CHINACAST EDUCATION CORPORATION v. WU SHAOQING AND OTHERS

IN THE HIGH COURT OF THE

HONG KONG SPECIAL ADMINISTRATIVE REGION

COURT OF FIRST INSTANCE

ACTION NO 1424 OF 2016

____________________

HCA 1424/2016

BETWEEN
	CHINACAST EDUCATION CORPORATION	Plaintiff
	and
	WU SHAOQING	1st Defendant
	WU CAIYU	2nd Defendant
	JIANG XIANGYUAN	3rd Defendant
	TONG CHI KAR CHARLES ( 湯子嘉 )	4th Defendant

____________________

Before: Mr Recorder Stewart Wong SC in Chambers

Date of Hearing: 1 November 2016

Date of Decision: 8 November 2016

____________________

D E C I S I O N

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A. Introduction

1.  This is the hearing of an application by the 4^th defendant for security for costs, made under Order 23, rule 1(1)(a), Rules of the High Court (Cap 4A), and section 905 of the Companies Ordinance (Cap 622), against the plaintiff on the grounds that the plaintiff is ordinarily resident out of the jurisdiction, and there is reason to believe that it will be unable to pay the costs of the 4^th defendant if ordered to do so.

2.  The plaintiff is a company incorporated in the State of Delaware in the United States of America.  Its shares were (but no longer) listed onthe NASDAQ stock market during the period when the alleged events set out below were supposed to have taken place.  ‌In the Amended Writ of Summons, it states its address to be in California, the United States of America.

B.  The pleaded case and the evidence

3.  In the Statement of Claim, the plaintiff complains of the issue and sale of some of its shares (called “the Wu Shares” therein) to the 1^st defendant. It alleges that:

(1)  The issue and transfer of the Wu Shares to the 1^st defendant wascaused by inter alios the 3^rd defendant and one Chan Tze Ngon (also known as Ron Chan), although the 1^st defendant had not paid for them.  The issue and transfer of shares constituted a breach of the fiduciary duties owed by Ron Chan to the plaintiff.

(2)  The Wu Shares were subsequently transferred by the 1^st defendant to the 2^nd defendant.

(3)  The 2^nd defendant then sold the Wu Shares to another entity.   There is no allegation of impropriety against the purchaser.

(4)  About half of the proceeds of sale were transferred by the 2^nd defendant to the 3^rd defendant.

(5)  The 3^rd defendant then transferred part of the said proceeds of sale, in the total sum of HK$22,920,000, to the 4^th defendant.

(6)  All of the above happened in 2009 and 2010.

(7)  The 3^rd defendant was at all material times the Chief InvestmentOfficer and President–China of the plaintiff.  Ron Chan was at all material times the director, chairman and Chief Executive Officer of the plaintiff.

(8)  The 1^st, 2^nd and 4^th defendants acted as the agents or nominees of the 3^rd defendant in the above transactions.

(9)  The defendants knew of the impropriety of the transactions to which they were involved.

(10)  In particular, as against the 4^th defendant, it is alleged that he must have known of the impropriety of the money he received, and, as a matter of Delaware law:

“In receiving part of the Sale Proceeds of Wu Shares as well as other funds to the extent of HK$63.34 million from the 3^rd Defendant and his wife within an approximately 18‑month period from May 2010 to December 2011 for no or no commercial reasons and/or with the knowledge of the impropriety of such part of the sale proceeds, the 4^th Defendant became subject to a trust [by knowing receipts] and/or restitutionary claim and/or proprietary claim by the Plaintiff in respect of such part of the sale proceeds. ”

The same allegation is made against the 4^th defendant as a matter of Hong Kong law with the words in square brackets added.

4.  In his Defence, the 4^th defendant denies knowledge of any wrongdoing or alleged wrongdoing of the other defendants.  ‌He alleges that:

(1)  Through the introduction of a friend, he came to know the 3^rd defendant in about late 2009 or early 2010.  He did not know Ron Chan or the 1^st or the 2^nd defendants.

