WONG KAM SAN AND ANOTHER v. YEUNG WING KEUNG AND OTHERS

HCA 2036/2005

IN THE HIGH COURT OF THE

HONG KONG SPECIAL ADMINISTRATIVE REGION

COURT OF FIRST INSTANCE

ACTION NO. 2036 OF 2005

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J U D G M E N T

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1.  The present action can be regarded as the second chapter in the dispute between the Plaintiffs and 1^st to 4^th Defendants in relation to the shareholding and control of the 6^th Defendant.  The main dispute had been litigated in HCA 1653 of 2004.  After trial, Deputy Judge L Chan gave judgment in favour of the Plaintiffs on 11 April 2006 in respect of the beneficial ownership of 75 shares.  There was an appeal against that judgment.  It was dismissed by the Court of Appeal in CACV 166 of 2006 on 31 January 2007.  Although some defendants intended to apply for leave to appeal to the Court of Final Appeal, that application has yet to be heard. 

2.  In the meantime, the trial of this action has come on.  There is an order for speedy trial.  I have refused an application to adjourn this trial pending the outcome of the intended appeal to the Court of Final Appeal and I would not repeat my reasons for that ruling. 

3.  Even though the 5^th Defendant was not a party to HCA 1653 of 2004, at the beginning of the trial Mr Vaughan accepted the following proposition set out in Mr Jat’s opening,

“Although Sunny Growth is not bound by the issue estoppel, there is no evidential foundation for Sunny Growth to challenge the finding.  Hence, the factual disputes regarding [the beneficial ownership of the 75 shares] as pleaded in [the pleadings in this action] cease to be live issues.”

4.  The proposition was put forward on the basis of the materials filed in this action, including witness statements and documents in the trial bundles.  I am of the view that the concession of Mr Vaughan was properly made.

5.  Mr Yuen accepted on behalf of the 2^nd to 4^th Defendants that they are bound by the findings in HCA1653 of 2004.  As a matter of law, since they were parties in HCA 1653 of 2004, I do not see how a different position can be taken.

6.  The trial therefore proceeded on the basis that at all material times the beneficial ownership of the 75 shares belonged to Wong, the 1^st Plaintiff.

7.  It is therefore unnecessary to go through chapter 1 of the dispute in this judgment.  Those interested can refer to the judgment of Deputy Judge L Chan and the judgment of the Court of Appeal in CACV 166 of 2006.

8.  I will briefly introduce the parties.  The 6^th Defendant [“Hawkins”] is a party to a mining joint venture called Shunfeng in mainland China.  Hawkins held 80% interest in that joint venture.  Chapter 2 of the dispute focused on the validity of an allotment of 9,900 shares [“the allotment”] of Hawkins in July 2005 in favour of the 3^rd Defendant [“Kan”] and the subsequent acquisition of those 9,900 shares by the 5^th Defendant [“Sunny Growth”].   

9.  Before the allotment, the registered shareholders of Hawkins were the 2^nd Plaintiff [“Trengei”] holding 25 shares, the 4^th Defendant holding 74 shares and the 1^st Defendant [“Yeung”] holding 1 share.  Trengei is beneficially owned by Wong.  According to the finding in HCA 1653 of 2004, Wong was also the beneficial owner of the other 75 shares.  The authorized capital of Hawkins was 10,000 shares at $1 each.  Hence the un-issued capital before the allotment was 9,900 shares.

10.  The directors of Hawkins in July 2005 were Wong, Liu Yong (a nominee of Wong), Yeung, Kan (a sister of Yeung) and the 2^nd Defendant [“Yau”] (wife of Yeung).

The allotment and the dispute

11.  On 14 July 2005, two meetings of Hawkins were purportedly held,

(a)    An EGM passing these resolutions,

i)       The extension of an invitation to Kan to subscribe for shares in Hawkins and to take over the operation of the company as its major shareholder;

ii)      Authorizing the Board to approve the allotment of 9,900 shares to Kan at $1 each;

iii)     Authorizing the Board to exercise the power of the company to deal with allotment and to issue additional shares.

(b)    A board meeting authorizing the allotment of 9,900 shares to Kan at $1 each and inviting Kan to take over the operation of the company as its major shareholder.

12.  According to documents, 9,900 shares were allotted to Kan on 14 July 2005.  A return of allotments was filed with the Companies Registry on 18 July 2005.  The return was signed by Yau on 14 July 2005.

13.  The 9,900 shares were subsequently transferred to Sunny Growth on 25 July 2005.  Sunny Growth said it had paid $9,900 for the 9,900 shares.  Although I have not seen the register of members kept by Hawkins, parties agreed that I can proceed on the basis that the transfer was registered.  A share certificate was issued to Sunny Growth and the transfer was recorded in the annual return filed with the Companies Registry.

14.  The effect of the allotment was a substantial dilution of the interest of the existing shareholders in Hawkins.  Wong originally held  100% of the shares beneficially.  After the allotment, if that was a valid allotment, his beneficial ownership was reduced to 1%.

15.  It is not disputed by the defence that the 9,900 shares, representing a 99% interest in Hawkins had a value much greater than $9,900.  According to a valuation report by a chartered surveyor in August 2000, the market value of the mining rights held by the joint venture company was RMB 938 million.  It is trite that one must have the necessary funds injected before the potential could be realized and profit generated.  Hence, it would not be right to take 80% of that market value as the net worth of Hawkins.  Even so, as Mr Chan acknowledged in his evidence, the 99% interest in Hawkins must worth a great deal more than $9,900. 

