Re Chinese Estates Ltd

HCCW000094/1975

IN THE HIGH COURT OF HONG KONG

COMPANIES (WINDING-UP)

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Coram: McMullin, J.

Date of Judgment: 30th March 1976.

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JUDGMENT

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1. I am indebted to counsel on both sides in this case for the thoroughness with which the issues lying between them have been exposed and explored. It is a tribute to their industry that after an argument which occupied some six days at hearing, I find myself now in a position to dispose of this matter without a very elaborate discussion of the many subsidiary issues raised in the course of that argument. The petitioners, who seek an under s.177 of the Companies Ordinance, constitute some 10% of the shareholders in the Chinese Estates Ltd. but between them through their holdings in the shares of the company, constitute a large minority - about 28% - of the voting power. They are opposed in the present petition by the Directors and their supporters who, I am informed, can muster in opposition something slightly over 30% of the company's plebiscite. There would appear to be a "silent minority" somewhat larger than either of the opponent groups.

2. The company was formed in 1922 by a small group of persons closely bound by ties either of family or friendship for the purpose of managing and developing a plot of land in Central District which had been purchased somewhat earlier. The company which began life as a small private company was converted into a public company in 1925. There are now 99 shareholders about 1/3 of whom received their holdings by inheritance or otherwise from the former members. Most of the directors are the successors, designated under the Articles of Association, of the original directors who were appointed for life. The main asset of the company throughout its entire life up to 1974 was the building, known as the China Building, which had been erected on the land shortly after its purchase. For many years the principal revenue of the company derived from the rents paid by the many tenants of the building. It was a steady and considerable revenue for the tenants were mainly business firms and the site is in one of the prime commercial areas of the Colony. I may say at once that I agree with Mr. Zimmern when he says that the principal purpose of the company, defined by opening 3 or 4 clauses of the Objects, to which all the other stated Objects are subsidiary, may be described as consisting in the possession, management and development of land and buildings thereon. It was I think correctly described as essentially a rental business company with no cash flow problem. Nonetheless, as the company prospered there was built up over the years a substantial portfolio of shares in other companies, purchased out of annual profits. No objection is made on this score for this is something which the directors were empowered to do in virtue of powers given by the Objects (see para. J thereof). In the earlier years the major part of the company's profits accrued annually from the rents. The building is however rent-controlled and gradually the prudent management of the share portfolio caused it to become the major source of the company's annual income. Between 1969 and 1973 rents amounted to about 9 ½ million dollars while in the same period the portfolio yielded to the company an accretion of wealth in the region of 25 million. There is no doubt that this company has prospered. In 1946, immediately after the war, the annual balance sheet showed a net profit for that year of $150,000. In 1974 the figure was 4 ¾ million, but in addition the company's share investments were said to be worth in that year, about $100,000,000 on the market. The accounts kept since the Pacific War show that more than half of the net annual profits, sometimes considerably more than half, were annually distributed by way of dividend to shareholders. But although Article 150 of the company's articles permits the payment out of annual profits of a bonus to directors and company employees not exceeding 20% of the declared profits no such bonus was paid up to 1957. From that year onward, however, the directors were regularly allocated a bonus out of these funds at a rate of 5% of profits each year from 1957 to 1965. This rose to 7 ½% in that year and was maintained at that rate until 1972. In 1973 the allocation was 10% of the net profits and in 1974 it was raised to 15%. There is no evidence of any objection having been made by or on behalf of the shareholders in connection with these payments up to 1972, but it is on affidavit that, at the annual general meeting of the company, one of the petitioners did protest in 1972 - a year in which a very large figure of net annual profit was shown, apparently from the sale of shares. Although the percentage was still only 7 ½% in that year there does not appear to have been any protest in the subsequent years when the rate rose to 15%. Indeed apart from that instance, and until the present dispute arose, the domestic affairs of this company appear to have been undisturbed by any appearance of discontent, much less of acrimony, among the shareholders in relation to the conduct of the company's affairs by the directors.

