DELANEY'S INTERNATIONAL INCORPORATED v. CELTIC CHARM LTD AND OTHERS

HCMP 2678/2015

[2018] HKCFI 521

IN THE HIGH COURT OF THE

HONG KONG SPECIAL ADMINISTRATIVE REGION

COURT OF FIRST INSTANCE

MISCELLANEOUS PROCEEDINGS NO 2678 OF 2015

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J U D G M E N T

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1.  This is the trial of the petitioner’s petition brought under s 724 of the Companies Ordinance (Cap 622) on the basis that the affairs of Celtic Charm Limited (“Company”), the 1^st respondent herein, have been conducted by Kevin Murphy (“Murphy”) and John Raymond Guy (“Guy”), the 2^nd and 3^rd respondents, in a manner unfairly prejudicial to the petitioner’s interests.

2.  The Company was incorporated in Hong Kong on 3 June 2011.  It is the holding company of a wholly foreign‑owned enterprise named Guangzhou McCawley’s Food and Beverage Company Limited (“WFOE”).  The WFOE owned and operated two Irish‑themed pubs in Zhujiang district and Nanhu district in Guangzhou respectively.

3.  The petitioner is a company incorporated in the BVI which was represented in this venture by Mr Noel Smyth (“Symth”) and Mr William Giles (“Giles”).

4.  The 2^nd and 3^rd respondents were both businessmen resident in Mainland China with experience operating Irish‑themed pubs there.  They were up until last month represented by solicitors and counsel but recently began acting in person.  On 15 January 2018, they sent notices to the court indicating they would not attend the trial.  Their witness statements, as a result, do not form part of the evidence.  Further, there were a number of respondents’ documents the authenticity of which has been disputed since January 2017.  Since the respondents have not come to propound these documents, I do not think it appropriate to place any weight on them.

5.  The parties’ relationship began in 2005 when Smyth and Guy were brought together at the Johnnie Walker Golf Classic in Beijing.  They both had experience in the food and beverage business.  Smyth had an interest in the Delaney’s group and Guy was an owner of a pub in Shekou, Guangdong called McCawley’s.  Thereafter they kept in contact and met from time to time in the Mainland, Hong Kong and overseas.  They and Giles, a fellow director of the petitioner with Smyth, and Murphy, a business associate of Guy in the McCawley’s brand, also became acquainted with one another and made trips to sporting events together and had become friends though it is probably fair to say that Smyth and Giles were somewhat closer friends with Guy than with Murphy.  I accept the evidence that Smyth and Giles thought of the respondents as good friends whom they trusted.

6.  The idea of the petitioner and the respondents embarking on a joint venture was floated early on in 2010.  The idea was initially to build an Irish pub together in the Mainland with a prospect later on for the petitioner to acquire shares in some of the respondents’ businesses in the Mainland and for the respondents to acquire shares in the Delaney’s group’s businesses.  In broad strokes their intention was to merge the Irish pub side of the two businesses. Although there were other owners in the Delaney’s group, Smyth and Giles were the only two involved in these discussions with the respondents.

7.  This mutual interest culminated in a meeting at the Garden Hotel in Guangzhou on 2 June 2011 when the four men discussed the terms of the joint venture.  At the end of that day, Giles, himself a Hong Kong solicitor by profession, typed out a two‑and‑a‑half page Heads of Agreement between Advanced Packaging Asia Limited (“Advanced Packing”) (a company of Murphy and Guy), the petitioner, Guy and Murphy, which they all signed on the spot.  This agreement provided that:

(i)   The joint venture will operate as a PRC “WFOE” to be established which will be 100% owned by a Hong Kong limited company which will be owned equally by the petitioner and Advanced Packaging.

(ii)   The investment by the petitioner and Advanced Packaging in the joint venture shall be by way of loan which shall be repaid in equal shares before any distribution of profits by the joint venture.

(iii)   The joint venture will be governed by a Board of Directors in the Hong Kong holding company which will meet no less than four times a year with two directors from Advanced Packaging and two from the petitioner.  Initially, the board will consist of Guy and Murphy from Advanced Packaging and Giles and Smyth of the petitioner.  The chairman of the board will have a casting vote and the chair will alternate between Advanced Packaging and the petitioner every six months. 

(iv)   Smyth will be the managing director of the joint venture with overall weekly operational control. 

(v)   Advanced Packaging will provide “back office” services to the joint venture including the preparation of monthly management accounts. 

(vi)   The joint venture will operate under the McCawley’s name which has been registered as a trademark in the PRC.

