PHOENIX TELECOMMUNICATION LTD. v. DRAGON INVESTMENT CO. II LLC

HCMP 514/2002

IN THE HIGH COURT OF THE

HONG KONG SPECIAL ADMINISTRATIVE REGION

COURT OF FIRST INSTANCE

MISCELLANEOUS PROCEEDINGS NO. 514 OF 2002

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JUDGMENT

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1. This is an application by the Plaintiff ("Phoenix") for an injunction to restrain the Defendant ("Dragon") from presenting a petition against it.

2. The relationship and dealings between these parties have a complex history, but for present purposes, the following summary would suffice.

Sino-American

3. The relationship and dealings between Phoenix and Dragon arose from a company called Sino-American Telecom Inc ("Sino-American"). Sino-American was controlled by Allan Yuen. Its primary asset was its interest (through a subsidiary) in a joint venture with a Chinese partner on the Mainland.

4. By way of raising finance, Sino-American had issued convertible loan notes to a number of creditors, including (a) certain Arab interests (collectively called "the Rana group"), (b) Dragon, a Cayman Islands company within the ACL group of companies which was based in Hong Kong, (c) Rose-marie Fox, who was a director of Sino-American and (d) Italian interests in the names of P. Elser Trust and Elser & Co.

5. By the last quarter of 1997, Sino-American was in serious financial difficulties from trade and bank debts. Its noteholders had also fallen out with Mr Yuen.

Petition to wind-up Sino-American

6. This led to a petition being presented for the winding-up of Sino-American. The petitioner was Dragon. It was not Sino-American's largest creditor but ACL had a base in Hong Kong.

7. The petition was opposed, mainly by Mr Yuen. His case was at first that Sino-American was not insolvent. His alternative case was that the petition was not being presented in good faith as Dragon's ulterior motive was to force Sino-American into liquidation, so that it and other noteholders could take over Sino-American's interest in the JV for their own benefit.

Appointment of provisional liquidators for Sino-American

8. On 14 May 1998, Dragon successfully applied to the Court for the appointment of provisional liquidators for Sino-American pending the determination of the petition.

Liability for fees and costs

9. As usual, the Provisional Liquidators required the petitioner (Dragon) to furnish them with an indemnity in respect of remuneration costs and disbursements to the extent not paid out of Sino-American's assets.

-Indemnity from Dragon to Provisional Liquidators

10. On 16 June 1998, Dragon gave such an indemnity to the Provisional Liquidators.

-Counter-Indemnity from noteholders to ACL

11. On the same day, 5 noteholders (including ACL) provided counter-indemnities to ACL. These were the Rana group, Ms Fox and her husband, Inglesa and Global Assets. The Counter-Indemnities referred to the indemnity issued "at our request" in favour of the Provisional Liquidators, and agreed to indemnify ACL (in various percentages) for all losses, costs and expenses arising out of the indemnity given to the Provisional Liquidators.

-Liability of Dragon to Herbert Smith

12. Apart from its exposure to the Provisional Liquidators, Dragon also incurred legal costs in instructing solicitors to prosecute the opposed petition. Dragon's solicitors were Herbert Smith, a different set of solicitors from those advising the Provisional Liquidators.

13. If the petition was ultimately successful, the opposing contributory Mr Yuen would in the ordinary course have to bear the taxed costs of the petition. Further, to the extent that the costs could not be recovered from Mr Yuen, the Companies (Winding-Up) Rules provide that the taxed costs of a petitioner's solicitors would be second in the order of priority of payments out of the assets of a company on winding-up.

14. However, until the recovery of costs from Mr Yuen or Sino-American's assets on liquidation, the primary liability for payment of legal costs still lay with the petitioner (Dragon). Although Mr James Collins-Taylor (for Dragon) says in his affidavit that the petition had been brought "as a result of agreement and for the benefit of all noteholders and creditors of Sino-American", the fact was that none of the other noteholders was listed as a Supporting Creditor in the petition, nor was there any documented agreement that the noteholders would contribute towards Dragon's primary liability for Herbert Smith's fees. Those fees were not covered in the Counter-Indemnities.

Incorporation of Phoenix

15. Meanwhile, pending the hearing of the petition, some of the noteholders were concerned that the Chinese partner in the JV might terminate the JV, leaving little, if anything, of value in Sino-American if it should be wound-up.

