LAM HON HUNG v. SHUI HING TEXTILES INTERNATIONAL LTD AND ANOTHER

HCMP 1585/2005

IN THE HIGH COURT OF THE

HONG KONG SPECIAL ADMINISTRATIVE REGION

COURT OF FIRST INSTANCE

MISCELLANEOUS PROCEEDINGS NO. 1585 OF 2005

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D E C I S I O N

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The application and the progress of the petition

1.  This is an application for leave to amend a petition presented under section 168A of the Companies Ordinance, Cap. 32.  The petitioner, Lam Hon Hung, holds 20% of the issued shares of the subject company, Sun Hung International Limited (“the Company”), formerly known as Shui Lung Textiles Limited.  78% of the shares is held by Shui Hing Textiles International Limited, the 1^st respondent herein.  The Company is the 2^nd respondent.

2.  The business of the Company is garment manufacturing.  It has two wholly-owned subsidiaries, Longrise (HK) Limited (“the Dongguan Holding Company”) and Global Best Development Limited (“the Shao Guan Holding Company”).  The Dongguan Holding Company holds a factory in Dongguan by an entity known as Dongguan Xiangjia Knitwear Company Limited (“the Dongguan Factory”).  The Shao Guan Holding Company holds a factory in Shao Guan by an entity known as Global Best Knitwear Company Limited (“the Shao Guan Factory”).  These two factories (“the Factories”) are the main assets of the Company.

3.  The Company is a subsidiary of the 1^st respondent, and the 1^st respondent is a subsidiary of USI Holdings Limited (“USI”).

4.  The petition was presented on 29 July 2005.  The petitioner seeks an order that the 1^st respondent is to purchase all his shares in the Company at a price to be determined by the court.  It is alleged in the petition that when the petitioner joined the Company, there was an understanding that he would be involved in the management of the Company and its factories and the finances of the Company and its subsidiaries would be under the management of the 1^st respondent.  The petitioner was appointed the managing director of the Dongguan Holding Company and the Shao Guan Holding Company, and the legal representative of the Factories.

5.  The main allegations of unfairly prejudicial conduct alleged in the petition may be summarized as follows:

(1) the 1^st respondent tried to induce the petitioner to sell his shares in the Company to it claiming that the petitioner’s shares were worthless;

(2) when the petitioner held out that he would only sell his shares at a reasonable price, the 1^st respondent tried various ways to damage the business of the Dongguan Factory and to tighten control over the finances of the Company and the Factories.  Further, the 1^st respondent caused the board of the Company to pass a resolution in March 2005 to cease business, claiming that the Company had been suffering losses for the last 4 years ending on 31 December 2004 and had a negative net asset value.  The petitioner disputed the alleged figures of indebtedness in the accounts, asserting that the accounts of the Company should be fully investigated;

(3)    shortly thereafter, the petitioner was wrongfully excluded from the management of the Dongguan Factory and he was dismissed from his positions in the Factories.

6.  The 1^st respondent filed evidence in opposition in November 2005 and in January 2006.  Lists of documents were exchanged in July and August 2006.  In September 2006, the petitioner filed his evidence in reply, in which he raised a number of allegations not mentioned in the petition concerning the manipulation of the accounts of the Factories.

7.  The 1^st respondent did not raise objection to this and responded to the new allegations in the affirmations filed in February 2007.  Thereafter, another round of evidence was exchanged in relation to these new allegations, in September and November 2007.

8.  In February 2008, the petitioner issued a summons for specific discovery.  In the affirmation in support of this application, the petitioner deposed that the documents sought are relevant to his complaints in relation to the wrongful handling of the Company’s accounts in, inter alia, these two respects:

(1) under-stating the profits of and wrongfully attributing losses to the Company and its subsidiaries by making the “Mainland Remittances”; and

(2)    over-charging the management fees against the Company.

These issues did not feature in the petition.

9.  The application for specific discovery was opposed by the 1^st respondent.

10.  On 9 July 2008, I gave directions directing the petitioner to file and serve a summons to amend the petition with a draft amended petition annexed within a stipulated time, and adjourned the summons for specific discovery sine die with liberty to restore after the disposal of the amendment application.

