CHAN CHING AND ANOTHER v. BEIJING RUI HE LTD

HCMP 1359/2012

IN THE HIGH COURT OF THE

HONG KONG SPECIAL ADMINISTRATIVE REGION

COURT OF FIRST INSTANCE

MISCELLANEOUS PROCEEDINGS NO 1359 OF 2012

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REASONS FOR DECISION

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INTRODUCTION

1. On 15 Ocotober 2012 I made an Order (“the Order”), upon an application made by the 1^st and 2^nd Plaintiffs (collectively as “the Plaintiffs”), that Mr Osman Mohammed Arab and Mr Wong Kwok Keung of RSM Nelson Wheeler Corporate Advisory Limited of 29^th Floor, Caroline Centre, Lee Gardens Two, 28 Yun Ping Road, Causeway Bay, Hong Kong be appointed until the determination of the Originating Summons herein or until further order as interim receivers (“Interim Receivers”) of Beijing Rui He Limited (“the Company”) with power to act jointly and severally.  The Order expressly restricts and limits the powers of the Interim Recievers, inter alia, to the conduct of an arbitration (“the Arbitration”) between Legend New-Tech Investment Limited (“Legend New-Tech”) and Lenovo Star Investment Company (“Lenovo Star”) on the one hand, and the Company on the other hand.  The Arbitration was being administered by China International Economic and Trade Arbitration Commission (“CIETAC”), and the Order authorized the Interim Receivers to conduct the Arbitration in the name of and on behalf of the Company, and to do all things reasonably necessary for that purpose.  Various incidental powers are also expressly conferred on the Interim Receivers for the purpose of enabling them to conduct the Arbitration, but it is not necessary for me to set them out in these Reasons for Decision.

2. The Order was made upon certain undertakings (“the Undertakings”) given by the Plaintiffs requested by me.  The reasons why I requested the Undertakings from the Plaintiffs will be apparent from the paragraphs below.

3. The following are my reasons for making the Order.

THE BACKGROUND

The Various Companies

4. The Company is a company incorporated in Hong Kong and is wholly owned by a BVI company called Beijing RunchangCompanyLimited (“Beijing Runchang”).  Beijing Runchang is in turn owned by a Cayman Islands company called China Vocational Education Company Limited (“CVE”). The Plaintiffs are the directors of the Company appointed by a company called Fresh Gain Limited (“Fresh Gain”).  Fresh Gain is a wholly owned subsidiary of New World Strategic Investment Limited.

5. Fresh Gain had entered into a sale and purchase agreement dated 22 April 2011 with CVE and various other persons and entities (“the SPA”), pursuant to which the Fresh Gain was to acquire 19.385% interest in CVE for a consideration of US$33,800,000 (“the Consideration”).

6. CVE was originally formed for the purpose of raising funds to finance the business of one Beike Haoyue Technology Company Limited (“Haoyue”). Haoyue is a company incorporated in Mainland China and is engaged in education related business in the PRC.  Haoyue is effectively controlled by CVE.

7. Mr Zhou Jiting (“Zhou”), Mr Zhou Mengkui, Ms Zheng Xianghong, Mr Chen Wenhe and Mr Li Jingbiao were the founders of Haoyue (collectively as “Zhou’s camp”). Zhou’s camp also controlled Beijing Ruiming Company Limited (“Beijing Ruiming”), the biggest shareholder of CVE.

8. There were, at the time of the hearing before me, 12 directors sitting on the board of the Company.  They included Zhou’s camp, 2 representatives from Fresh Gain (i.e. the Plaintiffs), and 5 representatives from three other investors (referred to at the hearing respectively as “Carlyle”, “PineBridge” and the “C2 Investors”).

The Loan and the Three Agreements

9. Before it entered into the SPA, Fresh Gain was made aware of the existence of a loan owed by Haoyue to Lenovo Star in the sum of RMB 200 million (“the Loan”).  Lenovo Star is a subsidiary company of Legend Holdings Limited (“Legend Holdings”), a company listed in Hong Kong.  Legend New-Tech, an indirectly wholly owned subsidiary of Legend Holdings, is a related company of Lenovo Star.

