World One Investments Ltd v. Chow Cheuk Lap and Others

HCA1135/2013

IN THE HIGH COURT OF THE

HONG KONG SPECIAL ADMINISTRATIVE REGION

COURT OF FIRST INSTANCE

ACTION NO 1135 OF 2013

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BETWEEN

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D E C I S I O N

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1.This is an application for an interlocutory injunction to stop the completion of a share placement exercise by Universal Technologies Holdings Ltd (“Universal”), which is a listed company in Hong Kong.

2.This application is premised upon a derivative action which has been brought by the plaintiff on behalf of Universal (the 7^th defendant in this action) for alleged breach of director’s duties on the part of the 1^st to 6^th defendants. 

The parties

3.The plaintiff is a shareholder of Universal holding about 16% of its share capital.  The board of directors of Universal (“Board”) is made up of 9 directors – 1^st to 6^th defendants (“defendants”), Mr Lau Yeung Sang (“Lau”), Mr Xu Hui (“Xu”) and Dr Cheung Wai Bun (“Cheung”). 

4.The 1^st defendant is a non-executive director.  The 2^nd and 3^rd defendants together with Lau and Xu are executive directors.  The 4^th defendant is the chairman of the Board.  The 5^th and 6^th defendants, together with Cheung, are independent non-executive directors (“INEDs”). 

5.There is no controversy that the present dispute arose from disagreements between two camps of directors.  On one side, there are Lau, who owns the plaintiff, and Xu.  It is said by the plaintiff that the other side is made up of the defendants.  However, let me say at the outset that there is no real evidence that the 5^th and 6^th defendants were not acting independently in carrying out their duties as directors of Universal and I reject any suggestion otherwise.  According to the plaintiff, the 1^st to 4^th defendants (together with the 5^th and 6^th defendants) represent the interest of or are closely associated with Eastcorp International Ltd (“Eastcorp”) and Ever City Industrial Development Ltd (“Ever City”).  These two companies are related and together own about 16% of the shares of Universal.  As of 18 June 2013, about 55% of Universal’s shares are in the hands of the public.

The plaintiff’s case

6.In summary, the plaintiff says that there is a power struggle between two camps who represent the major shareholders of Universal.  The Eastcorp camp has been in control of the Board since the conclusion of an AGM of Universal on 3 June 2013 (“AGM”).  Shortly thereafter, the defendants rushed through a board resolution to place up to 200 million new shares of Universal (approximately 10.65% of the existing issued share capital of the company) without proper consideration of Universal’s financial needs but with the ulterior motive to have the shares acquired by their associates so as to gain an edge over the plaintiff in any voting of shareholders.

The key issues

7.Very sensibly, counsel before the court had focused their arguments on two key issues the resolution of which will determine the outcome of this application.  They are as follows:

(i)      Whether Universal is in need of funds to continue its business operation;

(ii)     Whether the derivative action is properly constituted.

Burden of proof

8.Before I proceed further, I should touch upon the burden of proof which the plaintiff has to discharge in this application. The undisputed evidence is that 192 million of new shares have been placed with 6 investors (the independence of these investors is challenged).  To enjoin the transaction now will in effect give the plaintiff final relief in this action. It is well established that in such circumstances the plaintiff is required to satisfy a high burden.  Various descriptions have been used for the higher threshold – “at least likely to succeed”, “at least very likely to succeed” and “overwhelming balance on the merits” (see Hong Kong Civil Procedure 2013, vol 1 at 29/1/18). 

9.Mr Fong, who appeared with Mr Lau for the plaintiff, did not dispute that he bears a higher burden.  However, for reasons apparent below, the resolution of this application does not turn upon the higher burden.

Fragilities in the plaintiff’s case

10.Before I deal with the key issues identified above, I should address a number of factual matters for two reasons.  It serves to flesh out some of the details of the plaintiff’s case and to demonstrate that the plaintiff’s case is not founded upon solid evidence.

11.Firstly, I am unable to see anything sinister in the change of directors which took place recently.  According to Mr Fong, prior to the AGM the dynamics of the Board was such that there were 5 directors on the side of the plaintiff (Lau, Xu and the 3 INEDs) and 4 on the side of Eastcorp (the 1^st to 4^th defendants).  The AGM was attended by shareholders holding over 90% of the shares of Universal.  At that meeting, two of the INEDs were due to retire from their directorship and were not re-elected, whereas the 2^nd to 4^th defendants were re-elected (the 1^st defendant was not required to retire).  The upshot was that the Eastcorp side then enjoyed majority control of the Board (1^st to 4^th defendants against Lau, Xu and Cheung).  

12.Shortly after the AGM and on the same day, a board meeting was held by which the 5^th and 6^th defendants were appointed to replace the two retired INEDs.  The plaintiff says that the control of the Board by the Eastcorp side was reinforced by the appointments. 