16.  Not surprisingly, soon after the Plaintiffs learnt of the allotment in September 2005, the present action was commenced on 17 October 2005 to set aside the allotment and rectify the register of Hawkins to cancel the shares transferred to Sunny Growth.

17.  The Plaintiffs’ case is that the allotment is invalid since it was not authorized by the Articles of Association of Hawkins nor its shareholders (Para. 17 of the Statement of Claim).  More specifically, the Plaintiff’s evidence is that Trengei did not receive any notice of the purported EGM of 14 July 2005 and Wong and Liu did not receive any notice of the purported board meeting of the same date.

18.  Section 57B(1) of the Companies Ordinance provides that except for a pro rata offer to existing members, the directors of a company shall not without the prior approval of the company in general meeting exercise any power of the company to allot shares.

19.  The allotment was not a pro rata offer to existing shareholders.  The contravention of Section 57B(1) nullifies the effect of any purported allotment.  This is highlighted by Section 57B(7).  The English version of Section 57B(7) is a little bit ambiguous in respect of the scope of sub-section (7).  The Chinese version clearly states that the exception under sub-section (7) is only applicable to allotment to subscribers pursuant to the agreement in the subscription to memorandum.  By necessary implication, any allotment in contravention of Section 57B(1) in cases outside the Section 57B(7) exception is invalid in law.  The present case is not within that exception.

20.  This conclusion is reinforced by Section 57C of the Companies Ordinance.  Under that section, the court is given the power to validate an allotment which was invalid by reason of, inter alias, any provision in the Companies Ordinance when it is satisfied that in all the circumstances it is just and equitable so to do.  Section 57B is the specific provision in the Ordinance dealing with allotment and it is likely to be one of the sections for which relief under Section 57C is aiming at.  

21.  In this respect, the law in England is materially different.  Section 80(1) of the Companies Act 1985 simply provides,

“Nothing in this section affects the validity of any allotment.”

22.  Section 57B(1) is supplemented by Clause 48 of Table A which is applicable to Hawkins pursuant to Clause 1 of Hawkins’ Articles of Association.

23.  Hence without the approval in a properly held EGM, any purported allotment by the board on 14 July 2005 will be invalid.

24.  Further, the Plaintiff also relies on the lack of notice to Wong and Liu as directors to challenge the validity of the board meeting of 14 July 2005.

25.  The want of notice to Trengei, if established, would render the purported EGM invalid and subject to a point raised by Mr Yuen as regards Clause 100 of Table A, the want to notice to Wong and Liu would render the purported board resolution to allot shares as invalid, see Re HomerDistrict Consolidated Gold Mines Ex parte Smith (1888) 39 Ch D 546; In re Portuguese Consolidated Copper Mines Ltd (1889) 42 Ch D 160; Re a Company, ex parte Shooter [1990] BCLC 384 at p. 389-390; Lee Leung Nang Stewart v Karen Lee HCA 1496 of 2006, 18 Jan 2007.

26.  These are the essence of the Plaintiffs’ primary attack.  Mr Jat identified such attack as attack on formal validity.

27.  The Plaintiffs also mounted a secondary attack based on the lack of proper purpose on the part of the directors for the allotment (viz that a causative purpose in the exercise was to dilute the shareholding of Wong and to frustrate the purpose of HCA 1653 of 2004).  Further, it is said that the shareholders who purportedly approved the allotment acted in breach of trust in destroying the control of the beneficiary over Hawkins.  The latter attack was not clearly pleaded in the Statement of Claim.  After hearing arguments during the course of opening, I ruled that the point is open to the Plaintiffs and the trial had been proceeded on that basis.       

28.  This secondary attack is characterized by Mr Jat as attack on substantial validity.  If he succeeds on the formal validity argument, there is no need to rely on this secondary attack in the claims against the 1^st to 4^th Defendants.  

29.  The 1^st Defendant was present at most of the trial although he did not formally appear as a party and chose to sit in the public gallery instead.  He was adjudged bankrupt and the trustee in bankruptcy did not consider necessary to appear.  The 1^st Defendant told this court he did not wish to say anything.  He had not filed any defence nor did he indicate in any way he wished to take part in the proceedings.  To the contrary he indicated to this court he wished to seek medical consultation for some alleged illness on his part.  Given the circumstances, I do not think it is right for this court to insist that he should take part in the action.  However, there is no doubt in my mind that he is quite aware of what has been going on and there is no reason why this judgment should not bind him.   

30.  The main defence in respect of the formal validity attack is that notices had been duly given with regard to the meetings of 14 July 2005.  Hence, the main issue in that respect is a dispute of fact.

31.  In respect of the substantive validity attack, the defence is that the allotment was for the purpose of raising much needed capital for the mining operation and it was in the interest of Hawkins. 

32.  As regards Sunny Growth, the defence put forward a case that Sunny Growth was and is fully owned by Chan Che Shing [“Chan”] and his son.  It is contended that Sunny Growth acquired the 9,900 shares from Kan as independent and bona fide investor for value without notice of the underlying disputes between the other defendants and Wong in HCA 1653 of 2004.