16. On 10 June 1998, Phoenix was incorporated as a vehicle to provide advances for the JV, to be secured by Sino-American's interest in the JV (through its subsidiary) and a right of pre-emption. Although Phoenix's shareholding structure did not appear to be fixed at first, the shareholders comprised some (but not all) of the Sino-American noteholders, including Rana, Dragon, Ms Fox and Elser, together with a new investor. It was hoped that Phoenix would attract other investors outside the circle of noteholders, although eventually it was not successful in this respect.

17. Phoenix operated out of Dragon's offices and some of its staff were seconded from Dragon. It was managed apparently by Mr Collins-Taylor and Ms Fox, and Maurice Vallat (who had not previously been associated with Sino-American) was recruited as Chairman and Managing Director. Its lawyers were also Herbert Smith.

18. On 3 August 1998, the Court sanctioned the transaction whereby Phoenix obtained a charge over shares in the participant company in the JV and a right of pre-emption in respect of the interest in the JV.

19. However, it would appear to be common ground that Phoenix was having difficulties getting funds for its working capital as no new investors could be found and as the Rana group was not prepared to commit funds for it.

Costs in run-up to hearing of Petition

20. Meanwhile pending the hearing of the petition, costs accrued. On 21 September 1998, Herbert Smith presented 3 bills to Dragon, and by January 1999, the Provisional Liquidators had also run up considerable fees.

"Call" letter

21. On 28 January 1999, a "call" letter from Dragon to the Counter-Indemnifiers was drafted, apparently by Christopher Page (ACL's in-house counsel). As drafted, this "call" was purely for the payment of fees for the Provisional Liquidators. There was no reference to any proposed "diversion" of any funds so collected towards the working capital needs of Phoenix. It simply mentioned that the funds under the Counter-Indemnity did not go towards Phoenix's working capital.

22. Further this draft did not refer to any pre-existing agreement that the noteholders would have to contribute towards Dragon's primary liability to pay Herbert Smith's fees before liquidation and recovery from Mr Yuen or from sale of Sino-American's assets. Nor did it refer to any pre-existing agreement (as now alleged by Dragon) that Phoenix would take over Dragon's liability for Herbert Smith's fees for the petition. Instead, it noted that Herbert Smith's fees (other than those referable to Phoenix's share charge documentation) would have to be "covered as part of the proceeds of the liquidation".

23. The actual "call" letter sent out by Dragon less than 2 weeks later on 10 February 1999 was different. Whilst making the call under the Counter-Indemnity, Dragon said it intended to negotiate a reduction of the Provisional Liquidators' fees and to persuade them to take shares, or a note, in place of cash for their fees. In any case it was hoped that only a proportion of the outstanding fees would need to be paid at that stage. Dragon continued:-

"on behalf of and with the agreement of Phoenix, we propose to use the balance of any unused portion of the indemnity amounts as investment and working capital for the project".

24. In other words, the Counter-indemnifiers were being asked to put up funds for the Provisional Liquidators under the Counter-indemnity, but part of those funds would be "diverted" to Phoenix instead for its working capital, and the Counter-indemnifiers would have to put up again at a later stage whatever was owing to the Provisional Liquidators. As compensation for the Counter-indemnifiers' agreement, they would receive shares in Phoenix for the amount of their participation.

25. There was no mention in the "call" letter of Herbert Smith's costs for the prosecution of the petition, or of any pre-existing agreement that the noteholders would contribute towards, or that Phoenix would take over, Dragon's primary liability for those fees.

26. According to Ms Fox's affidavit, the Rana group did not wish to part with any more funds other than what it was obliged to pay under the Counter-Indemnity for the Provisional Liquidators' fees. The Rana group would only agree to the proposed "diversion" of funds to Phoenix if Phoenix gave an indemnity to repay the funds in the event that the funds were needed for the Provisional Liquidators.

"Phoenix-Dragon Indemnity"

27. On 14 April 1999, after a court hearing on 13 April 1999, Ms Fox signed a letter (prepared by Dragon) addressed to ACL and Dragon stating:

"in consideration for your agreeing to allow funds received under the indemnity call issued by Dragon dated 10 February 1999, and any funds received under any further indemnity calls, to be paid to parties and for purposes other than under the Indemnity provided to [the Provisional Liquidators] dated 16 June 1998 (the "Indemnity") or to meet legal fees (outstanding or yet to be incurred) in relation to Herbert Smith or other legal advisors of Dragon in connection with the liquidation of Sino-American Telecom Inc, the undersigned hereby fully indemnifies you and accepts liability for all legal and professional fees arising under the Indemnity or in relation to Herbert Smith".

