WONG LUEN HANG AND ANOTHER v. TOPMIX (INTERNATIONAL) CO LTD AND OTHERS

HCMP 1064/2019

[2020] HKCFI 245

IN THE HIGH COURT OF THE

HONG KONG SPECIAL ADMINISTRATIVE REGION

COURT OF FIRST INSTANCE

MISCELLANEOUS PROCEEDINGS NO 1064 OF 2019

_______________

_______________

_______________

AND

HCMP 1065/2019

IN THE HIGH COURT OF THE

HONG KONG SPECIAL ADMINISTRATIVE REGION

COURT OF FIRST INSTANCE

MISCELLANEOUS PROCEEDINGS NO 1065 OF 2019

_______________

_______________

_______________

(Heard Together)

______________

D E C I S I O N

______________

1.  These are the applications made by the plaintiffs, Mr Wong Luen Hang (“Wong”) and Mr Tsui Kwok So (“Tsui”) (together “Ps”), for an order under section 740 of the Companies Ordinance (Cap 622) (“CO”) to allow them (or their agents) to inspect and make copies of the records and documents of 2 companies, Topmix (International) Company Limited (“TICL”) and Topmix Industrial Limited (“TIL”), as described in the Schedules to the Originating Summonses dated 22 July 2019.

2.  TICL and TIL have been named as the 1^st defendant in both proceedings and they are represented by same legal team as Mr Chan Yuk Lung and Mr Chan Yuk Wai, who are respectively the 2^nd and 3^rd defendants.  As the stance taken by the defendants is the same, I will refer to them as “Ds”.  Where relevant, the 2^nd and 3^rd defendants will be referred to as “Chans”, and TICL and TIL together will be referred to as “Companies”. 

3.  The evidence was completed on 10 December 2019 when Ps filed the 2^nd Affirmation of Tsui (“Tsui 2^nd”). On 24 December 2019, Chans issued a summons to seek leave to file a second affirmation of the 3^rd defendant dated 23 December 2019 (“Chan 2^nd”) in opposition to the applications.  I refused to allow Ds to file and rely on Chan 2^nd as they have not been able to identify any new allegations raised by Ps in Tsui 2^nd to which they are entitled to respond, quite apart from the fact that it was adduced late. 

A.      BACKGROUND FACTS

4.  Wong is the father-in-law of Tsui.  Chans are brothers[1].

5.  TICL and TIL are Hong Kong companies and were incorporated in 1993 and 2003 respectively.  They engaged in the business of production and sale of carbon fibre automobile body parts in Hong Kong and the Mainland and were profitable until 2011. 

6.  Ps and Chans are equal shareholders in the Companies with each camp holding 50% of their shares.  Ps and Chans were directors of the Companies until 25 March 2006 when Tsui was removed as a director.  Although Chans claim that they held their position “in name only” and had no involvement in the management of the Companies, it is not in dispute that since the removal of Tsui, Chans have assumed complete control over the Companies. 

7.  TIL operated a factory in the Mainland through a wholly owned subsidiary, Dongguan Yik Cheong Fabric Manufacturing Factory (“Subsidiary”) which had 100 employees.  The Subsidiary held the lease of the premises used by the factory.  The 2^nd defendant was in charge of the factory.

8.  Faithful Rainbow Limited (“FRL”) was incorporated in Hong Kong in November 2011 and commenced its business of assembling automobiles in March 2012. 

9.  Ps claim that the 3^rd defendant controlled FRL through his friends or acquaintances, and most of the business and assets of the Companies have been wrongfully transferred to FRL.

10.  Pursuant to an agreement dated 1 June 2014 signed by the 2^nd defendant, TIL sold the entire equity of the Subsidiary to FRL for HK$5 million.  Ps say that the sale was made at an undervalue.

11.  Since 2007, the parties have been embroiled in various litigations which included:

(1) HCA 2654/2007, a derivative action brought by Ps on behalf of TICL against Chans (“2007 Action”).  After a full trial before Reyes J, on 30 April 2012, the 2007 Action was dismissed.  Ps were ordered to pay 80% of the costs incurred by Chans.

(2) In August 2011, Ps brought a derivative action on behalf of TIL against Chans (and others) in HCA 1382/2011 (“2011 Action”).

(3) In July 2015, Ps brought a further derivative action on behalf of TICL and TIL against Chans (and others) in HCA 1265/2015 (“2015 Action”). 

