RALOTTE INVESTMENTS LTD v. THE BAUHINIA LTD AND OTHERS

HCMP 3388/2013

IN THE HIGH COURT OF THE

HONG KONG SPECIAL ADMINISTRATIVE REGION

COURT OF FIRST INSTANCE

MISCELLANEOUS PROCEEDINGS NO 3388 OF 2013

____________

____________

____________________________

DECISION ON COSTS

____________________________

1. The Applicant seeks leave to commence a derivative action (“the Leave Application”) in the name of the 1^st respondent (“the Company”). The 2^nd respondent (“QVI”) and 3^rd respondent (“Richard Ng”) intervened and were joined as parties (collectively “the Respondents”). The intended defendants to the intended action achieved an overall settlement with the Company, including payment of the Company’s costs in these proceedings by the Respondents. The Applicant seeks leave to withdraw the derivative action. The remaining issue is one of costs:

(1) The Applicant seeks costs against the Respondents on an indemnity basis. 

(2) The Company supports the Applicant’s claim for costs but asks that they should be borne by Richard Ng personally. 

(3) The Respondents ask the Applicant to bear their costs and the costs $70,000 which the Respondents paid to the Company in relation to the Leave Application.

THE FACTS

2. The Company is engaged in the trading of toys and games, and is a supplying and sourcing agent for well-known toy brands.  Its shareholders and ultimate beneficial owners (“the Partners”) are depicted as follows:

Name of shareholder	Shareholding in Company	Ultimate beneficial owner/Partner
QVI Ltd (R2)	27.5%	Richard Ng (R3)
Cobyrne Ltd	30%	Jack Rubin
Ralotte Investments Ltd (Applicant)	42.5%	40% for Arthur Levine (father) and 2.5% for Robert Levine (son)

3. From about 1972, Richard Ng has been working as an employee of the Company and has been responsible for conducting its trade and managing its operation.

4. Since December 1998, the Company has had 2 directors, namely, Robert Levine and Garry Au-Yeung (“Garry”).

5. The relationship of the 4 Partners is governed by a Shareholders’ Agreement dated 15 May 2006.  Clause 2 thereof provides:

“That notwithstanding anything previously agreed to the contrary, each of the abovenamed (ie the beneficial shareholders of the Company: Jack Rubin, Arthur Levine, Robert Levine and Richard Ng) will be deemed to have one vote each when voting on matters in respect of the conduct of the company’s affairs and in respect of any matters affecting shareholders, directly or indirectly.”

6. The Intended Action was by the Company against 3 Intended Defendants, namely, Richard Ng as president of the Company, Kitty Lam as account manager of the Company and New Smart (HK) Ltd (“New Smart”) owned by Richard Ng’s son.

7. The Applicant discovered in September 2013 from the website of New Smart that the 3 Intended Defendants acted in competition with the Company.  The Intended Action involved wide ranging allegations of passing off by New Smart as having taken over or carrying on the business of the Company, breaches of contractual/fiduciary duties owed to the Company by Richard Ng and Kitty Lam, and conspiracy to injure the Company by unlawful means (collectively “the unlawful conduct”). The prayers for relief included injunctions and damages.

8. The Originating Summons for the Leave Application (“the OS”) was filed on 18 December 2013.

9. The Company has not filed evidence in these proceedings.  On 15 January 2014 (before the first call-over and hearing of the joinder application of the Respondents), Garry sent a letter to this court as a director of the Company stating that:

(i)  He had been advised by Robert Levine that the latter had a conflict of interest and could not assist Garry with making any board decisions on behalf of  the Company; and

(ii)  The court papers had been sent to other beneficial owners of the Company but he had not been given any instructions in the matter.

10. On 24 February 2014, the Company passed a resolution at an EGM (“the EGM”) authorizing Garry “to handle all matters in connection with the Originating Summons” and to “[appoint] solicitors on the Company’s behalf to take advice and represent the Company in respect of the Originating Summons”.

