C v. D1 AND ANOTHER

HCCT 3/2021

[2021] HKCFI 228

IN THE HIGH COURT OF THE

HONG KONG SPECIAL ADMINISTRATIVE REGION

COURT OF FIRST INSTANCE

CONSTRUCTION AND ARBITRATION PROCEEDINGS

NO 3 OF 2021

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REASONS FOR DECISION

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1.  This is the Plaintiff’s (“P”) application by summons dated 13 January 2021 for an order to continue the ex parte proprietary injunction granted by Lisa Wong J on 12 January 2021 restraining the 1^st and 2^nd Defendants (“D1” and “D2”, together “Ds”) from, inter alia, dealing with shares of any entities operating or holding any part of any [redacted] business accessible on or through the website [www.b.com] (“Injunction”), and an ancillary disclosure order (“Disclosure Order”). Upon hearing the parties, I declined to continue the Injunction on the bases that (1) P failed to demonstrate that it had a proprietary interest in any or all of the [Subject Entities], and (2) P did not have any basis for proceeding ex parte.

2.  These are the reasons for my decision.

A.  Factual background

3.  P is a very experienced businessman and an investor in start-ups and early growth companies.  D1 is the founder of a [redacted] platform on [www.b.com] (“[B]”).  D2 is a Hong Kong company and was, at least as at August 2017, the operator of [B].

4.  On 22 August 2017, P entered into an Investment Framework Agreement (“IFA”) with Ds, pursuant to which P will be allotted a number of shares in a yet to be incorporated company (“Investment Platform Company”) which corresponds to a 5% interest in D2 or its successor (“Target Company”) in return for an investment of RMB 25 million (“Investment Sum”). 

5.  The IFA contains the following material terms:

5.1.  Recital (1) provides that “[D2] (the “Target Company”) is a company … which operates the [redacted] platform business of [www.b.com]”.

5.2.  Clause 1 provides that “Target Company” or “Company” means [D2], including but not limited to any new company that shall acquire the entire business and assets of the Company”.

5.3.  Clause 2.1 sets out a restructuring exercise which Ds are obliged to perform within 90 days of the IFA (“Restructuring Plan”).  In summary, Ds are to incorporate the Investment Platform Company and a “Holding Company”.  The Investment Platform Company will, along with other shareholders, hold the Holding Company which, in turn, will hold 100% of the Target Company. 

5.4.  Clause 2.3 provides that P shall pay the first instalment of the Investment Sum of RMB 8 million upon the satisfaction or waiver of certain conditions (“1^st Instalment”), and that he shall, upon incorporation of the Investment Platform Company, immediately pay the balance of RMB 17 million (“2^nd Instalment”)

5.5.  Clause 2.2 states that provided that P has paid in full the Investment Sum, the Investment Platform Company shall within 10 days after its incorporation and its acquisition of the shares of the Holding Company, allot shares to P corresponding to a 5% indirect interest in the Target Company. 

5.6.  Clause 4 sets out P’s rights to disclosure of information under the IFA:

(a)  Clause 4.1 provides that “insofar as [P] […] holds shares directly or indirectly in the Investment Platform Company and/or the Target Company”, the Target Company and the Investment Platform Company shall, inter alia, provide P with the Target Company’s annual audited report and annual operation report, as well as notify P of specified material developments in the operation of the Target Company.   

(b)  Clause 4.2 provides that P has, inter alia, the right at any time to inspect any of the Target Company, the Investment Platform Company and their controlled related parties’ facilities, records and books, and to take notes and make copies of the same. 

5.7.  Clause 7.1 provides, inter alia, that if there is any applicable law and regulation that restricts or prohibits P from completing the transaction, each shall cooperate with P to make necessary adjustments to ensure the legalization of the transaction.

5.8.  Clause 11 provides that the IFA is governed by Hong Kong law and that any dispute in relation to the IFA shall be referred to HKIAC arbitration.

6.  On 25 August 2017, P paid the 1^st Instalment. 

7.  Subsequently, D1 informed P that various changes would have to be made to the Restructuring Plan in light of certain regulatory changes enacted by the Mainland authorities.  As such, Ds did not proceed with the Restructuring Plan within the 90-day timeframe as originally agreed.

8.  On 15 December 2017, P paid the 2^nd Instalment upon D1’s request despite the fact that the Investment Platform Company had not yet been incorporated. 

9.  Notwithstanding repeated demands, P did not receive any shares in the Investment Platform Company, D2, or any successor company.  Nor did he receive any profit distributions or detailed financial information to which he is allegedly entitled under Clause 4 of the IFA. 

10.  On 14 September 2018, D1 sent a letter to various investors in [B] including, inter alia, P via WeChat in which he declared that he would not set up the corporate structure as planned due to “external factors”, and that [B] would instead operate as a “new type of organization” with no shares and no board of directors.

