KARLA OTTO LTD v. BULENT EREN BAYRAM AND ANOTHER

HCA 821/2011

IN THE HIGH COURT OF THE

HONG KONG SPECIAL ADMINISTRATIVE REGION

COURT OF FIRST INSTANCE

ACTION NO 821 OF 2011

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J U D G M E N T

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Factual background

1.  This action arose out of what might be described as misplaced trust which is generated when parties are engaged in a romantic relationship.

2.  The plaintiff is an English company which forms part of the Karla Otto Group (“the Group”) of companies so called after their eponymous founder Ms Karla Otto (“Ms Otto”). The Group was established in 1982 by Ms Otto and is in the business of fashion, public relations and image consulting.

3.  The 1^st defendant is an individual currently resident in the United Kingdom.  The 2^nd defendant is a Hong Kong company which was incorporated by the 1^st defendant and of which he is the sole shareholder and director.

4.  Ms Otto and the 1^st defendant met in July 2007 and were in a personal relationship from that date until July 2010.

5.  It is common ground the 1^st defendant played an increasingly important role in the affairs of the Group from the start of his personal relationship with Ms Otto until March 2011. Ms Otto’s evidence is that the 1^st defendant was never formally appointed to positions of authority in either the plaintiff company or the Group but that he held himself out (and Ms Otto permitted him so to do) as either or both of the CEO and CFO of the Group.  He was not, however, as a matter of fact, formally a director, shareholder or employee of the plaintiff or the Group.

6.  The 1^st defendant’s evidence in his witness statement was that arrangements between him and the Group were more formal as evidenced by various consultancy agreements entered into in March 2008.  These consultancy agreements were not in evidence because by an order of Deputy High Court Judge Wilson Chan (now Wilson Chan J) dated 13 October 2016, the 1^st defendant had been ordered to produce certified translations of these agreements failing which he was to be debarred from relying on them at trial.  The 1^st defendant failed to produce the certified translations (and one sees here the start of what was evidently a preconceived plan not to participate any further in the action in Hong Kong).

7.  It is also common ground that from February 2009 the 1^st defendant became the sole administrator of the plaintiff’s UK multi‑currency bank account at HSBC which operated through an online platform called HSBCnet.

8.  The personal relationship between Ms Otto and the 1^st defendant came to an end in July 2010.  Notwithstanding this, the 1^st defendant continued to be involved in the affairs of the Group until Ms Otto’s suspicions were aroused in March 2011 by the 1^st defendant’s clandestine discussions with the plaintiff’s auditors in respect of the 2010 accounts.

9.  Ms Otto’s evidence is that an investigation was commenced by the plaintiff which revealed the 1^st defendant had misappropriated some EUR 1.8 million from the Group’s bank accounts which had ended up in accounts controlled by the 1^st defendant.  Of this a sum of EUR 200,000 had been transferred from the plaintiff’s HSBC account in London to an account at HSBC in Hong Kong in the name of the 2^nd defendant.  This was done by way of two remittances of EUR 100,000 made on 8 December 2010 and 25 January 2011 respectively.

10.  Ms Otto’s evidence was that she had discussed with the 1^st defendant the establishment of an office for the Group in Hong Kong but that nothing had been agreed or decided.  Specifically she had not authorised the 1^st defendant to establish any company in Hong Kong and she knew nothing about the existence of the 2^nd defendant until the investigation started in March 2011.

11.  The 1^st defendant’s evidence was to the effect that Ms Otto had delegated to him full power and authority to set up an office in Hong Kong.  He does not specifically say Ms Otto authorised him to establish the 2^nd defendant but suggests the establishment of the 2^nd defendant was part of the plan to set up an office in Hong Kong which would focus on business in China and the Asian market generally.  The 1^st defendant admits the transfer of the EUR 200,000 from the plaintiff to the 2^nd defendant but says this was an ancillary part of the opening of the Hong Kong office and was therefore authorised by Ms Otto and through her the plaintiff.

