SECURITIES AND FUTURES COMMISSION v. QUNXING PAPER HOLDINGS COMPANY LTD AND ANOTHER

HCA 2428/2013

IN THE HIGH COURT OF THE

HONG KONG SPECIAL ADMINISTRATIVE REGION

COURT OF FIRST INSTANCE

ACTION NO 2428 OF 2013

________________

________________________

________________________

A. The Application

1.  The 1^st and 2^nd defendants apply by summons for the variation of an injunction order first made by Chung J on 12 December 2013.  The summons, which was partially heard by Deputy Judge Marlene Ng on 3 January 2014, is now in the following form:

“1. The Injunction Prohibiting Disposal of Assets made by the Honourable Mr. Justice Chung on 12 December 2013 as varied by the Order made by Deputy High Court Judge Marlene Ng on 20 December 2013 and the Order made by the Honourable Mr. Justice Chung on 3 January 2014 (‘the Varied Injunction Order’) be varied to read as follows:­

Under paragraph 7 thereof:­

‘This Order does not prohibit:­

(a) The 1^st Defendant from withdrawing a lump sum of HK$798,143 on account of its ordinary business expenses (as more particularly set out in Schedule 5 annexed to this Order);

(b) The 1^st and 2^nd Defendants jointly from (in addition to the lump sum of HK$500,000 for payment of legal costs as varied by the order made by Deputy High Court Judge Marlene Ng on 20 December 2013) withdrawing a lump sum of HK$1,000,000 for payment of their legal costs and such payment be made out of the first account listed in Schedule 3 of the Injunction Order (Account No. 861-502-02039-0) to Messrs. Stevenson, Wong & Co.;

(c) The 1^st Defendant from:

(i) withdrawing from its account no. 861-502-02039-0 (the ‘ICBC Current Account’) at the Industrial and Commercial Bank of China (Asia) Limited (‘ICBC’) a lump sum of HK$2,729,521.20 for payments of its ordinary business expenses due and payable immediately or by 31 January 2014;

(ii) spending HK$560,000 per month from February 2014 onwards on its ordinary business expenses; such payments be drawn from the ICBC Current Account;

(iii) spending HK$2,125,000 per month until 30 April 2014 on legal advice and representation; such payments be drawn from the ICBC Current Account and made to Messrs. Stevenson, Wong & Co.;

(d) The 2^nd Defendant from spending HK$300,000 per month until 30 April 2014 on legal advice and representation; such payments be drawn from its account no. 861-600-01303-4 with ICBC and made to Messrs Stevenson, Wong & Co.’;

2. The 1^st Defendant's accounts nos. 861-502-03541-1 and 861-502-03540-8 both at ICBC be excluded from the Injunction Order for the purpose of settlement of dividend cheques paying declared but unclaimed dividends to shareholders. The 1st Defendant shall not by itself or through any other person operate either account or apply any of the funds therein for any other purpose;

3. Paragraph 1 of the Order of Deputy High Court Judge Marlene Ng on 20 December 2013 be amended by substituting the reference to account no. 861-600­01783-6 at ICBC with a reference to the ICBC Current Account;

4. Time for service of this Summons be abridged; and

5. Costs reserved.”

2.  I was informed by counsel for the defendants at the hearing, and I accept, that the need for funds to pay business expenses is a matter of some urgency.  Accordingly these reasons address only briefly the detailed arguments and submissions that were addressed to me.

B. Background

3.  This is summarized in the skeleton submissions of the parties and was expanded upon orally at the hearing on 17 January 2014.  In brief, the 1^st defendant is a company incorporated on 5 September 2006 in the Cayman Islands.  It is now listed on the Hong Kong Stock Exchange, that listing having taken place on 2 October 2007 pursuant to a public offer and international placing.  It seems to be common ground that approximately 345 million shares were issued to the public at that time, and that the 1^st defendant received in return gross proceeds of approximately HK$1,846 million.

4.  Further shares were offered in December 2010, and shares were then issued totalling approximately HK$112 million in value.

