DELCO PARTICIPATION B.V. v. HWH HOLDINGS LTD

HCA 2943/2015

[2019] HKCFI 1853

IN THE HIGH COURT OF THE

HONG KONG SPECIAL ADMINISTRATIVE REGION

COURT OF FIRST INSTANCE

ACTION NO 2943 OF 2015

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HCA 3040/2015

IN THE HIGH COURT OF THE

HONG KONG SPECIAL ADMINISTRATIVE REGION

COURT OF FIRST INSTANCE

ACTION NO 3040 OF 2015

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HCA 2939/2016

IN THE HIGH COURT OF THE

HONG KONG SPECIAL ADMINISTRATIVE REGION

COURT OF FIRST INSTANCE

ACTION NO 2939 OF 2016

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(Heard together)

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D E C I S I O N

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1.  There are two sets of applications before the court in each of the three actions relating to the plaintiff’s Reply: (i) the applications by one or more of the defendants for orders to strike out parts of those pleadings; and (ii) the cross-applications by the plaintiff for leave to amend those pleadings and their particulars.

2.  Mr Nip who appeared on behalf of the defendants asked for the hearing to be adjourned because (i) the defendants themselves intend to make substantial amendments to their pleadings; (ii) the court’s decision on an appeal relating to the defendants’ requests for particulars of the plaintiffs’ Reply is still pending.  I did not consider them to be valid reasons for an adjournment and accordingly the hearing proceeded, with the focus being on the plaintiffs’ amendment summonses because, as will be seen below, if the amendments were allowed notwithstanding the defendants’ objections, it would follow that the strike-out applications should fail (leaving only the question of costs).

Background

3.  The general factual background to the three actions is the same.  The actual history and relevant transactions are complex but, for present purposes, may be broadly summarised as follows.  For ease of reference I shall adopt the same abbreviations as used in the pleadings in question.

4.  In the 1990s, two Dutch businessmen, Mr Herman de Leeuw (“HDL”) and Mr Stephanus van Ooijen (“SVO”), through their group of companies called “Delco”, regularly sold scrap metals to Mr Fang An Kong’s (“Fang”) companies, which ran a scrap metal recycling business in Mainland China.  The business grew and the relationship developed, eventually to such a point that, in 1999, the two sides decided to set up a joint venture in the metal recycling business.  The joint venture vehicle was a company incorporated in the Mainland called Taizhou Chiho-Tiande Metals Co., Ltd (“CT Metals”).  The Dutch side set up a company called Delco Asia Co Ltd (“Delco Asia”) in 2001 to hold their investment in CT Metals.  In 2002/2003, there was a restructuring so that Hefast Holdings Corporation Ltd (“Hefast”), equally owned by the two sides, became the holding company of CT Metals.

5.  The joint venture was successful.  In about 2008, the two sides decided that it should go public.  For that purpose, a company, Chiho-Tiande Group Ltd (“CT”), was incorporated in the Cayman Islands to be the listed company.

6.  Prior to the listing, there were various sums owed by the companies within the joint venture group to Fang and Delco Asia respectively recorded as shareholders’ loans.  As part of the listing exercise, part of these shareholders’ loans were by agreement capitalised into shares in CT, with the uncapitalised portion to be repaid by CT.  Delco Asia’s uncapitalised portion of the shareholders’ loans was in the amount of HK$57,827,118.

7.  On 12 July 2010, CT was successfully listed in Hong Kong, with the two sides each holding a 34.5% shareholding interest in CT and another 3% through a BVI company.  The Delco side held its interest via Delco Participation BV (“Delco”) which is the plaintiff in each of the three actions herein, while Fang used a company called HWH Holdings Ltd (“HWH”) to do so.

8.  In October 2011, there was a restructuring on the Dutch side, as a result of which Delco acquired all the assets and liabilities of Delco Asia as at 31 December 2010. 

