DAVID CHIEN v. FRANCIS CHEUNG AND OTHERS

HCMP 2892/2012

IN THE HIGH COURT OF THE

HONG KONG SPECIAL ADMINISTRATIVE REGION

COURT OF FIRST INSTANCE

MISCELLANEOUS PROCEEDINGS NO 2892 OF 2012

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D E C I S I O N

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Background

1.  By these proceedings, the plaintiff (“Chien”) seeks from the court, under section 350B of the Companies Ordinance (“Ordinance”) and under the court’s inherent jurisdiction, an injunction to restrain the defendants from engaging in any act or conduct to perform, or further the performance of, an Agreement for sale and purchase of the shares in Tysan Foundation (Hong Kong) Limited (“Foundation”) dated 12 November 2012 (“Agreement”).  The Agreement was entered into between Tysan Holdings Limited (“Company”) and Fortunate Pool Limited (“Fortunate”), for the Company’s sale of 40% of its shareholding in Foundation to Fortunate at a price calculated by reference to the net asset value (“NAV”) of Foundation.

2.  Chien claims that the terms of the disposal of Foundation are not in the interests of the Company and that the defendant directors were in breach of their duties owed to the Company in approving the transaction.

3.  The Company is a Bermudian limited company registered under Part XI of the Ordinance, and is listed on the Main Board of the Hong Kong Stock Exchange (“Exchange”).  The Company and its subsidiaries (“Group”) operate business in Hong Kong, Macau and Mainland China.  Foundation is a wholly owned subsidiary of the Company which operates the foundation piling business of the Group.

4.  Chien holds about 11.58% of the issued share capital of the Company.  He and the defendants are all directors of the Company.  Victor Fung (“Fung”) is another director of the Company, who holds 8.58% of the shares of the Company.  The 1st defendant (“Cheung”) is the Chairman of the Board of directors and the single largest shareholder of the Company, holding about 40.59% of its shares.  Both Chien and Fung are substantial minority shareholders of the Company.  Fortunate, the purchaser named in the Agreement, is a company wholly owned by Fung.

5.  Chien claims that Foundation is regarded as a leader in the foundation industry, holding about 25% to 30% of the market share.  It is an approved contractor of the Development Bureau, the Housing Authority and the Building Department of the Hong Kong Government, and holds the licences required to carry out foundation and land piling works in Hong Kong and Macau.  According to Chien’s evidence, Foundation is a thriving business.  According to the Company’s public announcement dated 12 November 2012, its net profit after tax for the year ended 31 March 2011 was HK $103,480,000, and for the year ended 31 March 2012, the net profit after tax was HK $160,686,000.  According to the Company’s 2012 Annual Report, Foundation’s business contributed to 94.5% of the total revenue generated by the Company in the financial year.

6.  On Chien’s evidence, he received by e-mail on 17 October 2012 notice of a board meeting (“Notice”) of the Company, to be held on 12 November 2012 (“Meeting”), to approve “proposed major and connected transactions” of the Group.  No further details of the transactions were given in the Notice, and Chien telephoned the 2nd defendant (“Kwok”) to ask for an agenda for the Meeting (“Agenda”).  He was informed by Kwok that the Agenda was being prepared and would be circulated. 

7.  On 8 November 2012, Chien received the Agenda, which contained an item: that the board was “to consider and approve the proposed connected transactions (and the terms and conditions thereof), brief particulars of which are set out in the Schedule attached”.  The schedule attached to the Agenda (“Schedule”) states that “preliminary consideration and negotiations” had been undertaken for the Company to sell 40% of its equity share interest in Foundation (“Disposal”) to Fung, a director of the Company, conditional on the approval of the shareholders of the Company and compliance with the Listing Rules of the Exchange.  The Schedule further states that the Proposal was to be at a consideration to be agreed (“Consideration”), and that it was intended that the Consideration would be “at a fair value to be determined and agreed to by the parties taking into consideration, inter alia, the net asset value of (Foundation)”.  It was stated in the Schedule that as at 31 March 2012, the net asset value of Foundation was approximately HK $284.8 million. 

8.  The Schedule further states that in considering the proposed Disposal, the directors might wish to consider the importance of maintaining the continuity, stability and growth of Foundation’s business, “by establishing a long-term and closer relationship” with Fung, as well as the merits of the Company having an opportunity to realize and receive cash proceeds from the Disposal.

9.  Chien claims that he had only been given slightly more than one working day’s notice of the Meeting, with scanty particulars of the proposed Disposal, and was not provided with any draft documentation for the Disposal.  Chien further claims that at the Meeting, there was only a brief discussion on the Disposal. According to Chien, Cheung proposed at the Meeting that the Consideration for the Disposal should be equivalent to 40% of the unaudited combined NAV of Foundation and its subsidiaries as of 30 September 2012, which amounted to approximately HK $120 million.  Chien claims that despite the apparent lack of time and of information for proper consideration by the directors, and despite his suggestion to adjourn the discussion until the next board meeting on 26 November 2012, the Disposal was swiftly agreed to by all the directors at the Meeting - apart from Chien, who chose not to vote on the basis that he had not been provided with adequate time and information to consider the matter, and Fung who abstained from voting due to his interest in the Disposal.

10.  Chien claims that Cheung had pointed out to the directors at the Meeting that the primary reason for the Disposal was to reward Fung for his contribution made to the Company over the years.  On Chien’s case, the directors voted to approve the Disposal, without raising any question or seeking any information on the details, or the reasonableness of the proposed Disposal.

11.  Although the Schedule to the Agenda had stated that “preliminary consideration and negotiations” had been undertaken in respect of the Disposal, the Agreement for the sale and purchase of Foundation was signed immediately after the Meeting, on 12 November 2012.  A copy of the Agreement was obtained by Chien only on about 16 November 2012.  Chien claims that the draft of the Agreement had not been tabled at the Meeting, and that its terms had not been drawn to the attention of the directors at the Meeting.

