YU YUCHUAN AND OTHERS v. CHINA SHANSHUI INVESTMENT CO LTD

HCMP 360/2015

IN THE HIGH COURT OF THE

HONG KONG SPECIAL ADMINISTRATIVE REGION

COURT OF FIRST INSTANCE

MISCELLANEOUS PROCEEDINGS NO 360 OF 2015

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REASONS FOR DECISION
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Introduction

1. I have before me an application issued by the Applicants, who together hold 17.44% of the issued shares of China Shanshui Investment Co. Ltd. (“Shanshui Investment”), pursuant to sections 732 and 733 of the Companies Ordinance (Cap. 622), for leave to bring and continue unfair prejudice proceedings in the name of China Shanshui Investment Co. Ltd. against:-

(1) China Shanshui Cement Group Ltd (“Shanshui Cement”);

(2) Zhang Caikui (“Zhang Sr”);

(3) Zhang Bin (“Zhang Jr”, the son of Zhang Sr); and

(4) China National Building Material Co Ltd (“CNBM”).

2. Zhang Sr and Zhang Jr are directors and the former an indirect shareholder of both Shanshui Investment and Shanshui Cement.  CNBM acquired in October of 2014 a 20% interest in Shanshui Cement pursuant to a subscription agreement which is one of the unfairly prejudicial matters of which the Applicants complain. 

3. If the present application is successful, the Applicants intend to make an application in the unfair prejudice proceedings for an urgent interlocutory injunction to restrain Shanshui Cement from allotting shares pursuant to a share options scheme as described in its announcement dated 27 January 2015, including the convening or holding of any extraordinary general meeting for the purpose of considering and approving the grant of share options to Zhang Sr and Zhang Jr.  From the evidence filed by Shanshui Investment, it transpires that Shanshui Cement on 27 February 2015 gave notice for the extraordinary general meeting to be held on 20 March 2015.

4. At the hearing before me the Applicants were represented by Victor Joffe and M C Law and the Respondents by Linda Chan SC and Janet Ho.

5. Before turning to consider the application in detail I address the applicable principles by reference to which applications of this sort are to be determined.

Relevant Legal Principles

6. Sections 732 and 733 of the Companies Ordinance (Cap. 622) provide as follows:

“732. Member of company or of associated company may bring or intervene in proceedings:

(1) If misconduct is committed against a company, a member of the company or of an associated company of the company may, with the leave of the Court granted under section 733, bring proceedings in respect of the misconduct before the court on behalf of the company.

(2) If, because of misconduct committed against the company, a company fails to bring proceedings in respect of any matter, a member of the company or of an associated company of the company may, with the leave of the Court granted under section 733, bring proceedings in respect of the matter before the court on behalf of the company.

(3) …

(4) The cause of action in relation to the proceedings under subsection (1) or (2) is vested in the company. Any of those proceedings must be brought in the name of, and the relief (if any) must be sought on behalf of, the company.

733. Leave of Court to bring or intervene in proceedings

(1) On application by a member of a company or of an associated company of a company, the Court may grant leave for the purposes of section 732(1), (2) or (3) if it is satisfied that –

(a) on the face of the application, it appears to be in the company’s interests that leave be granted to the member;

(b) in the case of:-

(i) an application for leave to bring proceedings under section 732(1) or (2), there is a serious question to be tried and the company has not itself brought the proceedings; or

(ii) …; and

(c) except where leave is granted by the Court under subsection (5), the member has served a written notice on the company in accordance with subsection (3), and the notice complies with subsection (4).

(2) The Court may refuse to grant leave if it is satisfied that –

(a) in the case of an application for leave to bring proceedings under section 732(1) or (2), the member has, in the exercise of any common law right, brought proceedings on behalf of the company in respect of the same cause or matter; or

(b) in the case of an application for leave to intervene in proceedings under section 732(3), …

(3) The written notice must be served on the company, at least 14 days before the member applies for leave in respect of the company –

(a) in the case of a company as defined by section 2(1), by leaving the notice, or by sending the notice by post to, its registered office; or

(b) in the case of a non-Hong Kong company, in a manner that the notice is sufficiently served on the company by virtue of section 803.

(4) The written notice must state –

(a) the member’s intention to apply for leave for the purposes of section 732(1), (2) or (3) in respect of the company; and

(b) the reasons for that intention.

(5) The Court may grant leave to dispense with the service of a written notice for the purposes of subsection 1(c).”

