CHAN SUM TAI AND OTHERS v. CHAN SHIU KAU ANTHONY AND OTHERS

HCCW 373/2007

IN THE HIGH COURT OF THE

HONG KONG SPECIAL ADMINISTRATIVE REGION

COURT OF FIRST INSTANCE

COMPANIES (WINDING-UP) NO. 373 OF 2007

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IN THE MATTER of LUEN HING FAT LIMITED

and

IN THE MATTER of the Companies Ordinance, Chapter 32

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D E C I S I O N

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1.  This is an application for specific discovery by the petitioners in a petition presented under sections 168A and 177(1)(f) of the Companies Ordinance.  I will first relate the background matters.

The Company

2.  The company in question, Luen Hing Fat Limited (“the Company”), was founded in 1952 by 3 persons surnamed Chan from the same clan, 2 of whom were cousins.  Since the 1960s, the primary business of the Company was the leasing of Luen Hing Fat Building (“the Building”) until it was sold in June 2007, as well as other warehouse properties.  The Company also holds 85% shares in Luen Hing Fat Trading Company Limited (“Trading”), which is engaged in the trading and distribution of grocery and food products.

3.  The 14 petitioners together hold 16.27% shares in the Company.  The 1^st to 4^threspondents constitute the board of directors.  They and their family members hold 55%.  There are 45 shareholders in total, the majority of them had their shares passed down to them by the older generation.  It was alleged that the Company was founded and managed on mutual trust and confidence of all shareholders and was operated like a family company in which all members were entitled to participate and should have access to information about its affairs.  The respondents have denied that the Company is a quasi-partnership.

The petition

4.  The complaints of unfairly prejudicial conduct alleged in the petition, for the purpose of the present application, are as follows.

(1) The unauthorised related party loan

5.  In 2000, the Company made an unsecured loan with no fixed repayment terms to Kwong Yu Industries (Singapore) Pte Limited (“Kwong Yu”), a company related to the 1^st to 4^threspondents.  This loan stood at $5.4 million at the end of 2000, it was interest-free for the first two years and was interest-bearing at prime rate + 0.5% per annum from 2002.  Since 2002, a provision for doubtful debt of $2 million was made in the accounts every year for this loan.  No shareholders’ meeting had been called to approve this loan.  It was alleged that this loan was apparently contrary to section 157H of Cap. 32, which prohibits the making of loans or quasi-loans to a director and to a company in which a director holds a controlling interest, subject to certain excepted transactions.

6.  Related to this complaint are the allegations that the shareholders’ meetings of the Company had always been conducted in a very irregular manner and there was denial of access to the books and records of the Company.  The alleged irregularities were that proper notices with an agenda and the audited accounts were not sent to shareholders in advance, important matters such as directors’ remuneration and dividends had not been put to vote by shareholders, and minutes were not properly kept.

(2) The unauthorised sale of the Building

7.  In June 2007, the Company entered into a sale and purchase agreement to sell the Building, which was its most valuable asset.  It was alleged that the board of directors did so without consulting the shareholders or seeking their approval, that the sale was below the valuation obtained by the 1^st petitioner in February 2007, and that it should have been by tender instead of private sale.

(3) The unnecessary secured bank loan

8.  In 2001, the Company obtained a loan of $4 millionfrom a bank repayable within five years, on the security of a legal charge of one of its warehouse properties.  It was alleged that the Company had no need for cash and the loan was not obtained for the normal business of the Company but to finance the unauthorised loan to Kwong Yu.

(4) Pledging investment properties and providing a guarantee as security for general banking facilities

9.  In 1999, the Company mortgaged the investment properties with a net book value of $2.7 millionand $3.8 million to secure general banking facilities.  Also in 1999, the Company provided a guarantee for general banking facilities granted to Trading in the amount of $20 million.  It was alleged that the management had failed to give full explanation to the petitioners regarding these matters.

(5) Writing off bad debts

10.  Bad debts were written off by the Company in 2004 and 2005 of $264,100 and $153,600.  Trading made provision for doubtful trade-related debts of over $1 million in 2005 which was later written off.  It was alleged that bad debts of such amounts were unprecedented for the Company or for Trading.