The history of the action

12.  In May 2011, the plaintiff obtained Norwich Pharmacal discovery against HSBC in Hong Kong which revealed that a significant portion of the EUR 200,000 was still in the HSBC account of the 2^nd defendant in Hong Kong.  The plaintiff followed up with a Mareva injunction which remains in place today.

13.  In its statement of claim the plaintiff pleads that the 1^st defendant owed to it fiduciary duties because in acting on behalf of the plaintiff he had been entrusted with and assumed the duties and responsibilities of a shadow director and a fiduciary. The plaintiff goes on to plead that in breach of such fiduciary duties the 1^st defendant had diverted the sum of EUR 200,000 to the 2^nd defendant and that he was obliged to account to the plaintiff for the loss it had suffered.

14.  As for the 2^nd defendant, the plaintiff alleges that as its director, shareholder and controlling mind is the 1^st defendant, it is impressed with all the knowledge of the 1^st defendant as to his breach of fiduciary duty and therefore is liable to the plaintiff under various legal theories including constructive trust, unjust enrichment and dishonest assistance.

15.  A defence was filed by the 1^st and 2^nd defendants asserting in essence that everything had been done with the approval and authority of the plaintiff and Ms Otto and denying any liability to account for the EUR 200,000 received.  Further, it was said the 2^nd defendant had performed business services for the plaintiff which were evidenced by invoices allegedly issued in December 2010 and January 2011.

16.  A pre‑trial review was held before Deputy High Court Judge Wilson Chan on 13 October 2016.  Other than the order regarding the certification of translations which I have referred to above, the usual directions were given as to witness statements standing as evidence‑in‑chief, the attendance of witnesses for cross‑examination failing which their witness statements would not stand as evidence‑in‑chief, the filing of trial bundles and the filing of opening submissions and lists of authorities.  Specifically the defendants were ordered to lodge and serve their opening submissions and list of authorities by close of business on 23 December 2016.  The trial date was fixed for a four‑day hearing starting on 10 January 2017.

17.  At the time of the pre‑trial review, the defendants were represented by solicitors.  Subsequently, the defendants’ solicitors were granted leave to come off the record so that from 12 December 2016 the defendants have been acting in person.  No opening submissions or list of authorities were filed by the defendants either by the prescribed time or at all.

18.  On 6 January 2017 at 6:46 pm the court received a fax from the 1^st defendant which followed up on a telephone call to the trial judge’s clerk earlier that day.  The fax was accompanied by what purported to be a medical certificate and a request was made for an adjournment of the trial.  Given the request for the court to grant an indulgence, both the letter and the medical certificate are worth quoting in full.

19.  The letter is on notepaper headed with the name of the 1^st defendant and an address in London.  It reads:

“Dear Mr. Yu

Due to acute illness, I will not be able to attend the court hearing on the 10^th of January. I am kindly asking to reschedule the court date. Please find attached the doctor’s certificate.

Sincerely

Bulent Bayram”

20.  The medical certificate is handwritten and reads:

“Hereby is certified, that Bulent Bayram is not fit for travel due to acute illness (Jan 05‑10).”

It has a chop with the name Dr med Andreas Stein, a description and an address in Berlin. Dr Stein describes himself in German in the chop as a specialist in general medicine.  The certificate is signed but not dated.

21.  I found the medical certificate to be almost worthless.  There is no evidence of when the examination of the 1^st defendant took place nor where.  Given the doctor has a surgery in Berlin and the 1^st defendant is writing from a London address there is an obvious question mark as to how the diagnosis was undertaken.  Of more concern is the fact there is no description whatsoever of the illness apparently being suffered nor what steps were taken to arrive at this diagnosis.  The purported proscription on travelling seemed conveniently designed to prevent the 1^st defendant being present on the first day of the trial.

