EASTAR INDUSTRIES LTD v. LI WAI FONG AND ANOTHER

HCA 2128/2005

IN THE HIGH COURT OF THE

HONG KONG SPECIAL ADMINISTRATIVE REGION

COURT OF FIRST INSTANCE

ACTION NO. 2128 OF 2005

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J U D G M E N T

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1.  On 28 October 2005 the plaintiff was granted ex parte a Mareva injunction against the defendants, husband and wife.  The order was against specific assets of the defendants such as bank accounts in their names.  But it also targeted an apartment in Ho Man Tin and another account which were both in the name of one Christy Chan, who is the husband’s niece. 

2.  The injunction was ordered to run to a return date.  This is first an application to extend it until trial or further order, and secondly to compel the defendants to disclose all their assets. 

Background

3.  The plaintiff is essentially owned and controlled by brothers CH and CW Chan.  They had for some years known the 2^nd defendant and his wife the 1^st defendant in their capacity as owners and operators of a company which made and traded in toys.  I shall call that company for convenience Chong Shing.  Chong Shing was at the material time the owner of two properties.  One was a unit in Tuen Mun.  The other was a residential unit in Cypress Garden Ho Man Tin.  It was bought in July 1997 with mortgage assistance from DBS Bank.  It became thereafter the home of the defendants.

4.  In 2002 Chong Shing ran into financial difficulties and stopped trading.  The business was wound up, but it left the defendants with debts to creditors, the bank and others which were personal liabilities.

5.  The Chans and the defendants then got together.  The upshot was that the Chans decided to expand their existing operation into toy manufacturing and trading based in the PRC; for this purpose they incorporated the plaintiff.  The plaintiff employed the defendants; the 2^nd  defendant as Production Manager and the 1^st defendant as Sales Manager, both to begin in January 2003.

6.  In addition to a regular salary it came to be agreed that the 1^st  defendant would be entitled to a commission based on customers she introduced; this a means to tap into the former customer base of the now defunct Chong Shing.

7.  It is the plaintiff’s case that one of the Chan brothers laid down a minimum sales price to ensure an acceptable profit margin with a specific formula to be engaged by which that was to be calculated.

8.  Before things got underway the 1^st defendant was paid by advance commission $1.4 million and upon her request a further advance of $800,000.00; thus $2.2 million in all.  It was no secret that the defendants had need of these advances to keep their creditors at bay.  This included the DBS Bank; Chong Shing still owned the two properties which were still heavily mortgaged.  And the Ho Man Tin apartment was still their home.

9.  Then in November 2003 the 1^st defendant asked for a further advance.  The plaintiff obliged, on terms which included repayment provisions if she were to cease to be employed by the plaintiff for less than 3 years.  This increased the total indebtedness under the commission agreement by $600,000.00 to a total of $3.3 million.

10.  It is the plaintiff’s case that this further advance was made in reliance of an assurance by the defendants that they had for the plaintiff achieved orders of up to about $38 million, at a price which provided for the minimum gross profit to the plaintiff.  If this was right, the 1^st defendant would have been entitled to the $3.3 million as earned commission.

11.  But was it right?

12.  In June 2005, on the plaintiff’s account, an accounting irregularity emerged, which caused CH Chan to  call for an inspection of the records of all transactions undertaken by the defendants.  When repeatedly his demands were turned down, the defendants were terminated on a month’s notice. 

13.  What then unfolded was that the defendants had carried on business which was contrary to express directions and to the detriment of the plaintiff.  This included the purchase of raw materials at a price above the market price and sales which were below production costs.  The investigation remains ongoing.

14.  By this action begun in October 2005, the plaintiff seeks to recover repayment from the 1^st defendant of the advanced commissions paid to her, and from both defendants further relief including damages and an accounting of profits. 

The Ho Man Tin Apartment Changes Hands

15.  The $600,000.00 advance payment made to the 1^st defendant in November 2003 was asked for and paid because the DBS Bank was putting pressure on the defendants to settle the debts secured on the two properties, which were still owned in the name of Chong Shing.  There was no dispute about that, and no dispute that the 2^nd defendant’s family would be engaged to try and prevent foreclosure and thus save the defendants’ home.  So it was that Christy Chan took title to the Ho Man Tin apartment.

16.  As to the $600,000.00 advance, $200,000.00 of it was paid into an account of Christy Chan.

17.  What is in material and hot dispute is the beneficial ownership of the apartment and the $200,000.00.  It is the plaintiff’s case, denied by the defendants, that they told CH Chan that the purchase was a device to prevent an auction by the bank and their eviction.  The reality was that Christy would be holding the same in trust for them.  Miss Chan as it happened was also employed by the plaintiff and confirmed the arrangement to Mr Chan.

