TRADEPOWER (HOLDINGS) LTD (IN LIQUIDATION) v. TRADEPOWER (HONG KONG) LTD AND OTHERS

CACV 101/2008

IN THE HIGH COURT OF THE

HONG KONG SPECIAL ADMINISTRATIVE REGION

COURT OF APPEAL

CIVIL APPEAL NO. 101 OF 2008

(ON APPEAL FROM HCA NO. 1796 OF 2005)

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REASONS FOR JUDGMENT

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Hon Rogers VP:

1.  I agree with the reasons for judgment of Le Pichon JA.

Hon Le Pichon JA:

2.  This is an appeal from a judgment of Mr Recorder Jat SC dated 27 February 2008 dismissing the plaintiff’s claim to set aside a deferred share scheme involving the allotment and reclassification of shares in Tradepower (Hong Kong) Ltd (“Tradepower HK”).  At the conclusion of the hearing the appeal was allowed with reasons to be handed down, which we now do.

Background

3.  The plaintiff Tradepower (Holdings) Ltd (“Holdings”) was put into compulsory liquidation by a winding up order dated 19 April 2000.

4.  In 1994, it purchased office premises and car parks in a commercial building (“the properties”) for $23 million.  This was financed by a mortgage of US$2 million repayable over 10 years.  The properties were held through Tradepower HK, Holdings being the registered owner, at all material times, of 3749 out of 3750 of Tradepower HK’s “A” shares.

5.  Holdings, Tradepower HK and the second defendant Girvan Ltd (“Girvan”) were related companies: the fourth and fifth defendants (respectively “Mr Sonnenberg” and “Mr Divine”) owned Holdings and Girvan, and through Holdings, Tradepower HK.  Mr Sonnenberg and Mr Divine (collectively “the directors”) were the only directors of all three companies which were part of a larger group of companies.  Holdings and Tradepower HK were trading companies and Girvan, a real estate investment company.  Since September 1999, the third defendant (“Madam Ho”) has been the company secretary in all three companies and, since about 10 September 1999, the holder of one “A” share in Tradepower HK which is held on trust for Girvan.

6.  In about August 1996, Mr Sonnenberg and Mr Divine reached an in-principle agreement to sell the trading operations to “Grandlink”.  Holdings and Tradepower HK ceased their trading activities from about that date.  The sale of trading operations to Grandlink was finalised in September 1998.

7.  As the rentals derived from the properties which were let were insufficient to defray the mortgage repayments, until it ceased trading activities in August 1996, Tradepower HK made up the shortfall from its trading income.  From August 1996, Tradepower HK had to be put in funds to meet the shortfall from other sources if it were not to default on the mortgage.  Mr Sonnenberg and Mr Divine caused Girvan to fund Tradepower HK.  There was no finding as to precise amount of assistance provided save that it ranged from $2.3 million to $4 million.  Mr Sonnenberg’s belief (which the recorder accepted) was that by providing such funding, Girvan had acquired a beneficial interest in the properties.

8.  In May 1997, Elimor Financing Corp (“Elimor”) sued Holdings for over US$900,000 for breach of contract in respect of two shipments of umbrellas, claiming that they were defective and unmerchantable.  Mr Sonnenberg considered the claim unfounded.  However, in September 1998, Elimor was successful in obtaining an interlocutory judgment, with damages to be assessed.  Holdings lost its appeal from the interlocutory judgment in January 1999.  Despite this, Mr Sonnenberg believed that the amount could still be contested and the claim possibly extinguished.  

9.  Meanwhile, in December 1998, the directors of Holdings passed a resolution resolving, inter alia, that the shares of Tradepower HK would be sold to interested parties, failing which other options would be contemplated.  But by August 1999, there was still no buyer in sight.

10.  Holdings implemented the scheme in September 1999, having consulted Express Consultants Services Ltd (“Express”) as to a corporate restructuring of Tradepower HK so that Girvan would become its controlling shareholder.  The practical effect was that one of Holdings’ assets, its holding of “A” shares in Tradepower HK, (and effectively the properties) was transferred to Girvan.

11.  The scheme involved

(1) the conversion of Holdings’ 3749 “A” share in Tradepower HK into “B” deferred shares with no voting rights and, for practical purposes, no prospects of any dividends or return of assets;

(2) the acquisition by Girvan of the remaining 1 “A” share in Tradepower HK from Madam Ho who would then hold the same on trust for Girvan; and

(3) the issuance by Tradepower HK of 9 new “A” shares to Girvan.

12.  The petition was presented on 28 February 2000 and, as earlier noted, Holdings was wound up in April 2000.  The assessment of damages took place in December 2002 and final judgment was entered in favour of Elimor in the sum of US$977,654.35.

