Australian Securities and Investments Commission, in the matter of Sino Australia Oil and Gas Limited (prov liq apptd) v Sino Australia Oil and Gas Limited (prov liq apptd) [2016] FCA 201

FEDERAL COURT OF AUSTRALIA

Australian Securities and Investments Commission, in the matter of Sino Australia Oil and Gas Limited (prov liq apptd) v Sino Australia Oil and Gas Limited (prov liq apptd) [2016] FCA 201 File number: VID 161 of 2014

Judge: DAVIES J

Date of judgment: 4 March 2016

Catchwords: CORPORATIONS – application for company to be wound up on just and equitable ground – where company solvent – whether justifiable lack of confidence in conduct and management of company – s 461(1)(k) of Corporations Act (2001) (Cth)

Legislation: Australian Securities and Investments Commission Act 2001 (Cth) ss 19, 76 Corporations Act 2001 (Cth) ss 461(1)(k), 674, 728(1), 1041H Evidence Act 1995 (Cth) s 87

Cases cited: Australian Securities and Investments Commission v ABC Fund Managers Ltd (2001) 39 ACSR 443; [2001] VSC 383 Australian Securities and Investments Commission v ActiveSuper Pty Ltd (No 2) (2013) 93 ACSR 189; [2013] FCA 234 Australian Securities Commission v AS Nominees Limited (1995) 62 FCR 504; [1995] FCA 1663 Australian Securities and Investments Commission v Astra Resources PLC [2015] FCA 759 Australian Securities and Investments Commission v International Unity Insurance Pty Ltd (2004) 22 ACLC 1416; [2004] FCA 1059 Australian Securities and Investments Commission v Sino Australia Oil and Gas Limited [2015] FCA 531 Ebrahimi v Westbourne Galleries Ltd [1973] AC 360

Date of hearing: 18 February 2016

Registry: Victoria

Division: General Division

National Practice Area: Commercial and Corporations

Sub-area: Corporations and Corporate Insolvency

Category: Catchwords

Number of paragraphs: 27

Counsel for the Plaintiff: M Pearce SC with C Lye

Solicitors for the Plaintiff: Australian Securities and Investments Commission

Counsel for the First Defendant: P Corbett QC

Solicitors for the First Defendant: King and Wood Mallesons

ORDERS VID 161 of 2014 IN THE MATTER OF SINO AUSTRALIA OIL AND GAS LIMITED (PROV LIQ APPTD) BETWEEN: AUSTRALIAN SECURITIES AND INVESTMENTS COMMISSION Plaintiff

AND: SINO AUSTRALIA OIL AND GAS LIMITED First Defendant (and others named in the Schedule)

JUDGE: DAVIES J DATE OF ORDER: 4 March 2016

THE COURT ORDERS THAT:

1. The First Defendant be wound up under s 461(1)(k) of the Corporations Act 2001 (Cth). 2. Mr Peter Damien McCluskey be appointed as liquidator of the First Defendant. Note: Entry of orders is dealt with in Rule 39.32 of the Federal Court Rules 2011.

