Mistake Corrected – No Validation Order Needed for Issuing New Shares: Re China Ocean Industry Group Ltd [2021] HKCFI 247

17 February 2021

Correcting a widespread mistake, Mr Justice Harris in Re China Ocean Industry Group Ltd [2021] HKCFI 247 held that the Court has no jurisdiction to make a validation order after a winding-up petition in respect of the issue of new shares and convertible bonds (“CBs”).

The correct position is that a company subject to a winding-up petition may issue new shares and CBs without a validation order.

Background to the widespread mistake and the present case

For years, the Hong Kong Stock Exchange (“HKSE”) imposed a strict requirement that any listed company subject to a winding-up petition wishing to issue new shares and CBs must first obtain a validation order under section 182 of the Companies (Winding Up and Miscellaneous Provisions) Ordinance (Cap. 32) (“Ordinance”). Without a validation order, HKSE would not permit the issue of new shares and CBs.

China Ocean Industry Group Ltd (“Company”) is listed on HKSE and subject to a winding-up petition. The Company proposed to issue some new shares and CBs in order to raise finance.

Because of the HKSE requirement, the Company applied for a validation order.

Although the Company realised that technically such validation order would be beyond the Court’s jurisdiction under section 182, the Company made the application solely to comply with the HKSE requirement.

The Court’s decision and reasoning

Mr Justice Harris agreed with the Company’s submissions and held that the Court could not grant a validation order, and that the Company could proceed to issue new shares and CBs without a validation order.

His Lordship reasoned as follows.

Issuing new shares and CBs would not engage section 182 because section 182 is concerned only with a “disposition of the property of the company”, “transfer of shares”, or “alteration in the status of the members of the company”.

But issuing new shares and CBs would not involve an “alteration in the status of the members of the company”, let alone “disposition of the property of the company” and “transfer of shares”.

There are a few authorities for this position.

First, in Bank of China (Hong Kong) Ltd v Oasis HKTL 04A Ltd (Unrep., HCA 763/2008, 26 May 2008), DHCJ Lisa KY Wong SC held that the issue of new shares did not involve any “alteration in the status of the members of the company” within the meaning of section 232 of the Ordinance.

Secondly, some Australian authorities (including Sellers; in the matter of Beckley Forge [2003] FCA 523; (2003) 21 ACLC 1319 and Lollback v Brakepower [2010] NSWSC 1457) held that issuing new shares did not involve an “alteration in the status of members of a company” under the relevant Australian insolvency legislation in pari materia with section 182.

Thirdly, that issuing new shares and CBs would not engage section 182 is consistent with the rationale behind section 182 because issuing new shares and convertible bonds would not lead to existing contributories evading their liability.

While there were precedents in Hong Kong where the Court granted validation orders in respect of the issue of new shares and CBs, the Court’s attention was not brought to the correct authorities.

It follows that the precedents and the HKSE requirement were mistaken.

Commentary

This decision is a most welcome correction of the mistake made by many quarters about the need for a validation order in respect of the issue of new shares and CBs.

Correcting such mistake will save a lot of unnecessary costs in future, which is especially important to many companies subject to a winding-up petition.

Thanks to Mr Justice Harris’s wise decision, all the previous precedents granting validation orders for the issue of new shares may now be safely forgotten.

Look-Chan Ho acted for the Company in this case.

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