11. The Respondents opposed the Leave Application, challenging the necessity for the Applicant to resort to a derivative action since the board or the shareholders were clearly capable of moving the Company to sue the Intended Defendants in its own name for the alleged unlawful conduct.  The Respondents also asked that leave be refused because, while the OS was issued without prior attempt to resolve the complaints out of court, the Intended Defendants had, from 7 February to 30 April 2014 made various open offers to the Applicant and the Company in accordance with the Company’s lawful entitlements.

12. The Intended Defendants managed to reach a settlement agreement with the Company.  Although on a without admission of liability basis, in substance, New Smart agreed to account for profits earned from the alleged unlawful conduct to the Company and the Intended Defendants gave various undertakings in lieu of injunctive relief.

THE APPLICANT’S CLAIM FOR COSTS

13. The Applicant seeks to be indemnified for costs of the Leave Application out of the Company’s assets: section 168BI of Cap 32. It is necessary to show that the Applicant (A) acted in good faith and (B) has reasonable grounds to take out this Application.

14. It has also to be shown that the Company was able to meet the costs of the Intended Action at the time that leave was sought: Re F&S Express Ltd [2005] 4 HKLRD 743, Kwan J (as she then was),at 747, §28.

REASONABLE GROUNDS FOR TAKING OUT THE OS

A. The legal principles for granting leave under section 168BC(3)

15. Derivative actions represent an exceptional course of departure from “the proper plaintiff rule” in Foss v Harbottle (1843) 67 ER 189. In Waddington Ltd v Chan Chun Hoo (2008) 11 HKCFAR 370, at 386E-G, Ribeiro PJ stated as follows:

“In exercising its discretion, the court is effectively deciding, on the basis of criteria laid down by statute, whether the plaintiff should exceptionally be allowed to sue in place of the company which is normally the proper plaintiff …. The discretion is also obviously a safeguard against vexatious and inappropriate proceedings by disgruntled members.”

16. The relevant principles for granting leave under s.168BC of the Companies Ordinance were summarized by Anthony Chan J in Re Bold Pacific Limited (Unreported), HCMP 548/2013, 12 September 2013, §§15-19, 40:

“(16) The requirement for leave under s168BC of the Ordinance is a determination of the applicant’s standing to bring a derivative action. Therefore, the burden falls squarely on the applicant to convince the court that he should be allowed to bring the derivative action, rather than putting the burden on the company to persuade the court otherwise …

(17) Before the court would grant leave for the applicant to commence a derivative action under s 168BC, it has to be satisfied that:-

(1) It appears to be prima facie in the interest of the company that leave should be granted to the applicant (s 168BC(3)(a));

(2) There is a serious issue to be tried and the company has not itself brought the claim (s 168BC(3)(b)); and

(3) The applicant has to serve a written notice on the company pursuant to s 168BD of the Ordinance at least 14 days before he takes out the leave application …

(18) In considering whether it is in the interest of the company to bring the derivative action:

(1) …

(2) the court would consider whether the substance of the redress which the applicant seeks to achieve is available by means which does not require the company to be brought into litigation against its will. …”

17. The de facto majority shareholder who would have no difficulty in moving the company to bring an action was refused leave under s.168BC: Re Astrotec Company Limited (unreported) HCMP 923/2011, 3 May 2012, Harris J, §§4-6.

18. I can envisage difficulty in the classical situation of 2 shareholders each holding 50% shareholding and having a deadlock.  But if an applicant is able to procure a company, through its constitutional procedure, to bring an action, but does not invoke that procedure, the court may not grant him leave to commence a derivative action.  The rationale behind is to ensure procedural economy in the litigation process and that a shareholder should not be allowed to incur unnecessary legal costs.

APPLICATION OF THE LEGAL PRINCIPLES

19. I am satisfied that there were serious questions to be tried in the Intended Action.  The unlawful conduct was prima facie evidenced by the results of internet search and the terms of settlement that virtually gave the Company the reliefs sought in the draft statement of claim. 