REASONS FOR JUDGMENT 1 The Australian Securities and Investments Commission ("ASIC") has applied to wind up the first defendant ("Sino Australia" or "the company") on just and equitable grounds pursuant to s 461(1)(k) of the Corporations Act 2001 (Cth) ("the Act"). The application follows an investigation conducted by ASIC into suspected contraventions of the Act by the company and/or its officers in relation to a capital raising in 2013. 2 The investigation commenced in March 2014 when ASIC received a complaint from two of the company's non-executive directors, a Mr Faulkner and a Mr Johnson, detailing what they described as "matters of grave concern regarding the governance of the company." Those concerns related to the belief that the second defendant ("Mr Shao"), the then executive chairman, was seeking to use funds raised under an initial public offering in December 2013 for purposes unrelated to the purposes disclosed in the prospectus documents. On 13 March 2014, the Court, on the application of ASIC, made an order pursuant to s 1323 of the Act restraining the defendants from transferring any funds out of the company's Australian bank account. That order was extended on several occasions on an interlocutory basis during the course of ASIC's investigation. ASIC's investigation has ultimately led it to form the view that there were representations in the prospectus documents that were false and misleading in contravention of s 728 of the Act and representations made to the company's auditors that were false and misleading in contravention of s 1041H of the Act. ASIC has also formed the view that the company breached its continuous disclosure obligations under s 674. 3 On 4 May 2015, Sino Australia was placed into administration by resolution of the directors and Mr Darin and Mr Jess of Worrells Solvency & Forensic Accountants were appointed the administrators. On 15 May 2015, ASIC applied for an order terminating the administration of Sino Australia and for an order that Mr McCluskey be appointed as provisional liquidator. The administrators did not contend that it was in the interests of the company's creditors for the company to continue under administration, rather than have a provisional liquidator appointed (see s 440A(3) of the Act) and ASIC's application for a provisional liquidator proceeded on an unopposed basis. An order was made that Mr McCluskey be appointed as provisional liquidator: see Australian Securities and Investments Commission v Sino Australia Oil and Gas Limited [2015] FCA 531. 4 By its further amended originating process filed 21 May 2015, ASIC now seeks an order that Sino Australia be wound up pursuant to s 461(1)(k) of the Act on just and equitable grounds. ASIC has standing to bring that application under s 462(2) and s 464 of the Act. The application is supported by the provisional liquidator and there has been no opposition.

APPLICABLE PRINCIPLES 5 The classes of conduct which justify the winding up of a company on the just and equitable ground are not closed, and each application will depend upon the circumstances of the particular case: Ebrahimi v Westbourne Galleries Ltd [1973] AC 360 at 374, 376–9. There are some well settled principles, nonetheless. 6 In Australian Securities and Investments Commission v International Unity Insurance Pty Ltd (2004) 22 ACLC 1416; [2004] FCA 1059 at [136]–[139], Lander J usefully provided a summary of the authorities and principles relevant to the exercise of the Court's power under s 461(1)(k) of the Act. His Honour said: 136. There are a number of separate grounds which justify the making of a winding up order under this head. If mismanagement, misconduct or lack of confidence in the conduct and management of the affairs of a company is established, it may be appropriate to wind up the company under this head: Australian Securities Commission v AS Nominees Limited [(1995) 62 FCR 504] at 532-533; Australian Securities & Investments Commission v ABC Fund Managers [2001] VSC 383; (2001) 39 ACSR 443 at 469. 137. If the plaintiff can establish that there have been breaches of the provisions of the Act, including, but not limited to, breaches of directors' duties, inadequacy of accounts and inadequacy of record keeping, it may be appropriate to make an order under this head: Australian Securities Commission v AS Nominees Limited at 532-533; Australian Securities & Investments Commission v ABC Fund Managers at 469. 138. If there is a need to ensure investor protection, a winding up order may be made under this head: Australian Securities Commission v AS Nominees Limited and Others at 532-533; Australian Securities & Investments Commission v ABC Fund Managers and Others at 469. 139. An order may be made if a company has not carried on its business candidly and in a straightforward manner with the public: Australian Securities & Investments Commission v Austimber Pty Ltd [1999] FCA 566; (1999) 17 ACLC 893. Such an order would also be appropriate where the corporation has acted fraudulently or entered into sham transactions. Insolvency is not a precondition for the appointment of a liquidator on the just and equitable ground but, as the authorities caution, if a company is solvent, the winding up of a solvent company is an extreme step requiring a strong case: Australian Securities and Investments Commission v ABC Fund Managers Ltd (2001) 39 ACSR 443; [2001] VSC 383 at [124]. The provisional liquidator is of the opinion that Sino Australia is presently solvent but ASIC submits that there has been such misconduct and mismanagement of the company that a winding up order is justified notwithstanding the solvency of the company.

