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9 December 2019

Longrun Tea Group Company Limited – Listing Review Committee

On 29 November 2019, the Listing Review Committee heard an application by Longrun Tea Group Company Limited (the Company) for a review of the decision of the Listing Committee, set out in a letter dated 23 August 2019, cancelling the Company’s listing on the Main Board.

Having carefully considered all the facts and evidence, and all the submissions (written and oral) presented by the Company and the Listing Department, the Listing Review Committee decided that the Company’s listing should be cancelled under Rule 6.01A.

We set out below the Listing Review Committee’s reasons for its decision. Please note that this necessarily represents only a summary of the Listing Review Committee’s analysis, and does not purport to set out exhaustively the facts or address all of the arguments presented.

1.    The Company is an investment holding company principally engaged in the distribution of tea and other food products. The Company has a smaller, secondary business segment engaged in the distribution of pharmaceutical products.
 
2.    The Company’s shares have been listed on the Main Board since September 2002, although trading has been suspended since 15 June 2017.
 
3.    The trading suspension arose pending an inside information announcement about certain audit issues raised by the Company’s then auditors, Ernst & Young (EY). These issues related to two bank accounts, and in particular to inconsistencies relating to the balance in those accounts (the Audit Issues). EY expressed the view that the Company should engage an independent accounting firm to conduct an independent forensic investigation into the Audit Issues. The Company could not reach a consensus with EY regarding this work, and EY was removed as auditor and replaced by Moore Stephens CPA Limited (Moore Stephens).
 
4.    The Company appointed Baker Tilly Hong Kong Risk Assurance Limited (Baker Tilly) to perform agreed upon procedures in relation to the matters giving rise to the Audit Issues.
 
5.    Baker Tilly set out its findings in a report dated 17 November 2017. Amongst other things, Baker Tilly reported on a contractual arrangement (the Contractual Arrangement) involving one of the Company’s subsidiaries (YNLRT), a supplier of tea (the Supplier), and a potential purchaser of tea (the Third Company). The Supplier was owned by the Company’s founder/chairman (the Chairman) and the Chairman’s brother.
 
6.    In summary, it appeared that the Contractual Arrangement involved a loan from YNLRT to the Third Company, and a payment by the Third Company to the Supplier. It further appeared that the Supplier would then hold tea products, which were effectively reserved for the Third Company. However, the Third Company was under no obligation to complete the purchase of any such tea products, but it appears to have been contemplated that the Third Company could call for delivery of such tea products in future years. If the Third Company did seek delivery of the tea products, the Supplier was obliged under an exclusive arrangement to sell the tea products to YNLRT. YNLRT would then on-sell the same products to the Third Company.
 
7.    What transpired was that the loan under the Contractual Arrangement was not advanced from YNLRT to the Third Company, but was instead paid directly to the Supplier. The Supplier used the monies received to repay certain bank loans.
 
8.    The Contractual Arrangement was eventually unwound without any tea being purchased. First, there was a default in repayment on maturity in March 2017 of the loan agreement between YNLRT as lender and the Third Company as borrower. The agreement between the Third Company and the Supplier was then terminated. The Supplier repaid the Third Company, and the Third Company repaid the loan to YNLRT. The repayment was a few months late (in June 2017) but was made in full with interest. The interest rate under the loan agreement was 9% per annum. The loan exceeded RMB 130 million.
 
9.    The Company acknowledged that the loan constituted a major transaction but, contrary to the Listing Rules, was neither announced nor approved by shareholders.
 
10.    Moore Stephens disclaimed an opinion on the 2017 annual results due to insufficient appropriate audit evidence on the underlying commercial reasons for the loan, and the nature and reasons for the discrepancies and omissions of recording the loan before EY’s discovery in May 2017. This was at least in part because Moore Stephens had been unable to interview certain employees of the Group alleged to be responsible for the inconsistencies giving rise to the Audit Issues.

Resumption conditions

11.    Between September 2017 and August 2018, certain conditions were imposed on the Company that had to be met to the satisfaction of the Listing Department before the Company could resume trading. Amongst other things, these included requirements that the Company should:
 
(a)    address the Audit Issues;
 
(b)    publish all outstanding financial results and address any audit qualifications;
 
(c)    demonstrate that the Company has put in place adequate internal control systems to meet the obligations under the Listing Rules; and
 
(d)    demonstrate that there is no reasonable regulatory concern about management integrity, and/or any persons with substantial influence over the Company’s management and operations, which will pose a risk to investors and damage market confidence (the Regulatory Concern).