22.  If the 1^st defendant had shown he was ready for trial and had produced cogent evidence as to the nature of his illness, I would have been more sympathetic to his request for an adjournment.  Given the 1^st defendant’s failure to comply with the order of Deputy High Court Judge Wilson Chan of 13 October 2016 and the fact he had allowed his solicitors to come off the record without replacing them, this late application for an adjournment struck me as being no more than a blatant attempt to put off the evil day when the 1^st defendant would have to account for his actions.

23.  Since the introduction of Civil Justice Reform, the authorities have been replete with judicial statements as to the importance of observing milestone dates and the fact regard must be had to the use of judicial and court time in the wider public interest rather than the narrower interests of particular litigants.  As I said, a litigant who has complied with all orders of the court and who has shown himself manifestly ready for trial will be listened to sympathetically if illness or some other mishap requires him to ask for an adjournment.  A litigant, such as the 1^st defendant here, who is patently trying to game the system will have a much harder task in putting off trial dates which have been fixed for months.  This is particularly so when the material in support of the adjournment application is, as here, flimsy in the extreme.

24.  I therefore rejected the application for an adjournment, which application was of course opposed by the plaintiff, and directed that the trial should proceed as scheduled.

25.  Mr Surman, counsel for the plaintiff, opened his case.  He then called Ms Otto who duly adopted her witness statement as her evidence‑in‑chief and answered a number of clarificatory questions from counsel.  The affidavit of David Chatterjee filed on 10 June 2015 was also admitted into evidence.  Although the 1^st defendant was not present, and therefore his witness statement was inadmissible by virtue of the order of Deputy Judge Wilson Chan, I nevertheless read it de bene esse.

26.  Before closing his case Mr Surman reflected on the precise role the 1^st defendant had played in the plaintiff and the Group and whether his existing pleading was necessarily broad enough to embrace my potential findings on the evidence. Mr Surman applied for leave to re‑amend the statement of claim to add that the 1^st defendant had, in the assumption of duties and responsibilities, become either additionally or alternatively a de facto director as well as a shadow director and a fiduciary.  I duly granted this application which did not appear to me to change the gravamen of the case against the 1^st defendant but was more a matter of legal fine tuning.

The nature of a fiduciary duty

27.  To make good its case, the plaintiff has to show that the 1^st defendant owed to it fiduciary duties and that he was in breach of those duties in causing the sum of EUR 200,000 to be remitted from the plaintiff’s bank account to the 2^nd defendant.

28.  In the off‑quoted dictum of Millett LJ (as he then was) in Bristol and West Building Society v Mothew [1998] Ch 1:

“A fiduciary is someone who has undertaken to act for and on behalf of another in a particular matter in circumstances which give rise to a relationship of trust and confidence.”

29.  It is the plaintiff’s own case that the 1^st defendant was never formally appointed as a director of the plaintiff nor of the Group.  Likewise he was never formally appointed as an employee.  However, in his own witness statement the 1^st defendant says he was involved in the management of the Group and he particularises the wide range of responsibilities which he says he had.

30.  Most of the authorities on shadow and de facto directors concern of course third parties dealing with a company and the issue is generally one of whether a particular individual has been sufficiently cloaked with ostensible authority such that his acts or representations are binding on the company.

De facto director

31.  The Supreme Court in England in HMRC v Holland [2010] UKSC 51 considered the circumstances in which a person should be regarded as a de facto director of a company. Lord Hope of Craighead reviewed the authorities and concluded:

“It is plain from the authorities that the circumstances vary widely from case to case. Jacob J declined to formulate a single decisive test in Secretary of State for Trade and Industry v Tjolle [1998] 1 BCLC 333, as he saw the question very much as one of fact and degree. He was commended by Robert Walker LJ in Re Kaytech International plc [1999] 2 BCLC 351, 423 for not doing so, and I respectfully agree that there is much force in Jacob J's observation. All one can say, as a generality, is that all the relevant factors must be taken into account. But it is possible to obtain some guidance by looking at the purpose of the section. As Millett J said in Re Hydrodam (Corby) Ltd [1994] 2 BCLC 180, 182, the liability is imposed on those who were in a position to prevent damage to creditors by taking proper steps to protect their interests. As he put it, those who assume to act as directors and who thereby exercise the powers and discharge the functions of a director, whether validly appointed or not, must accept the responsibilities of the office. So one must look at what the person actually did to see whether he assumed those responsibilities in relation to the subject company.”

