Lin v Rainbow Group Management Ltd
[2014] NZHC 3060
•3 December 2014
IN THE HIGH COURT OF NEW ZEALAND AUCKLAND REGISTRY
CIV 2014-404-2302 [2014] NZHC 3060
UNDER the Companies Act 1993 BETWEEN
XIAOCAO LIN Plaintiff
AND
RAINBOW GROUP MANAGEMENT LTD
Defendant
Hearing: 20 November 2014 Counsel:
R M Dillon and T A Hwang for Plaintiff
S Maloney for DefendantJudgment:
3 December 2014
JUDGMENT OF HEATH J
This judgment was delivered by me on 3 December 2014 at 4.00pm pursuant to Rule
11.5 of the High Court Rules
Registrar/Deputy Registrar
Solicitors:
Queen City Law, AucklandLeeSalmonLong, Auckland
LIN v RAINBOW GROUP MANAGEMENT LTD [2014] NZHC 3060 [3 December 2014]
The application
[1] Ms Lin seeks an order putting Rainbow Group Management Ltd (Rainbow) into liquidation.1 Ms Lin holds a 20% stake in that company. Her application is supported by two other shareholders, Kan Shing Koo and Jin Zhang, who, together, hold 30% of the shares. The remaining 50% of the shares are held by Yi Yang Liu. His wife, Xhaoxia Zhang, is the sole director of the company.
[2] Ms Lin complains that she has not been receiving information from those in control of Rainbow’s business, and that they have persistently failed to comply with obligations cast upon them by the Companies Act 1993 (the Act). On the basis of financial statements for the year ended 31 March 2014, which were supplied to her recently, Ms Lin also contends that Rainbow is insolvent. Inability to pay debts as they fall due and persistent default are two grounds on which a liquidation order may
be based.2
[3] Although Mr Dillon, for Ms Lin, sought to advance those two grounds separately, in truth Ms Lin relies on the defaults and Rainbow’s alleged insolvency as support for her contention that it is “just and equitable” for the Court to put Rainbow into liquidation.3
[4] Despite the proceeding having been advertised, no creditor has appeared to support or oppose the application. Rainbow opposes the order sought, on the basis that grounds justifying liquidation have not been made out.
Background
[5] Rainbow was incorporated as a limited liability company in October 2010. At that time, Mr Liu held all shares in the company. He transferred minority shareholdings to two other people, a business partner and an employee. On 7
November 2013, Ms Lin acquired her 20% shareholding from the business partner. Ms Lin’s application to liquidate the company was filed on 3 September 2014, less
than one year after she acquired her shares.
1 Companies Act 1993, s 241(1) and (2)(c)(iii).
2 Ibid, s 241(4)(a), (b) and (bb).
3 Ibid, s 241(4)(d).
[6] Ms Lin alleges that:
(a) No shareholders’ meetings or annual general meeting has been held
since she became a shareholder on 7 November 2013.
(b)She has not been a party to any resolution in lieu of an annual general meeting.
(c) She has not received a share in dividends since becoming a shareholder of Rainbow.4
(d)She has not received any financial statements or any annual report since becoming a shareholder.
(e) She has not received any notice of meetings of shareholders.
[7] Ms Lin alleges that despite hr requests for copies of the financial statements5 of Rainbow from Ms Zhang and Mr Liu, she has been denied access to them. She states that she has never been asked to confirm an address to which a resolution in lieu of an annual general meeting should be sent. Mr Koo, who has been a shareholder since around November 2010, has filed a short affidavit to similar effect. A document signed by the other minority shareholder, Jin Zhang, has been produced as an exhibit by Mr Koo. It evidences Jin Zhang’s consent to a liquidation order. Neither Mr Koo nor Jin Zhang suggests that they have made any requests for information; they seem only to say that such information has not been provided to them.
[8] Ms Zhang considers that she has made efforts to contact Ms Lin about the company’s position but believes that Ms Lin has not availed herself of the opportunity to obtain information. Much of the contact appears to have been
through a social media site called “We Chat”. Extracts of messages sent and
4 In fact, no dividends have been paid.
5 Financial statements for the year ended 31 March 2014, containing comparable figures for the year ended 31 March 2013, were made available to Ms Lin after this proceeding was issued. They were made available on 13 October 2014.
received on that site have been produced in evidence by Ms Zhang.6 On her evidence, conversations that took place through that medium involved a group that included Rainbow’s shareholders.
