UDL HOLDINGS LTD AND ANOTHER v. LEUNG YUET KEUNG AND ANOTHER

HCA4409/2002

IN THE HIGH COURT OF THE

HONG KONG SPECIAL ADMINISTRATIVE REGION

COURT OF FIRST INSTANCE

ACTION NO. 4409 OF 2002

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J U D G M E N T

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1. This is an application for security for costs. The background leading to the present proceedings may be summarised as follows.

Background

2. The 1st plaintiff is a company incorporated in Bermuda and has since September 1991 been listed on the Hong Kong Stock Exchange. In February 2000, the 1st plaintiff proposed a scheme of arrangement under section 166 of the Companies Ordinance, Cap.32 involving each of the 1st plaintiff and 24 subsidiaries ("the Scheme"). The Scheme was sanctioned by the court on 18 April 2000 and became effective on 28 April 2000.

3. The 2nd plaintiff was at all material times a subsidiary of the 1st plaintiff. It is, however, not one of the 24 subsidiaries that participated in the Scheme. It was the registered owner of a trailing suction hopper dredger named "Kai Hong" whose port of Registry is in Hong Kong with an office number of HK-0103 ("Kai Hong").

4. The 1st defendant had been an executive director of the 1st plaintiff and a director of the 2nd plaintiff since June 1993 until about 18 January 2000 when he resigned. The 2nd defendant had been a non-executive director of the 1st plaintiff since December 1994 until he resigned in March 2000.

5. On 5 March 1997, a loan of HK$48,650,000 was granted by Nippon Credit Bank Limited ("Nippon Credit") to the 2nd plaintiff as borrower with the 1st plaintiff as guarantor. Kai Hong was pledged to Nippon Credit as security for the loan. In September 1997, the plaintiffs defaulted in repaying the loan. In the event, Nippon Credit commenced HCA314/1998 and obtained default judgment against them. On 13 November 1998, Kai Hong was ordered to be sold by open tender.

6. Shortly before the order for sale was made, two accidents happened and caused damage to Kai Hong. The first accident occurred on 4 April 1998 when a fire blazed out in the pump engine room of the vessel. The damage was subsequently repaired at the 2nd plaintiff's expense. The second accident occurred on 25 June 1998 when the port side main engine of the vessel was damaged. However, no remedial work had been carried out. It is the plaintiffs' case that the 2nd plaintiff proceeded to lodge insurance claims and the insurance benefits would amount to approximately US$1.1 million to US$1.5 million and that the 1st plaintiff, as the ultimate holding company of the 2nd plaintiff, was beneficially interested in the potential insurance claims, although the benefits of the insurance claims had already been assigned to Nippon Credit pursuant to a deed of covenant dated 7 March 1997.

7. On 21 January 1999, Kai Hong was sold to Healthy Wharf Limited ("HWL"), of which the defendants were shareholders and directors. HWL had put in the highest bid at HK$14,721,200 (about US$1.88 million). Kai Hong was then sold by HWL to Excelwise Enterprise Limited ("EEL") and was then sold to Success Team Limited ("STL"). Both EEL and STL were BVI companies beneficially owned by the defendants. Eventually on 23 April 1999, STL sold Kai Hong to Finagen SPA who brought as nominees for Dragonmar at US$3.1 million.

The plaintiffs' case

8. The plaintiffs allege that the defendants were aware of the outstanding insurance claims in respect of the loss damage caused to Kai Hong by the two accidents which would increase the value of the vessel provided that it was sold with the benefit of the insurance policies. This knowledge enabled the defendants (using their corporate vehicle HWL) to put in a high bid which included a condition that the policy be assigned to them. Substantially higher than any other bid, the defendants' bid was in the event successful.

9. The defendants admitted that they knew of the insurance claim before the bidding. The plaintiffs contended that it is clear from their evidence that before bidding they anticipated being able subsequently to sell Kai Hong for US$5 million after carrying out the necessary repairs. The 1st plaintiff, as the owner of the vessel, had suffered a loss to the extent that the sale was at an undervalue in the sum of US$1.5 million. Further the defendants are said to be liable to account to the 1st plaintiff for the secret and unauthorized profits made by them in the sum of US$1.2 million. They are trustees of the property and assets of the company, including confidential information and business opportunities.

