CHOI CHI WAI v. HONG KONG AGRICULTURAL SPECIAL ZONE LTD AND OTHERS

HCA 126/2013

IN THE HIGH COURT OF THE

HONG KONG SPECIAL ADMINISTRATIVE REGION

COURT OF FIRST INSTANCE

HIGH COURT ACTION NO. 126 OF 2013

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D E C I S I O N

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1. The plaintiff (“Choi”), the 2^nd defendant (“Cheng”) and the 3^rd defendant (“Lee”) are shareholders of the 1^st defendant (“the Company”). Since 2012, Choi has commenced legal proceedings against the Company, Cheng and Lee. The present action was commenced in January 2013, which comprises a derivative claim for the benefit of the Company and a personal claim against Cheng and Lee. By summons dated 21 January 2013, Choi applies for interlocutory injunction against Cheng and Lee (“the Summons”).

BACKGROUND

2. Choi, Cheng and Lee have background in farming.  Cheng was and still is a pig farmer and a pig auction house operator in Shao Guan, the Mainland, as well as a farming consultant to the Shao Guan Government.  Lee has been a local chicken and pig farmer for many years.  Until 2005, Lee and Choi together with another person operated a chicken farm in Shao Guan.

3. In February 2006, the parties founded the Hong Kong Agricultural Special Zone Development Association (“the Association”) with the object of promoting interest of local farmers in Shao Guan.  Amongst other members, Cheng was the Chairman while Choi and Lee were the Vice-chairmen.

4. In June 2006, the Company was incorporated.  The share capital was HK$10,000 divided into 10,000 shares at HK$1 each.  5,400 shares were issued to the parties with each having 1,800 shares.

5. In August 2007, the China Chamber of Commerce of Foodstuffs and Native Produce issued an invitation to tender for a franchise to import live pigs from the Mainland to Hong Kong.  By then, the 2 existing franchisees, namely Wu Fung Hong (五豐行) and Guang Nan Hong (廣南行), have been the veterans in the field.

6. The Company resolved to tender for the franchise.  For such purpose the parties sought to enhance its chance by resolving to increase the authorised capital of the Company from HK$10,000 to HK$50,000,000.

7. The Company successfully bid for the franchise, which was awarded to it in October 2007.  The Company became the new addition to the authorised importers of live pigs from the Mainland to Hong Kong.

8. Dispute between Choi of one part and Cheng and Lee of the other then arose.  The 2 camps accused each other of dictating the management of the business to the exclusion of the other.  Litigation eventually began.

9. In 2011, Choi, as a shareholder, applied for and succeeded in obtaining an order for inspection of the documents of the Company (HCA 53/2011)[1].  In April 2012, Choi petitioned to the Companies Court against Cheng and Lee on the ground of unfair prejudice, seeking to buy them out or alternatively to be bought out by them (“HCMP 729/2012”).  This was followed by Cheng and Lee causing the Company to commence proceedings in August 2012 against Choi for breach of fiduciary duty and, among others, an account of the business receipts allegedly misappropriated from the Company (“HCA 1441/2012”).  The present action was commenced in January 2013.

CHOI’S CASE

10. Choi’s case is that the Company started as a quasi-partnership founded on mutual trust and confidence among the shareholders.  For the purpose of the tender for the live pig import franchise, the authorised capital of the Company was increased by the creation of 49,990,000 shares of HK$1 each, ranking for dividends and in all respects pari passu with the existing shares.  Each of them was indeed allotted 16,666,667 shares.

11. According to Choi, this was pursuant to the shareholders’ agreement in December 2007 whereby the parties were entitled to apply and to pay for the allotment of the new shares in the Company in the same ratio as before (“the Capitalisation Agreement”).

12. However, Cheng and Lee are said to have refused to proceed with the allotment or to accept Choi’s payment for the new shares.  As a result, the Company ran the risk of financially incapable of meeting its obligation in paying the suppliers of live pigs.  To cope, Cheng and Lee resorted to high interest loans on behalf of the Company both from third party in 2008 and Lee in 2010.

13. Choi was removed from the board in March 2008.  According to him, he was unfairly excluded.

14. The actions in 2011 and 2012 mentioned above were respectively commenced.

15. In the present action, Choi contends that Cheng and Lee were in breach of their fiduciary duties as directors owed to the Company.  For that, Choi commenced the present action as a derivative action against them for the benefit of the Company.  Choi also holds Cheng and Lee personally liable to him for the breach of the Capitalisation Agreement.