32.  In the same case Lord Collins of Mapesbury reviewed the various tests which the courts had considered in deciding whether a person was a de facto director.  He concluded:

“A number of tests have been suggested of which the following are the most relevant. First, whether the person was the sole person directing the affairs of the company (or acting with others equally lacking in a valid appointment), or if there were others who were true directors, whether he was acting on an equal footing with the others in directing its affairs: Re Richborough Furniture Ltd. Second, whether there was a holding out by the company of the individual as a director, and whether the individual used the title: Secretary of State for Trade and Industry v Tjolle. Third, taking all the circumstances into account, whether the individual was part of ‘the corporate governing structure’: Secretary of State for Trade and Industry v Tjolle, at pp 343‑344, approved in Re Kaytech International plc [1999] 2 BCLC 351, 423, where Robert Walker LJ also approved the way in which Jacob J in Tjolle had declined to formulate a single test. He also said that the concepts of shadow director and de facto director had in common ‘that an individual who was not a de jure director is alleged to have exercised real influence (otherwise than as a professional adviser) in the corporate governance of a company’ (at p 424)…In fact it is just as difficult to define ‘corporate governance’ as it is to identify those activities which are essentially the sole responsibility of a director or board of directors, although perhaps the most quoted definition is that of the Cadbury Report: ‘Corporate governance is the system by which businesses are directed and controlled’ (Report of the Committee on the Financial Aspects of Corporate Governance, 1992, para 2.5).”

33.  In the subsequent English Court of Appeal case of In the matter of Mumtaz Properties Ltd [2011] EWCA Civ 610, Arden LJ, when analysing the question of whether a person’s role in the corporate governance of a company made him a de facto director, said one looks to see if the person “was one of the nerve centres from which the activities of the company radiated”.

Shadow director

34.  A shadow director is defined in section 2 of the Companies Ordinance (Cap 622) to be:

“…a person in accordance with whose directions or instructions (excluding advice given in a professional capacity) the directors, or a majority of the directors, of the body corporate are accustomed to act.”

35.  A similar statutory definition appears in section 251 of the English Companies Act 2006.  In Smithton v Naggar [2014] BCLC 1 602, Rose J summarised the authorities in England and the pithy recitation merits quoting in full:

“54. The leading authority on shadow directors is Secretary of State for Trade v Deverell [2001] Ch 340. The principles set out in the judgment of Morritt LJ can be summarised as follows:

i) The definition of a shadow director is to be construed in the normal way to give effect to the parliamentary intention ascertainable from the mischief to be dealt with and the words used. It should not be strictly construed;

ii) The purpose of the legislation is to identify those, other than professional advisers, with real influence in the corporate affairs of the company. But it is not necessary that such influence should be exercised over the whole field of its corporate activities;

iii) Whether any particular communication from the alleged shadow director, whether by words or conduct, is to be classified as a direction or instruction must be objectively ascertained by the court in the light of all the evidence;

iv) Non‑professional advice may come within that statutory description;

v) It is sufficient to show that in the face of ‘directions or instructions’ from the alleged shadow director the properly appointed directors or some of them cast themselves in a subservient role or surrendered their respective discretions. But it is not necessary to do so in all cases.

55. In Hydrodam Millett J said:

‘To establish that a defendant is a shadow director of a company it is necessary to allege and prove: (1) who are the directors of the company, whether de facto or de jure; (2) that the defendant directed those directors how to act in relation to the company or that he was one of the persons who did so; (3) that those directors acted in accordance with such directions; and (4) that they were accustomed so to act. What is needed is, first, a board of directors claiming and purporting to act as such; and, secondly, a pattern of behaviour in which the board did not exercise any discretion or judgment of its own, but acted in accordance with the directions of others.’

