XCHRX Re Rhine Holdings Ltd. (In Liquidation)

HCCW 510/1998

IN THE HIGH COURT OF THE

HONG KONG SPECIAL ADMINISTRATIVE REGION

COURT OF FIRST INSTANCE

COMPANIES WINDING-UP PROCEEDINGS NO.510 OF 1998

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D E C I S I O N

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1. This is an ex parte application by the Liquidators of Rhine Holdings Limited ("Rhine") for sanction under section 182 of the Companies Ordinance for the transfer of all the issued shares of the Company ("Rhine Shares") to New Rank City Development Limited ("the Investor") pursuant to a scheme of arrangement ("the Scheme") proposed to be made between Rhine and its shareholders. The Scheme itself is not before this court, nor is it subject to its approval : rather, the Scheme is proposed to be made in Bermuda, the place of incorporation of Rhine.

2. In the affirmation of Kennic Lai Hang Lui of 28 January 2000 made in support of the application, it was stated that :

"The purpose of the Scheme is to enable the Investor Company to acquire the listing status of Rhine at a consideration ...., which the creditors and the shareholders of Rhine may not be able to receive through the liquidation if not because of the Scheme...."

It was reiterated in paragraph 11 that :

"The Scheme is part of a proposal ('Proposal') by the Investor Company to acquire the listing status of Rhine on the Hong Kong Stock Exchange."

3. On 1 December 1999, (1) the Investor, (2) its proposed wholly owned subsidiary New Rank International Limited ("NRI"), (3) Rhine and (4) the Liquidators entered into an agreement ("the Agreement"), the salient terms of which are :

(1) The Rhine Shares would be transferred to the Investor as part of the Scheme in return for the allotment to the holders of the Rhine Shares of approximately 2% of the Investor's Shares in issue having an attributable net tangible value asset of not less than $5 million based on the estimated adjusted net tangible asset value of the Investor and its subsidiaries;

(2) A total of up to $15 million would be payable by NRI or the Investor to Rhine of which :

(a) $9 million after payment of the adjudicating costs of the claims of Rhine creditors would be paid to the creditors of Rhine as part of its available assets; and

(b) a sum not exceeding $6 million would be payable to the Liquidators as their fees, costs and expenses in connection with the transactions embodied in the Agreement and the costs and expenses of the liquidation of Rhine other than the adjudication costs of the claims of Rhine's creditors; and

(3) On completion of (1) and (2) above, all the Rhine Shares transferred pursuant to the Scheme would be re-transferred to the Liquidators at a nominal consideration of $1.

4. The Agreement provides for the funding by the Investor of three types of costs, fees and expenses incurred and to be incurred by the Liquidators in respect of the liquidation and the transaction contemplated by the Agreement, i.e. (1) fees and expenses incurred in the liquidation other than the costs resulting from adjudicating claims; (2) costs and expenses of the Liquidators incurred as a result of the implementation of the Agreement; (3) costs involved in the adjudication of claims which will form part of the $9 million payable to the creditors of Rhine.

5. The Liquidators have filed an affirmation containing the following summary :

"A.	Costs, fees and expenses incurred to date :-
	(1)	liquidation (including those of Special Managers) other than adjudication costs	$2,089,000
	(2)	in connection with the Agreement (including legal and other professional fees)	$4,266,600
	(3)	adjudication costs	0
			$6,355,600
B.	Estimated costs, fees and expenses to be incurred (up to distribution to creditors) :
	(1)	liquidation other than adjudication costs	$200,000
	(2)	in connection with the Agreement (including legal and other professional fees)	$2,541,400
	(3)	adjudication costs	$300,000
			$3,041,400
		Total : A + B = $9,397,000"

6. It will be noted that according to the Liquidators, over $6 million have been expended to date by way of costs and they expect that a further $3 million of costs etc. would be incurred. These are significant amounts of costs but the substantial part (approximately 75%) of the aggregate costs is attributable to the transaction.

7. It is material, at this juncture, to refer to clause 8 of the Agreement in greater detail.

"8.2	The Liquidators' Costs and Expenses are the costs, fees and expenses of the Liquidators arising from, in connection with or reasonably incidental to the preparation and the implementation of the Proposals, which shall include, without limitation, the following:
	....
	(d)	the fees and expenses of Pacific Challenge Capital Limited, the independent financial advisers to the Liquidators; and
	(e)	the fees and expenses of DBS Asia Capital Limited, the independent financial advisers to the holders of Scheme Shares;"

It appears from the definitions clause that in fact on 17 September 1999 NRI, Rhine and the Liquidators entered into a preliminary agreement relating, inter alia, to the terms of payment of the fees and expenses of the Liquidators and Rhine. Pursuant to clause 8.4, $1 million was deposited with the Liquidators upon the signing of the Agreement. A further $1.5 million was payable within five business days from the date the Listing Committee granting an approval in principle for the listing and dealing of the Investor's Shares and a further $2.5 million is payable within five business days of the satisfaction of certain conditions precedent which, inter alia, includes the approval of this application by the court. But the liability of NRI and the Investor for the Liquidators' Costs and Expenses is not dependant on the satisfaction of the conditions precedent. In other words, the Liquidators' fees are 'underwritten'.