(6) Provision for long service payments

11.  For the year ended 31 December 2005, provision for long service payments of $670,000 was made.  It was alleged that the management had failed to give an explanation to the petitioners on this.

12.  I will refer to the above complaints or issues by the numbers given above.

13.  Other complaints were made of unfairly prejudicial conduct, they have not been set out in the supporting affidavit of the petitioners in this application and the subsequent schedule I ordered to be provided by the petitioners, and are not relevant for present purpose.

The documents sought in this application

14.  In the summons for specific discovery issued on 23 May 2008, the petitioners seek an order that the respondents do serve on them a list of documents in their possession, power or custody verified on affidavit of the following categories relating to the above complaints of unfairly prejudicial conduct for the period from 1 January 1999 to 23 May 2007:

(a)     Company minutes books;

(b)    Company monthly and yearly management accounts;

(c)     All general and subsidiary ledgers;

(d)    Aging analysis of trade and other debtors;

(e)     All vouchers (e.g. journal, transfer, payment and receipt vouchers) and supporting documents thereof (e.g. rental agreements, bills and invoices);

(f)     Company’s bank statements, savings passbooks and deposit advices regarding all bank accounts and bank deposits maintained by the Company;

(g)     Banking facilities letters, guarantees provided by the Company, charges or mortgages executed by the Company and supporting documents and bank correspondence and statements for bank loans;

(h)     Letters of credit and underlying contracts, bank statements on letters of credit and other banking facilities and supporting documents;

(i)      Management letters or similar documents issued by auditors in respect of internal control weaknesses identified by auditors; and

(j)      Audit adjustments proposed by auditors for reconciling management accounts with audited accounts.

15.  I will refer to the classes of documents sought by the item numbers given above.

16.  The respondents filed and served a list of documents on 13 May 2008.  Prior to that, they had filed 3 affidavits in support of their application for a validation order and 1 affidavit in opposition to the petition, in which various documents were exhibited.  The respondents deposed that the Company does have in its possession, custody or power documents that fit the general description of the documents sought save for item (i).  They have provided a further affidavit, being the 6^th affidavit of the 2^nd respondent, to confirm clearly they have never had in their possession, custody or power the documents in item (i) and to give discovery in respect of item (j).

The approach in this application

17.  The principles governing specific discovery are well established and need not be recited. The court has a discretion to exercise whether to order discovery even if a prima facie case is made out for the possession, custody or power of the documents and their relevance to issues in dispute.  Under Order 24 rule 8, the court shall refuse to order specific discovery if it is of the opinion that discovery is not necessary either for disposing fairly of the cause or matter or for saving costs.

18.  There are no pleadings in a petition presented under section 168A or section 177(1)(f).  To find out what is in dispute, the court looks at the petition and the affirmation in opposition filed by the respondent. Although the issues may not be framed as precisely as in pleadings, the petitioner is confined to what he has stated in the petition.  The court will not travel beyond the allegations contained in the petition in adjudicating the matter (In re Fildes Brothers Limited [1970] 1 WLR 592 at 597G-598C).  Accordingly, a petition must set out with precision and sufficient particulars the matters complained of or relied on by a petitioner, as defects or omissions in the petition cannot be cured by the supporting affidavit or subsequent affidavits (Re Tourmaline Limited [2000] 4 HKC 348 at 354C-D).  It is important to bear this in mind, and guard against the possibility of allowing discovery to be made under the pretext that documents sought may fairly lead to a train of inquiry in respect of an issue or complaint that has not been raised in the petition.  Discovery must not be a fishing exercise.

19.  The other thing I wish to mention is that some of the classes of documents sought in this application are very broadly stated, such as items (e), (f) and (h).  An applicant who seeks discovery of a class of documents drawn in such wide terms would only make it easier for the other side to establish that discovery is not relevant or necessary for disposing fairly of the cause or matter or for saving costs.  Further, if the court is unable to re-define the proper limits of the class of documents that should properly be disclosed, the court may, in the exercise of its discretion, refuse disclosure of the entire class of documents.

