TOP POINT LTD v. K&L GATES (A firm of solicitors)

HCA 1088/2011

IN THE HIGH COURT OF THE

HONG KONG SPECIAL ADMINISTRATIVE REGION

COURT OF FIRST INSTANCE

ACTION NO. 1088 OF 2011

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BETWEEN

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D E C I S I O N

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1.  This is an application by the plaintiff for summary judgment.

The case as pleaded in the statement of claim

2.  A Geminis Funds SPC (“Geminis Funds”), on behalf of Geminis Greater China Fund I Segregated Portfolio, purportedly entered into an agreement with the defendant and dated 20 May 2011 to deposit US$1 million into the defendant’s client account.  This agreement is hereinafter called the Geminis Escrow Agreement.  Its relevant terms are:

“This is to appoint K&L Gates as our escrow agent. We will deposit up to US$1 million (“Escrow Sum”) into your firm’s client account in our name with a licensed bank in Hong Kong after signing this letter, and your firm will release the Escrow Sum (or any part of) as per our written instruction to be given from time to time provided that:

1. Upon receipt of a written notice of transfer of the whole or any part of the Escrow Sum from us, you shall within 1 business day effect such transfer, comply with the instructions contained in such notice and provide a copy of the bank remittance advice on the day such transfer is made.

2. K&L Gates undertakes and agrees that, throughout the continuation of this appointment as our escrow agent, it shall:

(a) subject to paragraph 1 of this agreement, not (nor shall it have or be deemed to have any power or authority to) dispose of, deliver, release or otherwise deal with the Escrow Sum or any interest therein;

(b) take all steps which may be necessary or expedient to preserve or protect our interests in the Escrow Sum; and

(c) not do or cause or permit to be done by any other person anything which may in any way depreciate, jeopardise or otherwise prejudice the value of the Escrow Sum.

…

6. K&L Gates hereby represents and warrants that it has full capacity and authority to accept this appointment and to carry out all the performance of duties contemplated herein and has taken all action (including the obtaining of all necessary governmental consents) to authorise the execution, delivery and performance of the appointment.

…”

The agreement was signed by one Navin Aggarwal, a former partner of the defendant, on behalf of the defendant.

3.  Geminis Funds purportedly pursuant to this agreement deposited US$1 million into the defendant’s client account on 23 May 2011. 

4.  A Capital Cosmos Financial Limited (“Capital Cosmos”) purportedly entered into another agreement with the defendant dated 31 May 2011 to deposit the sum of US$3.5 million into the defendant’s client account.  This agreement is hereinafter called the “Capital Escrow Agreement”.  The terms of this agreement, save the identity of the depositor, the date and the amount to be deposited, are the same as those in the Geminis Escrow Agreement.

5.  Capital Cosmos purportedly pursuant to this agreement deposited US$3.5 million into the defendant’s client account on 31 May 2011. 

6.  Both Geminis Funds and Capital Cosmos served recall notices dated 14 June 2011 on the defendant requiring the defendant to transfer the US$1 million and US$3.5 million respectively to their designated accounts.  The defendant did not comply with the recall notices.  Each of Geminis Funds and Capital Cosmos then executed a Deed of Assignment dated 27 June 2011 assigning all their rights under the two Escrow Agreements unto the plaintiff. 

7.  The plaintiff then instituted this action against the defendant for the repayment of the US$1 million and US$3.5 million with damages and interest.  The plaintiff now seeks final judgment under Order 14 for US$4.5 million with interest. 

8.  The first affirmation by Mr James Yang, the plaintiff’s director, basically verified the contents of the statement of claim.

The Defendant’s Case

9.  The defendant’s evidence unfolds a complicated picture.  The defendant’s case is presented by the affidavits of a partner, Mr Vincent Tso.  Mr Tso said in his 2nd affidavit that Mr Aggarwal had been arrested by the police officers of the Commercial Crime Bureau on 9 June 2011. He was charged on 24 June 2011 with three counts of theft of money held by the Hong Kong Bank for the defendant and three counts of forgery.  The defendant then engaged a team of forensic accountants to investigate the receipts and disbursements of funds said to have been paid into the defendant’s client account. 

10.  The defendant then instituted HCA1061 of 2011 against Aggarwal and obtained a worldwide injunction against him.  There were then 13 High Court actions brought by various parties against the defendant. Some of these parties said that they had provided “escrow” monies to the defendant under the auspices of Aggarwal.  The defendant suspects that some of these parties might have been involved in, and complicit with Aggarwal’s fraudulent conduct. 