10. The Loan was made by Lenovo Star to Haoyue pursuant to a loan agreement dated 7 February 2010.  Haoyue was however unable to make repayment of the loan at the end of the original loan period and an extension was given to Haoyue to make repayment on or before 8 November 2010.  Despite the extension, Haoyue was unable to make repayment at the extended repayment date.

11. A scheme was subsequently put in place to give time to Haoyue to make repayment.  It is not necessary for me to set out here the details of the terms of the scheme, which are contained in 3 agreements (collectively as “the Three Agreements”) involving the Company, Haoyue, Lenovo Star and Legend New-Tech.  The Three Agreements are all dated 8 July 2011 and consist of the following agreements:

(a) a Repayment Agreement (还款协议书);

(b) a Funds Entrustment Management Contract (资金委托管理合同);

(c) a Foreign Exchange Settlement & Repayment Arrangement (结汇和还款安排协议).

12. Pursuant to the SPA, Fresh Gain had paid the Consideration to CVE.  Out of the Consideration so paid, a sum of US$25,399,900 was transferred to Beijing Runchang and then to the Company on or about 29 June 2011.  The scheme required the Company to pay a sum (“the USD Fund”) of US$22,297,629.60 (which is equivalent to RMB 144,276,812.31) into the bank account of Legend New-Tech in Hong Kong.  It is Fresh Gain’s case that the purpose of this arrangement was put the USD Fund into an offshore account designated by Lenovo Star (the account of Legend New-Tech in Hong Kong) so that Lenovo Star could “oversee with comfort” that “Haoyue had sufficient asset backing and possessed the ability to repay the [L]oan in due course”.

13. After the completion of the SPA, Fresh Gain allegedly discovered, inter alia, that misleading and inaccurate financial information (concerning CVE and its subsidiaries) had been provided to Fresh Gain in order to induce it into entering into the SPA.  Fresh Gain then resolved to rescind the SPA on the ground of alleged misrepresentations, and commenced arbitration proceedings against the Company Warrantors (as defined in and) under the SPA for, inter alia, an order of rescission of the SPA and the return of the Consideration.  In the present proceedings, I am not concerned with the arbitration commenced by Fresh Gain.

Arbitration commenced by Lenovo Star and Legend New-Tech

14. The Arbitration was commenced by Lenovo Star and Legend New-Tech (collectively as “the Claimants”) against the Company in about February 2012.  The Arbitration was administered by CIETAC based on an arbitration clause contained in the Funds Entrustment Management Contract, which is one of the Three Agreements referred to above.

15. It is the Claimants’ case in the Arbitration that Lenovo Star is entitled to use the USD Fund for repayment of the Loan and that Legend New-Tech is entitled to transfer the USD Fund to Lenovo Star absolutely for the repayment.  It would appear from the Arbitration Application filed by the Claimants that they contend (inter alia) that:

(a) the USD Fund (which was “entrusted” (委托) to Legend New-Tech under the Funds Entrustment Management Contract) was in truth a specific pledge guarantee for repayment of the Loan owed by Haoyue to Lenovo;

(b) Clause 9 of the Repayment Agreement which states that Legend New-Tech has the right to retain the USD Fund until Haoyue has repaid the Loan shows that the USD Fund was intended as a specific pledge(特定质押物);

(c) upon payment of the USD Fund from the Company to Legend New-Tech on 12 July 2011, the transfer of fthe pledge was completed.

16. The Claimants seek reliefs in the Arbitration for, inter alia, confirmation that (a) the USD Fund is a specific pledge for the Loan; (b) Lenovo Star has a priority right for payment in respect of the USD Fund; and (c) Lenovo Star is entitled to apply the USD Fund for repayment of the Loan.