16. According to the pleading, Choi seeks the following relief:

(1) a mandatory injunction that Cheng and Lee shall cause the Company to accept his payment for the newly allotted shares;

(2) an injunction restraining the Company, whether by its directors, officers, agents or otherwise howsoever from borrowing from themselves or externally monies which carry interest for the purpose of carrying out the day-to-day operation;

(3) interlocutory relief under O.29 of the Rules of the High Court;

(4) damages payable to the Company for breach of fiduciary duties;

(5) costs.

THE DEFENDANTS’ CASE

17. The Company, which is separately represented, put forward one contention in defence, namely, that none of the shareholders has been called upon to pay for the newly allotted shares.  Having pleaded that, the Company expressed its willingness to be bound by any order made by the court.

18. As to Cheng and Lee, they contend that after the grant of the franchise, Choi refused to communicate with them and ran the Company as if it were his own business.  With the seal and other documents of the Company in his possession, Choi was able to seize and dictate the management of the Company.  Choi was said to have represented to the outside world that he was the person in charge; and have entered into numerous contracts on behalf of the Company.

19. In particular, in breach of his fiduciary duty to the Company, Choi has wrongfully directed the auction house to transfer the net proceeds of sale of the pigs to the personal bank accounts of his or his wife’s[2]. Since the end of November 2007, Choi had run the Company to the exclusion of Cheng and Lee.

20. Cheng and Lee deny the existence of the Capitalisation Agreement.  According to them, it was not a requirement for the purpose of obtaining and subsequently operating the franchise business that the Company had to maintain a threshold capital reserve. Indeed they resolved to authorise the allotment of the new shares in December 2007.  But they did so on the condition that Choi would surrender his control over the management of the Company and open separate bank accounts for the Company.  Choi did not do so.

21. Further, they contend that the shareholders were supposed to hold the shares subject to the constitutions of the Company, pursuant to which the obligation to pay for the shares would arise only if they were called upon to do so by the board of directors.  As mentioned, it was also the stance of the Company that the board has never made such call on shares.

22. As to Choi’s attempt to pay for the newly allotted shares, this first happened in January 2008 when he asked the professional accountant of the Company to accept his HK$3.5 million as his loan to the Company subject to Cheng and Lee doing the same, purportedly pursuant to the board’s resolution in December 2007.  But the board minutes disclosed in support was inaccurate and signed by Choi and a Mr Wong only.  That Mr Wong was proposed by Choi to be appointed as an additional director of the Company but was already rejected by Cheng and Lee during the meeting.  There was, Cheng and Lee say, no authorisation by the board of such loan by shareholder or director.

23. It was in March 2008 when Cheng and Lee as the majority resolved to remove Choi from the board.  This, according to Choi, was an act of exclusion of him from the management of the Company mentioned above.  But Choi, according to Cheng and Lee, managed to continue the conduct of the business until the monthly import permit of pigs expired at the end of April 2008.  Hence the timing at which Cheng and Lee are said to have resumed participation in the management of the Company.

24. However, unbeknown to Cheng and Lee, Choi had somehow registered a branch business in the name of the Company at the address of Choi’s own farm in Yuen Long, New Territories shortly after his removal from the board.  Cheng and Lee discovered that and informed the Business Registration Office of the unauthorised registration.  It was upon their complaint to the Business Registration Office that the registration was eventually cancelled in October 2008.

25. Cheng and Lee contend that the Company has so far managed financially and was a healthy and profitable going concern.  As to the borrowing by the Company, Cheng and Lee admitted obtaining payment guarantees from the committee members of the Association in favour of the suppliers from May 2008 and April 2009 with interest at the annual rate of 58% (though Choi admitted that on record, the borrowing had stopped).  They explained that no expenses had been incurred as a result.

26. As to the loan by Lee to the Company in 2010, it was said to be the result of Choi’s wrongdoing.  Choi was said to have misrepresented to one of the major suppliers of the Company about its serious lack of operating business funds, and thus causing the supplier to demand payment guarantee by way of cash instead of letter of credit as always.  In the circumstances, the Company eventually resolved to approve a loan from Lee at interest to the Company to cover that in March 2010.