Applicable Listing Rules and guidance

12.    The rules applicable to cancellation of listing were amended in 2018 and the current rules came into effect on 1 August 2018 (the Effective Date). Rule 6.01A(1) provides that “… the Exchange may cancel the listing of any securities that have been suspended from trading for a continuous period of 18 months.”
 
13.    Guidance Letter HKEX-GL95-18 (GL95-18) provides further guidance on long suspension and delisting. As noted in GL95-18, the objective of the amended delisting Rules is to keep the necessary trading suspension to the minimum, by facilitating timely delisting of issuers that no longer meet the continuing listing criteria. This, in turn, provides certainty to the market on the delisting process. The delisting Rules are also aimed at incentivizing suspended issuers to act promptly towards resumption and deterring issuers from committing material breaches of the Rules.
 
14.    Various transitional provisions are set out in Rule 6.01A(2). In the case of the Company, the relevant transitional rule is Rule 6.01A(2)(b)(ii), which applies to issuers which are not subject to a decision to commence the procedures to cancel a listing and a notice period for delisting immediately before the Effective Date, and when trading in that issuer’s securities has been continuously suspended for 12 months or more as at the Effective Date. Under that rule, the 18 month period referred to in rule 6.01A(1) commences 6 months before the Effective Date.
 
15.    The practical effect of the above rules is that the Company could be cancelled if it had not resumed trading by 31 July 2019.
 
16.    Paragraph 12 of GL95-18 emphasises that, under the Rules, the Exchange would cancel the listing of a long suspended issuer upon the expiry of the remedial period (prescribed or specific) if the issuer has not remedied the issues causing the suspension and re-complied with the Rules.
 
17.    Paragraph 19 of GL95-18 notes that the remedial period may only be extended in exceptional circumstances.

The Company’s steps towards resumption

18.    The Company submitted that it had, by 31 July 2019, taken many steps to address the resumption conditions. They are not all summarised here. For the purposes of this decision, the most relevant matters relate to the Contractual Arrangement and the Regulatory Concern condition.
 
19.    Amongst other things, the Company said that the loan was to induce and facilitate the Third Company to invest in tea products over which the Company effectively had exclusive distribution rights. If the Third Company ultimately wished to purchase such products, they would be sold to it by the Company (or its subsidiary), which would have obtained the products under the exclusive right to supply from the Supplier.
 
20.    The Company submitted there would be no downside to the Company under this arrangement if the Third Company eventually (as in fact transpired) chose not to purchase any tea products, as the Company was able to benefit from the substantial interest payable under the loan. The loan was advanced directly to the Supplier in order to have more control over the money. The failure to comply with the applicable Listing Rule requirements for announcement and shareholder approval was simply an oversight.
 
21.    In short, the Company submitted that the loan was made for commercially sensible reasons, and no Regulatory Concern should arise in respect of the Contractual Arrangement.
 
22.    The Company also proposed that, if the Listing Department was unsatisfied with the Company’s explanation, and continued to have a Regulatory Concern, then that could be addressed by a change in control, in that the Chairman would sell his shareholding to an independent third party. Under the proposed sale arrangements, the existing directors of the Company (including the Chairman and his brother) would resign. The Company submitted that the Chairman and his brother would then no longer have any influence in respect of the Company. A memorandum of understanding in relation to this proposed sale had been entered into by the Chairman and the prospective purchaser.

Listing Department’s recommendation to the Listing Committee

23.    As of 31 July 2019, the Listing Department was not satisfied that the Company had fulfilled all the resumption conditions. Amongst other things, the Listing Department did not consider it had received satisfactory explanation from the Company about the reasons for the loan. The Listing Department noted that the Third Company had no firm commitment to buy any tea at any point, and there appeared to be no plausible explanation of the reason why the monies were advanced to the Supplier directly by YNLRT – in this regard, the Listing Department noted that the money may have been spent by the Supplier, so any alleged control over the money was not effective. The Listing Department thought that the Contractual Arrangement was designed to disguise financial assistance to the Chairman and his brother.
 
24.    In relation to the proposed sale, the Listing Department noted that it had not been finalised, so it was not clear if it would proceed. There was a concern that the purchaser may be trying to obtain the listing status of the Company, without a genuine intention to develop the Company’s underlying business.
 
