The Judicial Committee of the Privy Council clarified several aspects of the law concerning just and equitable winding-up petitions, as well as shareholder disputes in general, in the case of Chu v Lau (on appeal from the British Virgin Islands).
In particular, the Board provided clarity on when and in what circumstances: (a) a shareholder dispute may be grounds for winding up a company; (b) the availability of an alternative remedy may bar winding-up relief, and (c) the absence of restrictions on transfers of shares may be relevant.
Background
Mr Lau, the appellant, and Mr Chu, the respondent were equal (50% each) shareholders in the British Virgin Islands (BVI) company, namely, Ocean Sino Limited (OSL) which they operated as a quasi-partnership. At the same time, OSL was the sole shareholder of a Hong Kong subsidiary, namely, PBM Asset Management Limited. PBM owned a 49% stake in another Hong Kong company, namely, Beibu Gulf Shipping. The rest of the 51% was originally held by an intermediate holding company of a Chinese state-owned enterprise.
In 2010, Beibu Gulf put forward order of eight shipping vessels for its shipping business. For that purpose, Mr Chu and Mr Lau, acting under PBM, invested substantial funds in Beibu Gulf, which were subsequently used to purchase the vessels. Four of these vessels were delivered but the orders for the other four were cancelled with Beibu Gulf receiving substantial refunds. As a result of the cancellation of the shipping vessels, Mr Lau wanted PBM to demand repayment of the unused funding which he considered to be a loan. Mr Chu, acting contrary to the terms of a previous written agreement, refused to do so contending that the funding was a contribution to Beibu Gulf’s working capital and that PBM could not unilaterally demand repayment. In time, other complications developed between the parties concerning their rights and obligations arising through their operation of OSL and PBM. The relationship between the business partners had fallen to the extent that, in May 2015, Mr Lau, through an application to the BVI Commercial Court applied to have OSL wind up on the ground that it was deadlocked.
Trial So Far
After trial proceedings commenced, the dispute(s) between the parties escalated and by the time of the trial at first instance, Mr Chu had seized control of Beibu Gulf and stripped it many of its assets. The trial judge at the court of the first instance held that there were an irretrievable deadlock and breakdown in relations between the partners. Moreover, the judge noted that although both parties played a part in their business relationship breaking down, Mr Chu was deemed to have been primarily responsible. Soon after, joint liquidators were appointed for OSL’s liquidation proceedings.
An appeal to the Eastern Caribbean Court of Appeal reversed the trial judge’s finding that OSL was deadlocked. The Court held that if OSL was deadlocked, given the purported availability of other remedies, in the exercise of his discretion, the trial judge should not have ordered the company to be wound up but instead should have ordered Mr Chu to buy Mr Lau’s shares in OSL.
The Judicial Committee of the Privy Council
The Privy Council reversed the decision of the Court of Appeal and restored it to the decision of the trial judge. The Privy Council held that OSL was indeed deadlocked and there had been an irreversible breakdown in the relationship of the business partners. Moreover, the Court held that the Court of Appeal was wrong to find that Mr Lau had unreasonably failed to pursue an alternative remedy and that the trial judge had been fully entitled to exercise his discretion to order the winding up. In reaching these conclusions, the Privy Council considered and clarified several important points of substantive and procedural law relating to just and equitable winding-up petition(s); along with minor points on unfair prejudice petitions.
Regarding the “deadlock”, Lord Briggs stated that are two circumstances upon which a company’s shareholders may seek to wind up a company for just and equitable petition. Firstly, a circumstance where the shareholders are unable to co-operate in the management of the company as to cause the company to cease functioning either at the respective board or shareholder level. Lord Briggs referred this to as “functional deadlock”, regardless of whether it is a “quasi-partnership”. Secondly, a situation where there is an irretrievable breakdown in the relationship of trust and confidence between the shareholders. However, as their relationship was established based on trust and confidence, winding up in this situation will only be justified where the company is found to be a “quasi-partnership) i.e. found to be subject to equitable considerations due to the nature of the relationship of the parties. The Privy Council also held that the second situation may also apply even if the dispute between the parties does not directly relate to the affairs of the company that is the subject of the winding-up petition.
