SANYUAN GROUP LTD v. THE STOCK EXCHANGE OF HONG KONG LTD

CACV 191/2008

IN THE HIGH COURT OF THE

HONG KONG SPECIAL ADMINISTRATIVE REGION

COURT OF APPEAL

CIVIL APPEAL NO. 191 OF 2008

(ON APPEAL FROM HCAL NO. 25 OF 2007)

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BETWEEN

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REASONS FOR JUDGMENT

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Hon Rogers VP:

1.  This was an appeal from a judgment of Reyes J given on 4 June 2008.The matter before the judge was an application for judicial review of a decision of the Listing Appeals Committee (“the LAC”) of the Stock Exchange of Hong Kong Ltd. (“the respondent”).The decision of the LAC had been given on 15 February 2007.It upheld the decision of the Listing (Review) Committee made on 13 June 2006, which in turn had upheld the decision of the Listing Committee, made on 8 December 2005, whereby the listing of the shares of the applicant was to be cancelled.

2.  The judge below had held in favour of the applicant and had ordered that the decision of the LAC should be quashed, and that the question of the applicant’s relisting be remitted to a differently constituted LAC.

3.  At the conclusion of the hearing of this appeal, this court allowed the appeal by the respondent and set aside the judgment in the court below, with reasons to be given in writing.

Background

4.  The applicant was listed on the Main Board of the respondent in November 1972.Up until the year 2002, the company and its subsidiaries had been engaged in transportation, property investment and pharmaceutical and healthcare businesses.In the last quarter of 2002, it discontinued its transportation business.On 4 May 2004 the respondent wrote to the applicant expressing concern about the applicant’s viability in the light of what had been revealed in the annual results for the year ended 31 December 2003.The respondent expressed concern about the low turnover and the adequacy of capital.Other issues of concern included, but were not limited to, the scale of the applicant’s operations, the significant capital deficiency and the financial difficulties experienced by the applicant.The letter drew attention to the provisions of Listing Rule 13.24 and required the applicant to provide a detailed submission demonstrating compliance with that Listing Rule.Attention was drawn to the fact that the respondent was empowered to suspend dealings in any securities or to cancel the listing of any securities in circumstances where it was considered that the issuer did not have a sufficient level of operations or sufficient assets to warrant continued listing.Shortly thereafter, on 12 May 2004, the applicant applied to the Listing Division to suspend trading in its shares.The reason given was that there was likely to be a subscription of shares in the company by an investor and possible settlement agreements with banks in relation to the group’s indebtedness.

5.  There followed an exchange of correspondence between the parties.On 14 May 2004, the applicant wrote to the Exchange providing information relating to its business and financial position as well as restructuring its debts.The respondent replied on 26 June 2004.Despite further correspondence from the applicant, on 20 July 2004 the respondent expressed its view that the applicant was unable to demonstrate that it currently had a sufficient level of operations or assets of sufficient value or intangible assets for which a sufficient potential value could be demonstrated, as required under Listing Rule 13.24, to warrant the continued listing of the applicant’s shares.The respondent also stated that it did not consider that the applicant would be able to comply with that Listing Rule even after the completion of the proposed debt restructuring.The letter made specific reference to the question of the low turnover, the value of the assets and level of operations and to the sufficiency of the funds available to the applicant.The level of debt was also referred to.The applicant was required to submit a proposal which would demonstrate its compliance with Listing Rule 13.24.These concerns on behalf of the respondent were repeated in a letter of 16 September 2004.

6.  On 31 December 2004 the respondent wrote to the applicant drawing attention to the delisting procedures set out in Practice Note 17.It was stated, quite clearly, that as of 12 November 2004 the applicant had been placed in the second stage of the delisting procedures and that it was required to submit a detailed viable resumption proposal within 6 months, namely by 11 May 2005.

7.  No proposal was forthcoming and on 20 May 2005 the respondent wrote to the applicant informing it that the Listing Committee had decided to place the applicant into the third stage of the delisting procedures as set out in Practice Note 17.It was pointed out that if no viable resumption proposal was submitted at least 10 business days before the expiry of 6 months following the announcement of the third stage, the Listing Committee’s approval for the cancellation of the applicant's listing would be sought.

8.  On 18 November 2005 the applicant submitted a resumption proposal to the respondent.That was examined by the Listing Division, which issued a report on 5 December. The Listing Committee met and considered that proposal on 8 December.That Committee concluded that the applicant was unable to demonstrate that it complied with Listing Rule 13.24 and, accordingly, approved the delisting of the shares of the applicant in accordance with Practice Note 17.The material parts of the letter of 9 December 2005 conveying the Listing Committee’s decision were as follows:

“The Listing Committee also noted that had the Proposal been viewed as viable under Rule 13.24, the Proposal, which includes the acquisition of the Jin Shun business, would under Listing Rules 14.06 (6) be treated as an arrangement which constitutes an attempt to achieve a listing of the business acquired and a means to circumvent the requirements for new applicants set out in Chapter 8 of the Listing Rules.In other words, the Exchange would treat the Company as if it was a new listing applicant under the Listing Rules.

