JANIE BABE INTERNATIONAL LTD (SUING ON BEHALF OF ITSELF AND 6TH DEFENDANT) v. HO TIT SING AND OTHERS

HCA 2138/2016

IN THE HIGH COURT OF THE

HONG KONG SPECIAL ADMINISTRATIVE REGION

COURT OF FIRST INSTANCE

ACTION NO. 2138 OF 2016

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D E C I S I O N

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The application

1.  This is the hearing of the application of the 1^st to 5^th defendants (“Ds”) by way of their Summons filed on 24 November 2016 (Ds’ Summons”) to strike out paras 32 to 47 and relief nos. (2) to (6) of the Statement of Claim (“the SOC”) on the grounds that they (a) disclose no reasonable cause of action; (b) are scandalous, frivolous or vexatious; or (c) are an abuse of the court process.

2.  The plaintiff (“P”) commenced a personal action as well as a common law derivative action on behalf of a company called Plus Development Ltd, which is joined as the 6^th defendant (“the Company”), against Ds.  P and Ds were the directors of the Company at all material times.  It is the common law derivative action which Ds now seek to strike out.

Background

3.  In this action, P (holding 50% of the Company’s shareholding) as represented by one Mr. Law Lam Wai, Barry (“Mr. Law”) at all material times forms a camp of the shareholders, and D1 controlling a company called “Pimpernel International Corporation” (holding 49% of the Company) (“Pimpernel”) together with the 4^th and 5^th defendants holding the remaining 1% respectively form the opposite camp.

4.  The Company previously held a property situated at 5^th and 6^th Floors and the Roofs on and above 6^th Floor level, Nos. 59 and 61 Wong Chuk Hang Road, Hong Kong (“the Properties”).  In June 2002, the Company purchased the Properties at HK$3.35 million, and they were sold in August 2010 for HK$66 million.

5.  According to P, owing to the unequal distribution of sale proceeds between P and other shareholders, P made his personal claim (“P’s personal claim”) against Ds for a proper distribution under paras 1 to 31 of the SOC.  As said, P’s personal claim is not subject to this striking out application.

6.  P further says that Ds had deliberately kept the material accounting information away from it, in particular, by failing to prepare for five audited reports for each financial year from 31 March 2012 to 31 March 2016 at all material times.  It is undisputed that these five audited reports were only prepared in one go on 8 December 2016[1]. In other words, all of them have not been supplied to P before this legal action was commenced on 17 August 2016.

7.  It is also P’s case that apart from what has already been distributed to it by Ds’ camp as the main bulk of its share to sale proceeds, almost all the rest of the Company’s funds have been withdrawn by D1 as director’s loans (“the alleged unauthorized loans”).

8.  P further contends that the failure on Ds’ part (1) to keep adequate accounting records, (2) to prepare the aforesaid audited accounts and (3) to hold the relevant AGMs (when such audited accounts were supposed to be approved) in the present context also amount to mismanagement of the Company by Ds (“the alleged mismanagement”).

P’s case for derivative action

9.  In gist, owing to the aforesaid alleged wrongful conducts of Ds, P claims that Ds have acted in breach of their fiduciary duties owed to the Company by mismanaging the Company and misappropriating its funds.  As such, P contends that there is a fraud on minority by Ds, who being the majority of the directors on the Board and are sufficient to constitute a quorum, have effectively controlled the Board and the Company’s properties and accounts and prevented the wrongs against the Company from being redressed.  P also contends that the alleged mismanagement on Ds’ part had effectively concealed the alleged unauthorized loans.

Ds’ contentions

10.  In my view, the main planks of Ds’ contentions challenging P’s locus in bringing the derivative action on the Company’s behalf are:-

  (1)   First, the derivative action was only pursued because of P’s personal claim against Ds for its share of the sale proceeds.

  (2)   Second, P is debarred from pursuing the derivative claim because P itself also received the unauthorized loan as its share of sale proceeds and knew that it was so.

The applicable principles for this striking out application

11.  A challenge to the plaintiff’s locus generally takes the form of an application to strike out the claim or to have the court determine as a preliminary issue that the plaintiff has no locus to sue on the company’s behalf.  (See Waddington Ltd v Chan Chun Hoo (2008) 11 HKCFAR 370, per Ribeiro PJ at para 14)

12.  In either case, the plaintiff is required to show to the satisfaction of the court that there is a prima facie case that the company is entitled to the relief claimed and the action falls within an applicable exception to the rule in Foss v Harbottle (usually the fraud on minority exception). See Waddington Ltd (supra), per Ribeiro PJ at para 20.

13.  According to Melvin Waxman v Li Fei Yu & Ors (HCA 1973 of 2012, 23 August 2013), which was also concerned with an application to strike out a common law derivative action, To J held that the essence of the term ‘prima facie case’ means sufficient evidence to pass the judge to make the issue fit for determination (at para 25).  As to what should be sufficient proof of a prima facie case, His Lordship further expounded at para 26 of his judgment that:-

“…If the issues in question are adequately pleaded and not contradicted by evidence filed by the parties, then the pleading alone would be sufficient proof of the prima facie case. But even if contrary evidence has been filed by the defendant, the courts are not required to conduct a trial by affidavit nor in all cases necessarily required to call the makers of the affidavit for cross-examination. The courts are capable of and well experienced in making provisional finding of facts on affidavit evidence in such interlocutory proceedings by testing the plaintiff’s case against documentary evidence, incontrovertible evidence, or evidence which is not in dispute. The court can determine against the backdrop of such contrary evidence whether the plaintiff’s evidence has passed the judge so as to make the issue or the case fit for determination by the tribunal of fact. In an appropriate case, the court may be satisfied on the basis of the pleaded case that the prima facie test is met, irrespective whether contrary evidence has been filed by the defendant…” (emphasis added)

