RE YAOHAN HONGKONG CORPORATION LTD. (in liquidation)

CACV 379/2000

IN THE HIGH COURT OF THE

HONG KONG SPECIAL ADMINISTRATIVE REGION

COURT OF APPEAL

CIVIL APPEAL NO. 379 OF 2000

(ON APPEAL FROM HCMP NO 2108 OF 2000)

_____________________

J U D G M E N T

_____________________

Hon Rogers VP :

1. This is an appeal whereby the liquidators of Yaohan Hong Kong Corporation Limited ("八佰伴") (in liquidation) (hereinafter referred to as "Company") seek an order that the undertaking which they gave to the court as recorded in an order dated 17 July 2000 be discharged.

The history

2. The Company was a holding company and its principal operating subsidiary was Yaohan Department Store (HK) Limited ("YDS"). The Company was listed on the Hong Kong Stock Exchange. That listing was suspended on 18 September 1997. YDS ceased its operations in November 1997. On 9 February 1998 the Company was put into creditors' voluntary liquidation under section 228A of the Companies Ordinance, Cap. 32. The appellants were appointed provisional liquidators and became joint liquidators on 9 March 1998.

3. The statement of affairs as at the date of the winding up was signed on 6 March 1998. The statement of affairs shows that the accrued expenses and other payables was over $91 million and that there was a total deficiency before the cost of liquidation of some $338 million. Although there was a book value of assets of some $277 million apart from about $100,000, the remainder of that amount was almost certainly irrecoverable as it comprised the book value of the shareholding in YDS and other subsidiaries as well as an advance to YDS upon which no recovery was to be expected.

4. A Committee of Inspection was formed. The parlous state of the Company's affairs resulted in a position where the liquidators' fees were unlikely to be paid. At the 4th meeting of the Committee of Inspection in April 1999, the liquidators reported that they had unbilled fees of around HK$1.35 million and that the cash balance was only HK$385,312.13 which would not be sufficient to pay the liquidators' fees and that "there would not be any dividends to the creditors of the Company."

5. It would seem that from the beginning of the liquidation, the only asset which the liquidators could envisage being of value was the listing status of the Company. The minutes of the Extraordinary General Meeting of the members which was held on 9 March records that Mr Stephen Liu, an assistant of the provisional liquidator, told the meeting :

"That the Provisional Liquidators had been approached by a number of interested parties since the date of their appointment and had received one proposal from an interested buyer. If the listing status of the Company could be sold for a consideration, the members and creditors might be able to receive in return shares or cash for their claims against the Company."

6. At subsequent meetings of the Committee of Inspection this was referred to as a rescue proposal. It would appear that the proposal was in the nature of the sale of an asset and not any form of rescue of the Company.

7. It is clear from the minutes of the various meetings of the Committee of Inspection that the liquidators had pursued the possibility of a sale of the listing status with some vigour. Despite this, by the 4th meeting of the Committee of Inspection on 30 April 1999, it appears that the prospects of finding a buyer were not particularly optimistic and that the Stock Exchange was putting pressure on the Company to come forward with acceptable resumption proposals by September, otherwise the listing status would be removed.

8. In October 1999 the liquidators sent a copy of a preliminary agreement dated 20 September 1999 to the members of the Committee of Inspection. That agreement was with Asia Standard Hotel Group Limited ("ASH"). The effect of that agreement was that the Company would have to become a subsidiary of a new parent with a view to the new parent being listed. The Company shareholders would have to swap their shares for ASH shares. The ASH shares they were to receive would have an underlying value of $10 million. The Company would receive cash of $10 million and if there were additional creditor claims, ASH shares with a net asset value of $1 million. There would also be a payment of $2.5 million towards the costs of implementing the proposal. After everything was completed the shares in the Company would be transferred to the liquidator for the benefit of the Company.

9. The provisional agreement was discussed at the 6th meeting of the Committee of Inspection on 2nd February 2000. At that meeting the outline of the provisional agreement was discussed. Reference was made to the fact that a shareholders' scheme of arrangement would be required. The payments to the Company were also specified. The meeting was told that the transfer of ASH shares to the net asset value of $1 million, which was conditional upon additional creditors filing claims after 27 July 1999, was something which ASH had offered when the liquidators had negotiated an increase in the amount to be paid to the Company. The meeting was also told that this contingent amount of shares had been replaced by a fixed issue of ASH shares with a net asset value of HK$800,000.