12.  In the 2015 Action, Ps applied for appointment of receivers over the Companies, which was dismissed by DHCJ Le Pichon on 11 March 2016 primarily on the grounds that (1) the assets which Ps said were in need of preservation and protection had already been dissipated, (2) Ps had not adduced “solid evidence” of risk of dissipation of assets on the part of FRL, which was said to be holding the business and assets derived from the Companies as their constructive trustee, (3) the Companies and FRL had offered undertakings not to deal with their assets other than in the ordinary course of business and for fair market value until final disposal of the action; and (4) the risk of damage to FRL if the appointment were made was not one which could adequately be compensated by damages, and the Companies did not appear to have the financial means to honour their cross undertaking as to damages.     

13.  The 2011 Action and 2015 Action have since been consolidated (“Consolidated Action”) and are still ongoing. 

14.  On 31 January 2015, the Companies ceased to carry on business. 

15.  The auditors of the Companies have disclaimed their opinions on each of the audited financial statements of the Companies for the years ended 31 March 2015, 2016, 2017 and 2018 (respectively “2015 AFS”, “2016 AFS”, “2017 AFS” and “2018 AFS”) essentially on the bases that they had not been able to obtain sufficient appropriate audit evidence on the specific areas identified in their reports.   

16.  According to Chans, since the cessation of the Companies’ business, they have been using their own funds to pay the expenditures of the Companies including legal expenses, audit fees and severance payments to employees.  

17.  Since January 2016, Ps have been raising queries on the relevant AFS, both at the annual general meetings (“AGM”) and through extensive correspondence exchanged with Ds.  It suffices to say that despite these queries, Chans have not provided comprehensive or consistent responses in respect of the following issues:

(1) The legal expenses incurred or said to have been incurred by the Companies in the 2007 Action, the 2011 Action and the 2015 Action (“Legal Expenses Issue”);

(2) The substantial increase in the amounts stated to have been owed by the Companies to Chans in the relevant AFS (“Directors’ Debts Issue”); and

(3) The debts and receivables of the Companies due to and from FRL (“FRL Debts Issue”).

18.  Against this background, Ps want to inspect the documents of the Companies concerning the aforesaid issues which, they say, require investigation so as to protect their economic interests as shareholders. 

19.  In the Schedules to the Originating Summonses, Ps also seek  (1) all management accounts and ledgers of the Companies for the years ended 31 March 2015 to 2018; and (2) in respect of TIL, all records relating to the amounts due to or from the Subsidiary for the years ended 31 March 2014 and 2015.  

B.      APPLICABLE PRINCIPLES

20.  The principles governing application under section 740 of the CO are well established and have been sufficiently stated in Re China Oriental Group Company Limited [2018] HKCFI 2066 at §§10 – 11 (per Ng J) as follows:

“10. First, in Re Bank of East Asia Ltd [2015] 4 HKC 137 at [25] and [26], Harris J summarized the relevant principles as follows:

(1) The ‘good faith’ and ‘proper purpose’ requirements constitute two separate and independent tests. The applicant must first, establish that he is acting in good faith and second, the court must believe the circumstances are such that the inspection sought is for a proper purpose.

(2) The burden of proof is borne entirely by the applicant.

(3) Section 740 is not an opportunity for shareholders to challenge the commercial decisions of the company’s management.

(4) In order to satisfy the ‘proper purpose’ criteria, it is not necessary to satisfy the court that the applicant has a specific or personal right that can only be protected through the inspection of records. A wish to inspect documents to investigate a genuine and credible belief that there has been corporate mismanagement is capable of constituting a proper purpose.

(5) Generally, where the court is satisfied that the ‘purpose’ is germane to a shareholder’s economic interest in the company a ‘proper purpose’ will have been satisfied.

(6) The court should be inclined to a liberal interpretation of ‘proper purpose’ with a view to advancing the protection of shareholder rights and interest and the maintenance of appropriate standards of corporate governance. This is particularly true in the case of publicly listed companies. The court should be more willing to grant inspection orders to protect the interests of members in publicly listed companies.

(7) As part of establishing a proper purpose, the applicant has to show that there is ‘a sufficiently reasonable case for investigation’ as regards past or future wrongful or other undesirable conduct. The shareholder may fail to obtain inspection where he fails to make out on his own material some kind of case for investigation, or where the corporation is able by leading evidence to dispel whatever suspicion has reasonably been aroused.

(8) Once the court is satisfied that the applicant has established a ‘proper purpose’, the company should be required to be transparent.

(9) The court is not required and should not endeavor to reach conclusions about the merits of the matters relied on as constituting a ‘proper purpose’. The court needs to be satisfied that a proper purpose has been established and that in the exercise of the court’s discretion it is a proper case in which to make an order for inspection.

