FOK LAI LOR NORA v. FOK YING TUNG MING YUAN DEVELOPMENT CO LTD

HCMP 974/2017

[2020] HKCFI 354

IN THE HIGH COURT OF THE

HONG KONG SPECIAL ADMINISTRATIVE REGION

COURT OF FIRST INSTANCE

MISCELLANEOUS PROCEEDINGS NO 974 OF 2017

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D E C I S I O N

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Introduction

1.  The Plaintiff, Nora Fok, seeks an order from the court pursuant to s222 of the Companies Ordinance (“Ordinance”), Cap 622, cancelling a special resolution of the Company passed at an extraordinary general meeting on 24 March 2017, which approved the reduction of the Company’s share capital (“Special Resolution”)[1].  The Special Resolution has two components.  The first involved the cancellation of capital to the extent of $861,000,000 representing $277.29 for each of the 3,105,000 issued and fully paid up shares of the Company.  The second approved the repayment to shareholders of $1,173,000,000 representing $377.78 for each of the 3,105,000 shares of the Company.

2.  Ms Fok contends that the Special Resolution ought to be cancelled because:

(1)    it is defective in that the amount of $861,000,000 stated in    the Special Resolution is not reflective of the Company’s accumulated losses near the date of the passing of the resolution;

(2)    the proposal for the reduction has not been properly explained to enable the shareholders to reach an informed decision, and Ms Fok in particular has been denied meaningful access to information and documents relevant to the proposal.

(3)    The alleged accumulated losses of $861,000,000 sought to be eliminated are not permanent in nature and have in fact been substantially reduced recently.

Background

3.  The Company is a private limited company incorporated      in Hong Kong on 10 December 1999.  It is owned by members of the Family of the late Henry Fok, including the Plaintiff who is his daughter.  Its principal business is investment holding.

4.  The Company’s business has been funded by a shareholder’s loan of approximately $3.52 billion provided by Henry Fok to the Company on 6 April 2006. The shareholder’s loan was capitalised pursuant to an ordinary resolution of the Company on 25 October 2006 and a shareholders’ agreement of the same date.

5.  Recital H of the Shareholders’ Agreement records that the sole purpose for the formation of the Company is to provide capital to support developments in Nansha, a newly designated pilot free-trade zone in the Pearl River Delta in the Mainland.

6.  The Plaintiff has since 27 October 2006 been one of the registered shareholders of the Company holding 135,000 out of 3,105,000 issued shares.  The Plaintiff owns approximately 4.34% of the Company’s issued shares.  This is not the first time that the Plaintiff has come before the court in an attempt to prevent the Company implementing a reduction of capital.  In January 2016 I heard a petition, which I dismissed, by the Company to reduce its capital for the same purpose as gives rise to the present case.  Its will be helpful to read that decision [2] to better understand my present decision.

7.  On 16 February 2017, the Company circulated a notice to the shareholders for convening an extraordinary general meeting (“EGM”) for the purpose of considering and resolving the Special Resolution for the reductions of the Company’s share capital, which I have described in [1].

8.  The EGM Notice enclosed various documents, including      (1) a circular in respect of the proposed reductions, (2) the Reports and Financial Statements of the Company and its subsidiaries for the period from 1 January 2016 to 31 August 2016; and (3) a letter from Hopkins Consulting Limited dated 14 February 2017 setting out various financial projections.

9.  Having received the EGM Notice and the enclosed documents, Ms Fok through her solicitors, Clifford Chance (“CC”), wrote to the Board of the Company to raise questions regarding the proposed reductions      of capital, and to request copies of all the documents referred to in      Hopkins’ Feb 2017 Letter.

10.  Ms Fok says that the Company refused to answer most of her questions and prevented Ms Fok and her advisers from having meaningful access to the relevant documents in advance of the EGM.

11.  Ms Fok’s representatives, Mr Nicholas Charles Allen, a certified public accountant, and Ms Kammy Cheung of CC were only able to attend the Company’s offices to inspect the Hopkins Documents at around 11:45pm on 24 March 2017, shortly before the EGM scheduled for 2:00pm that afternoon.  Ms Fok complains that they were also prohibited by the Company’s officers from making copies of the documents.

12.  Ms Fok attended the EGM at 2:00pm on 24 March 2017.  She requested that the EGM be adjourned as the shareholders, including herself, had not been provided with sufficient information to make an informed decision on the matter.  However, her proposal was voted against by the members.

13.  After certain discussions, the Special Resolution in respect of the proposed reductions of capital was put to a vote and was passed.