10. The 1st defendant is similarly liable to the 2nd plaintiff, of which he was at the material times a director. Although the 2nd defendant was not a director of the 2nd plaintiff, he would still be liable for having assisted the 1st defendant in his breaches of fiduciary duties as a director of the 2nd plaintiff. The plaintiffs claimed for the said sum of US$1.5 million or damages to be assessed, an inquiry as to damages for breach of confidence and loss of profits of US$1.2 million and an account for all profits made by the defendants.

The defendants' case

11. The defendants denied liability. In essence, they denied any breach of duty or confidence. They alleged that it was Mr Leung Yat Tung, the then chairman of the 1st plaintiff, who on or about 28 December 1988 told the 1st defendant that Kai Hong was to be sold by public tender with a view that the latter should help to persuade the 2nd defendant to participate. Mr Leung suggested that the defendants could bid for the vessel against the propositions, inter alia, that should they be successful in acquiring Kai Hong, Mr Leung would take the vessel from the defendants and help to procure the necessary repair and refurbishment work to bring it to an operational condition; and that once Kai Hong had been returned to operational condition, it would then be chartered to Mr Leung at such rates as to give the defendants a good return on their investment. The defendants alleged that Mr Leung had misrepresented them on the value of the insurance claims. He said the claims would be worth approximately US$1.6 million. The defendants acted on the misrepresentation and put in the bid via HWL. In the event, they had suffered a loss of profit in the region of HK$2.1 million.

Application for security for costs

12. Insofar as the 1st plaintiff is concerned, the defendants are relying on Order 23, rule 1(1)(b) of the Rules of the High Court. The relevant part of the rule provides :

" (1) Where, on the application of a defendant to an action or other proceedings in the Court of First Instance, it appears to the Court-

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(b) that the plaintiff (not being a plaintiff who is suing in a representative capacity) is a nominal plaintiff who is suing for the benefit of some other person and that there is reason to believe that he will be unable to pay the costs of the defendant if ordered to do so, or

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then if, having regard to all the circumstances of the case, the Court thinks it just to do so, it may order the plaintiff to give such security for the defendant's costs of the action or other proceedings as it thinks just."

13. Two criteria have to be met under Order 23, rule 1(1)(b) :

(1) the 1st plaintiff is a nominal plaintiff suing for the benefit of some other person; and

(2) there is reason to believe that 1st plaintiff will be unable to pay the costs of the defendants.

I will deal with them in turn.

Is the 1st plaintiff a nominal plaintiff?

14. Under Clause 19 of the Scheme, as soon as the 1st plaintiff receives any recoveries of their "Accounts Receivables" (other than inter-company debts... and the accounts receivables referred to in Clause 20) they shall remit and transfer such recoveries after deduction of all expenses incurred including all legal expenses to the Scheme Account and the Scheme Administrator shall be responsible for distributing such recoveries which constitute part of the Scheme Funds available for distribution to the Scheme Creditors under the Scheme. The term "Accounts Receivables" is defined to mean in essence all accounts receivables of the 1st plaintiff as at the effective date of the Scheme other than certain exceptions which do not apply here.

15. Mr Ip, appearing for the defendants, submitted that given the wide definition of "Accounts Receivables" in the Scheme and the fact that all matters complained of by the plaintiffs occurred prior to the effective date, any money received by the 1st plaintiff from the defendants, should they be held to be liable, must from part of all the accounts receivables of the 1st plaintiff as at the effective date. The 1st plaintiff is thus obliged to pay the money so recovered to the Scheme Account for distribution to the Scheme Creditors.

