RE GW ELECTRONICS CO LTD

HCCW 81/2016

IN THE HIGH COURT OF THE

HONG KONG SPECIAL ADMINISTRATIVE REGION

COURT OF FIRST INSTANCE

COMPANIES (WINDING-UP) PROCEEDINGS NO. 81 OF 2016

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D E C I S I O N

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1.  By a Re-Amended Petition dated 15 March 2016, Toshiba Electronics Asia, Ltd (Petitioner) applies to wind-up GW Electronics Co Ltd (Company) on the ground that it is insolvent and unable to pay its debt in the sum of US$15,263,129.39 (Debt). The Debt represents the outstanding payment for goods sold and delivered by the Petitioner to the Company under a Distributorship Agreement in respect of electronic memory products dated 1 January 2013 (Agreement).

2.  This is the hearing of the Company’s Summons dated 12 May 2016 to strike out the Petition on the grounds that: (a) it is an abuse of process because there is a bona fide dispute on substantial grounds over the Debt; and (b) in the alternative, the proceedings should be stayed in favour of arbitration pursuant to an arbitration clause in the Agreement.  The alternative ground is not pursued[1].  

Issue

3.  There is essentially 1 issue in this application, namely, whether the asserted defence of the Company is believable.  It is a factual issue which has to be evaluated bearing in mind the applicable legal principles.

Law

4.  The following legal principles are applicable to this application and not in dispute :

(1) Winding-up petitions should not be used as a means of debt collection: Asahi Iwasawa & Associates Management Consultants Ltd v SEC (Hong Kong) Co Ltd, HCCW 215/2013, unrep, 21 March 2014, §24;

(2) Where a creditor issues a winding-up petition in respect of a debt which is the subject of a genuine dispute aimed to pressure a company into paying, it would constitute an abuse of process: Re Yueshou Environmental Holdings Ltd, HCCW 142/2013, unrep, 16 July 2014, §12;

(3) The main reason for dismissing a petition where there is a bona fide dispute on substantial grounds is the danger of abuse of the winding-up procedure. A party to a dispute should not be allowed to use the threat of a winding-up petition as a means of forcing the company to pay a bona fide disputed debt: Parmalat Capital Finance Ltd v Food Holdings Ltd [2009] 1 BCLC 274, [9];

(4) The onus is on the company against which a petition is presented to adduce sufficiently precise factual evidence to satisfy the court it has a bona fide dispute on substantial grounds: Re ICS Computer Distribution Ltd [1996] 3 HKC 440, 444C;

(5) In discharging the onus, the court must be satisfied that the company’s assertions, considered in the context of the background which is undisputed or indisputable, are believable: Re Safe Rich Industries Ltd, CA 81/1994, unrep, 3 November 1994, pp 4-5;

(6) The court does not try the dispute on affidavit but is to determine whether a substantive dispute exists.  In so doing, the court has to take a view on the evidence to see if the company is merely raising a cloud of objections on affidavits or whether there really is substance in the dispute: Re Hong Kong Construction (Works) Ltd, HCCW 670/2002, unrep, 7 January 2003, §6(4);

(7) Where the defence rests on a collateral oral agreement, the effect of which is to vary the terms of the principal contract, it must be proved strictly, including the existence of an animus contrahendi on the part of all the parties to it: Bank of India v Surtani Murlidhar Parmanand [1994] 1 HKC 7, 11I-12C.

Background

5.  The Agreement contained the following termination clause :

(1) The Petitioner was entitled to terminate the Agreement in the event, inter alia, of the Company’s insolvency, bankruptcy, liquidation or dissolution (Article 17.1(ii));

(2) If the Agreement was terminated, at the Petitioner’s option, the Company should resell to the Petitioner its inventory of products, at the lower of either the actual price paid or the then prevailing prices of the Petitioner (Article 17.2).

6.  The Petitioner and the Company had a very good relationship and, save for an unfortunate error on the part of its bank, the latter had never failed to meet its payment obligation under the Agreement.

