RE YAOHAN HONGKONG CORPORATION LTD

HCMP2108/2000

IN THE HIGH COURT OF THE

HONG KONG SPECIAL ADMINISTRATIVE REGION

COURT OF FIRST INSTANCE

MISCELLANEOUS PROCEEDINGS NO.2108 OF 2000

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J U D G M E N T

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1. This is a petition under section 166 of Cap.32 for the court's sanction to a Scheme of Arrangement dated 27 May 2000 between Yaohan Hongkong Corporation Limited ("the Company") which is in liquidation and its shareholders.

2. The Company went into creditors' voluntary liquidation under section 228A of Cap.32 on 9 February 1998. Matthew Finbarr O'Driscoll and Wilfred Keith Timso ("the Liquidators"), partners in Ernst & Young were appointed provisional liquidators on that day and became joint liquidators on 9 March 1998. At the date of commencement of the winding-up, the Company's authorized capital was HK$135 million divided into 540 million shares of HK$0.25 each. 360 million of such shares had been issued and were fully paid-up or credited as fully paid-up.

3. The Company was a holding company and its principal operating subsidiary was Yaohan Department Store (HK) Limited ("YDS"). The Company was and remains listed on the Stock Exchange of Hong Kong Limited but on 18 September 1997, trading in its shares was suspended. YDS ceased operations on 20 November 1997 and the Liquidators were appointed provisional liquidators of YDS. As the Company was the major creditor of YDS, YDS's insolvency meant that the Company also could not, by reason of its liabilities, continue its business. The Company is hopelessly insolvent : its statement of affairs showed an estimated net deficiency regarding creditors of approximately $91 million. Since that date, additional proofs of debt have been lodged but not determined including what is known as the Macau claim of approximately $1 billion. The net deficiency may therefore be as much as $1.1 billion.

4. The Scheme forms part of an agreement entered into between (1) Asia Standard Hotel Group Limited ("ASH"); (2) Asia Standard International Group Limited, the parent company of ASH; (3) the Company (in liquidation) and (4) the Liquidators dated 27 April 2000 ("the Restructuring Agreement") which provides :

(a) for the payment by ASH of $9.5 million to the Company for distribution to its creditors and the allotment issued by ASH to the Company of 2.42 million shares of HK$0.10 each in the capital of ASH, also for the benefit of its creditors, and in each case subject to the payment of the costs and expenses of the liquidation of the Company; and

(b) by way of a scheme of arrangement, for the allotment and issue to the existing shareholders of the Company of 20 shares of HK$0.10 each in ASH for every 2,000 shares of HK$0.25 each in the Company held by the shareholders.

5. In substance the transaction contained in the Restructuring Agreement is identical to that considered by this court in Re Rhine Holdings Limited (in liquidation) HCCW 510 of 1998 (unreported), 29 March 2000. Admittedly, the scheme in that case was sanctioned in Bermuda, the place of incorporation of Rhine and the application to the Hong Kong court was for sanction under section 182 of Cap.32 to the transfer of all the issued shares of Rhine to the investor. But there is no material difference in the transactions or the nature of the asset involved : in each case, the companies concerned were listed on the Stock Exchange; they were hopelessly insolvent and the asset which the liquidators in each case sought to realize was a corporate asset. Because of the similarity of the transactions, it is necessary to consider Re Rhine Holdings Ltd more closely.

The effect of Re Rhine Holdings Ltd

6. The analysis of the nature of the asset in question is to be found in Re Rhine Holdings Ltd at pp. 6N - 9H. In brief, where the company is a public company listed on the Stock Exchange, its 'listing status' for want of a better description has a certain value to investors who desire to be listed. This is because under the Listing Rules as they stand, it is possible to obtain a listing by way of an "Introduction" under Rules 7.13 and 7.14(3) the effect of which is that the need for an initial public offering is dispensed with and the procedure shortened. Thus, even listed companies that have failed remain attractive to investors who wish to list on the Stock Exchange via the "Introduction" route.