Findings on notices and validity of the meetings

33.  From the above analysis, the first and foremost question is whether notice of the EGM of 14 July 2005 had been given to Trengei.  Even on the Defendants’ own documents, there is no evidence of any notice sent to Trengei.  The 2^nd to 4^th Defendants only produced documents issued by the Post Office showing letters being sent to Wong, Liu, Kan, Yau and Yeung by registered post on 29 June 2005.  There is no evidence of any document being posted to Trengei.

34.  Since Wong was in control of Trengei, it might be argued that the notices given to him were also notices to Trengei.  Yet, parties had not addressed this court on this point.

35.  Even assuming that the notices to Wong can be so treated, there is a dispute about whether Wong received the notices.  Wong testified that he only received a blank piece of paper through post.  He was not in Hong Kong at the end of June and early July.  Upon return to Hong Kong, he was notified by the Post Office that he had a registered mail.  He went to collect it.  Having discovered that it was a blank piece of paper, he notified his solicitor about it immediately.

36.  On 16 July 2005, the solicitors for the Plaintiffs wrote to Messrs.  Ivan Tang & Co., the then solicitors acting for the 1^st to 4^th Defendants putting on record that such a letter was received.  There was no response from the solicitors.

37.  On the same date, a copy of that letter was sent by the Plaintiffs’ solicitors to Hawkins.  There was again no response from Hawkins or the then directors, in particular the 1^st to 3^rd Defendants. 

38.  This episode occurred at a time when the Plaintiffs and the 1^st to 4^th Defendants were rigorously litigating about the beneficial ownership of the 75 shares held by Yeung and the 4^th Defendant in HCA 1653 of 2004.

39.  Around the same time, Yeung together with a financial advisor SCC Mandarin Financial Services Limited [“SCCM”] had made certain representations to the Chinese party to the joint venture.  In a letter dated 11 April 2005, SCCM informed the Chinese party that it had agreed to assist Hawkins in procuring a public listing and it would offer financial assistance to Hawkins with an injection of capital of US$20 million in the first phase after the restructuring of the management of Hawkins.  The letter was signed by the general manager again on 24 June 2005.

40.  That had led to a complaint from Wong.  In a letter dated 18 July 2005 from the solicitors for Wong to SCCM, it was alleged that SCCM had suggested Wong be removed as the legal representative for the joint venture company and Kan be substituted in his place.  The letter of 11 April 2005 was used as an inducement.  The complaint was grounded upon an injunction made in HCA 1653 of 2004 that the defendants in that action were restrained from taking steps to remove Wong as the legal representative.

41.  It is not necessary for present purposes to go into the details concerning the complaints on behalf of Wong to SCCM.  There was subsequent correspondence on the matter.  Messrs. Ivan Tang & Co, the solicitors firm that acted for the defendants in HCA 1653 of 2004 came on the record to act for SCCM in making a reply on 1 August 2005.  The complaints had led to the commencement of HCA 1507 of 2005 by Wong against Yeung and Lee Sing Leung [“Lee”] of SCCM and SCCM on 1 August 2005.  Messrs. Ivan Tang & Co acted for these defendants in HCA 1507 of 2005 until 1 September 2005.    

42.  As will become clear below, SCCM and Lee played significant roles in bringing Chan into the scene.  On the evidence before me, it is quite plain that the purported meetings of 14 July 2005 were not isolated events.  They were steps in the overall plan on the part of Yeung to apply for the public listing of Hawkins.  They were part and partial of a series of acts on the part of Yeung, Yau and Kan with the assistance of SCCM to strip Wong of his control over Hawkins.

43.  I wish to emphasize that in so saying, I am not suggesting any improprieties on the part of SCCM or Lee.  They are not parties to this action and I have not heard from them at the trial.  They could have been acting on certain instructions given by Yeung and they might have perfectly legitimate reasons from their points of view to assist Yeung.

44.  The point I try to make is that given the nexus between these events, it would be naïve to suggest that the implication stemming from the complaint in the letter of 18 July 2005 from Wong’s solicitors could have escaped the attention of Messrs. Ivan Tang & Co and their clients, viz. Yeung, Yau and Kan.

45.  Yet, when Yau, the only witness called on behalf of the 2^nd to 4^th Defendants, testified in the witness box, she asked this court to believe that the solicitors had not informed the defendants about this complaint.  I cannot accept such evidence.  Yau could not give any explanation why the defendants failed to take note of the copy of the same letter sent to Hawkins.

46.  As Mr Jat SC submitted, I think it is quite obvious that the 2^nd to 4^th Defendants deliberately chose to put forward Yau as the only witness in their defence because she was ignorant about matters and events which are relevant and significant for the purpose of this trial.  She only played a marginal role in the management of Hawkins and she did not take part in the discussions pertaining to the injection of funds into Hawkins.  She only had a sketchy picture based on what she heard from Yeung, her husband.  She had no personal knowledge about the purported needs for funds and the discussions with Chan or Sunny Growth.  She said she was only told by Kan about these on 14 July 2005.  She had no personal knowledge as regards the preparation of the notices and their posting.  That was handled by the secretary Ms Lai.