[9] Rainbow operates a karaoke and pool bar in Albert Street, Auckland; trading under the name “Pink”. A number of the messages that were sent by Ms Zhang provide information about problems with Rainbow’s business. In her messages, which I am satisfied were received by Ms Lin, she indicates (among other things) a need for help in the premises and assistance with financial problems; for example, a concern that a payment of rent might be missed. Mr Maloney, for Rainbow, submits that that demonstrates that Ms Lin had no concern with the business operations and is now using the present proceeding for some ulterior purpose. Certainly, there is no evidence that Ms Lin took steps to assist.
[10] While a firm of accountants, Premium Accounting Solution Ltd (PAS), was involved in the preparation of the accounts, that the firm that took no responsibility for the underlying accounting records used to compile them. For example, a standard disclaimer appears in the financial statements for the year ended 31 March
2014:
Compilation report to RAINBOW GROUP MANAGEMENT LIMITED
Scope
On the basis of information you provided we have compiled, in accordance with Service Engagement Standard No 2: Compilation of Financial Information, the financial statements of RAINBOW GROUP MANAGEMENT LIMITED for the period ended 31 March 2014. …
Responsibilities
You are solely responsible for the information contained in the financial statements and have determined that the accounting policies used are appropriate to meet your needs and for the purpose that the financial statements were prepared.
…
6 They were translated into English without any objection to its correction.
No Audit or Review Engagement Undertaken
… Our procedures do not include verification or validation procedures. No audit or review engagement has been performed and accordingly no assurance is expressed.
Disclaimer
As mentioned earlier in our report, we have compiled the financial information based on information provided to us which has not been subject to an audit or review engagement. Accordingly, neither we, nor any of our employees accept any responsibility for the reliability, accuracy or completeness of the compiled financial information nor do we accept any liability of any kind whatsoever, including liability by reason of negligence, to any person for losses incurred as a result of placing reliance on the compiled financial information.
(Emphasis added)
[11] The financial statements that were supplied to Ms Lin have some troubling features. They were first made available to Ms Lin by Rainbow’s solicitors, on 13
October 2014, yet were not produced as an exhibit to Ms Zhang’s affidavit of the
same day. The statements were exhibited to Ms Lin’s reply affidavit of 30 October
2014.
[12] I summarise some of my concerns:
(a) The amount paid for rent is shown as $292,684, compared with
$40,186 for the previous year. That is a significant increase that is not explained.
(b) Wages and salaries had risen from $86,550 (in 2013) to $163,971 (in
2014). No explanation for this is apparent from the financial statements.
(c) The financial statements record negative equity, which has risen from
$249,348 for the year ended 31 March 2014 to $544,896, for the following year.
(d)Strangely, a depreciation schedule shows buildings as an asset, whereas one of the most significant expenses is for rent. No explanation for that difference is given.
[13] The existence of the accountants’ standard disclaimer and the features I have identified do not give any cause for confidence that Rainbow’s accounting records comply with s 194 of the Act.
[14] Although there was no direct evidence from Ms Zhang to support the proposition, Mr Maloney submitted that the business only began sometime in 2013, which explained discrepancies between amounts recorded for the 31 March 2014 period, and those of the comparable period in 2013. That assertion does not seem likely. If that proposition were correct, the financial statements would be for no more than the three months ended 31 March 2013, and would ordinarily be expected to contain that description so as not to mislead users of the accounts. In the absence of evidence from the person who prepared the financial statements to the contrary, I am not prepared to draw an inference adverse to the accountants who compiled the financial statements.
[15] There are also inconsistencies in Ms Lin’s evidence. By way of illustration, I refer to her evidence about when she acquired her shares in Rainbow and the times at which she requested company information from Ms Zhang but was not supplied with it.
[16] Ms Lin, in her affidavit verifying the application, deposed that she acquired her shares “in or around November 2013”. In her evidence in reply, she refers to three requests that she made in person, in the presence of her boyfriend (Jiwei Xu) to access financial accounts. Two of the occasions to which Ms Lin refers are said to have been in September 2013, two months before she acquired her shares.
[17] The third occasion is said to have occurred in December 2013 when Ms Lin and Mr Xu visited Ms Zhang and Mr Liu at a nightclub business that the latter operate, known as “Kong”. On that occasion, Ms Lin says that Ms Zhang and Mr
Liu “asked us to visit their accountant’s office to obtain copies directly from their accountants”.