7. In determining whether or not to grant leave under section 733, the principal matters that the court is concerned with are:

(1) whether the proposed action appears to be in the interests of the company; and

(2) whether there is a serious question to be tried[1].

8. The threshold in respect of both these criteria is low.  As Lord Millett notes at paragraph 55 of his judgment in Waddington Ltd v Chan Chun Hoo [2] “in applying for leave the plaintiff is not required to establish a prima facie case but only that there is a serious question to be tried.”  Consistent with this in assessing applications for leave the prospects of success are to be investigated only to a limited extent; and the court should be slow to find against the applicant unless his prospects are so slim that he cannot be said to have any expectation of success[3].  At this stage it is not the court’s function to try to resolve conflicts of evidence or difficult questions of law, which require substantial argument and deliberation.  In practice, if the applicant is able to produce a draft pleading that sets out a case with some prospect of success when only the allegations contained in the pleading are considered, the criteria will be satisfied unless the respondent can demonstrate fairly readily that there is a serious flaw in the claim and that it has no real substance[4].  In most cases, if a “serious question to be tried” has been demonstrated, it is likely to appear to be in the company’s interests to bring proceedings.[5] 

9. The purpose of the notice under section 733(1)(c) is to allow the company to consider whether to contest or acquiesce to the application.  Leave to dispense with the section 733(1)(c) notice can be sought at the same time as the application for leave where the matter is urgent.  In the present case, a letter dated 18 February 2015 was issued to Shanshui Investment, inviting it to consider whether to contest or acquiesce. Shanshui Investment opposes the application.

Background

10. Shanshui Investment is a company incorporated in Hong Kong, with an issued share capital of HK$10,000 divided into 1,000,000 of HK$0.01 each.  As I have mentioned the Applicants are minority shareholders of Shanshui Investment, holding 17.44% of its issued shares.

11. Mr. Zhang Sr is the registered holder of 81.74% of Shanshui Investment’s issued shares. The Applicants say that of those shares 61.77% were at all material times, and are still, held by Zhang Sr on trust for the employees of the operating companies of which Shanshui Cement became the holding company following its listing (“Contributing Employees”).  How Zhang Sr has dealt with the shares the Contributing Employees say he holds on trust for them is the subject of other actions in which they seek a declaration that Zhang Sr and Li Yan Min hold those shares on constructive trust for them (“Trust Actions”).  There is a hearing before Mr. Justice G. Lam on 31 March 2015 on Zhang Sr’s application for leave to set aside the service of the Writ and the Contributing Employees’ application for interlocutory injunctions, directing Zhang Sr to attend an EGM of Shanshui Investment for the purpose of appointment of additional directors to the board of Shanshui Investment.  At present, the board of Shanshui Investment consists of 3 directors, namely, Zhang Sr, Zhang Jr and the 1^st Applicant.

12. Shanshui Cement is a company incorporated in the Cayman Islands, with its shares listed in the Hong Kong Stock Exchange (“HKSE”), with stock code 691.  Zhang Sr and Zhang Jr are both executive directors of Shanshui Cement, of which as I understand the evidence, Zhang Sr was the promoter, Shanshui Cement having its origins in the cement business that he created.  The Applicants say that the boards of Shanshui Investment and Shanshui Cement are controlled by Zhang Sr and Zhang Jr.

13. Until 3 November 2014, Shanshui Investment held 847,908,316 shares in Shanshui Cement, representing about 30.11% of the then issued share capital of the latter. 

14. Shanshui Investment makes three complaints about the conduct of Shanshui Cement’s affairs.  The first concerns the approval of a new general mandate at Shanshui Cement’s annual general meeting on 16 May 2014.  The second concerns the subscription agreement with CNBMmade on 27 October 2014.  The third concerns the implementation of a share option scheme.

The General Mandate

15. On 10 April 2014, Shanshui Cement issued a notice of its annual general meeting (“AGM”) to be held on 16 May 2014, setting out the resolutions to be proposed at the AGM, including the granting of a general and unconditional mandate to the board of Shanshui Cement to issue shares (“Mandate”).  According to Zhang Jr:

(1) On 23 April 2014, a written resolution was passed by the board of Shanshui Investment to authorize him to attend and vote at the AGM and to execute the proxy on behalf of Shanshui Investment.

(2) Shanshui Investment’s staff called the 1^st Applicant on his mobile number to try to tell him about the proposed written board resolution but those attempts were unsuccessful. Further, the 1^st Applicant had already moved out of his residence and did not leave behind any other contact information; thus Zhang Jr was not able to contact him concerning this board resolution.