DISTRIBUTION TO CREDITORS

8. According to the Statement of Affairs, the estimated liability to unsecured creditors is $226,250,109. However, the Liquidators have received claims of approximately $372,546,623. Over 99% of the total estimated realization value of Rhine's assets stated in the Statement of Affairs is due from Rhine's subsidiaries which are either insolvent, dormant or in liquidation. It is therefore likely that the Liquidators will not be able to realize any of the amounts due from the subsidiaries. As matters stand, in view of the Liquidators' costs which have priority, the creditors cannot realistically expect any distribution. If the court were to sanction the transfer of shares envisaged by the Scheme and the Scheme were to become effective, $9 million will become payable under the Agreement for the benefit of the creditors. After providing for preferential payments to employees of about $500,000 and estimated adjudication costs of $300,000, the unsecured creditors of Rhine can expect a dividend within the range of 2.2 - 3.6%, depending on the amount of claims actually admissible. As noted earlier, the debts are likely to range between $226 million and $372 million.

DISTRIBUTION TO SHAREHOLDERS

9. Under the Scheme reflecting the terms of the Agreement, holders of every 2,000 Rhine Shares will be entitled to exchange them for 52 Investor's shares. As there are 192,142,432 Rhine Shares in issue, just under 5 million new Investor's shares will be issued to the shareholders of Rhine. As the adjusted net tangible asset value per Investor's share is $1.31, the aggregate value of the Investor's shares distributable to Rhine's shareholders would be approximately $6.54 million. However, the affirmation of Mr Lui of 28 January 2000 stated the value of the Investor's shares to be exchanged to be $6.51 million. Then in his second affirmation of 15 February 2000, he gave a different value, namely, only $5.27 million. Presumably this latter figure reflected the anticipated placing price which of course is heavily discounted and does not necessarily reflect the market price which will only be known once the shares are traded. To add to this confusion, the written submissions dated 8 March referred to "approximately HK$5.5 million new Investor's shares [to] be issued to the shareholders of Rhine". As noted earlier, based on the number of Rhine Shares in issue, less than 5 million Investor's shares need be issued. At the hearing on 28 March, it was explained that this was meant to refer to $5.5 million worth of new Investor's shares based on the placing price. Be that as it may, the shareholders stand to receive a benefit of not less than $5 million but more likely to be worth $6.5 million under the Scheme.

THE TRANSACTION

10. Whilst sanction is sought relating to the proposed transfer of shares by the shareholders of Rhine, that, of course, is only one feature of a much larger transaction. The Investor is interested in Rhine not because of its former business but because it is a company that is listed on the Stock Exchange of Hong Kong. In the written submissions dated 8 April 2000, the Liquidators contended that the Scheme does not, on a true analysis, involve any disposition or dealing in any asset of Rhine or in the diminution in the value of any asset of Rhine. It was argued that what the Investor wishes to acquire is the issued share capital of Rhine which is not an asset of Rhine but that of Rhine's shareholders. Further, the listing status is not something that should be regarded as an asset belonging to Rhine : it is not something that is free-standing or readily transferable.

11. Rhetorically, I ask, why is this application being made by the Liquidators if the transaction does not in some way involve an asset of Rhine? If all the Investor wishes to acquire is the issued share capital, then logically the application ought to be made by the shareholders or the Investor but not the Liquidators. One would not expect the Liquidators to take such a prominent and active role in promoting a transaction if it did not involve the realization of a corporate asset for the benefit of Rhine's creditors. The Liquidators have no business in promoting the interests of anyone other than those of the creditors. To the extent that the assets realized filter down to benefit the shareholders under the statutory order for the application of assets, the interests of the shareholders are subsumed under the umbrella of the creditors' interests.

12. The nature of the transaction needs to be approached from the perspective of the Investor. It is a well known fact that generally speaking, investor interest exists in listed companies that fail. Since the flood of "backdoor listing" that occurred some years previously, the Listing Rules have been tightened up. Under rule 8.01 of the Listing Rules of the Stock Exchange, the basic conditions that have to be met as a pre-requisite to the listing of equity securities apply to every method of listing so that any potential acquirer must satisfy the Stock Exchange that it has an adequate trading record.

13. Rule 8.02 states :

"[t]here must be an open market in the securities for which the listing is sought. This will normally mean that: ... (2) in the case of a class of securities new to listing, at the time of listing there must be an adequate spread of holders of the securities to be listed ..., as a guideline, there should be not less than three holders for each HK$1,000,000 of the issue, with a minimum of 100 holders."