9.  From 2012 onwards, Delco took steps to exit from the listed company.  HWH also began to dispose of part of its interest in CT. In January 2012, Delco and HWH sold an aggregate of about 16% of CT shares to a third party called Sims.  Delco and HWH also agreed to re-invest into CT about two-thirds of the proceeds of sale by subscribing for convertible bonds (“CB”) issued by CT.  The principal amount of the CB subscribed for by Delco was HK$312.6 million, with interest at 4% per annum.  At the same time, by a Transfer Agreement between Delco and HWH, Delco sold approximately 1% of the shares in CT to HWH at HK$4.50 per share.

10.  In April 2014, Delco sold part of its shareholding in CT to a third party.  In January 2015, Delco sold the remainder of its shareholding in CT to HWH.  Subsequently in 2015, HWH transferred most of its shareholding in CT to a third party which has since controlled CT.

The plaintiff’s claims

11.  In HCA 2943/2015, Delco claims against HWH for the sale price of HK$46,883,466 for the 1% of CT shares pursuant to the Transfer Agreement of January 2012.  HWH says there was a 10% discount applicable, reducing the sale price to HK$41.9 million.  The discount is disputed by Delco, but subject to the defence of set-off referred to below, it is common ground that the price is due and owed to Delco.

12.  In HCA 3040/2015, Delco sues CT and Fang.  Delco’s primary case is that CT owes Delco the uncapitalised portion of Delco Asia’s shareholder’s loans in the amount of HK$57,827,118. CT defends the claim on the ground[1] (with which Fang agrees)[2] that Fang had personally taken up CT’s liability to pay that uncapitalised portion of Delco’s loans.  Delco therefore sues Fang in the alternative for that amount.

13.  In HCA 2939/2016, Delco sues (1) CT, (2) Chiho-Tiande (HK) Ltd (“CTHK”), (3) HWH, and (4) Fang.  The present applications concern only the claim against HWH and Fang.  Delco sues them for the first half-yearly interest payment of HK$6,252,000 under the CB due on 1 September 2012, which was due from CT but paid by CT (wrongfully, the plaintiff says) to HWH on Fang’s instruction on the basis that Fang/HWH would repay that amount to Delco.  It appears that HWH’s and Fang’s position is that, but for the defence of set-off, the sum is due from Fang to Delco.[3]

The defence of set-off

14.  The defendants’ case on the defence of set-off is that by June 2010, there were loans owing from Delco Asia to Fang totalling HK$104,117,969.19 (“Debts”).  The Debts were made up of two amounts, namely HK$31,772,969.19 and HK$72,345,000, which had respectively arisen as follows:

(1)  From 2002 to 2005, Fang advanced loans to Delco Asia totalling HK$45,134,110.59 and in 2010 a further loan of HK$5,267.  These loans had no fixed term and were unsecured, interest-free and repayable on demand.  In 2002 and 2003, Delco Asia made partial repayments to Fang in sums totalling HK$13,366,408.80.  Buy an audit confirmation in August 2011, Delco Asia confirmed that it owed Fang the sum of HK$31,772,969.19.

(2)  Further, in 2007 and 2008, HKM Metal Ltd (“HKM Metal”), a company owned by Fang, advanced loans to Delco Asia in the total sum of US$9,275,000, equivalent to HK$72,345,000, for the purpose of assisting Delco Asia’s business operations and development.  These loans also had no fixed term and were unsecured, interest-free and repayable on demand.  The loans were orally assigned by HKM Metal to Fang in around June 2013.

15.  The defendants aver that in June 2010, Fang and SVO orally agreed that the Debts should be repaid as and when Fang demanded and when Delco Asia had sufficient funds (“2010 Agreement”).  In particular, they also agreed that the funds available to the Delco group in the form of repayment by CT of the uncapitalised portion of the shareholders’ loans would be used to repay the Debts in part.  Therefore, when CT did make repayment of the shareholders’ loans in July 2010, the amounts due to Delco Asia were paid to Fang instead (in the sum of HK$55,501,079.97).  The set-off was not, however, effected in the accounts which recorded a receivable from Fang in relation to his receipt of repayment of the uncapitalised portion of Delco Asia’s shareholders’ loans, and separately recorded an amount payable to Fang in relation to the Debts or part thereof.