16. Mr Smith, SC, appearing for the plaintiffs, disagreed. He submitted that the Scheme does not really define "Accounts Receivables", except for the purpose of excluding inter-company debts and receivables charged by way of security to certain financial creditors. In the absence of a specific definition for the purposes of the Scheme, they must be given their ordinary dictionary meaning, that is to say, debts : see Black's Law Dictionary (7th ed.) at p.17. The plaintiffs' claim is not in the nature of a debt and therefore does not fall within the meaning of "Account Receivables". Counsel further submitted that the 1st plaintiff is in any event not suing on behalf of the Scheme. In this connection, he relied on Clause 13 of the Explanatory Statement to the Scheme. An identical clause can be found at Clause 21(a)(i) of the Scheme. Under that clause, the 1st plaintiff undertook to the Trustee for the benefit of the Scheme Creditors that it would provide a maximum of HK$2 million revolving fund during the term of the Scheme to finance all the costs of recovering the Accounts Receivables. According to Mrs Irene Leung Yu Oi Ling, wife of Mr Leung Yat Tung and a director of the plaintiffs, the 1st plaintiff is funding all the costs of the present proceedings : see paragraph 4 of her 2nd affirmation filed on 11 June 2003.

17. In my view, the term "Accounts Receivables" has to be understood in the context of the entire Scheme. (The definition clause, being exclusionary in nature, probably does not add much to its meaning.) Under the Scheme, the 1st plaintiff and the participating subsidiaries transferred to a new company all their "Unencumbered Assets" as defined, excluding "Accounts Receivables". This new company held the assets for the purpose of their realisation and distribution in accordance with the Scheme. "Accounts Receivables" were dealt with under Clauses 19 to 21 of the Scheme. Briefly, as soon as the 1st plaintiff and the participating subsidiaries received any recoveries of their "Accounts Receivables", they shall remit and transfer such recoveries to the Scheme Account for distribution. Legal proceedings for recovery are clearly contemplated. Further, under Clause 20(e), it was envisaged that accounts receivables might involve claims which were subject to arbitration proceedings. In my view, "Accounts Receivables" are not confined to debts. If that were the intention of the parties, there is no reason why the term "debts" is not used, as is the case in other clauses. When properly understood in the entire context, the term "Accounts Receivables", in my view, includes monetary claims in legal or arbitral proceedings so long as the cause of action accrued at or before the effective date.

18. The 1st plaintiff's claims are monetary in nature. The matters complained of and hence the causes of action all occurred before the effective date of the Scheme. Accordingly, any recovery by the 1st plaintiff in this action from the defendants has to be transmitted to the Scheme Account for distribution. The 1st plaintiff is thus a nominal plaintiff suing for the benefit of the Scheme Creditors. Mrs Irene Leung's assertion that the 1st plaintiff is not using the Revolving Funds to fund the present action is neither here nor there. Even if true, it does not alter the 1st plaintiff's status as a nominal plaintiff.

19. I next turn to the second criterion, namely, whether there is reason to believe that the 1st plaintiff will be unable to pay the defendants' costs.

Is the 1st plaintiff impecunious?

20. Mr Smith contended that the evidence does not show that the 1st plaintiff will be unable to pay the costs of the defendants if they are successful in their defence. On the contrary, the evidence shows that the 1st plaintiff has the resources to pay such costs if ordered to do so. In gist, the evidence relied on by the plaintiff shows that a right issue was successfully completed in December 2002 and thereby raised HK$6.6 million in working capital; that the interim report for the six months ended 31 January 2003 shows that the 1st plaintiff made a net profit of HK$3,426,000; that since the preparation of the said interim report, there have been further positive developments including the settlement of certain litigation and the removal of certain vessels from the threat of foreclosure; and that the unaudited net asset value of the 1st plaintiff is now HK$16,987,000.

21. The above, however, does not represent the full picture of the 1st plaintiff's financial position. As at 31 July 2002, the 1st plaintiff had a net liability of HK$8,030,000 : see the audited balance sheet which formed part of its annual report for 2002 exhibited as "ITK-2" to the affirmation of Mr Ip Tak Keung filed on 27 March 2003 in support of the present application. The performance of the 1st plaintiff's group of companies for the same period of time was equally bad, if not worse. In the chairman's statement in the said annual report, it is stated that "for the year ended 31 July 2002, the 1st plaintiff's group of companies recorded a net loss of HK$76 million, comprising HK$65 million as a result of relatively high operating gearing and low turnover, provisions of HK$26 million for the impairment in value of vessels as to reflect their reduced in-use value estimates down to net selling price and provisions of HK$22 million for the problematic in-dispute receivables." The Group had net current liabilities of HK$128,458,000 and net liabilities of HK$51,966,000. The above figures were prepared on a going concern. However, the auditors of the 1st plaintiff made a disclaimer of opinion in these terms : "Because of the fundamental uncertainties relating to the going concern basis, we are unable to form an opinion as to whether the financial statements give a true and fair view of the state of affairs of [the 1st plaintiff] and of the Group as at 31 July 2002 or of the loss of the Group for the year then ended."