56. That summary of the law was considered recently by David Richards J in McKillen v Misland (Cyprus) Investments Limited (‘Coroin Limited’) [2012] EWHC 521 (Ch). There the claimant shareholder sought permission to amend an unfair prejudice petition and particulars of claim to allege that Sir David and Sir Frederick Barclay were de facto and shadow directors of Coroin Ltd.  The learned judge said (in paragraph 23 of his judgment) that two qualifications to that passage from the judgment of Millett J emerge from the authorities.  First, it is not necessary that all the directors should act in accordance with the directions of the shadow director.  It is enough that a majority do so.  Secondly, it is not necessary that the shadow director should exercise control through the instructions which he gives over all the matters which are decided by the board.”

Fiduciary

36.  In Reading v AG [1951] AC 507 the House of Lords held that an army sergeant who had used his uniform to facilitate lorries smuggling illicit spirits to avoid inspection was liable to account to the Crown for the money he had been paid by the smuggler because he owed a fiduciary duty to the Crown.  In so doing the judgment of Asquith LJ in the Court of Appeal [1949] 2 KB 232 was specifically referred to and approved.  In that judgment at page 236 Asquith LJ had sought to summarise when a fiduciary relationship might arise:

“a fiduciary relation exists (a) whenever the plaintiff entrusts to the defendant property…and relies on the defendant to deal with such property for the benefit of the plaintiff or for purposes authorised by him, and not otherwise and (b) whenever the plaintiff entrusts to the defendant a job to be performed…and relies on the defendant to procure for the plaintiff the best terms available.”

Application to the present case

37.  Bearing in mind these legal principles, I consider the 1^st defendant was clearly acting as a de facto director of the plaintiff, and thus owed to the plaintiff the same fiduciary duties as if he were an actual director.  One such duty is of course not to make a personal profit for himself at the expense of the company.

38.  I am not persuaded however that the 1^st defendant was a shadow director of the plaintiff.  The essential element of being a shadow director, as the name suggests, is that of pulling the strings from behind the stage in such a way that the actual directors are essentially puppets who move only in accordance with the way the strings are pulled.  Ms Otto was clearly not a puppet.  She ran the business and her companies through all the years of her relationship with the 1^st defendant and I do not think it can seriously be contended she was only doing so because the 1^st defendant was pulling the strings.

39.  In addition, I find that by assuming control of the plaintiff’s bank account, albeit with the agreement of Ms Otto as a director and controlling shareholder of the plaintiff, the 1^st defendant entered into a fiduciary relationship with the plaintiff.  This seems to be a classic example of the first of the two circumstances described by Asquith LJ which I have referred to above, namely the plaintiff reposing with the 1^st defendant its money on the understanding the 1^st defendant will use the money for the benefit of the plaintiff or for purposes authorised by the plaintiff.

40.  It is clear no decision had been made by Ms Otto to incorporate a company in Hong Kong.  Even if such a decision had been made there can be no credible reason why such company should have as its sole shareholder and director the 2^nd defendant. The 1^st defendant used the plaintiff’s money to establish the 2^nd defendant and in so doing was in breach of his fiduciary duty to the plaintiff.  To the extent, the 1^st defendant has profited thereby he must disgorge that profit to the plaintiff.

41.  The case against the 2^nd defendant is that it is impressed with knowledge of the 1^st defendant’s breach of fiduciary duty and breach of trust and is therefore liable to account to the plaintiff for any assets which are in its hands which it knows to be traceable to the breach of trust.  The 2^nd defendant is of course a company.  It can only have knowledge through the medium of its directors.  As the 1^st defendant is the sole director of the 2^nd defendant it must follow that the 2^nd defendant through the mind of the 1^st defendant, has knowledge of the 1^st defendant’s breaches of fiduciary duty and trust.