7.  However, since about the end of 2014, one of the Company’s major customers, DTT, which was a strategic promotion customer of Toshiba for its “SLC wafers”, was in difficulty in paying the Company.  As a result of DTT’s non-payment, a substantial inventory was accumulated in the Company’s warehouse, and provisions would have to be made in the Company’s accounts in respect of the same.  Such provisions would adversely impact upon the credit facilities from its banks.  According to the Company, although it was not in financial trouble, it took steps to negotiate with the Petitioner to resolve the problem.

8.  It is common ground that there was a series of meetings between the management of the Company and the Petitioner during the end of August and September 2015.  It is the Company’s case that on 11 September 2015, Mr Mizuma, the Managing Director of the Petitioner, proposed the following terms to the Company :

(1) The Agreement be terminated by mutual consent (1^st Condition);

(2) All sums payable to the Petitioner by the Company under the Agreement, which were due by the end of September and October (Account Payable), were to be settled by delivery of all stored products purchased from the Petitioner (some of which had been fully paid) at prices to be determined by the parties (2^nd Condition); and

(3) The Company would provide its customer lists and other information, which were trade secrets and confidential information, to the Petitioner (3^rd Condition).

9.  The Petitioner’s proposal was, according to the Company, orally accepted by it via 2 of its Directors, Mr Lo and Mr Kwok.  The Company contends that the parties had thus reached a new agreement on the Account Payable (Oral Agreement).

10.  In respect of the Account Payable, it is uncontroversial that a payment in the sum of US$14,781,085.18 was due on 25 September 2015, and another sum of US$16,590,174.95 was due on 25 October 2015 (around HK$244M (million) in total). 

11.  The Company says that the Oral Agreement was performed as follows :

(1) Pursuant to the 1^st Condition, the parties agreed to terminate the Agreement.  A termination letter dated 14 September 2015 was sent by the Petitioner to the Company.  According to that letter, the Agreement was terminated “in accordance with Article 17.1”.  The Company’s evidence is that Mr Kwok and Mr Lo were uncomfortable with the wording of the letter, but they accepted it because of Mr Mizuma’s insistence and to maintain harmony in the relationship;

(2) Pursuant to the 2^nd Condition, the Company sent to the Petitioner on 15 September 2015 its inventories of all products kept at its warehouses and their purchase prices.  Later that day, in the course of discussing the prices, Mr Mizuma proposed that the return of products, subject to agreed variations of types and quantities, would fully and finally settle the Account Payable at HK$244M.  It is important to note that the prices of the repurchase were based on the prices at which the products were acquired from the Petitioner.  The proposal was accepted by the Company. Mr Mizuma also requested the Company to deliver additionally 2 million pieces of “SLC 4G” to the Petitioner at no cost.  It was said that the discussions were evidenced by a printout of what was written on a whiteboard;

(3) By an email dated 16 September 2015, Mr Lo confirmed to Mr Mizuma that the Company would return 1 million pieces of “SLC 4G” to the Petitioner at no cost;

(4) On 17 and 18 September 2015, the Company delivered to the Petitioner products worth at least HK$244M to settle the Account Payable;

(5) Pursuant to the 3^rd Condition, the Company had provided its customer lists and confidential information to the Petitioner.  Such information included resale price, payment terms, key contact person and contact method.

12.  The Petitioner vigorously denies the Company’s case.  The Petitioner’s case is that it terminated the Agreement upon realising that the Company was insolvent, and it had exercised the option under Article 17.2 to repurchase the majority of the Company’s inventory.

13.  In respect of the repurchase of finished products, the original sale price to the Company was adopted.  For the DTT related wafers, they were repurchased at prevailing price.  There were also some rejected items.  Consequently, the amount owed to the Petitioner was reduced to US$15,263,129.39.