11. Second, in Leung Chung Pun v Masterwise International Ltd [2014] 1 HKLRD 1129 at [25], Recorder Anderson Chow (as he then was) explained why the court should refrain from reaching conclusions on the merits of the applicant’s case on ‘proper purpose’ and how the court should exercise its discretion once a proper purpose is established:

‘Where, as in the present case, the application for inspection of a company’s records is for the purpose of enabling the plaintiff to carry out investigation into alleged misconduct or maladministration, it would not be possible or appropriate for the court to reach a firm conclusion on each complaint raised because, amongst other things, the evidence would likely not be complete, it is unlikely that disputes of fact can be resolved on affidavit evidence alone, and the complaint may well be raised again in subsequent proceedings for adjudication.  Accordingly, what I consider the court should do is to assess, on the basis of the available evidence, whether the plaintiff has made out a proper case for investigation taking into account such explanations as may be offered by the defendant.   If the plaintiff is able to make out a proper case for investigation, the court should move on to consider whether, in the exercise of its discretion, the inspection sought ought nevertheless to be refused.  The statute does not lay down any restriction as regards the matters which the court may take into account when exercising its discretion.  Thus, the court is entitled to take into account a wide spectrum of matters.  However, as cautioned by Harris J in Wong Kar Gee Mimi v Hung Kin Sang Raymond (supra), [34]‑[37], the court should strike a proper balance between (i) requiring the company to be transparent and (ii) not permitting the statutory jurisdiction to be used by a shareholder to challenge managerial or commercial decisions made by the board of directors of the company.  How this balance should be struck in any given case can only be determined on a case by case basis.’ (emphasis added)”

21.  Further, Mr Alan Kwong[2] submits and I agree that in considering an application under section 740, the court should also consider the following matters:

(1) The utility of the inspection, in that the court may refuse to exercise its discretion to permit inspection if it is satisfied that nothing of utility will come from the inspection (Leung Chung Pun v Masterwise International Ltd & Ors [2014] 1 HKLRD 1129 at §18 (per Recorder A Chow SC, as he then was).

(2) The procedure for inspection under section 740 “is not a form of and should not be used as a substitute for discovery” in civil litigation (Lehman & Co Management Ltd v Efficient Ltd [2011] 5 HKLRD 668 at §41 (per Chu JA)).

(3) Section 740 does not allow a shareholder to go on a “fishing expedition through vast amounts of the company’s records in search of a cause of action to support his mere suspicion of wrongdoing” (Wong Gar Kee Mimi v Hung Kin Sang Raymond [2011] 5 HKLRD 241 at §40 (per Harris J)).

C.      DISCUSSION

22.  There is no dispute that Ps, as long time shareholders, have economic interests in the Companies which they are entitled to protect and  if Ps make out a reasonable case for inspection of the 3 issues, that constitutes a proper purpose of the application.  The dispute between the parties is whether there is a need to investigate the 3 issues and, in respect of the Legal Expenses Issue, whether it is an abuse of process for Ps to bypass the discovery process in the 2015 Action and seek documents relating to such Issue in these applications. 

23.  The documents sought in the applications are in the main  documents relating to the 3 issues summarised in §17 above to which I now turn. 

C1.    Legal Expenses Issue

24.  According to the 2015 AFS and 2016 AFS and taking into account Chans’ repayment, the legal expenses incurred by the Companies were:

TICL
2015 AFS	2007 Action	HK$1,870,000
2016 AFS	2015 Action	HK$228,000[3]
TIL
2015 AFS	2011 Action	HK$600,000
2016 AFS	2015 Action	HK$200,000

25.  Further, Ps say that according to Note 10 to the 2018 AFS, TICL and TIL had incurred legal expenses of HK$2 million and HK$3 million respectively.

26.  Mr Terence Tai[4] submits that the substantial legal expenses charged to the Companies are “inexplicable” and Ps have reasonable ground to investigate the propriety of such expenses, in light of the following matters:

(1) The Companies are nominal parties in the derivative actions and, therefore, should have adopted a neutral stance in such actions.  

(2) The 2007 Action was concluded in 2012, and by 2015, the only outstanding matter was the taxation hearing between Ps and Ds. As such, it was unreasonable for the Companies to have incurred any legal expenses in respect of the 2007 Action in 2015. 

(3) The auditors stated in their opinion on TICL’s 2015 AFS that “[they] were unable to carry out audit procedures [they] considered necessary to obtain all the information and explanations to verify the accuracy, occurrence and the completeness of the legal and professional fee of HK$1,870,452 in the income statement for the year ended March 31, 2015. There were no other satisfactory audit procedures that [they] could adopt to verify the accuracy, occurrence and the completeness of the expense”.   