14.  Furthermore, in a striking context as in the present case where the defendant contends that the plaintiff is debarred from taking or maintaining a derivative action because of some unjust and/or inequitable conducts on the plaintiff’s part such as the action was brought with an ulterior purpose or where the plaintiff shareholder has allegedly received the benefits from the wrongdoings with the knowledge of the relevant facts, there is English authority to show that the court was still prepared to decide as a preliminary issue whether such equitable defences could indeed be made out.  See Barrett v Duckett [1995] 1 BCLC 243, per Peter Gibson LJ at p 250a-c; and the first instance decision of Barrett [1995] 1 BCLC 73, per Sir Mervyn Davies at pp 76c to 77d.

15.  However, to consider such question of equitable bar in a striking out context, I agree with the submission of Mr. Victor Dawes SC (appearing with Mr. Roger Phang), counsel for the plaintiff, that Ds are required to demonstrate conclusively on the strength of the available evidence that the relevant plaintiff has indeed committed such conducts that render it unjust or inequitable for him or her to bring such derivative action on the company’s behalf under the particular circumstances of the case.

16.  Putting it another way, if it is not plain and obvious that such equitable defences could be made out, for instance, owing to the existence of dispute of facts as required for the proper resolution of this equitable bar issue, striking out should not be ordered.  This is in my view consistent with the observation made by Barma J (as His Lordship) in the first instance decision in Waddington (HCA 3291 of 2003, 29 April 2005) at paras 115 and 116:-

“115. As to abuse of process, Mr Kotewall submits that where a derivative action is brought for an ulterior motive, it should not be allowed to continue (see Nurcombe v Nurcombe [1985] 1 WLR 370 and Barrett v Duckett [1995] 1 BCLC 243). He submits that in the light of what is described as a long history of hostilities between AC and TC, alleged improper dealings by AC in Playmates shares (by selling such shares prior to the commencement of these proceedings), and the weakness of the Plaintiff’s case, coupled with what is said to be the absence of any adequate answer to such points by the Plaintiff, it should be concluded that the Plaintiff has commenced these proceedings for an ulterior purpose.

116. To accede to this argument would require conclusions to be drawn as to the motives and purposes of the Plaintiff, or AC. I do not think that it would be right to do so summarily, without the relevant matters being properly explored. There are clearly likely to be disputed as to the underlying facts and the inferences to be drawn from them, and in the circumstances, I do not think it would be appropriate to strike the Plaintiff’s claim out on this ground.” (emphasis added)

The alleged unauthorised loans

17.  According to P’s pleaded case, it had once raised objection to the sale of the Properties at HK$66 million, but subsequently consented to it.[2]

18.  In his affirmation filed on P’s behalf opposing Ds’ Summons, Mr. Law deposed that after the assignment of the Properties in August 2010, P had been chasing D1 to D4 for information related to the amounts and whereabouts of the net sale proceeds.  In particular, in its letter to D1 to D4 dated 21 October 2010[3], P asked D1 to D4 to provide the completion statement of the sale and purchase transaction, and the Company’s audited financial statements for the last three years.  It also enquired about whether the sale proceeds had been transferred to the Company and the date of transfer.

19.  It was only after some rounds of exchange of correspondences, P and D1 (acting on behalf of himself and D2 to D5) finally on 1 February 2011 signed a statement (“the Statement”) showing that the balance of consideration (after deducting the deposit received in the sum of HK$11,200,000, the bank mortgage of HK$5,688,869 and other items totalling HK$113,952[4]) to be received by P and Pimpernal was HK$19,498,589.50 each.[5]

20.  In the Statement, the consideration is however stated at HK$56 million instead of HK$66 million.  It also stated that out of the balance payable to each party (ie HK$19,498,589.50), only HK$17 million is to be released initially, and the remaining amount of HK$2,498,589.50 shall be immediately released if, after the assessment by the IRD for the following tax year is completed, no tax is payable. 

21.  On 7 February 2011, P received a letter from Messrs Gallant YT Ho (solicitors acting for the Company in the conveyance transaction) confirming that the net sale proceeds (after discharge of the mortgage) was in the sum of HK$46,997,178.99, and it was paid to and received by the Company on 18 August 2010[6]. If one adds this figure with the bank mortgage of HK$5,688,869 as well as the deposit of HK$11,200,000 received earlier[7], this would yield a sum of HK$63,886,047.99. 

22.  On 11 February 2011, P also received a cheque (issued by the Company and signed by D1) in the sum of HK$15,880,000, being the balance of HK$17 million (as referred to in para 20 above) after deducting P’s share of commission in the sum of HK$1,120,000[8].