16.  The defendants say that the practice had been adopted as a conventional basis of the dealings between Fang’s group and the Delco group that their mutual receivables and payables would not be immediately set off against each other, but would instead be recorded separately as receivables and payables (as the case may be) in the accounts, but if either party was to demand payment at any time, there would be a set-off and only the net balance would be payable.

17.  In January 2012, on the basis of the 2010 Agreement, the consideration payable under the Transfer Agreements for the 1% shareholding in CT was not paid to Delco but, as was the convention, entered into the accounts as a sum receivable by Delco from HWH, while Delco remained indebted to Fang.

18.  On the basis of the 2010 Agreement also, in August 2012, the first coupon interest on the CB due from CT to Delco in the sum of HK$6,252,000 was paid to HWH instead of to Delco, in part payment by Delco of the Debts.  Following the convention, however there was no immediate set-off effected in the accounts, which instead recorded a receivable by Delco from Fang arising from this interest payment, as well as the Debts.

19.  In short, therefore, the defendants say that while Fang or HWH owe Delco the three sums of HK$41.9 million, HK$55,501,079.97 and HK$6,252,000, Delco in turn owes Fang or his companies the Debts in the sum of HK$104,117,969.19.  The net result is that Delco owes Fang HK$464,889.22.

The Scheme pleaded in the Reply

20.  In response to this defence of set-off, Delco denies that the Debts existed in fact, and pleads in its Reply in each action (and seeks to elaborate in the proposed amendments) a “Scheme” in order to explain how the Debts found their way into the books of accounts of Delco Asia including certain audit confirmations.  In essence, Delco’s case appears to be as follows:

(1)  From around 2000, the profits generated by the operating companies of the joint venture in the Mainland, including Taizhou Chiho-Tiande Foundry Co Ltd (“CT Foundry”) and CT Metals, were significantly under-reported in their accounts.[4]

(2)  The unreported profits proportionate to the Delco group’s interest in the joint venture were transferred from those operating companies to Fang or his associates and subsequently routed to the Delco group and reinvested in the joint venture, and/or reinvested in the joint venture directly or via other entities associated with Fang.  Delco is not aware of the detailed methodology but says that the under-reporting of profits was achieved by various methods which it then seeks to particularise.[5]

(a)  There was from 2001 onwards systematic under-invoicing by Delco Europe BV of shipments to CT Metals.  Delco Europe BV would issue an invoice which was paid by CT Metals and entered into the books of Delco Europe BV.  But Delco Europe BV would issue a second invoice of a higher amount which was sent to CT Metals and recorded in its books as the acquisition cost.  The goods were sold to purchasers at the market price.  The difference between the two invoices formed the unreported profit.  The percentage of the under-invoiced amount was 29% from 1 January to 12 April 2002.[6]

(b)  There was under-invoicing by Delco Europe BV in respect of materials purchased from its US subsidiary and on-sold to CT Metals.  The sale price to CT Metals was below the cost of purchase from the US subsidiary.  CT Metals booked the higher figure as its acquisition cost, and sold the goods to purchasers at the market price.  The difference between Delco Europe BV’s cost of purchase and the sale price to CT Metals represented part of the unreported profits.[7]

(c)  Advance payments were made by various “debtors” to Delco Europe BV in 2003.  These advance payments constituted the return to the Delco group of part of the under-invoiced amounts. 