(2)  Because the 3^rd defendant had a substantial amount of Hong Kong dollars (“HKD”) in Hong Kong which he could not usein the Mainland, and the 4^th defendant had a substantial amount of Renminbi (“RMB”) in the Mainland which he could not use in Hong Kong, for mutual benefit and convenience, they agreed that the 4^th defendant would lend some RMB to the 3^rd defendant in the Mainland, and the 3^rd defendant would repay the 4^th defendant in Hong Kong with HKD, at an exchange rate to be agreed each time.

(3)  As a result, through a series of transactions between May 2010 and December 2011, the 4^th defendant in the Mainland lent a total of RMB73,000,000 to the 3^rd defendant, who repaid him with a total of HK$86,276,000 in Hong Kong.

(4)  He has no knowledge of the source of the 3^rd defendant’s funds which he had received.

5.  In reply, the plaintiff alleges:

(1)  The 4^th defendant had a number of dealings with CCT(SH), a main operating subsidiary of the plaintiff in the Mainland managed by the 3^rd defendant who was a director thereof, and of which Ron Chan was the legal representative and general manager and in which he had overall management responsibility, and:

(a) CCT(SH) was the guarantor of one of the purported loan arrangements between the 3^rd and the 4^th defendants “for no reason”.

(b) The 4^th defendant had lent three loans to CCT(SH) totalling RMB32,750,000 at a daily interest rate of 2.5% although it was a cash rich company and had no need for any borrowing.  The interest rate was far in excess of what was allowed under the PRC law and was consistent with the pattern of high interest borrowing by the plaintiff’s subsidiaries in the Mainland caused byRon Chan and the 3^rd defendant in breach of their duties.  The 4^th defendant received a total of HK$15,921,616 from a person said to be the conduit for the dissipation of money misappropriated from the plaintiff.  The evidence relied upon by the plaintiff is the ledger entries of CCT(SH).

(c) A series of weekly payments were made by CCT(SH) tothe 4^th defendant totalling RMB1,176,200, when they hadno business dealings and there was no or no commercial reason for such payments.  The evidence adduced on behalf of the plaintiff for the purpose of this application does not, however, deal with these alleged payments, and I say no more about, and will disregard, them.

(2)  The aforesaid transactions give rise to the inference that the 4^th defendant was intimately related to Ron Chan, the 3^rd defendant and CCT(SH) under the control of its former management in his cash dealings and was aware of their wrongdoings.

(3)  For various reasons the dealings between the 3^rd and the 4^thdefendants were not “currency swap transactions”[1] as alleged.

6.  The sum of HK$22,920,000 the subject of the plaintiff’s allegation against the 4^th defendant is said by the plaintiff to be transferred to him in two tranches: a sum of HK$11,660,000 on 25 November 2010 and asum of HK$11,260,000 on 13 December 2010.  ‌The plaintiff’s case, as stated in the affidavit of its Chief Financial Officer, Douglas Nelson Woodrum (“Mr Woodrum”), is that on 18 November 2010 and 6 December 2010, the 2^nd defendant transferred respectively the sums of US$1,500,000 and US$2,970,000 to the bank account of the 3^rd defendant, out of which the two sums of HK$11,600,000 and HK$11,260,000 were then transferred to the 4^th defendant as aforesaid.  Those sums from the 2^nd defendant, it is said, were part of the sale proceeds of the Wu Shares.

7.  According to the 4^th defendant, there were indeed two such payments to him by the 3^rd defendant, but they were to repay respectively twoRMB loans made by him to the 3^rd defendant earlier, namely RMB10,000,000on 10 November 2010, and RMB20,000,000 on 30 November 2010,[2] pursuantto the loan arrangements made between them as aforesaid.   Bank records showing these payments, as well as five other such transactions which the 4^th defendant says were also such loans made by him to the 3^rd defendant who then repaid him later, in the Mainland and Hong Kong were produced by the 4^th defendant.  The plaintiff is unable to challenge the existence of the flow of money between the 3^rd and the 4^th defendants as shown by the bank documents produced by the 4^th defendant.

