RE SINO AMERICAN TELECOM INC

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REASONS FOR JUDGMENT

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Rogers J.A.:

1. This is an appeal by the Provisional Liquidators from a Decision and order of Mrs. Justice Le Pichon given on 3rd July 1998. The summons in respect of which the Decision was given was issued on 30th June and such are the law's delays that it was not until Tuesday 7th July 1998 that this matter could be heard by the Judge, a Decision given, an appeal lodged and then the matter reach this court. At the conclusion of the hearing we dismissed the Appeal and said that we would give our written reasons later, which we now do.

The Application below

2. The application before the learned judge was to sanction, under the provisions of Section 182 of the Companies Ordinance (Cap. 32), the sale of all the assets of the company, SinoAmerican Telecom Inc. ("the Company") to Phoenix Telecommunication Limited ("Phoenix") substantially in terms of the document which was attached to the application.

The background

3. The Company has a considerable background history. It is now a BVI company. It has two wholly-owned subsidiaries namely: Remoco (HK) Limited ("RHKL") and Goldremart (Holdings) Limited ("Goldremart"). Through RHKL the company is a joint venture partner in the Shenzhen Ligao Telecom Technology Company Limited. There is a joint venture partner namely: Shenzhen Wan Li Tong Industrial Development Company Limited ("WLT"). The joint venture business is concerned with telecommunication systems in Southern China. It would appear that the interest in this business is the only valuable asset which asset which the Company now has.

4. The major shareholder of the Company is at present Mr. Allan Yuen Shek Sang. In addition to being the major shareholder he is also a director of the Company. His shareholding, together with that of those who are loosely termed as being in his group, amounts to approximately 84.7% of the Company's issued share capital. Investors for the Company had been found outside Hong Kong, mainly from the United States but also, we understand, from the Middle East. They have invested considerable sums of money and figures of approximately US$17m. have been referred to in this context in the evidence. Those investments have been made, primarily, by means of loans to the company by what have been termed bridging notes and convertible notes. It would seem that those notes, or at least some of them, are convertible to shares and some carry warrant options. Although Mr. Yuen and his group at the moment owns 84.7% of the issued share capital. The holders of one tranche of the convertible notes would together own 49.3% of the issued share capital and Mr. Yuen and his associates would have their shareholding reduced to approximately 37.7% if and when the conversion and warrant options were exercisable and exercised.

5. Of the US$17m. invested by noteholders approximately US$10m. is due to Dragon Investment Company II LLC ("Dragon II"), a Cayman Island Company.

The winding-up petition

6. On the 14^th May 1998 Dragon II, filed a petition to wind up the Company based on the Company's inability to pay its debts. Provisional Liquidators were appointed and given, inter alia, the power to sell assets by way of private treaty, tender or auction subject to their obtaining the Court's leave to do so.

7. On 5^th June 1998, the Provisional Liquidators obtained an order from Madam Justice Beeson which amongst other things enabled them to "invite offers by way of private treaty from each and all of the shareholders and each and all noteholders of the Company as appearing in the Company's Registers of Shareholders and Noteholders on 22April 1996 and Star Telecom Overseas Limited, for all the Company's interest in all shares in and loans to its subsidiaries RHKL and Goldremart (Holdings) Ltd. and the Company's loans to Rightone Telecom (H.K.) Limited."

8. This was a very strange order, the like of which is unlikely to be found in authorities. I can only say that in this case it seems to me to have been undesirable. It has, perhaps, lead to the unfortunate misconception that the Court might be prepared to sanction transactions which otherwise it would not. The net effect of the order is that it may have encouraged the Provisional Liquidators not to go about their proper duties of ascertaining the value of assets they deemed it necessary to sell.

9. It would seem that there has been a serious falling out between Mr. Yuen and those who could be regarded as supporting him and not only investors, or noteholders, of the Company but also WLT. Mr. Chu Qing Hai who is a director of WLT wrote on 4 June 1998 stating that funds were urgently needed to be injected into the joint venture in order to enable suppliers to be paid otherwise the paging network, which was part of the joint venture business, would suffer and the joint venture may fail due to a termination of the licence.

10. The bid by Phoenix for which the Provisional Liquidators seek the Court's sanction to accept was received on the 23rd June 1998. The Provisional Liquidators had circulated the noteholders and other creditors of the Company and Star Telecom. Apart from that no other person or body had been circulated or invited to submit proposals for the purchase of the Company's assets.

11. Phoenix is a company which has been recently incorporated in the British Virgin Islands. It is clear from the papers that it is a creature of some of the creditors of the Company namely the noteholders. We were told during the course of the hearing that there were three major groups of shareholders of Phoenix namely Dragon II, a group which is referred to as Shanahan/Fox, namely a Mr. Shanahan and his wife, and finally an investor or group of investors who may be located outside the United States. In addition we were told that one company had advanced moneys to Phoenix and on the strength of that may become shareholders thereof.