Principles that govern reduction of capital

14.  As Mr Poon reminded me a cardinal principle of company law is the “Capital Maintenance Rule” which was devised for the protection of creditors of the Company: Trevor v Whitworth [3].  As a consequence, the law imposes restrictions on the reduction of a company’s share capital.  Since the commencement of the Ordinance on 3 March 2014, there have been two procedures by which a company may reduce its capital.  In addition to preserving the former procedure allowing for reductions of capital by court sanction (ss 226–232), the Ordinance introduces an alternative procedure whereby a company may reduce its capital by passing a special resolution supported by a solvency statement in compliance with ss 204–207 (ss 215–225) without having to obtain the approval of the court unless challenged by members or creditors (s220).

15.  Under the new procedure (ss215–216) a company may reduce its share capital by special resolution provided that all directors of the company make a solvency statement that complies with ss204–207.  The special resolution must be passed within 15 days after the date of the solvency statement.  Section 220 provides that a member or creditor of the company may, within five weeks of the date of the special resolution, apply to the court for cancellation of the resolution.  Section 222 provides that on an application under section 220, the court must make an order confirming or cancelling the special resolution, and may do so on such terms and conditions as it thinks fit.  The equivalent legislation in England and Wales does not contain any equivalent procedure for challenging the special resolution.

16.  In the case of court approved reductions various principles and conditions emerge from the authorities.  In summary they are as follows:

(1)     all the shareholders must be treated equitably;

(2)     the reduction proposal had been properly explained to the shareholders so that they could form an informed judgment on it;

(3)     the creditors must be safeguarded; and

(4)     the reduction is for a discernible purpose.

Fok Ying Tung [4]

17.  An issue that arises in the present case is whether the same principles and conditions apply to a reduction of capital under the new procedure so that if, on a challenge under s220, the applicant is able to demonstrate that an application to the court for sanction of a reduction would have failed to satisfy these principles and conditions, a special resolution should be set aside.  It is this issue that I address first.

18.  Division 3 of Part 5 of the Ordinance provides that a company may reduce its share capital by the methods specified in s211. Section 212 makes it an offence for a company to reduce its capital in contravention of Division 3; in other words other than in accordance with the methods specified in Division 3.

19.  Section 211 provides two methods by which a company may reduce its capital.  First, by a special resolution supported by a solvency statement under Subdivision 2 (the new method introduced at the time      of the enactment of the Ordinance).  Second, by a special resolution confirmed by the court under Subdivision 3.

20.  Subdivision 3 retains the court sanctioned route, which existed in the previous version of the Ordinance [5].  Although the wording has been changed, the procedure remains the same.  Unless the court directs otherwise, s277 (creditor entitled to object to the reduction) applies if the reduction involves either a diminution of liability in respect of unpaid shares or a payment to shareholders of any paid up capital.  Subdivision 3 does not give a shareholder an express right to object.  This suggests that the primary concern of the court is the protection of creditors and that their ability to be paid will not be jeopardised by a reduction in a company’s share capital.  This is the “Capital Maintenance Rule” to which Mr Poon referred.  Further support for this conclusion is provided by the requirement in the new alternative route provided by Subdivision 2 that the board produces a solvency certificate.  The production of a compliant solvency certificate is central to this new route.  Although, a shareholder is given an express right to come to court and object to a special resolution approving a reduction of capital, unlike the provisions of the English equivalent, which is the origin of Subdivision 2 [6], which does not contain an express provision enabling a shareholder’s challenge, it does not seem to me that deflects analysis from the obvious conclusion that the new route is intended to be quicker, cheaper and less technical than the existing method by which the court was invited to approve reductions, which in my experience      too frequently resulted in genuine and uncontroversial attempts to reduce capital as a means to write-off accumulated and permanent losses, becoming unnecessarily complex and expensive.

21.  It seems to me that although the broad principles that I have summarised in [16] are still applicable, the introduction of Subdivision 2 indicates that the new procedure is not meant to be overly technical.  In determining in the face of objection by a shareholder whether or not a special resolution should be set aside, the court should bear in mind that the protection of creditors is the primary concern and that the principles are a tool to assess whether or not something has gone sufficiently wrong with the process leading up to the passing of a resolution that there is a material risk of either a special resolution having been passed, which should not have been passed and/or a reduction of capital having been approved that potentially or actually prejudices creditors.  It is not a technical game in which success or failure is to be determined by unnecessarily technical analysis of, for example, the information made available to shareholders.  In the case of a shareholder the most likely legitimate concern is that shareholders have approved a reduction of capital, which exceeds the amount, which is available for distribution because of inaccurate information about the company’s debt at the time the special resolution is passed.