10. The meeting agreed the proposals including the fact that any ASH shares which would be received by the Company would be sold and the proceeds used in the liquidation.

11. There then followed discussion as to the fees and expenses which had been incurred in the liquidation to date. Again it transpired that the liquidators were dependant upon the implementation of the proposals in the provisional agreement for the payment in full of their fees which had already been incurred.

The Rhine Holdings Limited Decision

12. On 29 March 2000 the judge below handed down the decision in Re Rhine Holdings Limited (in liquidation) [2000] 3 HKC 543. Rhine Holdings Limited was a Bermudan company which was listed on the Hong Kong Stock Exchange. A scheme of arrangement had been approved by the Bermudan court. The effect of the scheme was that the shares in Rhine Holdings would be transferred to a purchaser in return for shares in the purchaser company. After the listing status had been stripped out of Rhine Holdings Limited, the shares in that company would be transferred to the liquidators for a nominal consideration. The shareholders in Rhine Holdings would receive shares in the purchaser company. The judge held that any benefit that would be received by the shareholders would be not less than $5 million and not likely to be more than $6.5 million. Rhine Holdings Limited would itself receive $9 million and a further $6 million would be paid to the liquidators by way of costs.

13. The judge considered the arrangement which had been arrived at and the reasons for the arrangement. These arose out of the form of the listing rules which permitted an application for listing of securities which were already in issue. Such arrangements are commonly referred to as back door listings. They have the advantage that many of the restrictions and requirements which are imposed in relation to initial public offerings do not apply.

14. The submission had been made in seeking the court's approval that the scheme did not involve any disposition or dealing in any asset of Rhine Holdings Limited or in the diminution in the value of any asset of that company. It was said that the listing status was not something that should be regarded as an asset belonging to that company. The judge examined that argument and came to the conclusion that it was misconceived. The purchaser was not interested in the shares of the company since they would only be temporarily in the purchaser's ownership. The judge said at p 550B-D:

"But the ability to facilitate or the facilitation of a listing of the investor or its company is derived from the fact that Rhine is a listed company. In my judgment, that ability of facilitation is a corporate asset.

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

15. What concerned the judge on that application was that there was an attempt to alter or vary the statutory order of the application of assets of an insolvent company. What in effect was being achieved was that the shareholders, who could expect nothing in the liquidation, were receiving assets of between $5 million and $6.5 million. The judge noted, however, that there was the unusual feature that this particular asset of the company could only be realised with the cooperation of the shareholders. In her view, that provided justification for providing some form of "sweetener" or token consideration to the shareholders in return for their cooperation. That amount, however, had to be tempered by the fact that the shares had no intrinsic value and that the shareholders could not realize any value on their own. The judge expressed her disapproval of the split of the consideration in the ratio of 6:4 between the creditors and the shareholders in the following terms at p 552C-E:

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

I am not satisfied that the apportionment of the benefit between the creditors and shareholders is fair and reasonable for reasons already stated."

16. On the footing that the shareholders would be gaining 40% of the benefit, there was no justification for all the costs of the liquidators which had been incurred in arranging the transaction to be borne out of creditors' funds. As a result the judge in that case approved the application upon the liquidators giving an undertaking that $1 million would be added to the fund available for distribution amongst the creditors out of the sum for fees, costs and expenses which were received or to be received by the liquidators under that agreement.

Events subsequent to the Rhine Holdings decision

17. The impact of the Rhine Holdings decision was, of course, clear. On that occasion the judge had been highly critical of the 6:4 split in the consideration between the creditors and the shareholders and had emphasised that the shareholders were only entitled, at the most, to token consideration in the form of a "sweetener". There then followed the 7th meeting of the Committee of Inspection in the present case. That meeting was shown a draft termination agreement terminating the preliminary agreement and a draft restructuring agreement. In brief the difference between the preliminary agreement and the restructuring agreement was that in the preliminary agreement the shareholders would receive 48% of the consideration whereas in the restructuring agreement they would receive approximately 33%. On the other hand the creditors in the preliminary agreement were to receive some 52% whereas in the restructuring agreement they were to receive 66.76%. The amount payable for the liquidators' fees and expenses was increased in the restructuring agreement to $3 million.

