WEI XING v. WILLWIN DEVELOPMENT (ASIA) CO LTD AND ANOTHER

HCMP 1922/2016

IN THE HIGH COURT OF THE

HONG KONG SPECIAL ADMINISTRATIVE REGION

COURT OF FIRST INSTANCE

MISCELLANEOUS PROCEEDINGS NO 1922 OF 2016

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J U D G M E N T

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1.  This is an application by the Applicant, a shareholder of Willwin Development (Asia) Company Limited (“the Company”), for an order under s 740 of the Companies Ordinance (Cap 622) (“the Ordinance”) for inspection of certain classes of documents.

Background

2.  The Applicant is a 30% shareholder while his brother, the 2^nd respondent herein, holds the remaining 70% of the shareholding in the Company.  For convenience I shall refer to them by their first names “Xing” and “Wen” respectively.  The Applicant and his wife Hu Ying (“Ying”) were previously directors of the Company, together with Wen.  It was held in HCA 797/2012 — an action brought by the Company and SWT (defined below) against Xing and Ying (and another) — that Ying had been relieved of her duties as director since June 2011, and was not treated by Wen as a co‑director at the latest after November 2011.[1] It appears to have been found that Xing ceased to be a director of the Company by November 2012.[2]

3.  Two other companies have been involved in the dispute between the two brothers, namely, Shenzhen Willwin Industrial Company Limited (“SWI”) and Shenzhen Willwin Technology Company Limited (“SWT”), both of which were incorporated in the Mainland.  Wen owns over 99% of SWI and has been its sole executive director.  SWT has been held ultimately by Wen (as to 58%), Xing (29%) and a third person called Chen Yonghong (13%).  Wen has been the only executive director of SWT.  He has also been the legal person’s representative of both SWI and SWT.

4.  As far as the Company’s business is concerned, it was held in HCA 797/2012 that it engaged in the sale and provision of test fixtures, test systems, test equipment and test instruments for electronic and computer hardware products and the supply of related technical services to clients primarily outside the Mainland.[3] In particular, in her judgment dated 8 March 2016, Mimmie Chan J said:

“48. … throughout the years, the brothers had been using WW [ie the Company] and SWI LH [the Luohu branch of SWI] (and its successor SWT) together, for the operation of their business of providing test systems and equipment or instruments for electronic and computer hardware products, and the related technical services. SWT and its staff on the Mainland may have been doing the substantial part of the work under orders received from clients, but this is hardly surprising as a manner of business operation these days. It is material that as evidenced by the documents disclosed by Apple in these proceedings, purchase orders had been placed with WW and in its name. WW was recorded in Apple’s database as the supplier of the relevant services and hardware. Purchase orders have been produced in evidence as having been placed by Annexure A companies, such as Apple and others, with WW. Invoices were issued by WW to Apple and other Annexure A companies. The defendants do not in fact dispute that invoices were issued by WW, and purchase orders from some clients were placed in the name of WW. They only claim that that was WW’s only and limited nominal role: as invoice issuers and money collectors for SWT.”

“52. … before the disputes which led to the commencement of legal proceedings, Wen and Xing had been content to be flexible with clients as to with whom purchase orders for their products and services should be placed, to facilitate the manner of payment or the currency in which payment was to be made by the clients. It is common knowledge that there are currency controls on the Mainland, and it is readily apparent that it would be more convenient for WW in Hong Kong to issue invoices to clients which are outside the Mainland and to receive payment from such clients in Hong Kong, in Hong Kong or foreign currency, under purchase orders issued by clients in WW’s name. On the evidence, Wen and Xing appeared to be content, before 2011, with treating WW and SWT as one entity, or as related entities in one group, before their disputes arose.”

5.  It appears that the brothers’ relationship had turned sour by 2011, and starting from 2012 various legal proceedings were instituted between them.  Not all of them are relevant for present purposes.

The Application

6.  By the present originating summons, Xing has initially asked for a very wide range of documents, but in his skeleton argument Mr Leon Ho, who appeared for Xing, had sensibly narrowed down the request to three categories of documents, which may be broadly described as follows:

(1)   minutes and resolutions of shareholders’ meetings from 2012 onwards; reports of directors and financial statements for the financial years ended 31 March 2013 to 31 March 2016;

(2)   documents relating to the sub‑contracting charges debited to the Company from the financial year 2010/11 onwards; and

(3)   documents relating to the loan to a director from the financial year 2011/12 onwards.