22.  There is no question in the present case of this application being driven by a concern that creditors will be adversely effected by the reduction.  Ms Fok’s objection is driven by a disagreement with the other family members, who hold shares in the Company on what the Company should be doing.  She thinks that it should continue to pursue the purpose, namely, supporting developments in Nansha for which her Father set it up.  The very large majority of shareholders disagree and take the view that the capital, which the Company no longer needs should be distributed amongst them.  As I explain earlier in this decision, Ms Fok has already successfully challenged an attempt to obtain approval of the reduction by the court [7].    It seems to me quite clear that Ms Fok’s application is made with a view to interfering with the majority view, nothing more than that.  Of course, it does not follow that the arguments advanced by Mr Poon on her behalf are wrong.  I accepted that Ms Fok’s objections to the Company’s first attempt to implement a reduction of capital were correct.  I now turn to consider Ms Fok’s objections to this new attempt to reduce the capital, which I have summarised in [2].

The amount of the loss stated in special resolution was not reflective of    the Company’s actual loss at the time of the EGM

23.  The date of the balance sheet was approximately seven months before the date of the EGM.  The financial statement for 2016 showed the Company incurring an accumulated loss of $860,374,330     as at 31 August 2016.  Ms Fok’s adviser, Nicholas Allen, who is a certified public accountant, has examined the unaudited management accounts for the period ending 30 November 2016.  He says they show that the losses continued to accumulate and as at 30 November 2016 a further loss of $9,920,229.75 had been made.  The audited financial statement for the period ending 31 December 2016 shows that the losses had accumulated to $904,050,349.  In other words a further $43,050,349 had been lost by the end of the year.  Mr Poon suggests that it is reasonable to infer that as the projects, which the Company has been financing are in their nascent stage [8], that the losses continued to accumulate and the divergence between the figure included in the first part of the Special Resolution and the actual accumulated losses diverged even more three months later when the EGM took place.

24.  Mr Poon submitted that unless all the losses as at 24 March 2017 had been eliminated, it is impossible for the second part of the Special Resolution for the repayment of capital to be implemented for the reasons explained in [19]–[22] of my earlier decision [9].  The first part of the special resolution will be reflected in a minute that will be registered at the Companies Registry.  Mr Poon says that it is clear that the accumulated losses had grown materially between 31 August 2016 and 24 March 2017 and that the Special Resolution, and any minute based on it, is misleading and for the reasons explained in my earlier decision the Special Resolution is defective and the Court should cancel it pursuant to s222(1).

25.  It is, of course, not practical for a company, which is loss making to pass a special resolution to approve a reduction of capital that involves a write-off of accumulated losses to identify to the dollar the amount of the accumulated losses at the time the special resolution is put to shareholders and certainly not at the time an application to sanction a reduction comes before the court.  In practice the way in which corporate finance lawyers dealt with this problem was to ensure that the process was started immediately after audited financial statements were available (sometimes these would be part way through a financial year as has been done in the present case) commonly supplemented by evidence from the auditor filed for the purposes of the petition hearing.  The position should be more straightforward in the case of a reduction under Subdivision 3 as all the papers could be prepared for the necessary general meeting prior to the end of a convenient accounting period and the meeting convened within a month.  In fact that is what I would expect a properly advised company to do.  The failure to do so potentially gives rise to the problem explained in [20] of my earlier decision.  There is no explanation in the evidence filed on behalf of the Company as to why it did not adopt what I consider to be a conventional and prudent approach.

26.  Mr Chan on behalf of the Company argued that it will never be possible for a special resolution to state precisely what a company’s losses are on the date it is passed.  For the reasons explained in the previous paragraph I agree.  However, it seems to me incumbent on a company, which delays convening an extraordinary general meeting a material amount more than the minimum period, which will commonly be about     a month, to explain why and demonstrate that losses have not been increasing materially.  It seems to me that an increase in excess of $43,050,349, representing a 5% increase in the loss, is material.

27.  Mr Chan also argued that as the Company’s financial position has improved and its asset value will exceed the value of the share capital after the reduction.  There is no risk of creditors or shareholders being misled.

28.  I will explain my conclusion in respect of this objection at the end of these reasons.

Lack of Informed Decision

29.  Ms Fok complains that the circular accompanying the EGM notice did not contain a proper explanation as to when and how the alleged accumulated losses of $860,374,330 were incurred or whether they were permanent or not.  She also complains that her questions to the Board were not satisfactorily answered and she was not given adequate access to supporting documents before the EGM.

