A-ONE BUSINESS LTD v. CHAU CHAM WONG PATRICK AND ANOTHER

HCA1868/2008

IN THE HIGH COURT OF THE

HONG KONG SPECIAL ADMINISTRATIVE REGION

COURT OF FIRST INSTANCE

ACTION NO. 1868 OF 2008

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    RULING ON PRELIMINARY ISSUE

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1.  In the light of the recent decision of the Court of Appeal in Pacific Electric Wire & Cable Company Limited v. Harmutty Limited and Ors [2009] 3 HKLRD 94, the parties proceeded very sensibly by way of arguing a preliminary issue before me, namely, whether the plaintiff’s claims were based on underlying allegations of fraud and, if so, whether the plaintiff was prevented from applying for summary judgment by reason of Order 14 rule 1(2)(b) which provides :

“(2)    Subject to paragraph (3) this rule applies to every action begun by writ other than

…

(b)   an action which includes a claim by the plaintiff based on an allegation of fraud,”

2.  As Rogers VP explained in the Pacific Electric Wire & Cable Company Limited case, there are two aspects of the exclusionary rule.  The first is that an application for summary judgment under Order 14 will not lie in a case comprising a number of claims, some of which are based on allegations of fraud whilst other claims are not.  That must follow from the wording of sub-rule 2(b) which refers to an action which “includes” a claim based on an allegation of fraud.  There was no dispute about this aspect of the rule and the submissions before me concentrated on the second aspect of the rule, expressed in these terms by Rogers VP :

“Secondly, the rule is not confined to excluding actions in which one of the claims is a claim for damages for fraud, what is excluded is any action where there is a claim in respect of which the underlying allegations on which the claim is based constitute an allegation of fraud.”

3.  Before addressing the submissions of the parties, I set out, as briefly as possible, the background of this case.  I do so by, firstly, introducing the relevant parties.

4.  A-One Investments Limited (“A-One Investments”) is a company incorporated in the British Virgin Islands (“BVI”) and is owned 50.45% by Patrick Cham Wong Chau, the 1^st defendant (“Chau”), and 49.55% by Leung Yung, the 2^nd defendant (“Leung”).  It is the controlling shareholder of Peace Mark Holdings Limited.

5.  A-One Business Limited, the plaintiff (“A-One Business”), is also incorporated in the BVI and is a wholly owned subsidiary of A-One Investments.

6.  Peace Mark Holdings Limited (“Peace Mark Holdings”) is a company listed on the Stock Exchange of Hong Kong since 1993.  Trading in its shares was suspended on 18 August 2008 and provisional liquidators appointed on 10 September 2008.

7.  Peace Mark Limited is a wholly owned subsidiary of Peak Mark Holdings.  Provisional liquidators were also appointed on 10 September 2008 for Peak Mark Limited.

8.  SFT Holdings de Finance et de Technologie (“SFT”) is a company incorporated in Switzerland and, prior to the Sale and Purchase Agreement dated 12 August 2008 (“SFT Agreement”), was owned 65% by A-One Business and 35% by Festina Lotus SA (“Festina”), a company incorporated in Spain.

9.  A-One Business was able to acquire a 65% interest in SFT because of an advance made by ABN AMRO Bank Limited (“ABN”) of HK$200,000,000, in September 2007, to A-One Investments for that purpose.  A-One Business was the special purpose vehicle used by A-One Investments to make the acquisition.  Other than its shareholding in A-One Business, the only other asset of A-One Investments was its substantial holding of shares in Peace Mark Holdings, large amounts of which were charged as security to ABN.  Later, in February 2008, the loan advanced from ABN was converted into lending under Zero Coupon Secured Exchangeable Bonds (“the Bonds”) due in 2013 and exchangeable for shares of Peace Mark Holdings which were issued by A-One Investments pursuant to a Subscription Agreement dated 29 January 2008.  DB Trustees (Hong Kong) Limited (“DB Trustees”) was the trustee and security trustee appointed under the Bonds.

10.  In addition to owning A-One Investments, Chau and Leung were directors of A-One Investments and A-One Business.  Chau was the Chairman of Peace Mark Holdings and Leung was the Chief Executive of Peace Mark Holdings.