Category 1 — minutes, resolutions, directors’ reports and financial statements

7.  It is not in dispute that after the total breakdown of relationship (at the latest by early 2012), Xing had not received any audited accounts of the Company or any minutes, resolutions or notices of general meetings (except the directors’ report and audited financial statements for the year ended 31 March 2012 and the minutes of an EGM held on 26 October 2012). The failure to provide the audited accounts to him — an undisputed member of the Company — is of course prima facie wrongful, and potentially an offence under statutory provisions such as ss 429 to 433 of the Ordinance which require directors to lay before the company in general meeting and send to the members the financial statements.  It is also clear that as a member Xing has a right to inspect and obtain copies of minutes and resolutions of general meetings: see ss 618 to 620 of the Ordinance.  For this part, Mr Vaughan, who appeared for the Company and Wen, did not oppose this part of the application.

Category 2 — sub‑contracting charges

8.  In respect of the other two categories, Xing has to invoke the power of the court under s 740 of the Ordinance, for they are not ordinarily documents within a shareholder’s right of access.  The central requirements are that the application is made in good faith and the inspection sought is for a proper purpose.  The principles governing such applications for inspection are not in dispute and have been set out in the decisions of Harris J in Wong Kar Gee Mimi v Hung Kin Sang Raymond [2011] 5 HKLRD 241 and Re Opes Asia Development Ltd (unrep, HCMP 447/2012, 17 May 2012) and of the Court of Appeal in Re LehmanBrown Ltd [2011] 5 HKLRD 668 and Veron International Ltd v RCG Holdings Ltd [2013] 3 HKLRD 657.  I do not propose to repeat them here.

9.  In relation to the documents concerning the sub‑contracting charges, the respondents did not deny that the Company sub‑contracted its work and paid sub‑contracting charges to SWT.  Historically such charges accounted for a very substantial portion of the Company’s expenses, as can be seen from the table below.

Year ended	Sales less discount (HK$)	Sub‑contracting charges (HK$)	Profit (Loss) for the year (HK$)
31/3/2008	12,169,555	9,392,000	453,467
31/3/2009	4,178,555	1,152,000	79,522
31/3/2010	5,823,149	2,496,000	213,817
31/3/2011	6,708,228	4,340,000	212,237
31/3/3012	3,140,440	2,041,000	(623,710)

10.  The 2012 audited financial statements were signed off in March 2014 and disclosed to Xing in the course of HCA 797/2012.  Xing engaged a forensic accountant to examine these statements and other documents and the accountant reported in December 2014, raising certain issues.  As a result, Xing requested for further documents from the Company in the course of 2015 and 2016 but none was provided.

11.  Xing had also raised queries with the Company’s auditors.  In 2012 the auditors said that the sub‑contracting charges had been paid by the Company to SWI but in 2016 the auditors said they had been paid to SWT instead. In letters in 2012, the auditors confirmed that no agreement or invoice had been produced to them for audit purposes.  The sub‑contracting charges were simply recorded as journal adjustments, based on journal entries supplied by Wen.  Payments were said to have been made in the form of cash withdrawal directly from the Company’s bank account, but no audit evidence was provided to show that the cash was paid to the sub‑contractor company.

12.  The upshot of all these is that substantial amounts (many times the profits of the Company) were paid by the Company to SWT (or SWI) as sub‑contracting charges.  Wen was a substantial shareholder of both SWT and SWI.  The Company’s auditors did not have access to any primary documents in auditing those charges and essentially relied on the representations of the management ie Wen. 

13.  As is well known, intra‑group trading activities provide opportunities for manipulating profit and loss: Re Gordon & Breach Science Publishers Ltd [1995] BCC 261, 269H.  In the present case a slight increase in the sub‑contracting charges paid would be sufficient to wipe out any profit the Company might have had in a particular year.  In my view these sub‑contracting charges are prima facie a proper subject for a shareholder of the Company to be concerned about.  They could have affected both the value of his shareholding and entitlement to dividends from any profit of the Company.

14.  Furthermore, Xing pointed out that Wen had been found by a Mainland court in 2012 (affirmed on appeal) to have misappropriated over RMB 1.4 million from SWT.[4] The rule in Hollington v Hewthorn [1943] 1 KB 587 means that those Mainland judgments are not admissible in Hong Kong as evidence of the facts found therein, but as submitted by Mr Ho I think they are admissible to show that these judgments and findings had been made by the Mainland courts, which in turn is relevant in supporting the purpose and bona fides of Xing in making the present application.