18. Two points from the minutes of the meeting should be mentioned. The first is that it was correctly stated, presumably by the liquidators that the Stock Exchange listing was an asset of the company, albeit that it could only be realised with the shareholders' approval. The second is that reference was made to the Kin Son case at the same time as reference was made to the decision in Rhine Holdings Limited.

19. The reference to Kin Son was a reference to an order which I had made in the case of Kin Son Electronics Limited. That was a similar scheme, in similar circumstances, where the listing status was an asset of an insolvent company and was to be stripped out of the company in a similar arrangement to that in the present case. On that occasion the split in consideration between the creditors and the shareholders was approximately two-thirds to one-third. However, it is clear from the minutes of the 2nd meeting of the Committee of Inspection that the liquidators in the present case had themselves been the liquidators in Kin Son. As such they would have been aware that the issues which were highlighted by Mrs Justice Le Pichon in the Rhine Holdings case were never discussed at any stage when the scheme of arrangement was before the court in the Kin Son Electronics Limited case. Indeed when I made the order in Kin Son Electronics Limited case, the question raised in Rhine Holdings was certainly not referred to when the application was made or by the court and I made the order without giving any written decision.

20. If, as would seem to be the case, the liquidators were making reference to the scheme which was approved in the liquidation of Kin Son Electronics Limited as a means of interpreting what would be appropriate in relation to the issues which had been raised in Rhine Holdings Limited, that exercise would have been wholly illegitimate. I can only say that had the Rhine Holdings decision been given and had I had the benefit of seeing it when the Kin Son scheme of arrangement was before me, there is a high probability that my order would have been very different.

21. So far as the present case is concerned, the split recommended by the liquidators, which was valued that stage as 68% for the creditors and 32% for the shareholders, was little different from the split of 60:40 of which Mrs Justice Le Pichon had been so critical in the Rhine Holdings case.

22. On 8 May 2000 the liquidators held the 2nd annual meeting of creditors. That was attended by 5 attendees on behalf of 6 of the creditors. The meeting was told of the "restructuring agreement" and of the division of consideration between the creditors and the shareholders. The assistant to the joint liquidators, who chaired the meeting, told the meeting that :

"... there was no real guidance for the Joint Liquidators as to the apportionment of the Consideration between the Company's creditors and shareholders."

On that basis those present voted in favour of 4 resolutions, one of which was :

"To endorse and rectify (ratify) the terms of the Restructuring Agreement relating to the proposed Scheme of Arrangement, whereby the shareholders of the Company, in consideration of the allotment and issue of ASH shares, will become the shareholders of ASH."

23. The scheme of arrangement itself was put before the court on the following day for the court's sanction of the holding of a meeting. It should be mentioned that the explanatory statement contained the statement :

"There is no specific basis on which any given apportionment of the value of the listing status of Yaohan between its creditors and shareholders could be said to be correct in absolute terms and there is no judicial guidance on this aspect."

24. That statement was picked up by the judge at the hearing. We were taken at length through the transcript of the hearing and it is clear that the judge was expressing disapproval of the split which had been arrived at. The judge said that, first of all, there was no evidence before her as to how the split was arrived at. A short while later, she said :

"To my mind, something token would be of the order of 5% ..."

Whilst indicating that when the matter returned for the approval of the scheme there were likely to be difficulties, the judge ordered the meeting of shareholders.

25. The meeting of shareholders took place and the matter returned to court for approval of the scheme on 4 July. At that hearing it was confirmed that there had been no further meetings of the Committee of Inspection or of the creditors and that ASH had not been approached since the previous hearing with a view to altering the split between the creditors and shareholders. The judge reserved her judgment.

