SECURITIES AND FUTURES COMMISSION v. CHIN JONG HWA AND OTHERS

HCMP 891/2014

[2020] HKCFI 1457

IN THE HIGH COURT OF THE

HONG KONG SPECIAL ADMINISTRATIVE REGION

COURT OF FIRST INSTANCE

MISCELLANEOUS PROCEEDINGS NO 891 OF 2014

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J U D G M E N T

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Introduction

1.  By Summons dated 18 October 2019 (“Summons”), the 1^st Respondent seeks leave to continue to be a director and be concerned with and take part in the management of 3 private companies incorporated in Hong Kong.  The application is supported by 2 affirmations of the 1^st Respondent (“Chin 1” and “Chin 2” respectively).  No evidence has been filed by the SFC. 

2.  The 3 companies are:

(1)     Best Treasure (China) Limited (實益(中國)有限公司) (“Best Treasure”);

(2)     Fast Star International Limited (捷星國際有限公司) (“Fast Star”); and

(3)     Warren Development Limited (華倫發展有限公司) (“Warren Development”).

3.  The application is opposed by the SFC.

Background

4.  By an amended Petition filed herein on 31 August 2016, SFC applied for relief against the 1^st to 4^th Respondents under section 214 of the Securities and Futures Ordinance, Cap 571 (“SFO”).  The relief sought consisted of inter alia disqualification orders against the 1^st to 4^th Respondents.

5.  SFC and the 1^st to 4^th Respondents agreed to dispose of the amended Petition by way of what is commonly known as the Carecraft procedure.  As far as the 1^st Respondent is concerned, after hearing the parties on 23 October 2019 and by Order dated 6 November 2019, this court made the following order against him:

(1)     The 1^st Respondent shall not, without leave of the Court, for a period of 6 years:

(a)     be, or continue to be, a director, liquidator, or receiver or manager of the property or business, of any listed or unlisted company in Hong Kong including the 5^th Respondent or any of its subsidiaries and affiliates (as defined in Appendix 1 to this Order);

(b)     in any way, whether directly or indirectly, be concerned, or take part, in the management of any listed or unlisted company in Hong Kong including the 5^th Respondent or any of its subsidiaries or affiliates (as defined in Appendix 1 to this Order);

(c)     the period of disqualification be stayed pending the determination of the Summons issued by the 1^st Respondent on 18 October 2019 or until further order from the Court.

6.  The other background facts have been set out in this court’s Judgment handed down on 6 November 2019 and shall not be repeated here. 

7.  The 3 companies are all incorporated in Hong Kong and unlisted.  The 1^st Respondent is their sole director and, via various BVI companies, holds 100% beneficial interests in them.  Other than acting for the 1^st Respondent as holding companies of a majority shareholding in the PRC companies mentioned below, they only have very minimal operations.  For instance, according to their 2017 and 2018 audited reports, their principal activities were all stated to be investment holding.  Further, none of the 3 companies had any operating revenue as such. 

8.  Best Treasure is the majority shareholder of Jiangsu Minan Electric Cars Co Ltd (“JM Electric Cars”) in the PRC and, according to its 2018 audited accounts, held 37.3% of its shareholding.  It has also recently acquired another 50% of JM Electric Cars, increasing its total shareholding to 87.3%.  Fast Star, according to its 2018 audited accounts, held 100% interest in Huzhou Huarui Physiotherapy Equipment Co Ltd in the PRC while Warren Development, according to its 2018 audited accounts, held over 71% interest in Anji Huarui Tourism Co Ltd in the PRC[1].

Deliberation

9.  In support of the Summons, the 1^st Respondent relies on the following 3 grounds in seeking exemption from disqualification:

(1)     The 3 companies are entirely beneficially owned by him merely for the purpose of investment holding.  They do not affect other shareholders or creditors (“Ground 1”). 

(2)     Best Treasure holds over 87% of JM Electric Cars’ shareholding.  His inability to act as Best Treasure’s director would lead to complications with the PRC authorities and thus adversely affecting JM Electric Cars’ business (“Ground 2”). 

(3)     As Hong Kong companies which invest in the PRC, the 3 companies are entitled to preferential tax treatment in the PRC (“Ground 3”).