CONSIDERATION 7 ASIC has alleged that the company falsely represented in its replacement prospectus that it held two patents and that its subsidiary ("HuaYing") also held two patents. The false representations were alleged in [22] of the amended statement of claim and the making and falsity of the representations were admitted by Sino Australia and Mr Shao in their defences. I am accordingly satisfied that by making the false statements in the replacement prospectus concerning the patents, Sino Australia contravened s 728(1)(a) of the Act. 8 ASIC has also alleged a contravention of s 728(1)(a) of the Act in relation to the disclosure of material contracts in the replacement prospectus. Mr Caridi, a senior manager at ASIC, swore an affidavit in which he deposed that ASIC's investigations had disclosed significant discrepancies between the statements in Sino Australia's replacement prospectus regarding the drilling and maintenance service contracts that Sino Australia claimed to have in China as compared to information received by ASIC from a foreign regulatory authority under a request for assistance made under the IOSCO Multilateral Memorandum of Understanding Concerning Consultation and Cooperation and the Exchange of Information. The information received from the foreign regulatory authority indicated that HuaYing had substantially fewer contracts servicing substantially fewer wells than had been stated in the replacement prospectus. The replacement prospectus listed 16 contracts servicing 1,260 wells with a worth of around ¥360,865,000 for the calendar year 2012. The information received from the foreign regulatory authority indicated that Sino Australia in that year had only four clients with seven contracts for 15 wells. On 16 April 2015, ASIC wrote to Piper Alderman, the then solicitors for the company, advising that the information in the possession of ASIC showed that if the information that ASIC had obtained was correct, Sino Australia's replacement prospectus vastly overstated the extent of its business in China. The letter set out in detail the significant discrepancies between the disclosures in the replacement prospectus and the information obtained by ASIC and requested as a matter of urgency the company's explanations for each of those discrepancies. That explanation was never provided. 9 Further support for ASIC's claim is found in the provisional liquidator's report. The provisional liquidator also made his own enquiries into the customer contracts listed in the replacement prospectus and those enquiries uncovered only 10 customer contracts relating to 189 wells. 10 In November 2015, ASIC amended its statement of claim to include, amongst other things, the allegation that the disclosure of material contracts in the replacement prospectus was misleading or deceptive and in contravention of s 728(1)(a) of the Act by reason that certain of the contracts identified did not exist and other contracts were for fewer wells than were identified in the replacement prospectus. Neither Sino Australia nor Mr Shao filed a defence to those allegations and the discrepancies between the contracts listed in the replacement prospectus and the contracts which have been able to be verified have never been explained. Senior counsel for ASIC brought to my attention that there was a downturn in the oil industry in 2014 and 2015, which may explain why there were fewer contracts and fewer wells being serviced by HuaYing in 2014 and 2015, but I accept ASIC's submission it does not explain why investigations have not uncovered the historical records of all the contracts represented in the prospectus to exist for the calendar year 2012. My attention was also drawn to a report by the independent director, Mr Gasteen, following a visit to China in July 2014 to view the company's and HuaYing's headquarters and operations. Mr Gasteen gave a positive assessment of the company's activities at that time but his report does not deal with the company's contracts in 2012 and does not refute ASIC's claim. 11 In the circumstances, whilst there are some inconsistencies as to how many contracts HuaYing actually had in the 2012 calendar year, I am satisfied on the evidence that the information about the material contracts in the replacement prospectus misstated the true position and was false and misleading. Accordingly, I am satisfied that the company contravened s 728(1)(a) in relation to the disclosure of its material contracts in the replacement prospectus. 