7. The central issues that arose for consideration in Re Rhine Holdings Ltd was the nature of the asset being realized and the appropriate apportionment of the consideration between the creditors and the shareholders. Having concluded that it was a corporate asset, I went on to consider (at 9J - R) what (if anything) the shareholders could expect to receive out of the transaction :

"... In the context of the facts of Rhine, the shareholders can have no expectation of any return being made in the liquidation. Yet the transaction enables assets worth at least $5 million if not $6.5 million to be distributed to the Rhine shareholders when under the statutory order for application of assets, the shareholders stand to receive nothing. On further consideration, it would appear that the asset to be realized does have an unusual feature inasmuch as it can only be realized with the co-operation of the shareholders. That being so, I can see the case for some form of "sweetener" or token consideration to be provided to the shareholders in return for their co-operation having regard to the fact that their shares have no intrinsic value and certainly no value that the shareholders on their own can realize."

8. The justification for providing some form of "sweetener" or token consideration was premised on the need for the shareholders' co-operation. But, as will become apparent, such co-operation is not indispensable.

9. In Re Rhine Holdings Ltd, the aggregate consideration (less the costs of the transaction) to be apportioned between the creditors and the shareholders totalled approximately $15 million. The transaction provided for an apportionment of 60% for the creditors and 40% for the shareholders. Not surprisingly, I did not find the apportionment either fair or reasonable given the respective expectations of the creditors and shareholders in the liquidation. There were also disquieting features regarding the apportionment, notably the conflict of interest of the liquidators in so far as they represented both the creditors and shareholders given the diametrically opposed interests of those two groups. There was also the fact that the liquidators stood to recover substantial liquidation costs which would otherwise have to be written off not to mention the not insignificant costs of the restructuring proposal. In short, the liquidators were not disinterested, as they should have been, in the transaction. Viewed objectively, because of the very attractive fee arrangement from the liquidators' point of view, there was every incentive to promote the transaction with enthusiasm and not to fall out with the investor. This inevitably gave rise to reservations as to how hard a bargain they drove. All these concerns also exist in the present case.

10. Although the application was approved, it was subject to the liquidators' undertaking to add $1 million from their fees to the fund for the creditors. It was stressed (at pp.14S - 15B) that :

" The fact that the court has, with the greatest reluctance, approved the application should not be viewed as a precedent for future applications unless the concerns and conflicts of interest are appropriately and adequately addressed."

11. I have dwelt on Re Rhine Holdings Ltd at some length because, factually, there are many common features with the transaction under consideration and the principles which that case established are applicable.

The Restructuring Agreement

12. Prior to the Restructuring Agreement, the Liquidators had entered into a Preliminary Agreement dated 20 September 1999 under which the value of the corporate asset, i.e. the listing status of the Company was to be apportioned between the shareholders and creditors (net of scheme costs of $2.5 million) in the ratio 48:52. Apparently, as a result of the decision in Re Rhine Holdings Ltd, the Preliminary Agreement was terminated on 27 April 2000 contemporaneously with the execution of the Restructuring Agreement. The table at Annexure 1 is a comparison between the two. The revised ratio was apparently arrived at after "considerable re-negotiation" by the Liquidators, presumably with the investor. Under the Restructuring Agreement, the ratio of benefit taken by the shareholders and the creditors is, broadly speaking, 33 : 67.

13. Paragraph 7(f) of the Explanatory Statement replicated the effect of the Restructuring Agreement set out at Annexure 1 and went on to state ：

" The realisation of the value of the listing status of Yaohan can only be achieved with the support of both its creditors and shareholders for the terms of the Proposal. In the case of the shareholders, their support, in the form of their approval for the Scheme, is essential.

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. All that can be aimed at is that the creditors and the shareholders respectively conclude that the allocation is fair in the circumstances, and support the Proposal on that basis."