11.  The defendant’s investigations also revealed that the plaintiff’s director, Mr James Yang, appeared to be a responsible officer of a number of corporations licensed by the Securities and Futures Commission.  These corporations are featured in the websites of two groups of companies called the Geminis Group and Evenstar Group.

12.  Two companies called Evenstar Master Fund SPC and Evenstar Capital Management Limited were the defendant’s clients, which had been billed by the defendant for work done between February 2008 and May 2011. However, there was no record of any billing for any work done for any escrow agreement as pleaded in the statement of claim that involved any Geminis, Cosmos or Evenstar entity. 

13.  There was also no one in the defendant’s partnership, apart from Aggarwal, who was aware of what had become of the monies deposited by Geminis Funds and Capital Cosmos into the defendant’s client account or of Aggarwal’s fraudulent activities. 

14.  The defendant also found some emails exchanged between Aggarwal and some people named in the websites of Geminis and Evenstar groups.  These emails appear to relate to the same type of escrow agreements as referred to in the statement of claim. 

15.  One set of emails exchanged between 20 November 2009 and 28 January 2010 related to an escrow fund of US$5 million (Exhibit TSKV-6).  The fund was offered by one Alan Chen of the Evenstar Capital Group. It was offered for one week and had to be returned on 30 November 2009.  There was a fee at US$80,000 payable to the depositor for the deposit of this fund for this week.  The fee was equivalent to interest at 83 per cent per annum on US$5 million. 

16.  The records of the defendant (Exhibit TSKV-16) show that this fund was deposited into the defendant’s client account on 23 November 2009.  The emails show that this fund was not repaid on 30 November 2009 but the period of deposit was extended to 4 December 2009 in consideration of another fee of US$100,000.  The fee of US$100,000 for four days was equivalent to interest at 182 per cent per annum on US$5 million.  The total fees of US$180,000 were transferred out of the defendant’s client account to an account of Evenstar Master Sub Fund I Segregated Portfolio on 30 November 2009. 

17.  The fund was again not repaid on 4 December. The emails show that there was a second extension of the deposit period from 7 December to 11 December.  The fee payable for this extension was also US$100,000 and was transferred from the defendant’s client account to the same account of Evenstar Master Sub Fund I on 7 December 2009. 

18.  There was then a third extension up to 18 January 2010 at the fee of US$180,000.  This fee was paid later date on 21 January 2010. 

19.  There was then a fourth extension lasting until 29 January 2010.  The fee payable for this extension was US$100,000 which was paid on 19 January 2010.  The fund of US$5 million was returned on 29 January 2010. 

20.  A total fee of US$560,000 was paid for the US$5 million to remain in the defendant’s client account from 23 November 2009 to 29 January 2010 or for 67 days.  The annualised rate for US$5 million principal is 61 per cent.  This overall rate is lower because of the much lower fees for the third and fourth extensions.  The overall rate up to the third extension is 113.5 per cent.  

21.  This fund was also deposited into the defendant’s client account purportedly pursuant to an escrow agreement in the same terms as those pleaded in the statement of claim and referred to above. These terms of the escrow agreement however do not provide for payment of any fee or interest.  The fees for the deposit of the escrow sum and extensions of the period of deposit were only mentioned in the emails.

22.  The terms of the escrow agreement also gave the defendant no liberty to use the escrow sum for any purpose whatsoever.  The defendant had to take all steps to protect the depositor’s interest in the escrow sum.  It should not do or permit anyone to do anything which may in any way depreciate, jeopardise or otherwise prejudice the value of the sum. 

23.  There was an instance in May 2010 when an escrow sum of US$5 million was not returned on time.  That attracted a penalty of US$20,000 per day which was equivalent 146 per cent per annum on the US$5 million principal. 

24.  Mr Tso of the defendant also pointed out that there was no counterparty to the so called escrow agreement.  There was also no due diligence undertaken by the depositor on the counterparty.  The depositor just used the defendant’s client account to remit monies in and out and, in the course of which, earning extortionate rates of return far exceeding what could be earned by depositing money in banks.  The defendant was however never in the business of paying fees or interest to anyone who deposited money with it for legitimate purposes, save for bank interest paid by the banks on the deposit. 

25.  It was also not part of the defendant’s ordinary business to provide stand-alone escrow services which are not incidental to the provision of legal service.  Geminis Funds and Capital Cosmos were not the defendant’s clients and no legal services had been provided to them. 