(vii)   The parties agree that should any dispute or other issues not specifically included in the agreement arise, they will negotiate in good faith to resolve them, failing which they will proceed to mediation and then arbitration under the rules of the HKIAC.

8.  Pursuant to their agreement, the Company was set up the next day.  The petitioner holds 50 of the 100 issued shares whereas Murphy and Guy (at their request, holding shares in their own names instead of through Advanced Packaging), hold 25 shares each.  All four men became directors of the Company.

9.  The petitioner understood from the respondents that it was necessary to set up a WFOE and all the steps in this regard were essentially left to them.

10.  The first pub was set up in Zhujiang, Guangzhou, and a lease was signed and dated 30 June 2011 with the landlord of the premises for a term of 8 years.  After completion of the construction works it opened for business in around September 2011.  The day‑to‑day operation of the Zhujiang pub was handled by Murphy and Guy as they were resident in Guangzhou.

11.  Within about two to three weeks of the end of each month the petitioner would receive management accounts which consisted of a balance sheet and profit and loss account.  These would contain the total turnover for the previous month but sometimes adjustments were made.  The reporting was detailed.  The pub sourced a lot of its food requirements from McCawley’s Shenzhen, a Mainland company owned by the respondents.  Whilst this could be considered a related‑party transaction, Smyth and Giles were content provided prices were competitive and quality ensured.

12.  The Zhujiang pub performed quite well at the beginning.  In the first 3 months of its operations the pub’s turnover, that is, food and beverage sales, was about RMB2.65 million generating net operating profit of about RMB127,000. In the first full year of business, 2012, turnover was RMB14.18 million with net operating profit of RMB1.96 million.  Unfortunately, there was a downward trend in 2013 with a small loss for the year of RMB21,000 followed by a much larger one in 2014 of RMB433,000, though turnover in 2014 was up on the turnover in 2013 by some RMB786,000.

13.  In mid‑2012, the WFOE managed to acquire a substantial quantity (several 20’ containers) of second‑hand pub and restaurant equipment which had been used at the Irish pavilion at the Shanghai Expo in 2010 and was being offered for sale at a very attractive price of RMB750,000. 

14.  In 2013 Guy raised the idea of opening another pub in an area in North Guangzhou called Nanhu.  The parties decided to proceed and an eight‑year lease was entered into in November 2013 between the WFOE and the landlord.  The plan was that part of the Expo pub fittings would be used in the Nanhu pub and the rest kept in storage on the upper floor of the rented premises.

15.  The project fell behind expectations.  Construction of the Nanhu pub only began in May 2014.  Construction cost was higher than expected and, after the pub opened for business, it incurred a loss of some RMB733,000 in the first 4 months of operations ending in December 2014. 

16.  Since by then the Zhujiang pub was also struggling to make a profit, it was clear there was a need to take some steps.  Through December 2014 various suggestions were considered to address the issue (such as various marketing ideas), but ultimately, it was recognised that the parties needed to meet to consider the various options; in particular the injection of further funding.

17.  It is necessary now to describe briefly the financial position of the joint venture.  By email dated 25 November 2014, Guy provided a summary of the WFOE’s financial position.  The email showed payments that were due or soon to be due totalling RMB547,500, whilst the debt owed to McCawley’s Shenzhen would have grown (by the end of the month) by RMB200,000.

18.  On 26 November 2014, Smyth responded stating:

“Hi John,

OK not happy reading but that’s reality so need to fix.

Need to look at a few scenarios all require Delaneys to put some money in but whilst we look at this can we get the funding from each party to exactly 50% for the two Gz pubs.

Assuming ZJ is 50/50 let’s look at Nanhu.

If Nanhu returned the monies received directly from ZJ (used for deposits) after Delaney’s paid back its loan — what then is the position for financing of the Nanhu project to make that an even 50/50.

Does that make sense to you?”

19.  According to Guy’s email of 3 December 2014 in response, each side had contributed an equal amount to the Zhujiang pub, namely approximately RMB2.76 million.  As for the Nanhu pub, the intention at that point was to bring each side’s capital contribution which then stood at RMB1,157,400 for the petitioner and RMB942,400 for the respondents through McCawley’s Shenzhen to RMB1.5 million. The petitioner duly paid the sum of RMB342,600 on 8 December 2014.  As for the respondents, McCawley’s Shenzhen was also acting as the WFOE’s major supplier and the WFOE was indebted to McCawley’s Shenzhen at that time for unpaid goods.  McCawley’s Shenzhen did not intend to make a cash payment of RMB557,600, but rather, it intended to convert that amount to investment loan account.