12.  The Agreement provides that completion of the sale and purchase of the Disposal was to take place not later than 31 January 2013.  Under clause 6 of the Agreement, the Company is to pay HK $6 million to Fortunate as liquidated damages if the Company should default in proceeding to completion, except by reason of non-fulfillment of the conditions precedent.  Under the Agreement, a Shareholders’ Agreement (“Shareholders’ Agreement”) is to be executed by the parties upon completion of the Disposal.  Chien complains of the fact that under clause 5 of the Shareholders’ Agreement, Fortunate is to be granted a call option (“Option”) to acquire an additional 15% maximum of the issued shares of Foundation, at NAV, if any person or entity, who holds less than 30% of the issued shares of the Company as at the date of the Agreement, should at any time thereafter increase its shareholding in the Company to 30% or more.

13.  According to Chien, the Disposal under the Agreement is not in the interests of the Company, as it is at a gross undervalue.  He claims that it is extremely unusual for a consistently profitable business like Foundation to be sold as a going concern on the basis of its net assets value.  According to the report of Deloitte, engaged by Chien to provide an opinion on the fair market value of the Company’s 40% interest in Foundation, an assets approach was not appropriate for a profitable going concern such as Foundation, and on an estimate of a maintainable net profit of between HK $98 million and HK $110 million for Foundation, the fair market value of 40% equity of Foundation is worth HK $278.6 to HK $312.7 million.  The Consideration under the Agreement, based on the NAV of Foundation, is HK $121 million which, on Deloitte’s valuation, is undervalued to the tune of over HK $150 million.  It is claimed by Chien that the defendants had acted in breach of their duties as directors of the Company in approving the Disposal at undervalue, and that Fung had participated in or had notice of the directors’ breach.

14.  It is further claimed by Chien that Cheung had failed to disclose at the Meeting that he had an interest in the Disposal, in that the Option to be granted to Fortunate upon completion of the Disposal not only allows Fung (through Fortunate) to gain majority control of Foundation, but had the practical effect of bolstering the position of Cheung as the single largest shareholder of the Company.  Whereas currently, Cheung is the only shareholder who has interests in over 30% of the shareholding of the Company, by granting the Option to Fung, any shareholder apart from Cheung (whose shareholding already exceeds 30%) and any new investor would be very hesitant to acquire shares in the Company which would bring their shareholding to over 30%, because by doing so, they would trigger the operation of the Option, and give Fung the right to acquire a controlling stake in Foundation and the principal business of the Group.

15.  Although completion of the Agreement is subject to approval of the Disposal by the shareholders of the Company, Chien claims that Cheung holds over 40% of the Company’s shares, and considering the usual apathy and non-attendance of shareholders at general meetings, it is an almost certainty that Cheung and those associated with Cheung would be able to secure the passing of an ordinary resolution to approve the Disposal, irrespective of any opposition from other minority shareholders.

16.  On 21 December 2012, a Supplemental Agreement was entered into between the Company and Fortunate, whereby the latest date for fulfillment of the conditions precedent and the latest date for completion were changed to 30 June 2013, and 31 July 2013 respectively.

17.  On 27 December 2012, Chien issued the first Originating Summons for an injunction to restrain the directors from engaging in any act to perform the Agreement (“1^st Originating Summons”).  The defendants applied on 24 January 2013 to strike out the 1^st Originating Summons, on the ground that Chien was not registered as a shareholder of the Company at the date of its issue, and had no locus standi to make claim under section 350B of the Ordinance.  On 30 January 2013, Chien issued a second Originating Summons (“2^nd Originating Summons”) for the same injunctive relief he originally claimed, after procuring the transfer of his shares in the Company from CCASS into his own name on 21 January 2013. 

18.  On 30 January 2013, Chien served notice on the Company under section 168BD of the Ordinance, stating his intention to apply for leave to bring statutory derivative proceedings on behalf of the Company under section 168BC.  On 22 April 2013, he issued proceedings by HCMP 841/2013 (“HCMP 841”) for leave to commence such proceedings against the Company.  The first hearing of HCMP 841 came before me on 6 May 2013, at the same time as the adjourned hearing of Chien’s application for injunctive relief and the defendants’ striking out application.

19.  The defendants’ response and opposition to Chien’s claims is manifold. 

20.  First, they raise factual disputes as to the events before and at the Meeting.  Cheung and Kwok deny Chien’s assertion that prior to the circulation of the Agenda, the directors did not have knowledge of the proposed Disposal.  Cheung claims that prior to the Meeting, he and Fung had “discreet and informal discussions” with all the executive directors of the Company, other than Chien. Kwok claims that the directors, other than Chien, “had varying levels of knowledge of the Proposed Disposal” prior to the Meeting.  The reason why there was no discussion with Chien was simply because he was never in the office, had all along been indifferent to the Company’s operations and business, and had only occasionally attended meetings of the Board by telephone.

21.  Next, they dispute Chien’s claim that he had asked for an adjournment of the Meeting, and had abstained from voting at the Meeting.  According to the defendants’ evidence, Chien was heard to say “yes” or “agree” when the directors voted on the Disposal.  The defendants also deny Chien’s claim that they had approved the Disposal without asking questions and without detailed discussion on the Disposal.  The manuscript notes of the Meeting (“Notes”), taken by the secretary, were produced to support the defendants’ assertions in these respects, and to show that the minutes of the Meeting (“Minutes”) were not inaccurate, as Chien had also alleged. 

22.  Kwok claims that the draft Agreement and documents were all available in the Company’s office, and that Chien would have been able to obtain these documents for perusal, if he had bothered to return to the office.  The defendants accordingly deny that any information had been withheld from Chien.

23.  The above factual disputes have to be determined at trial or the substantive hearing of the action.

24.  The gravaman of the defendants’ case is that Chien is simply a disgruntled director who has been outvoted by the majority on the board, and that there is no substance to his claim that the Disposal is at an undervalue or that the directors are in breach of their duties.  The defendants claim that they are all experienced businessmen, and had been fully aware of alternative valuation methods for the 40% interest in Foundation, but it was their decision that the commercial justification for the Disposal is the maintenance of a long-term and closer relationship with Fung, and that it would be in the interests of the Company to align the Group’s interests with the interests of Fung, thereby maintaining the long-term continuity, stability and growth of Foundation.