26. In the reserved judgment which was handed down on 17 July the judge recited the facts and came to the conclusion that in view of the fait accompli with which the court was presented and in the circumstances of the Stock Exchange deadline looming, there was no alternative but to approve the scheme, otherwise the creditors would receive nothing. The judge was, however, highly critical of the split because it disregarded the applicable legal principles. The judge considered that there should have been a scheme of arrangement involving the creditors as well as one involving the shareholders. Indeed, on the basis of the decision in In re Tea Corporation Limited [1904] 1 Ch 12, the shareholders would indeed have no basis for demanding a scheme involving them since they would in any event receive nothing on a liquidation. The judge said on page 11 of the judgment :

"The Liquidators have chosen to place the court in an embarrassing position. In effect, I am asked to make a commercial decision when the proper parties to do so are the creditors. As noted above, the Liquidators have not given a proper explanation of the true legal position to the creditors. Any 'consent' given by the creditors would have been vitiated by that failure."

On the following page the judge said :

"... It is not acceptable for liquidators to seek sanction to an arrangement which provides for an apportionment that disregards applicable legal principles and when it moves them to do so, to cause the court to be presented each time with Hobson's choice.

In order to drive this message home, it would be necessary for the court to impose some form of sanction not only on the Liquidators but also on their legal advisers. The Liquidators stand to receive from the investor by way of fees and disbursements in respect of the Restructuring Agreement a sum that is capped at $3 million. In my judgment, they and their legal advisers are to be deprived of part of their fees for this transaction which are to be paid to the Company for the creditors' benefit. This will in some measure compensate the creditors for the loss sustained.

Inasmuch as the Liquidators have failed to discharge their duties to the creditors, there is a strong case for depriving them of all their costs and legal disbursements in relation to the entire transaction. However, up until 29 March 2000 when Re Rhine Holdings Ltd was decided, it could be said that there was no judicial guidance in this area and on that basis, they should be entitled to at least part of the fees for seeking to realize a corporate asset.

Taking the matter in the round, balancing what would appear to be egregious conduct and fairness, the Scheme is approved upon an undertaking being given by the Liquidators to pay one-half of the Liquidators' own profit costs as well as one-half of legal disbursements incurred in relation to the Restructuring Agreement (including the Scheme) for the benefit of the creditors."

27. That undertaking was given when the draft order incorporating the undertaking was submitted to the court shortly thereafter. No attempt was made by the liquidators to return to court nor was any indication given by or on behalf of the liquidators that the undertaking was being given under protest. Mr Hamilton QC, who appeared on behalf of the liquidators on this appeal, informed the court that the judge was on holiday at the time. It was said that because of the urgency of the matter including the Stock Exchange deadline and the placing agreements, the liquidators would have been in difficulties in returning to the court and indeed the placing agreements might have been jeopardized.

28. In my view, if the liquidators wished to challenge the correctness of having to give the undertaking, they should at the very least have indicated their protest when the undertaking was given even if they did not apply to another judge in respect of it. Albeit that latter course would probably have meant that that judge would have left the final determination of the undertaking to Mrs Justice Le Pichon, but making such an application would have been the proper course to take.

29. As a result of the undertaking being given the order was perfected, and the scheme was approved. The liquidators themselves obtained a double benefit as a result of that. In the first place, they received the fees of $3 million payable under the restructuring agreement. In the second place, they stood to receive the benefit of the payment to the company by ASH. This would enable the liquidators' fees in the liquidation to be paid and, as indicated, these were substantial and there would otherwise have been no assets out of which they could have been paid. In those circumstances, the liquidators had a clear and substantial financial benefit to be gained from the restructuring agreement and the approval of the scheme of arrangement. Whereas, in the affidavit of 27 April 2000, the liquidators referred to a conflict of interest which they appreciated between the creditors and the shareholders and their position in that regard in negotiating the restructuring agreement, the conflict arising because of the financing of their own fees is an even greater conflict of interest, and that was not at the forefront of any submission.

30. The order incorporating the undertaking referred to in the judgment was entered on 19 July. On 11 August the liquidators applied ex parte for leave to appeal. That application was supported by an affidavit of one of the liquidators dated the same day. The affidavit refers to the undertaking in terms that it "could hardly be described as voluntary". It then goes on :

"The fact is that the Learned Judge placed the Liquidators in an impossible position of conflict of interest and effectively imposed a condition upon them, to the extent that if they did not give the undertaking the Shareholders' Scheme of Arrangement would fail and the creditors and shareholders would get nothing."