47.  If the 2^nd to 4^th Defendants were serious about their defence, I find it difficult to understand why they did not call Yeung, Kan or Ms Lai as witnesses.  Yeung was clearly available.  He had been in court for the most part of the trial.  He must be aware of all the details and could have testified on the basis of his personal knowledge.  Yeung was in fact called as a witness for the defendants at the trial in HCA 1653 of 2004 and he gave some evidence about the background of Sunny Growth which contradicted the evidence of Chan.  Since he was not called as a witness in this trial, the court is deprived of the opportunity of hearing his explanation about such discrepancy.

48.  Apparently, Kan also knows much more than Yau since Kan prepared a letter for “circulation” to shareholders of Hawkins 14 July 2005.  Yau said Kan located Chan as an investor.  This is disputed by Chan in his evidence.  This court is handicapped by the lack of evidence from Kan.  Even though she may spend a lot of time in mainland China, Kan is a Hong Kong resident and a defendant in this action.  There is no acceptable explanation why she could not come to testify at the trial.

49.  It does not take a lawyer to appreciate the best person to testify about the posting of the notices is Ms Lai.  Even though she had left Hawkins, there had been ample time for the defendants to obtain a witness statement from her before she left.  The allegation of lack of notice had been advanced from the very beginning.  The letter of 18 July 2005 should have alerted the defendants as regards the importance of proving due service of the notices.  The present action was instituted in October 2005.  The lack of knowledge as regards how the allotment came about had been raised in the first witness statement of Wong filed on 18 October 2005 (see paras. 20 to 22).  The lack of notices for the alleged meetings of 14 July was specifically raised with an allegation of the blank piece of paper being included in the envelope posted to Wong in June in the 2^nd Affirmation of Wong filed on 24 December 2005.  

50.  The Defendants could have obtained evidence from Ms Lai to refute the allegations of Wong.

51.  The Defendants could have called evidence from the handling solicitor in Messrs. Ivan Tang & Co to account for the apparent lack of response to the letter of 18 July 2005 from the Plaintiff’s solicitors.

52.  On the evidence before me, it seems that the Defendants did not even bother to make enquiry with Ms Lai at all.  Nor was there any enquiry with Messrs. Ivan Tang & Co about the lack of response to the letter of 18 July 2005.

53.  No evidence is led by the 2^nd to 4^th Defendants from witnesses who could have testified on the pertinent issues in the trial.  Instead, Yau was called to testify on matters which she did not know much about and most of her evidence is hearsay or even multiple hearsay.

54.  Although hearsay evidence is admissible, in assessing the weight to be attached to such evidence, the court has to take into account of the matters set out in Section 49 of the Evidence Ordinance.  Having regard to the overall circumstances in the present case, I am driven to the conclusion that it is reasonable and practicable for the 2^nd to 4^th Defendants to call Yeung, Kan, Ms Lai and the handling solicitor at Messrs. Ivan Tang & Co. to give evidence at the trial.  Insofar as Yau’s evidence based on information she obtained from Yeung is concerned, I do not have a clear picture regarding the circumstances under which Yeung passed her the relevant information.  As regards information obtained by Yau from Kan is concerned, as exemplified by the information in the letter of 14 July 2005, it seems likely that they were multiple hearsay.  Kan referred to information from a person called Kang.  The reliability of Kang is very much in issue and based on the evidence of Wong (on this point the defendants did not challenge him in cross-examination), Kang might have his own axe to grind.  Yeung and Kan were parties to HCA 1653 of 2004 and so was Yau.  They were involved in intense power struggle with Wong in terms of control over Hawkins.  The allotment, if valid, could have rendered the fight in HCA 1653 of 2004 meaningless.  Each of them could have a motive in misrepresenting the truth in order to justify the dilution of Wong’s beneficial shareholding in Hawkins.

55.  I accept Mr Jat’s submission that Yau was deliberately chosen as a witness to avoid cross-examination of those who really had personal knowledge on the matters.

56.  In the light of these, I do not attach much weight on Yau’s evidence.  Further, I am satisfied that I should draw adverse inference against the Defendants in accordance with the approach I set out in Ip Man Shan Menry v Ching Hing Construction Co Ltd (No 2) [2003] 1 HKC 256 at para. 155.

57.  More specifically, on the factual issue as regards the posting of the notices, I am entitled to infer that even if evidence were to be led from Yeung, Ms Lai and the handling solicitor at Messrs. Ivan Tang & Co., such evidence would not displace the prima facie case set up by the evidence of Wong and the letter of 18 July 2005 that what was contained in the envelope posted to Wong by registered mail at the end of June was a blank piece of paper.

58.  I have no hesitation in preferring the evidence of Wong to the evidence of Yau on this issue.

59.  It is therefore my finding that notices of the purported meetings of 14 July 2005 had not been given to Wong or Trengei.

60.  The purported EGM of 14 July 2005 is therefore invalid.

61.  Further, the EGM is also defective since it is common ground, as shown on the face of the minute, that only one shareholder attended the meeting.  Yeung was not in Hong Kong and there is no provision in the articles of association permitting attendance by telephone.  Mr Yuen and Mr Vaughan quite rightly conceded that in consequence the quorum requirement had not been satisfied.  Although this point had not been raised in the pleadings, it is a point clearly emerged from the evidence.  It is a simple point and there is simply no answer to it.  Neither Mr Yuen nor Mr Vaughan objected to this court taking into account of the lack of quorum when this point was raised by this court in closing submissions.  In the special circumstances, I think this court should take this into account as well.