Analysis

14.  To resolve the factual issue in question, I shall consider (a) whether the Oral Agreement is consistent with any business sense; (b) whether the Company’s case stands up to scrutiny; and (c) whether it is supported by any contemporaneous documents.

15.  The first point I should consider is whether the Company was insolvent at the material times.  It is an important backdrop against which the Company’s case should be evaluated.  In this regard, there is incontrovertible evidence in the form of written presentation made by the Company to the Petitioner on 27 August 2015.  According to such material, the Company was in a very difficult financial situation :

(1) There were doubtful debts or estimated provision of more than HK$145M and slowing-moving stock of about HK$55M.  Together, they tied up entirely the HK$200M capital contribution from the 2 shareholders of the Company;

(2) The provision of HK$145M would turn a profit for the financial year 2015 into a loss;

(3) The Company would require banking finance for at least 2 months for its normal business operations from August to December 2015.

16.  In 2 emails from respectively Mr Kwok and Mr Lo to Mr Mizuma dated 4and 5 September 2015, it was stated as follows :

(1) The Company had suffered a loss of HK$58.8M during the 1^st half of 2015 and was projecting another big loss of HK$141.7M for the 2^nd half.  Such loss did not include the DTT inventory of US$18.65M kept by the Company.  The loss was mainly on the account receivables from DTT in the sum of HK$140M;

(2) The Company’s shareholders could not provide further help;

(3) The Company was “definitely in very desperate situation” and “all the supporting banks will shut down [the Company]” if it could not solve the inventory and account receivables problems immediately.

17.  According to Mr Mizuma, whose evidence is supported by an exhibit, the Company had outstanding loans owed to the banks in the total sum of US$24.2M (or HK$189M) which would fall due between 11 September 2015 and 25 November 2015.  This evidence will have to be considered in light of the Account Payable.

18.  Mr Bleach SC, appearing with Mr Chan for the Petitioner, submitted that the evidence clearly shows that since late August or early September 2015, the Company was unable to continue its business and still pay its way, and was thus “unable to pay its debts” within the meaning of s.177(1)(d) of the Companies (Winding Up and Miscellaneous Provisions) Ordinance, Cap 32.  I was referred to Re Aloha Coffee Co Ltd (in liq) [2013] 1 HKLRD 356, §§22-23, where the court considered a similar statutory provision under s.51(3) of the Bankruptcy Ordinance, Cap 6.

19.  I agree that the Company was quite clearly insolvent at the material times.  I also agree with Mr Bleach that the denial by Company that it was so reflects poorly on the quality of its evidence, and is a matter to be considered by the court for the present purposes.

20.  The insolvency of the Company would entitle the Petitioner to invoke Article 17 to terminate the Agreement, as well as to repurchase the Company’s inventory at prices acceptable to it.  Why would the Petitioner agree to the terms of the Oral Agreement when the situation would be governed by Article 17?

21.  Mr Coleman SC, appearing for the Company with Mr Yip, accepted that the only advantage to the Petitioner under the Oral Agreement was the alleged confidential information of the Company. 

22.  It should firstly be pointed out that, according to Mr Mizuma’s evidence, the Company was required to provide a list of the end-customers including information on all backlog orders to the Petitioner. The information was required for end-customer management, and to protect Toshiba’s brand name in light of the imminent termination of the Agreement.  Mr Mizuma also said that the Petitioner might be able to assist the Company to press for payments from the end-customers so that it would in turn get paid. 

23.  Mr Mizuma’s evidence accords with common sense. The need for end-customer management was implicitly accepted in Mr Lo’s 3^rd affirmation, para 17(c).  Further, if the distributorship was coming to an end, the value of the list of Toshiba product customers is questionable insofar as the Company was concerned. 

24.  Furthermore, I am unable to find in the contemporaneous documents any suggestion that the Company was parting with its confidential information upon the termination of the Agreement.  This was an important issue because it was the only chip with which to bargain with the Petitioner.  Not only would one expect some record of the bargain, there ought to be some record of discussion of the kind of confidential information to be provided.  There is none.