20.  By 31 December 2014, according to Guy’s email of 21 January 2015, the respondents had contributed RMB1.5 million less RMB283,645. This was treated as RMB1.5 million by putting the RMB283,645 into a receivable for Nanhu, to be set off as goods were supplied by McCawley’s Shenzhen to Nanhu in January.  Meanwhile the Zhujiang pub owed RMB1,419,715 to McCawley’s Shenzhen as at 31 December 2014.

21.  There was clearly a problem to be dealt with on the cash flow and the parties duly planned a meeting to discuss matters on 22 January 2015.  But while it was understood that there was a need to deal with specific funding shortfalls, there was also a focus on dealing with the longer term strategies to ensure improved performance of the respective pubs.  Thus, for example, in mid‑January 2015 the parties were still exploring details of a potential PR campaign using a digital marketing firm.

22.  On 19 January 2015, the 31 December 2014 accounts were circulated for both pubs.  It showed that both pubs operated at a loss in November and December 2014.  The petitioner’s response to the poor numbers was that these results needed the parties’ urgent attention and could be dealt with at the already planned meeting on 22 January 2015.  However, it was very much the petitioner’s position that this cash flow issue could be fixed. There was no indication from Murphy or Guy that these results impacted on the sustainability of the joint venture or that McCawley’s Shenzhen would require immediate repayment in full of its debt.

23.  On 20 January 2015, Guy provided a list of payments that had to be paid as soon as possible.  That list totalled RMB691,710.49 and included the rent for January 2015 for McCawley’s Zhujiang in the sum of RMB214,710. The list did not feature any debt owed to McCawley’s Shenzhen.  In response to this list of payments, on 21 January 2015 Smyth noted that this would need to be discussed at the planned meeting the following day, but added “In the meantime should we send up money?” to which Guy replied that they had sent RMB150,000 from Shenzhen to meet the Zhujiang pub’s rent, but he did not seek any further funds despite Smyth’s offer.

24.  On 22 January 2015, Giles and Smyth met with Murphy at the Zhujiang pub.  Guy had planned to join but had to be absent for family reasons.  In light of the debts that were then outstanding, the petitioner offered further funding of RMB500,000 upon board approval.  The parties then discussed the longer term marketing initiatives to improve the pub’s performance.  The meeting resolved amicably with the petitioner to raise further funding at its board meeting the following week.  Smyth and Giles left Guangzhou the next morning in the understanding that the immediate cash flow problem was under control though obviously further future funding might be required and longer term strategic steps would need to be worked on and followed up.

25.  After they left, however, Murphy sent an email to them that afternoon whose tone was in stark contrast to their meeting.  It read:

“Having considered yesterday’s conversation and a subsequent discussion with John, we have concluded that the RMB0.5 million in new funding is much less than required when you consider old (non‑McCawley’s Shenzhen) monies owed to creditors and undoubtable losses that will occur early in 2015.

Therefore this is the course of action we are going to take:

(A) We ask Delaney’s to send RMB1.5 million as a loan to McCawley’s GZ bank account by Tuesday 27^th January 2015. Once received McCawley’s Shenzhen will transfer its Accounts Receivable from GZ McCawley’s to a loan account on equal terms to Delaney’s, both loans will attract an annual interest of 8%;

(B) One other option McCawley’s Shenzhen are willing to consider is Delaney’s take 100% ownership of EL Charro and John and I 100% ownership of Celtic Charm — immediately.

(C) Should neither (A) nor (B) options be acceptable to Delaney’s or you are just financially unable to agree the Legal Representative for GZ McCawley’s will stop the company (GZ McCawley’s) trading Thursday 29 January 2015. The following day Friday 30^th January an application will be presented to the GZ courts by McCawley’s Shenzhen for payment of the outstanding RMB1.5 million Accounts Receivable.

Please let me know which course of action Delaney’s will take.”

26.  Smyth and Giles were taken aback.  I accept their evidence that Murphy’s proposals, especially the demand for an immediate RMB1.5 million were never discussed at the meeting.  In addition to asking for copies of McCawley’s Shenzhen’s invoices, Giles wrote to Murphy that afternoon:

“Kevin,

As you know this was not what was discussed amicably yesterday which we were considering and would have reverted quickly. If you want to sort this out we should discuss this as old friends and gentlemen”.

27.  The correspondence continued in the next few days.  Giles asked Murphy to withdraw the “threat” in option (C) and continue the dialogue, which Murphy refused.  He also refused to mediate in accordance with the Heads of Agreement, stating in an email of 27 January 2015:

“The issue is at McCawley’s GZ, which is now trading actual insolvent. It has bills which are now due in excess of RMB2 million with no means of paying them. RMB1.5 million is owed to McCawley’s Shenzhen, we are in the process of recovering that debt.

