SECURITIES AND FUTURES COMMISSION v. QUNXING PAPER HOLDINGS COMPANY LTD AND ANOTHER

HCA 2428/2013

IN THE HIGH COURT OF THE

HONG KONG SPECIAL ADMINISTRATIVE REGION

COURT OF FIRST INSTANCE

ACTION NO 2428 OF 2013

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R U L I N G

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1. On 12 December 2013, the plaintiff (“SFC”) obtained an ex parte injunction against the defendants restraining them from disposing of their assets in Hong Kong up to the threshold of almost HK$2 billion and other ancillary reliefs.

2. The application is made under section 213 of the Securities and Futures Ordinance Cap 571 (“SFO”) to restrain the disposal of assets of a listed company, the 1^st defendant, and its subsidiary, the 2^nd defendant, in an amount equal to funds raised by the 1^st defendant from the investing public as a result of false and misleading information.

3. According to the SFC, investigation reveals that the 1^st defendant exaggerated the turnover both before and after the Initial Public Offering (“IPO”) in 2007, and as a result, substantial funds were raised by the 1^st defendant in 2007 by the IPO and later in 2011 by the open offer of new shares and warrants.  It is the SFC’s case that the investing public was misled by information contained in the public documents and, prima facie, there were breaches of various provisions in the SFO.

4. The ex parte injunction has been served and the 1^st and 2^nd defendants appear by counsel, Mr Li, before me today. 

5. Whilst the 1^st and 2^nd defendants deny the SFC’s allegations and say that an application will be made shortly to discharge the ex parte injunction, they are prepared, without prejudice to their opposition to the ex parte injunction, not to oppose the continuation of the injunction today, subject to the 1^st defendant’s application by summons dated 18 December 2013 to seek terms as to payment of incurred and prospective ordinary trading expenses and legal expenses for the continuation of the injunction, and to extend time for compliance with the order for filing and serving the disclosure affidavit.

6. Mr Li puts forward the 1^st defendant’s case on a simple and straightforward basis.  He says the value of the assets covered by the injunction is huge, ie, close to HK$2 billion, such that the injunction covers all liquid assets that the 1^st defendant has.  Indeed, the threshold is much more than the 1^st defendant’s known assets in the bank accounts of HK$130 million and estimated value of stock of HK$80 million now known to the SFC through inquiries with the various banks. 

7. This means, Mr Li says, that the 1^st defendant has no moneys to keep its business ongoing and to prepare for its legal response.  In short, the company will, in Mr Li’s words, “keel over” as a result of the oppressive conduct of the SFC. 

8. It is said that this is not the purpose of a Mareva-type injunction, which is not to prevent ordinary trading and business, not to prevent the defendant from putting forward a defence, and not to seek security.  Mr Li says the oppression here is exacerbated by the seizure of documents by the SFC shortly after the ex parteinjunction, which leaves the defendants with a paucity of documents to prepare their defence and to prepare the disclosure affidavit.

9. However, as Mr Ho SC, counsel for the SFC, points out, this is not how Mr Poon Tsz Hang, financial controller of the 1^st defendant, puts it in his affirmation filed on behalf of the 1^st defendant for their summons.  Whilst Mr Poon complains that some documents have been seized by the SFC, the 1^st defendant is said to be in the process of retrieving records for the purpose of complying with the order to make the disclosure affidavit, and Mr Poon further says the defendant merely needs time to do so.  In fact, according to the 1^st defendant’s summons, it is expected they will be able to do so by 9 January 2014.

10. Mr Li refers to the case of Avant Petroleum Inc v Gatoil Overseas Inc[1986] 2 Lloyd’s Rep 236 to say that a Mareva injunction should not interfere with normal trading and the defendant should be able to use funds for ordinary business expenses.  He refers to particulars of the amounts of incurred and prospective expenses set out in Mr Poon’s affirmation, and says that the past incurred expenses are supported by invoices and documents and come under the parameters of ordinary expenses of running a listed company.  Legal expenses, he says, comes within the reasonable range.

11. Mr Ho SC complains that Mr Poon’s affirmation has been carefully crafted to merely say the 1^st defendant maintains several bank accounts as set out in schedule 3 of the ex parte injunction order, which are now frozen, and the 1^st defendant cannot withdraw funds from and make payment for ordinary business expenses from those accounts.  Mr Ho SC says the evidence also shows that – and I do not think there is any dispute – the major operations of the 1^st defendant are in the PRC.  Mr Ho SC further says it is unclear whether the 1^st defendant has other assets not yet known in Hong Kong and further assets in the PRC.

12. Given that the major operations of the 1^st defendant are in the PRC, it is only reasonable or logical to expect there may be assets as well as, presumably, liabilities, both receivables and payables, in the PRC.  It may be argued that more likely than not there may be assets in the PRC.  Those assets, if any, are not frozen.  It is only assets in Hong Kong within the HK$2 billion threshold that will be caught by the ex parteinjunction.