25.  In the premises, the Company’s case that the Petitioner entered into the Oral Agreement by reason of the alleged confidential information is flimsy. 

26.  In respect of the allegation that the Company had reached an agreement with the Petitioner on the prices of the repurchase on 15 September 2015, the unchallenged evidence is that the repurchase exercise involved a very substantial quantity of products.  A substantial part of those products (“X6” components) were sold by the Petitioner more than 12 months ago and not covered by any product warranty.  An inspection of the products had to be carried out.  They were only delivered to the Petitioner on 17 and 18 September 2015, and the inspection was only completed on 29 September 2015. 

27.  In addition, there was the question of price fluctuation of the products, which is again uncontroversial.  It is therefore difficult to believe that Petitioner had agreed to repurchase the Company’s inventory at acquisition prices on 15 September 2015.  

28.  As regards the question whether the Oral Agreement was evidenced by any contemporaneous document, I do not find the printout of the whiteboard (see para 11(2) above) helpful in this regard. There was certainly no mention of the 3 Conditions.  A fair reading of the printout suggests that the parties were negotiating on the exit from the Agreement.  Indeed, the Company’s evidence that Mr Mizuma asked for the return of some “SLC 4G” products at no cost and its subsequent response confirm that state of affairs.  Moreover, one has to bear in mind that the warehoused products had yet to be counted and inspected.  I therefore do not see the printout as evidence of the Oral Agreement. 

29.  It is convenient to note here that, ultimately, there was no return of products to the Petitioner without cost.  The repurchase has been summarised in para 13 above. 

30.  I have not been able to find any contemporaneous document which may be in support of the Oral Agreement.  It must be remembered that the alleged Oral Agreement involved a very substantial sum of money.  It would be surprisingly not to have a paper trail for such a transaction. 

31.  On the other hand, even if the Petitioner’s internal records in the form of reports to Tokyo head office and meeting notes are to be ignored, there are documents which contradict the Company’s case :

(1) By an email dated 17 September 2015 (10:08 hrs) from Mr Mizuma to Mr Lo and Mr Kwok, the Company was informed about Tokyo head office’s request for payment of HK$20-30M in cash “until the end of this month”, and that some of the inventory would be returned later;

(2) By another email of the same day (15:31 hrs) from Mr Ishibashi to Mr Lo and Mr Kwok, it was stated that the counting of the goods would require a few days, and the result and value of those goods would be discussed after completion of the exercise.

32.  In his submission, Mr Coleman relied upon certain parts of the transcripts of recorded meetings between the parties which took place on 14, 15, 21 and 23 September 2015. Those transcripts were introduced at the hearing with the leave of the court notwithstanding the opposition of the Company.  However, I do not agree that those parts of the transcripts identified by Mr Coleman add much to the Company’s case.

33.  To begin with, as submitted by Mr Coleman, the proper understanding of what was said in the meetings cannot depend merely on textual analysis and/or inference.  Cross-examination of the attendees will be required.  However, it would not be right to determine this application on the hope that something may be uncovered in cross-examination.  To discharge its burden, the Company must adduce “credible evidence that demonstrates sound reasons to think that the asserted facts may be proved at trial”: Re Yueshou Environment Holdings Ltd, supra, §9.  I am unable to see such evidence in the transcripts. 

34.  Finally, I should mention that it is common ground that the negotiations over the termination of the Agreement also covered a sister company of the Company which was the Shanghai distributor of Toshiba products.  However, I do not see anything of significance arising from the negotiations over the Shanghai distributorship because the termination of the Agreement was not linked to the termination of that distributorship. 

35.  For these reasons, I am not satisfied that the Company has a bona fide dispute of the Debt on substantial grounds.  This application is accordingly dismissed with a costs order nisi in favour of the Petitioner with a certificate for 2 counsel, to be taxed if not agreed.

36.  Last but not least, I am grateful to counsel for their assistance.