8.  Regarding CCT(SH) (§5(1)(a) and (b) above), the 4^th defendant says:

(1)  He does not recall the details of the loans and the fact that CCT(SH) was a guarantor.

(2)  He denies entering into any loan transactions with CCT(SH) at all.  ‌However, having searched his bank records, he producesdocuments showing two more loans he made to the 3^rd defendant as per their arrangements, two of which correspond with two of the alleged loans in terms of timing and quantum.  The HK$15,921,616 was a repayment of the first of these loans, and the 3^rd defendant was unable to repay the second of these loans and by an agreement dated 17 August 2012 he transferred shares in a company in the Mainland to a nominee of the 4^th defendant as security for the loan.   ‌He notes that no bankingrecords or loan agreements have been produced by the plaintiff to evidence the alleged loans to CCT(SH), or any such loans evidence any involvement of his in the alleged wrongdoing of the 3^rd defendant.  The only evidence produced by the plaintiffregarding these alleged loans is the internal ledger of CCT(SH), which the 4^th defendant does not accept.

C.  The application for security for costs

9.  The legal principles regarding the grant of security for costs are not really in dispute, and the following are relevant:

(1)  The court may order a plaintiff to give such security for a defendant’s costs of the action as it thinks just.  The discretion is very wide and is unfettered.

(2)  While there is no inflexible or rigid rule that a plaintiff residentabroad should be ordered to provide security for costs, the court will normally do so because it is ordinarily just to do so.

(3)  If the plaintiff’s argument is that an order for security for costs would stifle its claim, then it is incumbent upon it to adduce evidence in support, by showing that not only itself but also its shareholders, or any parties funding the litigation, are unable (rather than merely unwilling) to provide the security if ordered.

(4)  An application for security for costs is not an occasion for the court to go into the merits of the case in any detail, to do a preliminary run at deciding the ultimate success or failure of the claim, or to resolve arguments on the strength or weakness of a party’s case save for relatively simple cases where on affidavit evidence in an interlocutory application the court can already see that there is a “high degree of probability of success” for the plaintiff (the test or standard adopted by Mr Lam, counsel for the plaintiff, based on Re Greater Beijing Region Expressways Ltd [2000] 2 HKLRD 776 at 794F per Le Pichon J,to which Mr Wong SC, counsel for the 4^th defendant, does notdisagree), in which case the merits of the plaintiff’s case should be taken into account.

If any authorities are needed for the above well‑established principles, I would refer to the three decisions made respectively by Anthony Chan J (26 September 2014), Deputy High Court Judge Saunders (5 June 2015) andDeputy High Court Judge Sakhrani (15 October 2015), all in HCA 1062/2012, under which the present plaintiff sued inter alios Ron Chan and the present 3^rd defendant (but not the 4^th defendant), and the cases cited by their Lordships.

10.  In his affidavit, filed in support of the plaintiff’s application for a Mareva injunction but also placed before me at this hearing (and cross‑referenced by Mr Alfred Wu (“Mr Wu”), a solicitor acting for the plaintiff, in his 4^th affidavit filed in opposition to this application), Mr Woodrum admits that the plaintiff is now impecunious, but then he also says that the plaintiff is in a position to meet its obligations in respect of its undertaking as to damages should an injunction be granted, and one of the means by which it may fund its litigation would be by way of shareholders’ loans.  Mr Wu also says that the plaintiff is funded in its recovery efforts, includingthese proceedings, “through shareholders’ funding”.  No evidence, however, is adduced as to the identities or means of the shareholders.

11.  In the light of the matters stated in the preceding paragraph, I do not think that the argument (which while maintained by Mr Lam is not really pressed by him) that an order for security for costs would stifle the claim is made out, in the absence of any evidence that the shareholders, who have so far been funding its litigation, are unable to provide any such security.