20. There is no dispute that the Company has not itself brought the claim and the Applicant has served the 14-day notice on the Company.

21. It was prima facie in the interest of the Company to bring the action to stop the unlawful conduct and recover loss.

22. There is no dispute that at the time the OS was issued, the Company was able to meet the costs of the Intended Action.  The Company had profit after tax at around HK$14.5m for the financial year ending March 2012.

23. However, Mr Lo, counsel for the Respondents, queries whether the substance of the redress was available by means which did not require the Company to be brought into litigation against its will: Re Bold Pacific Ltd.  He relies on the fact that the Levines had initiated buy-out negotiation in late November 2013.  There had been no demand letter before the OS.  Richard Ng thought that the complaints could be dealt with during negotiation of the buy-out offer, so he did not respond to the 14-day notice. Soon after the OS was issued, the Respondents have actively engaged in negotiation from February to April 2014 which ended up in full settlement of the underlying dispute. 

24. In my view, the fact that the Levines had a personal offer to sell their interests to Richard Ng was distinct from the Company’s interests to be protected by derivative action.

25. Moreover, Richard Ng had not responded to the 14-day notice.  He had neither informed the Levines that he was preparing the terms in response to their offer nor requested the Applicant to withhold proceedings in the meantime. Mr Ng had not denied the complaints in the draft statement of claim against him either.  There was evidence that New Smart was continuing to accept new business wrongfully diverted from the Company to it.  There was evidence from Robert Levine’s 2^nd affidavit of further solicitation of business for New Smart by Richard Ng and/or Kitty Lam in January and February 2014 after issue of the OS.

26. Therefore, it could not be expected that the substance of the redress was available by means other than legal action.

B. Good faith

27. The Intended Action was clearly for the benefit of the Company.  The fact that neither the Applicant nor the Company had made any attempt at all to resolve the complaints out of court was an irrelevant factor.  It was at best relevant to the question of costs of the Intended Action if instituted.

28. The fact that the Applicant had not asked for an urgent injunction to restrain the intended defendants’ conduct could not undermine the Applicant’s good faith either in protecting the legitimate interests of the Company.

29. It is Richard Ng’s case that the OS proceedings were to pressurize him into a deal and facilitate the Levines’ exit from the Company.

30. I disagree.  These proceedings were the result of his alleged breaches of fiduciary duties as disclosed on the available evidence. In any case, he was pre-destined to buy out the Applicant’s shareholding in the Company, so there was no question of his being pressurized.

31. The criteria laid down in s168BC and the requirement of good faith have been met at the time of issue of the OS.  But a more fundamental question to ask is whether or not there was an alternative to the Leave Application.

The necessity for the Leave Application

32. It is the Applicant’s case that it was impossible for the Partners to approve and direct Garry to instruct solicitors by voting; and that there was no alternative to derivative action.

33. Robert Levine explained that in reality Richard Ng has taken a leading and active role in management and could not be expected to give support to the litigation.  Jack Rubin and Arthur Levine were in the USA and did not play an active role in daily management.  Garry and Robert Levine were, in reality, no more than nominee directors.  No formal meeting of the board of directors had actually been conducted or convened at all times when Robert Levine was a director. 

34. Robert Levine had sought (without success) the support of Garry for the Company to bring the Intended Action.  According to Robert Levine, Garry took a neutral position and would require instructions from the Partners as a whole or at least an absolute majority (3 out of 4) for the Company to commence proceedings (“Garry’s requirement”).  Robert Levine also took the view that Garry would not attend a meeting and the meeting would be inquorate.

35. Likewise, Arthur Levine had sought (without success) the support of Jack Rubin. According to the double hearsay evidence of Robert Levine, (a) Jack Rubin indicated that he would not join in the suit on either side but would not put it in writing; (b) that when told on 2 individual occasions that an injunction would be sought and that proceedings would be commenced, Jack Rubin simply replied with “do what you have to do”.