30.  It is correct that the court has historically required the evidence in support of applications for reductions of capital to identify the permanent losses and explain why it is said that they are permanent.  On occasions this could be onerous.  It seems to me that a company is not required to undertake a similar exercise when it prepares a circular explaining a proposed reduction of capital to shareholders, particularly in the case of a private company, whose shareholders are likely to be more familiar with its affairs than those a public company.  Shareholders should be supplied with as much information as one might reasonably expect an intelligent and interested shareholder to expect to read in order to determine how to cast his or her vote in respect of the resolution.  A shareholder asked to approve a reduction of capital under Subdivision 3 is not entitled to receive the level of detail about the permanent losses that a cautious judge might require.

31.  The fact of the matter is that the large majority of shareholders supported the proposed reduction of capital and distribution, which they had already considered once before.  It is entirely fanciful to suggest that their decision was in anyway impacted by the absence of the information of which the Plaintiff complains as demonstrated by the fact that the Company passed another special resolution confirming the reduction of capital on 15 October 2018.  Neither is there any suggestion in the Plaintiff’s evidence that she would have voted in favour of the resolution if only her advisers had been provided with detailed accounting information that allowed them to advise her that there were no technical impediments (because in practice that is what we are dealing with) to voting for a resolution in the form set out in the circular.  The reality is she was trying to create problems and interfere with the reduction of capital, which she opposes because she will not accept the majority view about how the Company’s affairs are to be conducted.

32.  There is a further complaint about what her advisers      suggest were questionable financial projections.  Mr Poon summarises      this sub-head of complaint in [36] of his skeleton argument: “In sum, there were substantial defects in the explanation and provision of relevant information in relation to the proposed reductions such that it could not be said that the proposal was properly put to the shareholders for them to make an informed choice on the matter”.  The assumption inherent in      this submission is that if there are inaccuracies in the financial information provided to shareholders any special resolution subsequently passed      is defective and liable to be set aside.  I disagree.  What a shareholder advancing this type of complaint has to do is to demonstrate that the information provided was unsatisfactory to an extent or in a manner, which prevented shareholders making an adequately informed decision about whether or not to support the reduction in the manner formulated in the special resolution.  This does not necessarily mean that it has to be demonstrated that they might have voted differently if complete and/or accurate information had been provided (although this would probably be sufficient), but that even if it probably made no difference to the decision of the necessary majority (75%) the defects were so significant as to call into question the integrity of the process and render it something of a sham.  But that is not the case here.  The criticisms made by Mr Allen in his report criticising the accounts are fairly technical and it does not seem to me that even if he is correct they were so serious as to call into question the integrity of the approval by shareholders to a degree, which of itself justifies the court overturning the Special Resolution. 

Alleged losses not permanent

33.  One of the common reasons for reducing capital is in order that a company’s capital and balance sheet more accurately reflect its true financial position when substantial capital has been lost as a consequence of the company’s operations making losses.  Historically the court would only approve a reduction in respect of permanent losses out of a concern that it would be unfair to creditors if a non-permanent loss was written off, then recovered becoming available for distribution to shareholders by way of dividend [10].

34.  An unsatisfactory consequence of this was a company could not write-off what we now call impairment losses, which in practice were very likely permanent, but it was possible could be recovered. This issue has been addressed by the practice developing of the court accepting undertakings that any recovery would be treated as a non-distributable reserve as long as any actual or contingent liabilities, which would be admissible to proof in a winding up of the company commencing on the date when the reduction became effective, remain outstanding unless with the consent of the creditors to whom such liabilities were owed.  Mr Poon describes this as an exceptional exercise of the court’s discretion.  That may have been a fair characterisation of it when the practice first developed, but it is no longer apposite and the Companies Court has routinely during the course of the last 15 or so years accepted such undertakings if a company wishes to write-off losses, which may on a strict analysis not be permanent.

35.  Mr Poon descended into a great detail concerning both the authorities on this subject and how when dealing with reductions of capital of public companies the court had historically required a very detailed analysis of the character of the losses.  He submitted, certainly this was the substance of his approach, that when challenged by an application under s220 that some of the losses were not permanent the company was required to undertake much the same exercise as had been required by the court in a case such as Re Capital Asia [11]. I disagree.  In my view Mr Poon is clearly wrong in suggesting that the introduction of Subdivision 2 was not intended to alter the substantive law.  What was clearly intended was to avoid exactly the kind of expensive, time consuming and normally pointless exercise that Mr Poon advocated in his explanation of the historical practice.  What is important under the new court-free route is the solvency statement (for obvious reasons) and in my view it would be rare for the kind of painful distinctions Mr Poon advocated to have any significance or justify the court being interested in the kind of forensic analysis Mr Poon undertook if a sensible undertaking is offered.  I have appended to this decision the undertaking that has been proposed.  In my view it clearly cures any concerns of the sort that I have described in the previous paragraph.