12.  I should also mention that it is suggested by the plaintiff that its impecuniosity is caused by the wrongful acts of inter alios the 4^th defendant.  But, as Rogers VP said in Sunchase International Group (China) Ltd v Vincor Group of Companies (Investment) Ltd [2004] 1 HKLRD 731 at §6:

“That, it seems to me, is a matter which could only be decided once it has been decided that the plaintiffs have a good claim and that ends up being a circular argument.”

13.  Rather, the admission that the plaintiff itself is impecunious, the fact that there is no dispute that the plaintiff is ordinarily resident outside Hong Kong and there is no evidence that it has any assets in Hong Kong, suggest to me that the 4^th defendant has made out a prima facie case for me to exercise my discretion to order security for costs.  I shall consider the only remaining ground taken by the plaintiff in opposition, namely that it has a high degree of probability of success at the trial.

14.  Despite the valiant effort of Mr Lam to persuade me so, I am afraid that I cannot agree, for the following reasons:

(1)  I am conscious of the principle I refer to at §9(4) above.

(2)  The entire case of the plaintiff depends on the trial judge finding that the 4^th defendant did have actual knowledge (as this is so pleaded: constructive knowledge is not relied upon) of the factthat the money from the 3^rd defendant is, I am willing to assume for the purpose of this application, “tainted”.  As Mr Lam very fairly and frankly admits, there is no direct evidence of that and if the plaintiff is going to succeed at trial that has to be by way of inference.

(3)  Mr Lam points to a number of matters in support of his argument that the plaintiff has a high degree of probability of success.  I shall not embark on an assessment of their strength or weakness in any detail.  I shall simply make the following observations:

(a)  None of these matters, which I shall deal with briefly below, is direct evidence on the question of the state of knowledge of the 4^th defendant as to the propriety of the monies in question or any wrongdoing by others.  Whether these matters, individually or collectively, if established at trial, support the drawing of the necessaryinference as to knowledge is a matter for the trial judge,and it is not for me to attempt to predict that, save to saythat I am not persuaded that the plaintiff has shown that the degree of probability of that is high.  Whether to draw any inference of knowledge must be a matter for thetrial judge having regard to all the facts and circumstancesas he finds them to be after hearing all the evidence, including the testimony of all witnesses.

(b)  As for the alleged fact that CCT(SH) was a guarantor for the 3^rd defendant in one loan transaction (§5(1)(a) above), while on one hand it may be said that that, if established, shows that the 4^th defendant did have some dealings with CCT(SH), on the other the transaction does suggest that it was a loan arrangement between the 3^rd and the 4^th defendants as alleged.

(c)  The allegation of loans made by the 4^th defendant to CCT(SH) at exorbitant interest rate (§5(1)(b) above) is only supported by internal ledgers and not by banking documents.  ‌The 4^th defendant has provided an explanation for two of the three such alleged loans, supported by bank documents (§8(2) above), which I cannot dismiss out of hand at this stage.[3]

(d)  Even if the 4^th defendant did have some dealings with CCT(SH), that does not necessarily mean that he wouldhave the required knowledge of the alleged wrongdoing.

(e)  As for what the plaintiff says is a rather long time gap between payment by 4^th defendant to the 3^rd defendant and the repayment each time, whether the time gap each time is such as to make a case of “currency swap” inherently improbable must be a matter for trial with proper evidence and cross‑examination, as it cannot be a matter of judicial notice or mere common sense as to what should be the proper time gap.

(f)  Mr Lam also argues that the 4^th defendant has not produced all his bank account records to show that he did not have any other transactions with the 3^rd defendant (which may have explained the payments by the 4^th  defendant to the 3^rd defendant other than as the 4^th defendant alleges).   ‌With respect, the 4^th defendant has, in my judgment, produced some evidence (ie the bank records) in support of his positive case as to the true nature of the transactions between him and the 3^rd defendant, and there must be a sensible limit, at leastat this stage, given the limited scope of any examination on the merits of each side’s case, as to how much is required from him to prove a negative, ie that there were no other transactions.  Even if the 4^th defendant produces records of all his bank accounts in Hong Kong and the Mainland, it can always be suggest that there might have been more.