11.  In or around July 2019, P (together with other investors in D2) began raising concerns with Ds about their failure to perform the IFA.  It is unnecessary to set out the contents of these negotiations in detail (portions of which are in any event not before the Court as without prejudice material), save to note 2 events:

11.1. In March 2020, P was again informed that [B] would migrate to a “decentralized holding structure”, with no shares issued, no holding entity, no financial statements, no rights, no distribution of dividends and no transfer of shareholding. 

11.2. On 22 December 2020, P’s solicitors issued a letter to D1, reiterating its request for information under Clause 4 of the IFA, and demanding that he provide a detailed description of [B]’s ownership structure.  Ds’ solicitors provided a holding response by letter dated 30 December 2020. 

B.  The Injunction

12.  P’s application was made under section 45 of the Arbitration Ordinance (Cap 609), in aid of an arbitration to be commenced in the HKIAC.  It sought (and obtained on an ex parte basis) an order that:

“1. Until and including 22 January 2021 or until further Order of the Court, in respect of the shares of each of the entities operating or holding any business accessible through the website [www.b.com] (including the [redacted] listed in Schedule 1 herein – collectively the “[Subject Business]”) between 22 August 2017 and 12 January 2021 (“[Subject Entities]”), including but not limited to the following entities (the “Currently Known [Subject Entities]”):

(1)  [L]

(2)  [M]

(3)  [N]

(4)  [O]

(5)  [P]

(6)  [D2]

(7)  [Q]

(8)  [R]

(9)  [S]

(10)  [T]

(11)  [U]

(12)  [V]

(13)  [W]

(14)  [X]

(15)  [Y]

(16)  [Z]

each of [D1] and [D2] must not, [… ] in any way dispose of, or deal with, or diminish the value of, the shares of the [Subject Entities], […]”

13.  Schedule 1 sets out a list of 13 [redacted] businesses which are said to be businesses accessible through the website [www.b.com].

14.  P argues that there is a strong case that Ds have breached the IFA, and that P is entitled to specific performance in respect thereof.  He says that while the IFA set out a complex structure through which P would hold an indirect interest in the Target Company, the “primary purpose” of the IFA was in effect to acquire a 5% interest in the Target Company.  Since specific performance need not be ordered in strict accordance with the terms of the contract so long as there is performance in substance so to give effect to the mutual intentions of the parties, there is a strong case that he is entitled to an order for specific performance compelling Ds to transfer this 5% interest to him.[1]

15.  As for the scope of the Injunction, P submits as follows:

15.1.  In relation to the definition of “[Subject Business]”, P relies on the fact that Recital (1) of the IFA provides that the Target Company “operates the [redacted] business of [www.b.com]”.  He accepts that the definition of [Subject Business] is wider than the statement in the Recital, but contends that there is “at least a serious issue to be tried that the expansion of the business from the original business held by the Target Company, or at least part of such expansion, should also be held by or enure to the benefit of the Target Company, since it is likely to have originated, in whole or in part, from, inter alia, the capital, profits, expertise or goodwill of the Target Company”.[2]

15.2.  In relation to the list of the Currently Known [Subject Entities], P says that they are all entities involved in running the [Subject Business] and, as such, they all fall within the definition of “Target Company” in the IFA.[3]

15.3.  As for the necessity of freezing the entirety of the shareholdings in all of the [Subject Entities], P argues that this is precipitated by the secretive manner in which the [Subject Business] has been operated and held as well as Ds’ persistent and continuous breaches of its disclosure obligations under Clause 4 of the IFA, such that he currently has no visibility into what exactly the [Subject Business] comprises and how it is operated.  P argues that once proper disclosure is given, he will not object to varying the order to 5% of the entities which reflect his entitlement under the IFA.[4]

C.  No proprietary assets identified

16.  I assume for present purposes that P has a good case that Ds have breached the IFA.  However, as the matter now stands, P has simply not demonstrated that the IFA is susceptible to specific performance in the manner which he contends. 

17.  While specific performance can be granted in respect of a contract for sale of shares in a private company, the IFA is not an agreement for the sale of shares in an existing company.  P has not acquired any right in any shares or interest in the Target Company. Rather, Ds’ obligation under the IFA is to complete the Restructuring Plan (which ought to have taken place before P paid the 2^nd Instalment).  At its highest, P only acquires a right to compel Ds to complete the Restructuring Plan and allot shares in the Investment Platform Company to P.[5]

18.  I reject P’s submission that the Court (or an arbitral tribunal) is entitled to rewrite the contract to reflect the “substance” of the parties’ intentions and grant specific performance in respect thereof.  In my judgment, the authorities on which Mr Lam SC[6] relies do not support this proposition:

18.1.  In Xiamen Xinjingdi Group Ltd v Eton Properties Ltd [2008] 4 HKLRD 972, Reyes J notes at §93 that “equitable remedies are flexible and can be tailored to the exigencies of a given situation”.  However, when read in its proper context, it is clear that His Lordship was simply referring to the well-established rule that where performance of part of the contract is no longer possible, the Court may still (in its discretion) order specific performance in respect of the other obligations.  His Lordship did not suggest the existence of a freestanding and wide-ranging discretion to look behind the terms of the contract and grant specific performance of what it considers to be the “essence” of the parties’ agreement. 