36. Accordingly, there was no attempt to convene a board meeting or EGM before issue of the OS.

37. In my view, when it comes to ascertaining the views of a company in bringing an action, it is the shareholders’ agreement or articles that should govern the situation. The informal lobbying for support for insufficient.  The reliance on the usual or informal way of conducting company business in the past was equally insufficient.

38. I do not doubt the good faith of the Applicant.  However, its explanation for not convening a meeting cannot withstand scrutiny as a matter of fact and law.

39. Firstly, this was not the classic situation of 2 shareholders each holding 50% of the shares and were in a deadlock such that convening a meeting would have been futile.  Here, the Levines held 42.5% shares and might have been able to obtain a resolution in favour of instituting action if they had tried.

40. Secondly, there was no constitutional difficulty in convening a board meeting.  Article 96 of the Articles of the Company provides that 2 directors shall constitute a quorum. Questions arising at any meeting shall be decided by a majority of votes.  In case of an equality of votes the Chairman shall have a second or casting vote.  A director may, at any time, summon a meeting of the directors.

41. A board meeting could have been easily summoned as Robert Levine and Garry often met to discuss Company matters.  There was no evidence that Garry would not attend a board meeting if one was called for.

42. If a board meeting had been summoned, Robert Levine, with beneficial shareholding, would likely have been the Chairman rather than Garry, an employee with no shareholding.  The resolution would be carried by a simple majority of 1:0 or, if Robert Levine placed a casting vote, by 2:0.

43. Thirdly, there was equally no difficulty in convening a shareholders’ meeting pursuant to the Shareholders’ Agreement.  All 4 Partners could have voted under Clause 2 and only a simple majority was sufficient. Even if Jack Rubin were to abstain, a resolution would have been carried at least by 2:1 (if Richard Ng was absent or voted against) or by 2:0 (if Richard Ng did not vote).  Garry’s requirement was without legal basis.

44. Fourthly, the Company was able to hold the EGM, convened at the requisition of the Applicant. Richard Ng did not attend.  Jack Rubin informed Richard Ng beforehand that (a) he would appoint Garry as proxy of Cobyrne to attend the EGM; and (b) Garry would abstain from voting.  The resolution was passed.

45. There was no evidence as to what prompted Robert Levine to convene the EGM despite his perception of the shareholders’ and Garry’s views.  It was held after the OS was filed.  It was probably to facilitate the Company to enter into the negotiation and settlement.  Garry has not filed any affirmation to support or challenge Robert Levine’s views, or stated if he has changed his position between December 2013 and February 2014.

46. In any case, the entire negotiation thereafter leading towards settlement was led by the “neutral” director, Garry. He signed the settlement agreement on behalf of the Company.

47. The totality of the evidence put it beyond doubt that the board or shareholders would have had no difficulty in  holding a meeting to resolve suing the Intended Defendants in the Company’s own name had the proper constitutional mechanisms been invoked.  This would have been sufficient to dismiss the OS had it proceeded to full hearing.  Had the EGM been convened earlier, it would have saved all the trouble, time and costs (over $1m on the Applicant’s side) in these OS proceedings.

48. If I am wrong, the whole foundation for a derivative action was wiped out, at the latest, by 24 February 2014.  Once the Company stepped in, the Applicant should give way.  As a matter of principle, costs incurred by the Applicant thereafter will be at his/her own risk.

49. Mr McLeish submits that it was still necessary for the Applicant to continue these proceedings after the EGM because the resolution did not actually authorize the Company to commence or pursue the Intended Action.  At no time after the EGM had the Company ever evinced an intention to commence the Intended Action.  Rather, the Company was content to “slip-stream” in the wake of the Applicant’s continued prosecution of these proceedings in order to obtain proper redress for the wrongs done to it by the Intended Defendants. Even if the resolution could be construed as being sufficiently wide to authorize Garry to commence proceedings by the Company, it was nonetheless reasonable, Mr McLeish submits, for the Applicant to assume that Garry would not do so given Garry’s requirement.  That position was consistent with the Company’s only written submission to the court by letter dated 15 January 2014.