11.  The events leading to the present proceedings started around May 2008 when there was a rapid decline in the value of the listed shares of Peace Mark Holdings.  This posed a problem to A-One Investments because of its obligations, under the Bonds, to top up cash into a Cash Account if the value of the shares in Peace Mark Holdings fell below a certain level.

12.  The following account of the events is taken from the written submissions of Ms Linda Chan, counsel for the plaintiff :

“11.   There is very little dispute on the facts – the essence of A-One Business’s complaint brought by the Provisional Liquidators (‘PLs’) is that Chau has wrongfully diverted HK$138,000,000 – the proceeds of the sale of SFT and asset of A-One Business.  The circumstances that led to the unlawful transfer was that beginning around May 2008 the value of Peace Mark shares which secured the Bonds began to rapidly decline.  This triggered margin calls of substantial cash sums payable by A-One Investments to ABN – by 21.08.08 HK$165,000,000 was outstanding.

12. In an endeavour to raise cash to meet margin calls, Chau took urgent and desperate steps by (i) arranging personal borrowing – in this case from DBS and (ii) to sell A-One Business’s interests in SFT (the Peace Mark shares – could not readily be sold in the market).  Chau obtained personal loans from DBS Bank (Hong Kong) Limited (“DBS”) in breach of the Conditions of the Bonds, and on 12.08.08 “fire-saled” A-One Business’s only asset – SFT – an asset acquired by A-One Business using the loans provided by ABN.

13. As the fortunes of Peace Mark Holdings spiralled downward, A-One, Business was due to receive the proceeds of the SFT sale.  However, Chau was facing demands from DBS to repay his personal loan and on 25.08.08, Chau diverted the 1^st and 2^nd tranches of the proceeds of the sale of SFT – from the accounts of A-One Business to his personal account with DBS Bank (some HK$138 million), which DBS immediately took to pay down Chau’s indebtedness.

14. The ‘contemporaneous’ documentation available to the PLs (likely to have been created after the PL’s appointment) strongly suggests this payment to Chau had nil corporate benefit to A-One Business (or A-One Investments) and was later dressed up as a shareholder’s dividend, to which, in any event, Chau had no entitlement – the only shareholder of P’s being A-One Investments.

15. Restitution and repayment of the misappropriated sum is sought on a summary basis, Chau and Leung (who condoned in Chau’s act) having no arguable defence.”

13.  The key transactions, the subject of these proceedings, can be further explained as follows.

14.  On 9 May 2008, DBS granted a facility of HK$300,000,000 to Chau personally.  That facility was secured by a charge on cash deposits, all monies mortgage over stocks, shares and other securities, which was executed by A-One Investments in favour of DBS on 13 May 2008.  Subsequently, on 19 August 2008, Chau on behalf of A-One Business executed a Mortgage, Charge and Guarantee in favour of DBS, also as security for Chau’s personal loan of HK$300 million.

15.  On 14 May 2008, Chau drew down on the DBS facility and paid the proceeds into A-One Investment’s HSBC account.  On the same day, two cheques in an almost equivalent sum of close to HK$300 million were drawn from A-One Investment’s HSBC account in favour of Peace Mark Limited.

16.  On 12 August 2008, the SFT Agreement was entered into whereby A-One Business agreed to sell its 65% equity interest in SFT to Festina for CHF27,000,000, to be paid in 3 instalments on 15 August 2008, 22 August 2008 and 30 September 2008.

17.  On 18 August 2008, trading in Peace Mark Holdings shares was suspended and on 21 August 2008, A-One Investments defaulted on the Bonds by failing to deposit the balance of HK$165 million as top-up cash as required under the Bonds.

18.  On 25 August 2008, the sum of nearly CHF 20 million, being the 1^st and 2^nd instalments under the SFT Agreement, was remitted by Festina into A-One Business’s bank account in DBS.  This was converted to a sum of just short of HK$142 million and transferred into Chau’s DBS account as repayment of the DBS facility.

19.  On the face of it, there was no reason for A-One Business to pay the proceeds of the SFT Agreement to Chau.  The suggestion that the payment was in fact a payment of dividend to A-One Investments, and which A-One Investments directed A-One Business to pay over to Chau, came out later as explained by Ms Linda Chan in her written submissions as follows :

“103. The circumstances in which Chau and Leung disclosed the existence of the alleged loan, the so called ‘dividend payment’ and the fortuitous timing in which these materialised, strongly suggest they were recent fabrications in an attempt to give legitimacy to an unlawful diversion of the Company’s funds.