26.  The defendant has, however, discovered a genuine and legitimate deal which began in April/May 2009.  The transaction indeed involved counterparties.  One of Mr Yang’s companies was represented by another firm of lawyers.  The escrow agreement in that transaction involved three parties. 

27.  The defendant’s investigation into Aggarwal’s activities shows that, apart from the two instances of deposit of escrow sums referred to in the statement of claim, there were from January 2009 to June 2011 another 44 such transactions involving Mr Yang’s companies.  The sums paid to these companies exceeded the sums deposited by them to the defendant’s client account by HK$48,327,900.05 (Exhibit TSKV-16).  That means a deficit in the same sum had been created in the defendant’s client account at the end of these 44 transactions.

28.  It is the defendant’s case that the escrow agreements are sham arrangements.  Mr Aggarwal in fact made fraudulent use of these shams to borrow the so-called escrow sums for his own use.  The issue is whether the depositors, or those who control them, were complicit in Aggarwal’s fraud.  The alternative issue is whether these persons should, or ought to have known that these extraordinary arrangements were shams and hence they were not acting bona fide in procuring their companies to deposit the escrow sums into the defendant’s client account and getting the generous fees in return. 

The Plaintiff’s case

29.  Mr Yang made a reply affirmation.  He said that the defendant had, in the past 10 years, provided legal service to many of his companies in the Geminis/Evenstar Group.  He was personally known to Mr Tso who had introduced Aggarwal to him.  He also listed a number of transactions in which the defendant had either represented one of his companies or the counterparty to the transactions.  The counterparty in the legitimate transaction in April 2009 that Mr Tso had identified in his affidavit was one Golden Meditech Holding Limited.

30.  Regarding the deposit of escrow sums into the defendant’s client account pursuant to the so-called escrow agreements, he explained that they were for use as “fund proof”.  He said in his affirmation:

“13. In about January 2009, Mr Aggarwal approached me and represented to me that he had a number of PRC-based clients who were interested in acquiring a substantial stake in Hong Kong listed companies and, for that purpose, required what is commonly referred as “fund proof” to demonstrate that they had readily available funds or ability to arrange funds within Hong Kong to finance the acquisition.

14. Mr Aggarwal said the funds of the PRC clients were tied up in China and could not be remitted to Hong Kong in time for the potential bidding. Mr Aggarwal asked if my companies were interested in putting funds in K&L Gates client accounts in escrow which would enable K&L Gate’s clients to provide fund proof. Mr Aggarwal assured me that the PRC clients were clients of K&L Gates and all the funds provided by my companies would be deposited in K&L Gate’s client accounts and held in escrow, and the funds would only be released with the written consent of my companies. In return, the PRC clients would pay a commitment or arrangement fee to my companies and, if the bidding was successful, my companies might have the option to participate in the proposed acquisition.

15. The “fund proof” is commonly employed by potential bidders who require short-term finance or access to finance when making an offer for acquisition of a substantial stake in a listed company. In simple terms, the provider of the funds will make available funds to enable the potential bidder (normally a special purpose corporate vehicle) to demonstrate that it has the requisite funds or the ability to arrange funds for the purpose of the acquisition. In return, the provider of the funds would receive an arrangement fee for the provision of funds.”

31.  However, there appears to be an internal inconsistency in what Mr Yang said.  He said in paragraph 14 that he had been assured by Aggarwal that all funds would be held in the defendant’s client account and would only be released with the written consent of his companies. But he then said in paragraph 15 that the “fund proof” was short term finance made available to potential bidders to enable them to show the availability of funds or their ability to raise funds for the acquisition of a listed company or a substantial stake therein. 

32.  However, if the funds could not be used for any purpose, as the terms of the so-called escrow agreement would ensure, save with the written consent of the depositor, then they are not available to the potential bidder for any purpose.  It would be a gross misrepresentation for the defendant, or the potential bidder, to tell the potential vendor that such funds were available for use in the acquisition or could indicate the bidder’s ability to raise these funds. 

33.  Mr Yang also admitted that he did not know the identities of these unknown PRC entities.  One would imagine that he would therefore not consent to allow the funds of his companies to be used by these entities.  Before the funds could be used for any purpose of these unknown entities, he would, no doubt, want to know about them and the transactions that they were entering into.  He would also wish to carry out due diligence on these entities and the proposed transactions before he would allow the funds to be used.

