Regency International Hotels (Hong Kong) Ltd. v. Grandfield Pacific Hotel Ltd.

HCCW290/1998

IN THE HIGH COURT OF THE

HONG KONG SPECIAL ADMINISTRATIVE REGION

COURT OF FIRST INSTANCE

COMPANIES WINDING-UP PROCEEDINGS NO.290 OF 1998

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J U D G M E N T

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1. This is an application by way of motion by Union World International Limited ("Union World") and Bellington Associates Limited ("Bellington"), contributories holding 2,800 shares respectively in Grandfield Pacific Hotel Limited ("the Company") to strike out the Petition dated 1 May 1998 on the ground that it is-

(1) an abuse of the court process;

(2) that it is frivolous and vexatious; and

(3) that the Petitioner has no tangible interest in the winding up of the Company.

2. Union World and Bellington ("the opposing contributories") each holds 28% of the shares of the Company. The remaining 44% is held by Regency International Hotels (Hong Kong) Limited ("the Petitioner"). The directors of the Company are Bilton Sam Mak or Mark ("Mr Mak"), Leung Kai Man, Joseph ("Mr Leung") and Bellington.

The Petition

3. For the purposes of the present application, the court has to assume that the facts are as set out in the Petition. These are summarized below.

4. Mr Mak is the Chairman and Chief Executive Officer of Grandfield Pacific Inc. ("GPI"), a Canadian company listed on the Toronto Stock Exchange which specialises in the hotel business. Mr Leung is, inter alia, a director of Periwin Development Limited ("Periwin"), a company incorporated in Hong Kong which is the registered owner of the building known as No.18 Percival Street in Causeway Bay ("the Property"). Mr Mak and Mr Leung first met in May 1995. In August 1995, Mr Leung proposed that GPI and Periwin should enter into a joint venture whereby Periwin would convert the Property from commercial use into a hotel and GPI would set up and operate a hotel at the Property. In September 1996, Mr Mak discussed the joint venture with James Fong ("Mr Fong"), a shareholder and director of Can-Asia International Hotels Limited ("Can-Asia"), a company also specialising in the hotel business, and C.C. Cheung ("Mr Cheung"), a certified public accountant and shareholder and director of Polymeric International Company Limited ("Polymeric"), both of whom expressed their companies' interest in the proposed joint venture. Between September and November 1996, numerous meetings took place attended by Mr Mak and Harry Symington on behalf of GPI, Mr Fong on behalf of Can-Asia, Mr Cheung on behalf of Polymeric, and various representatives of Periwin, including Mr Leung.

5. The Petitioner's case is that at those meetings, the parties reached an understanding that Periwin would be responsible for converting the Property from commercial use into a hotel and carrying out the necessary modification works and that Periwin would apply for and obtain all necessary consents, permits and licences from the relevant authorities and the mortgagee of the Property for the establishment and operation of the Hotel, and that the Company would be responsible for the operation and management of the Hotel and for provision of soft costs and other operating equipment. The Petition further alleges that it was a "fundamental understanding" between the parties that should any officer or director of Periwin become a director or officer of the company to be formed by the parties for the establishment and operation of the Hotel, i.e. the Company, his involvement would be limited to review of its budgets, books, reports, accounts and management proposals. It is the Petitioner's case that Mr Leung and other representatives of Periwin assured the other parties that the officers or directors of Periwin would not interfere with or take part in any decision or work relating to the operation and day-to-day management of the Hotel.

6. Pursuant to those arrangements and to carry the joint venture into effect, the Company was incorporated on 15 October 1996. On 22 November 1996, Periwin and the Company entered into a joint venture agreement ("the JV Agreement") which, inter alia, provided that Periwin and the Company should enter into a lease of the Property upon the terms and conditions set out in Clause 5 thereof. It also set out Periwin's obligations in relation to converting the Property into a hotel. Clause 6 dealt with the management of the hotel which fell upon the Company. Clause 6.2 provided that the Company should appoint, during the term of the lease, Mr Leung and one director of Periwin as the respective president and deputy financial controller of the Company who should have access to and may review all the books, reports, management proposals and other papers of the Company and be informed of all important management matters concerning the Hotel.

7. To further carry the joint venture into effect, on 18 December 1996, a Shareholders' Agreement was entered into by Regency International Hotel (BVI) Limited, Can-Asia, Union World, Polymeric, Yau Lap Mo and Lui Kit Yuk, Kitty. 28% of the shares of the Company came to be vested in Union World. The shareholders other than Union World chose to hold their beneficial interest in the Company indirectly via shareholdings in the Petitioner. Can-Asia held 38.89% of the shares in the Petitioner, reflecting its beneficial interest in the Company of 28%. The Shareholders' Agreement recorded that the parties agreed that the board of the Company should consist of Mr Leung, Mr Mak and Mr Fong. It also contained a provision for majority decision by the directors.

8. The Petition further alleges that although Mr Leung was appointed a director and the President of the Company, and that Mr Choi assumed duties as the Company's Deputy Financial Controller, it was the understanding between the parties that they would not interfere with the operations or day-to-day management of the Hotel.

