Re Nu-west Natural Products Corp Ltd

HCCW 239/2006

IN THE HIGH COURT OF THE

HONG KONG SPECIAL ADMINISTRATIVE REGION

COURT OF FIRST INSTANCE

COMPANIES (WINDING-UP) NO. 239 OF 2006

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Before: Hon Kwan J in Chambers

Date of Hearing: 28 June 2006

Date of Decision: 28 June 2006

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D E C I S I O N

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1.This is a summons for a validation order under section 182 of the Companies Ordinance, Cap. 32.

2.On 13 June 2006, Lin Lester Chi Kee, who is a 50% shareholder and director, presented a petition to wind up Nu-West Natural Products Corp Limited (“the Company”) on the justice and equitable ground, alternatively for relief under section 168A.  The 1^st respondent, Chan Leuk Fu, is the other 50% shareholder and the only other director of the Company.  The Company is the 2^nd respondent.

3.The main business activity of the Company has been trading in pain-relieving pads under the brand name of “Riaxin” manufactured by a company incorporated in the United States known as Nu-West Natural Products Corp (“Nu-West US”).  Prior to April or May 2006, the Company had obtained supplies of such products from Nu-West US.  This company is owned by the petitioner’s son and the 1^st respondent in equal shares; its three directors are the petitioner, his son and the 1^st respondent.

4.On 20 June 2006, the 1^st respondent issued the present summons.  He seeks an order that notwithstanding the presentation of the petition, (a) payments made into or out of the bank accounts of the Company in the ordinary course of business, and (b) dispositions of property of the Company in the ordinary course of business for proper value, between the date of the presentation of the petition or further order, shall not be avoided by virtue of section 182 in the event of a winding-up order being made on the petition.

5.The 1^st respondent is prepared to give an undertaking to the court that if a validation order is made, he will only draw a salary of HK$40,000.00 a month from the Company’s bank accounts (being his salary before April 2006), and not HK$100,000.00 a month (which was the amount he has been withdrawing as his monthly salary for April and May 2006).  The 1^st respondent also made clear he has no present intention to dispose of the landed properties held in the name of the Company, and that is not what he is seeking to do in the present application.  He says the present application is only to validate payments and dispositions in the ordinary course of the Company’s business.  Lastly, he offered to give the petitioner a monthly report, listing all expenditures in the previous month and identifying the date of payment, the amount of payment and the name of the payee.

6.In support of his application, the 1^st respondent has filed two affirmations.  The petitioner has filed two affirmations in opposition, made by the former accounting clerk of the Company.  The petitioner also relies on the petition which is affirmed by him.

7.The Official Receiver has written to the court on 26 June 2006, taking the stance that as there is no allegation of insolvency and this being a shareholder’s dispute, he would like to be excused from attendance.

8.Mr Patrick Chong for the 1^st respondent submitted that where a company is solvent the onus is on the person opposing the granting of leave under section 182 and it is incumbent on the opposing party to adduce very clear and compelling evidence to suggest that the disposition is likely to be injurious to the interest of the Company.  He cited as support for his proposition Re Burton and Deakin Limited [1977] 1 WLR 390, as applied in Re Mi Fung Beads Company Limited, HCCW No. 224 of 2004, 19 April 2004, Barma J.

9.The way in which Mr Chong has formulated the proposition derived from Burton and Deakin as applied in cases in Hong Kong is not quite correct.  What Slade J said in Burton and Deakin at 397G to H was this:

“If on an application under section 227 [equivalent to our section 182] relating to a solvent company, (a) evidence is placed before the court showing that the directors consider that a particular disposition, falling within their powers under the company’s constitution, is necessary or expedient in the interests of the company, and (b) the reasons given for this opinion are reasons which the court considers that an intelligent and honest man could reasonably hold, it will in the exercise of its discretion normally sanction the disposition, notwithstanding the opposition of a contributory, unless the contributory adduces compelling evidence proving that the disposition is in fact likely to injure the company.”