(4) Similarly, in respect of the HK$400,000[5] incurred by TICL in the 2015 Action, the auditors stated in their opinion on TICL’s 2015 AFS that “[they] were unable to obtain the relevant invoices to ascertain the nature and accuracy of the amount.  There were no other satisfactory audit procedures that [they] could adopt to verify the amount”.

(5) The same qualified opinion was stated in respect of the HK$600,000 in TIL’s 2015 AFS.  

27.  Mr Tai further submits that Chans were generally unwilling to explain how the Legal Expenses were incurred by the Companies and when they attempted to explain, their explanations are “inconsistent and difficult to fathom”.  For example:

(1) In response to Ps’ request (made on 12 January 2016) for a detailed breakdown of the HK$1.87 million legal expenses, Chans simply referred to the auditors’ letter dated 12 February 2016, which stated that the sum related to the 2007 Action but did not provide any particulars or breakdown. 

(2) In their letter dated 18 March 2019, Chans stated that the HK$1.87 million related to the 2015 Action and was “only a provision of estimated legal and incidental expense which has not been paid out by [TICL]”. 

(3) In Chan 1^st §34(1), they changed their stance and said that the HK$1.87 million was the costs recovered by Chans from TICL as reimbursement of the costs incurred by them in defending the 2007 Action; and the reference to the 2015 Action in their earlier letter of 18 March 2019 was erroneous. 

(4) Chans are not entitled to seek reimbursement from TICL as Ps have already paid the taxed costs in full (being HK$1,472,350.40) to Chans.  

28.  Mr Kwong on the other hand submits that Ps should not be allowed to inspect the documents relating to the Legal Expenses Issue for the following reasons.

29.  First, it is said that the Legal Expenses Issue is the subject matter of the Consolidated Action as Ps have claimed that the sums of HK$1.87 million, HK$400,000 and HK$600,000 were legal expenses incurred by Chans but wrongfully charged to the Companies.  As such, the relevant documents will be disclosed by way of discovery and it is a waste of time and costs for Ps to bypass the discovery procedure and seek the same documents through the use of a section 740 application.  Putting it in another way, there is no utility for the court to make an “additional order” to require Chans to “make extensive disclosure at this stage”.

30.  Second, Chans have already answered the complaint and there is nothing further to investigate, taking into account the following matters:

(1) Chans were successful in the 2007 Action and, as such, they were entitled to recover their costs from TICL “in accordance with the company policies”, as stated in their letter dated 26 January 2018.

(2) By 2015, the costs which Chans were entitled to recover from Ps in the 2007 Action had not been taxed, and the auditors suggested that a “provisional estimate” should be stated in TICL’s 2015 AFS to reflect the fact that they would be recovering their costs from TICL.  This was explained in their letter dated 18 March 2019. 

(3) As TICL did not have any “circulating fund” to pay Chans, the costs incurred by Chans in the 2007 Action were recorded in TICL’s 2015 AFS as director’s loan.

(4) Ds do not dispute that the Companies are nominal parties in the 2011 Action and 2015 Action, and the legal expenses in the amounts set out in the table in §24 above were recorded in the Companies’ 2015 and 2016 AFS.  They say that “it is normal to have the costs because the legal representatives are required to respond in the litigation” and specifically, the HK$228,000 and HK$200,000 recorded in TICL and TIL’s 2016 AFS were mainly used to deal with Ps’ application for appointment of receivers.  

(5) The HK$8 million and HK$12 million stated in the 2018 AFS were estimated legal expenses of TICL and TIL respectively.  The auditors stated that of these estimates, HK$6 million and HK$9 million had not been incurred, but the auditors “could not find out in 2018 AFS that the [Companies] had indeed paid HKD2 million and HKD3 million for the costs”, and there are no records showing the same. 

31.  Third, it is said that the scope of the documents sought by Ps is “unduly wide”, and there is no basis for Ps to seek all the management accounts and ledgers of the Companies from 2015 to 2018. 

32.  In my view, Ps have a reasonable basis to be concerned about the propriety of the legal expenses recorded in the Companies’ 2015 to 2018 AFS and have made out a proper case for investigation of the Legal Expenses Issue for the following reasons.

33.  First, the directors, being responsible for the management of the company’s business, are under a duty to keep proper accounting records, to prepare financial statements and to explain the transactions recorded in the financial statements to the shareholders, particularly at general meeting at which they are laid.  This is reflected in the following provisions of the CO:

(1) Section 373(1) – (3) provides that:

“(1) A company must keep accounting records that comply with subsections (2) and (3).

