SHIH-HUA INVESTMENT CO., LTD (suing for and on behalf of itself as shareholder of EVERGLORY ENERGY LTD v. ZHANG AIDONG AND OTHERS

CACV 188/2017

[2021] HKCA 81

IN THE HIGH COURT OF THE

HONG KONG SPECIAL ADMINISTRATIVE REGION

COURT OF APPEAL

CIVIL APPEAL NO 188 OF 2017

(ON APPEAL FROM HCA NO 2682 OF 2016)

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J U D G M E N T

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Hon Lam VP:

1.  I agree with the judgment of Yuen JA.

Hon Kwan VP:

2.  I agree with the judgment of Yuen JA.

Hon Yuen JA:

3.1.  The present matter arises from CACV188/2017, which is an appeal from Harris J’s decision given on 26 July 2017[1] striking out HCA2682/2016, a Common Law Derivative Action (“CLDA”).  There is also an application for security for costs of the appeal.

3.2.  The action concerned a company called Everglory Energy Ltd (“the Company”). There have been a number of proceedings concerning the Company, but the facts material to the present matter can be summarized below.

Background

4.1.  The Company was incorporated in 2012.  Its two shareholders were Shih-Hua Investment Co Ltd (“SH”) and Motivi Point Consultant Ltd (“MPC”), each holding 50%[2]. MPC is controlled by Zhang Aidong (“ZAD”).  

4.2.  SH and ZAD were the two directors of the Company until a court order was made on 19 January 2017 reconstituting the board[3].

4.3.  SH had accused ZAD of misconduct in the management of the Company since 2014.  The misconduct was said to include diversion of the Company’s business opportunities, transferring funds without authority, making secret and unlawful payments, etc.

HCCW198/2016 (“the Winding up proceedings”)

5.1.  On 20 June 2016, SH issued proceedings in HCCW198/2016, for an order that ZAD buy out its shares, alternatively, that the Company be wound up. 

5.2.  The Company effectively ceased trading some time around mid-2016 when SH commenced the Winding-up proceedings[4].

5.3.  In those proceedings, SH issued a number of summonses, including an application for the appointment of provisional liquidators filed on 22 July 2016, and an application for reconstitution of the board of directors filed on 9 September 2016.

The July 2016 Injunction

6.  Meanwhile, on 20 July 2016, Harris J gave an injunction restraining the Company from making payments except for (1) repayment of debts set out in a schedule and (2) $2 million a month in the ordinary course of business (“the July 2016 Injunction”).

7.  On 3 October 2016, Harris J refused to hear on an urgent basis SH’s application for reconstitution of the board, which was contested. 

HCA2682/2016 (“the CLDA”/ “the Action”)

8.1.  About 10 days later, on 14 October 2016, SH issued a CLDA against 6 defendants, the Company being the 6^th defendant.  ZAD was named as the 1^st defendant, an employee of the Company who is said to act according to his instructions was named the 2^nd defendant, and companies said to be under ZAD’s control were named as the 3^rd to 5^th defendants.

8.2.  The allegations set out in the Statement of Claim[5] were similar to those alleged in the Winding-up proceedings.

SH’s applications to the duty judge

9.1.  On 25 October 2016, in an ex parte application filed under the Action, SH applied to the duty judge (Lok J) for an injunction to restrain the Company from disposing of funds received from certain customers.  It was granted.

9.2.  Another injunction in other specific terms was granted by DHCJ Yee on 22 November 2016 on another ex parte application made by SH filed under the Action.

9.3.  It was apparently not made clear to those judges that Harris J had already given the July 2016 Injunction on similar material.  

Reconstitution of the board

10.  On 4 January 2017, there was a hearing before A Chan J in the Winding-up proceedings.  On 19 January 2017, the judge gave SH an order (amongst others it had applied for) reconstituting the board of directors of the Company by replacing ZAD and SH with two professional persons from Grant Thornton (Mr David Bennett and Mr Barry Tong Piu) (“the Reconstituted Board”).