13.However, the fact is that the Eastcorp side had majority control of the Board with the blessing of the shareholders as a result of the AGM.  There is no suggestion of foul play in respect of the AGM and no reason for the court to take a sinister view of the matter. 

14.Secondly, whilst it is true that the share placement was debated at the Board meeting on 18 June 2013 without advance notice by way of an agenda item and without the availability of relevant financial material, the fact is that all the directors were present at the meeting with the exception of Cheung.  In addition, the CFO, Mr Daniel Tang was also there.  Given the presence of all the executive directors (Xu was the CEO of Universal until he was dismissed on 3 June 2013) and the CFO, it is difficult to see any real problem (and none has been shown) in discussing the share placement (a general mandate for which was given by the shareholders at the AGM). 

15.Further, there was considerable and at times heated debate about the share placement.  This tends to undermine the plaintiff’s case that the defendants failed to exercise reasonable care, skill and diligence in assessing and/or approving the placement resolutions. Furthermore, as pointed out by Ms Chan SC, who appeared for the defendants with Mr Li, neither Lau nor Xu objected to the placement.  The objections raised by them concerned the choice of placing agent and the placing price.  The price proposed by Lau, HK$0.58 per share was subsequently adopted by the Board. 

16.Thirdly, the plaintiff’s allegation of ulterior motive on the part of the defendants (see para 6 above) does not sit well with the documentary evidence that the placees would have to be independent parties.  Indeed, the placing agreement imposed undertakings on the placing agent to ensure that the placees are independent of and not connected with, inter alia, the directors or the substantial shareholders of Universal. 

17.The court of course maintains a healthy scepticism.  However, there is simply no evidence to suggest that the existing placees are in any way connected to the defendants, Eastcorp or Ever City.  One must not overlook the fact that Lau and Xu, being directors of Universal, must be entitled to find out from the placing agent the identity of the existing placees and make such enquiries as they see fit to ascertain their independence.  No such action has been taken.  Instead, this court has been invited to infer that the placees are not independent.  This is sheer speculation. 

18.Further, I find the alleged ulterior motive very difficult to understand in the context of a public company.  Anyone who wants to have more shares in Universal to enhance his voting right can buy from the market.  By the same token, the plaintiff can easily counteract the increase in shareholding of the Eastcorp side by acquiring more shares from the market. 

19.Finally, in respect of the plaintiff’s complaint that the defendants had failed to obtain better terms for the placement (the choice of placing agent and placing price), I find the evidence unconvincing. I should mention in particular that the suggestion that there were two prospective placees who had offered to pay in excess of the placing price lacks credibility.  As regards the allegation of unusual speed in putting the placement exercise into effect, again I see no substance in it.  It will be seen below that Universal was and is in urgent need of funds and it has been demonstrated by Ms Chan that the applicable stock exchange rules required such an exercise to be carried out swiftly. 

Universal’s financial need

20.With respect, the plaintiff’s case that there is no justification for Universal to raise funds, and hence the placement is not bona fide, is untenable.  Overwhelmingly, the evidence shows otherwise. 

21.First of all, according to Universal’s statement of financial position as at 31 December 2012, it had net current liabilities of nearly HK$255 million of which there were of bank loans from China Construction Bank (“CCB”) of about HK$218 million. 

22.In April 2013, CCB was pressing for the repayment of its loans.  Time extensions were sought by Universal for the repayment.  Despite what appears to be desperate efforts to raise funds, Universal was unable to fully repay the loans and was in default. Subsequently, certain assets which were used to secure the loans were forfeited by CCB.  It is a serious matter for a public company to have defaulted on its loan repayment.

23.Currently, Universal requires about HK$2 million per month for operating expenses.  Its cash position is in arrears.  In simple terms, there is no money to sustain its operation.  Mr Chan SC, who appeared with Mr Chow for Universal, told the court that Universal is in need of funds.

24.In the face of this evidence and the position maintained by Universal, Mr Fong suggested that Universal’s Mainland subsidiaries are cash rich and those resources can be utilised instead of a share placement. 

25.Firstly, it is not a matter for the court as to how a company is to utilise its resources.  It is a matter entirely for the directors.

26.Secondly, the suggestion is entirely lacking in particularity or evidential support.  It has been conceded that the suggestion can only apply to wholly owned subsidiaries.  This court has not been told which subsidiaries fall into this category, what resources they have and how the same may be used by Universal.  This is very surprising giving the fact that Xu was, until recently, Universal’s CEO, and Lau its executive director. If there were any substance to the suggestion, evidence would have been placed before the court.

27.Thirdly, the uncontradicted evidence of the defendants is that any financial assistance by the subsidiaries is restricted by exchange control and regulations over payment of dividends, and therefore not real alternative to raising funds by way of share placement.

