DIAGCOR BIOSCIENCE INCORPORATION LTD AND ANOTHER v. ZENDEX BIO STRATEGY INCORPORATED AND OTHERS

CACV 62/2021

[2022] HKCA 1636

IN THE HIGH COURT OF THE

HONG KONG SPECIAL ADMINISTRATIVE REGION

COURT OF APPEAL

CIVIL APPEAL NO 62 OF 2021

(ON APPEAL FROM HCA NO 2733 OF 2015)

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REASONS FOR JUDGMENT
and
DECISION ON COSTS

_____________________________________

Hon Au JA (giving the Reasons for Judgment and Decision on Costs of the Court):

A.  INTRODUCTION

1.  This appeal is brought by the defendants against the judgment of K Yeung J (“the Judge”) given on 20 January 2021 ([2021] HKCFI 146) (“the Judgment”) after an eight-day trial, whereby it was adjudged, inter alia, that:

(1)  There be a declaration that the 1^st defendant is liable to account to the 2^nd plaintiff as a constructive trustee of the sum of HKD3,448,060.86 on the ground of knowing receipt of money paid in breach of the 2^nd and 3^rd defendants’ breach of fiduciary duties; and

(2)  The 1^st, 2^nd and 3^rd defendants do jointly and severally pay the 2^nd plaintiff the sum of HKD3,448,060.86.

2.  At the end of the hearing, we dismissed the appeal. We indicated that we would hand down our reasons for judgment in due course and would deal with the questions of costs in it. This is what we do now.

B.  BACKGROUND

3.  The factual background of the case has been comprehensively summarised by the Judge in the Judgment. We do not propose to repeat the same save for highlighting matters that are relevant to the present appeal.

4.  The 1^st plaintiff is a Hong Kong company. It carried on business in research and development in bio-medical diagnostic products and provided molecular diagnostic laboratory services in Hong Kong. The 1^st plaintiff was founded by Professor Joseph Tam (“Dr Tam”) in 2006. Dr Tam was at the material time the Chief Executive Officer, a shareholder and director of the 1^st plaintiff.[1]

5.  The 1^st plaintiff had a plan (“the Plan”) to extend its service and products to the Mainland. The Plan involved the formation of a wholly owned foreign enterprise (“WOFE”) to hold an independent diagnostic / clinical laboratory (“ICL”) in the Mainland.[2]

6.  Dr Tam first met the 2^nd defendant in the 1980s when he was the leader of the DNA research group and the 2^nd defendant was one of the students in the Department of Biochemistry at the University of Hong Kong (“HKU”). The two met again in or about November 2011 at the HKU Centennial Dinner. Dr Tam told the 2^nd defendant about the Plan of extending the 1^st plaintiff’s service and products to the Mainland. The 2^nd defendant expressed interest in the idea.[3] The 2^nd defendant further introduced the 1^st and 3^rd defendants to Dr Tam.[4] The 1^st defendant was a company incorporated in the British Virgin Islands. The 2^nd and 3^rd defendants were respectively the Chief Executive Officer and managing director of the 1^st defendant.[5]

7.  From late 2011 to November 2012, Dr Tam and the 2^nd defendant discussed duplicating the 1^st plaintiff’s lab service in the Mainland by setting up an ICL in the form of WOFE.[6]

8.  Diagcor International Limited (“DCI”) was a subsidiary company of the 1^st plaintiff incorporated in Hong Kong on 27 November 2012. 廣州百皋醫學檢驗中心有限公司 (“Baigao”) was a company set up on 18 January 2013 by DCI in Guangzhou as a WOFE.[7]

9.  However, as DCI did not qualify for “Mainland and Hong Kong Closer Economic Partnership Agreement” (“CEPA”) status, no licence was obtained for Baigao as a WOFE to operate a private ICL. It is the plaintiffs’ case that, in mitigation of its loss, the 1^st plaintiff incorporated the 2^nd plaintiff as its wholly-owned subsidiary on 28 October 2013 and the 2^nd plaintiff obtained a business licence from the Administration of Industry and Commerce of Guangzhou Municipality on the same day by virtue of the 1^st plaintiff’s status.[8]