25.  The defendants claim that contrary to Chien’s assertion that all the directors had voted to approve the Disposal, the independent non-executive directors did not in fact vote at the Meeting, in order to preserve their position pending receipt of the opinion of the independent financial advisers, as required under the Listing Rules for the Disposal.

26.  Under the Listing Rules, the Company is required to seek shareholders’ approval of the Disposal before the Company can proceed with completion under the Agreement.  Leading Counsel for the defendants argued that if the shareholders do not approve the Disposal at the general meeting, the Disposal cannot proceed and there is no sale of Foundation at an undervalue, and no breach by the defendants of their duties as directors.  It has been highlighted that the Company is required under the Listing Rules to make full disclosure to the shareholders of all relevant information concerning the Disposal, including the fact of Fung being a connected person, and the interests of any other person connected with the Disposal.  If, after such full disclosure and with the benefit of all relevant information, including the advice of independent financial advisers and independent non-executive directors, the shareholders of the Company should approve the Disposal at a general meeting, Leading Counsel for the defendants argued that Chien cannot complain about the directors’ acts, which have been approved by the majority of the shareholders, as he will simply be a minority shareholder who has been effectively outvoted.

27.  Mr Manzoni SC emphasized that the Exchange will be, and has been, reviewing and approving the documents to be issued by the Company and to be submitted to the shareholders, to ensure that the disclosure obligations of the Company are complied with, and that the Disposal is fair, reasonable and in the interests of the Company.  The Exchange is exercising its regulatory role and duties, and the court should neither usurp the powers of the Exchange, nor preempt the Exchange from making its regulatory decisions, and the independent shareholders of the Company from making a commercial decision at the general meeting, as to whether to accept or reject the Disposal.

28.  The defendants have further raised technical objections to Chien’s application for injunction, as follows.

Any substantive claim?

29.  It was argued on behalf of the defendants that Chien has no substantive claim against them to support any application for injunction.  The defendants claim that at best, Chien only has a pending application (which was not issued until 22 April 2013) for leave to commence a derivative action under section 168BC of the Ordinance.  Mr Manzoni goes further to argue that because Chien’s applications under the 1^st Originating Summons and the 2^nd Originating Summons only seek an interim injunction pending the derivative action, these originating summons proceedings cannot be regarded as the substantive proceedings for final relief. 

30.  Both the 1^st Originating Summons and the 2^nd Originating Summons invoke the inherent jurisdiction of the court, in addition to section 350B of the Ordinance.

31.  For reasons which will be set out below, I am satisfied that there is a serious question to be tried as to whether the defendants are in breach of their duties as directors, and whether the Disposal is at an undervalue and not in the interests of the Company.  I do not accept Mr Manzoni’s submission that Chien’s cause of action on the Disposal being a fraud on the minority is unparticularized.  It is clear from Chien’s evidence that he is claiming that the defendants’ approval of the Disposal at undervalue amounts to a breach of their fiduciary duties, and/or an exercise of their voting power for improper purpose.  Whether Chien proceeds by way of a statutory derivative action under section 168BC of the Ordinance, after obtaining leave of the court in accordance with the procedure set out in Part IVAA of the Ordinance, or by exercise of his common law right as a member of the Company, Chien has a recognized legal right to restrain an unlawful act.  In such case, there can be no doubt that the court may grant an injunction, including an interim injunction, where it is just or convenient to do so for the purpose of protecting or asserting the legal rights of the parties (North London Railway Company v Great Northern Railway Company (1883) 11 QBD 30, 39).  To accede to Mr Manzoni’s submission, as to the court’s lack of power to grant an interim injunction, would indeed be a triumph of form over substance, as White J so clearly explained in the Australian case of Fayad v Bellpac Pty Ltd [2004] NSWSC 755.

32.  The court’s power and jurisdiction to grant interlocutory relief is not limited to the granting of relief in aid of the final relief sought in the same proceeding.  In a case of urgency, the court has power to grant interim relief even in the absence of substantive proceedings, upon undertakings by an applicant to issue proceedings within a specified time to assert legal rights in respect of the matters complained of.  The defendants say that no urgency has been established in this case, as can be demonstrated by the fact that the Meeting took place in October 2012, but Chien only saw fit to commence HCMP 841 in April 2013.  Nevertheless, the very broad inherent jurisdiction of the court is reflected in the dictum of Jessel MR in Smith v Peters (1875) LR 20 Eq 511:

“I have no hesitation in saying that there is no limit to the practice of the court with regard to interlocutory applications so far as they are necessary and reasonable applications ancillary to the due performance of its functions, namely, the administration of justice at the hearing of the cause. I know of no other limit.”

33.  As to whether section 350B (1) of the Ordinance envisages the grant of relief by a permanent injunction only (as Mr Manzoni claims), subsection (1) itself provides that the injunction may be granted “on such terms as the court considers appropriate” if “in the opinion of the court it is desirable to do so”. The power of the court under section 350 (1) is to grant an injunction to restrain, amongst other things, a person’s “breach of his fiduciary duties” as a director of a company.  If there is a serious question to be tried of a breach of fiduciary duties, I see no reason why the court should be precluded from granting an injunction in the interim of the member’s commencement of separate proceedings in respect of the breach (if the member so chooses), or until the trial of the derivative action, on such terms as the court considers appropriate. 

34.  In any event, Chien has on 22 April 2013 commenced HCMP 841 for leave to commence a statutory derivative action against the defendants, and there is a serious question to be tried as to whether leave would be granted to Chien.  For leave to be granted under section 168BC (3) of the Ordinance, Chien only needs to establish to the court that “it appears to be prima facie in the interest of the specified corporation” that leave be granted, and that there is a serious question to be tried.