104.   There was no reference whatsoever at the 2 October Meeting by Chau, Leung or M/s. Gallant YT Ho (which were at all times legal advisers of Chau, Leung, Peace Mark Holdings and the Group) that (a) Chau had issued any demand letter to A-One, whether on 11.08.08 or not, (b) A-One Business had declared a dividend of CHF19,999,993 on 25.08.08 to A-One and authorized direct payment of the same sum to Chau.

105.   It was only in Chau 2^nd filed on 03.11.08 that Chau produced, for the first time, a number of documents to justify the misappropriation of CHF19,999,993 on the ground that it was paid by A-One Business to A-One as ‘dividend’ and paid to him directly as repayment of an alleged loan of $300 million.

106.   The documents produced include :-

(1)   A Facility Letter dated 09.05.08 whereby DBS granted a revolving term loan of $300 million to Chau.

(2)   An undated document purporting to be an extract of the minutes of A-One Investments (certified by Chau) whereby A-One Investments agreed to pledge its shares in Peace Mark Holdings as security for the $300 million loan granted by DBS to Chau.

(3)   Drawdown notice and remittance advice both dated 14.05.08 showing $299,999,850 (being $300 million less bank charge) was drawn down by Chau and paid directly to A-One Investments’ HSBC account.

(4)   Emails from DBS to Chau requesting Chau to meet margin calls under the Facility Letter.

(5)   A Schedule and cheques showing that between 03.07.08 and 25.08.08, Chau repaid an aggregate sum of $238,083,254.03 to DBS.  Among this sum, $5.5 million was paid by Chau, $90,608,713 was paid by A-One Investments and $141,974,541.03 (or CHF19,999,995) was paid by A-One Business.

(6)   A letter dated 11.08.08 purporting to be a demand letter issued by Chau to A-One Investments for repayment of $300 million owed by A-One Investments.

(7)   Remittance advices dated 25.08.08 showing CHF19,999,993 was received by A-One Business from Festina.

(8)   A purported minutes showing A-One Business declared a dividend of CHF19,999,993 to be paid to Chau “directly in settlement of the loan for [A-One Investments] demanded by [Chau]”.

20.  Obviously, a defence which is fraudulent in the sense that it relies on documents fabricated after the event is not a ground for invoking the exclusionary rule in Order 14 rule 1(2)(b).  I have to ask myself whether the plaintiff’s claim is itself based on allegations of fraud and only if the answer is in the affirmative, can I invoke the exclusionary rule in this case.

21.  Before examining the averments in the Amended Statement of Claim, it is instructive to return to the decision in Pacific Electric Wire & Cable Company Limited and to have regard to the prevailing practice prior to that decision.

22.  The editors of Hong Kong Civil Procedure 2009 stated at marginal note 14/1/1 :

“The exclusion should be construed narrowly and is confined to an action based on fraud strictly defined in Derry v. Peek (1889) 14 App. Cas. 337 – it does not include an action based on fraud on a minority : Tan Eng Guan & Another v. Southland Co. Ltd. & Others [1996] 2 HKLR 117, CA (on this point, overruling Skink Ltd. (in liq.) v. Comtowell Ltd. [1994] 2 HKLR 26 (Kaplan J.) and Peninsula Fur Trading Ltd. v. George Chen Dah Sing, unreported, HCA No.3550 of 1987, March 14, 1988, Barnett J.); nor does it include an action based on a resulting or constructive trust or for money had and received, even though fraud may have been the means by which the funds claimed came to be used : Pacific Electric Wire & Cable Co. Ltd. v. Texan Management Ltd. [2007] 2 HKLRD 261 (Saunders J.).”