10.  As the management of the 1^st plaintiff did not have the experience or knowledge of establishing and operating an ICL in the Mainland, the 1^st plaintiff continued to seek assistance from the defendants. The 2^nd and 3^rd defendants were therefore engaged by the 1^st plaintiff as its consultants to help with the establishment and operation of an ICL in Guangzhou through the 2^nd plaintiff.[9]

11.  The 2^nd defendant was appointed as one of the first directors and General Manager of the 2^nd plaintiff until he was removed on about 13 April 2015. The 3^rd defendant was appointed as one of the first directors and legal representative (法人代表) of the 2^nd plaintiff until she was removed also on about 13 April 2015.[10]

12.  Things did not go smoothly and disputes arose which led to the present proceedings. Amongst the plaintiffs’ claims against the defendants were breach of agreements, misrepresentation, breach of fiduciary duties, duty to account, conversion, conspiracy, and misappropriation of funds. By the Judgment, the Judge allowed part of the 2^nd plaintiff’s breach of fiduciary duties claim but dismissed the other claims.[11]

13.  As mentioned above, this appeal relates only to the Judgment in allowing the 2^nd plaintiff’s breach of fiduciary duties claim.

C.  JUDGMENT ON THE 2^ND PLAINTIFF’S BREACH OF FIDUCIARY DUTIES CLAIM

14.  The part of the 2^nd plaintiff’s claim that was allowed relates to contracts for the development of a software system to run lab services (“LIS”).[12]

15.  It was the plaintiffs’ pleaded case that[13]:

(1)  On 24 February 2014, the 2^nd and 3^rd defendants caused the 2^nd plaintiff to contract with Wu Fan, a person purportedly working for a company in Beijing called 中軟, for the development of LIS at the price of RMB1,950,000 (“the 1^st LIS Contract”);

(2)  The 3^rd defendant further on the same day and without authority purported to sign on behalf of the 2^nd plaintiff another contract with the 1^st defendant for the development of LIS at the price of RMB2,765,000 (“the 2^nd LIS Contract”);

(3)  On 25 February 2014, the 3^rd defendant again without authority signed on behalf of the 2^nd plaintiff a third contract with the 1^st defendant for the development of LIS (“the 3^rd LIS Contract”), apparently superseding the 2^nd LIS Contract;

(4)  The 2^nd and 3^rd LIS Contracts were a sham as it was Wu Fan who was responsible for developing the LIS, but not the 1^st defendant. In any event, no LIS was ever developed and set up by the 1^st defendant for the 2^nd plaintiff;

(5)  On 2 April 2014, the 2^nd and 3^rd defendants caused the 2^nd plaintiff to transfer to the 1^st defendant RMB2,765,000 (converted into HKD3,448,060.86), being the contract price under the 2^nd and / or 3^rd LIS Contracts; and

(6)  As a result, the 2^nd plaintiff suffered loss in the amount of HKD3,448,060.86.

16.  In this regard, the Judge made the following factual findings[14]:

(1)  The 2^nd plaintiff did not execute the 1^st LIS Contract;

(2)  The 3^rd defendant entered on behalf of the 2^nd plaintiff into the 2^nd LIS Contract with the 1^st defendant for the same system as described in the 1^st LIS Contract for the contract sum of RMB2,765,000;

(3)  The 3^rd defendant entered on behalf of the 2^nd plaintiff into the 3^rd LIS Contract with the 1^st defendant for the same system as described in the 2^nd LIS Contract and at the same price;

(4)  Neither the 2^nd nor 3^rd LIS Contract was approved by Dr Tam or Mr Au Matthew Kam-Kuen (“Au”), the Chief Financial Officer of the 1^st plaintiff between 2 May 2014 and 30 June 2015;