OVERLAPPING ACTIONS

27. Mr Mak, appearing for Cheng and Lee, criticised the claim by Choi in the present action as an abuse of process on the ground that the complaint here already forms part of the basis for his case of unfair prejudice in his petition for relief under section 168A of the Companies Ordinance, Cap 32 in HCMP 729/2012.

28. Choi’s complaint is about breach of duties of the board of directors, particularly in their exercise of the power in respect of financing the business operation of the Company.  This is by nature alleged mismanagement of the Company.  It is the Company which has the locus to pursue the complaint against the directors.

29. According to the Points of Claim in HCMP 729/2012, Choi is indeed seeking the court’s authorisation of the Company to commence action against Cheng and Lee for the loss and damage as a result of their conduct as directors under complaint.  Choi is also seeking, among other relief, an account of profits obtained by Cheng and Lee as a result of their conduct under complaint.

30. As far as the complaint is said to constitute breach of the concurrent shareholders’ agreements and thus wrong done by Cheng and Lee to Choi as parties to the agreements, the loss will primarily be that of Choi’s interest in the Company in the form of his share of the profit (dividend), value of his shareholdings and any personal gain of Cheng and Lee (at the expense of the Company).  This should be taken care of in the valuation of the shares of the Company in the buy-out to be decided in HCMP 729/2012.

31. As far as Choi is concerned about ensuring that the Company continues to operate properly in the interim, which may be said to be for the benefit of the Company, he is indeed also seeking in HCMP 729/2012 all such interim directions for the proper and effective management of the Company, including specifically direction that the Company should properly substantiate its share capital.  In substance, they are no different from the relief being claimed in the present action.

32. Notwithstanding the above, Choi commenced the present action against Cheng and Lee for loss and damage allegedly done to the Company by way of derivative action; and for measures, interim and final, for the management of the Company, including the substantiation of its share capital.  This, Mr Mak submitted, calls for justification.

33. The justification, according to the pleading (§18 of the statement of claim), is this: HCMP 729/2012 serves the purpose of enabling Choi to seek relief against Cheng and Lee for unfair prejudice whereas the present action serves the primary purpose of enhancing the interest of the Company.  In view of the above discussion, I wonder if the distinction is real.

34. In my view, Mr Mak’s criticism of the present action being an abuse of process is not without reason.  Mr Mak mentioned striking out; yet no such application is before me.  Nevertheless, the above background remains relevant to my consideration of the present application.

THE APPLICATION

35. In the summons, Choi applies for interim injunctive relief  in the following terms:

(1) Cheng and Lee, as the directors of the Company, be enjoined to cause the Company to accept Choi’s payment of HK$5 million being the price for 5 million shares allotted to him by the Company in 2007 (“Injunction (1)”);

(2) Further or in the alternative, Cheng and Lee, their officers or agents otherwise howsoever, be restrained from borrowing on behalf of the Company any monies which is interest-bearing, save the existing mortgage loan in respect of the purchase of the office premises of the Company (“Injunction (2)”).

36. Though more specifically worded, Injunction (1) and Injunction (2) are similar in terms to the final relief claimed in the action.

37. Mr Yau, appearing with Mr Chan, for Choi clarified that Injunction (2) would serve as his client’s fallback, in the event that he fails in obtaining Injunction (1).  His stance effectively is that the Company may borrow only if it accepts his payment for his shares.

38. For the time being, Cheng and Lee have given their own undertaking not to borrow on behalf of the Company for its daily operation, which carries interest, save and except (i) the existing mortgage loan in respect of the Company’s office premises; and (ii) the Company’s existing bank overdraft facility capped at HK$2,000,000.  The undertaking will last until the disposal of the present application.

39. As to the evidence, I note that the defendants have not filed any affirmations, and apparently consciously.  Reference was made to the comment by DHCJ Ng during the call-over of Choi’s summons about the relevance of the pleadings and affirmations filed in other sets of proceedings.  Cheng and Lee have now provided copies of those pleadings and affirmations.

40. Strictly a party intending to rely on any court documents or affidavits filed in other actions should nevertheless depose to such intention by affidavit in the action in question and thereby rendering those previous documents proper evidence in the action.  The learned Deputy Judge’s directions reflected that.  Cheng and Lee did not do so.  But Mr Yau indicated he had no objection in this respect.