20.  With this, I turn to consider the classes of documents sought.  I group them together in the same way as counsel had done in their submissions.

Item (a)

21.  This item reads “Company minutes books”.  Apparently, what the petitioners seek are the minutes of both the shareholders’ meetings and directors’ meetings.  In the petitioners’ supporting affidavit, it was said that the minutes are relevant to and necessary for the disposal of issues (1), (2), (3) and (4).  In the submissions of Mr William Wong for the petitioners, he said the minutes are also relevant to issues (5) and (6).

22.  On issue (1), I am satisfied on the evidence, and I have borne in mind there had been several rounds of affidavits filed, there were no minutes of shareholders’ meetings relevant to this issue.  It was not alleged by either side that matters in issue (1) were ever discussed or considered in any shareholders’ meeting. The respondents had disclosed the minutes of a directors’ meeting on 27 March 2001.  Mr Michael Liu submitted on behalf of the respondents there were no other minutes of directors’ meetings relevant to this issue.  That is not apparent to me.  In the 2^nd affidavit of the 2^nd respondent, he deposed to the circumstances in which the Company came to open letters of credit for Kwong Yu in 2000 in return for handling fees and interest and how the amount outstanding from Kwong Yu arising out of this arrangement was recorded in the accounts. If the arrangement in 2000 was discussed in a board meeting and there were minutes of such meeting or meetings, the minutes should be disclosed.  The discovery I order here is confined to any minutes of directors’ meeting in 2000 relevant to the arrangement deposed to in paragraph 13(a) of the 2^nd affidavit of the 2^nd respondent.

23.  As for the related complaint of irregularities in conducting shareholders’ meetings, it would appear from the 4^th affirmation of the 1^st petitioner he acknowledged that shareholders were notified well in advance of shareholders’ meetings but the agenda was only provided to them when they arrived at the venue.  The disclosure of minutes of shareholders’ meetings is not going to resolve this dispute or other complaints raised in respect of irregularities.

24.  On issue (2), on the evidence filed on both sides, the only mention of this issue in a shareholders’ meeting was the annual general meeting in 2006 held on 16 September 2006, the minutes of which was disclosed.  Any dispute on what was said at that meeting would not be resolved by ordering disclosure of minutes of other meetings when there was not the faintest suggestion of anything discussed in any other meeting that might be of relevance.  That the petitioners as shareholders are entitled to inspect minutes of general meetings under section 120 of Cap. 32 or that they have similar rights under section 152FA is neither here nor there.  There is no application before me for inspection under these provisions in Cap. 32.  I am concerned with an application for specific discovery. The principles to be applied are very different.

25.  I agree with Mr Liu it is not necessary to order disclosure of minutes of shareholders’ meetings in this respect, but I disagree with him that there is no case for ordering disclosure of minutes of directors’ meetings.  In paragraphs 5 to 18 of the 1^st affidavit of the 2^nd respondent, he deposed to the measures taken by the board of directors from 2003 to June 2007 in some detail on the prospects and options of selling the Building.  If these measures were considered and discussed at board meetings, and if there were minutes of such board meetings, they are clearly relevant and necessary for the fair disposal of this issue and should be disclosed.  I order discovery to be given of any minutes of board meetings from January 2003 to June 2007 relating to the matters deposed to in paragraphs 5 to 18 of the 2^nd respondent’s 1^st affidavit.

26.  On issue (3), the respondents have disclosed the minutes of a directors’ meeting on 27 March 2001 in which the board resolved to obtain the loan of $4 million from a bank and the banking facilities documents.  There is no indication in all the evidence filed that that subject was considered in any shareholders’ meeting or any other directors’ meeting. No discovery will be ordered.