28.Finally, Mr Chan has a powerful argument against the grant of an injunction against the completion of share placement in question. Mr Fong has told the court that the plaintiff is not objecting to a share placement exercise but is objecting to the existing placement.  In light of this position, Mr Chan submitted that the complaints of the plaintiff that the placing price is too low and the commission payable to the placing agent too high are all answerable in damages.  There is no basis for granting an injunction.  I agree. 

Derivative action

29.I am prepared to overlook the technical deficiencies in the indorsement of claim and would consider the substance of the plaintiff’s claim as set out in its evidence. 

30.Under common law, a “plaintiff whose standing to bring a derivative action is challenged must establish a prima facie case that the company is entitled to the relief claimed and that the action falls within an applicable exception to the rule in Foss v Harbottle (usually the fraud on minority exception.)” (Waddington Ltd v Chan Chun Hoo (2008) 11 HKCFAR 370 at §20).

31.An explanation of the exceptions to the rule in Foss v Harbottle can be found in Heyting v Dupont & Anr [1964] 1 WLR 843 at 853 to 854 where the court of appeal approved the judgment of Plowman J:

“The judge stopped the action because he was of opinion that it did not come within the exceptions to the rule in Foss v. Harbottle. He held that the exceptions only cover the necessity of the case and were confined to cases either of actions ultra vires the company (which are not suggested here), or of fraud by the majority or oppression of the minority by them in the form usually called a fraud on the minority, that is to say, where some property or advantage is monopolised by the majority to the exclusion of the minority. The judge found that there was no case in the reports in which such an action had been held to be competent in the absence of some feature of this sort and no such case has been cited to us. In the comparatively recent case of Pavlides v. Jensen it was held by Danckwerts J. that the exception did not cover a case of negligence without fraud on the part of the majority. In that case it was said that the majority of the board had neglectfully parted with certain of the company’s property at a gross under-value. Danckwerts J. held that the minority could not complain. Here it was said that there had been misfeasance on the part of the defendant which did not indeed put any money or property into his pocket but which resulted in loss to the company because of delay in prosecuting the invention, and the judge held that the exception did not apply. For myself, I incline to the view that this was right. At any rate, to decide the other way would be to extend still further the exceptions to the rule that a company alone can complain of a wrong done to it. As Russell L.J.’s judgment shows, there are cases which suggest that the rule is not a rigid one and that exception will be made where the justice of the case demands it. I am content, as my brethren are, to assume that there may be misfeasance in respect of which the exception should be allowed, but I also agree with them that this is emphatically not a case where the rule should be further stretched.”

32.I am unable to see how the plaintiff’s allegations can constitute a fraud on the minority.

33.Further, I am inclined to agree with Ms Chan that the substance of the plaintiff’s case is one of negligence on the part of the defendants.  There is no suggestion that any of the defendants profited from the alleged negligent act.

34.In addition to fraud on minority, the plaintiff has to plead and show that the wrongdoers are themselves in control of the company such as to enable them to stifle any proposed action against themselves (Waddington, at §§11-13).

35.Ms Chan’s submission is that the control by the wrongdoer must embrace the control of majority shareholding as well as the board of directors.  Without the former, the control of the board can be changed.  In the absence of authority, I am not prepared to agree with Ms Chan insofar as a public company is concerned.  It is possible to control the outcome of a shareholders’ meeting of such a company without controlling the majority shareholding because of lack of attendance by some of the “public shareholders”. 

36.In this case, there can be no suggestion that the defendants or the Eastcorp side are in control of the majority shareholding of Universal.  However, I agree with Ms Chan that even if it is sufficient to satisfy the control element by having control of the Board, the plaintiff has not made out a proper case.  There is no evidence or allegation that the plaintiff had tried to move the Board to take action against the defendants in respect of the share placement and that the action was blocked by the defendants.

37.I have already noted that there is no real evidence that the 5^th and 6^th defendants had failed to act independently in discharge of their director’s duties.  For completeness, there is a letter from Lau’s solicitors to The Stock Exchange of Hong Kong Ltd dated 6 June 2013 by which he complained against the dismissal of Xu as the CEO of Universal.  It was stated in that letter that Lau had no complaint over the appointment of the 5^th and 6^th defendants as INEDs of Universal. 

Conclusions

38.For the reasons stated above, I conclude that Universal is in need of funds to continue its business operation and that this action is not properly constituted as a derivative action.  I dismiss the injunction application with an order nisi that the costs of and occasioned by the application be paid by the plaintiff to the defendants and Universal with certificates for two counsel. 

Mr Raymond Fong and Mr Keith Lau, instructed by Kelvin Cheung & Co, for the plaintiff

Ms Linda Chan, SC and Mr Laurence Li, instructed by Winnie Mak, Chan & Yeung, for the 1^st to 6^th defendants

Mr Warren Chan, SC and Mr Eric Chow, instructed by Samuel L C Yang & Co, for the 7^th defendant