is a shell and has no assets unless and until its shareholders choose to inject funds into it. So the indemnities contained in Schedule 3 are in reality worthless.

23. If I am wrong, there is an avenue for redress and I am sure that alternative will be pursued with alacrity by the Applicants if so advised.

24. For all these reasons, the application is dismissed.

25. Costs reserved.

APPENDIX

SCHEDULE 3

Particulars of the Consideration

As the Consideration, the Purchaser shall perform and comply with each of the terms set out in this Schedule 3.

1. Assumption of Company's Liabilities