RE ZHUANG PP HOLDINGS LTD

cacv 288/2005

in the high court of the

hong kong special administrative region

court of appeal

civil appeal no. 288 of 2005

(on appeal from HCCW NO. 56 of 2005)

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J U D G M E N T

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Hon Rogers VP:

1.  This was an appeal from a decision of Kwan J given on 5 August 2005.  The matter before the judge was an application taken out by the Company that the winding up proceedings which had been commenced in respect of it should be stayed or adjourned pending the conclusion of a High Court action in which it was the Company seeking relief against the petitioner.  Further, or in the alternative, the Company contended that the petition should be struck out on the ground that it was frivolous, vexatious and/or an abuse of the process of the court.  The judge dismissed the application and the Company appealed seeking an order that the winding up proceedings should be stayed or adjourned pending the conclusion of the High Court action.  At the conclusion of the hearing of this appeal judgment was reserved which we now give.

Background

2.  The judge set out the background to this application commencing at paragraph 4 of her decision.  In 1997 the petitioning bank had granted a five-year loan of $235 million (“the loan”) to East Champion Limited (“East Champion”).  East Champion was a subsidiary of the Company.  The loan was to be used to finance 50% of the purchase price of a commercial premises at Marble Road, North Point (“the Property”).  The loan was secured by a guarantee from the Company and by a mortgage on the Property.

3.  In March 2003, East Champion defaulted on the loan and in May 2003, the petitioner demanded repayment.  Shortly thereafter, the petitioner also made a demand under the Company’s guarantee.  The loan has not been repaid by either party.

4.  Almost immediately after the demands were made, the Company and three of its subsidiaries including East Champion commenced the High Court action against three former directors, the developer of the property, the petitioner and a valuer claiming that they had conspired to procure the purchase of the Property at a gross over value.  It was alleged the petitioner had “dishonestly assisted” in the breach by the former directors of their fiduciary duties by making the loan to East Champion when it knew or should have known that the purchase price of the Property was a gross over-valuation.  The claim against the petitioner was for damages and in the alternative for equitable compensation.

5.  Undaunted, the petitioner served a statutory demand on the Company claiming $3.5 million after giving credit for the estimated value of the Property.  This was met with an application for an injunction to restrain the petitioner from presenting a winding up petition on the basis of that demand.  Waung J granted an injunction to prevent petitioner presenting a petition whether in Hong Kong or Bermuda on the basis of the statutory demand or the loan until after the petitioner had obtained judgment.  The petitioner then counterclaimed in the High Court action for the sum due.  One of the matters relied upon in this application is that the petitioner sought summary judgment on its counterclaim and in January 2004 the master gave the Company unconditional leave to defend the counterclaim.

6.  The next step was that the petitioner sought to strike out the Company’s claim in the High Court action on the ground that it was scandalous, frivolous, vexatious or an abuse of process of the court.  It has been claimed that this was merely a tactical move because it was made in connection with an application for security for costs against the Company on the basis that it was located abroad.  The attempt to strike out the action was dismissed.  The petitioner succeeded in obtaining an order for security for costs against East Champion and one of the other plaintiffs, but not against the Company.

7.  In March 2004 Umbrella Finance Company Limited (“Umbrella”), another creditor of the Company, presented a winding-up petition against the Company on two grounds.  Firstly that it was unable to pay its debts and, secondly, on the just and equitable ground.  It was alleged that the Company had been stripped of its assets.

8.  There was an application for appointment of provisional liquidators which was heard by the judge herself.  In the course of her decision in the present case, the judge made two observations, in particular, relating to that application.  Firstly, that it was never in dispute in that application that Umbrella had made out a good prima facie case for a winding-up order.  Secondly, the judge observed that she had dealt with the quality of the Company’s evidence which sought to answer the allegations of asset stripping in a guarded way.  The judge said at paragraph 17 of her decision in the present case:

“These comments I made in my decision on 21 April 2004 should not be taken or construed to mean that no prima facie case was made out on the allegations of asset stripping or that the allegations were without merits.  There is no basis for the suggestion that Umbrella had attempted to wind up the Company on just and equitable ground based on the allegations of asset stripping and had failed.  All that happened was that I had dismissed its application to appoint provisional liquidators.”

9.  In view of the fact that the transfers had already taken place some time previously, the judge had not been persuaded there was a real need or urgency for provisional liquidators to be appointed.

10.  Umbrella sold its debt due from the Company and on 10 January 2005, an order was made by consent to dismiss its petition.  Although the petitioner in the present case had supported Umbrella’s petition, it was not informed beforehand of Umbrella’s decision to withdraw its petition, hence it had no opportunity to apply to be substituted as a petitioner in place of Umbrella.  It thus came about that, two weeks later on 21 January 2005, the petitioner began its own petition to wind up the Company in these proceedings.