(3)  It is averred that this Scheme was implemented by Fang with the knowledge and assistance of the Delco group.[8]

(4)  As a result of the Scheme, Delco Asia was reported as having contributed a total sum of HK$169,681,118 to the joint venture by way of shareholders’ loans (to Hefast and CTHK).[9]  This amount represented the unreported profits reinvested into the joint venture on the Delco group’s behalf.[10]

(5)  In the accounts of Delco Asia, however, it was necessary to show liabilities corresponding to such shareholder’s loans (especially given the audit to be conducted before the listing exercise). Accordingly, Delco Asia booked a number of payables totalling HK$169,843,599 (HK$31,772,969.19 to Fang, HK$72,345,000 to HKM Metal, and HK$65,730,897 to one Chern Shyn Kang), which were not in fact genuine debts required to be repaid but a sham.[11]

21.  It appears that Delco has derived some of the information for its pleading from a report by the Dutch Tax Authority after investigation into the tax returns of Delco Recycling BV and Delco Europe BV for the years 1997 to 2003.  Delco even proposed to preface particular (1) under paragraph 6.2 of its Reply with these words: “According to a report issued by the Dutch Tax Authority on 20 September 2005 …”.

Discussion

22.  As stated in Mr Nip’s skeleton and the opposing affirmation filed by the defendants, the grounds of opposition to the proposed amendments are that the findings or figures extracted from the Dutch Tax Report cannot serve as proper particulars of the Scheme, and Delco cannot reasonably have believed that such findings and figures are true for the purpose of pleading facts in these proceedings.

23.  In my view, it is wrong for Delco to propose to plead the words “According to a report issued by the Dutch Tax Authority on 20 September 2005 …” as referred to above.  The opinions of a foreign official are, with respect, not relevant to any issue in these proceedings. They are also not admissible as evidence of any fact found by such official: Hollington v F Hewthorn & Co Ltd [1943] KB 587.  What a pleading should contain is the material facts the party avers (RHC O 18 r 7(1)), not the evidence it relies on, let alone inadmissible evidence. 

24.  At the hearing, Mr Dawes SC who appeared for Delco accepted that references to the Dutch Tax Authority should be removed.[12]

25.  That said, there is nothing in principle to prohibit Delco from adopting certain findings reached by the Dutch Tax Authority as its own averments in these proceedings, provided there is sufficient evidential basis for them (other than the opinions of that authority, which are not evidence).

26.  Mr Nip submitted that because the Dutch Tax Authority had criticised Delco for preventing it from obtaining an accurate picture of the facts, Delco cannot now reasonably believe that the findings in the report are facts.  With respect, this is a non sequitur.  The fact that the management at the time of the tax investigation was not cooperative does not mean that Delco, now represented by an independent director, cannot form the view that the findings in the report are in fact correct.

27.  Mr Nip submitted that some of the averments in the proposed amended pleadings were speculation and without evidential basis once one ignores the Dutch Tax Report. 

28.  I shall examine the 3 main particulars pleaded in paragraph 6.2(1)(a), (b) and (c) of the proposed Re-Amended Reply in HCA 2943/2015, summarised in §20(2)(a), (b) and (c) above.

29.  It can be seen from the summary above that, overall, the Scheme is being pleaded not as the basis of any legal claim by Delco or anyone for relief in itself, but for the purpose of explaining away certain accounting entries in Delco Asia’s accounts and audit confirmations that are relied upon by the defendants as a defence to the otherwise largely undisputed claims of Delco.  The Scheme advanced did involve questionable practices such as double-invoicing, but the plea does not charge Fang with any fraud practised on or damaging Delco Asia.  In fact, Delco’s suggestion is that those practices were done with the knowledge of both sides.  The issue that the Scheme goes to is whether or not the Debts in fact existed.  The Scheme is not, however, an ultimate issue in itself, in the sense that whether or not the Scheme is eventually proved, the court still has to decide, separately, whether or not the Debts in fact existed, as to which the burden of proof lies on the defendants.  Whether or not there is sufficient particularity pleaded has to be seen in this context.