31. That statement was the liquidators' explanation for the giving of the undertaking. Seemingly, they were oblivious of the conflict of interest which they had placed themselves in. Their explanation for not returning to the judge below was that any application to the judge for a discharge or variation of the undertaking would be doomed to failure. Whether or not their anticipation of the judge's reaction to any application was correct, in my view, their failure to so apply was wrong.

The benefit of the order

32. In my view, this appeal must fail because the appellants have, as I have explained, taken the order, with considerable personal benefit to themselves. Having taken that order which they obtained by giving the undertaking, their appeal must fail particularly as they have not returned to the judge either before or after giving the undertaking with a view to the judge exercising the court's discretion to relieve the liquidators of the whole or part of their undertaking. A party cannot be allowed to affirm and then disaffirm an order.

33. The time scale and the difficulties in relation to the Stock Exchange deadline and the nature of the placing agreement with the placees, in my view, provide no reason for this court to hold otherwise.

Other matters arising on the appeal

34. It was a central theme of Mr Hamilton's argument on behalf of the liquidators that when approving the scheme of arrangement the court had no jurisdiction to consider whether the statutory order for distribution of assets on the liquidation would be breached. It was said that the court's jurisdiction was confined to ensuring that the statutory requirements relating to a scheme had been fulfilled and that no minority shareholder had been unfairly discriminated against. Of course the latter matters are points which the court must consider, but to suggest that a court could approve a scheme of arrangement, the effect of which was to breach the order of distribution of assets of an insolvent company in liquidation, in my view, only has to be stated to be seen to be clearly wrong.

35. As the judge below had explained in Re Rhine Holdings Limited there was justification for the giving of shareholders a token consideration simply because they had to vote at a meeting. Their shares were in name to be transferred to ASH. Those shares were, however, valueless. After the Company was put into liquidation the only rights the shareholders had were to participate in the assets of the Company according to the statutory provisions for the distribution of assets on insolvency. The listing status had been an asset of the Company. As such it had belonged to the Company as a separate and independent legal entity. As stated by Lord Diplock in Ayerst v C. & K. (Construction) Ltd [1976] AC 167 at 180F :

"... the effect of the statute was to give to the property of a company in liquidation that essential characteristic which distinguished trust property from other property, viz., that it could not be used or disposed of by the legal owner for his own benefit, but must be used or disposed of for the benefit of other persons."

36. Had the shares any value, there is no apparent reason why the scheme should not have provided that the shares should not have been re-transferred to the original shareholders once the listing status had been removed from the company. Presumably the reason why that was not to be done was the fact that there was not even the remotest possibility that the shareholders of the Company could receive anything in the liquidation. Suggestions that there might have been a breach of Article 105 at the Basic Law are even further removed from reality.

37. If it were to be suggested that the judge had misinterpreted the records of the 7th meeting of the Committee of Inspection and the 2nd annual meeting of creditors to the extent that although the minutes of the latter meeting did not mention Re Rhine Holdings Limited, the minutes of the Committee of Inspection meeting at which 3 creditors were represented did refer to that decision, then the matter should have been taken back to the judge. There is ample justification, it seems to me, for the judge's view that the decision in Re Rhine Holdings Limited was not, and at the very least not adequately, explained to the creditors. If they were told at the meeting of creditors that there was no real guidance for the liquidators as to the apportionment - and previously at the Committee of Inspection meeting they had been referred at the same time to both the Kin Son Scheme and the Rhine Holdings Scheme - there is more than ample justification for the conclusion that the creditors were not informed as to what the judge had meant in Re Rhine Holdings of a token consideration or "sweetener". The matter having been discussed in court on 9 May and there having been no further attempts to provide guidance to the creditors were something which the judge was justified in taking into consideration. If the liquidators considered that further explanation to the court was warranted they should have taken steps to give that explanation.

38. I would dismiss this appeal.

Hon Wong JA :

39. I agree with the judgment of Rogers VP.

Hon Woo JA :

40. I agree.