(5)  In the Excel spreadsheet entitled “[The 2^nd plaintiff’s] 固定資產費用預算(RMB)” (“the 2014 Budget Table”), which was sent to Mr Desmond Hau (director of the 2^nd plaintiff) by the 2^nd defendant by email dated 28 March 2014 (copied to the 3^rd defendant, Dr Tam and Mr Wong Shun Yun, director of the 2^nd plaintiff), a total sum of RMB1,950,000 was set out therein as one of the items against “軟件 & SOP”;

(6)  A sum of RMB1,950,000 for April 2014 in relation to “軟件 & SOP” was also mentioned in a document called “Baigao 3-Year P&L and Cash Flow Analysis”, which was sent to Au by the 2^nd defendant under cover of an email dated 7 June 2014 (copied to, among others, Dr Tam);

(7)  On 2 April 2014, the 2^nd plaintiff transferred RMB2,765,000 (or HKD3,448,060.86) to the 1^st defendant;

(8)  A LIS had in fact been developed for the 2^nd plaintiff, though there were problems with its functions. Wu Fan was involved in the process of the development of the LIS;

(9)  There is no record or evidence of Wu Fan having been paid under the 1^st LIS Contract or otherwise; and

(10)  Some of the hardware purchased in the process could also continue to be used.

17.  At trial, the defendants did not dispute that the 2^nd defendant as the General Manager and a director of the 2^nd plaintiff and the 3^rd defendant as the Legal Representative and the President of the 2^nd plaintiff owed the 2^nd plaintiff an implied duty of fidelity and / or fiduciary duties to act in good faith and in the best interest of the 2^nd plaintiff.[15]

18.  However, in relation to the LIS Contracts, the defendants through their oral evidence raised a defence of what the Judge described as the “Alleged Back-to-Back LIS Arrangements”. He explained this defence at [45(e) and (f)] of the Judgment as follows:

“(e) In the course of cross-examination, D2 and D3 suddenly volunteered detailed evidence in relation to the LIS Contracts. The effects of their evidence was that the quote from中軟for the development of LIS was expensive. Wu Fan of中軟in his personal capacity was however willing to provide the same service at a much lower price. The Board of P2 approved it in order to save costs. But Wu Fan in his personal capacity could not issue any invoice for the contract price. To facilitate that arrangement, a so-called back-to-back arrangement was entered into. In effect D3 caused P2 to enter into the 2^nd LIS Contract (subsequently superseded by the 3^rd LIS Contract) with D1 so that the relevant contract sum could be paid by P2 to D1, so that D1 could in turn arrange cash be paid to Wu Fan in Hong Kong. Tax could also be reduced;

(f) I will call the above for ease of reference the ‘Alleged Back‑to‑Back LIS Arrangements’;”

19.  Insofar as the 1^st LIS Contract is concerned, as noted above, the Judge held that the 2^nd plaintiff’s breach of fiduciary duties in this respect was not made out on the evidence. The contract sum for the 1^st LIS Contract, ie RMB1,950,000, was openly referred to in the 2014 Budget Table and the Baigao 3-Year P&L and Cash Flow, which was not consistent with the case pleaded by the 2^nd plaintiff. It was clearly not consistent with any fraud. In any event, the 2^nd plaintiff did not in fact execute the 1^st LIS Contract and there is no evidence that any sum has been paid by the 2^nd plaintiff to Wu Fan under the 1^st LIS Contract.[16]

20.  With respect to the 2^nd plaintiff’s breach of fiduciary duties claim concerning the 2^nd and 3^rd LIS Contracts, the Judge found on balance that this aspect of the 2^nd plaintiff’s case had been established. In particular, for the following reasons, it was held that what was done by the 2^nd and 3^rd defendants in relation to the 2^nd and 3^rd LIS Contracts was not done in good faith and / or in the best interest of the 2^nd plaintiff[17]:

(1)  The 1^st defendant was not a software house. It should have had no business in the development of LIS. Yet, the 2^nd and 3^rd defendants (i) caused the 2^nd plaintiff to enter into the 2^nd and 3^rd LIS Contracts with the 1^st defendant and (ii) caused the 2^nd plaintiff to pay the full contract price of the 2^nd and / or 3^rd LIS to the 1^st defendant, ie, RMB2,765,000 (or HKD3,448,060.86);