9. In November 1997, the working relationship between Mr Leung and Mr Fong broke down. To appease Mr Mak, Mr Symington and Mr Cheung and to persuade them to refrain from commencing legal proceedings, Mr Leung agreed to use Bellington to acquire Can-Asia's indirect interest in the Company (the Can-Asia/Bellington transaction) and agreed and confirmed that after Bellington's acquisition of Can-Asia's shares, no steps would be taken to dilute the shareholding of the Petitioner in the Company and that Periwin would compensate the Company for all loss suffered by the Company as a result of Periwin's breach of the Agreement and expenses incurred by the Company in operating the Hotel without the requisite licences or permits ("the agreement to indemnify").

10. The parties entered into an agreement to implement this proposal on 3 December 1997. Pursuant thereto, 2,800 shares in the Company were sold by the Petitioner and Can-Asia to Bellington at par value plus 5% and the portion of shareholders' loan contributed by Can-Asia to the Company in the sum of $1.96 million was assigned to Bellington by the Petitioner and Can-Asia in consideration of the sum of $2.058 million, payable by way of 12 equal monthly installments with interest at 11% per annum.

Grounds for relief

11. The Petitioner alleges that Periwin failed to obtain the requisite licences or permits for the establishment and operation of the Hotel. As at the day of the petition, those had still not been obtained and despite the absence of requisite licences and permits, Periwin demanded the Company to open the Hotel for business with effect from 15 November 1997. In summary, the petition for the winding-up of the Company on the just and equitable ground is based on the following matters :

(1) breach by Mr Leung of the fundamental understanding that he and Periwin would not participate in the day-to-day management of the Hotel ;

(2) Mr Leung's insistence on the Hotel being operated illegally before the requisite licences had been obtained and unlawfully before the DMC had been amended;

(3) Mr Leung's exploitation of the resources of the Company for the benefit of Periwin;

(4) Periwin's breach of the JV Agreement and Mr Leung's obstruction of action by the Company against Periwin;

(5) by reason of (3) and (4), Leung has allowed his role as the Company's President and director to conflict with his position as Periwin's director and acted in clear breach of the fiduciary duties he owes to the Company;

(6) by reason of (2), (3) and (4), the Company has traded at a loss;

(7) Mr Leung acted in breach of an agreement reached in the Can-Asia/Bellington transaction in that after the transfer of shares to Bellington

(i) Mr Leung raised further shareholders' loans and deemed those who failed to oblige as agreeing to a dilution of their shareholding;

(ii) the Petitioner had been excluded from the conduct of affairs of the Company and the Hotel;

(8) the Petitioner is now locked in as a 44% shareholder of the Company with Mr Leung.

The striking out application

12. The opposing contributories' attack is dealt with under the following subheadings, namely,

(1) the fundamental understanding;

(2) operating the Hotel illegally;

(3) the agreement to indemnify;

(4) the relief sought.

The fundamental understanding

13. The gravamen of the opposing contributories' attack is on the alleged existence of the fundamental understanding as pleaded in para.16 of the Petition. The submission is that it should be struck out because it is bound to fail, being wholly inconsistent with the appointment of Mr Leung as a director of the Company as provided for in the Shareholders' Agreement in that Mr Leung could not possibly discharge his duties and obligations as a director as required by law if he were subject to the constraints imposed on him by the fundamental understanding. Moreover, it was pointed out that the JV Agreement made no reference to any such fundamental understanding.

14. Leading counsel for the Petitioner submitted that the joint venture was in essence a quasi partnership between the owner of the Property and those with the expertise of operating and managing a hotel. The common expectation of the parties to the joint venture has come to grief because of a total breakdown of confidence and the absence of any spirit of co-operation between the parties. Whilst acknowledging that the JV Agreement made no specific reference to the fundamental understanding, Mr Leong drew attention to section 6 which contained provisions relating to the management of the Hotel. He therefore submitted that it is not correct to treat the JV Agreement as relating solely to an agreement to grant a lease. It was further submitted that having regard to the terms of the joint venture as pleaded in the Petition, the Company, which was to operate the Hotel, was to be in the control of those managing and running the hotel business, i.e. Mr Mak and Mr Fong, and not Mr Leung, the owner of the Property. From a layman's perspective, this was consistent with and reflected the fundamental understanding.

15. In my judgment, the Shareholders' Agreement must be viewed in the broader context of the joint venture rather than in isolation as a stand alone agreement. In that context, the existence of such a fundamental understanding is nothing exceptional since, as a practical matter, Mr Mak and Mr Fong could always outvote Mr Leung. I accept the Petitioner's submission that it is a factual matter which can only be determined at trial. I am therefore not persuaded that the existence of the fundamental understanding is demonstrably bad, or is an allegation that is bound to fail to warrant the striking out of the allegation at this stage.

16. A subsidiary point taken under this head is that the fundamental understanding could not have survived the disposal of 28% of the shares in the Company to Bellington in the Can-Asia/Bellington transaction. Even if (a point which is not conceded by the Petitioner) the fundamental understanding could not have survived the Can-Asia disposal, that of itself cannot be dispositive of the existence or otherwise of the fundamental understanding prior to the Can-Asia/Bellington transaction which remains a factual matter for determination at trial. As the Can-Asia/Bellington transaction is a subsequent event, it cannot impinge on the question whether the fundamental understanding could have existed in the first place.