23.  It was only until 10 October 2012, the Company’s auditor (CW Kwan & Company) (“the Company’s auditor”) supplied among other things, the audited financial statements for the years ended 31 March 2009, 2010 and 2011 to P[9]. It can be seen from the financial statement for the year ended 31 March 2011 that the loans to directors (D1 and P) are stated as HK$57,603,442.75 (as at 31 March 2011),[10] and the cash in bank was HK$2,192,301.02.  According to P’s pleaded case, P has not approved or adopted the two financial statements for the years ended 31 March 2010 and 31 March 2011 at any general meeting (which were only signed by D1 and D2 as directors).  Neither had these two financial statements been sent to P or been laid before the Company in any AGM.[11] 

24.  On 28 November 2012, P’s solicitors then wrote a pre‑action letter to D1 to D4 saying that P received only partial distribution of the sale proceeds.  The letter also stated that it was P’s understanding that all the sale proceeds including the portion which belongs to P has been drawn out of the Company’s account.[12] They demanded for the payment of the portion of sale proceeds payable to P (though without providing any specific figure for P’s entitled portion).  On 7 February 2013, P’s solicitors sent a further letter reiterating their demand.[13]

25.  Since the issue of that demand letter, there had been inaction on the P’s side for some time.  The next demand letter came on 6 August 2015 where P’s solicitors this time demanded for payment of the balance of P’s share of the sale proceeds in the specific sum of HK$2,498,589.50.[14]

26.  On 25 February 2016, P’s solicitors sent a letter to the Company’s auditor saying that ‘P has not received any notice convening general meeting of shareholders each year’, and P ‘has been deprived of the opportunities to review the Company’s financial statements’. In that letter, P’s solicitors also requested the auditor to supply audited reports of the Company for the past four years pursuant to section 405 of the Companies Ordinance (Cap.622).[15]

27.  On 7 March 2016, the Company’s auditor replied that the audited reports for the four financial years commencing from 1 April 2011 to 31 March 2015 had not been prepared by them.[16]

28.  On 2 June 2016, P’s solicitors wrote again to D1 to D4 raising the issue that the figure of HK$56 million has been wrongfully adopted as the sale price of the Properties in the Statement.  The figure of HK$66 million should have been used instead.  In other words, P said that it should be entitled to an additional HK$5 million on top of the sum of HK$2,498,589.50 as his outstanding entitled share to the net sale proceeds.  P’s solicitors thus demanded D1 to D4 to pay the sum of HK$7,498,589.50 to P.  In addition, P’s solicitors also brought up the matter that no AGM of the Company had been convened and failure of D1 to D4 to prepare for the financial statements in accordance with the statutory requirement for the past few years.  P’s solicitors demanded for copies of such financial statements.[17]

29.  In passing, P also pleaded at para 27 of the SOC that it found out in or around June 2016 that the calculation in the Statement was wrongfully adopted at HK56 million as the consideration.  The letter of 2 June 2016 was also pleaded at para 28 of the SOC.  In the prayer for P’s personal claim against Ds, it seeks rectification of the Statement to correct the consideration figure to HK$66 million and claims for the sum of HK$7,498,598.50.

30.  On 21 June 2016, Ds’ solicitors replied that P had been aware that the consideration for the sale of the Properties was HK$66 million and that HK$56 million would be adopted for internal calculation purpose only.  It was on such basis that the Statement was signed by P and Pimpernel.[18] Ds’ solicitors further explained that since the sale transaction (completed on 18 August 2010) was recorded in the financial year between April 2010 to March 2011, the IRD is entitled to follow up and issue re-assessment of profits tax within 6 years.  Thus the relevant profit tax position on the sale of the Properties could only be finalized or confirmed soon after March 2017.  In this connection, at para 14 of the Defence filed by D1 to D5 on 25 November 2016, such position is reiterated and it is further pleaded that ‘notwithstanding the non expiration of the 6 year period, the 6^th Defendant paid the said balance of HK$2,498,589.50 in court already’.

31.  It is against the above backdrop that P contends that D1 has withdrawn a total of HK$33,074,000 from the Company as unauthorised director’s loans to himself during the period between 28 April 2010 and 20 October 2010 (“the Relevant Period”) as revealed from the extract of general ledger of the Company (for the year ended 31 March 2011) (“the general ledger”).  The breakdown of HK$33,074,000 was provided at para 29 of Mr. Law’s affirmation[19]. Mr. Law also deposed that such withdrawals by D1 were without the consent or approval of P.[20] Pausing here, it is however worthy to note that P has not objected to a sum of HK$2.8 million withdrawn by D1 which also appeared in the general ledger as corresponds to the entry date of 16 May 2010, which also falls within the Relevant Period.  Prima facie, this sum corresponds to a portion of Pimpernel’s entitled share of the deposit (as reflected from the Statement).  P also received a corresponding sum of HK$2,800,000 from the Company on the same day.  Having said that, none of the remaining withdrawals by D1 during the Relevant Period matches with the other sums received by P from the sale proceeds.  Neither has D1 given any evidence to identify any withdrawals as representing to his entitled share of sale proceeds.  I shall return later to this issue of unauthorised withdrawals to the alleged extent of HK$33,074,000 by D1 at the appropriate juncture below.

32.  According to the general ledger which was produced for the first time in D1’s affirmation, the total drawings by the directors was HK$57,603,442.75 (as at 31 March 2011), and this is exactly the same figure for the “amount due from directors” as stated in the audited report for the year ended 31 March 2011.[21] Such audited report also stated that the loans to directors totalling HK$57,603,442.75 were made to D1 and P, and they were ‘unsecured, interest free and have no fixed terms of repayment’.[22]

33.  In his affirmation, D1 deposed that there was a prior agreement between P and himself that each of them can make drawings from time to time without the shareholders’ approval and such drawings would be recorded as loans to directors.  This is categorically denied by P.  As such, a factual dispute on this matter immediately arises, which in my view could only be properly resolved by the trial judge under the circumstances of this case. 