5.  The 1^st defendant is, primarily a holding company which owns 100% of its operational arm in the PRC, Shandong Qunxing Paper Ltd (“Shandong Qunxing”), through two wholly owned subsidiaries, one of which is the 2^nd defendant, and the other is Double Nation Ltd.  These four companies together form what has been referred to as the Qunxing Group.

6.  On 31 March 2011, the 1^st defendant issued a public announcement relating to the annual results of the Qunxing Group for 2010 referring to part of a KPMG auditor’s report which had resulted in KPMG making a disclaimer in regard to the financial statements of Qunxing Group.

7.  Thereafter, in April 2011 the SFC opened an investigation into possible offences under the Securities and Futures Ordinance (regarding possible disclosure of false or misleading information inducing transactions) and the Companies Ordinance (regarding possible misstatements in the prospectus).

8.  The 1^st defendant has filed evidence showing that it has appointed two independent firms of forensic accountants to look into the concerns raised by KPMG, and to review and investigate the audit issues.  Those investigations are said to have found no evidence of manipulation of revenue, profit and cash position, falsification of books and records or misappropriation of assets.  According to the SFC however, it is of the view that these investigations were unsatisfactory and insufficient.  As it is described in the plaintiff’s skeleton submission:

“In the circumstances, the SFC issued a Writ of Summons against Ds on 12 December 2013 seeking injunctive and other orders pursuant to s213 SFO for the purpose of protecting the investors who subscribed D1’s shares and warrants.”

9.  No statement of claim has yet been served, and by a separate summons the plaintiff seeks an enlargement of time of a further 14 days for service of that pleading.  That application was opposed, but at the conclusion of the oral hearing on 17 January 2014 I made an order allowing that additional time for service of the statement of claim, with consequential extension of time to the defendants for their defences.  Costs were ordered to be to the defendants.

10.  The 1^st defendant’s assets have been disclosed through the exchange of evidence and are:

(1) a credit balance in bank accounts of about HK$150 million;

(2) securities valued at about HK$2 million;

(3) cost on account held by third parties (around HK$2 million); and

(4) the shareholding in Double Nature, which in turn holds the 2^nd defendant, which in turn holds Shandong Qunxing Paper Limited.

11.  In the context of the issues on the application it is relevant to have regard to what are said to be the “unfrozen” assets that are said to be available to the 1^st and 2^nd defendant for the purpose of funding expenses and legal fees.  This is because the plaintiff submits that the court can pay regard to the assets and financial resources of the group companies of the defendant.

12.  It is common ground that the Qunxing Group has available cash resources in the region of RMB655,000,000, the largest part of which comprises of the cash position of Shandong Qunxing.  Moreover the owners of Shandong Qunxing, ultimately the 1^st defendant, has (or will have as and when a distribution is made) an entitlement to currently undistributed profits of Shandong Qunxing which accrued between 2007 to 2010 in the region of RMB1,300,000,000.

13.  Counsel for the parties, Mr Benjamin Yu SC for the defendants and Mr Ambrose Ho SC (leading Mr Norman Nip) helpfully and carefully analysed the authorities on this area.  It is a shortage of time alone that prevents me from setting out those submissions in more detail.

C. Procedural history

14.  The injunction order was issued by Chung J, inter alia, to restrain the removal or disposition of assets within Hong Kong up to the value of HK$1,968,000,000.  The matter has been rather active in the five weeks or so since the injunction was issued on 12 December 2013.  On 20 December 2013 an application for a variation of the order was made, and this was heard before Deputy Judge Marlene Ng who was able to deliver an oral judgment on the same day.  The judge held that the 1^st defendant was entitled to draw upon the funds which were the subject of the injunction order for the provision of funds to cover reasonable legal expenses.  The amount in the order was increased to HK$500,000.  The defendants say that this was to enable the 1^st defendant to comply with disclosure orders in the injunction order, and to prepare further affidavit evidence for a renewed application for allowance of expenses.  This latter was necessary because the deputy judge was of the view that the 1^st defendant had not provided sufficient evidence that its usual business expenses are, in the usual course of its business, drawn from the bank accounts which have been frozen.