(2)  The 2^nd and 3^rd defendants’ unpleaded “Alleged Back-to-Back LIS Arrangements” was rejected by the Judge;

(3)  The defendants did not have any other pleaded defence in this regard. In particular, the defendants had not pleaded the reasons why the 2^nd and 3^rd LIS Contracts were entered into and had not pleaded any defence that they subjectively believed that entering into the 2^nd and 3^rd LIS Contracts was in the interests of the 2^nd plaintiff; and

(4)  The 2^nd defendant was the 1^st defendant’s Chief Executive Officer and the 1^st defendant must have received the sum of RMB2,765,000 (or HKD3,448,060.86) with knowledge of the 2^nd and 3^rd defendants’ breach of fiduciary duties.

21.  With regard to quantum, the defendants’ position was that deduction should be made in light of the fact that a functional LIS system was delivered and that the 2^nd plaintiff would have had to pay RMB1,950,000 in any event. In this respect, it was the defendants’ evidence that the 1^st defendant paid RMB1,950,000 to Wu Fan in cash in Hong Kong as payment for the development of the LIS system and the defendants argued that such sum was incurred for the benefit of the 2^nd plaintiff, who did as a matter of fact enjoy the benefit of the LIS system delivered by Wu Fan.[18]

22.  While it was found that a LIS system, albeit not fully functional, had in fact been delivered and computer hardware had in fact been acquired, the Judge held that it was not part of the defendants’ pleaded defence that part of the sum of RMB2,765,000 paid to it had been paid to Wu Fan, or towards the acquisition of any hardware. On the state of the defendants’ pleaded defence, the issue of deduction had not been raised, and was not engaged. In any event, the Judge also rejected the relevant evidence from the defendants’ witnesses. Indeed, the Judge specifically made the factual finding that there was no record or evidence of Wu Fan having been paid under the 1^st LIS Contract.[19]

23.  Accordingly, the Judge refused to make any deduction.

24.  For the above reasons, the Judge allowed part of the 2^nd plaintiff’s breach of fiduciary duties claim in respect of the 2^nd and 3^rd LIS Contracts and assessed the quantum at RMB2,765,000, or Hong Kong dollar equivalent of HKD3,448,060.86.[20]

D.  THIS APPEAL

25.  In the Notice of Appeal filed on 17 February 2021, the defendants raised two grounds of appeal:

(1)  The Judge erred in law and in fact by finding that the 2^nd and 3^rd defendants breached their fiduciary duties towards the 2^nd plaintiff in entering into the 2^nd and 3^rd LIS Contracts. In particular, the defendants complain that the Judge erred in principle in concluding that the 2^nd and 3^rd defendants are liable for damages even though the Judge did not find the 2^nd and 3^rd LIS Contracts to be sham agreements, being the only pleaded case of the plaintiffs (“Ground 1”); and

(2)  Alternatively, the Judge erred in holding that the defendants are liable for the whole sum of HKD3,448,060.86. In particular, the defendants complain that the Judge should have deducted RMB1,950,000, being the value of benefit of the LIS system delivered to the 2^nd plaintiff, from the judgment sum (“Ground 2”).

26.  As further confirmed by Mr Chan for the defendants at the hearing, the defendants did not seek to challenge the Judge’s factual findings in the present appeal.

27.  We will now turn to consider each ground of appeal in detail.

E.  DISCUSSION

E1.  Ground 1

28.  As rightly said by Mr Chan at the hearing, this is in substance a pleading point ground. With reference to the principles on pleadings set out in Kwok Chin Wing v 21 Holdings Ltd (2013) 16 HKCFAR 663 at [21] and Sinoearn International Ltd v Hyundai – CCECC Joint Venture (a firm) (2013) 16 HKCFAR 632 at [30], Mr Chan submitted that the Judge’s finding of the 2^nd and 3^rd defendants’ breach of fiduciary duties was not based on the plaintiffs’ pleaded case and thus not permissible.