34.  On the aforesaid evidence before this court, I agree with Mr. Dawes’ submission that a prima facie case is established that the director’s loans to D1 without having obtained the prior approval of the company in general meeting was prohibited under the then prevailing section 157H(2) of the Companies Ordinance (Cap.32), which provides that:-

“(2) A company shall not, directly or indirectly-

(a) make a loan to a director of the company or its holding company;”

35.  Section 157HA(2) further states that:-

“(2) Section 157H does not prohibit a private company (not being a relevant private company) from doing anything that has been approved by the company in general meeting.”

36.  Further, it can hardly be denied that Ds were in control of the board and they were a position to prevent the Company from taking action against themselves in relation to such unauthorised loans to D1.  A prima facie case of fraud on minority is thus made out in these circumstances even although P is a 50% shareholder but without the board control.  See Barrett v Duckett (supra) at p 250d. 

37.  Mr Jeremy Cheung (appearing with Miss Candy Tang) counsel representing Ds further submits that an AGM was subsequently convened on 31 December 2016 whereby a resolution was passed to approve or ratify the subject directors’ loans.[23]  However, it is noted that before the convening of that AGM, P through their solicitors had challenged the earlier board meeting held to convene the AGM was irregular, and demanded Ds to withdraw the notice of AGM.  It also appears that on 31 December 2016, P did not send any representative to attend the AGM.  P has not consented to the ‘approval’ or ‘ratification’ of the unauthorised directors’ loans in question.  Without expressing any view as to whether the AGM convened was irregular or not, I am still of the view that prima facie the resolution passed at such AGM purporting to ratify the ‘loans’ made to D1 was invalid.  In my judgment, the appropriation of the company’s property or interest by a director is not a matter that can be ratified by controlling shareholder in oppression of the other shareholders constituting a ‘fraud on minority’.

38.  In Cook v Deeks [1916] 1 AC 554 (PC), Lord Buckmaster LC at pp 564-565 held that:-

“… Even supposing it be not ultra vires of a company to make a present to its directors, it appears quite certain that directors holding a majority of votes would not be permitted to make a present to themselves. This would be to allow a majority to oppress the minority. To such circumstances the cases of North-West Transportation Co. v. Beatty and Burland v Earle have no application. In the same way, if directors have acquired for themselves property or rights which they must be regarded as holding on behalf of the company, a resolution that the rights of the company should be disregarded in the matter would amount to forfeiting the interest and property of the minority of shareholders in favour of the majority, and that by the votes of those who are interested in securing the property for themselves. Such use of voting power has never been sanctioned by the Courts, and, indeed, was expressly disapproved in the case of Menier v. Hooper's Telegraph Works.” (emphasis added)

39.  In Melvin Waxman (supra), To J at para 51 said:-

“…[I]t is well established that a director is precluded from self-dealing or from entering into engagements in which his duties may conflict with his personal interest. The liability to account does not depend upon proof of mala fides (see: Regal (Hastings) Ltd V Gulliver [1967] 2 AC 134 at 137G-138G, per Viscount Sankey and 147A-F and 149A-150B, per Lord Russell). As I have observed, the Corporate Defendants belong to a different camp from WDI Technology. They belong to Frank who is their controlling mind and corporate will. On the basis that the entry in the books of the Company are concoctions afterthought, which the Plaintiff has established a prima facie case, the payments were, at the very least, interest free loans by the Company to Frank and the Corporate Defendants and therefore a fraud on the minority. Furthermore, appropriation of company’s money by a director is not a matter which can be ratified by shareholders (see: Burland v Earle [1902] AC 83 at 93-94, per Lord Davey; Cook v Deeks [1916] 1 AC 554 at 564, per Lord Buckmaster LC).” (emphasis added)

40.  However, the issue of unauthorised loans was complicated by the fact that P also received his share of deposit for the sale in two sums of HK$2,790,000 and HK$2,800,000 on 28 April 2010 and 6 May 2010 respectively (as admitted at para 27 of Law’s affirmation), and a further sum of HK$15,880,000 out of his share to sale proceeds on 11 February 2011 (as pointed out in para 22 above).

41.  And, these three sums totalling HK$21,740,000 as paid by the Company to P were booked as “Janie Babe Int’l Ltd drawing’ in the general ledger and as ‘director’s loans’ under the financial statements.  Though, they do not form any part of the said sum of HK$33,074,000 withdrawn by D1 during the Relevant Period as referred to in para 31 above. 

42.  Leaving aside the question of dispute over P’s personal claim for the moment, had the board of directors properly arranged the deposit of HK$11,200,000 and the balance of sale proceeds of HK$46,997,178.99 be declared as dividends to the shareholders out of distributable profit by reference to the Company’s account, each camp of shareholders can prima facie obtain about HK$29,098,589[24].

43.  However, for reason unknown it now appears that D1 had chosen to book the withdrawals of money as equivalent to the amounts of deposit and the net sale proceeds as director’s loans and without seeking the prior approval of the Company in general meeting for such loans. 