23.  That statement of practice was obviously based on the judgment of Godfrey JA in Tan Eng Guan & Another v. Southland Co. Ltd & Others :

“(2)    The ‘fraud’ point

The procedure for summary judgment is not available in ‘an action which includes a claim by the plaintiff based on an allegation of fraud’ : see O.14 r.1(2)(b) of the Rules of the Supreme Court.  The comparable exclusionary rule in England and Wales was abrogated on 1 June 1992; but, as pointed out at 14/1/1 of the Supreme Court Practice 1993 :

‘Notwithstanding this change it is anticipated that judgment under this order will only be granted when, if it is necessary to rely on fraud as the sole cause of action, the evidence of fraud is overwhelmingly clear.’  

It had been held in England and Wales that the exclusion was directed at and confined to actions based on a claim founded on fraud as strictly defined in Derry v. Peek (1889) 14 App. Cas. 337, namely, a false representation made knowingly without belief in its truth.  But it was difficult to perceive any justification for requiring a plaintiff to prove, at trial, a claim based on Derry v. Peek fraud, alone of forms of dishonesty, and, if the rules were to be reformed, the choice was either (a) to exclude from the scope of O.14 any claim based on anyform of dishonesty; or (b) to remove the exclusion altogether.  In England and Wales, the latter course was chosen.  However this may be, it was pointed out to us that, inHong Kong, the narrow construction of the exclusionary rule adopted in England had not been followed by Barnett, J. in Peninsula Fur Trading Ltd v. George Chen, HCA 3550/1987, 14 March 1988, unreported; nor by Kaplan, J., in Skink Ltd v. Comtowell Ltd [1994] 2 HKLR 26.  In both of these cases, it was decided at first instance that, for the purposes of the local O.14 r.1(2)(b), allegations of dishonesty were to be equated withallegations of fraud.  In the latter case, Kaplan, J. said (at p.37) :

‘As there will be no further jurisprudence on the subject from England in the light of the abrogation of this rule, it may be helpful if at some stage there was guidance from the Court of Appeal as to whether my approach and that of Barnett, J. is correct in the circumstances of Hong Kong.’

I think we should take this opportunity to give the guidance which Kaplan, J. invites.  For my part, I would hold that the approach of Barnett, and Kaplan, JJ. was not correct.  We are here concerned with the construction of words in our local rules identical with those (originally) contained in the rules in force in England and Wales, and authoritatively construed by the Court of Appeal there.  I think it unwarranted, and undesirable, for such identical procedural rules to be construed in different ways in, on the one hand, England and Wales, and on the other hand, Hong Kong.  There is no difference in the subject matter, or local conditions, which would warrant any such distinction.  What ought to be considered here is whether we should go down the path taken in England and Wales, and remove the (narrowly construed) exclusion altogether, or whether we should enlarge the scope of the exclusion, so as to preclude the use of O.14 in all cases of dishonesty as well as fraud strictly so-called.  Upon this question, which is one of policy, I express no opinion.  While the exclusion in question remains in force in Hong Kong, I would construe it narrowly, in accordance with the English authorities.  It follows that, since the present case is not one in which the claim of the plaintiffs is a claim for damages for fraud, it is not caught by the exclusion.  The fact that the expression ‘fraud on a minority’ is the expression commonly used to describe the circumstances in which the court will entertain a derivative action does not make such an action an action founded on fraud strictly so-called.  Accordingly, I would reject this ground of objection to the judge’s order.”

These observations were clearly obiter, as the Court of Appeal allowed the defendants’ appeal and dismissed the Order 14 applications against them, notwithstanding that they failed in their submission that the exclusionary rule applied.

24.  The plaintiff was clearly justified in bringing this Order 14 application, having regard to the prevailing practice at the time the application was issued.  However, the effect of the recent Court of Appeal judgment is to reverse that practice and to exclude, from Order 14 applications, any claim containing an underlying allegation which constitutes an allegation of fraud.  As is clear from the following passages in his Judgment, Rogers VP, with whom Le Pichon JA agreed, disagreed with Godfrey JA and his narrow construction of the exclusionary rule in Pacific Electric Wire & Cable Company Limited :

“30.   The application of Order 14 r. 1(2)(b) in this case was considered by the judge below as a preliminary matter in the hearing for summary judgment.  In the reasons for ruling handed down on 2 April 2007 the judge said at paragraphs 19-21 :

‘19. The causes of action upon which Mr Neoh relies to seek summary judgment do not include a cause of action based on an allegation of fraud.  Three causes of action are pursued in the summary judgment applications against the various defendants who are to be subjected to that procedure.  They are first, allegations based upon a resulting trust, second, allegations based upon a constructive trust, and third, a claim based upon money had and received.