11.  The grounds of the petition are succinctly stated in paragraph 30:

“In presenting this petition, the Petitioner relies on the following grounds:

(a) the Company’s management has deliberately transferred out of the Company the Company’s principal assets, being its equity interests in its major subsidiaries, with the purpose of defeating the Company’s creditors, such that:

(i) the Company’s substratum has gone;

(ii) the Company’s affairs have been conducted with a lack of probity and good faith towards creditors which makes it necessary for the Court to intervene; and

(iii) for the foregoing reasons it is just and equitable that the Company be wound up; and

(b) the Company is an unregistered company as defined in Section 326 of the Companies Ordinance which has ceased to carry on its business in Hong Kong.”

12.  The petition then goes on to expand upon the allegation of asset stripping indicating that the Company had been the holding company of what was termed the China United Group.  According to its accounts for the year ending the 31 December 2002 the Company’s interests in its subsidiaries was valued at $557 million and the shareholders funds were $297 million.  In January 2003 the Company became the wholly owned subsidiary of China United International Holdings Limited (“China United International”).  That was a company which had hitherto not commenced business and had no significant assets.  Following that, the Company was delisted from the Stock Exchange and then there were a series of steps taken to restructure the shareholdings in the subsidiaries held by the Company; the equities in the major subsidiaries were transferred or sold to companies within the group held by China United International.  In paragraphs 37 and 38 of the petition it is stated:

“37. The effect of these transfers (according to the Interim Report) was that afterwards the Company “became an insignificant part of the Group’s net assets”.  By 31 July 2003 the First Plaintiff had assets of HK$292 million and liabilities of HK$523 million.  In other words, its net asset position had deteriorated by HK$528 million in the space of 7 months, completely wiping out the shareholders’ funds.

38. The admitted purpose of the transfers to the New Group was to place the assets of the Company beyond the reach of creditors of the Company, while keeping them in the same control and ownership.  The Interim Report states that “the directors consider that the Group is not expected to suffer from any material losses resulting from disposal or liquidation of [the Company] .… the New Group will not be subject to challenge by any party as to the validity of the restructuring and/or to possible claims for compensation for any loss suffered by the [the Company] as a result of the restructuring…, the New Group has no legal obligation to assume the liabilities of China United as the New Group has not given any guarantees and collateral security to the lenders of China United”.”

13.  Paragraph 40 of the petition goes on to say that in the Interim Report, BDO International, who were the auditors of China United International and of the Company, qualified their opinion concerning China United International’s interim accounts because (amongst other reasons) of their fundamental uncertainty about whether the “going concern” basis was appropriate and whether the transfer of the Company’s assets to the China United International group was lawful.

14.  The Company avers that it has answers to these allegations.  But on the face of it they are particularly serious.  When looked at in the context of the fact that the loan which forms the subject of the petitioner’s original complaint was made in 1997 and that it was not until some six years later, after the term of the loan had expired, that the Company started to take active steps to complain, the commencement of the action after such a long time itself raises a question.  Then a few months after the claim had been made that there had been some conspiracy in relation to the Company’s purchase of the Property, there were a series of transactions in respect of which the judge was justified in concluding that a prima facie case of asset stripping had been made out.  It only remains to add that the Company has chosen to discontinue its action against the directors and against the property developer on terms which, so far as this court has been able to determine by inquiries of counsel or otherwise, do not include any admission of liability on the part of those against whom the action was originally brought.  Whether in the light of that the Company could ever prove its case against the petitioner and against the valuer can only, at best, be said to be highly conjectural.

The decision below

15.  The judge considered the various arguments which had been put forward on behalf of the Company.  These included the fact that the High Court action had reached the stage of witness statements and it was said that it could come on for hearing within about six months of last August i.e., the date of the hearing before the judge.  Not unusually with that sort of submission, it has proved to be a woefully inaccurate.  There still remains an application by the Company for discovery against the valuer.  I see no basis for suggesting that the Company has any intention to proceed with the action with any degree of appropriate dispatch.  Indeed the history of the action shows that it is the petitioner who has taken steps to push the action forward.  The judge, rightly in my view, discounted the fact that the petitioner held the property as security and therefore was not at risk.  The judge also observed that even if a winding up order were made against the Company, the liquidator could still pursue the action.  Clearly, it would seem that the judge was correct in this.  The reality of the situation is that the action is financed by the China United International.

16.  The judge considered the cases where the companies had cross-claims and came to the conclusion that a cross-claim was not a necessarily a bar to the making of a winding up order particularly in cases where the grounds for seeking a winding up were on the just and equitable grounds.  At paragraph 39 of the decision the judge observed that there had been no question raised as to the locus of the petitioner.  It was however that matter which formed the major part of the argument raised on by Mr Chan SC on behalf of the Company.

This appeal

17.  The argument raised on this appeal was that the petitioner could not establish that it had locus to present a petition until the cross-claim by the Company had been determined.  It was said that the petitioner’s claim would be overtaken by the cross-claim on the part of the Company.  Strong reliance was made upon the fact that the petitioner had been prevented from presenting a petition on the basis of the debt claimed and that its application to strike out the Company’s claim failed.  In addition it was said that the failure of the summary judgment application was also indicative that the petitioner could not establish its locus until the High Court action had been determined.