15.  In his affirmation Xing said that he was concerned that the Company’s affairs had not been conducted properly and that Wen had acted in breach of his fiduciary duties as a director and the Company’s funds had been diverted to other entities with no justification.  In order to verify whether there was in fact misconduct or other irregularity he needed to inspect the Company’s records and documents.

16.  Mr Vaughan criticised various other parts of Xing’s affirmation for making certain assertions contrary to the findings of the court in HCA 797/2012 (such as the assertions that the Company had no real business, that Xing and Ying ceased to be directors in 2011, and that Wen was in sole control of the finance of the Company).  While it is highly unsatisfactory that those assertions were still maintained despite the judgment in HCA 797/2012, I do not think that they detracted from the basis for the application to inspect this category of documents.

17.  Mr Vaughan also attacked the timing of the application, contending that there had been substantial delay which threw doubt on the purpose of the application.  He also pointed out that the originating summons herein was issued only two days after post‑trial directions were given in HCA 797/2012 requiring Xing to give discovery.  It can be said that the application was not taken out expeditiously, but I do not draw any inference from the timing that negatives the proper purpose or bona fides of the application.  The parties had another piece of litigation in HCA 797/2012 to attend to where the trial ended in November 2015 and judgment was handed down in March 2016.  Xing had made 4 rounds of requests for documents on 5 March 2015, 24 September 2015, 29 January 2016 and 29 February 2016 respectively.  The matter was not left entirely dormant.

18.  As to the post‑trial directions in HCA 797/2012, I do not see the relevance of the fact that Xing launched the application shortly after the directions were given.  Even if Xing, having lost HCA 797/2012, was in part motivated by a desire to “hit back” with an application for inspection, I do not think that would necessarily show a lack of proper purpose or good faith.  After all, he is a long‑standing 30% shareholder of the Company and even though he has himself been guilty of wrongdoing vis-à-vis the Company in relation to certain events prior to 2012 (as found in HCA 797/2012), this should not prevent him from protecting his continuing interests as a shareholder against potential wrongdoing by others.  As Harris J said in Wong Kar Gee Mimi, supra, at §§21 & 22, once the primary purpose for the application for inspection is considered to be “proper” in that it is germane to the applicant’s status as a shareholder, then any secondary purpose in seeking the records is irrelevant.  As Harris J also said, so long as the applicant acts in good faith and for a proper purpose, then the fact that there is hostility between the parties is equally irrelevant and is no bar to an application for an inspection order.  Even if Xing was looking for material to find a just and equitable winding‑up petition (as Wen alleged), that is not in itself a ground for refusing this application.

19.  The respondents further submitted that the issue of sub‑contracting had been considered in HCA 797/2012. For example, in her judgment there at §45, 48, 52 and 54, Mimmie Chan J referred to the fact that Xing and Ying had signed accounts for the years ending 31 March 2007, 31 March 2008, 31 March 2009 and 31 March 2010 which contained references to sub‑contracting charges and that Wen and Xing had effectively agreed to treat the Company and SWT as one entity.  That, however, as the judge made clear, applied only to the period before the relationship broke down.  There is nothing to suggest that, as from 1 April 2010 (which is the beginning of the period to which the relevant documents sought relate), Xing and Ying consented to the amounts of sub‑contracting charges debited to the Company.

20.  Accordingly, I am satisfied on the evidence that the application for inspection of this category of documents has been made in good faith and the inspection is for a proper purpose and that there should be an order that Xing and/or his agent be authorised to inspect and make copies of the following records and documents of the Company:

(1)   All minutes and resolutions of meetings of the Board of Directors of the Company in relation to the Company’s sub‑contracting operations from 1 April 2010 to the date of the Order.

(2)   All price quotations, purchase orders, invoices, receipts, agreements from 1 April 2010 to the date of the Order between the Company and its subcontractor(s), and all documents showing payments to such subcontractor(s), including but not limited to bank statements, bank transfer slips, and documents showing details of set‑off.

(3)   All documents provided to the Auditor in preparation of the sub‑contracting figures in financial statements of the Company for the years ended 31 March 2011–2016, including but not limited to all written instructions provided to the Auditor in relation to the sub‑contracting charges, summaries, tables, spreadsheets, and journal entries.

Category 3 — loan to director

21.  The third category of documents concerns a loan by the Company to a director, namely, Wen.  The financial statements for the year ended 31 March 2012 showed that the Company had advanced a loan in the amount of HK$1,787,990 to Wen.[5] As can be seen from the table in §9 above, this amount is more than half of the revenue of the Company for that year.  It was also very substantial compared to net assets of HK$223,521 as at 31 March 2012.  The notes to the accounts stated the advances to be “unsecured, interest free and repayable on demand”.  In a letter in 2012, the auditors stated that there was no specific audit evidence provided to them for the amount owed which was apparently taken simply from the ledgers.