28. There was no letterhead on the document, but only one name (Phoenix) had been typed at the end of the letter. Ms Fox's signature was placed above Phoenix's name. The document was also signed by Mr Marco Elser against the words "principal, Elser & Co". Phoenix now disputes the effect of this document.

Winding-up of Sino-American

29. On 9 June 2000, an order was made for Sino-American to be wound-up. On 6 July 2000 however, Mr Yuen launched an appeal. This appeal was subsequently dismissed.

Falling out of noteholders

30. In the meantime however, in the spring of 2000, the noteholders had themselves started to fall out, with Dragon in one camp and the other noteholder- investors of Phoenix in the other. Phoenix moved out of Dragon's office and came under the management of Ms Fox and Mr Vallat.

Payment of Herbert Smith by Dragon

31. Meanwhile, to ensure that Herbert Smith would continue to represent it at Mr Yuen's appeal, Dragon paid Herbert Smith the sum of $600,000 in July 2000, and in October 2000, Dragon paid Herbert Smith a further sum of $380,000.

Dragon's statutory demand on Phoenix

32. On 20 June 2001, Dragon issued a statutory demand against Phoenix in the sum of $1.6m, comprising the sums of $600,000 and $380,000 which Dragon claimed was due to it by Phoenix under the "Phoenix-Dragon Indemnity", and the balance being said to be "due to Herbert Smith".

33. Dragon's case now is that Phoenix is liable to pay Herbert Smith's fees under the "Phoenix-Dragon Indemnity" even though Phoenix itself had not received funds equivalent to Herbert Smith's fees.

34. On 4 July 2001, Phoenix's solicitors replied with various challenges to the validity of the statutory demand. They also requested that notice be given before Dragon proceeded with the presentation of a petition. This was agreed to by Dragon's solicitors on 5 July 2001.

35. On 30 January 2002, Dragon's solicitors threatened action against Phoenix. On 5 February 2002, the present proceedings were commenced by Phoenix for an injunction to restrain Dragon from presenting a petition. It has been suggested by Phoenix that the reason why Dragon chose to threaten action in January 2002 was to sabotage a bid to be made by Phoenix at a meeting of Sino-American's creditors. It is not necessary for me to deal with this allegation as it has been held that even if a petitioner has a malicious ulterior motive for obtaining a winding-up order, that per se is not sufficient for a court to restrain presentation of the petition (Bryanston Finance Pty Ltd v De Vries (No. 2) [1976] Ch 63).

Legal principles

36. It is well-established law that a petition to wind-up a company is a summary procedure, and if the company can show that there are substantial grounds which support its bona fide dispute of the alleged debt, the Court would not (unless the dispute is capable of being determined simply) undertake a trial at the hearing of the petition, but would strike out the petition.

37. The petition would be struck out on the basis that a petitioner with a debt which is disputed on substantial grounds has no locus standi to present the petition, and the presentation of a petition in those circumstances would be an abuse of the process of the Court. The same approach should be taken on a company's application to restrain the presentation of a petition (Mann v Goldstein [1968] 1 WLR 1091, 1098).

38. Thus, if a company can show, before a petition is presented by a particular alleged creditor, that the presentation of a petition by that creditor would be such an abuse of process, then the company would be entitled "as of right" to restrain the presentation (Stonegate Securities Ltd v Gregory [1980] 1 Ch 576).

39. Of course, in considering the company's evidence disputing the debt, the Court does not simply accept the company's allegations in isolation, but would see whether they are believable in the context of documents or evidence which are beyond any reasonable dispute (Re Safe Rich Industries Ltd CA 81/94, unrep.).

40. But if the company can show a bona fide substantial dispute, then in my view the Court should restrain the presentation of the petition without taking into account the question of the company's solvency. If a petitioner's debt is bona fide disputed on substantial grounds, he has no locus standi to present a petition anyway. To suggest (as in the discussion in McPherson's Law of Company Liquidation 112-121) that the Court should not restrain the presentation of such a petition or that it should not strike it out, on the basis of protecting other creditors who have chosen not to present a petition themselves or to apply to be substituted as petitioners, would be to enable officious persons, by manipulating the Court's process, to inquire into a company's financial position and to disrupt its business activities. That would obviously not be right.