35.  It is clear in my view that the court has power to grant an injunction in the interim of the court’s determination of Chien’s application for leave in HCMP 841, or until further order, whether to be made under section 350B or section 168 BC of the Ordinance.  So long as the court is satisfied that the defendants are about to commit a misfeasance, or that a wrongful act is imminent, the court has jurisdiction and power to grant a quia timet injunction to restrain the wrongful act or misfeasance which is imminent but has not yet commenced, if it is necessary and just so to do.

36.  The defendants have argued that there is no breach of duties on their part, as the shareholders have yet to approve the Disposal, and the Disposal will be reviewed by the Exchange before it is put to the shareholders.  Although the Disposal has not yet taken place and completion is subject to shareholders’ approval, the board of directors have resolved at the Meeting to approve the Disposal.  If their approval is not in the interests of the Company because the Disposal is at an undervalue, they are already in breach of their duties as directors of the Company, and there is “a factual situation the existence of which entitles (Chien) to obtain from the court a remedy against another” (per Diplock LJ in Letang v Cooper [1965] 1 QB 232 at 242).  I do not agree that Chien does not have any cause of action against the directors just because the shareholders have yet to consider the Disposal and they may yet approve it.  As Mr Yu SC, leading counsel for Chien points out, misfeasance by the directors cannot be ratified by the shareholders in general meeting.  Such ratification does not have the effect of preventing any member from bringing a derivative action under s168BC (s 168BF), or from applying to the court for leave under s168BC. 

37.  It would be astonishing in my view for a director of a company, and a listed company in particular, to suggest that he is not in breach of his duties owed to the company by failing to properly consider a major transaction to be entered into by the company, because the transaction can be, and has yet to be, considered by the shareholders who can make their own decision on information to be provided by the company to them.

38.  Directors are appointed on the basis of their experience and expertise, and are entrusted on that basis with the management of the business of the company.  In law, they have the obligation to carry out their duties with the care and skill expected of them, and they are custodians of the assets in their control for the company and its shareholders.  As directors, they also have fiduciary duties of utmost good faith, and cannot exercise their power for improper purposes, for their own benefit or otherwise than for the benefit and in the best interests of the company for which they act.  Directors of public companies are under the same if not more onerous duties, bearing in mind that they are governed by the Listing Rules, and considering the fact that public investors look to them for the proper governance of the company and its compliance with the Listing Rules.  It is not open to any director, whether labelled independent or not, to delegate his duties back to the shareholders, for them to consider whether the transactions of the company, which transactions the directors were called upon to approve, are in the best interests of the company and commercially justifiable, or not.  The defendant not only have the right, as they have chosen to highlight, but also the duty, to decide where the Company’s interests lie.

39.  Nor can the directors excuse their lack of vigilance or their failure to act prudently and in the best interests of the company, by their expectation that the Exchange will be carrying out its duties to examine the public company’s proposed transactions, in discharge of the Exchange’s own duties of ensuring a fair market. 

Any breach of duties by directors?

40.  In considering whether the defendants as directors had in any way acted in breach of their fiduciary duties, I bear in mind the observations made by the court in Howard Smith Limited v Ampol Petroleum Limited [1974] AC 821, at 835, in its consideration of whether the directors in that case were abusing their fiduciary powers for an improper purpose, and it was alleged that they were acting honestly:

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

41.  In delivering the judgment of the court, Lord Wilberforce further explained at page 832 :

“… when a dispute arises whether directors of a company made a particular decision for one purpose or for another, or whether, there being more than one purpose, one or another purpose was the substantial or primary purpose, the court, in their Lordships’ opinion, is entitled to look at the situation objectively in order to estimate how critical or pressing, or substantial or, per contra, insubstantial an alleged requirement may have been. If it finds that a particular requirement, though real, was not urgent or critical, at the relevant time, it may have reason to doubt, or discount, the assertions of individuals that they acted solely in order to deal with it, particularly when the action they took was unusual or even extreme.”

42.  As to whether directors had their own interest to serve when making a decision, Lord Wilberforce had this to say (at page 834):

“Further it is correct to say that where the self-interest of the directors is involved, they would not be permitted to assert that the action was bona fide thought to be, or was, in the interests of the company; ...

But it does not follow from this, as the appellants assert, that the absence of any element of self-interest is enough to make an issue valid.  Self interest is only one, though no doubt the commonest, instance of improper motive: and, before one can say that a fiduciary power has been exercised for the purpose for which it was conferred, a wider investigation may have to be made.”

43.  Adopting this approach, the court should look objectively at all the circumstances of the directors’ exercise of their duties and powers, giving respect to their judgment as to any matter of management and credit to the bona fide of their opinion, but that is not enough.  The court should also consider, objectively, whether it can be said that the decision made by the directors is fair, and in the interests of the Company.

44.  The importance of an objective test was also accepted by Knox J in Smith v Croft (No 2) [1988] 1 Ch 114, as he cited (at p 161) passages from the judgment in In re Halt Garage (1964) Ltd [1982] 3 All ER 1016:

“Counsel for the liquidators submits, however, that if this is right it leads to the bizarre result that a meeting of stupid or deranged but perfectly honest shareholders can, like Bowen LJ’s lunatic director, vote to themselves, qua directors, some perfectly outlandish sum by way of remuneration and that in a subsequent winding up the liquidator can do nothing to recover it. It seems to me that the answer to this lies in the objective test which the court necessarily applies. It assumes human beings to be rational and to apply ordinary standards. In the postulated circumstances of a wholly unreasonable payment, that might, no doubt, be prima facie evidence of fraud, but it might also be evidence that what purported to be remuneration was not remuneration at all but a dressed up gift to a shareholder out of capital…”

45.  It is with this approach in mind that I turn to the evidence on the directors’ decision, and the process by which the decision was reached, that the Disposal is in the interests of the Company and approved.

Method of valuation

46.  It has never been suggested that the Company required financing and that the Disposal was to generate funds for the Company or its subsidiaries.  The defendants have sought to justify the Consideration in various ways.