The effect of the proposed sale

12. The effect of the proposed sale and purchase agreement was analysed by the judge below. In essence it involves the transfer of all the assets of the Company, except for the statutory books and records (which are clearly valueless), to Phoenix. Phoenix will in return provide the consideration which is set out in Schedule 3 of the proposed sale and purchase agreement. That schedule had been reproduced in the judgment below and will not be repeated here. The essential elements of it are, however, that the creditors will be entitled either to 15% of the amount owing to them or to shares in Phoenix in lieu. If they opt for the 15% alternative, Phoenix will undertake to pay the full amount owing within a period of 36 months but, that undertaking is clearly conditional upon the success of Phoenix conducting its business affairs. As was submitted to us, in default of Phoenix discharging the liabilities, the Company would remain liable; of course, the Company would by then have been stripped of its assets. The net effect of this transaction would be that Mr. Yuen and those who have been referred to as being within his group would be left with the shares in a company with no assets at all and the creditors behind Phoenix, namely those who are referred to above, would in effect have taken over the business of the Company through Phoenix.

Section 182 applications

13. The basis of the statutory scheme governing the liquidation of insolvent companies is that the free assets of the insolvent company at the commencement of the winding-up should be distributed rateably amongst the company's unsecured creditors. In a company winding-up the preservation of the assets for the benefit of the creditors generally is achieved by Section 182 which reads:-

14. It may, however, be beneficial not only for the company but also for the unsecured creditors for some of the assets to be sold. Thus the legislature gave the court power to sanction a disposal of assets. No principles that should govern the exercise of that jurisdiction have been written into the legislation. The discretion vested in the court would, therefore, be held to be entirely at large, to be exercised according to general principles which apply to every kind of judicial discretion.

15. It would be inappropriate in an application of this nature to attempt to expand on the factors that should be taken into account in considering the exercise of the discretion in respect of companies where a provisional liquidator has been appointed. It can, however, be safely said that in those circumstances the court will naturally look to see whether full value is to be obtained for the assets to be disposed of.

16. Before turning to the Decision below it is pertinent to point out that despite the fact that the Provisional Liquidators were appointed on 14^th May 1997 no attempt has been made, at least as yet, to assess or estimate the value of the Company's assets in particular the value to be attached to its interest in the joint venture in Shenzhen.

The Decision below

The learned judge refused to sanction the "sale" of the assets because she said:-

17. This approach is not altogether surprising. In his Fourth Affidavit Mr. John Lees, one of the Provisional Liquidators, said

Given Mr. Lees' considerable experience in the field of liquidations it was, perhaps, a slightly bold approach for Mr. Bell, on behalf of the Provisional Liquidators, to argue that the judge had been wrong in law in holding that it was in essence a scheme of arrangement.

Was this a scheme of arrangement?

18. What is commonly called a scheme of arrangement is dealt with under Section 166 of the Companies Ordinance that reads as follows:-

The first point taken by Mr. Bell, on behalf of the Provisional Liquidators, is that any arrangement is not between the creditors or any part of them but between Phoenix and the Company (in this case the Provisional Liquidators). That in my view is to take far too jejune a view of the situation. Mr. Lees evidently thought that as a practical matter the proposal was a scheme of arrangement. Furthermore, the "bid proposal" which was despatched to each of the creditors explaining the proposal which Phoenix was putting forward started with the sentence:-

In such circumstances to treat Phoenix as being part of the creditors is not to lift the corporate veil. At least for the purposes of consideration of this bid proposal the corporate veil never existed in the first place. In any event it would be wrong for a court to consider that such a transaction simply on the basis that some of the creditors had arranged their affairs to be conducted in the name of a company. Such a course would be blinding the Court's eyes to reality.

19. However, even if the Court were to adopt the facile approach of treating Phoenix as having a separate identity from the noteholders which it represents, the evidence before the court shows that the bid proposal involves an arrangement, if not a compromise, between the noteholder creditors, or, if looked at in another way, a number of classes of the creditors and the company.

20. The first option in the proposal put forward is that all the creditors (i.e. the noteholders) will have the option of exchanging the "liability" which the company has towards them for new shares to be issued to them by Phoenix and for convertible notes to be issued with a face value equal to the face value of the liability which the Company owes to the creditor and which is being exchanged. Clearly if a creditor takes that option the Company's liability to the creditor in respect of the particular note would be extinguished. The exhibits show that virtually all the noteholders had demonstrated an intention to accept that option. The alternative would be for them to wait to be paid out in full, provided there was a successful completion of an initial public offering or private placement. What grounds there are for thinking that there may be such a successful operation has not been explained so far but the fact that the proposers of this bid proposal can put forward such a suggestion indicates that the underlying assets sought to be transferred to Phoenix might have more value, at least in their eyes, than they have been prepared admit. The exchange of the liability from the Company to the noteholders, for an equity in Phoenix, which is the option which apparently finds favour with the noteholders, would itself be a Scheme of Arrangement.