But it is possible under Chapter 7 of the Listing Rules to obtain a listing by way of an "Introduction" :

"An introduction is an application for listing of securities already in issue where no marketing arrangements are required because the securities for which listing is sought are already of such an amount and so widely held that their adequate marketability when listed can be assumed." (Rule 7.13)

"Introduction will normally be appropriate in the following circumstances: ... (3) where a holding company is formed and its securities are issued in exchange for those of one or more listed issuers. Any reorganisation by way of scheme of arrangement ... must first be approved by a special resolution of the listed ... issuers." (Rule 7.14(3))

14. Where the investor can take advantage of an "Introduction", it would be able to obtain a listing without the necessity of undertaking marketing arrangements to ensure, for example, that sufficient shares in the investor are held in sufficient numbers of different members of the public. This facilitation in the listing process appears to be what the Investor is desirous of having and in respect of which it is willing to pay a considerable sum of money.

15. In my judgment, the Liquidators' analysis that what the Investor wishes to acquire are the Rhine Shares and nothing else is misconceived. If the application is sanctioned and the Scheme proceeds to completion, the Investors' ownership of the Rhine Shares would be purely transient or momentary : once the exchange of shares has been effected and the consideration paid, all the Rhine Shares will in fact be retransferred to the Liquidators at a nominal consideration. The only reason for the exchange of shares is that it will enable the Investor to take advantage of the "Introduction" mechanism for listing. It is thus not the shares of any company in liquidation that would be of interest to the Investor : only the securities of a listed issuer would be of interest. But the ability to facilitate or the facilitation of a listing of the Investor or its company is derived from the fact that Rhine is a listed company. In my judgment, that ability or facilitation is a corporate asset.

16. Whilst the Rhine shareholders are the owners of the Rhine Shares, of themselves, the Shares have no value in the context of this liquidation since even creditors cannot expect a dividend.

17. When the application first came before me on 11 February, I was greatly exercised by what appeared to be an attempt to alter or vary the statutory order for the application of assets. In the context of the facts of Rhine, the shareholders can have no expectation of any return being made in the liquidation. Yet the transaction enables assets worth at least $5 million if not $6.5 million to be distributed to the Rhine shareholders when under the statutory order for application of assets, the shareholders stand to receive nothing. On further consideration, it would appear that the asset to be realized does have an unusual feature inasmuch as it can only be realized with the co-operation of the shareholders. That being so, I can see the case for some form of "sweetener" or token consideration to be provided to the shareholders in return for their co-operation having regard to the fact that their shares have no intrinsic value and certainly no value that the shareholders on their own can realize.

THE LIQUIDATORS' ROLE IN THE TRANSACTION

18. It is incumbent on the Liquidators to realize corporate assets and to distribute them in accordance with the statutory order. As noted above, where the statutory order applies, the interests of the creditors and the shareholders coincide although the shareholders stand to receive a return only after all the debts have been repaid. But the realization of the particular corporate asset under consideration is not such a case. This is because in determining how the consideration proposed to be paid by the Investor is to be apportioned between the creditors and the shareholders, their interests are diametrically opposed : what goes to the shareholders will not go to the creditors and vice versa.

19. The terms of the Agreement give rise to considerable disquiet in two respects. First, in so far as one can discern from the Agreement, the Liquidators were effectively representing the interests not only of the creditors but also of the shareholders where, in fact, those interests conflict. There was no separate representation of the shareholders and the Liquidators appeared to have represented both sets of interests. This is evident from clause 8 of the Agreement where it was specifically provided that the Liquidators' fees and expenses were to include not only the fees of the financial advisers to the Liquidators but also those representing the interests of the shareholders. Where a conflict of interest arises, the Liquidators' role ought to be confined to the interests of the creditors : there can be no possible justification for the Liquidators to defray any part of the expenses that are not expenses necessarily and properly incurred on behalf of the creditors. In other words, the costs attributable to the shareholders should not be borne by the creditors. If, as would appear to be the case, the Liquidators represented both sides, it stands to reason that they may not have driven the best bargain for the creditors.

20. Second, the provisions of the Agreement relating to the Liquidators' fees and expenses are predicated on a fee arrangement that is particularly attractive to the Liquidators but which may not be in the interest of the creditors. Leaving aside the costs incurred in connection with the Agreement, the liquidation expenses to date apparently amount to over $2 million. The assets recoverable by the Liquidators are not even sufficient to defray those expenses. In fact, they fall considerably short. So, in the absence of the transaction, the Liquidators will in all probability be out of pocket in respect of the balance. The Agreement not only ensures that the liquidation costs incurred to date are paid, considerable additional fees would be generated although there is a cap of $6 million. In those circumstances, it is not difficult to discern what incentives existed to cause the Liquidators to promote the transaction with enthusiasm.