[18] Ms Lin says that she and Mr Xu went to PAS’s office but that she did not have access to anything more than the “details of the shareholdings”. Ms Lin’s affidavit continues:
7.… [PAS] refused to allow me to see financial statements until Zhaoxia Zhang and her husband Yiyang Liu provided formal consent to the release of the financial documents.
8.I attach a copy of the financial statement I received from the defendant’s solicitor on 13 October 2014. This was the first time I saw any financial documents for the defendant. This is attached and annexed as “Annexure A”. This shows the defendant company is insolvent.
[19] I have to say that the evidence of both Ms Lin and Ms Zhang is scant and unsatisfactory. Ms Lin, despite the intra-shareholder nature of the disputes, did no more than to swear an affidavit verifying the application. Ms Zhang provided little explanation about the company’s business, even though she is best placed (as director of Rainbow) to correct any misunderstandings under which Ms Lin may have been labouring.
[20] No corroborating evidence was provided to support that given by either Ms Lin or Ms Zhang. Ms Lin’s evidence might have been corroborated by Mr Xu. From Ms Zhang’s perspective, either her husband or an accountant from PAS (Sean Zhang7 is shown as the chartered accountant responsible for the compilation of the financial statements) could have given evidence.
Analysis
[21] The grounds on which the Court may put a company into liquidation on the application of a shareholder are:
241 Commencement of liquidation
…
7 There was no evidence about whether he and Ms Zhang are related.
(4) The Court may appoint a liquidator if it is satisfied that—
(a) The company is unable to pay its debts; or
(b) The company or the board has persistently or seriously failed to comply with this Act; or
…
(bb) the company, or 1 or more of its directors or shareholders, has in a persistent or serious way failed to comply with duties relating to the company—
(i) under this Act; or
(ii) under the Financial Reporting Act 1993 while in force, except that this subparagraph does not apply after 5 years have elapsed after this subparagraph came into force; or
…
(d) It is just and equitable that the company be put into liquidation.
….
[22] I am not prepared to liquidate Rainbow on the ground that it is unable to pay its debts as they fall due. While the financial statements for the year ended 31 March
2014 suggest that, on a balance sheet test for solvency,8 Rainbow was in a parlous
state at that time, the primary focus when one looks at inability to pay debts as they fall due is on liquidity.9
[23] On the face of the accounts, there are significant shareholders’ advances to the company which are recorded as liabilities. They total $565,332. As no creditor has supported the current application, it is likely that liquidity is being found from that source. I have no information about when the debts to the shareholders might fall due for payment.
[24] So far as persistent failure to comply with obligations under the Act is concerned, this is more a ground on which one would expect the regulator, the Registrar of Companies, to bring an application to liquidate, as a last resort to
enforce statutory obligations. It is not a ground that one commonly finds advanced
8 Companies Act 1993, s 4(1)(b).
9 Ibid, ss 4(1)(a) and 241(4)(a).
at a private law level. I consider, as with the issue of balance sheet insolvency, that the failure of the company to comply with particular obligations under the Act (or, at least, the absence of evidence to say that it did) is something that can go into the mix in determining whether the “just and equitable” ground has been made out. In any event, the evidence of Ms Lin (and to a lesser extent Mr Koo) is not sufficient to satisfy me that the alleged defaults were “persistent”, for the purposes of the Act.
[25] In Jenkins v Supscaf Ltd,10 I reviewed relevant principles in determining whether a liquidation order should be made on just and equitable grounds. The application in that case was based on a breakdown in relationship between shareholders. Such a breakdown, with the consequential loss of trust and confidence, is the best foundation on which the present application to liquidate can be put.
[26] The breadth of the discretion to liquidate on the just and equitable ground was discussed in Ebrahimi v Westbourne Galleries Ltd.11 Delivering the principal speech in that case, Lord Wilberforce said:12
The superimposition of equitable considerations requires something more, which typically may include one, or probably more, of the following elements: (i) an association formed or continued on the basis of a personal relationship, involving mutual confidence – this element will often be found where a pre-existing partnership has been converted into a limited company; (ii) an agreement, or understanding, that all, or some (for there may be “sleeping” members), of the shareholders shall participate in the conduct of the business; (iii) restriction upon the transfer of the members’ interest in the company – so that if confidence is lost, or one member is removed from management, he cannot take out his stake and go elsewhere. (at 379)
[27] Westbourne Galleries reinforces the notion that a company may be put into liquidation on the “just and equitable” grounds if, had the shareholders been partners, those grounds would have been sufficient to justify an order dissolving a partnership. The underlying premise for that principle is that the relevant company was formed to conduct a joint venture to which the incorporators were parties:
generally, see Re Yenidje Tobacco Co Ltd13 and Loch v John Blackwood Ltd.14
10 Jenkins v Supscaf Ltd [2006] 3 NZLR 264 (HC).
11 Ebrahimi v Westbourne Galleries Ltd [1973] 3 AC 360 (HL).
12 Ibid, at 379. See also Lord Cross, at 383–384 and 387.
13 Re Yenidje Tobacco Co Ltd [1916] 2 Ch 426 (CA) at 431-432 (Lord Cozens-Hardy MR, with
[28] In my view, this principle cannot apply in the present case. Although Rainbow is a small company, Ms Lin elected to acquire a minority stake from someone associated with Mr Liu, knowing (and probably intending) that she would play no active role in the management of the company. There is no evidence of any due diligence on her part at the time she acquired the shares. Ms Lin’s evidence is that she made three requests for financial information. That evidence is unreliable in
at least two respects.15
[29] To justify a liquidation order, Ms Lin must demonstrate (at least) both (a) a lack of trust and confidence in Ms Zhang’s management is justified and (b) that liquidation of the company is the only appropriate method of bringing her commercial relationship with the Liu/Zhang interests to an end. Whether that has been proved satisfactorily must be assessed on all of the evidence available to me, as opposed to that available to Ms Lin when the application was first brought.16
[30] During the course of the hearing, I formed a tentative view that the evidence was sufficient to establish that Ms Zhang was attempting to exclude Ms Lin from company affairs and that a deadlock had emerged that might justify a liquidation order. I fear that I may have done an injustice to Mr Maloney’s argument in forming that provisional view. In mitigation, my approach was coloured by (what I perceived to be) an undue focus on procedural points.
[31] On reflection, I have been struck by the paucity of evidence to support Ms Lin’s claims. Her first affidavit did no more than to verify the allegations in the statement of claim. Her second affidavit is materially inconsistent with the first, so far as the suggestion that three requirements for information were made after she
bought her shares.17 Mr Koo’s evidence does little to advance her position.18
whom Pickford LJ agreed) and 434-435 (Warrington LJ).
14 Loch v John Blackwood Ltd [1924] AC 783 (PC).
15 See para [16] above.
16 Jenkins v Supscaf Ltd [2006] 3 NZLR 264 (HC) at paras [103]–[107].
17 See paras [15]–[16] above.
[32] In the absence of a true shareholder deadlock of the type discussed in Jenkins v Supscaf19 and any clear evidence of an inability to pay debts as they fall due, this is not a case in which it would be appropriate to make an order putting Rainbow into liquidation. The evidence on default of obligations cast upon the company and/or its director by the Act has little probative value when a claim to liquidate has been brought less than one year after shares were acquired. Evidence about the occasions on which company information was sought is neither compelling nor corroborated.20
[33] There are other means by which Ms Lin can extricate herself from the company. The most obvious means of solving the problem is by the acquisition of her shares for proper value. As the company has no specific Constitution,21 it is necessary to find a provision in the Act under which that could be done.
[34] One route by which acquisition of shares might be achieved is through a proceeding based on s 174 of the Act. Another is to seek information formally under s 178 or, if grounds existed, to ask the Court to appoint a third party to verify the financial position, under s 179.22 However, the remedy of liquidation is not, on the evidence currently before me, appropriate.
Result
[35] For the reasons given, the application to put Rainbow into liquidation is dismissed.
[36] Although Rainbow has been successful in opposing the liquidation application, I do not consider that costs should be awarded in its favour. Whatever else, Ms Zhang has exhibited a somewhat cavalier response to Ms Lin’s concerns. Further there remain a number of unanswered questions about the accounts of the company23 which could readily have been explained either by Ms Zhang or someone
from PAS who had responsibility for their preparation.
19 Ibid.
20 See paras [16] and [20]above.
21 Companies Act 1993, s 28.
22 I draw attention to s 179(6) of the Act, in relation to the costs of such an exercise.
[37] In those circumstances, I make no order as to costs.
P R Heath J
Delivered at 4.00pm on 3 December 2014
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