3. In 1974, without prior notification to or consultation with the shareholders, the directors negotiated the sale of the China Building, and in June of that year the sale was completed that price of $136,360. In his affidavit replying to the petition the Chairman of the Board, Sir Kenneth FUNG Ping-fan, says that over the years offers to buy the building had been made to the Board and had been considered and that this offer in 1974 had been accepted as being exceptionally favourable. His attitude is that the sale of the building at that price was in the best interests of the company.

4. Nothing further seems to have happened until October 1975 when the present petitioners requisitioned an extraordinary general meeting to consider a proposal that the funds accruing from the sale be distributed to the shareholders. Upon legal advice that this was not permissible a second requisition was issued proposing that the funds should be carried to the profit and loss account for the same purpose. That was on 1st November 1975. The directors in their turn proposed a general overhauling of the Articles of Association and an extension of the Objects of the company. These several proposals were to be discussed at an extraordinary general meeting on the 1st of December but prior to that the petitioners, by letter of 18th of November, suggested that the directors should support a proposal to have the company voluntarily wound up. The directors suggested in return that this proposal should be put to the shareholders in general meeting. This offer was not taken up and eventually all these proposals and counter proposals were withdrawn, neither party apparently being confident of obtaining the necessary 75% majority of the available votes. Thereafter the present petition was filed. Thus, in brief outline, the history of this dispute.

5. It has not been argued that in selling the building the Board was acting beyond its powers nor is it suggested that the act of the directors was in any sense unlawful. What is said is that the conduct by the Board of the management of the company's principal asset, and more specifically the manner in which that disposal was effected, has resulted in a total frustration of the company's primary Objects. The petitioners, therefore invoking the provisions of s.177 of the Companies Ordinance ask that the court should now, in the exercise of its equitable jurisdiction, grant them the order which they seek on the ground that it is just and equitable that the company be wound up and its surplus assets distributed among those entitled to them.

6. Mr. Zimmern does not, of course, contend that the mere sale of the China Building would be enough in itself to constitute a sufficient reason for invoking s.177. He acknowledges the authority of the decisions in re Kitson & Co. Ltd.⁽¹⁾, Taldua Rubber Co. Ltd.⁽²⁾ and Galbraith v. Merito Shipping Co.⁽³⁾, all of which are strongly relied upon by Mr. Cheung for the respondents; and he concedes that the complaint of the petitioners does raise as a central issue in the present case the issue which was the sole ground of complaint in those cases, viz. : whether the undisputed evidence shows that the substratum of the company has now totally fallen away. However, relying on the dictum of Lord Parker of Waddington in Cotman v. Brougham⁽⁴⁾ at page 520 to the general effect that the court's task in such cases is to do justice by examining the equities of the cases between the company and its shareholders, counsel invites me to apply the principles stated in those cases subject to the corrective gloss which he finds in the judgment of Lord Wilberforce in Ebrahimi v. Westbourne Galleries⁽⁵⁾. Although that case was not one which concerned failure of substratum", the purport of the learned judge's remarks on the topic in that case was of a general nature, and amount to the exhortation that the courts should apply the "just and equitable" rule without undue timidity in regard to the needs of the given case and without feeling themselves bound by any supposed categorization, deriving from the decided cases under that rule, definding and limiting the range of its application. Counsel does not suggest that Galbraith's Case⁽³⁾ and the other cases were wrongly decided but he asks me to say that since the decision in Ebrahimi v. Westbourne Galleries⁽⁵⁾ I am no longer bound by the many strong expressions used by the judges in the earlier cases to denote the heavy burden of proof which falls upon him who alleges that justice and equity favour the winding up of a company on the ground that its substance is gone. A fair and representative example of the rigour of these expressions is given in the words used by Lord Moncrieff in Galbraith v. Merito Shipping Co.⁽³⁾ where at page 456, in making a summary of the views of the courts in earlier cases, he adopts the principle that :

"... before the substratum should be found to have been withdrawn, business within the objects of incorporation should have become at least in a practical sense 'impossible'."