21. Trade creditors who are not prepared to accept the equity option in Phoenix would be paid 15% of their liabilities in cash and the balance in full "as and when the business of the purchaser (Phoenix) enables payment to be made".

22. To suggest that the implementation of these proposals would not effect a change in the rights, even of the non-opting trade creditors, involves the failure to appreciate that the rights of the trade creditors would clearly be altered. On a very simple practical level, at present the trade creditors would, if a winding-up order were made, be entitled to their rateable share of the assets of the Company, such as they exist, If the transaction which is the subject of this application is allowed to proceed the Company would have no assets at all left other than the statutory books and records. Clearly the trade creditors' rights would be affected.

23. Mr. Bell, on behalf of the Provisional Liquidators sought to rely upon the judgment of Brightman J. in NFU Development Trust Limited (1973) 1 All ER 135 in particular at page 114. On analysis, however, the decision did not help him. At the passage to which he was referring Brightman J. was indicating that a scheme of arrangement which involved the confiscation of assets with no corresponding benefit was not a scheme of arrangement which was covered by the equivalent of Section 166. In the course of his judgment, Brightman J. said that perhaps those observations went to merit more than jurisdiction. For my part I can see no relevance of this Decision to this case other than the fact that all the assets would be stripped out of the Company and any benefit to the Company is somewhat illusory.

24. One of the major parties who would clearly lose in this arrangement would be Mr. Yuen and what has been termed his group. Effectively what would be happening is that the joint venture interest in the Shenzhen project would be stripped away from him. This is summed up in the second affidavit of James Desmond Collins-Taylor in the sentence "They (the investors in Phoenix) need to be in control of the affairs of the Company to be confident that the venture will succeed." In my view it would be wholly wrong to use the Court's power to sanction a sale of assets in effect to settle what is in effect an investor's dispute.

25. Mr. Bell sought to rely on re Bank of Credit & Commerce International S.A. (No.2) [1992] BCC 715 for the proposition that even if the transaction covered by the proposal did constitute a Scheme of Arrangement the Court could nevertheless use its power to approve a compromise rather than to insist on a full scheme of arrangement. That, however, was an exceptional case and it is unnecessary to analyse the facts thereof other than to say that the court was fully satisfied that the proposed compromise was just and equitable and appropriate to be entered into. In coming to that decision the court held that the decision of Plowman J. in Re Trix Ltd [1970] 1 WLR 1421 did not pose an absolute bar which made it incompetent for the court to approve the compromise. Nevertheless, the principles enunciated by Plowman J. in Re Trix Ltd were not doubted as general propositions applicable in normal circumstance. He had said, for example, at 1424A cited at page 731 in the Bank of Credit & Commerce International SA

And then at page 1424C:-

The same considerations apply here. As the judge below pointed out this is a case where there may well have to be meetings of separate classes of creditors and indeed shareholders and their interests have to be consulted. As was pointed out in the course of argument the evidence shows that Ms. fox has approached the noteholders individually by telephone after which there had been no meeting. Such a procedure by a party clearly interested in the acceptance of the bid proposal would be unacceptable under the Section 166 procedure, or, indeed, in any other situation where the court needed to be satisfied that shareholders or creditors were properly, accurately and fairly informed prior to taking a decision.

26. Finally, it seems to me that the court is being asked to perform a task which it should never have been asked to perform. In effect the assets of the Company are being sold by the liquidator who was professed himself to be ignorant of their value to those who appear to have considerable knowledge, if not full knowledge, of the workings of the Company and the value of its assets and when the only invitations, bar 1, to make such bids have been given to those who could be expected to have inside information. Far from protecting the assets of Company, the Provisional Liquidators have thus put themselves in jeopardy of letting go of the assets at an undervalue.

27. At the commencement of this appeal the court inquired of counsel as to the provenance of the funds for the bringing of the appeal. That provenance transpired to be Dragon II namely a major noteholder and a shareholder in Phoenix. Given the manner in which this has been presented and the matters referred to by Yuen J. in her judgment with which I agree, any urgency attached to this application appears to have been far more apparent than real.

28. In view of the foregoing, I consider that this application has been made in a partisan manner for the benefit primarily of some of the creditors, and the costs of this appeal should not be allowed in any winding-up.

Yuen, J.:

29. This was an application by the Provisional Liquidators of the Company to the Companies Judge to sanction, under s.182 of the Companies Ordinance, an agreement between the Company and one Phoenix Telecommunication Ltd. ("Phoenix"), a BVI company formed by some of the Company's creditors, for the sale of the Company's assets.

