Hong Kong: Shareholders’ Disputes, Windings-Up Of Solvent Companies And Section 182 Dispositions

Last Updated: 26 February 2014
Article by Richard M. Tollan and Justine T.K. Lau
Most Read Contributor in Hong Kong, October 2018

Keywords: shareholders disputes, windings-up, solvent company, Companies Ordinance, CO

Did you know that dispositions of property of a solvent company made after the commencement of a winding-up will unlikely be disturbed unless it can be demonstrated that the disposition is not in the interests of the company?

Two recent decisions, handed down in the context of shareholder disputes, highlight the atypical application of section 182, Companies Ordinance (Cap 32)(CO) to solvent companies. For another atypical application of the CO, see our recent Legal Update "Major Shareholder Obtains Relief Pursuant to Section 168A" of 20 December 2013.

Section 182 relevantly provides:

In a winding up by the court, any disposition of the property of the company, including things in action, and any transfer of shares, or alterations in the status of the members of the company, made after the commencement of the winding up, shall, unless the court otherwise orders, be void.

Dispositions and Insolvent Companies

Applications for validation orders are typically made by a company subject to a winding-up petition for "one off " transactions or payments which can be demonstrated to the satisfaction of the court as being for the benefit of not only the company but its unsecured creditors as a whole. The principles for the exercise of the court's discretion in these circumstances are well established by the authorities. The observations made by the English Court of Appeal in Re Gray's Inn Construction Co Ltd1, adopted in Hong Kong2, relevantly provide:

It is a basic concept of our law governing the liquidation of insolvent estates...that the free assets of the insolvent at the commencement of the liquidation shall be distributed rateably amongst the insolvent's unsecured creditors as at that date...There may be occasions, however, when it would be beneficial, not only for the company but also for its unsecured creditors, that the company should be enabled to dispose of some of its property during the period after the petition has been presented but before a winding-up order has been made. An obvious example is if the company has an opportunity by acting speedily to dispose of some piece of property at an exceptionally good price. Many applications for validation under the section relate to specific transactions of this kind or analogous kinds. It may sometimes be beneficial to the company and its creditors that the company should be enabled to complete a particular contract or project, or to continue to carry on its business generally in the ordinary course with a view to a sale of the business as a going concern...

In considering whether to make a validating order the court must always...do its best to ensure that the interests of the unsecured creditors will not be prejudiced. Where the application relates to a specific transaction this may be susceptible of positive proof. In the case of completion of a contract or project the proof may perhaps be less positive but nevertheless be cogent enough to satisfy the court that in the interests of the creditors the company should be enabled to proceed...

Since the policy of the law is to procure so far as practicable rateable payments of the unsecured creditors' claims, it is...clear that the court should not validate any transaction or series of transactions which might result in one or more pre-liquidation creditors being paid in full at the expense of other creditors, who will only receive a dividend, in the absence of special circumstances, making such a course desirable in the interests of the unsecured creditors as a body.3

Shareholders' Disputes and Solvent Companies

Slightly different considerations apply in the case of solvent companies. In solvent windings-up the court recognises that:

"If on an application under section 227 [equivalent to section 182, CO] 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."4

That is, the court will not generally look behind the actions of a solvent company subject to winding-up proceedings if the transaction or dissipation is in the interests of the company as a whole.

Two recent decisions illustrate the pragmatic approach adopted by the Hong Kong courts in determining whether section 182, CO orders will be appropriate. In the matter of Chan Mei Chun v. K & A International Co Ltd5, the court was asked to validate transactions in the context of a shareholders' dispute. The Honourable Mr. Justice A. Chan cited with approval the decision of Harris J in Re Emagist Entertainment Ltd6 that "where the court is faced with a shareholder's Petition in respect of a solvent company which has a valuable ongoing business, the directors should be allowed to continue to operate that business normally and without close supervision by the Companies Court"7. On the facts before him, Chan J concluded:

"This court cannot allow the dispute and/or mistrust between the parties [shareholders] to prevail over the interest of the Company or its creditors. The evidence is that the Company has a turnover of some HK$160 million. There are employees and creditors to be paid. I see no justification to allow [the petitioner's] application to be developed into a satellite litigation..."8

In the matter of Winbless Inc v. Central Billion Inc9, applications were made by two companies subject to winding-up petitions for validation orders to dispose of certain very substantial properties held by them. Validation orders were made by consent of the parties (sibling shareholders of the companies) but a subsequent application was made to determine the disposal of the sale proceeds of those properties in light of disagreement as between the sibling shareholders in respect of a shareholders' agreement entered into between them in relation to the subject companies, among others. His Lordship summarised the applicable legal principles as follows:

"Directors are agents of the company entrusted with its operation. The court will not readily substitute its opinion for that of the directors or interfere with their exercise of discretion in the operation of the company. The principle has therefore developed that if the directors consider a particular disposition falling within their powers as directors is necessary or expedient in the interests of the company, and if the court considers that the reasons given are such that an intelligent and honest person could hold that view, the court would normally sanction that disposition notwithstanding that it may be opposed by a contributory unless there is very clear and compelling evidence to suggest that the disposition is likely to be injurious to the interests of the company. This is all the more so where the company is solvent and the court does not have to be burdened with the interest of the creditors..."10

In his discussion of the facts before him, his Lordship observed "these companies are hugely solvent companies with unappropriated profits amounting to nearly [HK]$500 million, but liabilities in the amount of about $3 million. Even if the sales proceeds are distributed, there will still be huge reserve left in the sum of $381 million. By any stretch of imagination, the reserve will be more than enough to cover any potential claims of any known creditors and liquidation expenses...It is inconceivable that by making the distribution, the companies will be at risk of not being able to pay their winding-up expenses."11

The court went on to order the distribution of sales proceeds in accordance with the shareholding structure of the respective companies, thereby respecting the business decisions made by management (who had proposed this method of distribution but was concerned to ensure this remained appropriate in the context of the winding-up petitions).

Both recent decisions illustrate the court's willingness to ensure that profitable businesses are not unnecessarily stymied by shareholder disagreements resulting in the issue of winding-up petitions.

Originally published 21 February 2014

Footnotes

1 [1980] 1 All ER 814

2 Re APP (Hong Kong) Ltd (unreported; 8 March 2004, Kwan J (as she then was) [2004] HKCFI 81, HCCW1130/2003)

3 [1980] 1 All ER 814, 819-820

4 Re Burton & Deakin Ltd [1977] 1 All ER 631, 637

5 (unreported, 27 November 2013, Chan J, [2013] HKEC 1991, HCCW317/2013)

6 [2012] 5 HKLRD 703

7 (unreported, 27 November 2013, Chan J, [2013] HKEC 1991, HCCW317/2013), paragraph 2

8 Ibid, paragraph 6

9 (unreported, 16 December 2013, To J, [2013] HKEC 1992, HCCW317 and 373/2013)

10 Ibid, paragraph 8

11 Ibid, paragraphs 11 and 13

Learn more about our Hong Kong office and Corporate & Securities, Litigation & Dispute Resolution and Restructuring, Bankruptcy & Insolvency practices.

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© Copyright 2014. The Mayer Brown Practices. All rights reserved.

This article provides information and comments on legal issues and developments of interest. The foregoing is not a comprehensive treatment of the subject matter covered and is not intended to provide legal advice. Readers should seek specific legal advice before taking any action with respect to the matters discussed herein. Please also read the JSM legal publications Disclaimer.

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