Conclusion

36.  It is clear from s221, and in particular, ss221(2) that the court is given a flexible and discretionary jurisdiction to manage reductions of capital under Subdivision 2.  The sub-section reads:

“The Court may give any directions and make any orders it thinks expedient for facilitating or carrying into effect any such arrangement.”

37.  Section 222(1) requires the court to make “an order confirming or cancelling the special resolution for reduction of share capital, and may do so on any terms and conditions it thinks fit.”  The court is given a discretion to determine, which order to make.

38.  The discretion must be exercised judicially with regard to      the principles that I have discussed in earlier sections.  In my view the overarching considerations are the protection of creditors and ensuring that shareholders have been adequately appraised of the information they might reasonably be expected to consider in deciding how to vote the special resolution.

39.  Despite the fact that in my view a longer than desirable gap was left between the audit date of the financial report, which states the accumulated losses and the date of the EGM and also questions have been raised as to whether all the losses are permanent, it is clear in my view that they represent no threat to creditor’s interests, particularly given the undertaking offered by the Company, or call into question the integrity      of the decision made by the large majority of shareholders, who clearly want the capital reduced.  As I have already explained, Ms Fok’s motive    in making this application cannot sensibly be said to arise from a genuine concern for either of these matters.  She is simply trying to use the ingenuity of her lawyers to stymie the wishes of other shareholders.

40.  I will, therefore, confirm the special resolution and make an order nisi that Ms Fok pays the Company’s costs with a certificate for two counsel.

1.     The Company undertakes that:

(i)     insofar as it has, since 31 August 2016, made recoveries or reversals in respect of the provisions for impairment losses against subsidiaries, associates, joint ventures and related companies identified in the Schedule hereto, which provisions (“the Provisions”) had been made in the accounts of the Company up to 31 August 2016, and

(ii)     in the event of the Company making any future recoveries or reversals in respect of the Provisions,

all such recoveries and reversals up to the aggregate amount of $1,042,039,796 (“the Limit”) will be credited as a special reserve under the Company’s share capital in the accounting records of the Company (“Special Capital Reserve”).

2.     The Company further undertakes that so long as there shall remain outstanding any debt or claim against the Company, which if the date on which the reduction of capital becomes effective (“the Effective Date”) were the date of the commencement of the winding-up of the Company would be admissible to proof in such winding-up and the persons entitled to the benefit of such debts or claims shall not have agreed otherwise, such reserve shall not be distributed and shall not be treated as realised profits for the purpose of sections 291 and 297 of the Companies Ordinance (Cap 622) PROVIDED THAT:

(a)     The Limit may be reduced by the amount of any increase, after the Effective Date, in the paid-up share capital of the Company as a result of the payment up of the share capital by the receipt of new consideration or capitalisation of distributable profits if such increase is not used to reduce the Limit;

(b)     The Limit may be reduced upon the disposal or other realisation, after the Effective Date, of any interest in any of the aforesaid subsidiaries, associates, joint venture and related companies by the amount of the provisions made in relation to such subsidiaries, associates, joint venture and related companies, as the case may be, as at 31 August 2016 (which

     amounts of provision are set out in the 3^rd column of the Schedule hereto) less such amounts (if any) as is credited to the Special Capital Reserve as a result of such disposal or realisation; and

(c)     In the event that the amount standing to the credit of the Special Capital Reserve exceeds the Limit after any reduction of the Limit pursuant to Provisos (a) and/or (b) above, the Company shall be at liberty to transfer the amount of any such excess to the general reserves of the Company and the same shall become available for distribution or to use any such excess to offset the accumulated losses of the Company, as the case may be.

3.     The Company undertakes that, for so long as the undertakings set out above remain effective, it will cause or procure its auditors to report, by way of note or otherwise, a summary of the undertakings in its audited financial statements.

4.     For the avoidance of doubt, all the above undertakings are without prejudice to the return of capital by way of payments to the shareholders of the Company as set out in part (b) of the Special Resolution passed by the Company’s members on 24 March 2017.