(2) The accounting records must be sufficient –

(a) to show and explain the company’s transactions;

(b) to disclose with reasonable accuracy, at any time, the company’s financial position and financial performance; and

(c) to enable the directors to ensure that the financial statements comply with this Ordinance.

(3) In particular, the accounting records must contain –

(a) daily entries of all sums of money received and expended by the company, and the matters in respect of which the receipt and expenditure takes place; and

(b) a record of the company’s assets and liabilities”.

(2) Section 379 provides that directors must prepare financial statements for each financial year that comply with sections 380 and 383;

(3) Section 380 provides that the financial statements must give a true and fair view of the financial position (including the financial performance) of the company as at the end of the financial year;

(4) Section 429 provides that the directors must, in respect of each financial year, lay before the company in general meeting, the financial statements, while section 430 provides that copies of the financial statements must be sent to the shareholders at least 21 days before the general meeting at which the copy is required to be laid; and

(5) Section 448(2) provides that a director is liable to compensate the company for any loss suffered by the company as a result of (a) any untrue or misleading statement in the report; or (b) the omission from the report of anything required to be included into it, if he had the requisite knowledge prescribed in subsection (3).

34.  The duty on the part of the directors to answer questions raised by the shareholders at general meeting at which financial statements are laid is mandated by the fact that if the shareholders are not satisfied with the answers provided by the directors, they can exercise their voting right not to approve the financial statements.  Indeed, it is an important aspect of proper governance that shareholders can require the directors to explain the transactions recorded in the financial statements in a satisfactory, coherent and consistent manner.  This is particularly so where the transactions recorded were of significant magnitude (as compared to the net assets of the company) or appear to be outside the ordinary course of business but  no or inadequate explanation has been provided in the reports of the directors or the notes to the financial statements.  

35.  In these proceedings, it has been asserted time and again by Chans that it was the “suggestion” or responsibility of the auditors to record the transactions in the way they appeared in the Companies’ AFS.  Such assertion is wrong in law as it is based on a misapprehension that the responsibility of preparing proper financial statements is on the auditors, when the relevant provisions under the CO (as summarised in §33 above) imposed such duties on the directors.  It is also wrong on the fact because in each of the auditors’ reports appended to the Companies’ 2015 to 2018 AFS, it was clearly stated that “[t]he directors are responsible for the preparation of financial statements in accordance with [the relevant reporting standard] and the Hong Kong Companies Ordinance, and for such internal control as the directors determine is necessary to enable the preparation of financial statements that are free from material misstatement, whether due to fraud or error”.   

36.  Indeed, in each of the auditors reports to the Companies’ 2015 – 2018 AFS, they stated that “the directors are responsible for the preparation of the financial statements in accordance with the [relevant accounting standard] and the Hong Kong Companies Ordinance”.  After having reviewed the Companies’ 2015 – 2018 AFS, the auditors specifically disclaimed their opinion on the legal expenses of the Companies.  These disclaimers support Ps’ case that there is a reasonable basis to investigate the Legal Expenses Issue.

37.  Second, it is not in dispute that the Companies, being nominal parties, have not taken any active steps in the 3 derivative actions.  In my view, Ps are justifiably concerned about the legitimacy of the legal expenses recorded in the Companies’ 2015 and 2016 AFS and require such matter to be properly investigated:

(1) In respect of the HK$1.87 million recorded in TICL’s 2015 AFS, Chans now accept that it represents the legal expenses incurred by them in defending the 2007 Action and that they have already received payment of HK$1,472,350.40 from Ps.  That being the position, unless Chans can establish their right to look to TICL to indemnify them of all the costs incurred (which I will address at §38 below), Ps must be allowed to investigate the transactions relating to these expenses.   

(2) As for the HK$228,000 and HK$200,000 said to have been incurred by the Companies in defending the 2015 Action, while I accept that some costs might have been incurred by the Companies in defending the application for appointment of receivers, I would expect such costs to be insignificant, given that the same legal team was engaged by Chans, FRL, 3 other defendants associated with FRL and the Companies in resisting the application and many of the allegations were directed against Chans and the persons said to be associated with them.  Indeed, the suggestion that the entire legal expenses in the amounts of HK$228,000 and HK$200,000 were incurred by the Companies in defending the application for appointment of receivers only surfaced, for the first time, in Chan 1^st.  Even then, Chans did not exhibit any document in support of their assertion that the entire amounts should be borne by the Companies but not the other defendants. 