34.  In order to boost his case, Mr Yang also referred to the long-standing relationship of his companies with the defendant, Aggarwal being a senior partner with substantial experience in corporate and commercial matters, fund proof was a normal and common arrangement in Hong Kong for substantial acquisitions by PRC based entities, escrow arrangement with a law firm as escrow agent was a normal and common practice, and the defendant was a large and reputable international law firm.  He further said that since he had no direct dealings with, or access to these PRC clients of the defendant, he relied entirely on the escrow arrangements with the defendant to safeguard the funds of his companies.

35.  I would, however, take the view that if his funds were indeed so securely protected, then it would not have been available to any potential bidder for any purpose.  In that case, I cannot understand who would be prepared to pay his companies the very generous fees above-mentioned.

36.  I should also mention that Mr Yang also relied on the fact that there were 44 concluded transactions which took place over 2½ years and involved other staff and partners of the defendant in their processing. 

37.  He also referred to certain mandates of introducer which he said were signed between his companies and the PRC clients of the defendant after the escrow sums had been deposited.  These mandates provided for payments of service fees, commitment fees and success fees by the PRC entities.  He said such fees had been paid by these entities.  But the defendant said that for those mandates of introducer that were purportedly related to these escrow transactions, they were part of the sham and no fee had ever been paid thereunder.  It also said that the so-called PRC entities mentioned in these mandates were Aggarwal’s puppets rather than real potential bidders.

38.  I also note that the payment that leading counsel for the plaintiff submitted as having been made pursuant to a mandate of introducer dated 20 November 2009 (Exhibit TSKV-6 at page 96) was more likely to be the US$80,000 fee paid for the deposit of the US$5 million escrow sum with the defendant from 23 November to 30 November 2009.

39.  Finally, Mr Yang said that his companies were dealing with Aggarwal as a partner of the defendant.  The escrow agreements were signed by Aggarwal as a partner and the escrow sums were paid into the defendant’s client account.

The Defendant’s reply

40.  Mr Tso made a fourth affidavit to deal with the fund proof issue.  He said:

“13. … My experience of fund proof is that, other than fund proof by an offeror in the case of a general offer, which is regulated by the Securities and Futures Commission (“the SFC”) as explained in paragraph 13 (sic) below, money is only required for a specific point in time, not, as appears to be the case between Mr Yang’s “companies” and Mr Aggarwal, over a period of time, repeatedly “rolled over”, with hugely exorbitant fees and interest, including “penalties” payable, with monies being rolled over and over, each time with hugely exorbitant fees and interest being payable over and over. In my experience as a commercial lawyer in Hong Kong, this is not “fund proof” for an acquisition of a substantial stake in a Hong Kong listed company.

14. Proper fund proof in a general offer case is regulated by the SFC under the Code on Takeovers and Mergers and Share Repurchase and would involve an SFC licensed financial adviser giving a statement that financial resources of the offeror are available for a period of time to satisfy its obligations in respect of the offer. Law firms are not in this category. In addition, in such case, funds cannot be recalled at the offeror’s discretion unless and until the general offer is completed and the offeror’s obligations are satisfied. This is obviously not the type of case under each of the so called “escrow agreements” as they all provided for 3 business days notice or shorter for the return of monies to the payor.”

41.  Another partner of the defendant, Mr Michael Chan, also made an affidavit.  He said he was the counter-signatory of some payment documents used for remitting money to Mr Yang’s companies.  He signed those documents by relying on Aggarwal’s bona fides and was not aware that the payments were illegitimate.  He said Agarrwal had defrauded him and the defendant.

The Plaintiff’s reply

42.  Mr Yang made a third affirmation to respond to Mr Tso’s fourth affidavit.  He said there were many types of fund proof including the type that his companies had engaged in.  He said the two escrow agreements in question were binding despite Geminis Funds and Capital Cosmos were not the defendant’s clients.  He also said that he had no need for due diligence on the PRC entities as the defendant was the counter-party and he relied on the defendant’s reputation.  He assumed that the defendant would have conducted due diligence on its clients before involving in the fund proof arrangement. 

43.  However, I would observe that Mr Yang’s confidence in the defendants seemed to be so overwhelming that he did not even bother to know who were these clients of the defendant and what they were intending to do. 

44.  Mr Yang also denied of any knowledge or involvement in Aggarwal’s fraud. 

The Plaintiff’s submissions

45.  Leading counsel for the plaintiff submitted that Aggarwal’s fraud had nothing to do with the plaintiff, Geminis Funds or Capital Cosmos.  The fraud is thus irrelevant to the plaintiff’s claim. 