22.  To say that the loan was a managerial decision is not a sufficient answer in this case.  A substantial loan to a director is clearly a matter potentially germane to the interests of shareholders — not least in this case because s 157H of the previous Companies Ordinance (Cap 32)[6] prohibited loans to directors and the exception in s 157HA(2) depended on approval by the company in general meeting, which is lacking, on Xing’s case, because no general meeting had been held.

23.  Nothing has been said or produced by the Company or Wen thus far to show how the conflict of interests was dealt with in deciding to grant the loan, why and how the loan was made, and whether the loan had been repaid.  These are matters a shareholder such as Xing can legitimately be interested in.  The documents of which inspection is sought are as follows:

(1)   All minutes and resolutions of meetings of the Board of Directors of the Company in relation to loans made by the Company to its directors from 1 April 2011 to the date of the Order.

(2)   All documents showing the terms of the loans between the Company and its directors from 1 April 2011 to the date of the Order.

(3)   All documents evidencing advancement and repayment of the Company’s loans to its directors, including but not limited to bank statements, bank transfer slips, journal entries, and documents showing details of set‑off (if applicable).

(4)   All documents provided to the Auditor in compiling the amounts due from directors to the Company in financial statements of the Company for the years ended 31 March 2012–2016, including but not limited to all written instructions provided to the Auditor in relation to the Company’s loans to directors, and all summaries, tables, spreadsheets, and journal entries.

24.  The arguments raised by the respondents against the application generally have been dealt with above and I shall not repeat the discussion here.  Specifically it was submitted here that the documents sought would be of no utility.  I do not entirely accept that argument.  In my view, inspection of the documents in §23(1) and (2) above can clarify for what reasons the loan was granted and what other terms of the loan there might be. I accept Mr Vaughan’s argument, however, that the documents in §23(3) & (4) above do not appear to be necessary, at this stage at any rate, given that Xing will be given audited accounts of the later years and there is nothing at the moment to suggest that the figures on loans to directors in the financial statements are wrong, incomplete or inaccurate.

25.  In all the circumstances it seems to me again that as far as the documents relating to loans to directors in §23(1) and (2) above are concerned, Xing’s application has been made in good faith and the inspection is for a proper purpose.  Accordingly, there shall be an order for inspection of those documents.

Disposition

26.  There will accordingly be the orders referred to above, with liberty to apply.

27.  In connection with costs, Mr Vaughan contended that Wen should not have been joined as a respondent at all and there should not be a costs order against him, relying on Re Opes Asia Development Ltd (unrep, HCMP 447/2012, 17 May 2012) at §42 and Leung Chung Pun v Masterwise International Ltd [2014] 1 HKLRD 1129 at §§66–68.  In myview, however, the present case is special and quite different from those two cases.  There are only 2 shareholders in the Company which is a private company: Wen and Xing.  There are at present only 2 directors of the Company: Wen and a person called Zheng Fang.  There is no evidence as to who Zheng is and why he or she has been appointed a director.  As 70% shareholder Wen is essentially in control of the composition of the Board.  Xing had been denied even the first category of documents above, ie resolutions and minutes of general meeting and audited accounts, to which a shareholder is plainly and indisputably entitled under the law.  There is and can be no explanation, and no reason has been offered by Zheng, why these documents had not been provided to Xing, except for the fact that Wen has been at loggerheads with him.  The second and third categories of documents relate to SWI’s or SWT’s dealing with the Company and Wen’s borrowing from the Company — matters in which Wen had a clear personal interest.  Wen’s response to the present application in correspondence or on his affirmations was not that he was only a director and would let the Company deal with it.  Instead he actively opposed the application and sought security for his own costs.  All the indicators there are suggest that the Company’s response has been dictated by Wen’s position and that this litigation is in substance a further episode of the acrimonious dispute between the two brothers Wen and Xing.

28.  Accordingly I think there is basis for an order that Wen should pay the costs of the application.  However, on a provisional basis, I do not think Xing should have all his costs because (1) the application as originally framed was hopelessly wide; and (2) his 1^st affirmation contains various assertions that are untenable in the light of the court’s findings in HCA 797/2012.  As an order nisi, I would order that Wen do pay Xing two‑thirds of the costs of the application, to be taxed if not agreed.