(3) As regards Ps’ complaint about the legal expenses described in Note 9(b) of TICL’s 2018 AFS and Note 10 of TIL’s 2018 AFS which, they say, show that legal expenses of HK$2 million and HK$3 million had already been incurred by TICL and TIL respectively, I do not think the position is as clear as Ps contend.  These Notes described the “contingent liabilities and commitments” of the Companies, and it is clear from the Income Statements and their Note 4 (which set out the details of the expenses) that no legal expenses were incurred by the Companies in the year ended 31 March 2018. Nevertheless, I accept that given the way Note 9(b) and Note 10 was drafted, and the bizarre explanation provided by Chans (see §30(5) above), there is a need to investigate the Legal Expenses Issue up to the year ended 31 March 2018.

38.  Third, as matter now stands, I do not think that Chans have established their right to seek indemnity from the Companies in respect of the costs incurred by them in defending the 3 derivative actions:

(1) I do not accept the bare assertion, in Chan 1^st, that Chans are entitled to seek indemnity of their costs in accordance with the (unidentified) “company policies”.

(2) At the hearing, Mr Kwong relies on Chan 2^nd (which I disallow) and contends that Chans are entitled to seek indemnity from TICL in respect of all their costs incurred in defending the 2007 Action under regulation 137 of Table A (which applies to TICL).  The contention seems to have overlooked the effect of section 468(3) of the CO, which provides that a provision to provide an indemnity for a director of the company against any liability attaching to the director in connection with any negligence, default, breach of duty or breach of trust in relation to the company is void.  It is unclear, and Chans have not attempted to address, why in light of section 468(3), they are entitled to (a) use the Companies’ funds to pay the costs incurred by them in defending the derivative actions, whether before or after final determination by the court, or (b) recover the costs disallowed by Reyes J on the basis that they were not wholly successful in their defence.  

39.  Fourth, I do not accept Ds’ assertion that the documents relating to the Legal Expenses Issue will be disclosed in the course of discovery in the Consolidated Action.  While it is true that Ps have  complained about the legal expenses incurred by the Companies in the 2015 Action (i.e. the HK$1.87 million, HK$400,000 and HK$600,000), the fact remains that to-date, no document relating to such complaint has been disclosed by Ds.  This is despite the fact that the 2015 Action was commenced more than 4 years ago.  It lies ill in Ds’ mouth to say that the documents sought by Ps will be disclosed in due course or that it is a waste of time and costs for Ps to seek such documents in these proceedings. 

40.  Fifth, I do not agree that the documents sought in relation to the Legal Expenses Issue is “unduly wide”, as the description is directed to documents relating to the legal expenses incurred by the Companies for the years ended 31 March 2015 to 2018.   

C2.    Directors’ Debts Issue

41.  It is not in dispute that despite the Companies’ cessation of business in January 2015, there was a substantial increase in the Directors’ Debts, as recorded in the Companies’ 2015 – 2018 AFS:

Amount due	As at 31.3.2014	As at 31.3.2015	As at 31.3.2016	As at 31.3.2017	As at 31.3.2018
TICL	(200,000)	1,223,071	847,471	1,447,471	1,147,471
TIL	76,556	1,168,406	1,209,556	1,309,556	909,556

42.  Ps’ case is that they became concerned about the sudden increase in the Directors’ Debts by HK$2.5 million within a year, after they had been provided with the Companies’ 2015 AFS.  Since then, they have been asking Chans to explain the reasons for the increase and specifically, whether the increase was attributed to the legal expenses charged to the Companies and, if so, whether Chans were willing to reverse such legal expenses charged but to no avail.

43.  Mr Tai argues that in respect of the Directors’ Debts Issue, Chans’ explanations have been changing and far from satisfactory in that:

(1) At the 2015 AGM, Chans said that the Directors’ Debts consisted of legal expenses.  In their letters of 18 February 2016, Chans said that the increase in the Directors’ Debts was primarily due to the legal costs incurred by the Companies in the 3 derivative actions.

(2) At the 2016 AGM, Chans asked Ps to write to the auditors to clarify what the Directors’ Debts related to, but when Ps pressed Chans to explain these Debts, they refused to give any constructive response.

(3) At the 2017 AGM, Ps asked Chans if they would reverse the legal expenses charged to the Companies (and hence reduce the Directors’ Debts), Chans refused to respond to their request.  In their letter dated 26 January 2018, Chans asserted, for the first time, that at least half of the Directors’ Debts comprised “previous outstanding salary, severance and/or long service payment payable to our directors”.

(4) While it remains unclear what gave rise to the increase in the Directors’ Debts, Chans had apparently caused the Companies to repay at least HK$1 million to themselves.  