13. Mr Ho SC asks me to consider the interim report of 2013 and points out that in the first half-year of 2013, the recorded cash and cash equivalent at about RMB 655 million appear to be much more than the known assets that are frozen in Hong Kong. 

14. Mr Li points out that these consolidated accounts cover not just the 1^st defendant’s assets.  Whilst that may be the case, it must be remembered that it is the consolidated accounts of the 1^st defendant. Further, the evidence from both sides makes clear that the major operations of the 1^st defendant are in the PRC, so it may be argued that it is likely there will be either receivables or other assets of the company in the PRC.

15. Against such background, Mr Ho SC asks me to consider FSA v Forsythe De Dietrich[2011] NICH 11 (13 June 2011).  In that Irish case, which referred to UK authorities, the respondents sought to vary the injunction obtained by the FSA, the regulatory authority which is equivalent to the SFC, for recovering legal costs from funds retained by the FSA or from bank accounts frozen by the injunction.  The FSA had shown on strong prima facie evidence that the defendants had substantial lawful deposits and banked some of them, but they operated a dishonest scheme to encourage further investments but without, in truth, investing those funds.

16. In that case, the defendant failed to provide information about assets and the court held that the defendant, in order to persuade the court to utilise the assets which had been frozen for legal expenses, had to satisfy a two-stage test as drawn from the UK authorities, at least one of which was from the UK Court of Appeal.[1]

17. In those UK authorities, it has been said that a defendant may not draw from a fund which may belong to the plaintiff until it is shown that there are no funds of his own from which he can draw.  Without disclosure of his assets, it is unclear whether he may or may not be able to use the other assets to conduct his defence and he must have access to the frozen assets.

18. Although FSA was arguably not seeking a proprietary claim as such, their position as a regulatory authority was to protect the assets of the persons who had invested in the scheme and their case was therefore synonymous with a proprietary claim.  The funds therefore should not be disbursed in costs unless the two-stage test was satisfied. 

19. In other words, the defendant had to show there were no other funds from which he could pay his lawyers and he himself had an arguable claim to the funds derived from the plaintiff either as moneys properly obtained from the plaintiff, by way of remuneration or for valuable consideration, or by showing that he had an arguable case for denying the plaintiff’s claim, which was akin to proprietary claim.

20. Mr Li submits that this case is distinguishable because here the SFC is only claiming for compensation, which is not a proprietary claim.  He says the IPO happened six years ago, so investors would have onsold their shares, perhaps many times over, and moneys from the fund-raising would have been disbursed as the working capital of the 1^st defendant.

21. Having considered both parties’ submissions and having considered the writ of summons as well as the authorities, I am not persuaded that the SFC’s claim is a proprietary claim or akin to a proprietary claim.  Here, the SFC asks for freezing of assets to a level of about HK$2 billion being the sum equal to the total amount of funds raised by the 1^st defendant from the public and for an administration of those funds.  Also the SFC will ultimately seek an order for the funds so administered to be distributed to the current shareholders and holders of unlisted warrants of the 1^st defendant.

22. The claim therefore appears to be compensatory and not proprietary in nature.  It is different from the FSA v Forsythe De Dietrichcase in that there was an attempt in that case to trace the investments which the defendant had encouraged the investors to provide to him but which he had not invested, so there was a proprietary and tracing claim in that case.

23. That being the case, the underlying basis for (a) the English Court of Appeal authorities cited in FSA v Forsythe De Dietrich, which was premised on a proprietary claim and on the use of funds which might belong to the plaintiff but were frozen or (b) as in the FSA v Forsythe De Dietrich case, the FSA’s role of protecting investors in such situation, is quite different.

24. Here, the SFC is seeking to seize assets of the 1^st and 2^nd defendants for the purpose of a just distribution to the current public shareholders and unlisted warrant holders.

25. But that is not the end of the matter.  Coming back to the Avant Garde Petroleum case, whilst O’Connor J said that the right test to apply is whether the defendant can show that the purpose for which he wishes to use the frozen assets, which is an ordinary business expense, is a proper use for which those or similar assets have been used by him in the ordinary course of trading. 

26. In short, the defendant has to show that the business trading expenses were ordinarily defrayed and obtained from those frozen accounts in the ordinary course of trading.  O’Connor J said that if that could be shown, such a purpose could then be regarded as a bona fide purpose “for the use of those assets”, ie, the frozen assets. 

27. It was on such basis that O’Connor J said further evidence of other assets that are available to the defendant need not be shown and it is a misuse of the Mareva injunction to require the party concerned to change his method of usual trading and to use other assets which are for different purposes to pay for ordinary trading.  It was on that basis that the disclosure of other assets was not required. 