30. The effect of the agreement would be to dispose of all the Company's assets, which comprise the Company's interests (whether as shareholder or as creditor) in three companies. One of the companies (Remoco) is involved, together with a Chinese company called Wan Li Tong, in a joint venture company called "Ligao Telecom", which operates a paging business in the PRC. Another company in which the Company is interested (as creditor) is a paging company in Hong Kong called Rightone.

31. The application was supported by a number of Affidavits from Mr. John Lees, one of the Provisional Liquidators, and Mr. James Collins-Taylor, a director of the petitioning creditor as well as of Phoenix.

32. One noticeable feature of Mr. Lees' Affidavits was the absence of any information as to the value of the assets to be sold. The Provisional Liquidators do not profess to be able themselves to value the assets, but they are nevertheless intending to sell the assets of the Company by private tender (limited to parties with knowledge of the existing business) without a valuation from any independent accounting firm or merchant bank. In Mr. Lees' 4^th Affidavit, he explained that he did not obtain a valuation because it would take at least two months and it would have been expensive (although no fees were quoted in his Affidavit).

33. Clearly where a court is asked to sanction an agreement by provisional liquidators to sell all the company's assets, in a situation where the value of those assets is unknown, extreme care must be taken to ensure that such a sale is necessary and that a proper price is obtained.

34. This is because the Company would be left with virtually nothing All the creditors' (and the contributories') statutory rights to distribution from the Company's assets (whatever their value is or may become) will be lost forever, in exchange for the consideration offered by the purchaser of the assets.

35. This effect on the creditors' rights to distribution was referred to by Mrs Justice Le Pichon in her judgment as driving "a coach and four through the statutory requirements for a section 166 scheme". Mr Bell for the Provisional Liquidators has argued that this was not a s. 166 scheme of arrangement, because the agreement in question is between the Company and Phoenix, not between the Company and any of its creditors.

36. That may be true but the effect of the present agreement on the creditors' rights to distribution from the Company's assets is no less drastic than in a scheme of arrangement. Under the Present agreement, the creditors who do not opt for equity (i.e. trade creditors who comprise mostly professionals) will get 15% of their claims in cash immediately but on winding-up, will get nothing at all, because the Company would no longer have any assets to realise. As to the balance, they would only be getting (in Mr. Lees' words) "the potential to recover the balance of such claims over a period of time" from Phoenix.

37. In the light of the significant effect of the proposed agreement on the creditors' rights, Mrs. Justice Le Pichon was, with respect, certainly entitled to require the matter to be fully explored as with a s.166 scheme. It may be true that these creditors comprise only a small proportion of the creditors overall, but the impact on them of a complete stripping of the Company's assets is severe, and their interests should also be considered.

38. Mr. Bell's fallback position was that even if this agreement was, or should be regarded as, a s.166 scheme, the court should still sanction it as a matter of urgency in the exigencies of the situation. He points to the evidence that the Ligao Telecom joint venture requires immediate funding: a tranche of US$2.5m was required by the end of June, and another tranche of US$2.5m will be required by the end of July. Rightone also needs some funding, but in relatively modest amounts.

39. Previously, these businesses had been supported by loans made available by some of the creditors, but these creditors are now only prepared to provide more funds if they could acquire the Company's assets through Phoenix. For instance, although Mr. Lees had previously negotiated a loan of US$3m, Phoenix has warned that if it is unsuccessful in its bid, it would "expect that any amount provided by it on an unsecured basis and under the secured facility will be immediately repaid".

40. It is said that the creditors have taken this position because they wish to exclude Mr. Allan Yuen from the management of the Company, and various allegations have apparently been made against Mr. Yuen. But it is difficult to see why the creditors should be adopting this position now when Mr. Yuen is no longer managing the Company, and Provisional Liquidators appointed by the petitioner are in place.

41. Absent these fears concerning Mr. Yuen's management, it is difficult to see why the creditors should not continue to support the Company in the short term pending the winding-up proceedings. If they did not do so, they would risk losing the benefit of all the previous investments they have made. The court was therefore entitled to take the view that the circumstances were not so dire as to require the agreement to be sanctioned as a matter of urgency before the matter could be fully considered. For these reasons, I too would dismiss the appeal.

Nazareth Atg CJHC:

42. I agree with Rogers JA and Yuen J.

43. I add the following. It has been argued strenuously that what we have here is not a s.166 scheme of arrangement. But even if not exactly such a scheme, the matter would have to be addressed upon broadly similar principles. What then, the question must be, would the role of the court be in giving or withholding approval. Clearly, it would have to be protective and require regard to be had to considerations similar to those in point in the approval of s.166 schemes of arrangement. I am left in no doubt that the judge was entitled to come to the decision she did. I also would dismiss the appeal.

44. The appeal is accordingly dismissed. There will be an order nisi that the costs of the appeal are not to be allowed in any winding-up.