We have put forward two solutions on how the inevitable consequence of a forced closure may be avoided. To date we have not received any replies.

Time is quickly running out and we await your reply to the options we put forward.”

28.  Giles replied immediately:

“Kevin

As we have said we are willing to negotiate on all 3 scenarios and certainly do not want the business to close. You promised to send the SZ invoices for our consideration but haven’t done so. We have other issues but as we have said we want a proper bona fide dialogue not threats, as we all agreed in the JV Agreement. Your two ‘solutions’ are not acceptable but we have money available if our concerns can be met. We have offered to meet you to discuss all matters, particularly as your stance has changed so dramatically from Thursday. It is that simple request which you have not responded to”.

29.  On the next day Giles wrote to Murphy saying, inter alia, “Given your conduct we don’t want to do business with you anymore.”, and made an offer for parting their ways which Murphy rejected.  In his email to Giles, on 29 January 2015, Murphy stated at the end, “Nonetheless, one way or the other it’s over and the sooner you come to that realisation the quicker we can get matters concluded and move on”.

30.  On 2 February 2015, Guy, in his capacity as the legal representative of the WFOE issued a notice to the Company’s board.  Guy set out the WFOE’s financial position as follows:

(a)   Suppliers’ invoices in excess of RMB2 million were overdue for 8 months.  In this regard it should be noted that Guy had on 31 January 2015 caused the WFOE to enter into a Second Debt Recognition Agreement (after the first dated 31 December 2014) whereby the WFOE recognised a debt to McCawley’s Shenzhen in the sum of RMB2,112,080.33.  It would appear that this “debt” to McCawley’s Shenzhen accounted for much if not all of this outstanding supplier debt.

(b)   Rent for February in the sum of RMB214,712 was due in relation to McCawley’s Zhujiang;

(c)   Staff salaries would be due on 15 February in the sum of RMB240,000.

31.  Guy then demanded immediate funding of RMB2.5 million plus a further RMB500,000 at the end of February 2015.  Clearly the vast amount of these funds were to pay the debt to McCawley’s Shenzhen.  Guy indicated that unless the funding was received by 6 February 2015, he would close the pubs on 8 February 2015 and terminate the leases.

32.  After a further similar letter of 10 February 2015 from Guy (enclosing the two debt recognition agreements but none of the invoices asked for by Giles on 23 January 2015), the two pubs were closed down on or about 16 February 2015 without further consultation with the petitioner or the board of the Company.  The Nanhu lease was apparently terminated on 12 February 2015 while the Zhujiang lease was terminated, apparently, on 31 March 2015.

33.  However, although the Nanhu pub shut permanently, the Zhujiang pub reopened on 11 March 2015, albeit under the name of McCawley’s Bar and Grill, and now owned by Murphy and Guy independently of the Company and the WFOE.

34.  An email from the Zhujiang pub’s manager in June 2015 to another director of the petitioner showed that it was apparently doing well, and had won the Best Pub and Best Burger awards in the City Weekend Awards. 

35.  A visit by Smyth and Giles to this Bar and Grill in August 2015 confirmed that the physical appearance of the premises had changed little (though it was clear that the façade and fixtures of the Nanhu pub were now used in the Zhujiang place).

36.  Most of the staff and their uniforms remained the same as when the pub was operated by the WFOE.  The manager was the same manager as employed by the WFOE. The licences displayed included the Certificate of Approval which was given on 18 August 2011 and issued on 20 June 2012, a liquor licence which appears to have been issued in 2011, a fire certificate issued in December 2011 and, finally, a food licence with the name of the WFOE.

37.  On the petition presented on 23 October 2015, and on these facts, it seems clear to me that the conditions for relief under the Companies Ordinance are satisfied.  The conduct of the affairs of the WFOE is capable in law of constituting, and did on the facts of this case constitute, conduct of the affairs of the Company: see Re Step By Step Limited (unrep, HCMP 838 to 840, 842 to 851 and 1208/2007 and HCA 2712/2006, dated 26 October 2007), at paragraph 47 and Astrotec Company Limited (unrep, HCCW 282/2011, 31 January 2013), at paragraph 103.

38.  It is of course for the petitioner to establish that the affairs of the Company have been conducted unfairly in a way that caused him prejudice. Unfairness and prejudice are distinct concepts and both need to be shown.  A member of a company will not ordinarily be entitled to complain of unfairness unless: (1) there has been some breach of the terms on which he agreed that the affairs of the company should be conducted; or (2) although those conducting the affairs of the company have stayed within their legal powers, equitable considerations make it unfair for them to exercise their powers the way they did.  (See O’Neill v Phillips [1999] UKHL 24.)