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Sufficient level of operations or have tangible assets of sufficient value and/or intangible assets

3.  Rule 13.24 requires an issuer to carry out, directly or indirectly, a sufficient level of operations or has tangible assets of sufficient value and/or intangible assets for which a potential value can be demonstrated to the Exchange to warrant the continued listing of the issuer’s securities.

4.  The Proposal essentially comprises of the continuation of the business operation of GenePro Medical Biotechnology Limited (“GenePro”), the commencement of business operation of JV Company as detailed in the Company’s [Sanyuan’s] announcement of 3 June 2005 and a proposed rights issue to raise HK$15 million for the Group’s working capital.

5.  GenePro is a wholly owned subsidiary of the Company, and specializes in DNA diagnostics, of which it develops and sells clinical diagnostic kits and provides clinical laboratory services. The business operation of GenePro has been incurring losses since its commencement in late 2001, which is largely due to the high research & development expenditure. GenePro business development was seriously stalled by the lack of funding due to the Group’s heavy indebtedness.The GenePro business is still at a preliminary stage and would not be considered a sustainable business for the purpose of Rule 13.24 due to its low level of operation and continued operating loss.

6.  The JV Company had only commenced operation in November 2005.The JV Company is run by Jin Shun Yi Yao Company, Jin Shun Branch (“Jin Shun”)'s previous management and that Jin Shun's customer base is expected to be transferred to the JV Company.The Company has endeavoured to use the track record of Jin Shun as an indication of how the JV Company will perform in the future.The Listing Committee is of the view that Jin Shun’s track record may not be indicative of the JV Company’s scale of operations.

7.  There is no confirmed order or sufficient track record to support the sustainability of its business run by the JV Company.It is noted from the Company’s submission that 99 drugs have been approved to be used by the government-run hospitals in Tianjin in 2006 under the centralized tendering system in China.However, the tenders were awarded to Jin Shun and not to the JV Company.

New business of which the Company has no track record or management experience

8.  Jin Shun commenced operation in August 2003 and it traded pharmaceutical products principally in Tianjin and Beijing, PRC.The JV Company took over Jin Shun’s business in November 2005.The Listing Committee however notes with concern that the Group effectively has no financial or management track record in the trading of pharmaceutical products and there is no evidence provided that the business can be sustained by the JV Company.The business operated by the JV Company is considered a new business and thus a fundamental change in the nature of the Company’s business.

9.  Based on the analysis of the Group’s business for the three years ended 31 December 2004 and six months ended 30 June 2005, turnover was generated from transportation services, rental of properties and laboratory testing services. There was no turnover generated from distribution of pharmaceutical products.Despite the Company’s representation that one of its two principal activities is in the pharmaceutical healthcare business, GenePro is not considered to be engaged in the pharmaceutical business based on the nature of its business.The pharmaceutical business would require the preparation and (especially medicinal) dispensing of drugs.Based on the Group’s financial records, the Group has never engaged in the pharmaceutical business contrary to the description in its annual report.The Listing Committee does not consider the Company’s failed attempts to invest in two joint venture companies with an intention to carry out pharmaceutical business as relevant.

Financial forecasts

10.  The Company forecasted a profit attributable to shareholders of HK$300,000 for the year ending 31 December 2006 and HK$2.3 million for the year ending 31 December 2007.As the profit forecast has not been reviewed by auditors and the assumptions are without reasonable basis, it was considered that the information provided by the Company was not adequate to substantiate the profit and cash flow forecasts prepared.

11.  The inclusion of the 99 drugs on the approved list used by the government-run hospitals in Tianjin in 2006 under the centralized tendering system in China did not provide a sufficient level of comfort on the sustainability of the sales and profit forecast as the hospitals and other customers would order the drugs on an “as-needed” basis.Historical orders alone may not provide a good basis for forecast on sale of these drugs under such circumstances.

Financial position

12.  The Group currently has limited working capital even after taking into consideration the proposed rights issue of HK$15 million.It was noted that the Group forecasted a net cash outflow from operations for the year ending 31 December 2006.There was no clear information given in support as to the sufficiency of the Group’s working capital and viability of the business model of the JV Company.

Regulatory licence

13.  The JV Company has not obtained the Good Supply Practice certificate.There is a real risk that the JV Company may need to cease its business operation in the future if such certificate was not obtained for whatever reason.