44.  Further, from the Company’s perspective, even if, for the sake of argument, D1 has obtained the informal consent from all shareholders (inclusive of P) to distribute the sale proceeds by direct return of funds to the shareholders (though this court has not decided on the legality or effectiveness of such method of distribution[25]), such consent from P would appear to have been confined to HK$21,740,000 on each side on the basis of equal distribution against the factual matrix as outlined above.  This is at least a triable issue.  In other words, it would still appear in such case that D1 had withdrawn a sum of about HK$14,134,000[26] according to the general ledger without the approval of the company in general meeting or the unanimous informal consent of shareholders.

45.  It is against such a context that Mr. Cheung submits it would be unjust or inequitable for P to bring the derivative action on the Company’s behalf by arguing that :-

(1)   First, P was not bona fide in bringing the derivative action. It was brought with an ulterior purpose by referring to P’s personal claim.

(2)   Second, P being a shareholder having full knowledge of the facts, has himself received part of the proceeds of an ultra vires act committed by the directors and retained the money at the same time.

46.  With respect, I do not accept both submissions after carefully considering all the relevant evidence and circumstances of this case.

47.  As for the first submission, I respectfully agree with Lewison J’s observation made at paras 119 and 121 of Iesini v Westrip Holdings Ltd [2010] BCC 420 as follows:-

“119. The idea that an action which is being pursued for a collateral purpose is abusive is not a new one in our law. Such an action is liable to be struck out as an abuse of process. In Goldsmith v Sperrings Ltd [1977] 1 W.L.R. 478 Bridge L.J. (with whom Scarman L.J. agreed) considered the meaning of a “collateral advantage” in this context. He said:

“The phrase manifestly cannot embrace every advantage sought or obtained by a litigant which it is beyond the court’s power to grant him. Actions are settled quite properly every day on terms which a court could not itself impose upon an unwilling defendant. An apology in libel, an agreement to adhere to a contract of which the court could not order specific performance, an agreement after obstruction of an existing right of way to grant an alternative right of way over the defendant’s land – these are a few obvious examples of such proper settlements. In my judgment, one can certainly go so far as to say that when a litigant sues to redress a grievance no object which he may seek to obtain can be condemned as a collateral advantage if it is reasonably related to the provision of some form of redress for that grievance. On the other hand, if it can be shown that a litigant is pursuing an ulterior purpose unrelated to the subject matter of the litigation and that, but for his ulterior purpose, he would not have commenced proceedings at all, that is an abuse of process. These two cases are plain; but there is, I think, a difficult area in between. What if a litigant with a genuine cause of action, which he would wish to pursue in any event, can be shown also to have an ulterior purpose in view as a desired by-product of the litigation? Can he on that ground be debarred from proceeding? I very much doubt it.”

…

121. In my judgment if the claimant brings a derivative claim for the benefit of the company, he will not be disqualified from doing so if there are other benefits which he will derive from the claim. In Nurcombe Lawton L.J. contrasted an action for the benefit of the company on the one hand, and an action brought for some other purpose on the other. Likewise in Barrett Peter Gibson L.J. drew the same contrast. Neither of them was considering a case in which a claim was brought partly for the benefit of the company, but partly for other reasons as well. In my judgment in such a case the considerations discussed by Bridge L.J. in Goldsmith come into play. In the present case it seems to me that Mr Iesini was entitled to form the view that unless the derivative claim was brought, Westrip would be left with no assets at all. Thus in my judgment the dominant purpose of the action was to benefit Westrip. It cannot, in my judgment, be said that but for the collateral purpose, the claim would not have been brought at all. The claim is, in my judgment, brought in good faith.” (emphasis added)

48.  By the same token, although P has his own personal interest to recover from Ds his outstanding portion of sale proceeds which he thought he was entitled to, that per se does not necessarily make the bringing of the derivative action mala fide.  This is because it is both natural and reasonable for P, as a shareholder, to see that the Company’s property is properly preserved and protected, otherwise the value of his shares will be diminished by the unauthorised depletion of the Company’s assets.  Viewed thus, P’s own interest as a shareholder in this case could coincide with the Company’s interest in the derivative action to see that the prima facie wrongs of appropriation of the Company’s money would be properly remedied or redressed.

49.  If the two camps of shareholders had decided to invest in the Properties (including leasing them out after its purchase for rental income) by incorporating their business of investment, they need to respect the corporate structure by not treating property or cash of the Companies as their owns.  The shareholders and the Company are separate legal entities. Any approval of director’s loans or other distribution of funds to shareholders has to be carried out intra vires and in accordance with the law and principles for the corporate governance.  Putting it another way, unless and until the company’s money can be lawfully distributed to the shareholders and of course without offending the law and principles on the maintenance of capital, the money remains belonging to the Company’s but not the shareholders.

50.  Regarding the second submission, Mr. Cheung seeks support for that proposition by citing Towers v African Tug Company [1904] 1 Ch 558 and Nurcombe v Nurcombe [1985] 1 WLR 370.

51.  In Towers, the directors made payments to the shareholders out of the capital.  That was illegal although they did so honestly. Subsequently, the directors recognizing their mistake, proposed to apply any future profits in wiping out the debit balance.  Three years after these payments had been made, two shareholders brought derivative action on the company’s behalf to seek for repayment of dividends unlawfully paid by the directors.  However, it was clear that both shareholders were fully aware of the illegal nature of the dividend payments, which they had received and remained in their ‘pockets’ at the time of trial. 