Operating the Hotel illegally

17. Put shortly, the opposing contributories' contention is that if the Hotel had been operated illegally, it could only have been with the knowledge, consent and/or acquiescence of the Petitioner. Therefore, it does not lie in the mouth of the Petitioner to complain about it. Specifically, the opposing contributories rely on a confidential report sent by Mr Symington to Mr Leung on or about 10 December 1997. Paragraph 1 reads :

"The issuance of an occupancy permit by the department of Home Affairs remains a major challenge. It would seem that the Building Department who make the 'final' approval call coupled to the Fire Service Department inspection and insurance of the FS501 certificate are hurdles that must be met - I do not believe that there is any short cut and or 'artificial' fix during this interim period whereby the Hotel is operating illegally - it is most essential that you manage the activity with lots of attention - the penalties are extreme - initially a fine of HK$100,000 with second offense HK$2000,000 and 2 years in jail - the individual targeted will be the PRESIDENT. It would also be prudent that the General Manager and or Deputy General Manager - give you the real follow up information and not just information you would like to hear!!!!!"

The General Manager and Deputy General Manager referred to are Mr Mak and Mr Yau respectively. Given that Mr Symington is the Food and Beverage Manager of the Company, and the President and Chief Operations Officer of GPI, it was submitted that Mr Symington, Mr Mak and Mr Yau, and therefore Regency BVI and the Petitioner, must have known that the Hotel was operating illegally.

18. Whilst the Petitioner may have known that the Hotel was operating illegally, as leading counsel for the opposing contributories had to acknowledge, it does not follow that knowledge on the Petitioner's part is necessarily to be equated with either consent, acquiescence or connivance in the illegal activity. The opposing contributories' case was therefore put on the basis that the Hotel could not have opened for business without the acquiescence of the Petitioner. This was an inference the court was invited to draw presumably because of Mr Mak and Mr Yau's respective positions in the Company.

19. For the purposes of a striking out application, consent, acquiescence or connivance are not matters of inference but must be established as a fact. Such findings can only properly be made after investigation at trial. Accordingly, the opposing contributories have not established the requisite consent, acquiescence or connivance to disentitle them to relief.

The agreement to indemnify

20. The opposing contributories further contend that the alleged agreement on the part of Mr Leung that Periwin would indemnify the Company in respect of loss attributable to Periwin's breach of the JV Agreement as incredible and should be struck out.

21. As I understand it, the submission is that Mr Mak had deposed to the fact that the loss suffered by the Company up to July 1998 is $20 million. If therefore Mr Leung did so agree to indemnify, the Company would be worth $20 million. As the shareholders have invested only $6.675 million in the Company, the argument runs, the Company's value is therefore 3 to 1. Because the shareholders have a right of pre-emption, had such an agreement existed, one would have expected Regency BVI to have exercised its pro-rata rights. Not only that it did not do so, in fact the premium paid on the shares in the Can-Asia/Bellington transaction was a mere 5%. These facts were relied on as demonstrating the falsity of the alleged loss. Further, on 17 December 1997, the Company applied for a loan of $2 million from Mr Leung. It was contended that if there had been an agreement to indemnify the Company, one would not have expected Regency BVI to refrain from exercising its pre-emption rights. In any event, it would not have made sense for the Company to ask for a loan at prime plus 2%.

22. The submission is thus premised on the Company being worth $20 million. In my judgment, this underlying premise - that the Company's value is $20 million - is misconceived. Whether the Company would be worth $20 million simply because of the alleged loss is questionable : it would depend on whether and to what extent the loss alleged can be substantiated and recovered from Mr Leung. Moreover, prima facie, there are plausible reasons why Regency BVI declined to exercise its pre-emption rights - in its view, to do so would be to throw good money after bad. I do not therefore accept that the allegation of the existence of the agreement to indemnify is unsustainable and ought to be struck out.

The relief sought

23. The opposing contributories rely on Re a Company (No.004415 of 1996) [1997] 1 BCLC 479 for the proposition that the relief sought (i.e. winding-up on the just and equitable ground) would not be granted by the court. But that case is distinguishable in that it concerned a complaint by the petitioner that dividends declared were inadequate which is materially different from the allegations made in the present case. Moreover, that decision is based on section 125(2) of the Insolvency Act 1986 which is a statutory injunction against the making of a winding-up order on the just and equitable ground save as a last resort. There is no counterpart to section 125(2) in the Hong Kong companies legislation. Accordingly, that authority is of little assistance and certainly does not show that the relief sought by the Petitioner is inappropriate and would not on any view be granted by the court.

Conclusion

24. In my judgment the opposing contributories have failed to demonstrate that the Petition is bound to fail : they have not shown that there is no arguable basis for the Petition. For these reasons, the application is dismissed.

25. There is to be an order nisi for costs in favour of the Petitioner.