Strike-Out of the CLDA

11.1.  On 25 and 26 July 2017, Harris J heard (amongst other applications) a summons issued by the defendants to strike-out the CLDA.  It should be noted that by this time, there was available to the judge a forensic report by Briscoe Wong Advisory Ltd dated 24 November 2016 which post-dated the applications before Lok J or DHCJ Yee, but which had also not been placed before Anthony Chan J in January 2017.  This report analyzed and rebutted a number of matters set out in a report from RSM Corporate Advisory (Hong Kong) Ltd on which SH had relied[6].

11.2.  Harris J struck-out the Action, for reasons appearing in the Reasons for Decision. 

11.3.  In summary, the judge noted that there was a substantial overlap between the complaints in the Winding-up proceedings and the CLDA, which invited the question why it was thought necessary to commence the Action. 

11.4.  The judge found that the purpose of the CLDA was to provide a platform for SH’s subsequent actions in applying to the duty judge (instead of Harris J) for ex parte injunctions, which was impermissible forum-shopping, and without fully and fairly disclosing to Lok J and DHCJ Yee that it had already presented similar material before Harris J[7].

11.5.  Further, the CLDA was originally issued on the basis that a wrongdoer (ZAD) was allegedly in control of the Company.  But the judge held that was no longer the case after the reconstitution of the board (which SH itself had sought)[8].  Upon such reconstitution, it was for the Reconstituted Board to consider if it wished to continue the Action.  But as SH had not put it in funds to investigate the allegations, the Board had expressly declined to continue with the Action.  As such, the alleged wrongdoer being no longer in control, and the Board not intending to continue with the Action, it should be struck out[9].

11.6  Further, the judge held that if he had not struck-out the Action, he would have discharged the injunctions given by Lok J and DHCJ Yee by reason of SH’s serious material non-disclosure[10] and would not have exercised his discretion to re-grant them[11].

11.7.  On 26 July 2017 and subsequently on 4 June 2018, Harris J ordered SH to pay the defendants’ costs.   

Appeal against strike-out and application for leave to appeal discharge of injunctions

12.1.  On 21 August 2017, SH filed a notice of appeal from the strike-out order (CACV188/2017).  It also wished to appeal the judge’s interlocutory orders discharging the injunctions granted by Lok J and DHCJ Yee, and sought leave to do so.

12.2.  On 30 November 2017, Harris J refused leave to appeal the interlocutory orders. SH then issued CAMP76/2017 to apply for leave from this court.  

12.3.  On 14 December 2017, the Registrar stayed both CACV188/2017 and CAMP76/2017 until after Harris J’s Reasons for Decision were available. 

12.4.  After the Reasons were issued in June 2018, the Registrar ordered that proceedings in CACV188/2017 be withheld pending determination of SH’s application in CAMP76/2017 for leave to appeal. 

12.5.  On 25 February 2019, this court[12] refused leave in CAMP76/2017[13].  

13.  In the meantime however, on 28 November 2017, the Reconstituted Board wrote to the court stating that the Company was insolvent on both the balance sheet and cash flow bases.  As the Board failed to facilitate a restructuring, it proposed to place the Company in liquidation.

Winding-up in HCCW173/2018

14.1.  On 25 June 2018, a creditor presented a petition to wind-up the Company.

14.2.  On 29 August 2018, the Company was wound up on the ground of insolvency.  The court file in those winding-up proceedings disclosed that:

(1)  an order was made on 23 September 2019 appointing Mr Bruno Arboit and Ms Galaxy Chan Mei Lan of Duff Phelps as joint and several liquidators (“the Liquidators”);

(2)  on 6 May 2020, the Official Receiver certified that the Liquidators have given security to her satisfaction;

(3)  on 20 October 2020, the court granted sanction to the Liquidators to take steps in relation to certain proceedings (not the Action).