18.  The assignment went through in December 2003.  But the defendants all along remained living in the apartment.

Later Developments

19.  Following the defendants’ termination in mid 2005, the plaintiff made demand of the 1^st defendant to recover part of the advances in commission paid to her.  That was not forthcoming.  Then it was that a search of the title to the Ho Man Tin apartment revealed  registration of a second legal charge the timing of which coincided more or less with the plaintiff’s letter of demand.

20.  Given their understanding that in reality the defendants had retained a beneficial interest in the apartment, the Chans decided that this was a ploy by the defendants to charge the equity and thus protect their asset from the plaintiff’s claim.

The Injunction

21.  Based on the above history and apparent circumstances of the defendants, the ex parte order was asked for, injuncting not only their property but the apartment and bank account in Christy’s name. 

The Defendants’ Response

22.  This emerged from an affidavit filed by the 1^st defendant supported by the 2^nd defendant.  She confirmed that the advances against commissions were needed and used to pay off debts and bank loans incurred by the failed business run under Chong Shing.  But she disavowed any irregularity in the manner in which she and her husband had carried on business for the plaintiff.  There were losses, but these naturally occurred as in most start-ups.  The defendants utilized costing formulae in purchasing and sales that they had employed for years.  These were known to and approved by the Chans.  The estimated sales which prompted the advanced commissions paid in November 2003 were genuine.  There was no misleading of that information.

23.  The sale of the Ho Man Tin apartment was a genuine one, born of the need to hold off the mortgagee bank which was threatening foreclosure.  This evidence was bolstered by the production of a letter of April 2003 from solicitors representing DBS Bank in which a demand for more than $6.8 million was made or that legal proceedings would follow.  Had Christy Chan not agreed to buy the bank would have held an auction.  But Christy did agree to buy, at a price which the bank accepted of $2.8 million.  Christy was assisted by her family who live in Canada.  The advantage and essential ingredient of the family transaction was that Christy and her family would permit the defendants to stay on in their former home at least for the meantime.

24.  And so they did until July 2005 when the defendants vacated and moved to live with the 1^st defendant’s mother in her home, which is their present address.

25.  Of course, the purchase price was fully absorbed by DBS Bank.  The payment at the time of $200,000.00 into Christy’s account was needed to make the sale and purchase possible.  A legacy of the defendants’ indebtedness was an outstanding loan due by the 2^nd defendant to Christy’s parents, his brother and sister-in-law.  The $200,000.00 was a partial repayment to enable the downpayment to be met.  Details of the original loan had been written down and this was produced.

26.  With no particular cause to save the Tuen Mun unit, DBS Bank sold that by auction and absorbed the proceeds.

27.  It is the defendants’ case that the Chans had no grounds to terminate their employment as happened.  And there has been no attempt to dissipate assets.  The freezing of their bank accounts coupled with the loss of income has caused hardship.  The sale of Ho Man Tin was not for the purpose of hiding assets or evading their obligations. 

28.  Christy Chan also went into print.  She deposed that the purchase was first motivated by giving the defendants a place to live but also to provide her with a home and one for her family when they visited.  She is to marry soon; that is why the defendants have now moved out.  Of the price of $2.8 million 30%, or $840,000.00, came from the family.  The balance was borrowed from the Hang Seng Bank.

29.  She did not tell Mr CH Chan that she was to hold the apartment on trust.  In fact, she was able to show that he introduced her to a bank officer of Hang Seng Bank, knowing that she was intending to purchase the apartment, in the conventional way.

30.  And that is how it happened.  She let the defendants stay on, at least until mid 2005, because that was the arrangement.  But she has been paying the mortgage, because she is the beneficial owner.  She does not hold in trust for the defendants.

31.  The charge which came to be a second charge registered against the title which apparently so concerned the Chans was to secure a short-term loan she required.  This was repaid after a month and the charge was discharged.  As it happened, this was prior to the application for an ex parte Mareva having been asked for and granted.

Further pleadings

32.  By defence and counterclaim recently filed the defendants deny conduct justifying their summary dismissal and counterclaim in damages and in the alternative for an accounting.

33.  The plaintiff in a reply refutes liability.

A Further Affidavit …..