52.  At p 567 Vaughan Williams LJ said:-

“Under those circumstances, what is it we have to ask ourselves here? If it be the fact, as I think it is, that these plaintiffs knew of all that had been done, received their dividends with knowledge of all the facts, and then brought this action with the money still in their pockets, ought they to be allowed to bring this action, which, as I have pointed out, is, to my mind, an action such as they can bring in consequence of their personal interest in the matter? I think not. I think that an action cannot be brought by an individual shareholder complaining of an act which is ultra vires if he himself has in his pocket at the time he brings the action some of the proceeds of that very ultra vires act. Nor, in my opinion, does it alter matters that he represents himself as suing on behalf of himself and others. …”

53.  In Nurcombe, a husband and wife were the only two shareholders in a company.  In their matrimonial proceedings, it came to light that the husband had breached his director’s duty by diverting a considerable benefit of a contract for purchase of certain land to another company as controlled by him.  In that action, the wife asked the family court to factor into such improper profits obtained by the husband out of such property transaction when assessing the financial provision she sought for.  The family court did subsequently make the lump sum award to her on that basis.  After the conclusion of the matrimonial proceedings, she then brought a derivative action as minority shareholder against her ex-husband for breach of director’s duty seeking payment of the profits of that very property transaction which the husband has diverted from the company.  By applying the principles in Towers, the English Court of Appeal refused the relief.  At pp 378-379, Browne-Wilkinson LJ observed that:-

“In my judgment, that case[27] established that behaviour by the minority shareholder, which, in the eyes of equity, would render it unjust to allow a claim brought by the company at his instance to succeed, provides a defence to a minority shareholder's action. In practice, this means that equitable defences which would have been open to defendants in an action brought by the minority shareholder personally (if the cause of action had been vested in him) would also provide a defence to those defendants in a minority shareholder's action brought by him.

The Juristic basis of this principle (which is applicable in many Jurisdictions in the United States of America) is not clear. … Without expressing any view on the correctness of this analysis (which was not fully examined in argument), I do not think it is necessary to adopt such analysis in the present case. Since the wrong complained of is a wrong to the company, not to the shareholder, in the ordinary way the only competent plaintiff in an action to redress the wrong would be the company itself. But, where such a technicality would lead to manifest injustice, the courts of equity permitted a person interested to bring an action to enforce the company's claim. … The Towers case [1904] 1 Ch. 558 shows that “all personal objections against the individual plaintiff” must be considered. It is for this reason that, in my judgment, a court of equity will not allow a minority shareholder to succeed in a minority shareholder's action where there are equitable defences which, as between the shareholder personally and the defendants, the defendants could properly rely on in equity, eg, the duty to elect between conflicting rights, acquiescence, or laches of the minority shareholders.” (emphasis added)

54.  However, the above two authorities must be considered in context.  In my judgment, there was interplay of two key principles behind them.  The first one is: not to allow the relevant plaintiffs to misuse or abuse the derivative action.  Or, to borrow Browne-Wilkinson LJ’s own words in Nurcombe : “the court will not allow such an (derivative) action to be used in an inequitable manner so as to produce an injustice.”  The second being whether there is a real necessity for the derivative action to be taken so as to do justice to the company under the individual circumstances of a particular case.  In Towers, if Vaugham Williams LJ’s judgment is read as a whole, one would see that His Lordship also gave significant weight to the fact that after the directors’ discovery of their mistake, the company and the shareholders had taken remedial steps to replace the capital and by the time of trial the ultra vires act will be shortly put right.  There was thus no real need for taking out the derivative action. Some paragraphs after the passage (as quoted at para 52 above, which is heavily relied on by Mr Cheung), Vaughan Williams LJ near the end of his judgment (at p 568) also had the following to say:-

“I must say in this particular case there is a strong inclination in my mind not to give the plaintiffs the relief which they ask, because, starting with the fact that capital had been distributed in the payment of this interim dividend, that fact had been recognised by the company and by the shareholders: it appears on the face of the balance-sheet, and they were minded to replace this capital, and had every prospect of completely replacing it out of the profits of the very year in which this action was brought.

Under those circumstances this action was wholly unnecessary and wholly uncalled for. It seems to me the Court is not bound, when it sees that this ultra vires act is in course of being put right, and will very shortly be put right, to give relief to a plaintiff who has acquiesced in the wrong, and who himself has part of the proceeds of the wrong in his pocket. Under those circumstances I think this appeal ought to succeed.” (emphasis added)

55.  In Towers, at pp 569- 570, Stirling LJ also had the following to say:-

“…That a shareholder who had received a dividend, without knowing anything of the illegality of it, might maintain such an action I do not doubt. Whether in some circumstances a shareholder so suing ought not to return what he had received in respect of dividend is another question. Why is it that this form of action is allowed? Primâ facie the proper plaintiff, where it is sought to bring back the property of the company into its own coffers, is the company itself. But there are exceptions to that rule; and what is the reason of the exceptions? Sir George Jessel, in the case which has been referred to of Russell v. Wakefield Waterworks Co., says this: “The exceptions turn very much on the necessity of the case; that is, the necessity for the Court doing justice. Now this is a case in which, to begin with, no one suggests any fraud or dishonesty on the part of the directors or any one else. The directors who paid the dividend made a mistake, but no one charges them with anything more than a mistake. … It does not seem to have ever been suggested by any one that an action should be brought by the company to recover the deficiency of the capital; and I think we ought to infer that what commended itself to the plaintiffs, as well as to the other shareholders, was to go on in this way; the company was prosperous, it was wiping out year by year a great part of the deficiency, and the intention was ultimately, when the whole deficiency, including the deficiency in capital, had been replaced, to pay a proper dividend, and not until then.  I do not think there was any necessity shewn, looking at all the circumstances of the case, for the intervention of the Court to compel the payment of this small sum—for such it really was—in the way the plaintiffs seek. …” (emphasis added)

56.  Bearing the above principles in mind, it is observed that firstly, if this court refused to allow the derivative action to proceed further, the prima facie wrong of appropriation of substantial sums of the Company’s money through the channel of unauthorised loans (or more fundamentally, the money withdrawn which remains unaccounted for by Ds to the tune of at least HK$14 million (in the sense as analysed in para 44 above) will remain un-redressed.  