12 The replacement prospectus also contained a table providing a summary of the historical consolidated financial performance of the group for the financial years 2010, 2011 and 2012 together with the forecast financial performance of the group for the financial year 2013. The forecasted net profit after tax for the financial year 2013 was $13,660,000. The company's Appendix 4E (preliminary final report) for the year ended 31 December 2013 recorded a net profit of $8,395,837. ASIC has alleged that following the issue of the replacement prospectus, the following material circumstances occurred: (a) in about June 2013, Sino began, through its operating subsidiary HuaYing, to provide services to customers in remote areas of China which resulted in increased staff costs and transportation costs; (b) between July 2013 and 12 December 2013, Sino incurred additional equipment lease expenses of $2.6 million because of delay in receiving delivery of capital equipment; (c) from about August or September 2013, Sino began experiencing delays in receiving payments from its Chinese state owned enterprise customers; (d) there were successive delays during the initial public offering which did not close until December 2013 resulting in increased costs of approximately $1 million. 13 ASIC has further alleged that those circumstances adversely affected Sino's likely future net profit after tax for the financial year ending 31 December 2013 and contributed to a 39% decrease in net profit compared to the forecast in the replacement prospectus. ASIC has alleged that by failing to disclose those circumstances in any of the prospectus documents Sino Australia contravened s 728(1)(b) and s 728(1)(c) of the Act. 14 In their defences, the company and Mr Shao admitted that the circumstances set out in (a), (b) and (d) above adversely affected Sino's likely future net profit after tax for the financial year ending 31 December 2013 but otherwise have denied the allegations. 15 It was submitted that the evidence showed that Mr Shao, who signed the Appendix 4E report as the company's chairman, knew about these circumstances before the close of the initial public offering. The evidence relied on by ASIC is the commentary on the full year results in the Appendix 4E report and Mr Shao's examination under s 19 of the Australian Securities and Investments Commission Act 2001 (Cth) ("ASIC Act"). The commentary includes the following statement: … financial strain in the domestic oil field services industry has been very common since the middle of year 2013 when the state governments reinforce their efforts to fight corruption in large state owned enterprises (SOE) such as PetroChina. It takes much longer time for payments to be made from state owned oil companies, as more approval processes are required before payments can be made. … The increase in Revenue are mainly derived from new markets in Xinjiang and Changqin Oilfields and due to its nature of competition, are less profitable resulting in the average revenue per contracted well drilled are comparatively lower than forecast by 11%. Hence, the lower average revenue per contracted well coupled with the higher cost of delivering the services due to the leasing cost resulted in lower gross margin, and hence the Group showed a $5 [million] negative variance against the Net profit after tax compared to the forecast stated in the Prospectus. 16 In Mr Shao's s 19 examination, he elaborated on some of these factors. At his examination on 28 May 2014, Mr Shao was asked what the reason was for the difference between the prospectus forecast and the actual profit as recorded in the Appendix 4E report, which was a drop of around 40%. Mr Shao (through an interpreter) stated: The first reason is it was scheduled that the IPO was successful in July and equipment would be in place to be used in time, but in 2013 we couldn't achieve the IPO in time or couldn't achieve the equipment purchasing time or the IPO, so the delay of IPO's timing increased the rental cost of the equipment. That's the first reason. … The second reason is due to the delay of the listings timing we have already trained staff and engineers – operatives and engineers – for the new equipment and they have undertaken long time training in 2012, so the cost of the staff has increased... The third reason is because in 2013 we opened the markets which is 7,000 kilometres away and so we needed to send the operatives from (indistinct) Province and that resulted in the huge increase in the staff cost. 17 Mr Shao was asked when that occurred in 2013. Mr Shao's answer was: We entered the (indistinct) market in June 2013 and also the cost to – the cost for the long distance transfer of the equipment has increased, and also we have a promotional prize for the new market. That net profit decreased from 47 per cent to 42 per cent which is 5 per cent for the promotion prize. The most important reason is the cost – the funding cost during IPO in Australia is much more than we expected. It's more than $AUD 1 million more than we expected. If we didn't have all the difficulties I mentioned above in 2013, the income and net profit would be much more than we expected – than the forecast. 