47.  It is the defendants’ case that the major reason for the Disposal is the benefit of retaining Fung as the key person in the Company, and aligning Fung’s interests with the interests of the Group.  Cheung explained that in around August or September 2012, Fung had mentioned to him that “he had been offered an opportunity by one of his friends to join them in an investment project”.  Cheung said he “had the impression that (Fung) was seriously considering making a significant investment in that project”.  According to Cheung, he recognized that if Fung were to invest substantially in the project concerned, which would be his own business, this new business might seriously draw his focus away from the Group.  Cheung explained that although there was never any threat of departure communicated by Fung to him, Cheung had “sensed” that should Fung pursue his own business in a significant way outside the Group, it could realistically lead to his departure from the Group.  As Cheung himself was considering his own retirement plans, and as Fung was considered to have made “unique contributions to the construction and piling business of the Company” (according to Kwok’s evidence), Cheung recognized that should Fung leave the Group before Cheung retired, it would pose a considerable problem for the Group.

48.  Cheung’s evidence is that in order to keep Fung committed to the Company, the Company, Fung or Fung’s family should “join in a co-investment project”.  Fung’s response was that he might acquire a significant minority share in the foundation business of the Group, instead of investing in his friend’s investment project.  According to Cheung, Fung’s initial suggestion was to pay a proportionate amount at a discount to the combined net asset value of Foundation and its subsidiaries, but Cheung considered this to be “a bit on the low side”.

49.  Cheung claims that he was keen to retain Fung within the Group, since he did not know how to run the foundation business (despite his being the Chairman of the Group).  He involved Kwok to advise him in his negotiations with Fung and to act as a go-between, since Cheung wanted to ensure that the negotiations with a party connected to the Company were at arms’ length, in the interests of the Company and in compliance with the regulatory requirements. 

50.  According to Cheung, in coming to an agreement on the Consideration, he was aware of the other key methods of valuing the business, including a price earnings ratio and a breakdown value.  However, he did not consider other methods of valuation to be appropriate for the Disposal.  The breakdown value was inappropriate since there was no intention to break up the foundation business.  Cheung claims that the foremost concern in his consideration of the Disposal was to secure for the foundation business of the Group “a continuous, stable and committed management through the formation of a strategic alliance with (Fung)”, and it was on such basis that he supported the Disposal.

51.  Cheung’s evidence is that he had taken into consideration a price earnings (“PE”) valuation for Foundation and its subsidiaries as a reference, but since the earnings of Foundation and its subsidiaries “are subject to fluctuation from year to year”, he considered that using a PE calculation to ascertain the value of Foundation on the basis of its “most recent year’s earnings” would not necessarily give a fair valuation of the business going forward.  According to Cheung, Kwok had reported to him that over a 6-year period, and after 3 consecutive years of losses, Foundation had generated an average of $89.3 million net profit a year, but that over a 10-year period, Foundation had contributed an average of only $46.7 million a year.  Cheung claims that based on these figures, he considered that a PE ratio for Foundation and its subsidiaries of 3.4 to 6.4 times average earnings, which was the PE for the Disposal, seemed reasonable.

52.  In particular, Cheung claims that the Consideration for the Disposal did not have to be identical to the consideration payable by a third party in an open market, because this would not take into account the strategic motivation for aligning the interests of Fung with that of the Group, and the Company would not have considered selling any interest in Foundation to any third party. Cheung highlighted that it was in the interests of the Company to retain Fung, and to have a buyer with the know-how and connections of Fung (paragraph 36 of his affirmation).

53.  Cheung explained (in paragraph 37 of his affirmation) that he ultimately came to the conclusion that the Consideration should be acceptable in principle, as he personally considered it to be reasonable in the circumstances, he knew that it would have to be vetted by the other directors before it was presented to the shareholders for their own determination, and the shareholders should not be deprived of the right to make a final decision whether or not to approve the Disposal after they have been appraised of the relevant information and the views of the independent financial advisers and of the independent non-executive directors.

54.  On the basis of the figures provided by Kwok to Cheung, Cheung had considered a PE for Foundation and its subsidiaries of 3.4 to 6.4 times its average earnings.  As Mr Yu pointed out, on that analysis, the value of the 40% interest in Foundation should be between $218.55 million to $411.3 9 million, by reference to the unaudited net profit after taxation of Foundation for the year ended 31 March 2012 (which is $160.7 million).  Under the Agreement, the consideration was $121 million.

55.  As evidence of the unstable or fluctuating income and profit contributed by Foundation, as referred to by Cheung, Kwok claims in her affirmation that whilst Foundation had contributed 133% to the profit of the Group for the 6 months ended 30 September 2011, its contribution decreased significantly to only 18.5% in the 6 months ended 30 September 2012.  Mr Yu has pointed out that this claim is highly misleading.  According to the Company’s Interim Report for 2012/2013, the Group sold its office property in Hong Kong for a consideration of $315 million.  The agreement for sale was entered into on 7 December 2011, and the sale was completed on 31 May 2012, with a profit of about $192 million recorded in this financial period.  This naturally distorted the profit contribution of Foundation to the Group for 2012.  I agree with Mr Yu that this throws doubt on the reliability of the assertions made by Cheung and Kwok, when they seek to downplay the profitability of Foundation and the importance of its contributions to the Group.

56.  Based on Deloitte’s valuation report of 1 March 2013, the fair market value of 40% equity interest in Foundation as of 12 November 2012 is estimated to be in the range of $278.6 million to $312.7 million.  If these figures are to be accepted, there is an under value of over $150 million.  In arriving at its valuation which was based on an estimate of the maintainable earnings of Foundation, Deloitte took into account its revenue and net profit for the years 2009, 2010, 2011, 2012 and the first half of 2013, arriving at an average estimated net profit of between $98 million to $110 million.

57.  The defendants have sought to criticize Deloitte’s valuation report, on the basis that it was “a desktop valuation”, with reliance only on information available in the public domain - since Deloitte did not have access to Foundation’s management when their analysis was prepared.  On the other hand, it is claimed that the defendants have direct and personal knowledge of the finances, prospects and intricacies of Foundation and its business. 