18.2.  P also relies on the learned Judge’s observation at §109 that if the Court granted an order for specific performance on those facts, “to a substantial extent the apparent ultimate objectives of the Agreement might yet be realised”.  However, this is merely a comment as to the appropriateness of ordering specific performance on the specific facts of that case, and not authority for the proposition that the Court may grant specific performance as long as the order “substantially” reflects the contract. 

18.3.  Finally, P refers the Court to Xiamen Xinjingdi Group Ltd v Eton Properties Ltd [2009] 4 HKLRD 353 §§29-31, where Le Pichon JA rejected the appellants’ submission that the registration of an arbitration award should be refused on public policy grounds as the award was no longer possible to perform.  This case is of no relevance to the present for 2 reasons.  First, there was no question of rewriting the contract in that case: the respondents were seeking to enforce the very terms of an award which the appellants contended had become impossible to perform.  Second, and more importantly, the Court’s exercise of discretion in the context of enforcement of arbitral awards is obviously substantially different from the exercise of discretion in whether to award specific performance.  As Her Ladyship explained at §28, the Court’s role in the former should be as “mechanistic” as possible: it cannot look at the merits or the underlying transaction and must enforce the award except for certain limited statutory grounds.  This may be sharply contrasted with the Court’s broad discretion in deciding whether or not to grant specific performance of a contract.

19.  In any event, I am not persuaded that the substantive purpose of the IFA was for the acquisition of a 5% interest in the Target Company without regard to what the parties actually agreed in the IFA.  The terms of the IFA make clear that P’s interest in the Target Company is only ever intended to be indirect:

19.1.  Recital (3) provides that “the Investor […] wishes to invest in the Target Company RMB25 million, […] and through directly holding shares in the Investment Platform Company (defined below) to acquire indirectly 5% of the shares in the Target Company […]” (underline added).

19.2.  Clause 2.2 provides that “Completion […] the Investment Platform Company shall allot to the Investor ordinary shares of the Investment Platform Company (the [AS] Shares).  It shall be guaranteed that the [AS] Shares acquired by the Investor (on the Completion Date) shall represent 5% indirect shareholding in the Target Company […]” (underline added). 

20.  At the hearing, Mr Lam SC accepts that the IFA was a sophisticated contract negotiated and entered into between experienced commercial parties.  This is another weighty consideration pointing against his submission that the precise holding structure of the shares in D2 is simply a “structural technicality”[7] which may be ignored by the Court.

21.  Furthermore, even if P’s 5% indirect interest can be regarded as a beneficial interest in 5% of the shares in the Target Company (which I do not accept), P is at most only entitled to a proprietary injunction over this interest.  There is no basis for P to seek an injunction to enjoin Ds from dealing with, or diminishing the value of, all the shares of all the [Subject Entities]. 

22.  It is well-established that in order to justify the grant of a proprietary injunction, the plaintiff should ordinarily adduce some reasonable evidence of the existence of a specific asset in which he has a proprietary right and that the same is being held by or under the control of the defendant (Zhang Yan v ASA Bullion Ltd, [2019] HKCFI 179, HCA 1555/2018, unrep., 23 Jan 2019, §11(4) per Recorder Eugene Fung SC).  “Target Company” is defined in clause 1 of the IFA as D2 “including but not limited to any new company that shall acquire the entire business and assets of [D2]”.  As Mr Lam SC rightly accepts at the hearing, P does not have any evidence that any of the [Subject Entities] acquired the entire business and assets of D2.  In my view, this renders a proprietary injunction in respect of any [Subject Entity] other than D2 wholly untenable.

23.  I reject P’s contention that there is a serious issue to be tried that he has a proprietary interest in any entity which owns or operates a “business which is accessible on or through the website [www.b.com].” First and foremost, the definition of Target Company in the IFA does not extend to every entity which is involved in operating some aspect of D2’s original virtual currency trading platform business—it only includes those entities which acquire “the entire business and assets of [D2]” (underline added), if any.  Second, the suggestion that P has a proprietary interest in entities operating additional businesses developed on top of the Target Company’s original business offends against the basic principle of separate corporate personality.  Taking his case at its highest, P is at most a shareholder of D2 (or its successor); he does not have any proprietary interest in its underlying capital, profits, expertise or goodwill. As such, it is difficult to see how P can claim to “trace” such resources into the “expanded business” and thereby claim to have an interest in all those companies which operate this “expanded business”. 