13.  The liquidators sought to set aside the scheme on the basis that it enabled the directors to strip Holdings of a valuable asset in favour the directors’ own company, i.e. Girvan, shortly before Holdings was wound up to the prejudice of the creditors of Holdings.  The recorder found that the shares of Tradepower HK in September 1999 were valuable assets and that there had been a disposition of property but dismissed the claim to set aside the scheme, holding that there was a valid and credible reason for the scheme and that, accordingly, dishonest intention on the part of the directors had not been established.

This appeal

14.  Two issues arise in this appeal:

(1) whether the recorder’s holding that there was a valid and credible reason for the scheme was fundamentally flawed such that this court is entitled to review the recorder’s conclusion that Holdings had failed to prove an essential element of its cause of action, namely, a dishonest intention to defraud on the part of its directors; and

(2) in any event, by implementing the scheme, the directors of Holdings were guilty of misfeasance and breach of fiduciary duty and should be held personally liable for any loss thereby occasioned.

Dishonest intention

15.  The first matter to be considered is the validity of the recorder’s reasoning as to the existence of a valid reason for the scheme.  That reasoning appears from the following extracts from the reasons for decision:

“72.  … what was operating in Mr Sonnenberg’s and Mr Divine’s mind was the idea that Girvan had, by virtue of its financial support of Tradepower HK, acquired a beneficial interest in the Properties which was likely to increase in the future.  But Girvan had no interest, direct or otherwise, in Tradepower HK or the Properties.  In those circumstances, it is in my view reasonable for businessmen like Mr Sonnenberg and Mr Divine to find the situation unacceptable and wish to rectify it.  Hence they sought advice from professionals to regularise the situation, and they were advised by Express that the Scheme was the proper method to do so.

73.   In my judgment, there was a clear aim of the Scheme, namely, to “align” the beneficial ownership of Tradepower HK (and indirectly the Properties) with Girvan which in fact serviced, and would have to continue to service, the mortgage repayments.  It was, in my view, a natural and reasonable thing for Mr Sonnenberg and Mr Divine to do at the time.

…

84.   … It seems to me that, objectively viewed, their intention was to regularise what was reasonably considered to be an unacceptable situation created by the mismatch between the beneficial ownership of the Properties with the party which had been providing a substantial part of the funds needed for acquiring the Properties and which would have to continue to provide such funding…”

16.  Mr Chow SC, who appeared for Holdings, identified several respects in which the recorder’s reasoning is unsustainable.  First, underlying that reasoning is the premise that Tradepower HK did not have sufficient financial resources to service the mortgage payments and had to rely on Girvan for financial assistance.  However, the audited accounts and management accounts of Tradepower HK tell a different story.  First, Tradepower HK’s audited accounts for the year ended 31 December 1998 show that the amount due from Girvan to Tradepower HK increased from just under $6 million to over $26.4 million representing a net increase of about $21 million.  Second, Tradepower HK’s management accounts as at 30 September 1999 show that Girvan was indebted to Tradepower HK for over $1.2 million.

17.  Mr Wright who appeared for the defendants relied heavily on the fact that the recorder considered Madam Ho a “credible witness”.  He submitted that Madam Ho had “clearly explained” at trial how the entry showing $26.4 million as an “amount due from a related company” i.e. Girvan came about in the audited accounts for 1998, that it was a ‘notional’ figure and that the recorder had accepted the explanation.  However, although the recorder considered Madam Ho a credible witness, his acceptance of Madam Ho’s evidence was not unqualified, his qualification (at § 16 of the reasons) being this:

“unless any particular aspect …is shown to be wrong by undisputed contemporaneous documents or other incontrovertible evidence.”

18.  It would be convenient to refer to salient parts of Madam Ho’s evidence here.  She is “not a qualified accountant” (Tr. 95E) and in 1998 when she was first asked to look at the books of Tradepower HK, her feeling was that

“it was a (sic) like a room filled with rubbish which I couldn’t get in”

(Tr. 95L)

Up until 1996, Kwan Wong Tan & Fong had been the auditors but a new firm took over in 1997.  When they had questions, the new auditors had no one to ask but Madam Ho who said this:

“…but in fact I myself did not understand nor did I know how the figures came about …”

(Tr. 95R)

In relation to the accounts of the three companies concerned, Madam Ho said:

“The only thing I could [do] at that time was to organise the companies and to flush off certain figures …In 1998 from the accounting records I could see the figures and by then I was in the position to adjust the figures and make them right.  And from the records I saw that Girvan was owing Tradepower (Hong Kong) a certain amount.  But I would like to stress that it was only a certain amount or certain figure.  I didn’t see anything like cash or what …”

(Tr. 96E-I)

Further ‘explanation’ for the amount of $27 million owing by Girvan (a net increase of $21 million) can be found in the following extract:

“ COURT:  Yes, I was about to ask you how did that 21 -- where did that $21 million came from.  Are you able to tell us very quickly how come the accounts would say that during the year Tradepower (Hong Kong) lent Girvan 27 million or 21 million?