58.  Even if Deloitte’s valuation is not appropriate for Foundation, there is nothing in the evidence to show that the directors had before them at the Meeting, when the Disposal was put to them for approval, any form of objective valuation of the Company’s 40% interest in Foundation.  In her attempt to justify the directors’ approval of the Consideration for the Disposal, Kwok referred in her affirmation to the opinion of the independent financial adviser (“IFA”) appointed by the Company, Centurion Corporate Finance Ltd (“Centurion”).

59.  To the extent that Centurion relies on interviews with “senior management” of the Company and Fung, and discussions with the executive directors involved in the negotiations with Fung, for its understanding of and its views on the method of valuation, which is stated to be in contrast with Deloitte’s reliance only on public documents, it would appear from the evidence that the information which Centurion relied upon would have been obtained from Fung (who is interested in the Disposal as purchaser), Cheung (who claims in his affirmations to know nothing about the running of Foundation’s business), and the only other director said to be involved in the negotiations, Kwok.  Even leaving aside the plaintiff’s assertions of Kwok’s close association with Cheung, I have reservations as to whether it can be seriously maintained that Centurion was in a far more superior position than Deloitte in terms of assessing the adequacy of the valuation method used for the Consideration.  I cannot accept that there can be significant difference between the information known to the internal management of Foundation or of the Company, and that which is disclosed to the general investing public in the Company’s announcements, annual reports, financial statements and its other public documents, bearing in mind the obligations of the Company under the Listing Rules.  In particular, rule 2.13 of the Listing Rules provides that for any announcement or corporate communication of a listed company, the information contained in the document must be accurate and complete in all material respects and not be misleading or deceptive, by omitting material facts of an unfavourable nature.

60.  I do not consider that Centurion’s opinion, as expressed in its draft report, can support the directors’ decision.

61.  First, Centurion was only appointed as IFA after the Meeting, and their draft report was only produced in December 2012.  Centurion’s opinion, and their report (draft or otherwise), were not made available to the directors, who never took their views into consideration when they decided at the Meeting to approve the Disposal.

62.  Nor did Centurion express any independent view as to whether it was reasonable to use the method of valuation adopted for the Disposal, ie using the combined NAV of the Group as at 30 September 2012.  Centurion only pointed out that the Disposal was not driven by any financial gain purpose, and stated that they concur with the board on its decision that the Disposal confers a benefit on the Group.  In their draft report, Centurion states:

“Independent Shareholders should note that the Proposed Disposal is not driven by any financial gain purpose and while valuation of the Proposed Disposal could theoretically use other methods such as price earning multiple or cash flow multiple or enterprise value multiple, none of such methods was used to determine the value of the Sale Shares.  We understand this is because both parties to the Sale and Purchase Agreement have an in-depth understanding of the risks involved in the foundation business in general and as such, the basis of the net book asset value as represented by the Combined NAV as at 30 September 2012 has been agreed to by the parties to the Sale and Purchase Agreement as being fair and reasonable, in the light of the underlying reason for the Proposed Disposal.  On the basis of the various reasons for and benefits of the Proposed Disposal as set out in the section headed “3.  Reasons For and Benefits of The Proposed Disposal” immediately below, we concur with the Board on its decision to use Combined NAV as at 30 September as the basis for the Consideration and we are therefore of the opinion the Consideration is fair and reasonable.” (Emphases added)

63.  The reasons given in section 3 of Centurion’s report are those given by the directors, namely: that Fung is the key person in leading the Group, and is considered to be essential to its growth and development, for maintaining continuity and stability of the Group through establishing a long-term alliance with Fung ; the Company will continue to benefit from the growth in Foundation; the Company has the opportunity to receive cash proceeds from the Disposal; and the Disposal will give the shareholders an opportunity to share in the fruits of the Disposal.

64.  Centurion states, as its views on the valuation method and the Consideration, as follows:

“Following our interviews with senior management of the Company and Mr Fung, we are of the view that the Proposed Disposal is not driven by any short term financial gain or cash flow needs of the Tysan Group. The Proposed Special Dividend and the cash position of the Group as set out in the preceding section illustrates that the Tysan Group does not have the need for most (if not all) the cash from the Proposed Disposal. The Consideration of approximately HK $121 million in cash is therefore, not the reason for, but rather, the result of, the Proposed Disposal.

Apart from using the Combined NAV of Tysan Foundation, following our discussion with the Executive Directors involved in the negotiation with Mr Fung, we understand that (i) these Executive Directors were also aware of other alternative valuation methods such as price-earnings multiple, price-to-book ratio, discounted cash flow multiple or market comparables; and (ii) as set out in the “Letter From The Board”, the Consideration is the result of arm’s length negotiations between the parties concerned balancing the wishes and demands of the parties and the reasons for and benefits of the Proposed Disposal to the Company as conceived by the Executive Directors. Mr Fung, being the Vice Chairman and Managing Director of the Company, is the recipient of other executive incentives including stock option and bonus and are (sic) well aware of these incentives. We understand Mr Fung has initiated the negotiation for a 40% interest in Tysan Foundation at the outset.

The Proposed Disposal is solely driven by the need to align Mr Fung’s interests with that of the Tysan Group.  The Board has clearly come to a conclusion that the alignment of Mr Fung’s interests with that of the Tysan Group under the current circumstances is the right form of shareholding structure to bring the Business forward.”

65.  As Mr Yu pointed out, there is nothing in Centurion’s report to say that in its professional and independent view, the NAV is the appropriate and reasonable valuation method to be adopted for the Disposal.  All that Centurion has done in its draft report is to reiterate that the board had decided to use the combined NAV as at 30 September 2012 as the basis of the Consideration, that the directors involved in the negotiations were aware of other valuation methods, that the Company did not need the cash from the Disposal, and that the board wanted to align Fung’s interests with that of the Group.  At most, Centurion has stated, in its draft report, that it concurred with the board’s view, without a clear explanation as to why, objectively, it so concurred that the use of the NAV as at 30 September 2012 for the Consideration is fair, reasonable, and in the interests of the Company and the shareholders as a whole. It comes as no surprise that the Exchange has raised queries as to Centurion’s draft report since it came into being.