24.  I also reject P’s submission that such a broad injunction is justified by the lack of visibility into the holding structure of the [Subject Entities] arising out of Ds’ persistent and continuous breaches of their obligation to disclose information under clause 4 of the IFA.[8]

24.1.  First, P’s right to information under Clause 4.1 does not appear to be engaged: on the face of the IFA, it only applies “insofar as [P] holds shares directly or indirectly in the Investment Platform Company and/or the Target Company”.  No shares ever having been allotted to P, he simply cannot rely on this clause to demand information from Ds.

24.2.  More pertinently, P’s lack of evidence simply means that he is unable to make out a case of a proprietary interest in the [Subject Entities] to the requisite threshold.  Whether this failure was precipitated by Ds’ breaches of the IFA is, strictly speaking, irrelevant.  P’s suggestion that it is for Ds to produce evidence showing that there is in fact no connection between D2 on one hand, and the [Subject Business] and the other [Subject Entities] on the other[9] places the burden of proof on the wrong party.

25.  In the premises, I consider that P has failed to demonstrate the existence of any proprietary interest which may be made the subject of the Injunction.

D.  No basis for ex parte application

26.  Independent of the above, I consider that the Injunction should not be continued on the basis that P had no justification for proceeding ex parte. 

27.  It is well-established that ex parte relief is only justified in cases of extreme urgency or where there is a need for secrecy (Slik Hong Kong v Gerald Evans, HCA 1424/2005, unrep., 25 Jul 2005, §§2-3 per Lam J, as he then was).

28.  In his submissions before the ex parte Judge and at the return date hearing, Mr Lam SC disavows any reliance on extreme urgency but contends that there was a need for secrecy on the facts of the case. He submits that D1 had made it abundantly clear that he no longer intends to comply with the terms of the IFA and instead seeks to operate the [Subject Business] under a fluid and malleable corporate structure which can be readily restructured should he wish to do so.  Mr Lam SC also points out that Ds had access to immense resources, most of which are in [reacted]-assets which transcend national borders and conventional methods of control and enforcement.

29.  However, as the factual background set out above indicates, D1 first indicated his intention to abandon the original corporate structure set out in the IFA in September 2018.  The parties then conducted lengthy negotiations throughout 2019 up until at least June 2020.  The parties were in communication as recently as late December 2020, when P demanded, inter alia, that Ds comply with their obligations to provide information pursuant to clause 4 of the IFA.  In light of these matters, the suggestion that Ds might restructure the [Subject Business] in order to frustrate arbitration proceedings if they were aware of P’s intention to commence arbitration proceedings or apply for interim relief is fanciful.

E.  Conclusion

30.  In conclusion, I decline to continue the Injunction.  As Mr Lam SC accepts at the hearing, the Disclosure Order falls away if the Injunction is not continued.

31.  My decision to not continue the Disclosure Order does not excuse Ds from having failed to comply with the Disclosure Order during the period leading up to the return date hearing, given that it was, at the time, a valid order of the Court.  That said, as I indicate to the parties at the hearing:

(1)  P ought to have drawn to the attention of the Judge at the ex parte application the usual practice of the Court in dealing with applications for disclosure of information, particularly one which depends on P demonstrating his entitlement to the assets being enjoined, is for the application to be dealt with inter partes;

(2)  P has no right to seek the wide ranging information listed out in Clause 4.1.  In any event, the information sought to be disclosed in the Injunction is not based on, and is irrelevant to, Clause 4.2;

(3)  In light of my conclusions above that P had no basis to obtain the Injunction; and

(4)  To avoid any wasteful satellite litigation, I consider it appropriate to grant an order that Ds be granted a retrospective extension of time to comply with the Disclosure Order until after the determination of P’s summons dated 13 January 2021[10].

32.  Costs should follow the event.  As for the basis of costs, Ms Cheung submits that the Court could award costs on an indemnity basis so to reflect its displeasure of P’s incorrect use of the ex parte procedure.  Having considered the matter in the round, while I do think that it was incorrect for P to apply ex parte, I do not think their actions were so egregious so to warrant an order of indemnity costs (cf. Global Communications Inc v Chinacomm Ltd, HCA 1978/2011, 8 March 2013, §§5-6).  In the circumstances, I order that P pay Ds’ costs on a party and party basis, to be assessed by way of gross sum assessment.  I direct that Ds lodge their statement of costs within 4 days of these Reasons for Decision, and that P file his objections (if any) within 3 days thereafter.