62.  Since the EGM is invalid, by reason of Section 57B of the Companies Ordinance, the allotment must be invalid irrespective of the validity of the purported directors’ meeting on 14 July 2005.

63.  In the light of that, I do not need to deal with Mr Yuen’s submission on Clause 100 of Table A.

The implications of the invalidity of the EGM for the different defendants

64.  Once it is decided that there had not been any valid EGM, the 1^st to 4^th Defendants would not have any defence to the claims since they must be taken to have notice of the defects, particularly the defect in terms of quorum.  However, the position of Sunny Growth, the 5^th Defendant, has to be considered at greater length.

65.  Mr Jat submitted that by virtue of the contravention of Section 57B, the allotment was not valid for all purposes and intents.  Hence, the defence of bona fide purchaser of a legal interest without notice does not assist Sunny Growth because it does not have a legal title to the shares allotted.  In this connection, counsel relied on some dicta of Harman J in Re a Company, ex parte Shooter [1990] BCLC 384 at p. 389-390.

66.  Mr Vaughan does not challenge that analysis in his closing submissions.  He accepted that if the allotment was void, no legal right to the shares would have been transferred to Sunny Growth and therefore its bona fides could not salvage the transfer in its favour.   

67.  Given the plea of bona fide investor for value without notice made by Sunny Growth, I think it is necessary to consider whether the Turquand rule can be invoked in favour of Sunny Growth.

68.  Pennington’s Company Law 8^th Edn. sets out the English common law position as follows at p. 404,

“Mere procedural defects on the issue of shares will not prejudice a subscriber or allottee who is unaware of them, or his successors in title, because they may rely for their protection on the rule in Royal British Bank v Turquand.  But the protection of the rule will not be available where an issue of shares is defective in substance, as it is when the directors never allot the shares at all, and the share certificate issued to the subscriber is forged by the company’s secretary, or when the contract for allotment is void … or when the shares are allotted to directors or their nominees in breach of the directors’ fiduciary duties to the company.  In these cases the company may treat all the allotment as void or voidable against the original allottee, but not invariably against persons to whom he transfers his shares.”

See also Palmer’s Company Law Para. 5.734

69.  In the present context, I have found that there were two defects regarding the EGM.  The first one relates to the giving of notice for the meeting.  The second relates to the lack of quorum for the EGM.  In my judgment, it is eminently arguable that these defects are procedural defects and the Turquand rule is applicable (see Pennington’s Company Law 8^th Edn. p. 136-137).

70.  I have to bear in mind the difference between the English statute and Section 57B of our Companies Ordinance mentioned above.  Whilst I have no quarrel with the proposition that an allotment in contravention of Section 57B is invalid, it does not follow that the Turquand rule could not cure the defect in terms of legal title being conferred on an outsider transferee who had no notice of the defect.  Very often, the Turquand rule is relied upon to prove good title in the conveyancing context.

71.  Further, even assuming that a contravention of Section 57B is a defect in substance, the analysis at Pennington’s Company Law 8^th Edn. at p. 405 may be relied upon,

“If a person takes a transfer of shares whose allotment was defective in substance, and he gives value and has no notice of the defects and is registered as a member of the company, the company is precluded from disputing his title to the shares for the following reasons:

(1)     A registered transfer of shares involves a novation, by which the company enters into a fresh contract with the transferee in terms identical to those of the original contract with the subscriber or allottee.  Because of this, the transferee’s title is not vitiated by any defects in the original contract, as it would be if he were a mere assignee of a chose in action.    

(2)     Shares are transferable by a statutory provision, which does not provide that the transfer will be subject to equities.  Where a legal chose in action is assignable at law in this way, a purchaser for value takes free from equities of which he is unaware, whether they make the chose in action voidable, or absolutely void.

(3)     By registering the transfer, the company waives any right it may have to raise equities against the transferee.”

72.  The transfer to Sunny Growth had been registered and a share certificate had been issued by Hawkins to Sunny Growth.  Even though the Plaintiffs are shareholders of Hawkins instead of Hawkins, as far as the cause of action based on invalidity of the EGM is concerned, it is a derivative action and it is arguable that the these principles are equally applicable. 

73.  In view of the positions taken by the parties, the submissions on the implication of the Turquand rule and its interaction with Section 57B were not as fully developed as it would otherwise have been.  Nor have I heard any submissions on the analysis of Pennington set out above.  Given my view on the facts as set out below, it is not essential for my resolution of this case to decide on this interesting point of law.  In the circumstances, I shall assume without deciding that if Sunny Growth did not have notice of the defects regarding the EGM at the time of the transaction, it can rely on the Turquand rule to resist the Plaintiffs’ claim.  

74.  On the other hand, it is well settled that a person dealing with a company on notice that the directors are exercising a power of the company for purposes other than the proper purpose of the company cannot rely on the ostensible authority of the directors and cannot hold the company to the transaction: see Rolled Steel Products Holdings Ltd v British Steel Corporation [1986] Ch 246 at p. 295-6 and p. 306-7.

75.  The crucial question is whether Sunny Growth had any notice of the irregularities (including improper purpose and breach of trust).  Before I address this question, I need to discuss the secondary attack based on substantial validity.         