28. But then, here, there is no evidence before me that the known frozen assets are the only accounts of the 1^st defendant in Hong Kong or, more significantly, that ordinary business expenses were usually defrayed from these frozen accounts.  The only evidence is that the 1^st defendant cannot withdraw funds from these known frozen accounts to make payment of ordinary business expenses, but there is no evidence that these expenses are, in O’Connor J’s words, a purpose for which those or similar assets have been used by the 1^st defendant in the course of their ordinary trading.

29. Indeed, I have no idea whether any or some of these expenses were paid out of these frozen accounts or whether there are other assets in Hong Kong, in PRC and elsewhere, in particular the PRC where the main operations are located.  The burden is on the 1^st defendant to demonstrate that the moneys should be so paid out of the known frozen accounts, and Mr Ho SC says that the evidence so far gives an incomplete picture, and therefore the application is premature.

30. On the above analysis, I agree with Mr Ho SC’s submissions in respect of the ongoing and recurring trading expenses, there is not enough information before the court to dictate an order be made that they should come out from those frozen accounts and from no other assets when the main operations from the 1^st defendant are in Mainland China.

31. For this, I need to refer to, perhaps, very briefly, the summary in the Hong Kong Civil Procedure 2014 Vol 1, para 29/1/79 at p 662.  It says that, in relation to a Mareva injunction: 

“ Assets are only released or accepted from a Mareva injunction (in so far as they are not in excess of the plaintiff’s claim) for a proper purpose. …… Where the defendant seeks the release of funds subject to a Mareva injunction to meet certain expenses, the court should consider whether the defendant has shown by sufficient evidence that (a) he does not have other assets available to meet those expenses; and (b) the purpose of the application is not an attempt to dissipate the assets to frustrate the plaintiff’s enforcement of the judgment. …… In considering whether the defendant has other assets available to meet expenses, the court is not limited to the funds to which the defendant has a strict legal right if there are reasonable grounds for believing that the defendant can obtain money elsewhere, including in appropriate cases, by lifting the corporate veil to take into account the resources of the defendant’s parent company.

……

……  Where the defendant has hidden away substantial assets overseas, it would be unjust to permit the defendant to use assets subject to a Mareva injunction to pay expenses. …… The court must seek to balance the risk of deliberate dissipation of frozen assets by the defendant against abuse of the freezing order to pressurise the defendant illegitimately. ……”

32. Here, there is simply not enough information before the court as to the payment of incurred and recurring expenses, where they are sourced and whether there are other available assets, whether in Hong Kong or overseas, to defray those expenses.  However, in coming to this conclusion, it of course does not prevent the 1^st defendant at any time to put in adequate evidence to defeat Mr Ho SC’s suggestion that it is premature to make any proper application.

33. Whilst the same principles ordinarily apply also to other legitimate expenses including legal expenses, and particularly expenses on a retainer or recurring basis, I need to consider whether, on balance, any interim measure is required in relation to legal expenses which are to be incurred essentially for dealing with this litigation and particularly the injunction and compliance with the disclosure order.

34. I bear in mind that this is not a recurring ordinary expense to be considered as I have discussed, but this concerns a matter which has suddenly befallen the 1^st defendant.

35. In all the circumstances, I am persuaded that the 1^st defendant should be allowed, as an interim measure, quick access to reasonable funds to deal with the matters on an interim basis, pending sufficient disclosure of the assets or particularisation of how funds are going to be available to be used by the company for the purpose of ordinary trading or general legal expenses on, perhaps, a medium-term consideration.

36. I bear in mind that this approach is what has been adopted at the ex parte stage when HK$100,000 was allowed for legal expenses. However, I have to re-consider such interim measure as more matters have come to light, and I have heard submissions from both parties, but noting that the disclosure of the 1^st defendant’s assets is still pending.

37. I also bear in mind that there is urgency in compiling an affidavit over the next few weeks for the purpose of making proper disclosure in compliance with the court order, and the 1^st defendant may well need to mount suitable application on sufficient evidence to deal with ordinary trading expenses, if they see fit.

38. In those circumstances, in dealing with such interim matters, I think quick access to funds is, on balance, reasonable.  I am told that legal expenses incurred to date is HK$485,850, which includes expenses in dealing with the SFC’s seizure of documents, and that recurring expenses on a monthly basis are about HK$700,000. 

39. Bearing in mind that I am dealing with this as an interim measure, particularly more for the purpose of compliance with the court order and to enable the 1^st defendant to mount an application for payment of ordinary trading expenses, if they see fit, and if they do have sufficient evidence for such purpose, I believe that viewed from such perspective, I am going to allow HK$500,000 for that purpose.

40. It may well be that, in due course, further application will be made and there may be a basis for granting more but, at this stage, I do not see sufficient basis for the reasons that I have given.