11.  This summons to amend the petition was issued on 17 October 2008.  At the hearing on 28 November 2008, the 1^st respondent’s counsel, Mr Patrick Chong, informed the court that the application would be opposed on these grounds:

(1) the proposed amendments are inconsistent with the documents exhibited by the petitioner and the petitioner’s allegations are flawed;

(2) they are scandalous and made with ulterior motive and would delay the fair trial of the action; and

(3)    they relate to the affairs of the Company’s subsidiaries and are not the affairs of the Company.

The amendments sought

12.  I gather from the 1^st respondent’s submission in this hearing that it only objects to the amendments in paragraphs 66 to 87 of the draft amended petition.  So there is no objection to the other amendments, including the amendments that raise the issue of over-charging management fees against the Company in paragraphs 88 and 89.

13.  The amendments under attack allege false accounting practice and manipulation of the accounts of the Factories, that the 1^st respondent had converted income or profits or funds of the Factories into alleged loans owed to the 1^st respondent or the Shui Hing group of companies, and that the alleged indebtedness of the Company or the Factories was a sham and fictitious and did not exist.  Had these income or profits or funds been properly booked as income, they would represent valuable assets or resources which would ultimately belong to the Company.  By such manipulation, substantial losses were attributed to the Company through its subsidiaries, in order to support the 1^st respondent’s contention that the petitioner’s shares in the Company are worthless.  These allegations are based on a series of e-mails from accounting staff appointed by the 1^st Respondent to the Factories, Ms Tao Xizhen, Ms Maria Dai, Mr Du Feipeng and from Mr Edmund Lee, the financial controller of USI.

14.  The well-known principles applicable to the amendment of pleadings as stated by Lord Brandon in Ketteman v. Hansel Properties Limited [1987] 1 AC 189 at 212F to H have been applied to a petition presented under section 168A (Re Playmates Investments Limited [1996] 4 HKC 577 at 582F to H).  Amendments should in general be allowed if they are necessary to enable real questions and controversy between the parties to be decided, provided they will not prejudice the other party and if any prejudice can be compensated by an appropriate order as to costs.

The 1^st respondent’s objections at present

15.  In Mr Chong’s submission for this hearing, the main thrust of his argument is that the amendments under attack should be refused because the amendments summarized earlier are unsubstantiated and are bound to fail.

16.  He submitted that the allegations are not borne out by the e-mails relied on by the petitioner.

17.  A total of 6 e-mails were referred to in the draft amendments.  I have read them thoroughly and the documents attached.  The petitioner has sought to summarize the contents of these e-mails in the amendments.  There is no need to set them out.

18.  Mr Chong has made his own analysis of these e-mails in his submissions.  I do not propose to set out his analysis in detail.  In short, he submitted that the concern raised in the e-mails related only to the accounting treatment of the accounts of the Factories filed for the purpose of tax in the PRC, there was no suggestion that the monies of the Factories (as opposed to accounting treatment) had been misplaced,  and there was no concern raised as to the audited accounts of the Company in Hong Kong, so the petitioner’s allegation that the 1^st respondent had converted income of the Factories into loans owed to the 1^st respondent or the Shui Hing group of companies cannot be substantiated.

19.  It is not in dispute that for the purpose of the present application, unless I am satisfied the petitioner’s allegations and inferences on the e-mails, as summarized in paragraph 87 of the draft amendments, are obviously unsustainable, I should give leave to amend.

20.  I have little difficulty in coming to the view that the submission of Mr Chong must be rejected.  The meaning of the contents of the e-mails is nowhere as clear as he has contended.  Nowhere was it expressly stated that the income of the Factories was booked in the Hong Kong accounts.  As submitted by the petitioner’s counsel, Mr Kenneth Lee, it is necessary to read the e-mails as a whole against the relevant background for a reasonable inference to be drawn.  None of the accounting staff who sent the e-mails – Ms Tao, Ms Dai and Mr Du – had made affirmations in the rounds of evidence filed by the 1^st respondent.  The 1^st respondent’s response to the inferences drawn by the petitioner from these e-mails was one of non-admission (see the 3^rd affirmation of Simon Lum, paragraph 29).

21.  I reject also the contention that issues of false accounting raised as regards the Factories would have no bearing on the accounts of the Company.  It was stated in the 3^rd affirmation of Simon Lum at paragraphs 6 and 7 it was a long-established practice that in analysing the Company’s financial performance, the accounts of its wholly-owned subsidiaries and factories of such subsidiaries would necessarily be taken into account on a consolidated basis, and that the true financial condition of the Company and its subsidiaries should be ascertained by examining the accounts of the Company together with its subsidiaries and the factories of such subsidiaries.