29.  In particular, it is argued that while the only particular of breach of fiduciary duties pleaded by the plaintiffs was that both the 2^nd and 3^rd LIS Contracts were sham agreements, the Judge did not make any findings that the 2^nd and / or 3^rd LIS Contracts were a sham. Instead, the Judge formed his own view that the entering into the 2^nd and 3^rd LIS Contracts and the payment of the sum of RMB2,765,000 was done not in good faith and / or in the best interest of the 2^nd plaintiff. This, Mr Chan said, was not open to the Judge as this finding went beyond the plaintiffs’ pleaded case in fixing liability against the 2^nd and 3^rd defendants. In support, Mr Chan further emphasized that the plaintiffs have not even pleaded that the 2^nd and / or 3^rd defendants were not acting in good faith and / or in the best interest of the 2^nd plaintiff as a further and / or alternative basis for any breach of fiduciary duties insofar as the 2^nd and / or 3^rd LIS Contracts are concerned.[21]

30.  Moreover, Mr Chan argued that, in so ruling, the Judge further erred in placing the burden of proof on the defendants to show that they had acted in the best interest of the 2^nd plaintiff.[22]

31.  To properly consider Mr Chan’s above contentions, we must first look at the relevant pleas in the Amended Statement of Claim at §§46, 51 and 52 as follows:

“46. Further or alternatively, as directors and senior management of the 2^nd Plaintiff, the 2^nd and 3^rd Defendants owed an implied duty of fidelity and/or fiduciary duties to the 2^nd Plaintiff:-

(1) to act in good faith and in the best interest of the 2^nd Plaintiff;

(2) not to misappropriate the money of the 2^nd Plaintiff;

(3) not to make secret profits for himself/ herself from the use of the 2^nd Plaintiff’s assets;

(4) not to commit fraud and/or deceit against the 2^nd Plaintiff; and

(5) not to conspire with others, by illegal means, to injure the 2^nd Plaintiff’s interest.

...

51. The 3^rd Defendant had purportedly signed a contract dated 24 February 2014 on behalf of the 2^nd Plaintiff with the 1^st Defendant, without the knowledge or consent of the Board under which it was agreed that the 1^st Defendant would develop the LIST for the 2^nd Plaintiff at the price of RMB2,765,000 and the 2^nd Plaintiff agreed to pay the whole contract price to the 1^st Defendant within 30 days upon signing the contract (the ‘2^nd LIS Contract’)

(1) On 25 February 2014, the 3^rd Defendant without the knowledge or consent from the Board purportedly signed another contract on behalf of the 2^nd Plaintiff with the same terms as the 2^nd LIS Contract with the 1^st Defendant apparently superseding the 2^nd LIS Contract (the ‘3^rd LIS Contract’).

(2) On 2 April 2014, the 2^nd and 3^rd Defendant, with the assistance of Chen Qiu Jing, caused the 2^nd Plaintiff to transfer the total contract price purportedly under the 2^nd or 3^rd LIS Contract in the amount of RMB2,765,000 (converted into HKD3,448,060.86) to the 1^st Defendant’s account with Standard Chartered Bank (Hong Kong) Limited in Hong Kong without the knowledge or consent of the Board.

(3) The 1^st Defendant received the sum of HKD3,448,060,86 knowing that the sum had been paid to it in breach of the 2^nd and 3^rd Defendants’ fiduciary duties to the 1^st Plaintiff and/or the 2^nd Plaintiff.

(4) 2^nd LIS/3^rd Contract is/are a sham in that (i) Wu Fan was the person being commissioned to develop the LIS and not the 1^st Defendant; and (ii) no LIS was ever developed and set up by the 1^st Defendant for the 2^nd Plaintiff.

(5) The 2^nd LIS Contract and the 3^rd LIS Contract were only discovered after the 2^nd and 3^rd Defendants were removed from their position in the 2^nd Plaintiff in about April 2015.