10.What the judge said at 397B to C is also worthy of note:

“Thus, if before the presentation of a petition a shareholder were to come to the court in an attempt to restrain a particular disposition of the company’s property contemplated by the board of directors and falling within their powers, he would not generally succeed, unless he could prove bad faith or other exceptional circumstances.  He would not be able, merely by adducing prima facie grounds for criticising the wisdom or beneficial nature of a particular transaction, to place upon the company or its board of directors the onus of justifying the proposed disposition by detailed evidence.”

11.Mr Samuel Chan submitted on behalf of the petitioner that the court should exercise its discretion to dismiss the application, owing to exceptional circumstances here.  He also relied on this proposition in Gore-Browne on Companies, 45^th edition, para 58[17A]:

“If the court considers the reasons given to be such as an intelligent and honest man could reasonably hold, it will normally grant relief; but if the company’s solvency is in serious doubt, and especially if the real issues concern the interests of contributories rather than creditors, relief may be refused.”

12.I would accept as correct the proposition in Gore-Browne, citing as support the decision of Mervyn Davies J in Re a company [1987] BCLC 200.  As noted by Mervyn Davies J at 203a to c, in Burton and Deakin, the party opposing the validation order was not a director of the Company but merely a contributory.  The objection was taken only to certain particular transactions to be validated, not in respect of payments made in the ordinary course of business.  So the judgment in Burton and Deakin dealt with objections as to particular transactions and Slade J had expressed his views in that context, stating that he was unable to see why shareholders should be able to interfere with directors’ decisions merely because a petition was presented.

13.I will first consider the submission of the petitioner that the solvency of the Company is in serious doubt.

14.Audited accounts up to December 2004 and management accounts up to May 2006 are placed before the court.  Mr Chan made the point that the net assets have diminished from HK$4.3 million in the financial year of 2003 to HK$2.6 million in May 2006.  The balance sheet as at May 2006 gives current assets at HK$3 million odd, the current liabilities are HK$2.3 million odd.

15.Of the current liabilities, the largest creditor is Nu-West US, with a claim of HK$2.1 million odd.  On the face of it, the Company would appear to have net current assets of HK$700,000.00.

16.Mr Chan however pointed out that in the current liabilities, there are included three amounts described as “advance payment” in the total of HK$837,054.99, which have been appropriated by the 1^st respondent for the benefit of a rival company he set up in the United States, bearing a similar name to Nu-West US called New West Natural Products Corporation (USA)(“New West US”).  If these amounts of “advance payment” are excluded (and there is no indication from the 1^st respondent at the moment how these amounts would be brought back into account, he merely stated these amounts are for goods “to be” supplied to the Company and would benefit the Company), the net current assets would become an adverse balance of HK$137,000.00 odd.  Mr Chan also pointed out that as at 24 June 2006, the Company has total cash balances just short of HK$400,000.00.  Even with the HK$0.5 million which the Company expects to receive from its largest customer Mannings store in July 2006, this would only bring the cash balance to about HK$1 million.  The Company is still short of cash in settling its debt to Nu-West US.

17.The 1^st respondent claims there are good prospects for the Company if it is to continue trading, pointing to the arrangements it has made with the Mannings store.  But it is a fact that in the last two months in April and May 2006, the Company has been trading at a loss.  This loss was brought about because the 1^st respondent has been drawing HK$100,000.00 a month as his salary, without the approval of the board.

18.If one is to apply the cash flow or liquidity test, it cannot be said that the Company is solvent.  It has not been shown that the Company is well able to pay its debts as they fall due.  Thus, I am not able to say when the petition is heard, the battle is likely to be solely between the shareholders, with the major creditor of the Company taking no interest in it.

19.Secondly, Mr Chan submitted that the real issues here concern the interests of contributories, and the discretion should be exercised against the making of a validation order, particularly as the Company’s solvency is in doubt.

20.It is necessary to examine the purpose for which payments out of the Company’s accounts are required.

21.The 1^st respondent says that payments would be for the ordinary course of business of the Company.  But there is a dispute as to whether what he did in the past two months could be regarded as within the ordinary course of business and in the interest of the Company, or whether these acts are unfairly prejudicial to the petitioner.  This issue would need to be resolved at the hearing of the petition.  I also bear in mind that at the moment, I have only limited evidence from the 1^st respondent regarding the allegations of unfair prejudice in the petition.