21. The provisions relating to fees in the Agreement appear to offend certain basic principles and as such are objectionable. Apart from placing the Liquidators in the invidious position of representing conflicting interests, the provisions allocate to the Liquidators a tranche of the overall consideration, effectively underwriting fees to the not insignificant amount of $6 million and ensuring that no part of that would accrue to the creditors. In the ordinary case, the Liquidators would realize the assets and their fees, necessarily and properly incurred would be paid in priority, leaving the balance for the creditors. Insofar as the provisions are meant to forestall any direction for taxation for fees necessarily and properly incurred, they are also objectionable.

22. What the evidence does not address at all is how the apportionment of the consideration between the creditors and the shareholders was arrived at. Fees apart, the 'consideration' being paid by the Investors is $15 million. How was the split of 60:40 between the creditors and shareholders arrived at? Plainly the Liquidators could not have negotiated with themselves although they appeared to represent both sets of interests. Whilst advice from independent financial advisers have been procured for the shareholders, it would not appear that they played any role in negotiating 'the division of spoils'. Rather, they simply opine that what is proposed is fair and reasonable. It was suggested at the hearing held on 24 February that the Investor may have had a hand in arriving at the split. If it were the case that the Liquidators were in fact negotiating with the Investor, I entertain grave reservations as to how hard a bargain was conducted on behalf of the creditors given the fee arrangement. At any rate, there is no evidence as to what advice the Liquidators took or any details of the negotiations.

EXERCISE OF THE DISCRETION

23. In considering how the court's discretion ought to be exercised, the apparent failure of the Liquidators to appreciate the conflicts of interest is sufficient reason to cause the court to view the application with circumspection. It is of the greatest importance that office holders and their advisers recognize the existence of conflicts of interest where they exist. That said, the Liquidators, however misguided, were genuinely attempting to realize the value of the corporate asset about which there are no decided cases to afford guidance.

24. I am not satisfied that the apportionment of the benefit between the creditors and shareholders is fair and reasonable for reasons already stated. Moreover, there does not appear to be any justification for all the costs of the transaction to be thrown onto the creditors when the shareholders are reaping a substantial windfall. On the other hand, the withholding of the court's sanction would deprive the creditors of receiving any dividend distribution at all. If the court were to sanction the transfer, a return of between 2.2% and 3.6% is anticipated.

25. At yesterday's hearing, I gave an intimation that after considerable hesitation, and with the greatest reluctance, in principle, I am prepared to grant the section 182 application but only upon certain conditions relating to taxation and an undertaking. On further reflection and in order to avoid the additional costs that an opposed taxation inevitably involves, I propose to take a broad brush approach as follows.

26. The transaction costs to date are $4.266 million. 40% of those costs ought not to be borne by the creditors, i.e. $1.7 million. Taking into account the fact that apparently future costs have to be absorbed or waived by the Liquidators because of the $6 million cap, an allowance should be made for this. As to the amount of the allowance, it is noted that the estimated figure of $2.54 million is not particularized. Further, the aggregate costs (untaxed) of the transaction of about $7 million appear to be wholly excessive. In all the circumstances, doing the best I can, I will round the figure down to $1 million as a fair figure attributable to the costs of the shareholders. Accordingly, I will approve the application upon an undertaking by the Liquidators that a sum of $1 million will be added to the fund available for distribution amongst the creditors out of the $6 million of fees, costs and expenses received or to be received by the Liquidators under the Agreement. It is entirely a matter between the Liquidators and their legal advisers if and how the $1 million ought to be apportioned between them. If there is any point that I have overlooked in arriving at the $1 million figure, I am prepared to entertain further submissions. For that purpose, there is to be liberty to restore.

27. At this point, it will be opportune to remark upon the Liquidators' approach to the present application. The Liquidators and their solicitors did not appear to treat the application with any degree of seriousness notwithstanding what I consider to be a novel and difficult issue, free from authority as it was and the fact that court approval was a condition precedent under the Agreement. The difficulty was exacerbated by the fact that the application was ex parte. Ergo, the court did not have the benefit of any opposing argument. Counsel was only instructed to appear at the adjourned hearing after the court had identified certain difficulties with the application.

28. Notwithstanding the very substantial amount of costs associated with the Agreement which the Liquidators have already incurred (apparently over $4 million to date), they appear to have been remarkably reluctant to incur legal expenses when it came to the court application. Surely it is incumbent on the Liquidators to ensure that the court would be given the sort of assistance that it is entitled to expect in ex parte applications of this kind.

29. The fact that the court has, with the greatest reluctance, approved the application should not be viewed as a precedent for future applications unless the concerns and conflicts of interest are appropriately and adequately addressed.