18 Later, the following questions and answers were given: Q: Mr Shao, in your affidavit that you swore last week you indicated that there had been stoppage in relation to payments from state owned enterprises as a result of a government initiative – broad based initiative. Is that the case? A: Privilege. It was not stoppage, it was opposed and delayed. However in February and March we still had some funds coming in and it's not that the government is not giving – is not providing us the fund, it's that the fund is delayed. Q: When did the delay start? A: It was not – privilege – it was not proceeding well since – it hasn't been proceeding well since last August but now we still have some funds coming in. Q: So the delays started in around last August? A: September. Q: Mr Shao, before you said that the companies can apply for loans. Do the companies in China have the capacity to apply for loans? A: Yes, the bank has the capacity. Privilege. Q: Have the subsidiaries approached the banks for loans? A: Yes. Q: When was the approach made? A: Privilege. At the beginning of this year, because we knew a bad fund flow will impact the production, so since then we have been communicating with the banks. 19 I accept ASIC's submissions that the statements made by Mr Shao at his examination are admissible in evidence against him pursuant to s 76 of the ASIC Act. I also accept that his statements are admissible under s 87 of the Evidence Act 1995 (Cth) as admissions against the company: Australian Securities and Investments Commission v Astra Resources PLC [2015] FCA 759, [124]–[126]. This evidence establishes that Mr Shao knew well before the close of the initial public offering that the projected net profit after tax of $13.66 million in the replacement prospectus was wrong and knew that the circumstances alleged by ASIC in its amended statement of claim would impact on the company's net profit to 31 December 2013. Sino Australia did not disclose this in any of its supplementary prospectus documents and I am accordingly satisfied on the evidence that Sino Australia contravened s 728(1)(b) and (1)(c) of the Act in relation to the profit forecast. 20 ASIC has also alleged that the profit downgrade was information that a reasonable person would expect to have a material effect on the price or value of Sino Australia's securities. Given the size of the variation between the profit forecast published by Sino Australia in its replacement prospectus and the actual profit recorded in March 2014 and Mr Shao's knowledge in 2013 that the actual profit would be impacted by the circumstances alleged by ASIC, I am also satisfied that the company contravened the continuous disclosure requirements of s 674(2) of the Act by failing to disclose that profit downgrade to the market. 21 ASIC has also alleged that false and misleading statements were made in the replacement prospectus concerning the inclusion of $3,114,000 in the company's cash flows. The amount was recorded as "proceeds from the convertible notes". The provisional liquidator has reported to the Court that his review of the company's Australian bank accounts indicates the proceeds from the convertible notes were never paid into the company's Australian bank accounts. The company told ASIC that the proceeds were deposited into an offshore bank account with Longjiang Bank, Daqing Branch in China in the name of HuaYing. Ms Lau of KLC Kennic Lui & Co, an affiliate of Ferrier Hodgson, the provisional liquidator's firm, attended the company's Chinese offices and interviewed Mr Shao. The provisional liquidator reported that during Ms Lau's attendance at the Chinese offices of the company, Ms Lau reviewed both the management accounts of HuaYing for the years ended 31 December 2010 to 31 December 2014 and the bank account statements for the period 1 January 2013 to 9 April 2015 and was unable to identify specifically bank deposits in relation to the convertible notes proceeds. The provisional liquidator also reported that Mr Shao advised Ms Lau that only some of the proceeds from the convertible notes were deposited into that bank account and the balance was paid in cash. Ms Lau was not able to obtain further information regarding the amounts deposited or paid in cash, nor was she able to obtain an explanation as to the ultimate use of the amounts paid in cash. As the entry in the accounts is unable to be verified, I am accordingly satisfied that accounting for the proceeds as cash or cash equivalent in the company's forecast statement of financial position was false and misleading in contravention of s 728(1)(a) of the Act. 22 ASIC has further alleged that the company made representations to Grant Thornton Australia Limited ("Grant Thornton"), the company's auditors, in the course of Grant Thornton's work in preparing Sino Australia's audited financial statements for the years ended 31 December 2012 to 31 December 2014. ASIC has alleged that representations made by Sino Australia as recorded in the audited financial statements prepared by Grant Thornton were false and contrary to s 1041H of the Act on the basis of discrepancies with HuaYing's management accounts, as follows: Year Net Asset Position Net Profits Grant Thornton audited financial statements HuaYing management accounts Grant Thornton audited financial statements HuaYing management accounts 2012 ¥141,336,831 ¥85,795,891 ¥52,397,726 - ¥7,274,515 2013 ¥226,896,208 ¥110,831,918 ¥66,017,842 - ¥5,517,701 2014 ¥239,030,264 ¥101,804,810 ¥27,686,555 - ¥4,642,801