...

52. By reason of the matters set out in paragraph 51 above, the 1^st Plaintiff and/or the 2^nd Plaintiff have suffered loss and damage in the amount of HKD3,448,060.86. It is averred that:

(1) The 1^st Defendant:

(a) is liable to account to the 1^st Plaintiff and/or the 2^nd Plaintiff as a constructive trustee on the ground of knowing receipt of money paid in breach of the 2^nd Defendant and the 3^rd Defendant’s fiduciary duties.

(b) holds all sums in the amount of HKD3,448,060.86 received by it as a constructive trustee for the 1^st Plaintiff and/or the 2^nd Plaintiff; and

(2) The 1^st, 2^nd and 3^rd Defendants are jointly and severally liable to the 1^st and/or 2^nd Plaintiff in damages for conspiracy and breach of fiduciary duties.” (Emphases added)

32.  It is Mr Chan’s principal contention that the only particulars of breach of fiduciary duty of the 2^nd and 3^rd defendants pleaded at §51(4) of the Amended Statement of Claim is that the 2^nd and / or 3^rd LIS Contracts is / are a sham. There are no other particulars of breach pleaded. In particular, it was never pleaded with any particulars that the 2^nd and 3^rd defendants were not acting in good faith and / or the best interest of the 2^nd plaintiff in causing the 2^nd plaintiff to enter into these contracts.

33.  We are not convinced by the defendants’ submissions. Mr Chan’s suggested reading of the pleading is plainly too restrictive and incorrect.

34.  When the above quoted paragraphs of the Amended Statement of Claim are read properly as a whole (as they should be), it is objectively plain to us that firstly, the plaintiffs have pleaded that the defendants owed a fiduciary duty to them to act, amongst other, in good faith and in the best interest of the 2^nd plaintiff. See §46(1) of the Amended Statement of Claim.

35.  Secondly, the pleaded particulars of breach of fiduciary duties clearly extended beyond the assertion that the 2^nd and 3^rd LIS Contracts were sham agreements. The particulars of breach of fiduciary duties included the following:

(1)  The 3^rd defendant caused the 2^nd plaintiff to enter into the 2^nd and 3^rd LIS Contracts without the knowledge or consent of the board of the 2^nd plaintiff.[23]

(2)  The 3^rd defendant caused the 2^nd plaintiff to enter into the 2^nd and 3^rd LIS Contracts with the 1^st defendant, which never developed or set up any LIS for the 2^nd plaintiff.[24]

(3)  The 2^nd and 3^rd defendants caused the 2^nd plaintiff to pay the contract sum of RMB2,765,000 to the 1^st defendant.[25]

36.  Thirdly, based on all these pleaded particulars, the plaintiffs further pleaded at §§52(1)(a) and 52(2) that the defendants were in breach of their “fiduciary duties”, which must refer to all those duties specifically pleaded at §46(1) of the Amended Statement of Claim, including the duty to act in good faith and in the best interest of the 2^nd plaintiff.

37.  Once read as such, and given the Judge’s corresponding factual findings (which are not challenged or challengeable), it was plainly open to the Judge to conclude and find that, by causing the 2^nd plaintiff to enter into the 2^nd and 3^rd LIS Contracts with the 1^st defendant which did not develop LIS (as pleaded and found), without the consent and knowledge of the 2^nd plaintiff’s board (as pleaded and found) to supersede the 1^st LIS Contract with a much higher contract price (which sum was paid to the 1^st defendant), the 2^nd and 3^rd defendants had not acted in good faith and in the best interest of the 2^nd plaintiff.[26]

38.  Moreover, in the absence of any relevant defence pleaded by the defendants, and the Judge’s rejection of the evidence in relation to the “Alleged Back-to-Back LIS Arrangements”, it must also be correct for the Judge to go on to hold that the 2^nd and 3^rd defendants did not subjectively believe that entering into the 2^nd and 3^rd LIS Contracts and the payment of the sum of RMB2,765,000 was in the best interest of the 2^nd plaintiff.[27]

39.  By reason of the above, it is clear that the defendants’ complaint under this ground about the pleading point is misplaced and without merit.

