KIM SIE JOONG AND ANOTHER v. NG CHEUK NGON AND OTHERS

HCA552/2002

IN THE HIGH COURT OF THE

HONG KONG SPECIAL ADMINISTRATIVE REGION

COURT OF FIRST INSTANCE

ACTION NO.552 OF 2002

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R U L I N G

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1. The defendants apply for an order that paragraphs 44 to 46 of the Statement of Claim and paragraphs (b) to (d) of the prayer for relief be struck out. Their grounds are primarily that these paragraphs disclose no reasonable cause of action and alternatively that they are frivolous and vexatious.

2. In an application under Order 18, rule 19(1)(a) (no reasonable cause of action), evidence is inadmissible. One must have regard only to the pleadings. There is in fact little in the way of evidence to support the application on the alternative ground under sub-paragraph (2). The only affirmation filed is that of the defendants' solicitor who simply exhibits the Articles of Association of the 4th defendant.

3. This is a derivative action. The plaintiffs plead that they bring it for the benefit of the 4th defendant ("Billion Market") against the 1st defendant who is in de facto control of the company, and claims to be the majority shareholder therein. The plaintiffs plead various acts on the part of the 1st defendant and others which inter alia amount to schematic fraud on the minority which cannot be ratified, and in respect of which they reserve their right to bring an action in their personal capacity. They also plead that the acts complained of fall within the definition of "unfairly prejudicial acts" under section 168A of the Companies Ordinance, Cap.32.

4. The plaintiffs are shareholders in Billion Market, each holding 10% of the shareholding which consists of issued capital of 1,000,000 $1 shares. The 2nd and the 3rd defendants are husband and wife, Mr and Mrs Tsou. Prior to 12 November 2001 the 1st and the 2nd plaintiffs, the 1st defendant and the 7th defendant each held 10% of the shareholding. The 3rd defendant held 30% ("the 3rd defendant's shareholding"). The remaining shareholders need not concern us here. The directors were one Kelly Ng, the 1st plaintiff, the 1st and the 2nd defendants. At a shareholders' meeting on 12 November 2001 two more directors were appointed but the plaintiffs do not accept the legality of these appointments.

5. The principal object of Billion Market is to develop an industrial site in Chang Sha, Hunan Province, into a residential and commercial complex. To this end, it entered into a joint venture with an organisation in Hunan Province. A corporate vehicle named Hunan Rich City Real Estate Development Co. Ltd ("Rich City") was formed to carry out the project. Subsequently the Hunan Organisation caused a Hong Kong company controlled by it called Goldco Holdings Ltd to enter into a new joint venture with Billion Market to continue the project. Billion Market holds 77% of Rich City's registered capital of RMB10 million and Goldco the other 23%.

6. Rich City had seven directors, four appointed by Billion Market, and three by Goldco. The four appointed by the Company were its own directors, namely Kelly Ng, the 1st plaintiff, the 1st and the 2nd defendants. There was a change in the directors after 20 November 2001, but the 1st defendant remained.

7. The plaintiffs aver that as at 16 August 2001 Rich City's estimated shortfall of income against expenditure was RMB26,486,517.77, and that it owed RMB59,340,824.03 to associated individuals who had made loans to it. In particular it owed the 2nd defendant $16,187,167.46 and the 1st defendant RMB35,983,264.61, and smaller amounts to other lenders. It is averred that in April 2001, unknown to shareholders or the Legal Person of Rich City, the 2nd defendant purported to agree on behalf of Rich City to transfer all its properties which were yet to be sold to the 1st defendant for RMB33,000,000.00, payment whereof was discharged by the 1st defendant treating his loans as discharged.

8. It is not in dispute that in September 2001, the 2nd and 3rd defendants entered into an agreement with the 1st defendant whereby they effectively sold Mrs Tsou's shareholding and Rich City's debt of RMB16,187,167.46 to the 1st defendant for RMB2,000,000.00.

9. The averments to which the defendants object relate to this transaction and are as follows :

"44. Kim and Lau contend that the benefit of satisfying the Company's debt, in the case owed to the Tsous, at such significant discount, should be enjoyed commonly by all shareholders of the company. Likewise, Mrs. Tsou's shareholding should be taken up by the remaining shareholders pro-rata to their existing holding. Alternatively, Ng Cheuk Ngon should have in exercise of his duty as a director, revealed the full terms of his agreement with the Tsous so that the Company's board and the shareholders could reach a well-informed decision as to whether they should approve or otherwise intervene in the transaction.

45. The primary position of Kim and Lau is that instead of seeking to set aside the transaction in the name and for the benefit of the Company, Ng Cheuk Ngon should be held as the constructive trustee of the benefit he obtained out of the transaction for the benefit of the Company and where appropriate the general body of creditors as well.