57.  The situation become even more unsatisfactory because the audited report for year ended 31 March 2013 also revealed that since 31 March 2012, the directors’ loans has further increased by two million dollars to HK$59,603,442.75 (as at 31 March 2013), again without any evidence of prior approval of the Company in general meeting.  Consequently, the cash at bank was further depleted to HK$161,591.02.[28] Such debit balance of HK$59,603,442.75 remains the same up to 31 March 2015, and then slightly adjusted downward to HK$59,602,842.75 (as at 31 March 2016)[29] according to the audited reports subsequently produced by Ds after the commencement of this action. 

58.  Despite P’s repeated demands upon Ds to account for such additional director’s loan, Ds gave no reply to offer any explanation.[30]  They only sought to approve or ratify the same as part of the directors’ loans in the total sum of HK$59,602,842.75 at the AGM convened on 31 December 2016, which validity was called into question as discussed above.

59.  In light of the aforesaid, unlike the defendant directors in Towers, Ds so far have failed to produce any effective evidence to show that they have really purged their own wrongs done to the Company or made any attempt to do so.  As discussed above in paras 37 to 39 above, not only the purported resolution passed in the AGM convened on 31 December 2016 was prima facie invalid to ratify the unauthorised loans in question, that act would appear to be a means devised to keep such wrongs from being remedied at the continual expense of the Company.  As pointed out in para 32 above, the loans in question are unsecured, interest free and have no fixed terms of repayment.  In law, these are monies of the Company but not D1’s before they can be properly distributed to the shareholders in accordance with the law and principles governing corporations.  And yet, Ds’ camp were in truth allowing D1 to treat those loans as if they were belonging to the shareholders themselves as revealed from the Statement.  It is thus highly questionable whether D1 indeed had any intention to repay those monies withdrawn (as sourced from the sale proceeds) which was booked as ‘loans to director’.

60.  Secondly, given P’s denial of his knowledge of or consent to the sale proceeds being distributed by way of the unauthorized loans, it would prima facie be inappropriate to rule on such factual dispute in this striking out context (which resolution is material for the proper determination as to whether the equitable bar as contended by Ds could be made out) in light of Barma J’s observation made in Waddington[31].

61.  Putting it another way, the current evidence is not so plain and obvious, as in the case of Barrett v Duckett, to enable this court to form a conclusive view that P had  indeed participated in the subject wrongs in such a way so as to render it unjust or inequitable to allow them to bring the derivative action on the Company’s behalf. 

62.  So far, there is no evidence that P has ever requested for loans from the Company or the sale proceeds be distributed by way of directors’ loans.  The financial statement for the year ended 31 March 2011 was not provided to P until 10 October 2012.[32]  P did not sign on any financial statement as director.  Neither is there any evidence before this court to suggest that P had been involved in the preparation of the financial statements.

63.  At this hearing, it is also observed that Ds have not really contested P’s evidence that the Company’s documents (including the book and accounts of the Company) are kept by any one or more of Ds, and they are at no time in the control or possession of P.  Mr Law also deposed on P’s behalf that Ds have in fact been managing the Company to the exclusion of P.  Over the years, Ds have failed to consult P on major decisions of the Company.  The decision to sell the Properties is one of such instances which was made by D1 to D4 without the prior knowledge or consent of P, and its consent only come retrospectively.[33]

64.  Viewed thus, the current state of evidence do not in my view prevent P from saying that he genuinely believed that the sale proceeds could be distributed by way of unanimous consent of all the shareholders at the material times. 

65.  In fact, Mr Dawes cited In re Duomatic Ltd [1969] 2 Ch 365, 373 and submits that the distribution of the sale proceeds of the Properties to P in the sum of HK$21,740,000 was consented to (though informally) by all the shareholders who have a right to attend and vote at a general meeting of the Company and is therefore valid and effective.  However, it is unnecessary for this court to decide whether Duomatic principle can really go that far to render the distribution of the subject Company’s money to shareholders under the circumstances of this case legally effective for the disposal of this striking out application[34]. This is because as pointed out in the preceding paragraph, even assuming the subject distribution of sale proceeds (which belonged to the Company) cannot be effectively done by way of the informal unanimous consent of shareholders, the available evidence did not preclude P from saying that he had genuinely believed under a mistake of law that this could be done so. 

66.  Apart from the aforesaid, insofar as the sum of HK$21,740,000 now in the hands of P is concerned (which form Ds’ key personal objection against P), if the Duomatic principle could really apply in this case, the unanimous consent would appear to be confined only to the sum of HK$21,740,000 as received by each camp of shareholders according to P’s pleaded case.  As such, the unauthorised loans to D1 for the amount of HK$14,134,000 (as mentioned in para 44 above) and a further sum of about HK$2 million (as mentioned in para 57 above) would remain unaccounted for by Ds.  On the other hand, if the Duomatic principle could not apply and there was no other defence P could raise for keeping those monies in their pocket, such sum of money as distributed to P and Pimpernel as their respective share of the sale proceeds agreed under the Statement would still technically belong to the Company and are liable to refund to the Company by both camps of shareholders. In such event, after the refund, the monies can nonetheless be redistributed back to the shareholders in accordance with the Companies Ordinance. 