Phoenix's grounds for disputing the debt

41. So the sole issue before me is:- has the company here (Phoenix) shown a bona fide dispute on substantial grounds? Phoenix disputes the debt on the grounds that:-

(a) the "Phoenix-Dragon Indemnity" was not valid as

(i) Ms Fox signed it only as a shareholder of Phoenix, and not on behalf of it;

(ii) in any event, it was only intended to be binding if it were signed by all other Phoenix investors, including the Rana group, and (contrary to Ms Fox's understanding until the service of the statutory demand) it had not been so signed;

(b) even if the "Phoenix-Dragon Indemnity" were valid, it should be limited only to the amounts received by Phoenix, and not impose a separate burden upon Phoenix to pay Herbert Smiths fees in the petition;

(c) if the "Phoenix-Dragon Indemnity" was so limited, there is no outstanding liability to Dragon when credit is given for the shares of Phoenix allotted to Dragon.

42. Phoenix only needs to establish a bona fide dispute on substantial grounds on any one of these points for an order to restrain the petition.

"Phoenix-Dragon Indemnity" valid?

43. Phoenix has challenged the validity of the "Phoenix-Dragon Indemnity", first by contending that it was not the company's document as it had not been executed by it.

44. I am not satisfied that a sufficient dispute per se has been made out on the basis that Ms Fox signed the "Phoenix-Dragon Indemnity" in her capacity as a shareholder only and not on behalf of the company.

45. She had signed her name above a line under which were typed the words "Phoenix Telecommunication Limited". There would have been no reason for her to have signed her name in that position if she were signing the document in her capacity only as one of the shareholders of that company. There has been no sufficient explanation from her as to why she had chosen to sign her name above the line for "Phoenix" if she only intended to sign in her personal capacity as a shareholder.

46. The fact that Mr Elser had signed that document as principal of Elser & Co (a shareholder of Phoenix) does not mean that Ms Fox had signed it in her capacity as a shareholder only as well.

47. Ms Fox raised the argument that if it had been intended to be Phoenix's document, Mr Collins-Taylor (who was managing Phoenix at the time) would have signed it, but that is not likely as Mr Collins-Taylor was an officer of Dragon, and obviously questions might be raised later if he were to have signed a document of Phoenix in favour of Dragon.

48. As for the point made by Phoenix that Mr Vallat was not consulted, it would appear from Mr Elser's own affidavit that Mr Vallat was not present when the document was presented for Ms Fox to sign.

49. Accordingly, if Phoenix's only argument was that it had not signed the document, then I would not have been disposed to restrain the presentation of the petition.

50. However Phoenix's second point is that the document was only intended to be binding upon it if all its shareholders signed it, and Rana had not. I find that there is a bona fide dispute on substantial grounds in relation to this point.

51. Phoenix's allegation that that was the understanding at the time is supported by the affidavits of Ms Fox and Mr Elser. Although there is a discrepancy in that Ms Fox refers to the agreement of "all" shareholders, and Mr Elser refers only to the agreement of the Rana group, it is clear that Rana was the crucial shareholder. The Rana group was the largest noteholder-investor in Phoenix but it had been reluctant to commit funds.

52. It is common ground that Rana never signed the "Phoenix-Dragon Indemnity". According to Ms Fox's affidavit, she was told by Rana's present representative Mr Mazen Hassounah (but only after the statutory demand was served in 2001) that the former representative Dr Al Mubarak had refused to sign the "Phoenix-Dragon Indemnity" as Rana was not prepared to contribute towards Herbert Smith's fees for the petition. Before the statutory demand was served, she had assumed that the Rana group had signed the document because Mr Collins-Taylor had not sought her assistance to pursue the Rana group for its signature.

53. Mr Collins-Taylor says in his affidavit that from June 1998 onwards (i.e. when Phoenix was incorporated) it was "acknowledged" by Phoenix's directors and shareholders that it would be "responsible for all of Herbert Smith's fees" and that the "Phoenix-Dragon Indemnity" was "formal recognition" of that responsibility.

54. However, if that were so, one would have expected much clearer language recording the agreement. Instead, Phoenix's alleged liability to pay Herbert Smith's fees is mixed with references to the Counter-Indemnity and indemnity calls. It is difficult to reconcile Dragon's allegation of Phoenix's pre-existing obligation to pay Herbert Smith's fees with the reliance placed in the document on the "consideration" provided by Dragon viz. the "diversion" of funds from the noteholders under indemnity calls.