46. To this end, Kin and Lau are prepared to pay their share (pro-rata to their shareholding of the Company) of contribution in substitution of Ng Cheuk Ngon to obtain 30% shareholding of the Tsous and their loan interest in the Company."

10. Obviously paragraph 44 needs amendment in any event. So will paragraph 46. There seems to be a blurring of the identities of Billion Market and Rich City, as well as of Mr and Mrs Tsou. It is averred that the 2nd defendant lent the money to Rich City rather than Billion Market, referred to in the Statement of Claim as "the Company". I understand that the contention is in fact that the benefit of the assignment at a substantial discount of Rich City's debt (owed originally to Mr Tsou rather than "the Tsous") should be enjoyed by Billion Market and/or commonly by its shareholders. It was agreed that I deal with the summons on that basis.

11. Under the rule in Foss v. Harbottle (1843) 2 Hare 461, the proper plaintiff is the party injured, in whom the cause of action is vested. The rule and its exceptions are set out in Prudential Assurance Co. Ltd v. Newman Industries Ltd (No.2) 1982 Ch 204 at 210 :

"The classic definition of the rule in Foss v. Harbottle is stated in the judgment of Jenkins L.J. in Edwards v. Halliwell [1950] 2 All E.R. 1064 as follows. (1) The proper plaintiff in an action in respect of a wrong alleged to be done to a corporation is, prima facie, the corporation. (2) Where the alleged wrong is a transaction which might be made binding on the corporation and on all its members by a simple majority of the members, no individual member of the corporation is allowed to maintain an action in respect of that matter because, if the majority confirms the transaction, cadit quaestio; or, if the majority challenges the transaction, there is no valid reason why the company should not sue. (3) There is no room for the operation of the rule if the alleged wrong is ultra vires the corporation, because the majority of members cannot confirm the transaction. (4) There is also no room for the operation of the rule if the transaction complained of could be validly done or sanctioned only by a special resolution or the like, because a simple majority cannot confirm a transaction which requires the concurrence of a greater majority. (5) There is an exception to the rule where what has been done amounts to fraud and the wrongdoers are themselves in control of the company. In this case the rule is relaxed in favour of the aggrieved minority, who are allowed to bring a minority shareholders' action on behalf of themselves and all others. The reason for this is that, if they were denied that right, their grievance could never reach the court because the wrongdoers themselves, being in control, would not allow the company to sue."

12. The plaintiffs are relying on the 5th exception. They plead fraud on the minority. In the words of Joffe on Minority Shareholders : Law, Practice and Procedure, 2000 edn at page 10, a member of a company "may bring a derivative claim under this exception where he can establish two things, namely (a) that the transaction in question constitutes a fraud on the minority and (b) that the wrongdoers are in control of the company."

13. Fraud does not simply mean deceit but also embraces breach of the director's fiduciary position. The minority shareholder who has no other remedy may sue "where directors use their powers intentionally or unintentionally, fraudulently or negligently in a manner which benefits themselves at the expense of the company" - per Templeman J in Daniels v. Daniels, 1978 Ch 406 at 414.

14. The defendants argue that the pleadings show that the plaintiffs are not bringing this action on behalf of Billion Market but on behalf of themselves. I think this can be dealt with quite simply; the exception provides that the minority may bring the action on behalf of themselves and all others.

15. As to the assignment of the debt the defendants argue that Billion Market would have no right of action in any event. The debt is not an asset of the company. Any creditor can assign to whom he chooses a debt which is owed to him. There is no need to give notice to the debtor. The assignment had nothing to do with Billion Market and it has no locus to intervene. Further it makes no difference that the 1st and the 2nd defendants were directors of Billion Market; they were not appropriating an asset, or taking to themselves an opportunity which Billion Market should have had.

16. The plaintiffs argue that the 1st defendant as director owed a fiduciary duty to the Billion Market. That would include the duty to act in good faith and not to put himself in a position where his interest will conflict with that of Billion Market. A person would not lightly buy the book debt of a company unless he is an insider and privy to the condition of the company. In fact, the 1st defendant was a director of Rich City. Any opportunity for Rich City to benefit by increasing its assets or reducing its liability as also an opportunity accruing to the benefit of Billion Market. So the information that the 2nd defendant was prepared to sell the debt owed to him at what appears to be a huge discount must be a corporate opportunity and asset properly belonging to Billion Market. It was his duty to disclose this to Billion Market and in failing to do so he was in breach of fiduciary duty.

17. On the pleadings the 1st defendant paid out RMB2,000,000.00. That bought him two things. The first was a debt of RMB16,187,167.46 which Rich City owed to the 2nd defendant. At the time, the 1st and the 2nd defendants were directors of the Billion Market and of Rich City and the 1st defendant was a shareholder of the Company. Billion Market was the majority partner and shareholder in Rich City.