16. On 16 May 2014, at the AGM of Shanshui Cement, a resolution was passed to grant a general and unconditional mandate (“Mandate”) to the board of Shanshui Cement to issue shares.  It was passed by 959,318,70 votes for, and 651,260,320 against. It is not disputed that the Mandate Resolution was passed by the use of the votes of Shanshui Investment.  The Applicants say that in breach of their fiduciary duties owed to Shanshui Investment, Zhang Sr and Jr caused Shanshui Investment to cast its votes at the AGM in favour of the Mandate Resolution.  In short the Applicants say that it was not in Shanshui Investment’s interests to approve a mandate that gave the board of Shanshui Cement the opportunity to cause additional shares to be allotted diluting Shanshui Investment’s strategic interest in Shanshui Cement.  It is relevant that a general mandate in materially the same terms had been approved at each AGM since the listing.  By reason of the common directorships, Shanshui Cement through Zhang Sr and Zhang Jr was aware, say the Applicants, of this breach of fiduciary duties.

17. The Applicants also suggest that the execution of the proxy was not properly approved by Shanshui Investment because the 1^st Applicant did not receive notice, that Shanshui Cement knew about it (by virtue of the common directorships) and thus the Mandate Resolution is liable to be set aside.  The Applicants say that at common law, notice of a board meeting must be given to every director.  As a general statement of principle, and subject to any qualifications in the articles, this is correct.[6] For example, article 100 in Table A does not require notice to be given to a director who is overseas.  Indeed the position at common law is that notice does not need to be given to a director, who is overseas unless he is easy to reach[7]. The 1^st Applicant questions Zhang Jr’s evidence and says that he had his fax number and he could have sent a text message. The 1^st Applicant’s evidence in respect of service of documents on him is not, however, satisfactory. In his affirmation he also complains that he was not given notice of any board meeting to approve the appointment of Hogan Lovells to represent Shanshui Investment in these proceedings.  Subsequently, in an affirmation of Li Cheung Hung, Shanshui Investment has exhibited documents showing that notice of the board meeting was sent to the fax number the 1^st Applicant says could have been used to contact him in April and May 2014.  The documents also suggest that the fax number was provided in November 2014.  On the basis of the evidence before me, I am of the opinion that it is probable that Shanshui Investment did sufficient to satisfy the requirement to give notice and, if that is not correct, the inadequacy is appropriately treated as an irregularity that does not invalidate the board’s resolution as even if he had been given notice the Zhangs could pass the resolution even if the 1^st Applicant objected.  It also seems difficult to see how in April 2014 it could reasonably be argued that voting in favour of a general mandate that had been approved each year since the listing in substantially the same, conventional, terms was in breach of fiduciary duty rather than a commercial issue over which reasonable business people could disagree.

The Subscription Agreement

18. On 27 October 2014, Shanshui Cement entered into a Subscription Agreement with CNBM, under which CNBM agreed to subscribe for, and Shanshui Cement agreed to allot and issue, 563,190,040 shares (representing approximately 20% of the then existing share capital of Shanshui Cement) at the subscription price of HK$2.77 per share.  This could only be entered into if the Mandate was valid.  The first of the Applicant’s complaints about the Subscription Agreement is that if, as they contend is the case, it was not at the very least it is arguable that the Subscription Agreement is liable to be set aside.  In my view in respect of this issue the Applicants have not established a serious issue to be tried.

19. Second, the Subscription Agreement was not entered into bona fide in the interests of Shanshui Cement but in the interests of Zhang Sr, CNBM and Mr Song Zhiping (“Song”).  This is also unfairly prejudicial to the interests of Shanshui Investment.  As a result of the Subscription Agreement, Shanshui Investment’s shareholding in Shanshui Cement was diluted from 30.11% to 25.09%.  The Applicants say that it is to be inferred from the following matters that Zhang Sr instigated the subscription for his personal reasons rather than genuine commercial ones.

20. As a result of the misconduct on the part of Zhang Sr in dealing with the shares that has given rise to the Trust Actions, the Contributing Employees lodged complaints with the Mainland authorities.  They suggest that being concerned for his personal safety, Zhang Sr approached Mr Song, a Secretary of the Party Committee and the Chairman of CNBM, the latter being a state-owned enterprise, for help.  As a result, Zhang Sr agreed with Song that he would procure Shanshui Cement to issue shares to CNBM to make CNBM the second largest shareholder of Shanshui Cement.  