15.1.  On 4 December 2020, this court wrote to the parties noting that as liquidators had been appointed and are the proper persons to consider the further conduct of the CLDA, submissions should be made on the issue whether CACV188/2017 had become academic and should be dismissed, and rendering the summons for security for costs of that appeal otiose.  The parties were referred to the judgments in Re Shun Kai Finance Co Ltd [14] at para.22, citing Re Ocean Time Development Ltd at para.54[15] and were directed to file and exchange submissions on the above issue.  The Liquidators were also asked to make a report.

15.2.  On 18 December 2020, submissions were provided by SH and the defendants respectively, and a report was provided by the Liquidators.

16.  The common feature of the submissions and report was that all acknowledged that the appeal had become academic in light of the Company’s liquidation[16].

SH’s submissions -

17.1.  However SH submitted that it should nevertheless be allowed to proceed with the appeal for the sole purpose of determining costs (of the Action, and of the appeal insofar as it has progressed). 

17.2.  SH submitted that Harris J’s strike-out was unjustified, as the CLDA was properly constituted from the outset by SH on behalf of the Company, and though the board was later reconstituted, the new directors had expressly authorised and directed SH to continue the Action, as per the following documents prior to the hearing before Harris J in July 2017:

(1)  an email from the Reconstituted Board to SH’s solicitors dated 22 February 2017, in which it said “clearly on the basis that we have no funds we are unable to consider taking over the derivative action and would ask you to continue this and keep us informed of the status”;

(2)  a letter from the Reconstituted Board to both SH and MPC dated 20 June 2017 in which it said:

“Turning now to the matter of the Existing Derivatives [including the CLDA]. As you know, these actions were on foot at the time of the New Directors’ appointment and we confirm that, for the time being, the New Directors are of the view that the Company is not in a position to take over the Existing Derivatives”;

(3)  a letter from the Reconstituted Board to SH’s solicitors dated 19 July 2017 referring to various interlocutory applications in the CLDA to be heard by Harris J on 25-26 July 2017, in which it said:

“The New Directors do not have full clarity on the disputed transactions or the location of the Sale Proceeds and in the circumstances where the Sales Proceeds may be shown to be assets of the Company, we write to confirm our support for the Plaintiff’s applications”.

SH submitted that it would be unfair to deprive SH of its right to appeal the strike-out so as to overturn the costs order Harris J made against it.

17.3.  Finally, if the Liquidators did not wish to pursue the appeal, SH invited the court to grant it leave to continue the appeal, citing Fargro v Godfroy [17].

D1-D4’s submissions -

18.1.  The defendants submitted that the appeal should not proceed because even if SH succeeded, there is no indication that the Liquidators would take over and prosecute the Action. 

18.2.  As for costs, the defendants submitted they should remain to be borne by SH as (1) the appeal was wholly unmeritorious, and (2) SH has taken no steps to discontinue it even after the Company was wound-up.

The Liquidators’ report -

19.1.  The Liquidators reported that as they have had difficulty gathering information and had limited available funds, “the liquidators are not currently in a position to progress or make an informed view as to the merits of the allegations made by SH in [the Action]/CACV188 of 2017”.

19.2.  As the CLDA has become academic, they “would therefore respectfully abide by any decision of the Court of Appeal to dismiss CACV188 of 2017 and the Respondents’ summons seeking security for costs in respect of that appeal”.

19.3.  The Liquidators further reported that the books and accounts made available to them were limited, and that they were not able to perform any meaningful investigation due to the lack of key accounting documents.  

Discussion

20.  The issue is whether, despite all parties’ agreement that the appeal is academic, it should nevertheless proceed for the limited purpose of SH’s wish to overturn Harris J’s order of costs. 