39.  I can appreciate that the respondents might not think it right that McCawley’s Shenzhen should continue indefinitely to be owed long‑outstanding sums, but there was no opposition from the petitioner against treating such sums as the respondents’ contribution of shareholders’ loans and no categorical refusal by the petitioner to contribute an equivalent amount, only resistance to immediate payment of the substantial sum of RMB1.5 million  demanded “out of the blue” on 23 January 2015 without being discussed at the meeting the previous day.  With the discussed contribution of RMB500,000 from the petitioner following the meeting, and a matching injection by the respondents, the non‑McCawley’s Shenzhen debts would be met and there would be time for the parties to discuss and iron out their differences, if any. 

40.  There is no evidence of any Mainland law which required the immediate closure of the two pubs at the time, particularly where the petitioner, at least, was prepared to provide further financial support.  Instead, the petitioner was presented with an ultimatum, and deprived of the opportunity, as envisaged under the Heads of Agreement, for the board to discuss and consider questions of the management of the joint venture, including in particular the proposed closure of the two pubs which formed the substratum of the Company. The pubs were closed down eventually when the petitioner was still waiting for copies of the invoices of McCawley’s Shenzhen to check in order to respond to the sudden demand.

41.  Even if it was necessary to close the Nanhu pub (whether as a commercial decision or otherwise), this was a decision that under the Heads of Agreement should be made by the Company’s board and the termination should be negotiated and managed in a manner best suited to protect the WFOE’s interest and its ownership of all the valuable items within the pub.  It was highly prejudicial for Murphy and Guy to unilaterally close the Nanhu pub and especially to do so in a manner in which the ultimate outcome meant that all recoverable assets became taken over by McCawley’s Shenzhen without compensation to the WFOE. Even now it is not clear whether the WFOE had been formally put into liquidation in the Mainland or whether formal debt recovery process had been taken by McCawley’s Shenzhen.

42.  Further, the Zhujiang pub was quickly reopened by the respondents who seemed to have taken over it as a turnkey business complete with all decorations, equipment, fittings, licences and staff.  There is no evidence to support the respondents’ allegation that everything became owned by the landlord upon default in the payment of rent.  So the WFOE’s assets were simply taken over by the respondents, including the Expo Pub fittings estimated to be worth much more than the price paid for them.  Yet, none of this has been accounted for to the WFOE or the Company.

43.  I am inclined to the view that there was a quasi‑partnership based on personal relationship and trust but it is not an essential part of the petitioner’s case.  On the facts established by the evidence, it is impossible to avoid the conclusion that the respondents, in taking these steps from late January to March 2015, had not acted with solicitude for the interests of the Company and had placed themselves in a position where their interests and McCawley’s Shenzhen’s interests were preferred to those of the Company and its subsidiary, the WFOE.

44.  In these circumstances it is appropriate for the court to order that Murphy and Guy buy out the petitioner’s shares in the Company. 

45.  So far as the valuation date is concerned, instead of using the date of the petition and making adjustments for the effect of the prejudicial acts found, it seems to me the appropriate date in this case is 31 December 2014 given that this represents the last date prior to the commencement of the unfairly prejudicial acts and, practically, there are balance sheets for both the Nanhu and Zhujiang Pubs as at 31 December 2014 such that the consolidated position of the WFOE can be easily calculated.  The balance sheets as at this date are not disputed by the petitioner which avoids any concern that later balance sheets have been manipulated, and this date would also involve little need for the participation of Murphy and Guy and, therefore, less likelihood of further delay and disputes over access to documents.

46.  Since the Company is to be valued prior to the loss of the assets and business, it should be valued as a whole, on a going concern basis.  There will be no need for any discount or premium to be applied to the share value.  There will be interest on the price from the valuation date of 31 December 2014, at the rate that the courts generally apply to commercial cases, namely, prime plus 1% per annum.

47.  The valuation is to be conducted by a valuer to be appointed.  For that purpose the parties should, within 7 days, each propose the name of a valuer and seek to agree on the valuer within a further 7 days.  In the absence of any agreement between them, the parties shall, within a further 7 days, submit the name of their respective proposed valuer to the court for the court’s determination.  There will be liberty to apply in relation to the valuation exercise as well as the costs of the valuation.

48.  There will be an order for costs of these proceedings in favour of the petitioner against the 2^nd and 3^rd respondents on the party‑and‑party basis, to be taxed if not agreed.