18.  In my view, the various decisions which have been made in respect of the petitioner’s application for summary judgment and its inability to present a petition on the basis of the debt demonstrating insolvency are not determinative in the matter.  It is still for the Companies Court to take a view on the matter as was explained by Lord Green MR in Re Welsh Brick Industries Ltd [1946] 2 All ER 197.

19.  This court was taken to a number of decisions where a winding up was sought in cases where there were cross-claims.  In my view the correct approach was explained in Re Bayoil SA, Seawind Tankers Corp v Bayoil SA [1999] 1 BCLC 62.  After reviewing all available authorities, including Stonegate Securities Ltd v Gregory [1980] Ch.576, the full transcripts of the judgments of Lord Denning MR, Harman and Russell LJJ in Re Portman Provincial Cinemas Ltd reported at (1964) 108 SJ 581 and the judgments of Harman, Danckwerts and Edmund-Davies LJJ in LFH Wools Ltd [1970] Ch.27, Nourse LJ stated at page 70 the conclusion that where there was a genuine cross-claim with substance in it the petition should be dismissed or stayed except where there were special circumstances.  Ward LJ reached the same conclusion based on the same cases and Mantell LJ agreed with Nourse LJ’s judgment.

20.  In my view that was the approach of the judge below and even if it were not it is the approach which I would take.  True it is that the Company’s claim cannot be struck out.  There are, however, a number of very serious matters which, in my view, take this case into the category of special circumstances.  This is not a case where a creditor simply seeks payment of a debt and there is a monetary cross-claim by the Company.  In this case, the grounds of the petition are that not only has there been serious asset stripping but the allegation is that that asset stripping was done specifically to defeat the creditors and, most importantly, it was done in respect of what, prior to the commencement of the asset stripping, was a publicly quoted company in Hong Kong.

21.  The importance of this fact cannot be overlooked.  It is an undoubted fact that the financial services sector in Hong Kong is one of the most crucial parts of the local economy.  It is unnecessary to quote statistics as to the size of the financial markets in Hong Kong, nor is it necessary to contrast the relative size of the financial market to the economy as a whole in Hong Kong in comparison to other places.  It suffices to say that the importance of sound corporate governance, let alone merely modest ethical standards, is vital if Hong Kong is to retain its place in the financial services world, not to speak of prospering.  Complacency cannot be tolerated when it comes to allegations of serious misconduct by those in control of public companies in Hong Kong.

22.  Viewed in that light, there can be no doubt of the importance of determining the issues raised on the petition with dispatch.  If, as the Company says, the allegations in the petition are erroneous, the sooner that is determined and the allegations disposed of the better.  It can do the reputation of Hong Kong and its financial services sector immense harm to have these allegations perpetuated and unresolved.  If, however as the petitioner says, there has been corporate manipulation which amounts to little short of fraud in the commonly understood meaning of the word, the sooner that is revealed to be true and steps taken to undo what has been done and to prevent repetition, to the extent possible, again the better.  The damage that would be inflicted to the public interest if the allegations in the petition proved true and nothing were done about it would be lasting.  The matter would be cause of criticism of the efficacy of corporate governance in Hong Kong for a long time to come.

23.  Mr Chan SC, on behalf of the Company, averred that everything which had been done complied with the rules of the Stock Exchange and the Securities and Futures Commission.  Even if that be correct, that is not an answer to the allegations, moreover the rules of the Stock Exchange have been radically revised since the time of the events now complained of.  Nor is it any answer that the shareholders of the Company may have voted in favour of a scheme that would, in effect, have left them better off because they would be shareholders in a company with the same business as the Company but relieved of its debts without the necessity of payment.

24.  As regards the claim by the Company, the judge was, in my view, correctly very guarded about its strength.  The claim was mounted late.  It had the hallmarks of a rearguard action to delay the petitioner recovering its debts.  If there is validity in the complaints in the petition, the Company’s action could be seen as the first step in a prolonged process of delay.  The history of the prosecution of the action demonstrates that the Company has not been anxious to pursue it with any vigour.  10 months ago the judge was told that the action could be tried in six months time.  Since then it has been applications by the Company which have further delayed the progress of the action and still to this day it cannot be said that there is any realistic possibility in the action being tried in this calendar year.

25.  For these reasons, I consider that there are special circumstances in this case which far remove it from a situation where there are simply cross-claims arising out of normal transactions.  In this case the petitioner does have a claim and that is sufficient in my view to give it locus to present and prosecute the petition.  In the circumstances of this case the judge was perfectly correct not to delay the determination of the important matters which are raised by the petition.  I would therefore dismiss this appeal with an order nisi of costs in favour of the petitioner.

Hon Le Pichon JA:

26.  I agree.