30.  It is to be borne in mind that Delco’s case is in part based on inference.[13] There is no dispute that even serious allegations such as fraud may be established by inference.  Part of the factual matrix from which Delco would invite an inference to be drawn includes the lack of actual evidence showing how the alleged loans giving rise to the Debts came to be made, the fact that the Debts booked in Delco Asia’s accounts were in an aggregate amount (HK$169,843,599) close to the shareholders’ loans recorded in Delco Asia’s favour (HK$169,681,118), the alleged incredibility of certain features of Fang’s case on the Debts, as well as certain features in Delco Asia’s accounts which were both highly unusual and consistent with the existence of the Scheme.  In the present context the court is not concerned with whether the inferences in question should actually be drawn — that is a matter for trial if the pleading raises an arguable case. 

31.  As to the double-invoicing pleaded in paragraph 6.2(1)(a), first, while the conclusions in the Dutch Tax Report are not admissible, there is nothing in law to prevent Delco from relying on the evidence available to the Dutch Tax Authority for supporting its own averments in these actions.  For example, the report stated that “[v]arious documents and emails found on the taxpayer’s computer show that Delco Europe BV had been systematically under-invoicing its Chinese joint venture, Taizhou, starting in 2001, for its shipments delivered to China”.[14]  Such documents, some of which are indeed annexed to the report, may be relied on even though the findings and opinions in the report are inadmissible.

32.  Secondly, the evidential basis of Delco’s averment of the Scheme is not merely the Dutch Tax Report.  According to the 5^th affidavit of Mr Erik Hammerstein (who has been appointed by a Dutch court as an independent director to handle the affairs of Delco in light of an ongoing dispute between HDL and SVO), he has been informed by HDL and SVO that the Debts were “not genuine debts with repayment obligations for the reasons [he] shall explain hereinbelow”. 

33.  The affidavit states that it is not true that the Debts arose from loans upon SVO’s request.  It is said that from around 2000, profits generated by the operating companies of the joint venture in the Mainland including CT Metals and CT Foundry were significantly under-reported in their accounts.  These unreported profits were transferred from the operating companies to companies or persons associated with Fang and subsequently re-invested in the joint venture on account of the Delco group.

34.  It is said that the Delco group (including HDL and SVO) were not aware of “the detailed methodology relating to the implementation of the Scheme” but understood that “the under-reporting of profits in the PRC Operating Companies was achieved by various methods, such as through mis-invoicing the purchase and sale of inventory, false accounting” and “the reinvestment of the Unreported Profits took place in the form of provision of scrap metals and/or funds, which were ultimately accounted for by the Joint Venture as payable to Delco Asia”.

35.  The affidavit further states that:

“ 36.  Delco’s Group (including HDL and SVO) had knowledge of the Scheme at the material times and Delco Asia assisted in its implementation through (1) the practice of under-invoicing in its dealings with the PRC Operating Companies and (2) by adjusting its accounts in the manner described below so as to be consistent with the operation of the Scheme. It did not have visibility of how the Scheme operated in the PRC companies.

…

38.  A number of adjustments were required to be made to Delco Asia’s 2008 accounts to reconcile the discrepancies between the accounts of Delco Asia and the account of the Joint Venture which arose as a result of the Scheme.

39.  Delco Asia and found were subsequently recorded in the Capitalisation Agreement as having contributed HK$169,681,118 and HK$223,561,264 respectively to the Joint Venture by way of shareholder’s loans. To my knowledge and understanding, the sum of HK$169,681,118 represented Unreported Profits reinvested into the Joint Venture on Delco Asia’s behalf.

40.  In light of the scheme, and for the purposes of tidying up Delco Asia’s accounts ahead of a listing of the Joint Venture, Delco Asia booked a number of different payables in its accounts fan and companies associated with him which corresponded to the said sum of HK$169,681,118. …”

36.  There are also other matters raised by Delco all of which, it seems to me, will have to be considered as a whole at trial for the purpose of assessing what inferences may and should be drawn.  Thus, Delco relies on its averment that Delco Asia was asset-rich at the time and did not need loans to finance its business operations as alleged that the defendants. Delco has also referred to features of Delco Asia’s audited accounts for the years 2004 to 2010 which, it submits, are consistent with the Scheme it alleges and contain indications that the Debts did not exist but were artificially booked.  For example, the audit opinions were qualified because, inter alia, the auditors were not able to obtain sufficient information to assess whether certain “other payables” were correctly stated including the HK$72,345,000 allegedly owed to HKM Metals, and Delco Asia’s directors were either unwilling or unable to demonstrate that those liabilities actually existed or were correctly valued.  There were in addition significant amendments of the sales to CT Metals in Delco Asia’s 2007 and 2008 accounts which, according to the plaintiff, were consistent with the Scheme it alleges.  There is also evidence from SVO denying the 2010 Agreement alleged by the defendants.