66.  Apart from Centurion’s draft report which was only provided after the event, there is no evidence that the directors had considered at the Meeting the valuation of Foundation on any other basis besides the NAV as at 30 September 2012, and how the valuation on the basis of the NAV would compare with other figures using a PE ratio or other methods of valuation, before they decided to accept the Consideration at NAV as being fair and reasonable.  Even accepting that the directors were prepared to agree to the Disposal to Fung at a discount for all the reasons they accepted, without knowing the difference between the NAV, and the fair market value of the Company’s 40% interest in Foundation, the directors cannot be seen to have fairly and reasonably concluded at the Meeting that the Consideration based on the NAV is reasonable, and in the interests of the Company.

Alignment of interest

67.  Leaving aside Deloitte’s valuation, since it is the defendants’ claim that the Consideration was in their mind justified by the benefit of establishing a closer relationship with Fung, there is a similar scarcity of evidence as to the directors’ consideration of whether the Disposal was the appropriate way to align Fung’s interests, and whether the interests of the Company were adequately protected in the alleged alignment.

68.  Mr Yu has highlighted the fact that even on the defendants’ evidence, there is no clear evidence that Fung had ever made clear, let alone threatened, any intention of leaving the Company.  Cheung’s evidence is simply that Fung had mentioned an opportunity to join his friends in “an investment project” - whatever that may mean, and it was only Cheung’s speculation that this might draw Fung’s focus away from the Group.

69.  According to the public documents of the Company, and there is no basis at all to doubt the accuracy of the documents of a listed company made available to the general public and its investors, the Company has all along awarded Fung generously for his contribution, in the form of substantial directors fees.  For the financial year 2011/2012, Fung received remuneration of $10.36 million (contrasted with Cheung’s remuneration of $13.22 million), which was an increase of 11.10% from the remuneration he received of $9.325 million for the financial year 2010/2011.  The relevant figures are as follows:

Financial Year	Remuneration to Victor Fung	Year to year percentage increase
2005/06	HK$2.703 million
2006/07	HK$3.34 million	+23.57%
2007/08	HK$7.665 million	+129.49%
2008/09	HK$7.396 million	-3.51%
2009/10	HK$7.253 million	-1.93%
2010/11	HK$9.325 million	+28.57%
2011/12	HK$10.36 million	+11.10%

70.  There is no evidence of the directors having considered or discussed at the Meeting the related issues of whether Fung’s remuneration from the Company would be reduced as a result of his acquisition of the 40% of the interests in and profit of Foundation, whether Fung would be committing to a definite period of service to Foundation, whether there was any assurance that after the Disposal of the 40% equity in Foundation to Fung, Fung would not take up the investment in his friend’s project (which Cheung was eager to avoid) or indeed, any other alternative form of incentive payments to Fung.  In short, even if the directors were prepared to consider conferring a benefit on Fung to secure his long-term alliance, they never made the necessary assessments to consider the magnitude of the benefit granted to Fung by virtue of the Disposal.  I do not dispute that directors of a company may consider it appropriate to pay generous remuneration to its director as a reward for his directorship, and that this is a matter of management for the board to consider.  Nevertheless, a decision to make payment to or to confer benefit on the director cannot objectively be said to be reasonably made, unless the directors have in the process of their decision taken into their proper and balanced consideration the relevant factors, including the factors concerning the interests of the company as well.  It is important to bear in mind that in this case, the reward or benefit conferred on Fung deprives the Company of its substantial asset and capital.

Benefit to Cheung

71.  The plaintiff further claims that there is a serious question to be tried whether the conduct of Cheung and Kwok in approving the Disposal amounted to a breach of their fiduciary duties and that they were not acting bona fide. The Option granted to Fung under the Shareholders’ Agreement had the effect of bolstering Cheung’s position as the single largest shareholder of the Company. Cheung had an interest in the Disposal which envisaged, as an express term of the Agreement, the signing of the Shareholders’ Agreement upon completion, but this was never disclosed at the Meeting.  This casts doubt on the bona fide of Cheung and Kwok who were chiefly responsible for the negotiations on the terms of the Disposal.

72.  The fact that Cheung was already a majority shareholder of the Company and the effect of the facility agreements between the Company and various banks, which require Cheung to retain control of at least 30% of the shares and voting rights in the Company, does not, as Mr Yu pointed out, answer the complaint made by Chien that the Option would deter other existing or new shareholders from acquiring over 30% of the Company’s shares.  In that way, the Option confers a benefit on Cheung by fortifying his position as the single largest controlling shareholder of the Company.

73.  Kwok’s evidence, that it was never the intention to give Fortunate the automatic right to acquire a maximum 15% of the shares in Foundation, is simply contradictory to the express provisions of clause 5 of the Shareholders’ Agreement, which provides:

“In the event that, at any time after the date of the Shareholders’ Agreement, there shall have a substantial change in beneficial ownership of Tysan Holdings (in manner defined) then Fortunate Pool shall have the option to require Tysan Holdings to sell to Fortunate Pool such number of the issued shares beneficially owned and registered in the name of Tysan Holdings up to a maximum of 15 percent of the issued share capital of (Foundation).” (Emphasis added)

74.  The defendants’ evidence of the telephone conversation between the solicitor of the Company and the representative of the Exchange, after the signing of the Agreement on 12 November 2012, that no option would be granted to Fortunate even after execution of the Shareholders’ Agreement is a complete change of position, to resile from the Agreement only after the Exchange had raised queries about Cheung’s position.  It is not a convincing explanation, or any explanation at all, as to Cheung’s interest under the Option and the Shareholders’ Agreement.