17. The Plaintiffs contend that the Company has a good defence to the claim made by the Claimants in the Arbitration.  In gist, the Plaintiffs say that:

(1) There was nothing in the Three Agreements which expressly provided that the USD Fund would constitute a specific pledge guarantee;

(2) On the contrary, there were express terms in the Funds Entrustment Management Contract which provided that the USD Fund was to be “entrusted” to Legend New-Tech for management and use.  Such management and use was to be in investment and projects designated by Legend New-Tech;

(3) There was nothing in the Funds Entrustment Management Contract to permit the USD Fund to be used for repayment of the Loan;

(4) Under Clause 5(3) of the Funds Entrustment Management Contract, Lenovo expressly warranted that Legend New-Tech would transfer the USD Fund to the Company’s account once the account of a WFOE (as defined therein, which is a company by the name 北京万博鹏科技有限公司) was established;

(5) Clause 9 of the Repayment Agreement, when referring to the right of Legend New-Tech or Lenovo Star to deduct sums paid by Haoyue or the Company, expressly provided that “for the avoidance of doubt”, such deduction shall not include the USD Fund paid by the Company pursuant to the Funds Entrustment Management Contract;

(6) There was no room for the implication of a term to convert the sum entrusted to Legend New-Tech into a specific pledge guarantee, coupled with the power to apply the same for repayment of the Loan;

(7) The suggested use of the USD Fund for repayment of the Loan is contrary to foreign exchange regulations in the PRC, which prohibit the use of foreign currencies to repay a loan in RMB currency.

18. It is not for me in this application to decide the merits of the parties’ respective arguments made or to be made in the Arbitration.  That is a matter for the arbitral tribunal to decide.  For the purpose of this application, I need only say no more than that I am satisfied that there is at least an arguable defence that may be advanced by the Company in opposition to the Claimants’ claim.  It is also clearly in the interest of the Company to defend the Arbitration.  If the Company does not defend the Arbitration, it is likely that the Claimants will be able simply to walk through the Arbitration and the Company may suffer the consequence of having the USD Fund used to repay the Loan owed by Haoyue to Lenovo Star.

19. What I need to decide is whether there is a sufficient case made out for me to exercise my discretion to appoint interim receivers for the purpose of conducting the Arbitration on behalf of the Company.

Events after the commencement of the Arbitration

20. Zhou’s camp maintained that the Company should not contest the Arbitration as the Claimants’ claim was, in their view, good.  They proposed and appointed an arbitrator, who was a PRC professor by the name of Huang Yong.

21. Fresh Gain’s position, as represented by the Plaintiffs, is that the Company should defend the Arbitration.

22. I pause to add that, at the time of the hearing before me, Zhou’s camp constituted 5 out of 12 of the directors of the board of the Company.  Accordingly, although Zhou’s camp outnumbered Fresh Gain in terms of representation on the board, Zhou’s camp did not control the board.  Hence the stance of the remaining directors (who were appointed by Carlyle, PineBridge and the C2 Investors) became important as a majority of the board could only be consitututed with their support.

23. The stance of the other 5 directors are, however, not clear.  They have apparently sided with the Plaintiffs, at a directors’ meeting held on 12 October 2012 (i.e. 3 days before the hearing before me), to reject the proposal made by Zhou’s camp to appoint Messrs Dechert to represent the Company in the present proceedings (and accordingly at the hearing before me the Company was not legally represented – this is despite the fact that Godfrey Lam S.C. who was apparently instructed by Messrs Dechert previously, had put in a skeleton submission on 12 October 2012).  Yet, as evidenced by the events mentioned below, by the time of the hearing, there did not appear to be a sufficient measure of agreement amongst the directors to enable them to pass a resolution on whether to defend the Arbitration or not.

24. By a letter dated 28 May 2012, Zhouwrote to the other directors to inform them that CIETAC had agreed to an extension of the deadline for the filing of defence by the Company (originally due on 31 May 2012), but the new deadline was to be confirmed.

25. By a letter dated 31 May 2012, Fresh Gain wrote to Zhou’s camp, the Company and CVE to request them to notify all the directors of the deadline for filing of the defence of the Company as soon as the said deadline was confirmed, so that all parties could discuss how the Arbitration may be “actively contested” (积极抗辩).