15.  The defendants contend that the deputy judge also held that a contention advanced by the plaintiff, that the claims made were in the nature of proprietary claims, was wrong, and that the legal principles on allowance for expenses out of assets under proprietary claims therefore do not apply.  This matter having been decided by the deputy judge against the plaintiff, the defendants contend that the plaintiff is now bound by an issue estoppel on this point.

16.  On 3 January 2014, Chung J allowed certain variations and gave directions for the filing of further evidence.  Subsequently the defendants have adduced evidence to show that the 1^st defendant’s expenses are habitually paid by way of drawings from its bank accounts, with ICBC Asia and Hang Seng Bank.

17.  The hearing before me was therefore the continuation of the adjourned hearing, subject to the additional matters raised formally by the defendants’ summons of 16 January 2014.  The defendants deny the allegations made by the plaintiff, and inform me that it is intended to apply to set aside the injunction as soon as practicable.  The variation of the Injunction Order is needed urgently however to enable usual business expenses and imminent legal expenses to be met.

D. Law and practice

18.  It is, I think, common ground that a distinction is to be drawn between injunctions ordered in respect of assets over which the plaintiff asserts a proprietary claim, and cases where the injunction is made in a claim seeking damages.  In the former situation the assets “frozen” are putatively those of the plaintiff while in the latter case the injunction is granted so as to prevent the dissipation of assets and removing the assets from the reach of the plaintiff.

19.  Where there is a proprietary claim the court will ordinarily expect the injuncted party to establish that recourse to the frozen assets is necessary because there are no other assets available to be used.

20.  If the claim is not a proprietary claim, then the principles applied are, according to the plaintiff, summarized at paragraph 20.054 of Gee “Commercial Injunctions”, 5^th ed:

“In exercising this discretion whether or not to grant an application to vary an injunction the court acts in accordance with what is ‘just and convenient’. This is the test laid down in s.37(1) of the Supreme Court Act 1981. On an application for a variation, the claimant has already established a real risk of dissipation and a good arguable case. The principles which apply in considering whether to grant a variation are the same as those which apply when considering whether or not to grant Mareva relief so the fact that the defendant’s purpose in applying for the variation is not deliberately to frustrate enforcement of a judgment does not mean that the variation is to be permitted Later authorities, including a judgment of Lord Donaldson MR. (as he had become), show that the test for risk of dissipation is not one depending on the subjective intent of the defendant or his ‘design’, but depends on evidence establishing objectively a real risk of dissipation of assets. Motive for making the proposed payment is not to be equated with the risk of unfair dissipation of assets.

The correct test is to consider objectively the overall justice of allowing the payment to be made including the likely consequences of permitting it on the prospects of a future judgment being left unsatisfied, and bearing in mind that the assets belong to the defendant and that the injunction is not intended to provide the claimant with security for his claim or to create an untouchable pot which will be available to satisfy an eventual judgment.

Therefore, the principle is that a defendant can use his own money which is frozen under a Mareva injunction to fund the defence provided that it is apparent that there are no other funds or source of payment which should as a matter of objective fairness be used to pay for the defence rather than the frozen funds.  This may require the defendant to adduce ‘credible evidence’ about his other assets before the court can be satisfied that it is just that he should be able to use the particular frozen assets.”

21.  The task of the court therefore is, according to the plaintiff, to consider objectively the overall justice of allowing the payment to be made. In so doing, it will need to consider whether the defendant has shown by sufficient evidence that he does not have other assets available to meet the payment.

22.  As far as the defendants are concerned, the emphasis is to be placed on the fact that a Mareva injunction is not intended to improve the position of the plaintiff but instead is to prevent further injustice by a defendant removing assets to frustrate a future judgment.  The defendant should not be prevented from using his assets to pay his debts as they fall due or from using those assets for disbursing proper legal expenses for the conduct of the defence.