18. The second thing which the 1st defendant bought was the 3rd defendant's shareholding of 40% in Billion Market. We do not know what the shares were worth, nor indeed what where the chances of the debt being paid by Rich City. Given that Billion Market only existed to hold shares in Rich City, and the latter was heavily in debt, it seems likely that they were not worth much, but on any reckoning the price paid for Rich City's debt represents a large discount.

19. A director is under a duty to account to the company for all profits which he acquires by reason and in the course of acting as director, or by the use of opportunities or knowledge gained by him while acting as such. See Regal (Hastings) Ltd v. Gulliver (Note) [1967] 2 AC 134 H.L. (E.) per Viscount Sankey at 137 :

"The general rule of equity is that no one who has duties of a fiduciary nature to perform is allowed to enter into engagements in which he has or can have a personal interest conflicting with the interests of those whom he is bound to protect."

20. Lord Macmillan at page 153 usefully encapsulated what the plaintiff would have to establish as a matter of fact :

"The plaintiff company has to establish two things: (i) that what the directors did was so related to the affairs of the company that it can properly be said to have been done in the course of their management and in utilisation of their opportunities and special knowledge as directors; and (ii) that what they did resulted in a profit to themselves".

21. In this case there the most likely inference is that the 1st defendant utilised his opportunities and special knowledge as a director in the purchase of the debt. As a director of Billion Market and Rich City he would be in a good position to know the value of what he was buying. So would the other director, from whom he bought it. It is also most likely that he made a profit or at any rate a potential profit on the purchase at such a great discount. In any event, Rich City now owes him over RMB16,000,000.00.

22. However, I think what is more important is that if Billion Market, instead of the 1st defendant, had bought the debt, although that debt is not an asset in the hands of Rich City, it would have become one in the hands of Billion Market, in that Rich City would have owed the debt to Billion Market. Billion Market would have a right to repayment of the debt as a creditor in priority to its right to receive a dividend. If Rich City had to go into liquidation, again Billion Market could rank as a creditor. Either way it would be better off.

23. Looked at in this light is seems to me that the 1st defendant had a fiduciary duty at least to apprise Billion Market and/or the other shareholders of this commercial opportunity, rather than buying it for himself. That Billion Market might not have wanted to buy the debt, or could not have raised the money, makes no difference, on the various authorities referred to in Regal (Hastings) Ltd.

24. The question of the 3rd defendant's shareholding is more difficult. A shareholder prima facie has the right to deal freely with his property and transfer it to whom he pleases; Re Smith v. Fawcett Ltd [1942] Ch. 304. That right can be restricted by the Articles of Association but such restriction must be clear. Re Swaledale Cleaners Ltd [1968] 1 WLR 1710. There is no such restriction in the Articles of Billion Market. The only restriction lies in the right of the directors in their absolute discretion to decline to register any transfer of any share; that appears in Part II of Table A in the First Schedule to the Ordinance, and is applied to Billion Market by its own Articles.

25. There has been some argument about Billion Market's power to purchase its own shares and the effect of changes to Table A made after Billion Market was registered. I do not think this makes any difference. Billion Market had such power under section 49I of the Ordinance. I do not think that the shares would normally be seen as an asset, which the fiduciary duty of a director/shareholder would compel him to procure for the company rather than himself.

26. However, the plaintiff avers that Billion Market is a quasi-partnership founded on mutual trust and confidence, and that the 1st defendant owes the other shareholders a duty to act in good faith as if they were his partners. Alternatively, he owes them a duty to act openly and fairly in relation to the business affairs he had with Billion Market in his private capacity. This the defendants deny but if it is ultimately found to be correct it would follow that the 1st defendant should have disclosed his purchase of the shares to the other shareholders, particularly where it was linked with his purchase of Rich City's debt at a discount, which raises the question of whether there was also some element of discount in the sale of the shares.

27. It is only in plain and obvious cases that the court should exercise its discretion to strike out pleadings; see the Hong Kong Civil Procedure 2002 at paragraph 18/19/4. In my view it is by no means obvious that the plaintiff has no reasonable cause of action in respect of the 1st defendant's purchase of Rich City's debt; rather the reverse. The position is less clear regarding the purchase of the shares, particularly having regard to the plaintiff's pleading of quasi-partnership, but I do not think it is plain and obvious that there is no case. In any event, the two sales cannot be seen in isolation. They were linked. It is difficult to see that if there was a duty to reveal the one, there would not be a duty to reveal the other.

28. I conclude that, although the paragraphs which the defendants seek to have struck out need to be amended to make it clear that the debt was that of Rich City and not that of Billion Market, the application must be refused. I think those necessary amendments should be the subject of a separate application; it is not for me to draft them.

29. The summons is accordingly dismissed with costs (nisi) to the plaintiff in any event.