44.  Mr Kwong submits that there is nothing to investigate in respect of the Directors’ Debts Issue as Chans “have already responded to all the pertinent issues”. 

45.  I do not agree.  As discussed in §§33 – 35 above, as directors of the Companies, Chans are under a duty to prepare financial statements which give a true and fair view of the financial performance of the Companies and to answer questions raised by the shareholders on such statements.  The duty to explain is all the more acute where the transactions concerned were ones in which the directors were interested.  The inconsistent responses identified by Mr Tai (which Mr Kwong does not dispute) show that Chans have failed to discharge their duties in this regard.  One would expect if the directors considered the answers previously provided by them to be incorrect, they should at the minimum set out detailed responses to explain the inconsistencies, and provide documents in support of their latest answers.  Neither has been done by Chans.  

46.  For the above reasons, I consider that Ps have made out a reasonable case for requiring the documents sought to assist their investigation of the Directors’ Debts Issue.

C3.    FRL Debts Issue

47.  As stated in §10 above, the Subsidiary was transferred to FRL pursuant to an agreement dated 1 June 2014 signed by the 2^nd defendant on behalf of TIL.  On 31 January 2015, the 3^rd defendant joined FRL as its operation director.  According to the auditors’ letter dated 12 February 2016, FRL was both a customer (as to raw materials) and supplier (as to finished goods) of the Companies.

48.  In February 2016, Chans disclosed a tri-partite settlement agreement (“Settlement Agreement”) which, on its face, shows that the amount recorded as due by TICL to FRL (HK$441,468) and the amount recorded as due by FRL to TIL (HK$2,469,148) were “set-off” and settled with 10 post-dated cheques dated between February and November 2016.  

49.  However, Chans did not cash in the post-dated cheques until much later, in 2018-2019[6] owing to, inter alia, the “friendly relationship” between Chans and FRL and the unfavourable economic condition of the market.

50.  Against the above fact (which is not in dispute), Mr Tai submits that Chans, being directors of both the Companies and FRL, are in a position of conflict and, therefore, ought to make full disclosure of how the debt owed by TICL to FRL (HK$441,468) and the debt owed by FRL to TIL (HK$2,469,148) arose, and to provide documents to explain the basis for entering into the Settlement Agreement (which allowed a “set-off” of these 2 sums) and how the amounts were subsequently repaid and accounted for. 

51.  Mr Kwong submits that the FRL Debts Issue is not a “live issue”, in light of the following matters which he says are “unchallenged”:

(1) Ps have not suggested any misconduct on the part of Chans in relation to the debt owed by FRL to TIL (i.e. HK$2,469,148).  They are not entitled to challenge “managerial decisions” made by the directors;

(2) Chans have explained that the debt arose from purchase of automobile parts;

(3) Chans agreed to extend the time for FRL to repay the amount due gradually owing to the unfavourable environment; and

(4) As reflected in TIL’s 2015 to 2018 AFS, FRL did gradually repay the debt to TIL, and the amount was fully repaid by 2019. 

52.  I do not think it is right for Mr Kwong to say that Chans’ evidence on the FRL Debts Issues is “unchallenged” or that Ps have not alleged any misconduct against Chans.  Both in Tsui 1^st and Tsui 2^nd, Ps have complained about the FRL Debts Issue in particular, (1) the fact that Chans are in a position of conflict, (2) the inconsistent explanations provided about the FRL Debts, including the set-off and other form of alleged repayment, and (3) the amount received by Chans in settlement of the Directors’ Debts.    

53.  For the same reasons set out in §§33 – 35 above, I consider that Chans were (and still are) under a duty to explain the FRL Debts Issue.  The duty is heightened given that they are in a position of conflict.  As a result of their failure to discharge such duty, and the inconsistent explanations given by them in the past 3 years, the position remains entirely opaque.  In the circumstances, Ps must be entitled to investigate the FRL Debts Issue.

C4.    Other documents sought by Ps

54.  In both applications, Ps sought all “management accounts and ledgers of the [Companies] for the financial years ended 31 March 2015, 2016, 2017 and 2018”. 

55.  In effect, Ps are seeking to inspect all the books of accounts of the Companies from 2015 to 2018.  No evidence has been put forward in Tsui 1^st or Tsui 2^nd to justify a wholesale inspection of all the books of accounts of the Companies.  Nor has Mr Tai in his 2 sets of submissions made any attempt to justify an inspection of such a wide scope.  This seems to be a fishing expedition on the part of Ps which is not permissible in a section 740 application.