14. This statement raises two issues to which I now turn.

Shareholder approval

15. The question is whether shareholders' approval is essential. It would appear not, based on the English Court of Appeal's decision in In re Tea Corporation Limited [1904] 1 Ch 12. In that case it was held that the court has jurisdiction to sanction a scheme of arrangement with the creditors and contributories of a company in liquidation, notwithstanding the dissent of one class of contributories, if the court is satisfied that having regard to the value of the company's assets, that class has no interest in the matter because, for example, on a distribution of assets there would be no assets available for that class. See Boyle & Marshall on Practice and Procedure of the Companies Court at 3.2.4. As stated by Vaughan Williams LJ in the Tea Corporation case at p.23 :

"...if you have the assent to the scheme of all those classes who have an interest in the matter, you ought not to consider the votes of those classes who have really no interest at all."

16. As was explained in the judgment of Stirling LJ (at p.25), the provision of a benefit to a class of persons under the scheme does not mean that that class had an interest in the assets of the company :

"... There are three classes of persons who claim to be interested in the assets of the company, namely, (1.) the creditors of the company, secured and unsecured; (2.) the preference shareholders; (3.) the ordinary shareholders... the assets are not sufficient to meet the claims of the creditors and the preference shareholders, and ... the ordinary shareholders have no interest. In this state of things it seems to me that it was within the power of the Court to sanction the scheme, as regards the creditors ..., and as regards the preference shareholders .... But it is objected that the scheme gives to the ordinary shareholders an option to take shares in the new company, and that the inference is that they had an interest in the assets. It is answered that the scheme deals only with the creditors and the preference shareholders, and that the offer of shares to the ordinary shareholders is really a concession to them on the part of the preference shareholders which those shareholders were entitled to make. It seems to me that this is the right view."

17. Romer LJ (at p.24) considered that the shares offered to the ordinary shareholders :

"... must be regarded as rather in the nature of a gift by the creditors and the preference shareholders to the ordinary shareholders, and not as shewing that they had an interest in the assets which they were surrendering. Certainly the ordinary shareholders cannot be heard to complain of a gift being made to them when they had no right to it but for the scheme ..."

18. Therefore it matters not that the dissenting class was offered something under the scheme for that was in the nature of a gift. What that class cannot do is to hold the others to ransom. See Ho on Public Companies and Their Equity Securities at 15.7.4. Given the insolvency of the Company, any offer of ASH shares to the shareholders would have been a concession on the part of the creditors. Even assuming the shareholders were to vote against the Scheme, the court would have had the power to approve it notwithstanding their dissent under the Tea Corporation principle.

19. In the present case, the Scheme involves only one class and it may be thought that that renders the ratio decidendi in Tea Corporation inapplicable. The holding in the Tea Corporation case cannot so easily be bypassed. In the exercise of its discretion, the court must have regard to the true nature of the transaction and the real transaction is the Restructuring Agreement of which the Scheme is only part.

20. In my judgment, the Scheme, if properly structured, should have included rather than excluded the creditors as a class. After all, it is a corporate asset that is being realized. If there was more than one way of structuring the scheme, it remains incumbent on the Liquidators to opt for that which advances and protects the creditors' interests and entitlement. There was no reason why the Restructuring Agreement should not have provided for a scheme that covered two classes i.e. the creditors and the shareholders.

Judicial guidance on the apportionment

21. Given my decision in Re Rhine Holdings Ltd, I am at a loss to understand how it can be said that there is no judicial guidance on the apportionment of the value of the corporate asset in question. The statement in the Explanatory Statement is accordingly untrue.

22. Then at the hearing of the summons for directions for a court convened meeting of shareholders on 9 May 2000 ("the May hearing"), I took pains to expand upon the meaning of a "token consideration" or "sweetener". I intimated that a payment of about 5% would almost certainly fall within that description.

23. Quite obviously, the Liquidators and their legal advisors either do not agree with my decision in Re Rhine Holdings Ltd or have chosen to ignore what it holds since by no stretch of the imagination can 33% of the net consideration be regarded as 'token'. With the greatest respect, the Liquidators are not at liberty to disregard that decision so long as it is not reversed.