22.Nevertheless, there is clear evidence showing that in the two months before the petition was presented, the 1^st respondent has been withdrawing money from the Company for the benefit of New West US to the tune of HK$800,000.00 odd, leaving unsettled the invoices of Nu-West US to the extent of HK$2.1 million odd.  It is not in dispute that the Company did not make payment against its accounts payables to Nu-West US for the month of May 2006.

23.The 1^st respondent admitted in his affirmation he had instructed the manager of the Company to remit to his personal bank account US$100,000.00, which he claimed he would hold on trust for New West US, pending the opening of a bank account for New West US.  This amount was recorded in the ledger of the Company as a loan of the Company to New West US.  The loan was for the payment of pain-relieving pads ordered or manufactured by New West US and to be supplied to the Company.  There is also evidence that the 1^st respondent set up a web site for New West US and caused visits to the web site of Nu-West US and the Company to be re-directed to the new web site of his own company.  It is quite clear that this must have been done with a view to divert business to the 1^st respondent’s own company.

24.The 1^st respondent has not asserted that the petitioner was informed of his setting up of New West US.  The documentary evidence produced by the petitioner would suggest otherwise.  Mr Chan drew my attention to a fax from the 1^st respondent to Madam Wong Yim on 26 April 2006 in which the 1^st respondent instructed her to supply raw materials to New West US not Nu-West US, and Madam Wong was requested not to use e-mail for reason of secrecy.

25.I understand proceedings have been brought in the United States against the 1^st respondent and New West US for breach of fiduciary duty, misappropriation of trade secrets and other causes of action.

26.The 1^st respondent asserted that he is entitled to order pain-relieving pads for the Company from his own company instead of Nu-West US for a variety of reasons, which are not necessary to go into.  He may or may not be right about this.

27.If a validation order is made, the 1^st respondent would be able to draw freely from the Company’s accounts.  The monthly report he has offered to supply to the petitioner of payments made after the event would give little protection.  Although the petitioner is a 50% shareholder and one of the two directors, he has never been an authorised signatory to any of the Company’s accounts and he has no control over how and what payments are to be made.

28.Mr Chong submitted that if it should transpire that the payments validated were not in the ordinary course of business, it would be open to the petitioner to challenge the payments, after a winding-up order is made.  It is all very well if the Company is clearly able to pay debts as they fall due.  But this does not seem to be the position here.

29.I am to take a balancing exercise in this application.  I take into account the broad nature of my discretion under section 182.  I realise that if no validation order is made, the Company may well be paralysed.  In a solvent company with no shadow of insolvency, it is only right that a company should continue trading, pending the hearing of the dispute of shareholders in the petition, to preserve the value of shares in the company for the benefit of all the shareholders.

30.In the present situation, if a validation order is made and the 1^st respondent is allowed to continue to operate in the manner he has been doing for the past two months, substantial funds of the Company may well be moved to the 1^st respondent’s new company by the time the petition comes to be heard. 

31.There is evidence that the 1^st respondent has embarked on a course of action to shift the business of supplying the Company to New West US, with the help of funds advanced by the Company.  To allow the bank accounts to be operated freely by the 1^st respondent would continue to deplete the Company’s assets to the prejudice of those interested in its assets, the petitioner who holds the other 50% of the shares and the major creditor of the Company, Nu-West US.  I do not consider the operation of the bank accounts in the way proposed by the 1^st respondent would be for the benefit of those interested in the value of the assets of the Company, or that the carrying on of business in the way the Company has been operating in the last two months would be in the best interest of the Company.

32.I am not prepared to grant a validation order to enable the Company to operate on the basis that the 1^st respondent has presented to the court.  I would dismiss the application for a validation order. 

33.I order the 1^st respondent to pay the petitioner’s costs of this application in any event.

Mr Samuel Chan, instructed by Messrs Liau, Ho & Chan, for the Petitioner

Mr Patrick Chong, instructed by Messrs Au & Vrijmoed, for the 1^st Respondent