The law

10.  In SFC v Fung Chiu[2009] 2 HKC 19, Kwan J (as she then was) identified the 2 important objectives in the exercise of the court’s jurisdiction to make a disqualification order:

“ 12. … firstly, protection of the public against the future conduct of persons whose past records as directors of listed companies have shown them to be a danger to those who have dealt with the companies, including creditors, shareholders, investors and consumers; and secondly, general deterrence in that the sentence must reflect the gravity of the conduct complained of so that members of the business community are given a clear message that if they break the trust reposed in them they will receive proper punishment.” (emphasis added)

11.  Of similar effect is the observation of Barma J (as he then was) inRe Styland Holdings (No 2) [2012] 2 HKLRD 325 at [129]:

“ So far as the making of disqualification orders is concerned, it is well established that the purpose of making such an order is not so much to punish errant directors, as to protect the public from companies being run by persons who are not fit to do so, and who pose a danger to creditors of and investors in companies (see Re Lo Line Electric Motors Ltd [1988] BCLC 698, 703e per Browne-Wilkinson V-C). Deterrence of similar conduct on the part of directors of other companies is also an objective (see e.g. SFC v Fung Chiu [2009] 2 HKC 19 per Kwan J at paragraph 12).” (emphasis added)

12.  In Riverhill Holdings Ltd [2007] 4 HKLRD 46 at [19], Kwan J (as she then was) noted that in making an Order under s 214(2)(d) of the SFO, the Court has power to extend the disqualification Order to all or such companies as it considers appropriate, as a response to misconduct or misfeasance by a director of a listed corporation.  Hence, it would appear permissible for the Court to disqualify the 1^st Respondent from acting as a director of any listed or unlisted company in Hong Kong, as the Order of 6 November 2019 provides, or from acting as director of any listed or unlisted company in Hong Kong, subject to exceptions, as the 1^st Respondent contends in his application.  The question is: under what circumstances should such exceptions be made?

13.  In the context of disqualification under the English insolvency regime[2] the court has recognised that, so long as the conduct in question is honest and not lacking in commercial integrity, even if the director falls short of the standard of competence which might be expected of a director of a publicly listed company, it does not necessarily follow that the director is unfit to be concerned in the management of any company, however small, private and simple its affairs may be: Re Barings plc (No 5) [1999] 1 BCLC 433, 485h-486c (citing Re Atlantic Computers plc unrep, 15 June 1998, Lloyd J).  

14.  However, as G Lam J pointed out in Securities and Futures Commission v Wang Jian Hua & Ors unrep, HCMP 745 of 2013, 30 May 2016, at [17]:

“ It is to be recalled that the power to order disqualification in the present context is primarily protective rather than punitive in character. The fact that misfeasance has been committed in relation to a listed company does not mean that only listed companies and their shareholders need protection from the person concerned. The impugned conduct may be such as to show that the respondent is unfit to be a director of companies with the attendant duties and responsibilities generally. …”

15.  In the context of s 206G(1) of the Corporations Act 2001 of Australia (“2001 Act”), a person who is disqualified from managing corporations may apply to the Court for leave to manage inter alia a particular class of corporations or a particular corporation. 

16.  In Adams v ASIC (2003) 46 ACSR 68, an application was made pursuant to s 206G(1) of the 2001 Act for leave to manage 5 corporations.  Lindgren J of the Federal Court of Australia summarized the relevant principles for an application of the kind before his Lordship at [8]:

(1)     The applicant bears the onus of establishing that the court should make an exception to the legislative policy underlying the prohibition.

(2)     That legislative policy is one of protecting the public, not one of punishing the offender.

(3)     Another objective is to deter others from engaging in conduct of the particular kind in question.

(4)     A further objective is the more general one of deterring others from abusing the corporate structure to the disadvantage of investors, shareholders and others dealing with a company.

(5)     The prohibition itself contemplates that there will be hardship to the offender.  Therefore hardship to the offender alone is not a persuasive ground for the granting of leave.

(6)     The court in exercising its discretion will have regard to the nature of the offence of which the applicant has been convicted, the nature of his involvement, and the general character of the applicant, including his conduct in the intervening period since he was removed from the board and from management.  Where, as here, the applicant seeks leave to become a director and to take part in the management of particular companies, the court will consider the structure of those companies, the nature of their businesses and the interests of their shareholders, creditors and employees.  One matter to be considered will be the assessment of any risks to those persons or to the public which may appearto be involved in the applicant’s assuming positions on the board or in management.

Ground 1

17.  The 3 companies may be wholly-owned by the 1^st Respondent, but it does not necessarily follow that protection of those who may deal with them in the future, eg creditors or investors, is thereby rendered otiose—these potential future creditors or investors also need protection.

18.  Indeed, according to their 2018 audited accounts, all 3 companies had current liabilities to the tune of tens of millions of US$.  While these liabilities were stated to be payables to or loans from inter alia related companies, it is unclear on the evidence why these liabilities were incurred in the first place if they only had very minimal operations.  It is also unclear whether and how default on these liabilities might in turn adversely affect those related companies and whoever dealt or deals with them.

19.  Further, the need for sending a clear message to members of the business community ie the need for general deterrence is still valid in this case, irrespective of whether or not the 3 companies are wholly-owned by the 1^st Respondent. 