Regarding the position of the parties at the time of trial, the Court of Appeal had held that in assessing whether or not a winding-up petition was well-founded, the court considers the factual position prevailing as at the date of the commencement of proceedings and that subsequent event is to be disregarded insofar as they demonstrate deadlock or a breakdown in mutual trust and confidence. The Privy Council, however, rejected this Court of Appeal approach, reasoning that the wording of the legislation provides that a court may wind up a company if it “is of the opinion that it is just and equitable” and to do so, that must be a reference to a court assessing the facts at the time of trial. Moreover, the fact that a just and equitable winding-up order is essentially discretionary relief meant that it was clear that in assessing whether or not to grant a winding-up order on the just and equitable ground the court ought to assess the facts as they are at the time of trial. The Privy Council lastly held that the trial judge was correct to conclude that there existed a deadlock between the parties by the application was filed and that matters arising after the filing of the application only made matters worse.
Regarding the conduct of the petitioner, the Privy Council rejected the respondent (Mr Chu)’s argument that the sought relief ought to be refused even if there was a deadlock as Mr Lau was partly responsible for the breakdown and came to court with “unclean hands”. Reiterating Lord Cross in Ebrahmi v. Westbourne Galleries [1973] AC 360, the Privy Council held that the relief will only be refused in this context if the petitioner is the “sole” cause of the deadlock.
Regarding alternative remedies, the Privy Council put forward particularly useful advice to consider in an application for a winding-up order. In the BVI, as in the UK, a petitioner is not entitled to a winding-up order if they have acted unreasonably in seeking such relief rather than some alternative remedy. It was held that Mr Chu had the legal burden of proof to establish that the petitioner had acted unreasonably in not pursuing an alternative remedy and that the respondent must therefore identify the existence of such remedies at trial and prove that they were reasonably available to rely on such matters as a defence to the petition. Moreover, Mr Chu, not only had to demonstrate the factual availability of an alternative remedy, but it must also be able to establish that the proposed alternative remedy is “sufficiently attractive as an alternative make it unreasonable to continue to seek a winding-up”. Based on this, the Council rejected arguments on purported alternative remedies that had not been pursued at trial or which Mr Chu had failed to prove were reasonably available to Mr Lau.
Regarding the relevance of restrictions on the transfer of shares, Mr Chu argued that the lack of any formal restrictions in OSL’s constitutional documents on the transfer of shares was relevant to the assessment of whether (a) OSL was a “quasi-partnership”; (b) there was a “functional deadlock” in the affairs of OSL, and (c) Mr Lau was acting unreasonably by seeking a winding-up order rather than attempting to sell his shares. The Privy Council rejected all three propositions.
The Council, on the point of “quasi-partnership”, found that Mr Chu sought to rely on the three indicia identified by Lord Wilberforce’s judgment in Ebrahmi; that a “quasi-partnership” will typically be found to exist where one or more of the following factors are present: (a) an association formed or continued based on a personal relationship involving confidence; (b) an agreement that the shareholders shall participate in the management of the business; and (c) a restriction upon the ability of a member to transfer his interest in the company. The Council held that none of these three factors were necessary elements for the superimposition of equitable considerations. Therefore, in this case, the absence of a restriction on the transfer of shares did not justify interfering with the trial judge’s findings that OSL was a “quasi-partnership”.
As for the relevance of a “functional deadlock”, the Council held that a lack of restrictions may only be relevant if the petitioner could be expected to sell his shares on “fair terms”. In a “quasi-partnership”, an incoming third-party purchaser would be highly unlikely to pay a fair value. Therefore, the lack of restrictions did not provide any basis for departing from a finding of “functional deadlock”.
Finally, regarding the relationship between just and equitable winding-up and unfair prejudice, the Court of Appeal had held that on a petition for a winding-up order a court may, in the alternative, make a share purchase order (a relief commonly ordered where unfair prejudice is established). The Privy Council took the opportunity to clarify the relationship between the two statutory regimes for shareholder relief.
The Council held that in the absence of a finding of unfair prejudice a court had no power to make a share purchase order on the application for a winding up. Accordingly, in a “deadlock” case, in the absence of identifiable unfairly prejudicial conduct concerning the affairs of the company, a respondent will not be able to defend the petition by arguing that the petitioner has acted unreasonably by not pursuing unfair prejudice relief.
Click here to view the original judgement.
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