The creditors' consent

24. After the decision in Re Rhine Holdings Ltd and before the May hearing, the Liquidators held a meeting with the committee of inspection of the Company. The minutes of the meeting dated 13 April 2000 recorded that :

"Accordingly, the Joint Liquidators had recently negotiated the final terms with ASH, including the apportionment of consideration as between Yaohan itself and the shareholders as set out in the Restructuring Agreement.

It was understood that the SEHK listing was an asset of Yaohan but that the listing asset could only be realised with the Yaohan shareholders' approval. Accordingly, the objective of the allocation of the consideration as between Yaohan itself and its shareholders was to provide the shareholders with the minimum amount considered necessary to have a reasonable prospect of getting the Proposal approved at the shareholder meetings..." (emphasis added)

25. The explanation given to the committee of inspection was incomplete and inaccurate. How the "minimum amount" was ascertained was not explained. It would appear that no effort was made to convey to the committee of inspection that in Re Rhine Holdings Ltd the court considered that only some form of "sweetener" or "token consideration" could be justified. Then on the day prior to the May hearing, the second annual creditors' meeting was held. The minutes recorded that :

"The Chairperson advised that the Restructuring Agreement terms had been agreed by the COI at the Seventh COI Meeting. The COI members had given the Joint Liquidators the authority to enter into the Restructuring Agreement on the best terms available, recognising that these may change from those set out in the Restructuring Agreement.

The Chairperson drew creditors' attention to the fact that there was no real guidance for the Joint Liquidators as to the apportionment of the Consideration between the Company's creditors and shareholders. The apportionment used in the Restructuring Agreement was derived from negotiations between the Joint Liquidators and ASIL." (emphasis added)

26. It will be noted that there was no mention of Re Rhine Holdings Ltd and its effect. As noted above in the context of para.5(f) of the Explanatory Statement, the statement of fact made is untrue.

27. As will have become apparent, both meetings preceded the May hearing. After that hearing when the Liquidators could not have been under any illusion as to what the court meant in Re Rhine Holdings Ltd. Yet, they went ahead regardless and did not see the need to convey the court's observations to the creditors who could then have been asked to make a decision as to whether or not to proceed in the light of the court's observations. It would appear that the Liquidators were more jealous of the interests of the shareholders than those of the creditors.

28. 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.

Exercise of the discretion

29. Without the Scheme, the creditors cannot expect a dividend distribution. If the Scheme were sanctioned, the anticipated dividend is between 1% and 15% depending largely on whether the Macau claim is admitted or rejected in full. Were the court to refuse to sanction the scheme, the only beneficiary would be the Liquidators since their costs in relation to the Restructuring Agreement are underwritten to the extent of $2.5 million by the investor even if the Scheme is not sanctioned. The creditors stand to receive nothing. This would be a most regrettable state of affairs.

30. The court is left in the invidious position of having to sanction the Scheme notwithstanding the loss to the creditors as a result of the unfair and unreasonable apportionment agreed to by the Liquidators when at least the creditors will receive something rather than nothing if sanction were withheld. In practical terms, the difference or loss to the creditors, had the shareholders been offered a token consideration of, say, 5%, ranges between $5.6 million to $5.9 million depending on the placing price and net tangible asset value of ASH shares. In other words, over $5 million has been given away to the shareholders by the Liquidators at the expense of the creditors.

31. Nevertheless, Liquidators must realize that they are not at liberty to disregard the law. 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.

32. In order to drive this message home, it will 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.

33. 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.

34. 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. Disbursements other than legal disbursements are not affected. This may appear to be draconian but faced with what can only be a deliberate refusal to pay heed to applicable legal principles, I have little choice and it must be borne in mind that upon the Scheme being implemented the Liquidators stand to recover the not insignificant liquidation costs unconnected with the Restructuring Agreement estimated to be between $2.4 million and $3.5 million which they would otherwise have to write off.