It is here that we reach the Kernel of counsel's case for the present petitioners for Mr. Zimmern does not undertake to show that the evidence before me is sufficient to prove that it is now impossible for the managers of Chinese Estates Ltd. to carry on the main business of the company. He could not do so in face of the company's abundant available resources and the expressed intention contained in the averment of the Chairman of the Board to engage once more directly in that business when a suitable property is on offer. But what he says is that the substratum of the company is indeed gone because, although it may be in a position to resume the service of its primary purpose it is at the moment not serving that purpose and, he maintains, it is in the highest degree unlikely to return to it in view of the variety of circumstances all of which bear upon the past behaviour and present intentions of the management. I do not propose to enter into a detailed examination of the various indications relied upon as showing an attempt to effect a total change in the character of the company. Principal among them is the sale of the property without consultation or advance warning and prominent among the supporting factors are the following :

It is indeed this phrase, copied from the formal proposals which were withdrawn before debate and which may be found in the Third Schedule to the petition, which Mr. Zimmern flourishes in the forefront of his charge as the clearest demonstration in words of the directors' fixed intention to abandon the company's traditional line of business and to move it from its moorings in the secure if unexciting backwaters of rental and development towards the insecure attractions of the share market with its glittering but sometimes insubstantial promises. It is this alleged transformation of the company's character which, counsel says, forces the petitioners to protest that they have lost confidence in the management of the company and that they wish to take their stake out of it.

7. To all of these complaints Mr. Cheung for the directors has made detailed, lengthy and often spirited replies. I hope it will not prove unduly disappointing to the parties if I decline to adjudicate the merits of the several subsidiary grounds put forward to support this general impeachment of the Board and the replies thereto. I think it is preferable, in view of the conclusion to which I have come upon the petition, that I should leave that debate largely untouched. I will content myself therefore with the observation that, notwithstanding the able advocacy on both sides by way of explaining the positions of the opposing parties, I am surprised that the directors should have taken so momentous a step as the sale of the company's principal asset without going first to their constituents; just as I am surprised that the conduct of the directors which has allegedly disquieted the petitioners at least as long ago as 1972 should never have been made the subject of general discussion and critical examination in the company's domestic forum at a meeting called for that purpose. The Articles make the usual provision for extraordinary general meetings but those lists remain unattended even to the present moment and in all the company's long history, so far as I am aware, the nearest approach to a joust within them came with the putting forward, and precipitate withdrawal, of the proposals and counter proposals concerning voluntary liquidation and alteration of the Objects and Articles. It is true, of course, that a strong Board may be difficult to control and it is true that a wide measure of autonomy is nowadays granted to the managers of a limited company. But this company is not a multi-national combine with a distant Board of "faceless men". On the contrary, its domestic and familial character has been stressed by both sides. One hopes, if only for the vindication of the worth of democratic suffrage, and despite the reality of power blocks among the shareholders, that if it should be necessary for any of the parties to approach the court again for any similar purpose, there may be then upon display something more convincing than at present appears in earnest of the suitors honest endeavour to achieve an accommodation of views on the company's policies in the company's parliament.

8. But all of that is by the way, for as it seems to me the petition is not supportable on the ground put forward. Try as I may I cannot see that that ground amounts to more than the allegation that the substratum of the company has fallen away. The company is in an enviable financial condition; even without some 80 million dollars which have already been distributed to the members, including the present petitioners, since the sale of the China Building, it retains ample funds for investment in further properties of the same kind; the directors have published an unequivocal statement of intention to do so; it already holds - no doubt as part of its portfolio only - a controlling interest in another company which owns a similar property on a closely adjacent site. Yet despite all of that it is alleged not that the directors may be going to change the nature of the company, but that they have already done so because, it is said, their behaviour shows (whatever they may say) that their true intention is not to resume the normal business of landowning and development. Without this alleged evidence of true intention the petitioners do not say - I pressed Mr. Zimmern on the point - that the sale of the property without consultation was enough to invoke the just and equitable rule; nor was the alleged misbehaviour of the directors in relation to the payment of bonus, nor the attempt to alter Article 150 nor any of the other allegations of want of probity nor these things taken together - but apart from the sale of the property - sufficient to invoke it. It was the determination not to persist with the company's true objects which all of these things together were said to show which, in counsel's view, admitted the petitioners to that relief. And that makes the question of intention the very fulcrum on which his argument turns. In re Kitson & Co. Ltd.⁽¹⁾ the directors of a company formed to carry on the business of general engineering agreed to sell the company and its goodwill and they passed a resolution to discontinue the engineering business and to use the company's money to purchase shares in certain other companies which were more or less insolvent. A petition was presented to the court for an order for winding up on the ground that the substratum of the company had gone. New directors having been appointed at the time of the hearing of the petition an affidavit was put in for them showing that, contrary to the proposals of the former directors, they intended to continue the engineering business. The petitioners, however, alleged that there was no true intention of carrying on that business. In relation to that argument Lord Greene has this to say on page 439 :