46.  Counsel also relied on section 7 of the Partnership Ordinance, Cap. 38 which provides:

“7. Every partner is an agent of the firm and his other partners for the purpose of the business of the partnership; and the acts of every partner who does any act for carrying on in the usual way business of the kind carried on by the firm of which he is a member bind the firm and his partners, unless the partner so acting has in fact no authority to act for the firm in the particular matter, and the person with whom he is dealing either knows that he has no authority or does not know or believe him to be a partner.”

47.  Counsel submitted that Aggarwal was acting as an agent of the defendant firm and the escrow sums were paid into the defendant’s client account. 

48.  Counsel also referred to the 44 completed escrow arrangements and submitted that they were irrelevant in that they were made between the defendant and companies that were independent legal personalities. However, counsel also relied on the fact that these transactions were done in the open, spanning across 2½ years and involved many people in their processing. 

49.  Counsel also relied on section 12 of the Partnership Ordinance which provides:

“12. Where, by any wrongful act or omission of any partner acting in the ordinary course of the business of the firm or with the authority of its co-partners, loss or injury is caused to any person not being a partner in the firm, or any penalty is incurred, the firm is liable therefor to the same extent as the partner so acting or omitting to act.”

50.  Finally, counsel relied on money had and received by the defendant to the use of Geminis Funds and Capital Cosmos which ground has not even been pleaded in the statement of claim. 

Analysis and Decision

51.  I disagree with the submissions of leading counsel for the plaintiff.  For the purpose of this application, I think whether Mr Yang’s companies had been involved with Aggarwal’s fraud is an issue to be canvassed at the trial.  This has been pointed out by Mr Tso in his affidavits. 

52.  At this stage, and on the evidence available, the terms of the escrow agreement as disclosed in the agreement and the fees payable as referred to in the emails made the escrow arrangements look too good to be bona fide.  I would, however, make haste to say that this is still the early stage of the proceedings and my observation is made only for the disposal of this application.

53.  Regarding section 7 of the Partnership Ordinance, it all depends on whether the so-called stand-alone escrow arrangements made between Aggarwal and Mr Yang’s companies can or cannot be said to be part of the defendant’s usual business.  This is hotly disputed by Mr Tso, who says in effect that such arrangements were not, and could not be, for fund proof.  In the light of my observation above, this matter should also be tried. 

54.  There are also the questions of whether Aggarwal in fact had no authority to act for the defendant in entering into these apparently unusual escrow arrangements and whether Mr Yang and/or his colleagues were aware of the lack of authority in Aggarwal. 

55.  Regarding the question of independent legal personality in the 44 completed arrangements, I think the question of their relevance to the two escrow agreements is also a matter that needs to be tried. I note that the defendant’s case is pinpointed at Mr Yang and his colleagues who were behind their companies in effecting these arrangements and benefitting from the defendant’s client account to the tune of HK$48,327,900.05. 

56.  Regarding the fact that these transactions took place over a period of 2½ years and involved many persons in the defendant, this again is a matter to be canvassed at the trial.  I do note that Mr Michael Chan has already said in his affidavit that he was not aware of the fraud and had relied on Mr Aggarwal.  Discovery by the defendant may show the identities of other people who were involved in the processing of these arrangements and remittances.  It may be necessary to canvass the extent of their knowledge, if any, in Aggarwal’s fraud. 

57.  For the application of section 12 of the Partnership Ordinance, it again depends on whether Aggarwal was acting in the ordinary course of business of the defendant in effecting these escrow arrangements. 

58.  Finally, on the un-pleaded claim of money had and received, I think there is the need to find out at the trial whether the money was paid to the defendant in the defendant’s own right, or rather were loaned to Aggarwal by being channelled into the defendant’s client account to cover up the deficit created by Aggarwal’s wrong doing.

Order

59.  In these premises, I cannot give summary judgment to the plaintiff.  I also do not think this is a case for conditional leave to the defend as the defendant’s defence is not shadowy at all.  However, I do not think I should dismiss the plaintiff’s Order 14 summons as the defendant’s arguments in defence only came out in Mr Tso’s affidavits and not prior to the plaintiff’s summons.

60.  I, therefore, give the defendant unconditional leave to defend with a costs order nisi that the costs of the application be in the cause.  I also certify the application fit for leading counsel.