26. A Counsel’s Opinion was obtained by Fresh Gain, which was sent to all directors, in which Counsel set out his opinion that the Company has a good defence to the claim made by Lenovo Star and Legend New-Tech in the Arbitration.

27. By a letter dated 4 June 2012 issued by the Plaintiffs to the other directors (the letter also enclosed the Counsel’s Opinion referred to above), the Plaintiffs proposed that a litigation committee be established.  They also pointed out that as Zhouand his son, Zhou Mengkui, are personal guarantors of the Loan (and have been sued as such by Lenovo Star in proceedings commenced by Lenovo Star in the Intermediate People’s Court of Beijing Municipality against Haoyue and others), they have a conflict of interest in the matter and should not be involved in the conduct or handling of the Arbitration.

28. By a letter dated 5 June 2012, Zhou replied on behalf of the Company informing the other directors, amongst other things, that the Arbitration was fixed for hearing on 21 June 2012 and that the Company was required to submit its defence and other supporting evidence by 15 June 2012.

29. As no Defence was filed by the Company, the Plaintiffs then took upon themselves to file a Defence on behalf of the Company on 15 June 2012

30. The arbitral tribunal held a hearing on 21 June 2012.  Both the Plaintiffs and Zhou’s camp appointed legal representatives to attend the hearing, but their authority to represent the Company was questioned by the arbitral tribunal.  The tribunal apparently took the view that in the absence of proof of any authority by anyone to repressent the Company, the Company would be treated as being in default in defending the proceedings.  The tribunal pointed out to the Plaintiffs that they may apply to the Hong Kong court to obtain a decision on who may represent the Company, and that they should notify the tribunal should any such application be made to the Hong Kong court.

31. The Plaintiffs then commenced the present proceedings in the Hong Kong court by taking out an Originating Summons on 4 July 2012.  They reported to CIETAC of the commencement of the proceedings on 5 July 2012, and requrested for a stay of the proceedings in the Arbitration pending the resolution of their application to the Hong Kong court.

32. Lenovo Star objected to the stay and requested the tribunal to hear the Arbtiration as soon as possible.

33. A second hearing was held by the arbitral tribunal on 26 September 2012 in which the following directions were made:

(1) The tribunal would not accept new evidence;

(2) If Lenovo Star and Legend New-Tech considered necessary to reply in writing or to supplement their reply to the arbitrator’s questions raised at the second hearing, they should make their submissions before 20 October 2012;

(3) The tribunal did not recognise the status of the representative of the Company as the respondent to the Arbitration.  Unless the Company reached consensus for defence or by resolution of the board of directors or by order of the Hong Kong court appoint receivers to conduct its defence, the tribunal would not accept any submission or statement made on behalf of the Company for consideration;

(4) Unless docmentary proof was provided to the tribunal by 20 October 2012 that satisfied the tribunal on the representation of the Company, the tribunal would proceed with the Arbitration in the absence of the Company.

34. It was in these circumstances that Mr. Benjamin Yu S.C., leading Mr. Victor Dawes and acting for the Plaintiffs, made the submission to me that the Company was in a deadlock, and that there was an urgency for the appointment of interim receivers to take charge of the conduct of the Company’s defence in the Arbitration, as there was a grave risk that the tribunal would proceed with the Arbitration in default of any defence or representation by the Company.

35. In light of the indication given by the tribunal of its intention to proceed in the absence of the Company (unless documentary proof was provided to the tribunal before 20 October 2012 that resolved the question of authority/representation to the satisfaction of the tribunal), I accept that there is an element of urgency in the present case.