Conclusion on breach of duties

75.  All the above matters show that there is a convincing case that the directors had acted in breach of their duties, in approving the terms of the Disposal which are not in the interests of the Company, as the Disposal amounts to a sale of the most important and substantial business of the Group at undervalue.  A disposal of a company’s major asset at undervalue is misappropriation of the company’s asset, and I cannot accept that this can ever be a matter of internal management of the board, with which the court cannot interfere.  The case is totally distinguishable from Kwok Ping Sheung Walter v Sun Hung Kai properties Ltd [2009] 2 HKLRD 11, which deals with management decisions regarding the choice and appointment of the chairman and executive directors on the board, and with Kwok Shun On v Wong Sai Ming & Others [2001] 3 HKLRD 811, which deals with bona fide commercial decisions of the board.  Nor can a misappropriation of the company’s assets be a decision of the directors which can be ratified by the shareholders in general meeting.  The mere fact that a particular director does not personally benefit from the misappropriation (even if true) cannot alter the fact that it is a transaction at undervalue, not in the interests of the company and shareholders, and is accordingly not fair and reasonable.

76.  It is clear from the evidence of Cheung and Kwok how they view, and would as shareholders/directors vote on, the Disposal.  Even if the court should consider the votes of shareholders who may approve the Disposal, there is a substantial risk that Cheung and those associated with him would vote in order to support the directors’ decision to approve the Disposal, as opposed to their voting independently to secure the benefit of the Company, such that these votes should be disregarded.

Irreparable damage and balance of convenience

77.  Bearing in mind the shareholding of Cheung and those associated with him, I accept that there is a real possibility that they will be able to secure sufficient votes at the general meeting to support the defendants in the approval of the Disposal, unless injuncted by the court.  The business of Foundation and its subsidiaries is the main source of profit for the Company, contributing to about 94.5% of the total revenue generated by the Company in the 2012 financial year (according to the 2012 Annual Report of the Company).  The Company would lose its 40% interest in Foundation, and completion of the Agreement would set into motion the execution of the Shareholders’ Agreement which will, in turn, cause a fundamental change in the management structure of Foundation.  The Company, and the plaintiff as a minority shareholder, would be affected and damage would be irreparable.  On the evidence, there is also a likelihood that investors would lose confidence in the Company after its loss of a significant part of its main business, such that the share price of the Company would be adversely affected.

78.  Cheung’s evidence does not support the claim that Fung would leave the Company if the Disposal should fall through, or because an interim injunction is granted to restrain the implementation of the Disposal on its present terms.

79.  The injunction sought is to restrain the directors from performing the Agreement, and not a mandatory injunction.  Nevertheless, to the extent that the court has to be satisfied to a “high degree of assurance” that at the trial (or at the hearing of the application for leave to start a derivative action under section 168BC) it will appear that the injunction was rightly granted, I am satisfied that Chien has established that the defendants were in breach of their duties as directors of the Company.

80.  In all the circumstances, I consider that the balance of convenience and injustice is in favor of the grant of the interim injunction, in the terms sought, until the determination of Chien’s application for leave under section 168BC of the Ordinance, or until further order.

Striking out of 1^st Originating Summons

81.  Leading Counsel for the defendants submitted that the striking out application has become academic at the time of the hearing, since Chien had become a registered shareholder and issued the 2^nd Originating Summons.  On behalf of Chien, it was submitted that the striking out application was misconceived and should be dismissed, in the light of the decision in Re Luen Fat Paints Company Ltd HCMP 1791 of 2009, 11 February 2010.  Lam J (as he then was) held that a person who was not yet a registered member of a company could make an application under section 168BC of the Ordinance, so long as he was able to satisfy the court subsequently that he had become a registered member of the company by the time when leave was granted under section 168BC.

82.  Striking out should be reserved for cases which are clear and obvious.  In view of the decision in Re Luen Fat Paints Company Ltd, and also bearing in mind that the 1st Originating Summons (like the 2^nd Originating Summons) relies on the inherent jurisdiction of the court, in addition to section 350B of the Ordinance, I do not consider that the matter is a clear case for striking out.  It cannot be disputed that Chien at all material times held his shares in the Company through CCASS.  Nor can it be disputed that in law, CCASS has no beneficial interest in the shares deposited into CCASS, and that the proprietary interests in these shares remain in Chien (decision of Yuen J (as she then was), In the Matter of CA Pacific Finance Ltd ( in Liquidation) HCCW 36/1998, 17 December 1998).  Given the nature of a shareholder’s interests in shares held at CCASS, I consider that a flexible approach may be adopted by the court in the interpretation of “member” within the context, for both section 350B and section 168BC of the Ordinance.  I would adopt the same approach as Lam J did in Re Luen Fat, and find that Chien could make the application under section 350B so long as he can satisfy the court that by the time when the injunction is granted, he had become registered as a member of the company.

Orders

83.  For all the above reasons, I grant an injunction: to restrain the defendants, whether by themselves or their servants or agents, from directly or indirectly engaging in any act or conduct to secure the completion of the sale under the Agreement for Sale and Purchase of Shares of and in Tysan Foundation (Hong Kong) Limited dated 12 November 2012 entered into between Tysan Holdings Limited and Fortunate Pool Limited and the Supplemental Agreement to the said Agreement for Sale and Purchase entered into between Tysan Holdings Limited and Fortunate Pool Limited dated 21 December 2012, until determination of HCMP 841 of 2013, or until further order.   

84.  The defendants’ summons (issued on 24 January 2013) to strike out the 1^st Originating Summons is dismissed, with costs.

85.  Since the 1st Originating Summons is superseded by the 2^nd Originating Summons, I will not make any order on the 1^st Originating Summons, save that the costs of the filing of evidence in the 1^st Originating Summons, which evidence was ordered on 31 January 2013 to stand as evidence in the 2^nd Originating Summons, be included in the costs of the 2^nd Originating Summons.

86.  I make an order nisi that the costs of and occasioned by the 2^nd Originating Summons, including the costs of the hearing on 18 January 2013, 6 May 2013 and 10 May 2013 be paid by the defendants, with certificate for counsel.