The purpose of the allotment and the breach of trust

76.  Mr Jat formulated several propositions based on the relevant authorities on director’s duties in allotting shares.  They are not seriously challenged by the defendants.  I accept the following as correct statement of principles,

(a)     The directors’ power to allot shares is a fiduciary power which must be exercised for a proper purpose: Hogg v Cramphorn Ltd [1967] Ch 254; Howard Smith Ltd v Ampol Ltd [1974] AC 821;

(b)     The court has to examine the substantial purpose for which the shares were allotted.  If the purpose was to destroy an existing majority or to create a new majority which did not previously exist, even if it is not for the self-interest of the directors, that would be unconstitutional and unlawful, Howard Smith Ltd v Ampol Ltd [1974] AC 821;

(c)     The aggrieved shareholder has a personal right to apply to set aside the allotment: Residues Treatment &Trading Co Ltd v Southern Resources Ltd (No. 4) (1988) 14 ACLR 569.   

77.  In addition, Mr Vaughan referred to Hilder v Dexter [1902] AC 474 at p. 480 where Lord Davey held that there was no obligation on the part of a company to issue shares above par just because they are saleable in the market at a premium.

78.  I have already commented on the unsatisfactory state of evidence from Yau regarding the defence case of lack of capital for the operation of Hawkins.

79.  Given my misgivings as regards her evidence, I am not satisfied that the purpose of the allotment was to raise capital for Hawkins even taking into account of the documentary evidence relied on by Mr Yuen.  The allotment only raised $9,900 for Hawkins.  For reasons given below, I reject the suggestion that the allotment was tied in with an irrevocable commitment to inject capital by Chan.  There was no reference to such commitment in the notices and the minute for the meetings of 14 July 2005.  Nor was it referred to in Kan’s letter of 14 July 2005.

80.  On Sunny Growth’s case as put by Chan in his evidence, he did not inject funds into Hawkins until 22 June 2006 (see Para. 17 of his witness statement), almost one year after the allotment.  The loan agreement between Chan, Sunny Growth and Hawkins was only made on 3 December 2005.  Further, under clause 2 of the loan agreement, the capital was injected by way of loan for a few months with a maturity date on 10 October 2006.  Interest was charged at a rate of prime plus 4% per annum.  Chan actually demanded the return of the loan on 2 November 2006 and upon non-repayment, a winding-up petition was presented on 23 November 2006.

81.  It is difficult to reconcile these conducts on the part of Sunny Growth and Chan with the assertion that the purpose behind the 9,900 shares allotment and transfer was to provide much needed working capital for Hawkins on a long term basis.

82.  I do not find any commercial justification for the allotment.  Bearing in mind the disputes between Wong and Yeung and HCA 1653 of 2004, and also taking into account the manoeuvre by Yeung and SCCM to remove Wong as a legal representative for Hawkins in the joint venture, the irresistible inference is that the allotment is part and partial of an overall effort by Yeung to prevent Wong from getting back the control over Hawkins.

83.  In other words, the substantial purpose of the allotment was to replace the existing majority with a new majority created out of the allotment.  Applying the principles set out above, the directors were not acting in the interest of Hawkins in approving the allotment.

84.  It follows from my finding on the purpose of the allotment that the 4^th Defendant was acting in breach of trust in authorizing the allotment at the purported EGM of 14 July 2005.  The intention was to reduce the 100% beneficial shareholding of Wong to a mere 1% and to frustrate the recovery of control over Hawkins by Wong through HCA 1653 of 2004.  Manifestly, it is against the interest of the beneficiary, particularly bearing in mind that the value of the 99% must substantially exceed the $9,900 that the allottee had to pay to acquire the same.  

85.  Hence, from a substantial point of view, the allotment is also invalid. 

Was Sunny Growth a bona fide purchaser without notice?

86.  I regret to say the evidence of Chan (as a witness for Sunny Growth) is even more unreliable than that of Yau.  He clearly had substantial experience in commercial matters, having invested in other businesses before.  He was aware of the need to undertake a due diligence exercise before making an investment.  He said he was introduced to this investment opportunity by SCCM and Lee and he relied on them to carry out the due diligence exercise. 

87.  Yet surprisingly, Chan claimed he did not know about the litigation in HCA 1653 of 2004 and the fight between Wong and Yeung as regards the 75 shares at the time of the transfer.  He said he only learnt about that in October 2005 after the present action had been instituted.  He said he then learnt from Lee about the dispute and he was assured by Lee that Wong’s claim was ludicrous.  He did not regard it as a serious concern and did not pay further attention on it.  Without any further investigation into the merits in HCA 1653 of 2004, he entered into a loan agreement dated 3 December 2005 for a sum of US$5 million to be lent to Hawkins as loan capital.  

88.  Lee was aware of the trial of HCA 1653 of 2004 in April 2006 and the judgment of Deputy Judge L Chan.  One would imagine the finding by the judge on the beneficial ownership of the 75 shares coupled with the ongoing challenge to Sunny Growth’s 9,900 shares in the present action would have put any reasonable investor on guard and withhold further injection of funds for the time being.  Despite that a substantial portion of Chan’s capital was allegedly injected into Hawkins on various dates since 22 June 2006.  

89.  The only explanation given by Chan regarding such oddity is a disingenuous excuse that he had promised to invest into Hawkins in July 2005.  That alleged promise was not evidenced in writing and there is no documentary evidence to support the assertion.  Moreover, given the outcome in HCA 1653 of 2004 and the challenge to the propriety regarding the allotment and transfer of the 9,900 shares, it is incredible that a bona fide investor would continue to make the capital injection in the manner as Chan did.