34.  …. was forthcoming from Mr CH Chan.  This was filed a few days ago, in response to that of the 1^st defendant.  He repeated that apparent irregularities in the business dealings by the defendants led to substantial losses suffered by the plaintiff, in the face of the 1^st defendant’s denials.  What has now emerged are losses of $13 million for the year 2004/5.  Immediate termination was justified.

Legal Principles

35.  In order to succeed in a claim for a Mareva, it is incumbent on a plaintiff to show:-

1.      that he has a good arguable case on a substantive claim over which the court has jurisdiction;

2.      that there are assets within the jurisdiction;

3.      that the balance of convenience is in favour of a grant;

4.      that there is a real risk of dissipation of assets or removal of assets from the jurisdiction which would render the plaintiff’s judgment of no effect;

5.      the plaintiff must comply with a strict duty of full and frank disclosure; see the White Book 29/1/56.

A Good Arguable Case

36.  Mr Ng for the defendants went to considerable pains to try to show that the plaintiff’s claim is bound to fail at trial.  But there are numerous issues in dispute that can only be resolved at trial.  On the face of it the defendants may have to repay the advanced commission and there are other outstanding matters going to a liability in damages.  Suffice for me to say that the plaintiff has on the papers done enough to satisfy me it has a good arguable case.

Assets Within the Jurisdiction

37.  No issue has been taken with this requirement.

Balance of Convenience; a Risk of Dissipation

38.  These run together and become the major issue for me to resolve.

39.  There is a material dispute of fact; as to whether the defendants and Christy Chan told one of the Chan brothers that the sale and purchase was in reality a device to preserve the defendants’ home, in which they have all along retained an interest.

40.  But there are a number of matters which are beyond argument.  The defendants were under pressure from their mortgagee bank.  To preserve their home, at least for the meantime, an ‘inhouse’ sale was necessary.  Christy and her family were required by the bank to pay a minimum $2.8 million and did so.  Another bank provided the balance over and above a 30% downpayment.  One of the Chan brothers introduced Christy to a bank officer; thus he knew of a deal which had no element about it of the former owners retaining an interest.  All the purchase money was paid to the defendants’ mortgagee.  There is documentary support to the proposition that to assist in the family funding the downpayment, the 2^nd defendant paid off or reduced a family loan.  There was and remains no attempt to hide this.  Christy has all along been paying the mortgage and otherwise has been assuming the rights and obligations of a property owner.

41.  Above all, the raising of a second mortgage by Christy, which is what, it seems, raised the alarm bells that there was a move afoot by the defendants to dissipate their assets, has been clarified by her as being for a short-term loan which was repaid almost immediately.  And had the Chans’ solicitors bothered to undertake a search of the title before mounting the injunction, the release would have been spotted.

42.  The Chans have to concede that the second charge was a false alarm. 

43.  But Mr Lam for the plaintiff submitted there is another cause for concern; that the issues giving rise to the claim show that the defendants are capable of commercial immorality, and that should be taken into account in determining the risk factor of dissipation. 

44.  However, those issues are hotly contested. 

45.  Courts do give consideration for what might be regarded as an unacceptably low standard of commercial integrity, but only when the evidence is solid rather than a bare allegation; see, for example, Honsaio Trading Limited v Hong Yiah Seng Co. Ltd [1990] 1 HKLR 235, and Jiangman Chao Cheng Thread Co. Ltd v Ng Siu CACV 47/2000 (unreported).

46.  There is not nearly enough undisputed evidence before me to label the defendants in this way.

47.  I conclude that there is nothing before me that points to there being a real risk of dissipation of assets.  There is ample evidence to upset the bare allegation that the defendants have an interest in Ho Man Tin.  Christy Chan’s assets should not have been injuncted.  The parlous financial circumstances of the defendants was no secret.  There was no justification for a grant of the Mareva in the first place, and even less for pursuing its extension to trial.

Full and Frank Disclosure

48.  This is a strict obligation, given that the original application, as here, is usually ex parte and given the Draconian consequences of having one’s assets frozen.  Mr Lam rightly conceded that the plaintiff’s advisors should have searched the registry to get the up-to-the-minute situation of the title.  Had they done so, they would have spotted the discharge of the second charge. 

49.  I accept this was not an intentional lapse, but it was still a serious one, and does not excuse the plaintiff.  I find there has not, by this dereliction, been appropriate disclosure.

50.  I leave open for consideration the defendants’ rights in damages.

Result

51.  The summonses’ of 31October and 2 November 2005 are dismissed.  Costs, nisi at first instance, are to the defendants to be taxed if not agreed on a common fund basis and paid forthwith.