21.1.  The crucial point is that whatever alleged claims there are in the Action, they are the Company’s (not SH’s) claims.  In normal circumstances, it is for the board of directors of the Company to decide whether there is any substance in them, and even if there is substance, whether to pursue them or not.  A board may properly decline to pursue claims if it thinks it is in the best interests (legal or financial) of the Company not to do so.

21.2.  The CLDA was commenced by SH on the ground that the then board was not able or willing to protect the Company’s interests because ZAD was in control.  But it transpired that even when independent professional persons (who were appointed to fulfil the duty to protect those interests) were placed in charge of the Company, they did not consider it appropriate to prosecute the claims in the Action. 

21.3.  In the case of the Reconstituted Board, its solicitor appeared before Harris J on 25-26 July 2017, informing the court that as SH had not put it in funds, the Board was not in a position to continue with the Action[18].  That was a proper reason for the Board’s decision not to pursue the claims in the Action.  SH has not explained why it did not put the Company in funds so that the Board could investigate and pursue whatever claims it (the Board) considered the Company had.  SH was apparently only prepared to expend funds to pursue the claims by itself, when the alleged claims are clearly claims belonging to the Company which was now in the hands of professional independent persons.

21.4.  As for the Liquidators, it is clear from Re Shun Kai Finance ([22]) that on a winding-up order being made, a CLDA would fall by the wayside, as the rationale for such an action (a wrongdoer in control not allowing the company to sue) no longer applied.  The liquidators have become the governing body of the company, and the right to control the litigation is vested in them. 

22.  In the present case, it is significant that the Liquidators had said in their report that they do not intend to pursue the claims for 2 reasons: not only because of insufficient funds, but also as they have not been able to gather relevant information regarding the claims because the books and records of the Company are incomplete and allegedly false. 

23.  In other words, both sets of independent professionals controlling the Company at different times have decided not to pursue the claims in the Action.  In this respect, it is important to note that the Liquidators are officers of the Court, and the reasons for their decision is not only financial, but also because of a lack of objective materials to substantiate the alleged claims. It is pertinent that SH has not complained that it has in fact provided sufficient materials to the Liquidators, but that the latter have refused, neglected or failed to appreciate the effect of such materials.  If that were the case, SH could have applied to court under s.200(5) Companies (Winding Up and Miscellaneous Provisions) Ordinance Cap 32, as a person aggrieved by an act or decision of liquidators.  It has not done so.    

24.  That being the case, the appeal should not be allowed just because SH, a contributory, wished to pursue it contrary to the Liquidators’ decision not to do so.  Even if the request in SH’s submissions is treated as an application by summons for the court to grant it leave to pursue the appeal (and presumably the Action, if successful), the Court would have refused it.  As noted earlier, whatever alleged claims there were in the Action, they were the Company’s claims, not SH’s claims, and the Liquidators have decided, without challenge, that these claims are not objectively substantiated by reason of the lack of proper documentary evidence.  For that reason, the court “acting as a filter against any totally wrong-headed action” (Fargro p.374) would not have directed SH to pursue the Action for the Company.  To allow a contributory to pursue the appeal (and the Action), in the light of the Liquidators’ views that there is no sufficient and reliable documentary evidence in support, would be tantamount to permitting an abuse of process.

25.  Finally it is noted that Harris J had made an order that the costs of the Action be borne by SH personally.  Insofar as SH thereby has a personal interest in setting aside that order for costs, it has not sought leave to do so, and s.14(3) High Court Ordinance Cap. 4 provides that no appeal shall lie against a costs order without the leave of the Court.  No application for such leave has been made or granted.  However even if SH were to have made such an application before this court, it would not have been granted in light of the reasons set out above for dismissing the appeal for want of objective materials to substantiate the alleged claims.  

Order

26.  Accordingly, the appeal should be dismissed with costs to be paid by the appellant SH to the respondents.  The summons for security for costs is thus otiose, and no order should be made save that the costs of the summons should be paid by the appellant to the respondents.