21. The subscription price of HK$2.77 is much lower than the net asset value of Shanshui Cement of at least HK$4.1 per share and, notwithstanding that the market price of Shanshui Cement’s shares at the Completion Date was about HK$2.77 per share, agreeing to CNBM acquiring a strategic stake at this price excites suspicion as to the motives behind it.

(1) The quantity of shares involved under the Subscription Agreement was very substantial, representing 20% of the then issued share capital of Shanshui Cement and making CNBM the 2^nd largest shareholder of Shanshui Cement.

(2) Should CNBM acquire such substantial quantity of shares on‑market (as opposed to off-market), this would inevitably have driven up the share price in the market such that it would not have been possible for CNBM to acquire the Shanshui Cement shares at the price of HK$2.77 per share.  This is all the more so if CNBM’s intention to acquire a substantial stake in Shanshui Cement was made known to the market, given that CNBM is a state-owned enterprise with substantial financial backing from the Mainland authorities.

(3) For a transaction of such magnitude, the net asset value of the shares of the listed company would be adopted as the starting point.  The net asset value per share calculated using the net asset value in Shanshui Cement’s interim report dated 30 June 2014 exceeds HK$4.10.  The subscription price was at a 32% discount to net asset value.

(5) Further, the fact that the subscription price of HK$2.77 is too low is also reflected in the transactions in the market. On about 1 December 2014 (i.e. within 1 month after the completion of the Subscription Agreement), Asia Cement Corporation (“Asia Cement”) acquired about 252,794,500 shares in Shanshui Cement at the price of HK$3.58 per share so as to become the 2^nd largest shareholder in Shanshui Cement again.

22. One would expect there to be evidence to show the transaction between CNBM and Shanshui Cement was at arms’ length.  There is none.  There is no suggestion that Zhang Jr was involved in the negotiation.

23. Shanshui Cement’s announcement dated 27 October 2014 gives as one of the purported reasons for entering into the Subscription Agreement using the net proceeds from the subscription for the purpose of partial redemption of Shanshui Cement’s US dollar bonds and to replenish the general working capital.  However:

(1) The US dollar bonds are in fact not due for repayment until 25 May 2016 and 27 February 2017 respectively.

(2) Further, as shown in its 2014 interim report, Shanshui Cement as at 30 June 2014 still had cash of about RMB2,154,521,000.

Share Options Scheme

24. By an announcement dated 27 January 2015, Shanshui Cement announced that its board had passed a resolution (“Share Options Resolution”) that options to subscribe for a total of 207,300,000 new shares in Shanshui Cement be offered to Zhang Sr, Zhang Jr, Li Cheung‑hung and other grantees at an exercise price of HK$3.68 per share (“2015 Share Options”).  Insofar as the grant of the share options to Zhang Sr and Zhang Jr is concerned, it is conditional upon the approval of the shareholders as required by Rule 17.04(1) of the Listing Rules and the Share Option Scheme.  The grant of the share options to other grantees does not require any further approval at an extraordinary general meeting.  In a letter dated 13 February 2015 from Shanshui Cement to Wong & Lawyers, it was revealed for the first time that the option to subscribe the 154,700,000 shares was allegedly granted to 136 employees.

Name	No. of shares option offered
1. Zhang Sr	23,600,000 shares
2. Zhang Jr	20,000,000 shares
3. Li	9,000,000 shares
4.Other grantees	154,700,000 shares
Total	207,300,000 shares

25. The Applicants contend that this is unfairly prejudicial to the interests of Shanshui Investment as it would, if the options are all exercised, resultin a further dilution of Shanshui Investment’s shareholding in Shanshui Cement from 25.09% to 23.64%, and it would lose the ability to block any special resolution put to members in general meeting.  The Applicants say that in addition to the matters leading up to the Share Options being granted commencing with the general mandate and then the Subscription Agreement, which themselves excite concern, there are a number of matters which demonstrate that there is a serious question to be tried as to whether the grant of the 2015 Share Options was unfairly prejudicial to the interests of Shanshui Investment.

26. First, the share options were offered pursuant to a share option scheme (“Share Option Scheme”) adopted by Shanshui Cement on 14 June 2008.  Under the Share Option Scheme, the maximum number of shares in respect of which the options may be granted shall not in aggregate exceed 10% of the total number of shares in issue as of the Listing Date (the “Scheme Mandate”).  This amounts to 260,336,000 shares. 