90.  Moreover, notwithstanding Chan was allegedly aggrieved by Lee’s alleged failure to inform him about the dispute between Wong and Yeung prior to October 2005, and Chan’s claim of loss of substantial money in terms of his investment in Hawkins, Chan did not consider making any claims against Lee or SCCM.

91.  Another inexplicable feature in Chan’s evidence is his apparent lack of interest in the attitude of Trengei towards Sunny Growth’s intended investment into Hawkins.  He admitted he was aware of the existence of Trengei as a minority shareholder.  However, Chan said he relied on SCCM and Lee in conducting due diligence and that included enquiry as regards Trengei.  Chan was unable to tell this court what steps SCCM and Lee had taken in that regard.  He did not call Lee or anyone from SCCM to give evidence in support of his case of due diligence having been carried out.

92.  At some point in his evidence, when Chan was pressed about whether he regarded SCCM or Lee as his agent, he wavered and said SCCM was the agent of the vendor.  If SCCM and Lee were not his agents, Chan could not truthfully testify that they carried out the due diligence exercise for him.  If that were so, the real position was that Chan did not carry out any due diligence despite his awareness of the need to do so.

93.  It would not be difficult for Chan to learn about the dispute between Wong and Yeung in HCA 1653 of 2004 had due enquiry been made.  Given the involvement of SCCM and Lee in the matter since 2004, I am sure that they knew about that dispute well before July 2005.  Bearing in mind that SCCM is a licensed financial advisor, had Chan asked them about Trengei and its attitude towards the proposed allotment to Kan and transfer of 9,900 shares to Sunny Growth, SCCM would most likely have disclosed the dispute to Chan.

94.  I find it remarkable that Sunny Growth did not call Lee or anyone from SCCM to support its case of bona fide investor without notice.  If there is any truth in Chan’s assertion that he was relying SCCM and Lee to conduct due diligence and they had not informed him about the dispute between Yeung and Wong, the matter is crying out for explanation.  I do not understand that there would be any difficulties in obtaining evidence from them.

95.  If Lee were called as a witness, he would be able to tell the court whether Chan had been told about HCA 1653 of 2004 and if not, why not.  He would be able to tell this court whether Chan had instructed SCCM to conduct due diligence for Sunny Growth.  He would also be able to tell the court about why funds were not injected at the same time as the transfer of shares and whether the allotment had to be made in favour of Kan instead of Sunny Growth.

96.  Judging from what happened after Chan learnt about the judgment in HCA 1653 of 2004 in April 2006 as mentioned above, it is quite probable that SCCM had in fact told Chan and therefore Chan was actually aware of the dispute even at the time when the shares were transferred to Sunny Growth in July 2005. 

97.  In the circumstances, this court is entitled to draw adverse inference against Chan that if he were to call Lee or someone else from SCCM as witness, that witness would not give evidence supporting his case.   

98.  Mr Jat had further highlighted some other unsatisfactory aspects of the evidence of Chan in his closing submissions.  I do not propose to repeat in details those submissions.  In short, I find it difficult to believe in Chan’s story of how little he had familiarized himself with the affairs of Hawkins before deciding to invest into it.  On the one had, Chan suggested he had seriously committed to invest US$5 million to US$7 million, so much so that he felt obliged to continue with the injection of funds despite the outcome of HCA 1653 of 2004.  On the other hand, he claimed that he was lax in the investigation of the affairs of Hawkins before deciding to make such commitment as he was only paying $9,900 for the shares.  I am afraid Chan cannot be allowed to blow hot and cold at the same time.  If he had made an irrevocable commitment for the injection of US$5 million, it does not lie in his mouth to claim at the same time that he did not find it necessary to pursue his due diligence exercise seriously.   

99.  On the whole, I do not find Chan to be a reliable witness.  I am sure that he had not told me all the material facts leading to Sunny Growth’s involvement in Hawkins.  I do not believe he had no notice of the dispute between Yeung and Wong before Sunny Growth decided to invest into Hawkins.

100.  I am not even satisfied that Yeung or his associates had no interest in Sunny Growth.  Although Chan claimed that he and his son are the only shareholders of Sunny Growth, Yeung had testified in the trial of HCA 1653 of 2004 that Yeung’s brother had an interest in Sunny Growth.  He also suggested that SCCM might also have some interest.  Yeung had not testified at the trial before me and I have no opportunity to hear from him the basis on which he gave such evidence under oath.  Since Mr Vaughan did not have the chance to cross-examine Yeung, I should not attach too much weight on that piece of evidence.

101.  However, there are two additional pieces of evidence that are relevant in this context.  First, SCCM did represent to the Chinese party in their letter of 11 April 2005 that it was confident in providing financial facilities to inject a first instalment of US$20 million into Hawkins immediately upon the re-organization of the management of Hawkins.

102.  This had to be read together with the plea in Paragraph 27(c)(i) of the joint defence of 2^nd to 6^th Defendants filed on 14 November 2005.  It was pleaded as follows,

“Pursuant to an agreement dated 18 September 2004, SCCM committed to inject an initial capital investment of US$20 million to the Shunfeng project of the 6^th Defendant.”

