THE DECISION of Pacific Challenge chairwoman Lily Chiang to sell out of the company is the latest twist in a continuing legal battle that cuts to the heart of the corporate governance debate in Hong Kong. Legal action was initiated in Bermuda last March by Norwegian fund Kistefos Investment, alleging that Pacific Challenge was being run in a way detrimental to minority investors. The claim is thought to be partly based on the proposed acquisition in 2000 of an Internet company in which Ms Chiang had a large interest for almost 30 times its net asset value. If a court rules that the minority investors' interests were harmed, it could be potentially embarrassing for Ms Chiang, who is also vice-chairwoman of the Hong Kong General Chamber of Commerce. However, any verdict looks like it will be a long time in coming. The battle has barely completed the first legal round. The court threw out an attempt by Kistefos to wind up Pacific Challenge in October. However, it ruled that a case should be heard on whether Pacific Challenge should buy out Kistefos' 21.78 per cent stake at a price determined by the court. Pacific Challenge is trying to stymie any such hearing. Kistefos in turn is appealing the court's decision that Pacific Challenge should not be wound up. Both appeals are scheduled to be heard in mid-June. So far the only winners are the lawyers who get more fees and trips to Bermuda - where Pacific Challenge is incorporated - when the case appears before the courts. Last week, Pacific Challenge announced that Ms Chiang would sell her entire interest in the firm at a huge premium to the market price. E1 Media Technology, which is 60 per cent owned by Ms Chiang, sold a 29.5 per cent stake in Pacific Challenge for HK$153 million, or HK$1.81 per share, to independent investor Zhang Mingyu. This part of the transaction valued the shares at 5.56 times their market price of 32.5 HK cents prior to the deal. E1 Media, Ms Chiang and another shareholder together plan to place another 4.17 per cent stake at 29 HK cents to 32.5 HK cents each. Ms Chiang will then have no shares in Pacific Challenge. Why did Mr Zhang pay such a huge premium? The announcement of the deal offered no clue but one possible reason is that Pacific Challenge has a cash pile of HK$184.11 million and a net asset value of HK$241.33 million as of September 30. So Pacific Challenge had cash on hand of 64.2 HK cents per share and a net asset value per share of 84.2 HK cents. Given these figures one could argue that as trading in Pacific Challenge was relatively illiquid the stock was undervalued. However, the asset figures are still far below Mr Zhang's purchase price of HK$1.81 per share. By buying only 29.5 per cent, Mr Zhang avoids having to make a general offer for all Pacific Challenge shares under the Hong Kong takeovers code. The trigger threshold for a general offer was reduced from 35 per cent to 30 per cent last year. Investors are now deemed to have effective control at 30 per cent, which is why transactions often have premiums to market value for stakes this size. If Mr Zhang were able to control the firm through his 29.5 per cent stake the deal would make more sense. However, the premium is still a mystery as it will be difficult for Mr Zhang to control the company, which could still be wound up by the Bermudan courts. Kistefos has already vowed that its legal battle will continue despite Ms Chiang's decision to bail out of Pacific Challenge. Moreover, control is far from guaranteed for Mr Zhang when Kistefos, the second-largest shareholder, holds 21.78 per cent. The legal action shows Kistefos is prepared to go to great lengths to argue its case and could organise other shareholders to outvote Mr Zhang if they disagree. Kistefos has shown before that it is capable of rallying shareholder support. The disagreement between Ms Chiang and Kistefos appears to have started when Pacific Challenge proposed to buy Internet company Cents.com for HK$170 million. Cents.com, which was owned by E1 Media, had net assets of only HK$5.9 million. The proposed investment was voted down by shareholders in July 2000 when Kistefos is thought to have led a revolt. The Pacific Challenge saga highlights important corporate governance issues in Hong Kong regarding enforcement and disclosure. The case is taking a long time to be resolved - and in Bermuda, where investors cannot watch - and will no doubt be expensive. Such actions can only be afforded by a small number of investors. Little information has been disclosed about Mr Zhang, who will become the largest shareholder, and his plans for Pacific Challenge. Last week's announcement from Pacific Challenge said Mr Zhang had been general manager and chairman of Chongqing Gang-Tian Hotel. The announcement declined to say he had been an executive director of Hong Kong listed Hansom Eastern (Holdings) for little over a year ending in January. Mr Zhang's future intentions for Pacific Challenge were outlined as continuing with 'its existing principal business activities of corporate finance advisory and trading'. This tells us little as it omits one principal activity of Pacific Challenge, which is sitting on its HK$184.11 million cash pile and accruing the interest. For the six months to September 30, Pacific Challenge had turnover of only HK$14.2 million, of which over a third was categorised as interest income and others. So Pacific Challenge currently does relatively little and what matters most to other shareholders is Mr Zhang's plans for the cash-pile. All that investors are told in the announcement is that 'based on the extensive business connections, experience and expertise of Mr Zhang in PRC and in listed securities portfolio investments . . . Mr Zhang will be able to contribute towards the further development of the company by bringing in more extensive exposure to business connections and opportunities and by deploying the financial and investment skills of the group in projects emerging in other parts of PRC which may arise after its accession into the World Trade Organisation'. This tells investors precisely nothing about the company's future development. Shareholders are also being kept in the dark about Kistefos' legal action. Only the broad outline of Kistefos' petition is known and not the basis of the allegations to enable investors to assess for themselves the likely impact of the legal action. Neither side seems prepared to release more details about the case. With so many details unknown, it is hard to make a well-informed judgment about Pacific Challenge. Besides deciding the fate of the company, the case may also have repercussions on Hong Kong's reputation for fair dealings. As vice-chairwoman of the chamber of commerce, Ms Chiang has a duty to uphold the highest standards of probity in business life. Investors will be watching the outcome with interest.