PRINCIPLES

41. The principles for application for interlocutory injunction are not in dispute.  The claim must raise a serious question to be tried; and that damages will not provide an adequate remedy, if the plaintiff succeeds eventually.  The balance of convenience must also lie in favour of granting the interim injunction before an order will be made.

42. For an application effectively for final and mandatory relief, the court will not exercise its discretion to grant the interim relief unless it feels a high degree of assurance that at trial, it would be shown that the injunction was rightly granted.  It remains a question of balancing the risk of injustice to the parties as a result of the grant and the withholding of such interim relief: see Music Advance Limited v Incorporated Owners of Argyle Centre Phase I [2010] 2 HKLRD 1041; Sunlink International Holdings Ltd v Wong Shu Wing [2010] 5 HKLRD 653.

DISCUSSION

The derivative action

43. In line with his criticism of the derivative action discussed above, Mr Mak submitted that the same, which is liable to be struck out, could not give rise to a serious question to be tried.

44. As a matter of substance, Mr Yau first argued by reference to what was said to be nature of the shares newly allotted.  He argued that the shares newly allotted were expected to be paid for, relying on the allotment of the shares pari passu with the existing shares.  The 5,400 shares in the hands of the 3 shareholders so far were all paid up.

45. Mr Mak argued that that the shares rank pari passu with the existing shares only refers to the rights attached to the shares (such as voting and dividend) instead of connoting the alleged condition of immediate payment of the consideration for the shares.  The shares are under the control of the directors who may at such times as they think fit give any person the call on any shares (art 3 of the articles of association).  As far as the nature of the newly allotted shares is concerned, I tend to agree with Mr Mak.

46. Further, that Cheng and Lee resorted to loans instead of substantiating the share capital was the exercise of their power as directors conferred by the Company’s constitution (art 21 of the articles of association).  In the absence of allegation of ultra vires or mala fide or fraud, such management decision of the directors would not fall within the exception to the rule in Foss v Harbottle.  This also sounds right to me.

47. Mr Mak also took pleading points, including that it has not been explicitly pleaded that Cheng and Lee actually prevented an action from being brought in the name of the Company so as to justify his bringing the action for its benefit.  That Cheng and Lee, as the majority in the Company, are his opponents does not per se answer the need of pleading.  There is authority in support: Lau William John v Wan Yuk Lin, HCA 1255/2006 (28 July 2008) (at §§19; 26).

The personal claim by Choi

48. There is then the claim on the basis of the Capitalisation Agreement against Cheng and Lee personally as the contracting parties.  Mr Mak doubted the existence of a concluded agreement by reference to the documentary evidence, including:

(1) the applications for the allotment whereby the shareholders agreed to hold the shares when allotted subject to the constitution of the Company (hence subject to call under art 3 of the articles of association mentioned above); and

(2) the minutes of the meetings on 20 December 2007 and 30 December 2007 (both not signed by Cheng or Lee) which still recorded proposal and discussion in relation to payment for the shares; and

(3) the letter from Choi’s solicitors in January 2008 recapitulating the alleged resolution to pay for 7% of the shares of the Company at HK$3.5 million.

49. Mr Mak submitted that the above documents tend to show that even after the increase in share capital and allotment, the parties still in the process of discussing the payment for the shares.  He submitted there was no concluded agreement.

Serious question to be tried

50. Mr Yau accepted that in the case of call capital, it would indeed be for the directors to decide whether and when to make the call on shareholders.  As to the Capitalisation Agreement, Mr Yau accepted that whether this existed, as Choi alleges, and whether the agreement in respect of allotment of the additional shares were subject to conditions precedent, as Cheng and Lee allege, are triable factual dispute.

51. For the present purpose, I am prepared to consider that the above dispute gives rise to serious questions to be tried.  I go no further than that.

Justification for interim injunction

52. On the above basis, I proceed to consider whether the interim injunction sought could be justified.

53. Mr Yau sought to justify the interim injunction on the following grounds:

(1) The Company would need to live up to its promise in its tender for the franchise in respect of its capital strength.  This was likewise the agreement between the shareholders.  Otherwise the Company would fail to function properly; and there would be the risk of losing the franchise.