23.  For the defendants, the task of the court is to consider the motive for the payment, and specifically, “… whether there is an ulterior motive involved in removal of assets from the jurisdiction to defeat any judgment that may be obtained.”  See Campbell Mussels v Thompson (1984) Law Society’s Gazette 2140, and Avant Petroleum Inc v Gatoil Overseas Inc [1986] 2 Lloyd’s Rep 236, at 242.

E. A quasi proprietary claim?

24.  The plaintiff submits that its claims in these proceedings are akin to a proprietary claim, and that therefore the approach to the application for the variation of the injunction order should follow the two stage process referred to in (for example) Ostrich Farming Corporation Limited v Ketchum [1997] EWCA Civ 2953.

25.  The defendants do not accept that to be correct, submitting that a review of the relief sought in the writ makes it clear that although acting on behalf of the shareholders, and in the public interest, the relevant claims made are nevertheless primarily claims for monetary damages.

26.  Based on a perusal of the writ it seems to me that the defendants are correct in this submission, and I do not agree that the fact that the claim is founded on alleged breaches of the Securities and Futures Ordinance (Cap 571) or the authorities relied on by the plaintiff (these being FSA v De Dietrich [2011] NI Ch 11 and Director of the Assets Recovery Agency v Creaven [2006] 1 WLR 622) alter that position.  In De Dietrich,for example, the court referred to proceedings involving “… joint provisional liquidators whom I appointed at their request to protect the assets of the persons unfortunate enough to have invested in these schemes…”  In Creaven, the court was concerned with an Act intended to “…deprive defendants of property obtained through unlawful conduct …, and for that property to be transferred for the benefit of the community.”  The plaintiff’s claims here are, so far as relevant to an injunction, primarily for monetary compensation.

27.  Accordingly, I do not agree that the approach to be adopted is any different in the present case than it would be in the case of an “ordinary” Mareva injunction.

F. Issue estoppel?

28.  In the light of my conclusion in regard to the nature of the claim it is not necessary for me to reach any conclusion as to the defendants’ contentions regarding the alleged issue estoppel arising out of the deputy judge’s extempore judgment. 

G. Availability of funds from PRC

29.  This is a matter on which the evidence is clear.  Considerable funds exist in the hands of Shandong Qunxing.  These funds amount to many multiples of the amount of the legal costs and other business expenses sought to be released by the defendants.  The plaintiff submits, and I agree, that there is credible evidence to suggest that transfer of funds from the PRC to Hong Kong is both administratively possible and, at the least, not impracticable.  I do not think that it is necessary to dwell on the detail further; having come to the conclusion which I have, that “ordinary” principles are to apply to any consideration of a variation of the injunction, it seems to me that the approach summarised in the extract from Gee quoted above fairly represents the correct approach, and is the approach I adopt, namely:

“… to consider objectively the overall justice of allowing the payment to be made including the likely consequences of permitting it on the prospects of a future judgment being left unsatisfied, and bearing in mind that the assets belong to the defendant and that the injunction is not intended to provide the claimant with security for his claim or to create an untouchable pot which will be available to satisfy an eventual judgment.”

30.  The factors, in brief are these therefore.  The defendants have a requirement for funds (I turn to the amount of funds below) to enable the payment of “ordinary” business expenses and for the payment of (extra-ordinary) legal expenses.  Those funds are sought on a continuing basis as far as the business expenses are concerned, and on an interim basis, covering the period until end April 2014 as far as legal expenses are concerned.

31.  The evidence shows that the usual modus operandi of the defendants is for business expenses to be met from the defendants’ own funds, not from remittances or dividend payments from the subsidiaries.  Not surprisingly, the evidence does not address legal expenses, of the present sort at least.

32.  The monetary “value” of the plaintiff ‘s claim is many times larger than the amount in fact secured by the injunction and the amount sought by the summons would, in the period to end April 2014, amount (by my calculation) to approximately HK$11.6 million or (approximately) 7.5% of the “frozen assets”.  Permitting the variation as presently sought would not, on the face of things, significantly affect the prospects of a future judgment being left unsatisfied.  