67.  In my view, both scenarios should neither in principle nor speaking in terms of justice preclude the derivative action from being brought by P on the Company’s behalf against Ds for the purpose of protecting the Company’s interests and property.

68.  In these circumstances, after putting P’s conducts under scrutiny and considering the overall justice of this case, I am of the view that the present derivative action should be allowed to proceed to trial.  In particular, it is pertinent to recall that derivative action is to provide a procedural device enabling the court to do justice to the company controlled by miscreant directors or shareholders (per Lawton LJ at Nurcombe at p 376A-B).  By allowing the derivative action to proceed under the particular circumstances of this case, not only that I see no abuse or misuse of the court’s process by P, there is also a real necessity for such action being taken so as to do justice to the Company, otherwise the prima facie appropriation of its money by D1 without the Company’s due approval will remain un-readdressed. 

The alleged mismanagement

69.  When the above facts and evidence are set in their proper perspective, one would have no difficulty to appreciate that Ds’ contentions made in their skeleton submissions with respect to the alleged mismanagement (all of which I have fully considered) also cannot stand.

70.  I agree with Mr. Dawes’ submission that a prima facie has been made out that the alleged mismanagement is part and parcel of Ds’ fraud on the minority, and the effect of such alleged mismanagement in respect of the Company’s books and accounts aimed at concealing D1’s unauthorised director’s loans in light of the case development outlined at the earlier parts of this judgment.

71.  In particular, there is sufficient evidence raising a prima facie case that, first, the delay in the provision of the audited reports for the years ended 31 March 2010 and 31 March 2011 could prevent P from knowing that the sale proceeds received by the Company had in fact been distributed by way of unauthorised loans.  Second, the non-provision of audited reports for the subsequent financial years (until after the commencement of this action) also prima facie help concealing the additional unauthorised director’s loan of HK$2 million (as referred to in para 57 above).  Third, apart from the aforesaid, it further transpired that after being pointed out by Mr. Law in his affirmation that two respective sums of HK$5 million and HK$10 million as mentioned in the general ledger are wrongly stated as P’s drawing both made on 13 September 2010, D1 admitted for the first time at paras 10 and 11 of his 2^nd affirmation[35] that they were in fact not P’s drawing; but still, neither D1 nor the other relevant defendants (i.e. D2 to D5) have further explained to whom such monies (which are supposedly to be part of the directors’ loans according to the audited report for the year ended 31 March 2011) were actually paid, or the current status of such monies.

72.  In this light, it does not really matter P has not pleaded that the Company suffered any loss directly arisen from the alleged mismanagement at the material times as Ds contended, because the ultimate loss is the money being appropriated by way of the unauthorised loans and allegedly concealed as aforesaid.  It would also be of avail to Ds by saying that they have now produced the general ledger, and the financial statements to P and held the AGM to approve those financial statements.  In my view, those acts of Ds were actually done after the commencement of this action and should not preclude P’s common law derivative claim with respect to the alleged mismanagement from being properly constituted in any event. 

73.  Viewing thus, with respect, Mr. Cheung’s argument that P, as a shareholder, could have sought for ‘alternative remedy’ under section 740 of the Companies Ordinance (Cap.622) by applying for the production of financial records, and pursuant to sections 566, 568 and 569 to call for a general meeting, or to apply with the Court to convene a general meeting under section 570 are clearly misconceived.  This is because Ds nonetheless cannot point to any alternative remedy as available for redressing the alleged unauthorised loans which constitutes a fraud of minority (as explained above) of which the alleged mismanagement forms part.  

Conclusion

74.  Due to the above reasons, the issues of both the alleged misappropriation and alleged mismanagement are fit for determination at trial.

75.  This court is also satisfied that P has established a prima facie case that the Company is entitled to the reliefs claimed and that there is fraud on minority by virtue of Ds’ appropriation of the Company’s property without its due approval, and the alleged mismanagement was aimed to conceal such wrongs of Ds.

76.  In these circumstances, the averments made in the SOC with respect to both the alleged mismanagement and the alleged unauthorised loans and their corresponding reliefs as prayed for should not be struck out.

Disposition

77.  In the premises, I order that Ds’ Summons be dismissed.  The parties agree that costs should follow the event.  As each side was represented by two counsel, and in their respective statement of costs already lodged with this court, both sides also claimed for the fee incurred for engaging two counsel.  Taking further into account the complexity of the legal principles involved in this case on derivative action, I consider it fair and appropriate to grant certificate for two counsel to P in the circumstances. 

78.  As such, the 1^st to 5^th defendants are ordered to pay the costs of Ds’ Summons to the plaintiff forthwith with certificate for two counsel, which shall be summarily assessed on paper.

79.  For such purpose, the plaintiff is directed to serve their statement of costs on the 1^st to 5^th defendants within 7 days from the date of this order (if this has not yet been done), and the 1^st to 5^th defendants do file and serve their list of objections with 7 days thereafter.

80.  Lastly, it remains for me to thank counsel on both sides for their helpful assistance rendered to the court.