The Group’s outstanding legal proceedings

14.  The Company has not addressed its outstanding litigations with Core Pacific-Yamaichi International (H.K.) Limited and China Energy Promotion Limited.Taking into account the tight cash flow of the Company, the outstanding litigations if they were to proceed and the judgments were to be made against the Company would have an adverse impact on the Company’s financial position and its operations would be greatly affected.

Experience of the Company’s senior management

15.  The Board only has one director who is experienced with the Company’s new business, that is, the JV Company’s operations.This was not considered sufficient as the JV Company's operation is the Company's only principal business.”

9.  Further, submissions were made on behalf of the applicant and on 13 June 2006 the Listing (Review) Committee considered the application by the applicant for a review of the decision of the Listing Committee.It upheld the decision of the Listing Committee and gave the following reasons:

“1. The Review Committee endorsed the points set out in paragraphs 3 to 6 of the First Decision Letter.

2. Even with the benefit of the unaudited financial information of the JV Company for the three months ended 31st March 2006 which was submitted by the Company at the Review Hearing, the Review Committee was not satisfied that the Company had complied with Rule 13.24 of the Listing Rules.

3. Taking the above factors as a whole, together with the other facts and circumstances of this case, the Review Committee was not persuaded that the Decision was incorrect.”

10.  The applicant then sought to take the matter to the LAC.At the hearing, the LAC had before it written submissions of Mr Zhao, the managing director of the applicant, a supplementary Listing Division Report for the purposes of the review and a supplemental written submission by Asian Capital (Corporate Finance) Ltd. on behalf of the applicant.A transcript of the hearing before the LAC was provided to this court and it appears that the meeting lasted nearly 2½ hours.The LAC comprised 3 directors of the respondent, namely the chairman, a retired banker and a retired asset manager.The committee came to the conclusion that the decision of the Listing (Review) Committee should be upheld and that the respondent should proceed with the delisting of the applicant in accordance with Practice Note 17.In the letter announcing the decision, the LAC’s reasons were given in the following terms:

“1. despite the passage of time over which this review has been pursued, the Appeals Committee was not satisfied on the basis of the submissions made that the Company’s level of activities complies with Rule 13.24; and

2. the Company has failed to demonstrate that its business could be sustained or generate profits for the future.”

11.  The judge below held that there was “merit” in the applicant’s argument that the respondent should have informed it what quantum of turnover, profit or assets was considered sufficient for the purposes of Listing Rule 13.24.In paragraph 30 he said:

“An applicant must at least be entitled to know what standard of operation or what sort of asset base he is expected to have in order to qualify for re-listing.If his resumption proposal is rejected, an applicant cannot simply be told that his turnover, profit or assets are considered insufficient.That is tantamount to giving no reasons.The applicant further needs to be informed in what sense his financial numbers have been deemed to be insufficient.The applicant is entitled to know just what level of operation or asset base he has fallen below.”

12.  Interestingly the judge went on to say that although he considered that an objective standard had to be identified, but, as a matter of discretion, that standard could be deviated from for various reasons.

13.  The judge then considered the other grounds on which it was said that judicial review should be granted.These included arguments that the LAC had failed to take into account relevant matters and also arguments that it had taken into account irrelevant matters.The judge correctly rejected those arguments.It is unnecessary to refer to all of them.One matter was that the judge did not consider that it was irrational to characterise the transition in the applicant’s business as constituting a fundamental change.The judge also said that he did not consider the Listing Committee’s concern about the lack of confirmed orders to be irrational.

14.  The applicant had relied upon comparisons with other companies that were listed on the Main Board and three companies that had been relisted.In respect of that, the judge noted that it was the respondent’s duty to assess the applicant’s resumption proposal in the light of the circumstances that were relevant to the applicant.

This appeal

15.  On this appeal, Mr Scott SC, who appeared on behalf of the respondent, emphasised that the appeal was brought because of the respondent’s concern that the decision in the court below imposed an impractical and undesirable requirement upon the respondent.Each company had to be considered individually.It would be impossible for the respondent to set a benchmark which would apply to all companies and, in any event, even if an attempt were made to set a benchmark there would be ample scope for disagreement and challenge.

16.  In my view, the respondent’s objections are well founded.The provisions of Listing Rule 13.24 in themselves demonstrate that there is a great deal of flexibility in their application.The judge specifically rejected the arguments that irrelevant considerations had been taken into account and, perhaps more importantly, that relevant facts had not been given adequate consideration.There was no suggestion that the applicant had not been given an adequate chance to make representation, that its case had not been properly heard, still less that there was any bias in the various committees.In those circumstances, it was for the members of those committees, who were experienced professionals in various aspects relevant to the operations of the respondent, to give the matter proper consideration and to determine whether or not the applicant should be relisted.