20.  As the SFC rightly emphasizes in its written submissions, the 1^st Respondent’s misconduct in the present case was serious and extended beyond mere lack of care or incompetence.  They involved:

(1)     failing to fully disclose material facts to the Board of the 5^th Respondent;

(2)     causing the 5^th Respondent to make false or misleading representations; and

(3)     acting in breach of his fiduciary duties to the 5^th Respondent.

21.  For these reasons, this court is not persuaded that Ground 1 has any merits.

Ground 2

22.  On the evidence furnished by the 1^st Respondent in Chin 1, the project that JM Electric Cars has invested in is the production and sale of battery electric vehicles.  The total investment of this project is approximately RMB2.5 billion.  According to his understanding, the Ministry of Industry and Information Technology of the PRC only permitted 10-odd corporations including JM Electric Cars to produce such vehicles.  The PRC exercises very strict control over the battery electric vehicles industry.

23.  JM Electric Cars’ investment project has just started and the project has only been constructed recently.  As shareholders of the corporation must be familiar and experienced in the automotive parts industry, the project concerned has all along been managed by him.  The PRC authorities also know that he has been investing and managing the business.  Due to the tight control over the industry, if the 1^st Respondent ceases to be a director of Best Treasure or is otherwise unable to participate in its management, it may cause “unnecessary speculation and reaction” and may affect the business and his investment in JM Electric Cars.

24.  In addition, investment in battery electric vehicles projects is huge, the market is competitive and relevant technologies are being updated constantly.  As such, there is a higher risk in operating such newly-established corporations.  Since the 1^st Respondent has over 30 years of experience in the automotive industry, he is able to identify JM Electric Cars’ strategies and development directions according to the market to avoid risks and to seize market opportunities, so that it can develop sustainably. 

25.  In Chin 2, the 1^st Respondent further explains that, in his experience of dealing with the PRC Ministry of Industry and Information Technology, changes in the management of the shareholders of electric car companies would cause the authority to reconsider the permit granted.  In other words, the 1^st Respondent would risk losing the entire electric car project if he is barred from acting as Best Treasure’s director and thereby suffers serious personal detriment. 

26.  To begin with, as noted above, hardship to the offender alone is not a persuasive ground for the granting of leave.

27.  Second, SFC criticizes the 1^st Respondent’s evidence on the potential adverse impact on JM Electric Cars should he cease to be Best Treasure’s director as merely his own bare assertions.  This court agrees.  There is no independent and credible evidence to support his assertion of “unnecessary speculation and reaction” if he cannot serve as director of Best Treasure or how likely the PRC Ministry of Industry and Information Technology would revoke the permit granted to JM Electric Cars after reconsidering it. 

28.  Importantly, in Chin 1, the 1^st Respondent relies on Article 19 of the “Provisions on the Administration of Investments in the Automotive Industry” which on its face only imposes conditions on and applies to shareholders of legal entities of newly-established independent pure electric vehicles enterprise.  Hence, even if one accepts the 1^st Respondent’s evidence in this regard, there is no particular requirement on who can serve as director of the shareholder of JM Electric Cars ie Best Treasure.  Hence, for the 1^st Respondent to continue his involvement in the business operation of JM Electric Cars, he can become a registered shareholder of Best Treasure and/or be appointed as JM Electric Cars’ business consultant so as to develop its business sustainably.

29.  For these reasons, this court is not persuaded by Ground 2 either.

Ground 3

30.  According to KPMG Advisory (China) Limited’s tax advice dated 4 November 2019 exhibited in Chin 2, when a PRC enterprise distributes dividends to a Hong Kong tax resident which holds at least 25% shares in the PRC enterprise, the Hong Kong shareholder is entitled to a reduced tax rate of 5%, as opposed to 10%. 

31.  In the 1^st Respondent’s written submissions, his counsel submits that the 3 companies are Hong Kong tax residents and hold more than 25% shares in the PRC companies in question with valuable assets in a range of businesses and are expected to generate substantial profits.  Given the considerable scale of these PRC companies’ business, the 3 companies would be able to derive substantial benefits from the reduced tax rate of 5%.

32.  As the SFC rightly points out, there is nothing in the evidence to suggest that the 3 companies would cease to enjoy any such tax benefits in the event that the 1^st Respondent ceases to be their director.  That being the case, the tax benefits argument is a complete red herring—there is no correlation between the 1^st Respondent continuing to act as their director and their enjoyment of the preferential tax treatment. That is sufficient to dispose of Ground 3.

Conclusion

33.  All in all, this court is not persuaded that the 1^st Respondent has discharged his burden of showing why he should be exempted from disqualification in respect of the 3 companies.  The Summons must be dismissed.

Disposition and costs order nisi

34.  The Summons is hereby dismissed.  There shall be an order nisi that costs of the Summons be to the SFC, to be taxed if not agreed, and paid by the 1^st Respondent forthwith, certificate for 2 counsel.

35.  Lastly, this court thanks the parties for their helpful assistance.