The discrepancies are supported by the provisional liquidator's report. The provisional liquidator reported that: Given the size of the variances between HuaYing's management accounts and the amounts recorded in the Grant Thornton work papers, there is a potential for the consolidated 30 June 2012 financial statements detailed in the replacement prospectus to be materially misstated. However, given the constraints identified throughout this report, further investigation will be required to reconcile the differences and in particular accessing the audit working papers and adjustments made by Grant Thornton, would be essential. 23 I accept on the basis of the discrepancies between management accounts and the consolidated working audit papers of Grant Thornton that there has been a contravention of s 1041H. 24 On the findings I have made, there has been substantial and serious misconduct and mismanagement in the affairs of the company. In the circumstances, having regard to the nature and extent of the contraventions, a strong case has been made out for an order that the company be wound up on just and equitable grounds, notwithstanding that it may be solvent. The order is justified in order to prevent and condemn the repeated breaches of the law: Australian Securities Commission v AS Nominees Limited (1995) 62 FCR 504; [1995] FCA 1663 at 532–3 (FCR); Australian Securities and Investments Commission v ActiveSuper Pty Ltd (No 2) (2013) 93 ACSR 189; [2013] FCA 234 at [23]. 25 I am fortified in my conclusion that it is appropriate that the company be wound up by the evidence that there is serious reason also to have concern about the competency of the management of the company. The evidence showed that Mr Shao, the major shareholder, chairman and managing director of Sino Australia, on his own admission, has no knowledge or understanding of the regulatory regime for public companies in Australia and totally relied on the two Australian directors. Critically, as he has no ability to read or write English and the prospectus documents were not translated, he did not read the prospectus documents himself, although he signed those documents for and on behalf of the company as its chairman. Furthermore, the company's own solicitors provided advice to it in May 2015 that the management of the company was dysfunctional. The advice included that: Plainly the Company is not travelling well. For the Board to be effective in protecting shareholder interests (and creditors) it must be provided with accurate and timely information. That is not happening possibly because the China management are incompetent, wilfully disregarding governance obligations and/or are dishonest. The practical problem is that because of distance and in your case language the non-executive Board are unable to change management behaviour. The problem that has revealed itself through the latest issues raised by ASIC is that there is likely to be a conflict between those members of the Board who were not responsible for or involved in the preparation of the Prospectus and those that were or who owe allegiances to those who were. The vital work for the Board right now in protecting shareholder value is to conduct a thorough investigation into ASIC's concerns. The efforts that you, Perry and Hector have made to have that investigation undertaken are either being ignored or positively frustrated by inaction. At this level the events of the last few weeks have revealed an organisation that is, to look kindly on the situation, incompetent and dysfunctional, and to look critically at the situation is quite possibly constructed on a series of falsehoods. What is readily apparent from the events of 2015 is that the Board as a collective is unable to address the serious deficiencies in the Company. Given the confluence of disclosure issues, solvency concerns, the apparent casual disregard for legal requirements by the executive management team, the conflicting interests of those Board members who were involved in the matters that ASIC is investigating and those that were not, concerns about competency of management and the general dysfunction and paralysis my view is that you can have no confidence that left in the hands of the current board and management that the affairs of the Company can be carried out properly and for the benefit of shareholders. 26 It has long been established that a company may be wound up where there is a "justifiable lack of confidence in the conduct and management of the company's affairs" and thus a risk to the public interest that warrants protection: Australian Securities and Investments Commission v ActiveSuper Pty Ltd (No 2) at [20]. In this case, there is strong evidence to conclude a justifiable lack of confidence in the conduct and management of Sino Australia. 27 In view of my conclusions, it is unnecessary to consider the additional arguments advanced by ASIC supporting the order for the winding up. I will accordingly order that Sino Australia be wound up and that Mr McCluskey be appointed the liquidator. I certify that the preceding twenty-seven (27) numbered paragraphs are a true copy of the Reasons for Judgment herein of the Honourable Justice Davies.

Associate: Dated: 4 March 2016

SCHEDULE OF PARTIES VID 161 of 2014

Plaintiff: AUSTRALIAN SECURITIES AND INVESTMENTS COMMISSION First Defendant: SINO AUSTRALIA OIL AND GAS LIMITED (PROV LIQ APPTD) Second Defendant: TIANPENG SHAO Third Defendant: RUIYU HE Fourth Defendant: HSBC BANK AUSTRALIA LIMITED Fifth Defendant: WRIXON GASTEEN Sixth Defendant: ZHANHAU YUAN Seventh Defendant: GUANGBIN ZHONG Eighth Defendant: YU LU Ninth Defendant: TIANXIANG SHAO