17.  In paragraphs 36-38 the judge made reference to statements made by the chairman of the LAC in an affidavit filed for the purposes of these proceedings.In the affidavit it was stated that the LAC did not consider that the turnover of around $610,000 was a sufficient level of operation.That was in respect of the only operating subsidiary of the applicant.Likewise it was stated that the LAC did not consider that the turnover of the Tianjin Jin Shun joint-venture of around HK$73,059,000 was sufficient to satisfy Listing Rule 13.24 which in any event fell short of the applicant’s own projections by a significant margin.It was also stated in the affidavit that the expenditure on staff costs of only around HK$265,800 per month during a six-month period indicated to the LAC that the applicant’s management did not have sufficiently adequate resources to build its business.In each of those respects the judge rhetorically asked the question as to what level of resources the LAC considered would be an adequate figure.In my view it is not for the court to challenge the conclusion which the three committees, culminating with the LAC, reached.As a matter of fairness or propriety the decision would be the same whether a figure was given or not.As a practical matter I do not see how the various committees could, with accuracy, give the various figures.It was their duty to exercise their judgment and decide whether or not, given the provisions of Listing Rule 13.24, the applicant should be relisted.

18.  In any event, if appropriate levels are to be considered reference might be had to chapter 8 of the Listing Rules.That chapter sets out the qualifications for listing.Under the heading “Basic Conditions”, at paragraph 8.05, it is stated as follows:

“The issuer must satisfy either the profit test in rule 8.05(1) or the market capitalisation/revenues/cash flow test in rule 8.05(2) or the market capitalisation/revenue test in rule 8.05(3).”

19.  It is unnecessary to set out those tests because it suffices to say that the figures revealed by the applicant are so far removed from anything that would qualify for a new listing that any reference to those figures in this regard would be meaningless.Whereas the respondent does not require the levels set out in chapter 8 to be met when considering whether to sanction a relisting, the profit levels, market capitalisation and revenue levels referred to in chapter 8 must be some indication of what reasonably can be expected of a listed company.Rule 13.03 in chapter 13, which relates to the continuing obligations, provides that:

“The continuing obligations set out in this Chapter are primarily designed to ensure the maintenance of a fair and orderly market in securities and that all users of the market have simultaneous access to the same information.Failure by an issuer to comply with any applicable continuing obligation may result in the Exchange taking disciplinary action in addition to its powers to suspend or cancel the listing.”

20.  It is thus that under the heading “Sufficient Operations”, paragraph 13.24 reads:

“An issuer shall carry out, directly or indirectly, a sufficient level of operations or have tangible assets of sufficient value and/or intangible assets for which a sufficient potential value can be demonstrated to the Exchange to warrant the continued listing of the issuer’s securities.”

21.  Two other matters may be referred to.The first is that the primary reason put forward by the applicant for the need to have benchmarks for a company seeking a relisting was that it would give guidance to a company seeking relisting.For my part, I fail to see how the existence of a benchmark could cause a company to alter the important criteria as to its operations.The relevant criteria relating to a particular company would remain the same whatever the benchmark.

22.  The second point is that, quite apart from anything else, the second paragraph of the LAC decision shows that the LAC was not satisfied that the applicant had demonstrated that its business could be sustained or that profits could be generated for the future.In other words, the LAC was not satisfied that the applicant had put forward a credible proposal.That, in itself, is a qualitative decision which the LAC was perfectly entitled to take and no grounds had been shown impugning that decision.Rather, the applicant’s failure to meet even the projected levels given in its relisting proposal aptly demonstrates the inadequacy.

23.  For these reasons I considered that the appeal should be allowed.

Hon Le Pichon JA:

24.  I agree with the reasons for judgment given by Rogers VP.

Hon Stone J:

25.  I also agree with the reasons for judgment of the Vice President.

26.  In a case involving a ‘benchmark’, it seems to me that from a judicial viewpoint a correlative benchmark principle is that any court should hesitate long and hard before moving to interfere with the decision of a market regulator.

27.  That is not to say that this never can be done; instances of lack of due process/procedural unfairness sometimes render such interference inevitable by way of judicial review.

28.  What has happened in this instance, however, is that an innovative ‘procedural unfairness’ argument mounted on behalf of the respondent in the court below has had the effect of producing a de facto gloss to the operation of the Listing Rules – which it must not be forgotten represent the product of extensive consultation between regulator and market – so that, the reasoning went, unless the Listing Committee dealing with the respondent’s relisting application had condescended to indicating an appropriate assets/operational ‘benchmark’ which was to be met in order to achieve the desired relisting, such rejection of this application thereby was procedurally tainted, and thus was required to be sent back and reconsidered by the LAC in accordance with the view of the learned judge as to the necessity of imposing such a ‘benchmark’.

29.  With great respect, this seems to me to be a case of judicial review exceeding appropriate bounds, the obvious and immediate practical implications of this decision not surprisingly causing the regulator to be severely exercised – hence this appeal, which in my judgment was susceptible to only one result.