40.  For the same reasons, there is nothing in Mr Chan’s further contention that the Judge wrongly reversed the burden of proof. As we have observed above, it was open to the Judge on the plaintiffs’ pleaded case to find and conclude that the 2^nd and 3^rd defendants were not acting in good faith and in the best interest of the 2^nd plaintiff in causing it to enter into the 2^nd and 3^rd LIS Contracts. Once it is so held, there is simply no issue of reversing the burden of proof, as given the pleaded case and the evidence adduced by the plaintiffs to support those pleas, it was then up to the defendants to show that they indeed acted in good faith in so doing. This, they sought to do by raising for the first time at trial through oral evidence the “Alleged Back-to-Back LIS Arrangements”, which was however rejected by the Judge.

41.  Further, the defendants argue that the Court ought to have found that Wu Fan developed the LIS system as an agent of the 1^st defendant[28]. This can be disposed of briefly. We agree with the plaintiffs’ submissions that there is no basis to argue that the Judge was wrong in not finding such agency as the same was never the defendants’ pleaded case[29].

42.  In addition, the defendants also raised other points in the Notice of Appeal which were not elaborated in their skeleton submissions, namely:

(1)  The defendants contended that given the 2^nd plaintiff needed a LIS system and that the defendants did deliver a functional LIS system, it cannot be correct to say that the development of a LIS system in itself constitutes breach of fiduciary duty by the 2^nd and 3^rd defendants[30]. However, this was not the Judge’s findings. The Judge found that the 2^nd and 3^rd defendants were in breach of their fiduciary duties owed to the 2^nd plaintiff on the basis that the 2^nd and 3^rd defendants did not subjectively believe that entering into the 2^nd and 3^rd LIS Contracts (which were not approved by the board of the 2^nd plaintiff) with the 1^st defendant (which was not a software house and should have had no business in the development of the LIS) and the payment of the sum of RMB2,765,000 was not in the interests of the 2^nd plaintiff[31]. Accordingly, this sub-ground is without merits.

(2)  The defendants suggested that the Court ought to have found that the plaintiffs had knowledge of and did approve the 2^nd and 3^rd LIS Contracts[32]. In this regard, the defendants have not identified any error on the part of the Judge in findings otherwise. This sub-ground similarly fails.

43.  In the premises, we rejected Ground 1.

E2.  Ground 2

44.  At trial, the defendants argued that even if there was a breach of fiduciary duties, the quantum should be reduced taking into consideration the fact that a functional LIS system was delivered and that the 2^nd plaintiff would have had to pay RMB1,950,000 (with reference to the 1^st LIS Contract) in any event. In this regard, the Judge found that while a LIS system had been delivered and computer hardware had been acquired, it was not part of the defendants’ pleaded defence that part of the sum of RMB2,765,000 paid to the 1^st defendant had been paid to Wu Fan or towards the acquisition of any hardware. The issue of deduction had not been raised in the pleadings and was therefore not engaged. On this basis, the Judge refused to make any deduction[33].

45.  In this appeal, the defendants argued that the issue of whether any money had been paid to Wu Fan or towards the acquisition of any hardware or whether the defendants’ evidence should be accepted is irrelevant as the crucial question is whether the 2^nd plaintiff had indeed gained an identifiable benefit[34].