27. From the adoption of the Share Option Scheme in June 2008 until January 2015, Shanshui Cement granted share options only once, on 25 May 2011, for 7,300,000 shares. This was commercially justified – for at that time Shanshui Cement’s profits almost doubled from RMB1,004,917,000 to RMB 2,311,654,000 between 2010 and 2011.  The share options then granted represented 2.8% of the maximum number of shares that may be granted under the Share Option Scheme.  It was unusual, say the Applicants, for Shanshui Cement to grant the 2015 Share Options in the following circumstances:-

(1) According to its annual report for 2013 and the interim report for 2014, the net profits of Shanshui Cement dropped significantly – from RMB 1,074,712,000 to RMB 151,652,000 for the first 6 months of 2014.

(2) Notwithstanding the poor performance in the first 6 months of 2014, Shanshui Cement’s board still resolved to grant options to subscribe for 207,300,000 shares, representing almost 80% of the shares that it could grant under the Shares Option Scheme.  With the very substantial drop in net profits for 2014, the question immediately arises as to why the board saw fit to reward the staff with such a substantial grant of share options – when there was no or very little justification for it to do so.

28. Second, from the evidence filed by Shanshui Investment, it appears highly doubtful whether the genuine purpose of the 2015 Share Options was to reward the employees:- 

(1) According to Zhang Jr, the grant of the 2015 Share Options served a dual purpose:- 

(a) to provide incentives to its employees and its subsidiaries (including the directors) to work with commitment towards enhancing the value of Shanshui Cement; and

(b) to retain and attract high calibre people whose contributions are or may be beneficial to the growth and development of the Group.

(2) Nonetheless, from the list of employees who were granted share options (“List of Employees”) disclosed by Shanshui Investment, it appears that there were employees who had made little contribution and some had already retired from the Shanshui Group.

29. Third, before the grant of the 2015 Share Options, one would expect that the board of Shanshui Cement would discuss the merits of granting the 2015 Share Options.  However, the evidence indicates that there was no such discussion:-

(1) Not only the board, but also the Remuneration Committee, merely passed a “paper resolution” approving the grants.

(2) In both written resolutions, a draft letter to the grantees (“Draft Letter to Grantees”) was said to have been attached to the written resolutions as Appendix 2.  However, the draft letter to grantees was not attached to either of the resolutions of the board or of the Remuneration Committee.  It is not clear if the draft letter to grantees was in fact attached to the draft written resolutions.  If they were not it suggests the board was not giving serious consideration to the operation of the Share Options scheme.

(3) Whilst it is not the Applicants’ case that the board could not pass a paper resolution, the contemporaneous documents record no discussion as to whether the 2015 Share Options ought to be granted, or the merits of the respective candidates, the number of options to be granted or the price at which the options would be exercised.

(4) The independent directors are expected to provide independent judgment and supervision of the management. Nonetheless, on the evidence, it appears that the INEDs are simply rubber-stamping the decision of the management.

30. Fourth, although Shanshui Cement maintains that the grant of the 2015 Share Options was not approved by Zhang Sr or Zhang Jr and was only approved by the INEDs, this claim is not supported by the contemporaneous documents:

(1) The written board resolution approving the grant of the 2015 Share Options was clearly signed by both Zhang Sr and Zhang Jr.

(2) Secondly, from the evidence, it is highly doubtful whether the INEDs are truly independent.  In particular, Hou could not be “independent” for the purpose of Rule 3.13(8) of the Listing Rules.

(a) Hou was the Chairman of the Remuneration Committee and an INED who approved the 2015 Share Options. 

(b) However, Hou was not independent, because he was at all material times and is still a beneficiary of the Zhang Trust and yet no disclosure of that fact was made by Hou.

(c) Hou is thus “financially dependent” on Zhang Sr with the latter being the trustee of the Zhang Trust, which Zhang Sr has alleged is a discretionary trust and Hou’s entitlement under the Zhang Trust subject to Zhang Sr’s discretion as trustee. 

31. On 9 February 2015, the Applicants through their solicitors, Wong & Lawyers, wrote to Shanshui Cement, requesting it to undertake not to issue any shares under the 2015 Share Options or to convene an extraordinary general meeting for that purpose.  However, Shanshui Cement wrote back on 10February 2015 and did not offer any undertakings. Notwithstanding that Shanshui Cement had notice of these proceedings, it proceeded to issue notices on 27 February 2015 for an extraordinary general meeting to be held on 20 March 2015.