103.  Notwithstanding the splitting of the legal representation for 2^nd to 4^th Defendants on the one part and the 5^th Defendant on the other part, there has not been any application to amend the defence up to the end of this trial.  Further, the averment in Paragraph 27(c)(i) and the letter of 11 April 2005 were highlighted by Mr Jat in the course of his opening.  Despite that, I have not heard anything on behalf of the 5^th Defendant to withdraw this plea as part of its defence.

104.  Secondly, on 2 December 2005, a company was set up at Liaoyeung by Sunny Growth by the name of “辽阳日升矿产品加工有限公司”.  Chan was the managing director and Kan and Yau were directors.  Yau mysteriously disclaimed any knowledge of her appointment as director of this company in her evidence.  Chan merely said she might have forgotten about it.

105.  Chan claimed that this company was another project which had no relation with the investment into Hawkins.  However, in an affirmation of 29 August 2006 made by the daughter of Chan, Angela Chan in the capacity as general manageress of Sunny Growth, she claimed that two sums remitted to this company in early December 2005 amounting to US$2 million in total were injection of capital by Sunny Growth into Hawkins by way of shareholder’s loans.

106.  Chan said he was not aware of this as he was having a medical condition at that time.  However, he agreed that he had authorized his daughter to make the affirmation.  He also said it was a mistake of the secretary.  However, he did not call his daughter nor his secretary to explain to this court how such a mistake had come about.

107.  Further, Chan himself repeated a similar assertion in his winding-up petition presented against Hawkins in HCCW 621 of 2006 on 23 November 2006.  For this purpose, it is immaterial that this time Chan was asserted to be the lender as opposed to Sunny Growth.  The important point is that Chan asserted in that petition that the US$2 million was lent to Hawkins.

108.  I acknowledge that these are not direct evidence that someone other than Chan and his son had an interest in Sunny Growth.  But this court is entitled to take these matters into account in asking given that Sunny Growth continue to inject substantial funds into Hawkins even after the judgment of HCA 1653 of 2004, is it likely that there are some other beneficial shareholders of Sunny Growth other than Chan and his son.  Looking the matter in terms of inherent probabilities, as I have already observed above, it is simply incredible that an independent unconnected party would continue with such investment.  On the other hand, it would make more sense if the funds were coming from a source connected with Yeung.

109.  Given my view on the credibility of Chan, I do not accept his evidence on the shareholdings of Sunny Growth on its face value.

110.  Drawing all the threads together, my finding is that on the balance of probabilities, Sunny Growth was not a bona fide investor without notice.  On the contrary, it must have notice of the dispute between Wong and Yeung before the allotment and the transfer of shares in July 2005.

111.  Further, just in case that I was somehow wrong in my conclusion on actual notice, I will also hold that Sunny Growth must have constructive notice of that dispute.  As held by the English Court of Appeal in Wrexham Association Football Club Ltd v Crucialmove Ltd [2006] EWCA Civ 237 at Para. 46,

“… the very nature of a proposed transaction may put a person on inquiry as to the authority of the directors of a company to effect it, even if he has no special relationship with the company.  That must be the more so where the person has a special relationship with the company …”

112.  In the present context, the substantial change in the shareholding structure as a result of the allotment and transfer (with the existing shareholders being reduced to a mere 1 % minority) should by itself put Sunny Growth on inquiry as regards the attitude of the existing shareholders, including that of Trengei.  Further, it should also put Sunny Growth on inquiry in terms of the compliance with Section 57B.  A reasonable bona fide investor will at least ask for inspection of the EGM minute.  Such an inspection would immediately reveal that there was no meeting as only one shareholder attended the purported meeting. 

113.  With notice of such dispute and irregularities, it would be imprudent on the part of Sunny Growth to invest into Hawkins without finding out more about the purpose of the allotment.  In the circumstances, Sunny Growth should be held to have at least constructive notice of the substantial invalidity of the allotment.

114.  Not being a party without notice, Sunny Growth cannot rely on the Turquand rule nor the doctrine of bona fide purchaser without notice to resist the Plaintiffs’ claims.

Results

115.  For these reasons, there will be judgment in favour of the Plaintiffs against all the defendants.  I grant relief in terms of Paragraph 4.1 of Mr Jat’s closing submissions, viz.

(a)     a declaration that the allotment was void and invalid;

(b)     an order that the Allotment be set aside;

(c)     an order that the 9,900 shares be cancelled;

(d)     an order that the share register of Hawkins be rectified accordingly;

(e)     an injunction against Sunny Growth that, pending the rectification of the share register, it be restrained from exercising any power as shareholder of Hawkins. 

116.  The counterclaim has been abandoned and it is dismissed accordingly.

117.  As regards costs, I make a costs order nisi that the 1^st to 5^th Defendants shall bear the costs of the Plaintiff, such costs to be taxed if not agreed.

118.  I also make a specific costs order regarding the costs of the adjournment on 20 March 2007.  Sunny Growth shall pay the Plaintiffs’ costs of that adjournment, which I fix pursuant to Order 62 Rule 9(4)(b) at $80,000 and it shall also pay the 2^nd to 4^th Defendants’ costs of that adjournment, which I fix pursuant to Order 62 Rule 9(4)(b) at $43,000.  These costs shall be paid out of the $140,000 paid into court by Sunny Growth on 21 March 2007.

119.  I shall also release the $800,000 paid into court by the Plaintiffs back to the Plaintiffs.