22. The working capital of HK$6.6 million raised by the rights issue in December 2002 did not improve the 1st plaintiff's position. Even assuming that the working capital was not spent, it would only reduce the 1st plaintiff's net liabilities from HK$8,030,000 to HK$1,430,000. Further, despite the rights issue, as shown in the condensed consolidated cashflow statement in the unaudited interim results for the six months ended 31 January 2003 (exhibit "LYOL-5" to Mrs Leung's affirmation filed on 9 May 2003), the cash and equivalents at the beginning of the period in the sum of HK$3,626,000 was reduced to a negative balance of HK$43,000 at the end of the period. There had been a further diminution in turnover to HK$13,480,000.00 producing a gross profit of merely $112,000 for the six-month period ending 31 January 2003. The Group had the net decrease in cash and cash equivalents of HK$3,669,000 in the period in question despite the injection of working capital by the said rights issue in December 2002.

23. As noted, the gross profits for the above period was a mere HK$112,000. However, the 1st plaintiff reported a net profit of HK$3,426,000 for the Group in the six-month period ended 31 January 2003 in the unaudited interim results. However, no explanation was given for the tremendous increase of 'Other revenue' from HK$910,000 in the six-month period ended 31 January 2002 to HK$25,207,000 in the six-month period ended 31 January 2003 although it would appear that the so-called revenue was primarily a paper exercise with reversal of impairment losses of HK$15,659,000 and overprovision of rental expenses. Even with such revaluation, the Group remained to have net liabilities of HK$21,169,000.

24. A sum of HK$2 million and HK$4.5 million had been recovered in HCA9544/2001 and HCA4545/2001 by the 1st plaintiff's related companies. But they had to be paid into accounts designated by the secured creditors, presumably for repayment of secured loans owed by those related companies. Accordingly, those recoveries do not improve the cashflow of the Group and even taking them into account, the net liabilities of the Group stood at HK$14,669,000. The sum of HK$5.6 million recovered by another related company in the settlement of HCA5307/2001 did not improve the overall position either.

25. Mrs Leung asserted in paragraph 7 of her 2nd affirmation that she was advised by the 1st plaintiff's Financial Controller that by virtue of the settlement of litigation and the winding-up order made against Universal Dockyard Limited ("UDL") on 9 June 2003, they resulted in a net asset value of the Group in a positive figure of HK$16,987,000. Mrs Leung did not go into detail as to how this unnamed Financial Controller came to his advice. Further, such advice is inconsistent with the following statement made at p.27 of the 1st plaintiff's Annual Report 2002 :

"Save for the estimated litigation costs and expenses amounting to approximately HK$200,000, the Directors are of the view that the legal proceeding concerning [UDL] will not have any material impact on the Group and the Shareholders."

According to this statement, the winding up order made against UDL resulted in a likely loss of litigation costs and expenses estimated at HK$200,000 and not any increase in net asset value. Mrs Leung has not offered any explanation on the discrepancy.

26. The test is if there is reason to believe that the 1st plaintiff will be unable to pay the costs of the defendants if they are successful. Having carefully considered all the evidence before me concerning the 1st plaintiff's financial strength, I am so satisfied. The 1st plaintiff's assertion that it is financially capable of paying the defendants' costs if so ordered is not borne out by the evidence summarized in paragraphs 21 to 25 above. This brings me to consider whether in all the circumstances, security for costs should be ordered against the 1st plaintiff.

Whether to order security against the 1st plaintiff

27. The principles governing how the court should exercise its discretion when considering an application for security are well settled. In short :

(1) The court has a complete discretion whether to order security, and accordingly it will act in the light of all the relevant circumstances.

(2) The possibility or probability that the plaintiff company will be deterred from pursuing its claim by an order for security is not without more a sufficient reason for not ordering security.