(2) In that event, the loss of the Company and Choi as a shareholder would not be adequately compensated by way of damages.

(3) Loss of the franchise would also affect the public interest in that there would be one less importing agent of live pigs.

54. As far as it was argued that the Company has failed to live up to the promise or representation made to the franchiser in respect of the capital of the Company, I am not impressed that that is correct as a matter of fact.

55. The terms of the invitation for tender were contained in the announcement dated 31 August 2007.  Section 1 of the announcement set out the requirements of the bidder, which appeared in broad terms.  As to the capital, the bidder was required to possess certain capital ability and strong operation ability (“具備一定的資金實力和較强的經營能力”).  As I read it, the requirement as to capital strength was not specific, whether as to the form of the capital strength or how the same was expected to be maintained.

56. The Company’s tender document submitted in September 2009 stated that the registered capital of the Company was HK$50 million.  It was also said that upon successful tender, the Company would have over 80 members subscribing to its shares giving rise to capital of over HK$80 million.  Assuming that the Company managed to successfully bid for the franchise partly because of the above representation in the tender document, I see no falsity in that about the registered capital of the Company.  Whether the capital was fully paid up was neither here nor there, if one refers to the terms of the invitation for tender and the representation in the tender submitted by the Company.

57. Interestingly what may not sound true is the other representation that some 80 members would subscribe to the shares of the Company in the amount of HK$80 million.  The Company apparently resolved to bid in its own name for the franchise, knowing that the Association was not minded to do so.  The basis for such representation in the tender is unclear; but that is not material to the present determination.

58. Mr Yau submitted that the Company could not function properly without funding by way of capital contribution in accordance with the share allotment.  But the evidence does not suggest that the Company has not been functioning in terms of transacting business and importation of pigs.  One should not lose sight of the fact that the Company has been operating under the franchise for the past 5 years.

59. As to how the operation was financed, the evidence shows that the Company has been relying on substantial loans.  That, according to Choi, did not inspire public confidence as opposed to shareholders’ payment for the shares allotted.  But Choi has not produced actual evidence of how the third parties, including the franchiser, view, if any of them actually knows such internal management, that the Company’s working capital substantially came from credit facilities instead of paid up capital of shareholders.  More importantly, there is no evidence suggesting the alleged risk of the franchiser forfeiting or terminating the franchise as a result of the financial arrangement of the Company.

60. To address the concern to enable the Company financially to keep operating, Mr Mak submitted that any extra fund could have been injected by way of shareholder’s loan.  Unlike Injunction (1), this alternative, as an interim measure, would not have the practical effect of violating the constitution of the Company or usurping the management of the Company at this stage, while the trial of the dispute is still pending.  As I understand from the correspondence between the parties and submission in court, the defendants had no problem with that, provided no strings attached.  At the end of the day, the cost and expense of borrowing, if they turn out to be unjustified and avoidable, would be recoverable by the Company.

61. Following the above discussion, the projected risk of loss of the franchise altogether and hence substantial unquantifiable loss has not been established to be real. What remains of Choi’s loss will be that as a shareholder.  As mentioned, this will be reflected by proper valuation of the shares in the order to buy-out in HCMP 729/2012, if these complaints are established as unfair prejudice for the purpose of that action.  Judging from the other relief sought in that action, I am not impressed that damages (or the like) will be inadequate remedy.

62. As to the public interest argument, this hinges upon the projected risk of termination or forfeiture of the franchise as an importer of live pigs in Hong Kong.  The above discussion refers.  In view of the existence of 2 other relatively longer-standing franchised importers, the projection of the impact of the Company dropping out of the field on the supply of live pigs in Hong Kong sounds like an assumption without regard to the other variables such as measures that may be taken by the exporter and the other franchised importers in such event.

Conclusion

63. In the circumstances, I am not satisfied that discretion ought to be exercised in favour of granting Injunction (1).  I am not granting Injunction (2) either, which would inevitably have deprived the directors of their management power to borrow on behalf of the Company in accordance with its constitution.

ORDER

64. The application is dismissed with costs to Cheng and Lee, to be taxed, if not agreed, with certificate for counsel.  The costs order is nisi; and shall become absolute in the absence of application within 14 days to vary.