Can a company continue to conduct financial transactions in the face of winding-up proceedings by its shareholders?
In Harbour Front Ltd v Money Facts Ltd  HKEC 249, Fonfair Company Limited ("Company") was the subject of an unfair prejudice petition. The Company has two shareholders, and each shareholder (both being companies) is owned respectively by two brothers. There is a long-running dispute between the brothers over the control and management of the Company, and in April 2015, one brother ("Petitioner") presented an unfair prejudice petition ("UPP") to the Hong Kong Court seeking relief from conduct by the Company which he alleged was prejudicial to his company's interests as a minority shareholder. The Hong Kong Courts have a wide discretion to award relief in the event of a successful unfair prejudice petition, with the usual remedy being a 'buy-out order' for one party to buy out the shares of the other. In this case however, the UPP was drafted to include a winding-up order as an alternative remedy. Consequently, the Company's assets were frozen (and could not be disposed of) pending the hearing of the Petitioner's application for the appointment of Receivers. It was in these circumstances that an application for a Validation Order was made to the Hong Kong Court ("Validation Order").
Validation Orders are sought where a company wishes to conduct financial transactions (e.g. access its bank account to pay employees) whilst its assets have been frozen as a result of winding-up proceedings. In this case, a Validation Order was sought to enable the Company to renew a recently-expired lease on a piece of Company-owned property ("Property"). The Petitioner objected to the application for a Validation Order primarily on the ground that the manner in which his brother had dealt with the expired lease was one of the matters giving rise to the UPP in the first place and that consequently, the application should not be granted until the issues underlying the UPP have been determined.
Solvent companies with ongoing businesses
In assessing an application for a Validation Order, the Hong Kong Court will first consider whether the company is solvent
It was held in Re Wah Yin Cheong Co Ltd  HKEC 892 that the weight attached to the opposition to an application for a Validation Order is very different in circumstances where the company is solvent with ongoing business as compared to the situation where a winding-up petition is presented on the ground of insolvency. Where a company is solvent with valuable ongoing business, the directors should be allowed to continue to operate that business normally, and without close supervision by the Court.
In the present case, the Court was satisfied that the Company is an ongoing business that was solvent on both a net profit and cash-flow basis.
The Hong Kong Court will also consider the nature of the company's ongoing businesses
An exception to the general rule on non-interference with the discretion of directors may exist where there is an underlying dispute between the shareholders that goes to whether or not a company should continue in its current form, and where it is possible that the value of the company's assets will be depleted if it is permitted to continue trading. To determine whether a particular case falls within the ambit of this exception, the Hong Kong Court will identify the precise nature of the Validation Order that it is being invited to make.
In the present case, the Court found that it would be artificial to view the proposed transaction as "anything other than a straightforward commercial decision to continue with an existing commercial arrangement" in view of the fact that the Company's "sole activity is holding the Property for profit", and given that there is "no suggestion that the rent is materially out of line with the market rent". Therefore, the Court saw no reason to refuse the Validation Order on the ground that the Petitioner was concerned about purported connections between his brother and the prospective tenant of the Property.
Opposing an application for a Validation Order
As held by the Hong Kong Court in this case, "an application for a validation order is not an opportunity [for shareholders] to argue about the wisdom of a proposed transaction [by the Company]". The Hong Kong Court is generally unlikely to refuse to make a Validation Order in respect of a solvent company with valuable ongoing business, because the responsibility of managing the business of a company is entrusted by the company's articles of association to its directors. However, this is not a hard and fast rule in circumstances where the Hong Kong Court will also take into consideration exceptional circumstances and factors such as whether the proposed transaction falls clearly outside the company's ordinary course of business, and whether there is proven bad faith.
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