(3) The court must carry out a balancing exercise. On the one hand it must weigh the injustice to the plaintiff if prevented from pursuing a proper claim by an order for security. Against that, it must weigh the injustice to the defendant if no security is ordered and the defendant finds himself unable to recover costs from the plaintiff in due course.

(4) In considering all the circumstances, the court will have regard to the plaintiff company's prospects of success. But it should not go into the merits in detail unless it can clearly be demonstrated that there is a high degree of probability of success or failure.

(5) The court may order any amount up to the full amount claimed by way of security, provided that it is more than a simple nominal sum; it is not bound to order a substantial amount.

(6) Before refusing to order security on the ground that it would unfairly stifle a valid claim, the court must be satisfied that, in all the circumstances, it is probable that the claim would be stifled. There may be cases where this can properly be inferred without direct evidence. The court should consider not only whether the plaintiff company can provide security out of its own resources to continue the litigation, but also whether it can raise the amount needed from its directors, shareholders or other backers or interested parties. It is for the plaintiff to satisfy the court that it would be prevented by an order for security from continuing the litigation.

See Wing Hing Provision v. Hanjin Shipping [1998] 4 HKC 461, per Godfrey JA at p.464. With these general principles in mind, I turn to consider whether I should order security against the 1st plaintiff.

28. Submissions have been made on the merits of the parties' respective case. But I do not think I need to go into the merits in detail for neither party can demonstrate that there is a high degree of probability of success or failure. The 1st plaintiff is not contending that its claims will be stifled if security for costs is to be ordered. In fact, they maintained that they are able to pay the defendants' costs if so ordered. Having considered all the circumstances, it is in my view an appropriate case to order security for costs against the 1st plaintiff. I will come to the question of quantum in a moment. I will turn to the 2nd plaintiff's position first.

Whether to order security for costs against the 2nd plaintiff

29. Section 357 of the Companies Ordinance, which applies to the 2nd plaintiff, provides that the court may order security for costs where it appears by credible testimony that there is reason to believe that the company will be unable to pay the defendant's costs if successful in his defence. Mr Smith did not seriously dispute that the 2nd plaintiff is impecunious within the meaning of the section. However, he contended that there was a complete overlap of claims advanced by the plaintiffs. Security for costs should not be ordered against the 2nd plaintiff : John Bishop (Caterers) Ltd and another v. National Union Bank Ltd and others [1973] 1 All ER 707; Hong Kong Civil Procedure 2002, Vol.1, para.23/3/5, at p.381. Should the court find that there is only a partial overlap of claims, the 1st plaintiff undertakes to pay any costs ordered against the 2nd plaintiff which would not otherwise be payable by the 1st plaintiff.

30. It remains a matter of discretion whether to order security for costs in a co-plaintiffs scenario. As a general rule, security for costs should not be ordered if one of the plaintiffs is able pay the defendant's costs or has assets within the jurisdiction to meet any adverse costs order. Mr Smith's submissions primarily rest upon the assertion that the 1st plaintiff will be able to pay for the 2nd plaintiff the defendants' costs if so ordered. However, as I have already ruled, there is reason to believe that the 1st plaintiff itself will be unable to pay the defendants' costs if so ordered. The 2nd plaintiff cannot in the circumstances rely on the 1st plaintiff's alleged ability to pay the defendants' costs in order to avoid the application of section 357.

31. I will therefore order security for costs against the 2nd plaintiff as well.

Quantum

32. I now come to the quantum of security. I have carefully considered the skeleton bill of costs put forward by the defendants and the parties' submissions. The costs incurred prior to this application which are in the region of HK$110,000 are not in dispute. The bulk of the security for costs relates to the costs for this application, the costs for the preparation of the trial and the trial itself. In my view, it is premature to order security for costs for the entire action. I will only order security up to the stage of completion of discovery and preparation of witness statements. And a sum of HK$450,000 is reasonable in the circumstances.

Conclusion

33. For the above reasons, I will order that the plaintiffs do give security for the defendants' costs by paying into court the sum of HK$450,000 within 14 days from today, and that all further proceedings be stayed until the security is given. I will also make an order nisi that the defendants shall have the costs of this application in any event, to be taxed if not agreed.