42.  In addition, in allowing itself to be the vehicle into whose name the plaintiff’s funds were sent, the 2^nd defendant knowingly assisted the 1^st defendant in his breach of fiduciary duty and is thus liable to compensate the plaintiff by way of equitable compensation for the loss it has suffered as a result of the 1^st defendant’s breach of fiduciary duty.

Relief

43.  As well as seeking monetary compensation for the loss it has suffered, the plaintiff also seeks equitable relief in respect of the interest it asserts it has in the 2^nd defendant. In short, the plaintiff asserts that its money was used to incorporate and establish the 2^nd defendant.  As that money derived from the 1^st defendant’s breach of trust, the plaintiff says it can trace the money into assets which have been bought using the money where such assets remain in the hands of the 1^st defendant.

44.  The plaintiff seeks various heads of relief relating to the shares in and books and records of the 2^nd defendant, all of which relief seems logically to flow from the assertion, if made good, that everything relating to the 2^nd defendant which is owned or held by the 1^st defendant is held on trust for the plaintiff. As I consider the plaintiff has made good the aforesaid assertion I am prepared to grant the consequential equitable relief which is sought in the prayer to the plaintiff’s re‑amended statement of claim save for two matters where I need to give reasons.

45.  First, the plaintiff seeks a declaration that it has a first and paramount lien on all shares in the 2^nd defendant registered in the name of the 1^st defendant.  It also seeks such ancillary relief as may be required to enforce the lien.

46.  Given that I propose to make a declaration that the 1^st defendant holds any shares in the 2^nd defendant on trust for the plaintiff and a consequential order requiring the 1^st defendant to deliver up such shares to the plaintiff, I do not see what extra benefit is gained by the plaintiff in having a declaration made that it has a lien over the shares.  I therefore decline to grant this head of relief.

47.  Secondly, the plaintiff also asks that the court order the 1^st defendant to resign as a director of the 2^nd defendant.  I was concerned as to whether I had jurisdiction to make such an order.  Mr Surman drew my attention to sections 728 and 729 of the Companies Ordinance.  The material parts of section 728 are as follows:

“(1) Section 729 applies, if in relation to a company —

(a) a person has engaged…in conduct that constituted…(iii) a breach specified in sub‑section (4)

…

(4) The breach specified for the purposes of section (1)(a)(iii)…is

(b) a breach of the person’s fiduciary or other duties as a director owed to the company.”

48.  If therefore a breach of fiduciary duty is established the jurisdiction of the court under section 729 is engaged.

49.  Section 729 reads:

“(1) The Court may…

(a) grant an injunction, on terms that the Court thinks fit —

(i) …requiring the person to do any act or thing.”

50.  This therefore vests in the court a wide power to make orders against a defaulting director who has been found to be in breach of fiduciary duty and this includes a power to order the director to perform a positive act.  I am satisfied therefore that I do have power to order the 1^st defendant to resign as a director of the 2^nd defendant.

Conclusion

51.  In conclusion I therefore make the following orders:

(1) A declaration that the defendants hold the sum of EUR 200,000 on trust for the plaintiff.

(2) An order that the defendants do pay to the plaintiff the sum of EUR 200,000.

(3) A declaration that the 1^st defendant holds on trust for the plaintiff shares in the 2^nd defendant registered in his name and the books and records of the 2^nd defendant.

(4) An order for delivery up to the plaintiff of any share certificates in or books or records of the 2^nd defendant in the possession, custody or control of the 1^st defendant.

(5) An order that the 1^st defendant resign forthwith as a director of the 2^nd defendant.

(6) An order the defendants do pay interest on the sum of EUR 100,000 from 8 December 2010 and on the sum of EUR 100,000 from 25 January 2011 until the date hereof at a rate of 1% over Hong Kong prime rate.

(7) An order that the defendants do pay the plaintiff the costs of this action to be taxed if not agreed.