20.  Mr Neoh’s argument, which I accepted, was that in relation to each of those three causes of action, while a fraud was the means by which the funds were transferred out of PEWC, and were concealed from PEWC, it is not necessary for the plaintiff to establish the fraud to establish the cause of action.  It is sufficient, Mr Neoh says, if he can demonstrate simple that PEWC’s funds were used for the acquisition of the property.  The particular means by which the funds came to be used in that way, while interesting and illustrative, do not constitute an essential step in the causes of action.  The crucial element is not how the funds came to be used, but that PEWC’s funds were used to acquire the property.

21.  I was satisfied that in order to find liability upon the causes of action upon which Mr Neoh relies, a finding of fraud, in the classic sense, is not required.  That said, I record that Mr Neoh appreciates the heavy burden upon him having regard to the requirement of knowledge involved in establishing a constructive trust.’

31. In my view, consideration not only of the skeleton argument put forward on behalf of the plaintiff but, importantly, also of the judgment of 18 January demonstrates quite clearly that, although the claims made in the case may be framed in respect of constructive trust, resulting trust and money had and received, the claims in the action are based on allegations of fraud that include deliberate dishonesty.  As is pointed out in Bullen & Leake & Jacob’s Precedents of Pleadings 16^th edition page 841, an action in fraud will usually include one or more of a number of distinct causes of action amongst which are listed ‘money had and received’ and ‘constructive trusts : knowing receipt and dishonest assistance’.  Furthermore, as Mr Whitehead SC, who appeared for Mr Hu, pointed out, in paragraphs 18-07 and 18-08 of Clerk & Lindsell on Torts 19^th Edition and the third supplement thereto, it is made quite clear that active non-verbal conduct can amount to deceit.  In this case, the allegations of the concealment of facts from the plaintiff when there was a duty to disclose, and the connivance at the preparation of false financial statements and accounts would be clear allegations of fraud.

32.    In my view, it is no answer to the challenge in this case that the provisions of Order 14 r. 1(2)(b) exclude this action, to say that the plaintiff can proceed on one or other or all of the three causes of action, namely resulting trust, constructive trust and money had and received, for the simple reason that the necessary allegations which are made by the plaintiff include allegations of fraud. 

33.    Mr Neoh SC, who appeared on behalf of the plaintiff, sought to rely on a statement of Godfrey JA in the case of Tan Eng Guan And Another v Southland Co Ltd and other [1996] 2 HKLRD 117 when he said that he considered that the approach of Barnett J and Kaplan J had been incorrect.  He went on to say that the approach of the English courts should be followed.  Quite apart from the fact that Nazareth VP said that he would prefer not to express any view on the matter of the construction of Order 14 r. 1(2)(b) and to reserve that for future argument and that he thought the point had not been sufficiently addressed in argument, it is not entirely clear what aspect Godfrey JA was referring to.

34.    The Southland case involved an allegation of fraud on the minority.  That is a very different form of claim to an action for deceit.  If Godfrey JA was simply saying that fraud on the minority was not encompassed by the word ‘fraud’ in Order 14 r. 1(2)(b), then I have no difficulty whatsoever in agreeing with him.  If, however, he was attempting to say that despite the fact that claims in an action were based on allegations of fraud which encompassed deliberate dishonesty, Order 14 r. 1(2)(b) did not apply to other claims in the action, then I consider he was clearly wrong.  I would add that Godfrey JA had been in the court in the appeal from the decision of Kaplan J in the Skink case but had decided the appeal on the basis that the facts showed an arguable defence.”

25.  There is no doubt that I am bound by the Court of Appeal decision in Pacific Electric Wire & Cable Company Limited. Accordingly, I have to determine whether or not the plaintiff’s claims contained any underlying allegations which constituted an allegation of fraud.