32. In the circumstances, the Applicants are concerned that there is a real risk that shares will be issued by Shanshui Cement under the 2015 Share Options and thus the shareholding of Shanshui Investment in Shanshui Cement will be further diluted below 25% unless Shanshui Investment obtains an interlocutory injunction against Shanshui Cement to restrain Shanshui Cement from proceeding with the 2015 Share Options.

Notice

33. As I have already mentioned it was not possible given the time frame for the Applicants to give the required notice under section 733 before issuing these proceedings, but in the circumstances I will order that notice is dispensed with. 

Shanshui Investment’s position

34. Shanshui Investment’s position, effectively that of the Zhangs, can summarised succinctly.  First they suggest that the nature of the complaints are not “misconduct” for the purposes of section 732 and leave cannot properly be granted under Division 4 to commence the proposed unfair prejudice petition.  Secondly, the case set out in the draft petition is narrower than that now articulated in argument and is bound to fail.  The Applicants are limited to the case in the draft Petition and, therefore, the application should be dismissed because it does not establish a serious issue to be tried.  Thirdly, there is no need to pursue the complaints by a statutory derivate action.  They be grafted onto the existing common law derivative action.  I disagree with these first three objections for reasons that I will address at the end of this decision.

35. Fourthly, they say that attempts were made to give the 1^st Applicant notice of the proposed written resolution to approve Zhang Jr representing Shanshui Investment at the annual general meeting on 16 May 2014 and there is nothing in the contention that the proxy was defective and the approval of the general mandate invalid.

36. Fifthly, they say that the agreement with CNBM rather than questionable was clearly in Shanshui Cement’s best interests.  They point out that there is a synergy between their respective businesses.  CNBM is an important company in the building materials industry in the Mainland.  The significant rise in the share price (by close of business on 9 March 2015 the share price had risen 73.6%) indicates a very positive market reaction. The decision by Asia Cement, which has a 20% interest in Shanshui Cement, to increase its shareholding after the price had risen significantly illustrates this.  Ms. Chan took me through Shanshui Cement’s financial statement to demonstrate that given the company’s gearing and the interest on its bonds (8.5%) it was perfectly sensible to raise money through an allotment in order that debt could be retired.

37. I accept that there is force in all these points.  However, I am not at this stage asked to determine the complaints but to decide whether they give rise to a serious issue to be tried and that it is in Shanshui Investment’s interest that the Petition be prosecuted.  As Mr. Joffe emphasised the issue is not whether the deal with CNBM can be justified commercially, the issue is whether or not it was instigated by Zhang Sr for an improper, collateral purpose.  If it was Zhang Sr and Zhang Jr exercised their powers as directors for a purpose other than for which it was granted and the decision is liable to be set aside.  This is clear from the House of Lord’s decision in Howard Smith Ltd v Ampol Petroleum Ltd [8]:

“Thus, and this is not disputed, the issue was clearly intra vires the directors. But, intra vires though the issue may have been, the directors’ power under this article is a fiduciary power: and it remains the case that an exercise of such a power though formally valid, may be attacked on the ground that it was not exercised for the purpose for which it was granted.

…

Further it is correct to say that where the self-interest of the directors is involved, they will not be permitted to assert that their action was bona fide thought to be, or was, in the interest of the company; pleas to this effect have invariably been rejected (e.g. Fraser v. Whalley, 2 Hem. & M. 10 and Hogg v. Cramphorn Ltd. [1967] Ch. 254) – just as trustees who buy trust property are not permitted to assert that they paid a good price.

But it does not follow from this, as the appellants assert, that the absence of any element of self-interest is enough to make an issue valid. Self-interest is only one, though no doubt the commonest, instance of improper motive: and, before one can say that a fiduciary power has been exercised for the purpose for which it was conferred, a wider investigation may have to be made. This is recognised in several well-known statements of the law. Their Lordships quote the clearest which has so often been cited:

“Where the question is one of abuse of powers, the state of mind of those who acted, and the motive on which they acted, are all important, and you may go into the question of what their intention was, collecting from the surrounding circumstances all the materials which genuinely throw light upon that question of the state of mind of the directors so as to show whether they were honestly acting in discharge of their powers in the interests of the company or were acting from some bye-motive, possibly of personal advantage, or for any other reason.” (Hindle v. John Cotton Ltd. (1919) 56 Sc.L.R. 625, 630‑631, per Viscount Finlay.)