50. Without disrespect, such contentions cannot stand up to scrutiny.

(i) The Company’s negotiation for settlement went well beyond handling the OS (which was limited to the grant of leave under s.168BC).  If, as Mr McLeish submits, the resolution had not authorized the Company to commence or pursue the Intended Action, much of Garry’s acts in the settlement would have been unauthorized.

(ii) If the Company really had not been authorized to commence or pursue the Intended Action, it begged the question why it was not put on the agenda in the first place.

(iii) The fact that the Company had not evinced an intention to institute the Intended Action was irrelevant.  When one talks about the proper plaintiff rule, it is about a company seeking redress in its own name for wrongs done to it, with discretion to do it by legal action or alternative dispute resolution.

(iv) If one were to ask the Company in February to April 2014 whether or not it would pursue the Intended Action, the answer could not be clearer.  The Company preferred to explore settlement first.  In those circumstances, the court, in the exercise of its discretion, would not have granted the Leave Application without first waiting for the outcome of that exploration.

(v) As stated, Garry’s requirement was without legal basis.  The Applicant’s reliance on it was misplaced.

51. I find that the Applicant could have but did not try to move the Company to bring an action by convening a meeting before issue of the OS.  The Leave Application was inappropriate proceedings by a disgruntled shareholder: Waddington Ltd v Chan Chun Hoo.  It was not shown to be necessary.  The Applicant should not be entitled to costs.

52. In any case, the Applicant’s costs on and after 24 February 2014 in:

(a) advising on the adequacy of the terms of settlement; and

(b) advising on whether to pursue or discontinue the Intended Action in the light of the proposed terms of settlement;

fell outside the ambit of s 168BC and are not recoverable from the Respondents.  The fact that the Respondents conceded many of the Applicant’s suggestions makes no difference to my conclusion.

OTHER GROUNDS

53. Mr Lo submits that the Applicant has wrongly insisted on further relief than what the Company was entitled to in law, eg duration of Richard Ng and Kitty Lam’s undertakings to the Company, and undertaking of New Smart not to solicit business from the Company’s customers when New Smart owed no such duty in the first place.

54. Mr Lo’s submission, even if accepted, would not have affected the grant or refusal of leave.  At best, it would only have caused the court to grant leave subject to revision of the draft statement of claim.

COSTS ON INDEMNITY BASIS

55. In deference to counsel, I just briefly deal with the question of whether costs, if to be borne by the Respondents, should be on indemnity basis.  I bear in mind the principles in §62/App/12, Hong Kong Civil Procedure, 2014.

56. I do not find the Respondents to be dragging their feet.  Five offers went to and fro in between about 3 months.  What the Respondents did was to substantively dispose of the underlying dispute.  Such conduct was far from being oppressive or having a base ulterior motive as suggested by Mr McLeish.  Nor was it intended to put the Applicant to as much trouble and expense as possible.  I would have refused to order costs on indemnity basis.

COSTS OF THE COMPANY

57. Under the settlement, the Respondents shall, amongst others, pay the Company a sum of HK$70,000 as costs in the present proceedings.

58. Having regard to my findings in paragraphs 51 to 52, the Applicant should reimburse the Respondents for such costs.

CONCLUSION

59. Though a minority shareholder, the Applicant could and should have tried to persuade the Company by convening a board or shareholders’ meeting in accordance with the Company’s Articles or Shareholders’ Agreement before the OS was issued.  The Leave Application was not shown to have been necessary even though the requirements of s.168BC could be met.

60. I give leave to the Applicant to withdraw the OS.  On a nisi basis, the Applicant should:

(1) bear the Respondents’ costs of and incidental to the OS, including all costs reserved; such costs are summarily assessed and allowed at $350,000; and

(2) reimburse the Respondents for $70,000, being costs they have paid to the Company for these proceedings.

61. I thank counsel for their able assistance.