22.  Leave should be given to the petitioner to amend the petition to raise the issue properly so that the real controversy between the parties may be determined in this petition.

23.  It may be that ultimately the analysis put forward by Mr Chong at the present hearing could be ruled at the trial to be the correct interpretation of the e-mails.  But the present application is not the appropriate occasion for a definite ruling to be made.

If the allegations relate to the affairs of the Company

24.  I turn to the other ground of opposition raised by the 1^st respondent, namely that the affairs of the Factories should not be regarded as the affairs of the Company under section 168A.  As stated by Powell J in In Re Dernacourt Investments Pty Limited (1990) 2 ACSR 553 at 556, para. 8:

“The words ‘affairs of a company’ are extremely wide and should be construed liberally:

(a) in determining the ambit of the ‘affairs’ of a parent company for the purposes of section 320 [of the Companies (NSW) Code, equivalent to our section 168A], the court looks at the business realities of a situation and does not confine them to a narrow legalistic view;

(b) ‘affairs’ of a company encompass all matters which may come before its board for consideration;

(c) conduct of the ‘affairs’ of a parent company includes refraining from procuring a subsidiary to do something or condoning by inaction an act of a subsidiary, particularly when the directors of the parent and the subsidiary are the same: he referred to Scottish Co-operative Wholesale Society Limited v. Meyer [1959] AC 324 at 342, 343, 361, 363, 367; Re Norvabron Pty Limited (No. 2) (1986) 11 ACLR 279 at 292; Re Cumberland Holdings Limited (1976) 1 ACLR 361 at 374, 375, 376.”

25.  The English Court of Appeal has cited the above dicta with approval in Re Citybranch Group Limited [2005] 1 WLR 3505 at 3513F to H, para. 29.

26.  The way in which the affairs of a subsidiary are conducted can constitute unfairly prejudicial conduct in respect to the parent company’s affairs (Re Citybranch Group Limited, supra, paras. 21 to 33; In re Norvabron Pty Limited, supra, at 292; In re Dernacourt Investments Pty Limited, supra, at 561; and Waddington Limited v. Chan Chun Hoo Thomas and Others, FACV No. 15 of 2007, 8 September 2008, para. 77, per Lord Millett NPJ).  The requisite element of de facto control by one company over the affairs of another company would normally be satisfied in the situation of a parent and subsidiary, via the control of the composition of the board of directors, or by the control of the voting power exercisable by the shareholders.

27.  Looking at the business realities of the present situation, for the purpose of this application, I am satisfied it is arguable that the affairs of the Company would include the business of the Factories and that justice and commonsense would require the court to look at the economic entity of the entire group instead of focusing on the separate legal entities of various companies.

Order

28.  I give leave to amend as per the draft annexed to the summons.  The petitioner is to file an amended petition within 7 days hereof.  Service of the amended petition is dispensed with.  I would also dispense with a verifying affirmation for the amended petition, as the petitioner has already filed affirmations dealing with the amendments.

29.  The parties are to seek directions by letter as regards the petitioner’s summons for specific discovery within 7 days hereof.

30.  The petitioner seeks an order that the costs of and incidental to this application be to the 1^st respondent in any event, save for the costs of this hearing.

31.  For the costs of this hearing, the petitioner asks for an order that the costs are to be paid forthwith by the 1^st respondent and on an indemnity basis.  This is on the basis that the grounds of objection of the 1^st respondent are wholly without merit, that the grounds of opposition indicated at the earlier hearing in November 2008 were largely abandoned, that much of the evidence the 1^st respondent indicated to the petitioner it would refer to in this application was not relied on, and that the 1^st respondent’s actual grounds of objection only became apparent when the submission of counsel was received 3 days before the hearing.  This has led to a huge amount of wastage of time and costs for the petitioner.

32.  I am persuaded the circumstances here are appropriate to depart from an order that the costs of today’s hearing be awarded to the 1^st respondent in any event.  I decline to award indemnity costs but will order costs to be paid forthwith.

33.  The order of costs that I make is as follows.  The costs of and incidental to this application be to the 1^st respondent in any event, save for the costs of this hearing, which are to be paid by the 1^st respondent to the petitioner forthwith, assessed on a gross sum basis at $105,000.