  A.    Girvan had borrowed money from Tradepower Holdings.  But since Tradepower (Hong Kong) had taken over the amount due from Girvan to Holdings, that’s why Girvan owed money to Tradepower (Hong Kong).

  COURT:  Was that sum treated as borrowed from Tradepower (Hong Kong)?

  A.    It was treated as money owed to Tradepower (Hong Kong) by Girvan.  But as I have said, they were all figures only.  And as I have already stated, I had to make them reasonable and feasible.  And during the process a lot of figures would have to be flushed away, would have to be cleared …”

  (Tr. 113J-P)

19.  Putting it mildly, Madam Ho’s approach to accounting records and the preparation of proper accounts could be said to be unorthodox: see, for example, her perception that they are “all figures only” (Tr. 116E), that she needed to “flush off” certain figures (Tr. 96E), to “adjust” the figures and “make them right” (Tr. 96H) and to “streamline” the accounts (Tr. 115E).  Whatever is to be made of her approach, what is clear from her evidence in response to the court’s query about the entry in the 1998 audited accounts of Tradepower HK showing an amount due to it from Girvan, is that Girvan was indebted to Holdings and Holdings had transferred the benefit of that debt to Tradepower HK.  In short, what they establish is that Girvan was indebted to Tradepower HK.

20.  The directors would have approved and signed the 1998 audited accounts and would have authorised the preparation of the management accounts.  I am therefore unable to accept Mr Wright’s submission that the entries in the audited accounts do not mean what they say and that the entry could be disregarded.

21.  The second and third respects in which, it was submitted, the recorder’s reasoning was flawed can be dealt with together.  Mr Chow submitted that far from “regularising” an allegedly unacceptable situation, the scheme was singularly “irregular”.  The thrust of his submission was that from the point of view of the directors, since they owned both Holdings and Girvan and effectively also Tradepower HK, it would not have mattered whether Tradepower HK was owned or controlled by Holdings or Girvan but for the fact that there was a judgment against Holdings and the obvious prospect of compulsory liquidation.  While quantum still had to be assessed, what Elimor was claiming by way of damages - over US$900,000 - was no secret.  That was the reason why it mattered to the directors which of Holdings or Girvan should own Tradepower HK.

22.  Mr Chow submitted that in so far as Girvan had acquired some beneficial interest in the properties by dint of the fact that it had assisted Tradepower HK in making some of the mortgage repayments, there were obvious and correct ways to “regularise” the situation such as making a declaration of trust to the extent of the beneficial interest which it was thought represented Girvan’s entitlement, creating a charge in favour of Girvan to the extent of its perceived beneficial interest or selling the properties and distributing the net proceeds accordingly.

23.  For his part, Mr Wright sought to support the recorder’s reasoning by contending, at some length, that the “A” shares were worthless and an asset of no value.  Reference was made to a 2-page chart which had been produced as an exhibit at the trial in support.  Since Madam Ho did not give evidence to explain its contents, in my view, no assistance can be derived from it.  In any event, the short answer to Mr Wright’s submissions on whether the “A” shares were valuable is the recorder’s finding (at § 76 of his reasons) that they were “valuable assets, in the sense that there was a net asset value attributable to them”.

24.  In my view, the scheme made Girvan the controlling shareholder of Tradepower HK and effectively the owner of all the properties when all it had done was to service some of the mortgage repayments.  It totally ignored the fact that Tradepower HK had itself serviced the mortgage repayments for a period of time, quite apart from having expended $7 million (representing approximately 30% of the purchase price) when the properties were first acquired.  In those circumstances, there can be no justification for Holdings to have given away all its interest in Tradepower HK and, effectively, the properties as opposed to only a proportional part of the net equity in the properties.

25.  In implementing the scheme, it was incumbent on the directors, inter alia, as directors of Holdings to consider whether it would be to Holdings’ advantage to do so.  Given that the scheme was to be entirely at Holdings’ expense (by Holdings giving away its “A” shares in Tradepower HK for no consideration), and given the recorder’s finding that they were valuable assets, in my view, on no footing could it be said that the scheme would benefit Holdings or promote its interest.