26.  Ms Linda Chan submitted that the plaintiff’s claim in this case did not contain any underlying allegations of fraud.  She asserted that the plaintiff could have made an allegation of fraud in this case but did not do so and that there was no difference in substance between the claim for misappropriation of assets in this case and the claim for fraud on a minority in Tan Eng Guan v Southland Co. Ltd.  Indeed, she made the cogent submission that a fraud on a minority by the misappropriation of assets was not different, in substance, from a fraud on the majority or single shareholder by the same misappropriation of assets.  Be that as it may, it is not for me to gainsay the judgment of the Court of Appeal.  The present case is not a fraud on a minority and cannot be exempted from the exclusionary rule on that ground.

27.  Ms Linda Chan also submitted that the plaintiff’s claims were akin to the claims made in Bishopsgate Investment Management v. Maxwell [1993] BCC 120 where the plaintiffs succeeded in obtaining Order 14 judgment.  However, as submitted by Mr Alexander Wong on behalf of the defendants, a challenge on jurisdiction was not made in that case and for good reason, the narrow construction had been given to the exclusionary rule in England and there was no Derry v. Peek claim for damages for fraud in that case.  I agree with Mr Alexander Wong and I do not find that the Bishopsgate case helps me in any way.

28.  I must turn to the pleaded case to determine whether or not the plaintiff’s claims contained any underlying allegations which constituted an allegation of fraud.  The plaintiff avers in §§16 and 17 of the Amended Statement of Claim as follows :

“16.   Wrongfully and in breach of their duties and their duty as trustees of A-1 Business, on 25 August 2008, Chau and Leung procured or caused A-1 Business to transfer the entire sum of CHF 19,999,993 from A-1 Business’ Account to Chau’s personal account at DBS, no.8380780280 (‘Chau’s Account’), which was converted into HK$141,974,541.03 on the same day, for the purpose of repaying the personal loan owed by Chau to DBS.

17. The transfer of CHF 19,999,993 from A-1 Business’ Account to Chau’s Account is invalid and has no legal effect in that :-

(1)   it constituted misappropriation of A-1 Business’ asset;

(2)   at the time the transfer was made, Chau was neither a creditor nor a shareholder of A-1 Business and, accordingly, had no entitlement to receive any sum from A-1 Business;

(3)   it was not made in the interest or for the benefit of A-1 Business and was made at the expense and to the detriment of A-1 Business; and

(4)   it was made for an improper purpose namely, to benefit Chau personally.”

29.  Mr Cosimo Borrelli, in his third affidavit in which he deposed to his belief that the defendants had no defence to the plaintiff’s claims, stated that the surreptitious circumstances in which the purported demand letter and the purported minutes dated 25 August 2008 came to be produced by Chau and Leung suggest that they were documents created by Chau and Leung sometime after 2 October 2008 but before 28 October 2008 in order to justify the misappropriation of the first two instalments from the plaintiff.

30.  No matter how hard the plaintiff tries to divorce a consideration of the defence relied upon from a consideration of the plaintiff’s claim, I conclude that it is not right or proper to do so and that the plaintiff’s claim based on misappropriation can only succeed if the Court rejects the defence put forward.  It is therefore implicit in the plaintiff’s case that the defendants acted fraudulently, or, to put it another way, that the plaintiff’s case contained underlying allegations which constituted allegations of fraud on the part of the defendants, namely, the after the event falsification of documents to create a fictitious declaration of dividend from the plaintiff to A-One Investments which was used by A-One Investments to repay a loan obtained from the 1^st defendant.

31.  Even if I were able to view the plaintiff’s pleaded case of misappropriation in isolation, I would conclude that it was implicit in the plaintiff’s pleaded case that the 1^st defendant dishonestly misappropriated the proceeds of sale from the account of the plaintiff.  Absent a justification for the appropriation, the act of the 1^st defendant in doing so must be regarded as a dishonest act.  If “fraud” within the meaning of Order 14 rule 1(2)(b) includes the use of fraudulent means, it must include dishonest misappropriation, and I so conclude.

32.  Mr Alexander Wong submitted that even if the plaintiff’s case contained underlying allegations which constituted allegations of fraud on the part of the 1^st defendant only, if the Order 14 procedure was not available against the 1^st defendant, it could not be available against the 2^nd defendant as the claims against the 2^nd defendant were parasitic upon the success of the claims against the 1^st defendant which were based on underlying allegations of fraud.  I agree.

33.  For these reasons, I dismiss the plaintiff’s application for summary judgment and I will hear from the parties on the question of costs.