"To say that the question whether substratum has gone or has not gone can be affected by the intention that happens to exist in the minds of the board at a given moment appears to me to be going into irrelevant considerations. First of all, the board is not the company. Let it be supposed that at the time of the sale of the Kitson business, so far as the board was concerned they thought that there was no chance and that it was not desirable for the company ever to start again into engineering. It certainly is not proved nor was it proved that the shareholders had any such intention; but assume that it was. A little time afterwards something might happen to make them change their minds. They might see a profitable opportunity of using the company's money again in the engineering business. What has intention to do with it? We are dealing with the question of substratum, and to say that the substratum can exist at one moment and cease to exist a moment later, or vice versa simply through a change of intention of the board or of the shareholders (I know not which) seems to me to lead into a morass."

This passage was quoted with approval by Wynn-Parry, J. in re Taldua Rubber Co. Ltd.⁽²⁾ and it seems to me to be wholly apposite in the present case. Galbraith v. Merito Shipping Co.⁽³⁾ is a case which is in any respects strikingly similar to the present case inasmuch as the company there had, long before the petition was presented, sold the last of the ships which were its principal property, and had thereafter ceased for many years to carry on its principal object which was the business of shipowning. At the time of the petition it was however possessed of considerable assets in the form of investments in various securities. It was averred on behalf of the company that it was in a position to purchase other ships when a suitable opportunity occurred. The majority of the shareholders were against the liquidation of the company but the petitioner sought an order for winding up as just and equitable because in his view the company was no longer capable of carrying on its primary function not having done so for a very long period but was instead carrying on the business of an investment company - a similar allegation to that made by the petitioners in the present case. Also, as in the present case, there were allegations of mismanagement; of oppressive control by the directors and of undue self-enrichment by them.

9. I will conclude therefore with a quotation from the judgment of the Lord Justice Clerk (Lord Moncrieff) which appears at page 456 :

"But the Lord Ordinary appears to arrive also, and to arrive independently of any reference to the answers, at the opinion that the petitioner has failed relevantly to over a withdrawal of the substratum of the company as having resulted from the long term of years of non-activity on its part. The petitioner indeed makes farther averments of mismanagement of the company's affairs by its managers; of undue dominance over its affairs by the managers in the legitimate exercise of their voting power, and of their appropriation (though necessarily with the assent of the shareholders) of remuneration not expressly authorised by their agreement. I agree, however, with the Lord Ordinary in holding that these supplementary averments (so far as they raise matter of legitimate complaint) are such as should be addressed to the company in general meeting and not to the Court in this petition. And I further agree that a failure of substratum, as this phrase has been interpreted by the Court, is not evidenced by a mere discontinuance of business activities even for a lengthy period by a company; so long as this does not evidence a final and conclusive abandonment of the business, and so long moreover as the resources of the company as regards management and money have been conserved so as to admit of its re-entry on its interrupted activities when this shall be judged expedient."

10. Those words as it appears to me, admirably cover the situation here. I do not question that there may be some real substance in the discontents expressed by the petitioners but, such as they have been exposed to me, they are of a kind peculiarly apt for inquiry and examination in the domestic forum. That remedy will not necessarily be sovereign to resolve them, but these or any other petitioners, seeking to enlist the court's dissolving powers, for the kind of reasons now advanced, would need to show that they had first moved to test the extent of the area of disagreement before all the company's constituents and that an impasse had been reached which could not be surmounted save by the equitable intervention of the court. For their reasons given, however, the petition must be dismissed.

Representation:

(1) (1946) 1 A11 E.R. 435.

(2) (1946) 2 A11 E.R. 763.

(3) (1947) S.C. 446.

(4) (1918) A.C. 516.

(5) (1970) A.C. 360.