27.  For issue (4), the respondents have disclosed the board resolutions approving the mortgages and the guarantee and other relevant documents from the banks in extending general banking facilities.  There is no suggestion these matters had ever been discussed in any shareholders’ meetings all these years.  Mr Wong submitted the board resolutions were mere formalities provided to the banks for granting facilities and did not reveal the thinking process of the board.  He may be right on this, but there is nothing to suggest there were kept any other records of what was discussed and resolved at those board meetings.  I see no basis to order discovery.

28.  For the same reason, I see no basis to order discovery insofar as issues (5) and (6) are concerned. It was mere conjecture that those matters were discussed in directors’ meetings.

Items (b), (c), (e) to (h)

29.  These items are said to be relevant and necessary for the issues in (1), (3), (4), (5) and (6).

30.  Mr Wong submitted the classes of documents are sought because the full picture of the alleged misconduct of the respondents cannot be gauged from the audited financial statements alone.  Complaint was made in the 6^th affirmation of the 1^st petitioner that the audited financial statements did not “show the full picture” of the financial position of the Company and of Trading, and an example was given of some payments made by the Company on behalf of Kwong Yu and another entity related to the respondents called Wah Karm & Company Limited (“Wah Karm”) from an extract of the general ledger of the Company disclosed by the respondents.  The 1^st petitioner surmised there might be other payments made by the Company to Wah Karm or other companies in which the respondents have an interest.

31.  It was contended by the petitioners that the bank statements are necessary for them to understand the fund flow of the Company.  They also wanted to find out how did the directors make use of the funds borrowed from the banks.  It was said the classes of documents sought would enable the petitioners to understand the cash position of the Company and its financing needs which necessitated the borrowings from the banks, and to understand how the Company was managing the credit levels given to customers.

32.  There is no allegation in the petition of impropriety of any payments made by the Company on behalf of Kwong Yu (other than the unauthorised related loan), Wah Karm or any other companies in which the respondents may have an interest.  The discovery I am going to order, which is not to the extent as sought, is in respect of the existing complaints in the petition.  The gist of the complaints in issues (1), (3) and (4) was that the Company had no need to borrow from the banks if it had not been for the unauthorised related party loan to Kwong Yu.

33.  The 2^nd respondent in his 2^nd affidavit has explained the cash position of the Company, that it was not cash rich in 1998 as alleged by the petitioners, that the cash balance at year end was not indicative of the cash needs of the Company and of Trading, and he exhibited various tables prepared from the Company’s accounting records.  Although I have no reason to think the audited financial statements did not give a true and fair view of the state of affairs of the Company and of the group, as the disclosed financial statements had not been qualified in any way by the auditors all these years, I take into consideration that the audited financial statements would not contain the kind of detail the petitioners are looking at regarding the cashflow of the Company, not on a year-end basis but within a shorter period, and the actual use made of the funds borrowed from the banks.

34.  I order discovery only of these items: items (b) and (c), for the period from 1 January 1999 to 23 May 2007.  I decline to order discovery for items (e), (f) and (h), they are too broadly framed and I do not think they are necessary for the fair disposal of the issues or for saving costs.  I consider sufficient discovery has been given of the documents in item (g).  It does not appear that a case has been made out for discovery of the documents sought in this group for issues (5) and (6).

Items (d), (i) and (j)

35.  These items are said to be relevant and necessary for issues (1), (5) and (6).

36.  I have considered the latest affidavit made by the respondents on items (i) and (j) mentioned earlier.  I have given leave to the respondents to file this affidavit within three days hereof.  I think this affidavit is sufficient, I will make no order regarding items (i) and (j).

37.  The only remaining item is (d).  I consider it relevant and necessary for the disposal of issue (5), as it may show how the Company was or should be managing the credit levels given to customers.  I order discovery to be given, not for the entire period sought, but only in respect of those years for which the complaint of writing off bad debts was made in the petition, so the period for which discovery is required is from 1 January 2003 to 23 May 2007.

Orders

38.  The petitioners’ solicitors are to draw up an order for my approval.  A further list of documents is to be filed and this should be verified on affidavit.  I will hear the parties as to the time within which disclosure should be made.  This would be followed by inspection of documents within 7 days thereafter.

39.  I will also hear the parties on costs.