15.  The above consideration of the various matters is not intendedto be an indication of any view at this stage of the respective merits of eachparty’s case, but simply that I am not persuaded that the plaintiff has shown a high degree of probability of success by reference to those matters.  All of the above matters mayprovide grounds for cross‑examination of the 4^th defendant at the trial, and,with the benefit of full discovery, interrogatories (if any), witness statements, full cross‑examination, and submissions, a wholly clearer picture pointing one way of another may well emerge, but this is a matter for the trial judge.

16.  Rather, the fact remains that for each of the two HKD payments from the 3^rd defendant to the 4^th defendant sued upon, the 4^th defendant has produced bank documents, which Mr Lam says he is unable to challenge, showing that a corresponding[4] sum in RMB was transferred to the 3^rd defendant by the 4^th defendant not long before.  See §7 above.  Despite various points made by the plaintiff as to whether the transaction made commercial sense, which I note, such documents remain evidence in clear support of the 4^th defendant’s case which if accepted by the trial judge would be a complete answer to the plaintiff’s claim.  ‌The points made by Mr Lam may, as I said above, be used by the plaintiff to cross‑examine the 4^th defendant, but I cannot at this stage see them as necessarily undermining the 4^th defendant’s case to the required extent.  Whether the trial judge would accept or reject such points is not for me to predict and I am not going to embark on an examination of the evidence to consider the likelihood of that happening, save to say that I cannot say that there is a high degree of probability that he would not.

17.  I therefore do not take the view that the plaintiff has shown that it has a high degree of probability of success at the trial.  In my view, it is just that an order for security for costs be made.

D.  Quantum

18.  The 4^th defendant has submitted to me a skeleton bill, the latest version of which shows a total of HK$710,933 in profit costs and HK$1,288,000 in disbursements.  This is up to (and including) discovery.  The plaintiff has commented on the same.

19.  One point raised by the plaintiff in particular is whether the engagement of senior counsel by the 4^th defendant is reasonable.  In the light of the not insignificant sum involved, and the fact that a very serious allegation (in effect knowing participation in a fraud) is made against someone whose good reputation is particularly important (the 4^th defendant is the vice‑chairman and an executive director of a listed company in Hong Kong), I do not think that it is unreasonable for the 4^th defendant to engage both leading and junior counsel to act for him even at this early stage,although of course not every step or matter or hearing justifies the involvement of leading (or even junior) counsel.

20.  Taking a broad brush approach, having taken into account the comments made by Mr Lam, I order security for costs up to and including discovery in favour of the 4^th defendant, to be paid by the plaintiff into court within 28 days of the date of this decision, in the sum of HK$1,300,000.  This action is stayed until such payment is made (and any time limit imposedby any order of the court in this action and which would otherwise run during the stay will be automatically extended by the duration of any such stay).  If no such payment is made after 28 days, this action is to be dismissed with costs to the 4^th defendant to be taxed.

21.  Regarding the Summons issued by the plaintiff dated 31 October 2016 for leave to adduce the 6^th affidavit of Mr Wu, for the record I shall dismiss the same since the 4^th defendant does not have the chance to answer it.  In any event, having look at it on a de bene esse basis, I do not find it particularly helpful on the question of the degree of probability ofsuccess by the plaintiff as it really goes to the detail of a particular transaction not the subject of the claim itself.

22.  I make an order nisi that the 4^th defendant is to have the costs of this application (with certificate for one counsel), including the costs of the Summons issued by the plaintiff dated 31 October 2016 for leave to adduce the 6^th affidavit of Mr Wu, to be taxed if not agreed.

23.  I thank counsel for their assistance.

 

 

	(Stewart Wong SC)
	Recorder of the High Court

Mr Gary CC Lam, instructed by Norton Rose Fulbright Hong Kong, for the plaintiff

 Mr Anson Wong SC, leading Mr Alan Kwong, instructed by Hastings & Co, for the 4^th defendant