56.  Ps also ask for “records of the amount due from or owed to [the Subsidiary] for the financial years ended 31 March 2014 and 2015 including, without limitation, relevant bank statements, ledgers, internal notes and records and auditors’ breakdown” and “all records evidencing” the same debts.  I do not think Ps have made out a case for a need to inspect these documents, as neither their affirmations nor Mr Tai’s skeletons have raised this as an issue which requires proper investigation.  Although Mr Tai points to §40 of his skeleton where reference is made to the HK$4,348,913 as the “amount due from a subsidiary” which was written off in TIL’s 2015 AFS, this submission is in the context of the need to investigate the FRL Debts Issue, rather than as a self-standing issue. 

D.      DISPOSITION

57.  At the hearing, Mr Tai hands up 2 draft orders with proposed wordings on the form of order to be made by this court should Ps’ application be successful.  Mr Kwong does not object to the wordings proposed or the time for compliance with the order. 

58.  For the reasons discussed in Section C of this Decision, I am satisfied that Ps should be allowed to inspect the documents relating to the 3 issues identified in §17 above. I make the following order in each of the proceedings:

(1) The 1^st to 3^rd defendants shall within 14 days of this order (a) produce or caused to be produced to the plaintiffs (or their authorised representatives) for their inspection all the documents listed in the Schedule hereto, whether in printed or electronic form or any other form, and (b) permit copies of the same to be taken by the plaintiffs (or their authorised representatives);

(2) Liberty to apply; and

(3) There be a costs order nisi that the costs of and occasioned by the originating summons including the costs of the hearing on 31 December 2019 be paid by the 2^nd and 3^rd defendants, to be taxed if not agreed.  

59.  I consider that the costs of the applications should be borne by the 2^nd and 3^rd defendants, as the Companies are in effect nominal defendants and all the evidence and grounds of opposition are put forward by Chans on the basis that the issues identified by Ps do not require investigation, and they have failed in their opposition. Although Ps have not been successful in seeking the other documents (discussed in Section C4), as I said, neither the evidence nor the submissions are directed to such documents and not much time is devoted to it during the hearing. 

SCHEDULE

(to the Order in HCMP 1064/2019)

1. All records of breakdown of the “amount owed to the directors” by TICL, as stated in the audited financial statements of TICL, for each of the financial years ended 31 March 2015, 2016, 2017 and 2018 including relevant bank statements, ledgers, internal notes and records.

2. All records evidencing the “amount owed to the directors” by TICL, as stated in the audited financial statements of TICL, for each of the financial years ended 31 March 2015, 2016, 2017 and 2018 including relevant bank statements, all invoices, receipts and payment records in relation to sums advanced by the directors to TICL and payments made by the directors on behalf of TICL.

3. All solicitors’ bills, invoices, receipts, breakdown of work done and payment records of legal expenses incurred by TICL for each of the financial years ended 31 March 2015, 2016, 2017 and 2018 including relevant bank statements and ledgers.

4. Records of breakdown of the sum of HK$441,468 purportedly owed by TICL to Faithful Rainbow Limited in the financial year ended 31 March 2015 including relevant bank statements, ledgers, internal notes and records.

5. All records evidencing the sum of HK$441,468 purportedly owed by TICL to Faithful Rainbow Limited in the financial year ended 31 March 2015 including relevant bank statements, records of payment, invoices, receipts, quotation and delivery notes.

SCHEDULE

(to the Order in HCMP 1065/2019)

1. All records of breakdown of the “amount owed to the directors” by TIL, as stated in the audited financial statements of TIL, for each of the financial years ended 31 March 2015, 2016, 2017 and 2018 including relevant bank statements, ledgers, internal notes and records.

2. All records evidencing the “amount owed to the directors” by TIL, as stated in the audited financial statements of TIL, for each of the financial years ended 31 March 2015, 2016, 2017 and 2018 including relevant bank statements, all invoices, receipts and payment records in relation to sums advanced by the directors to TIL and payments made by the directors on behalf of TIL.

3. All solicitors’ bills, invoices, receipts, breakdown of work done and payment records of legal expenses incurred by TIL for each of the financial years ended 31 March 2015, 2016, 2017 and 2018 including relevant bank statements and ledgers.

4. Records of breakdown of the sum of HK$2,469,148 purportedly owed by Faithful Rainbow Limited to TIL in the financial year ended 31 March 2015 (“Faithful Rainbow Debts”) including relevant bank statements, ledgers, internal notes and records.

5. All records evidencing the Faithful Rainbow Debts including relevant bank statements, records of payment, invoices, receipts, quotation and delivery notes.

6. All receipts and payment records evidencing the various repayments purportedly made by Faithful Rainbow Limited in settlement of the Faithful Rainbow Debts including relevant bank statements.