33.  The defendants submit that Avant Petroleum v Gatoil [1986] 2 Lloyd’s Rep 236 demonstrates that it would be wrong to take into account the fact that the defendants might be able to instigate a new arrangement with their subsidiary (or bankers as in Avant Petroleum).  The injunction order should not be used to bring to an end a bona fide and established method of financing within the group structure.

34.  Set against that in considering the “overall justice” of any variation however is the acknowledged existence of very substantial funds in the subsidiary.  The existence of those funds has to be considered in the context of the evidence which shows no “practice” of distributing dividends to the holding companies, and the evidence which shows that there would be a number of administrative steps to be taken by Shandong Qunxing in China, including obtaining audited accounts and tax clearances before any remission of a dividend out of the PRC could be made.  The State Administration of Foreign Exchange would need to review and approve any proposed remission of funds.

35.  The defendants also submit, in reliance on authority, that the court should not act so as to interfere in decisions of Shandong Qunxing’s management as to how the affairs of that company are to be conducted.

36.  The defendants also contend, wholly unrealistically it seems to me on the present evidence, that the funds are “required” to be maintained for the running of that business. 

37.  It seems to me that it would be wrong, as a matter of principle to wholly disregard the assets available in Shandong Qunxing which company itself is an asset of the 1^st defendant as counsel acknowledged.  The fact that the funds are those of a separate company must be considered in the knowledge that the company in question is a wholly owned subsidiary, and the funds are very substantial.

38.  Also to be factored in is the evidence before me as to the usual business practice of the 1^st defendant, in not sourcing funding from Shandong Qunxing, and the procedural and administrative steps, as well as management decisions needed before any such funds could (in practical terms) be made available to the 1^st defendant.

39.  Balancing all of the above I have come to the conclusion that, in principle, the present application should be allowed subject to the variations I make below.  I would add to that conclusion an observation that were I being asked to consider a longer period of time than I am considering, then the position in regard to Shandong Qunxing would have weighed more heavily with me.

40.  As the evidence stands however it seems clear that a period of at least a couple of months would be needed before that money from that source could in fact be made available to the defendants.  Accordingly, it has relatively little bearing on a short term application.

H. The quantum

41.  The first sum sought by the 1^st defendant is approximately $2.7 million in respect of ordinary business expenses, either now due, or due by the end of January 2014.  Mr Yu SC provided a table setting out a breakdown of the sums claimed from which it can be seen that the bulk of that item relates to “annual” costs such as audit services, listing fees and so on.  I am satisfied that this variation should properly be made.

42.  Similarly I am satisfied that the amount of the monthly expenditure (HK$560,000) represents a proper variation to the injunction order.  However in light of my observations above, and the fact that the summons itself envisages that a further application may be necessary as at end April 2014, I limit this variation in time also to end April 2014.

43.  The third variation relates to legal costs and expenses, and is expressed as a monthly sum running to end April 2014.  Mr Yu SC explained that this head has been derived by averaging the anticipated total cost over a four month period.

44.  Both parties are agreed that this will be a complex piece of litigation, and given the amount of the claim this is not a circumstance in which the allowance of funds to the defence should be “stingy”.

45.  Set against that is the fact that the statement of claim has not yet been served and accordingly the defendants’ expenditure on legal fees is, to some extent, postponed.  Balancing those factors it seems to me that a variation so as to provide for $1,500,000.00 per month for the 1^st defendant’s legal expenses for the period up to end April 2014 (ie four months) should be made.

46.  Correspondingly, a variation to the injunction order should be made in respect of the legal costs of the 2^nd defendant (where some discrete issues may arise) at $150,000 per month for the same period.

47.  I make orders in terms of paragraphs 2, 3 and 4 of the summons dated 16 January 2014.

48.  I also make an order, as requested at paragraph 5 of that summons, reserving costs.