26.  Since the recorder’s conclusion that a valid reason existed for the scheme is unsustainable, his further conclusion that there was accordingly no dishonest intention falls to be reviewed.  In this connection, the meaning of “intent to defraud” creditors for the purposes of section 60 of the Conveyancing and Property Ordinance, Cap. 60 needs to be considered.  Such an intent may be inferred if the necessary effect of the transaction is to defeat, hinder or delay the creditors.  As Lord Hattersley LC explained in Freeman v Pope (1870) 5 Ch App 538 at 540-541:

“…it would never be left to a special jury to find, simpliciter, whether the settlor intended to defeat, hinder or delay his creditors, without a direction from the Judge that if the necessary effect of the instrument was to defeat, hinder, or delay the creditors, that necessary effect was to be considered as evidence of an intention to do so.  A jury would undoubtedly be so directed, lest they should fall into the error of speculating as to what was actually passing in the mind of the settlor, which can hardly ever be satisfactorily ascertained, instead of judging of his intention by the necessary consequences of his act, which consequences can always be estimated from the facts of the case …

…it is established by the authorities that in the absence of any…direct proof of intention, if a person owing debts makes a settlement which subtracts from the property which is the proper fund for the payment of those debts, an amount without which the debts cannot be paid, then, since it is the necessary consequence of the settlement …that some creditors must remain unpaid, it would be the duty of the Judge to direct the jury that they must infer the intent of the settlor to have been to defeat or delay his creditors, and that the case is within the statute.”

27.  As I understand it, it is not Mr Wright’s case that Freeman v Pope is no longer good law.  Indeed, Cunnane v Cunnane Pty Ltd (In Liquidation) and Another (1998) 192 CLR 557 to which Mr Wright made reference, cited Freeman v Pope with approval (at § 12).  Mr Wright appeared to place reliance on the following passage:

“30   … there is no intent to defraud if the person in question believes that others have no right or interest in or in relation to the property concerned and that the law accords them no opportunity or advantage with respect to that property.”

But that passage has to be understood in the context of the facts of that case.  The property concerned were shares in a shelf company which C had transferred to his sons and his wife at a time when C and his family company were in financial difficulties.  The judge found that the transfer had been made for full value.  The trustee of C’s bankrupt estate and the liquidator of the family company accordingly failed in their attempt to set aside the transfers.  The profits accruing to be shares were derived from an opportunity that arose after the transfer at full value and which was exploited by the owners of the shares after the date of the transfer.  Thus, the facts in Cunnane were very different.  In my view, Cunnane cannot assist Mr Wright when the disposition of the “A” shares to Girvan was not for value.

28.  As earlier noted, there was no possible justification for the scheme which operated to strip Holdings of a valuable asset, transferring it to a company owned by the directors themselves.  Given the judgment which was then in existence and having regard to the amount claimed (albeit that quantum still had to be assessed) which exceeded the value of Holdings’ other assets, the necessary consequence of the scheme was that it would have the effect of defeating Holdings’ creditors.  Viewed objectively, I agree with Mr Chow that the inference that the directors acted with intent to defraud the creditors of Holdings is irresistible.  For that reason, the scheme should be set aside.

Personal liability of the directors

29.  Independently of whether there was an intent to defraud which would result in the scheme being set aside, Mr Chow submitted that the directors should be held personally liable for misfeasance, breach of duty and breach of trust.  He submitted that they abused their power as directors of Holdings when they caused Holdings (as shareholders of Tradepower HK) to approve the scheme which, on any footing, could not said to be to have been to the advantage of Holdings or in its interest and which would benefit the directors themselves.  He seeks a declaration for misfeasance etc and consequential orders for all necessary accounts and inquiries.  The recorder did not deal with this aspect of the case in his reasons for judgment.

30.  Mr Chow submitted that in substance the scheme amounted to a return of capital to shareholders and, as such, it was a recognized exception to the general rule that any act which falls within the express or implied powers of the company conferred by its memorandum of association whether or not a breach of duty on the part of the directors could be approved and subsequently ratified by the shareholders and so be binding on the company.  Directors have no power to take assets out of the company by way of voluntary disposition to themselves.  Such an act being ultra vires the company is incapable of ratification by the shareholders.

31.  The decision of Hoffman J (as he then was) in Aveling Barford Ltd vPerion Ltd [1989] BCLC 626, 630i – 631i is clear support for Mr Chow’s submissions.  As Hoffman J explained (at 633b), the rule that capital may not be returned to shareholders is a rule for the protection of creditors.  The disposition need not have been made fraudulently or in bad faith before it could be set aside as a return of capital.

32.  In this case, the scheme was in reality a disposition by the directors of Holdings of a valuable asset for no consideration.  The beneficiaries of that disposition were none other than the directors themselves who were also the sole shareholders of Holdings.  Viewed objectively, in substance the scheme constituted a return of capital to Holdings’ shareholders dressed-up as a capital restructuring exercise.  In my view, Holdings is entitled to the relief sought in subparagraphs (3)-(5) of paragraph 1 of the notice of appeal and I would so order.

Hon Chung J:

33.  I agree.