…

In their Lordships’ opinion it is necessary to start with a consideration of the power whose exercise is in question, in this case a power to issue shares. Having ascertained, on a fair view, the nature of this power, and having defined as can best be done in the light of modern conditions the, or some, limits within which it may be exercised, it is then necessary for the court, if a particular exercise of it is challenged, to examine the substantial purpose for which it was exercised, and to reach a conclusion whether that purpose was proper or not. In doing so it will necessarily give credit to the bona fide opinion of the directors, if such is found to exist, and will respect their judgment as to matters of management; having done this, the ultimate conclusion has to be as to the side of a fairly broad line on which the case falls.”

38. It seems to me that the Applicants have demonstrated a basis for suggesting that Zhang Sr engineered the agreement with CNBM for his own reasons rather than simply because he thought it was a good commercial deal.  Ms. Chan submitted that even if this were the case the fact was that Zhang Sr and Zhang Jr were two of seven directors and there was no evidence to suggest that the other directors, including the INEDs knew of Zhang Sr’s alleged purpose in introducing CNBM and if they approved the subscription because they thought it was the right commercial decision ignorant of Zhang’s motive the resolution was unimpeachable.  This might be the right conclusion to draw at this preliminary stage if the court had been presented with evidence demonstrating that directors other than the Zhang’s had been involved in the negotiations with CNBM, there were reports and internal memorandum addressing what, it is argued, is a significant strategic commercial transaction and an independent advice from, for example, an investment bank dealing with the share price.  There is nothing of this sort.  On the contrary the board resolved to approve the subscription agreement the day it was signed.  I appreciate that placements can sometimes be agreed very quickly and at the current trading price, but it seems to me that there is a serious question as to whether or not, as Mr. Joffe suggested the court would be invited to infer, the majority of the board simply rubber stamped Zhang Sr’s decision without any genuine independent consideration of its merits.

39. In my view there is a serious question to be tried as to whether the subscription agreement was introduced and approved for impermissible reasons and without it being given proper consideration by the board.

40. The options invite a similar treatment to the subscription agreement.  There is nothing unusual about a listed company having an option scheme for its employees.  However, there is a material difference between the way in which Shanshui Cement proposes to deal with employee options this year and how it has dealt with them historically. There is no written explanation prepared for or by the board explaining why this is the case.  I accept that there is a serious question as to whether or not this departure from previous practice has been instigated by Zhang Sr to dilute Shanshui Investment in order to reduce its ability if its board is reconstituted as a result of the Trust Actions to prevent the necessary members’ resolutions approving further allotments of shares.

41. Normally if a serious question to be tried is established it follows that it is in the company’s interest that proceedings are commenced to correct the complaint.  This case is unusual.  It can reasonably be suggested that this is not clear.  As I have already explained there are sound reasons to argue that the impact of the subscription has been positive on Shanshui Cement and that trying to interfere with the subscription may have a negative impact on the share price and thus the value of Shanshui Investment’s interest in it. 

42. Judging whether or not it is Shanshui Investment’s interest to challenge the subscription is not easy.  On balance I conclude that it is.  The most sensible view to take on the current evidence is that if Zhang Sr has rushed into a deal with CNBM for the reasons the Applicants suspect the deal that has been struck was not optimal. It also tends to follow that Shanshui Cement is not being properly administered and the problem needs to be remedied. 

43. In paragraph 34 I identified a number of technical arguments advanced by Ms. Chan.  The first concerned the meaning of “misconduct” in section 734.  “Misconduct” is defined in section 733 to mean “fraud, negligence, breach of duty, or default in compliance with any Ordinance or rule of law”.  Ms. Chan argued that the authorities establish that if what a shareholder wishes to do is to remedy a breach of duty the correct procedure is to bring a derivative action, the complaint cannot be pursued by an unfair prejudice petition, which is the procedure for remedying mismanagement.  It is correct that if what a shareholder wishes to do is to remedy, for example, a specific breach of fiduciary duty by the directors the correct procedure is a derivative action. The reasons are explained by Millet J, as he then was, in Re Charnley Davies Ltd [9].

“Millett J in Re Charnley Davies Ltd (No 2) concluded that the essence of the petitioners’ complaint was not the unlawfulness of the respondent’s conduct, but its unfairness and its prejudicial disregard of their interest. They wanted to be bought out, not to achieve payment of compensation to the company: “They wanted relief from mismanagement, not a remedy for misconduct” (p.784). Millett J did not question the court’s jurisdictional ability on an unfair prejudice petition to make an order for payment of compensation, or for restitution to be made, to the company. What he did question, and in my respectful opinion rightly so, was the propriety of seeking such an order on an unfair prejudice petition if the essence of the complaint was not of mismanagement of the company but of misconduct by the director. In such a case, a derivative action was, in his view, the appropriate vehicle for relief.”