25.    The Listing Department was also concerned that the sale may not resolve the Regulatory Concern, as the Chairman and his brother might continue to have control or substantial influence over the Company after the sale.
 
26.    The Listing Department also had a concern about whether the Company on resumption would have a business that has substance and/or is viable and sustainable. This was a concern that the Company would not satisfy the requirements of Rule 13.24, which provides that: “An issuer shall carry out, directly or indirectly, a sufficient level of operations or have tangible assets of sufficient value and/or intangible assets for which a sufficient potential value can be demonstrated to the Exchange to warrant the continued listing of the issuer’s securities.

Listing Committee decision

27.    In August 2019, the Listing Department recommended to the Listing Committee that the Company’s listing be cancelled on the basis that the Company had failed to fulfil all the resumption conditions and resume trading by 31 July 2019.
 
28.    The matter was considered by the Listing Committee on 8 August 2019. The Listing Committee decided to cancel the Company’s listing under Rule 6.01A as the Company had failed to resume trading by 31 July 2019.

Further submissions

29.    The submissions made to the Listing Review Committee in relation to the Contractual Arrangement and the Regulatory Concern by both parties largely reiterated and expanded upon the matters summarised above. In particular, the Company made detailed written and oral submissions as to why the loan was in good faith and was commercially reasonable. The Company submitted that if the Listing Department was unsatisfied in relation to the Regulatory Concern, then that was unreasonable and subjective, and appeared to arise from an unwarranted distrust of the Company and/or its management, and there was no reason to doubt the integrity of the Chairman or his brother.
 
30.    In oral submission and in answer to questions from the Listing Review Committee, the Chairman said that the proposed sale and change of control was not his preference – he did not think it should be necessary and he wanted and intended to remain involved with the Company – but he was reluctantly willing to go through with a sale if it meant that the Company’s listing could be saved.

Listing Review Committee’s views

31.    The Listing Review Committee noted that, as a matter of fact, trading had not resumed by 31 July 2019. Accordingly, the Company’s listing could be cancelled under Rule 6.01A.
 
32.    The Listing Review Committee considered further whether or not the Company had satisfied the resumption conditions. The Listing Review Committee did not consider that the Regulatory Concern condition had been satisfactorily addressed. In particular, the Listing Review Committee was not satisfied with the explanation given by the Company regarding the Contractual Arrangement, and was not convinced of the commercial rationale for the arrangements relating to the loan. The Listing Review Committee noted that the money paid under the Contractual Arrangement was transferred between two companies under the Chairman’s control, and there was evidence that the money, once transferred, was used for other purposes by the Supplier. The Listing Review Committee noted that although the Company had instructed an investigation into the Audit Issues, the scope of that investigation (based on agreed upon procedures) gave less comfort than would have been the case had the Company followed the advice of its then auditors and arranged an independent audit investigation.
 
33.    The Listing Review Committee considered that the proposed sale was not a sufficient response to the Regulatory Concern issue as: (a) the sale had not been completed and it was uncertain whether it ever would be given it was only at a relatively preliminary stage; and/or (b) even if the sale were completed, the Listing Review Committee had doubts as to whether the Chairman would no longer be involved in the Company and its business, given his strongly professed preference not to sell, a doubt held by the Listing Review Committee over whether the proposed purchaser was truly arm’s length and independent, and the Chairman’s indications during the hearing as to how he expected the Company would be managed and operated after the sale.
 
34.    The Listing Review Committee was accordingly of the view that, as at least one of the resumption conditions (namely the Regulatory Concern condition) had not been satisfactorily addressed, and resumption of trading had, as a result, not taken place, the Company’s listing should be cancelled.
 
35.    As the findings above were determinative of the review, the Listing Review Committee did not consider it necessary to decide whether or not the Company had satisfied the other resumption conditions, or whether the Company did not or would not in the future satisfy the requirements of Rule 13.24. The Listing Review Committee accordingly expresses no view on these issues.

Decision

36.    The Listing Review Committee therefore decided to uphold the Listing Committee’s decision that the Company’s listing should be cancelled under Rule 6.01A.

Please note that decisions of the Listing Review Committee do not represent binding precedents, and do not constrain the discretion of or otherwise bind the Exchange or other committees (including without limitation the Listing Review Committee in respect of other matters).