55. The question would also arise as to why, if there was an "acknowledged responsibility" of Phoenix for Herbert Smith's fees for the petition, it had not been asserted in Mr Page's draft (where those fees were said to "have to be covered as part of the proceeds of liquidation"), or even in the "call" letter signed by Mr Collins-Taylor. Given that Dragon's case is that the noteholders had to fund both the Provisional Liquidators' fees (under the Counter-Indemnities) and at least part of Herbert Smith's fees (on behalf of Phoenix), and substantial sums had already been incurred for both, it is questionable at least why both sets of fees and the noteholders' liabilities for them were not dealt with by Dragon at the same time.

56. It is therefore at least prima facie arguable by Phoenix that it was only in April 1999 that Dragon sought an agreement from Phoenix to be responsible for Herbert Smith's fees for the petition. It is common ground that when Dragon first instructed Herbert Smith to present the petition, it had not been envisaged that Mr Yuen would cause the proceedings to become protracted and would cause more costs to be incurred than originally contemplated. It might also have been originally thought by Dragon that the noteholders would be honourable enough to contribute to the legal costs, even absent an agreement. However by April 1999, the Rana group was being difficult with funding. Since Phoenix itself had no funds, the agreement of its shareholders to provide it with funds was essential. Hence, Phoenix's contention that the "Phoenix-Dragon Indemnity" was signed on the understanding that all investors in Phoenix had first to sign it to agree to its terms.

57. The appearance of Mr Elser's signature on the "Phoenix-Dragon Indemnity" also supports Phoenix's case. He signed as "principal, Elser & Co", a shareholder of Phoenix. There is no mention in the document that he was signing only as a witness to Ms Fox's signature (as Mr Collins-Taylor alleges), and no reason has been suggested why her signature on this document needed a witness at all.

58. Dragon has sought to suggest that Phoenix's contention that it is not liable for Herbert Smith's fees for the petition was not believable against the context of Phoenix's budgets which included references to liabilities to the Provisional Liquidators and Herbert Smith. However, Mr Collins-Taylor was involved in the preparation of these budgets until the noteholders fell out in 2000. Further as one of Phoenix's plans was to acquire Sino-American's assets, and the fees of the Provisional Liquidators and the petitioner's solicitors would be charged on the assets, there was some ground for including these expenses in Phoenix's budget.

59. Further, Dragon has referred to the taped discussions and e-mail messages concerning the costs of Mr Yuen's appeal, in which Ms Fox and Mr Hassounah the new Rana representative had spoken about Phoenix's indemnity to Dragon for the Provisional Liquidators' fees and Herbert Smith's fees. Although these taped discussions and e-mail messages in 2000 will no doubt be subject to close scrutiny in any proceedings that may be instituted, Ms Fox has said on affidavit in answer to this that it had been assumed that the Rana group had signed the "Phoenix-Dragon Indemnity" and it was not until after service of the statutory demand in 2001 that it was realized that the former representative of the Rana group had refused to do so. Although there has been no affidavit from the Rana group directly, she has deposed on affidavit to having received confirmation of this from Mr Hassounah.

60. More importantly, there is Mr Elser's support on affidavit of Ms Fox's contention that the "Phoenix-Dragon Indemnity" was subject to the agreement of the other shareholders, in particular, the Rana group, and that it was understood that Mr Collins-Taylor would get the Rana group to sign the document. This is denied by Mr Collins-Taylor. This is a clear dispute of fact that is not capable of being resolved at summary winding-up proceedings.

61. In the circumstances, I take the view that Phoenix has put forward a sufficient case to raise a bona fide dispute on substantial grounds on the validity of the "Phoenix-Dragon Indemnity". It is therefore not appropriate to deal with the other issues raised by Phoenix, as other legal proceedings would probably be commenced.

62. Finally I would only note that Dragon's demand in the statutory demand is for HK$686,258.08 due to Herbert Smith and two payments of HK$600,000 and HK$380,000 due to Dragon under the "Phoenix-Dragon Indemnity". It is not suggested that these amounts were payable by Phoenix as moneys had and received. Accordingly, once Phoenix's liability to pay Herbert Smith's fees for the petition under the "Phoenix-Dragon Indemnity" is bona fide disputed on substantial grounds, this disputed debt cannot form the basis of a petition to wind-up Phoenix. Dragon would have to institute proceedings against Phoenix in the ordinary way.

Order

63. I would therefore give an order in terms of the Amended Notice of Motion and give an order nisi that the costs of the proceedings be to Phoenix to be taxed if not agreed.