44. As this passage also makes clear breaches of duty are capable of being matters that establish unfair prejudice. Indeed it is common, as one would expect, for breaches of duty to feature amongst complaints in unfair prejudice petitions as, although in a different context, I discuss in paragraphs 52 and 53 of my judgment in Re Asia Television Limited [10]. As a consequence there is an overlap between the subject matter of the 2 different types of proceedings, as Lord Millet notes in Waddington Ltd v Chan Chun Hoo [11]:

“Unfair prejudice proceedings are concerned to bring mismanagement to an end; derivative actions are concerned to provide a remedy for misconduct: see Re Charnley Davies Ltd (No 2) [1990] BCLC 760; Re Chime Corp Ltd (2004) 7 HKCFAR 546. While the court may have jurisdiction in the strict sense on a petition under s.168A to order payment of compensation to the company, the derivative action is the proper vehicle for obtaining such relief where the plaintiff’s complaint is of misconduct rather than mismanagement: see Re Chime Corp Ltd at p.571.”

45. If a breach of duty is a manifestation of mismanagement that requires remedying by the broad range of solutions available in section 725(1) the appropriate procedure is a petition issued pursuant to Part 14 Division 2 of the Companies Ordinance (Cap. 622). The fact that section 732(1) refers to “misconduct” does not in my view lead to the conclusion that the “proceedings” referred to section 732(1) cannot include an unfair prejudice petition.  ATV is an example of a case in which the Companies Court granted leave to commence derivative proceedings by way of unfair prejudice petition.

46. The second technical objection was that the draft Petition did not advance a complaint against the directors other than the Zhangs.  It is correct that a petitioner can only rely on matters included in his petition on the hearing of that petition.  That is not the stage that we are at and although it is desirable that a draft statement of claim or petition sets out fully the case an applicant wishes leave to pursue I do not think that it follows that if as the application develops it becomes apparent that the case is more appropriately put in a different way an applicant has to amend the draft pleading or forego the right to have leave to pursue a more developed version of his case.

47. The final point arises from the fact that the Applicants have already commenced HCA 2194/2014, which is a common law derivative action brought seeking similar remedies to those referred to in the draft petition.  The material differences are that in the High Court Action in addition to seeking orders setting aside the mandate, the subscription agreement and the allotment of shares, the Applicants also seek damages and equitable compensation.  The latter are not included in the draft petition.  The draft petition seeks in addition an order restraining an extraordinary general meeting approving the grant of the share options until Shanshui Investment is in a position to vote its shares after, I understand it intends, the determination of the application to appoint additional directors.  In addition it contains the normal prayer seeking such other relief as the court considers appropriate.

48. Mr. Joffe explained the reason for applying for leave to commence a statutory derivative action rather than amending the existing proceedings as follows.  The view is now taken that given what has taken place it may be appropriate to seek not just orders remedying specific wrongful acts but orders of a type that are only available under section 725(1), for example, reconstituting the board.  In my view it is preferable that if a derivative action is to be prosecuted that it takes the form of a statutory derivative action, subject to the leave of the court and with the wide discretion given to the Companies Court under section 725(1) in crafting orders to cure unfair prejudice and mismanagement.  As the Court of Final Appeal observed in Waddington [12] it is not desirable that the 2 different regimes remain available.  All the time that they do there is a risk of the present question having to be addressed as recognised by the inclusion of section 733(2)(a) which provides that the court may refuse an application if a shareholder has in the exercise of his common law rights brought proceedings on behalf of the company in respect of the same cause or matter.  Ms. Chan argues that section 733(2)(a) reflects the idea that “[i]n the various situations which may arise where a party seeks to take advantage of the availability of both the statutory and the common law derivative action, the court should exercise its powers, both express and inherent, to prevent the abuse of the court’s process and to ensure that the dispute is resolved fairly and expeditiously without unnecessary procedural complications” [13]. I accept that it would be wrong, self‑evidently so, to allow both a common law derivative action and a statutory derivative action to proceed at the same time.  This can be addressed by requiring the Applicants to undertake to apply for the withdrawal or dismissal of the High Court Action before the order giving leave is perfected.

49. The question of the costs of the application and the derivative action were not addressed at the hearing before me.  I reserve those issues and also give general liberty to apply.