DISCUSSION

36. I have no doubt that I have the jurisdiction to appoint a reciever if I am satisfied that the Company is incapable of managing its own affairs by reason of the absence of a properly constituted board or deadlock on the board of directors.  Section 21L of the High Court Ordinance (Cap.4) confers a very wide jurisdiciton on the High Court to appoint a receiver “in all cases in which it appears to the Court of First Instance to be just or convenient to do so”.  I have no doubt, as stated in Lightman and Moss:The Law of Administrators and Receivers of Companies, 4^th edition, para 29-003, that in a case where a company is incapable of managing its own affairs by reason of a deadlock on the board of directors, the Court may appoint a receiver to the company.  Such a situation may render it just and convenient for the exercise of the Court’s power under section 21L.

37. As Tang VP (as he then was) observed in Achieve Goal Holdings Ltd v Zhong Xin Ore-Material Holding Company Limited, CACV 324/2008, 24 November 2008, citing Lightman and Moss (supra, at para 29-014):

“... court-appointed receivers and managers, such as those appointed pendng resolution of litigation to determine who should manage the company, may have far-reaching powers of managenent.”

38. Moreover, as pointed out in Halsbury’s Laws of England, 5^th edition, 2009, Vol. 14 at para. 535:

“Where powers are delegated by the company to the directors, and the directors owing to dissensions and quarrels between them are unwilling or unable to act, the powers may be exercised by the company. If, owing to disputes amongst the directors, they are unable to act and the affairs of the company cannot be carried on, the court will interfere by injunction and by the appointment of a receiver and manager of the undertaking and assets of the company until the management of the company is restored to a proper footing.”

39. The present case is of course not a case of a company not being able to manage its affairs generally.  Certainly on certain matters, the board of the Company was perfectly able to make decisions.  A clear example is the board meeting held on 12 October 2012, when the board passed a resolution to reject the proposal of Zhou’s camp to appoint Messrs Dechert to represent the Company in the present proceedings.

40. What is clear to me, however, is that in the present case the board was simply unable to decide whether to defend the Arbitration or not.  For reasons that I am not entirely clear, the remaining 5 directors (aside from the Plaintiffs and the Zhou’s camp) appeared to be unable to make up their mind on whether to side with the Plaintiffs or Zhou’s camp on the question of defending the Arbitration.

41. As pointed out above, there was an element of urgency in this case as the arbitral tribunal had indicated that it would proceed with the Arbitration in the absence of the Company if the question of authority/representation was not satisfactorily resolved by 20 October 2012.

42. I have already indicated that I am satisfied that the Company have an arguable defence in the Arbitration and that it is clearly in the interest of the Company to defend the Arbtiration rather than having it resolved by default of defence.

43. In the circumstances, I am satisfied that there was a “deadlock” in the board of the Company in the sense that the board was not able to function properly by responding to the urgent situation imposed upon the Company.  As far as the Arbitration was concerned, the board was not able to manage the affairs of the Company properly and it is just and convenient for the Court to appoint a receiver to the Company to protect the Company’s interest in the Arbitration. I was therefore prepared (subject to the Undertakings mentioned above and further discussed below) to grant the Order.

44. Obviously the response of the Court to such a situation must be proportionate.  The Court’s intervention is merely to ensure that the Company’s interest in the Arbitration is properly protected.  There is no question of the assets of the Company being at risk and no question for intervention by the Court in that regard. Accordingly, in granting the Order I have specifically limited the powers of the Interim Receivers to the conduct of the Arbitration (with incidental powers necessary for such conduct).

45. In the course of the submissions of Mr. Yu, S.C., I indicated my concern on whether there was a need for the appointment of interim receivers if a litigation committee proposed by the Plaintiffs could be established to conduct the Arbitration on behalf of the Company.  Mr Yu S.C. helpfully took instructions and offered the Court with an Undertaking that the Plaintiffs would exercise reasonable endeavours in liaising with the other directors of the Company with the view to establish (if possible) a litigation committee acceptable to the board of directors of the Defendant (subject to compliance with the provisions of certain agreements which I do not need to detail here) with the mandate and power to make decisions on behalf of the Company (including instructing legal representatives for the Company) in the Arbitration.  The Plaintiffs further undertook to apply to the Court immediately for direcitons upon such a litigation committee being established.  The Order was accordingly made upon these Undertakings given by the Plaintiffs.