37.  I should mention that at the hearing neither side placed any significant reliance on the expert tax and accountancy evidence filed.

38.  Having regard to all the available materials at this stage, I do not think that the proposed amendments about the Scheme in relation to paragraph 6.2(1)(a) can be said to be wholly speculative.  I do not think it is necessary for there to be an agreement pleaded between Delco Asia and Fang before the Scheme can be established.  An agreement in the proper sense is not a necessary element of the plea.

39.  As to paragraph 6.2(1)(b) of the proposed Re-Amended Reply, the gist of the allegation is that Delco Europe BV purchased goods from its US subsidiary at a higher price and sold them to CT Metals at a lower price.  However, all that the primary materials derived from the Dutch Tax Report can show, it seems to me, is that Delco Europe BV sold certain goods to the Chinese joint venture at a price below their acquisition cost and thus made a loss.  There is no evidence of any double-invoicing and indeed none has been pleaded.  It is said that it is to be inferred that CT Metals recorded in its accounts some “higher figure” than the invoiced amount as the costs of acquiring the goods but it seems to me that there is no basis for such inference.

40.  As to paragraph 6.2(1)(c) of the proposed Re-Amended Reply, while the pleading was that advance payments of around US$2 million were made by various “debtors”, Mr Dawes SC explained at the hearing that the basis for saying that these payments constituted the return of under-invoiced amounts to the Delco group was that these payers were not in fact debtors and the transactions were unsupported by any sales invoices.  This was not, however, pleaded in the amendments.  More fundamentally, moreover, it seems to me if the money was returned to Europe in this way, there would not have been a large amount of payables to the Delco group accumulated in the accounts of the Chinese joint venture representing the under-reported profits.  It is said that money was returned or “routed” to the Delco group and then “reinvested” in the joint venture, but there is no pleading that the US$2 million was reinvested.  I consider that this particular should therefore be rejected. 

41.  Mr Nip also criticised paragraphs 6.7 and 6.7(A) (as amended and added in the proposed amendments) which aver that the accounts of Delco Asia for 2007 were adjusted, that Delco Asia booked in its 2008 accounts anew receivable of HK$144,720,690 from CTHK and that one of the purposes of these adjustments was to reconcile the mismatch between the amounts due to Delco Asia in the accounts of the joint venture company and the amounts due to the joint venture in the accounts of Delco Asia, which arose as a result of the Scheme.  As I understand the position, the fact of the adjustments is not in dispute.  Whether or not they were for the alleged purpose will depend on the evidence, and is not a matter that the plaintiff should be shut out now from trying to establish at trial.

42.  It follows from the discussion above that I would allow the amendments (subject to the revisions the plaintiff accepted at the hearing as mentioned above) except paragraphs 6.2(1)(b) and (c) and also their associated paragraphs, namely, paragraphs 6.2(3) and (4). 

43.  As an order nisi, I order that (i) save that Delco do bear the costs of issuing its summonses for leave to amend, there be no order as to the costs of the summonses for leave to amend; (ii) Delco do pay the relevant defendants the costs of and occasioned by the amendments to its Replies; and (iii) the costs of preparing the accountancy evidence on both sides be costs in the cause.

44.  On this basis it may be that the summonses for strikeout fall away and require no order except on the question of costs, though the arguments at the hearing were not focused on those summonses.  If the parties are unable to agree on the disposal of those summonses they may seek directions for them to be dealt with in a cost effective manner.