46.  We do not agree with this proposition. For the defendants to succeed in the deduction, they must establish that the benefit gained by the 2^nd plaintiff was conferred by the defendants. This much is clear from decision of the Supreme Court of New Zealand in Amaltal Corporation Ltd v Maruha Corporation [2007] 3 NZLR 192 at [29] and [30] (referred to with approval by the Court of Final Appeal in Libertarian v Hall (2013) 16 HKCFAR 681 at [94]):

“[29] We accept the submissions of Mr Miles that where a defaulting fiduciary seeks an offset against the compensation payable for its default, it must show that what is to be offset was an incontrovertible benefit to the person to whom the fiduciary duty was owed; and that it is for the defaulting fiduciary to establish that such a benefit has been gained…

[30] In a context like the present it would be wrong to make the party which has suffered from a fiduciary breach allow the errant fiduciary a deduction unless it is for a clear and manifest benefit conferred by the fiduciary. And when the fiduciary alleges that it has conferred such a countervailing benefit, it should be for the fiduciary to establish that this is so…” (Emphases added)

47.  Indeed, there is no reason why the defendants should be entitled to “offset” a benefit that they did not in fact confer. There is simply nothing to “offset”. As noted above, the LIS system was developed by Wu Fan and not the defendants.

48.  Further, as the plaintiffs rightly noted, Wu Fan, the proper party who did in fact develop the LIS system, may well have a valid claim against the 2^nd plaintiff for the work done. There is no justification to subject the 2^nd plaintiff to duplication of claims on the same subject matter.

49.  For the same reasons above, the defendants’ alternative position that there should be a deduction of RMB900,000, on the basis of the plaintiffs’ pleaded case that the 2^nd plaintiff’s board of directors authorized the price of RMB900,000 for LIS development, also falls away.

50.  In the defendants’ skeleton submissions at §27(4), a new point (not mentioned in the Notice of Appeal) arguing that the plaintiffs have failed to discharge the burden of proving the quantum was raised. This is in direct contradiction with the Judge’s finding on the quantum which was based on the 2^nd plaintiff’s payment of RMB2,765,000 to the 1^st defendant under the 2^nd and 3^rd LIS Contracts[35].

51.  The issue should instead be whether the defendants, as defaulting fiduciaries, established that they had conferred a clear and manifest benefit which entitles them to offset against the compensation payable for their default. As mentioned above, the Judge held that the defendants did not even put forward a pleaded defence on deduction, let alone established it[36].

52.  In the circumstances, Ground 2 is also dismissed.

F.  DISPOSITION AND DECISION ON COSTS

53.  For the above reasons, we dismissed the appeal.

54.  As to costs, the parties agreed at the hearing that costs should follow the event.

55.  However, Mr Wong for the plaintiffs asked for their costs to be taxed on an indemnity basis with certificate for two counsel for the following two reasons:

(1)  The grounds of the appeal were wholly without merits as they were based on a misreading and / or misunderstanding of the Judge’s analysis in the Judgment; and

(2)  Given that there was no challenge to the Judge’s factual findings and the narrow scope of issues raised under the grounds of appeal, it was wholly unnecessary for the defendants to include in the appeal bundles[37] all the documents used at the trial (such as all the witness statements) and the transcripts of the trial.

56.  With respect to Mr Wong, we are not satisfied that we should order indemnity costs against the plaintiffs in this appeal.

57.  First, although we have rejected the grounds of appeal, we do not find them to be so wholly without merits as to render the appeal an abuse of process. We do not think we should order indemnity costs on this basis.

58.  Second, Mr Wong is eminently correct to point out that the defendants ought not have included most of the documents in the bundles for the purpose of this appeal. However, given the grounds of appeal as stated in the Notice of Appeal and the defendants’ written submissions lodged, we are of the view that the plaintiffs’ legal representatives would and should not have properly spent any or much time on perusing those irrelevant documents for the preparation of this appeal. Mr Wong also did not say in his submissions that he and his team had spent any or much time on them. In the premises, this alone also cannot be a basis to justify an indemnity costs order.

59.  However, as this court has repeatedly emphasized, the practice of including voluminous irrelevant or unnecessary documents in the appeal bundles by legal representatives should rightly be criticised and discouraged. The appellants’ legal representatives should exercise proper care and due consideration in preparing the appeal bundles to include only those documents that are necessary and relevant to the issues that are required to be determine in the appeal. The defendants’ solicitors have a duty to their clients to only charge for only those documents that were necessary and relevant.

60.  Mr Chan for the defendants also opposed the grant of certificate for two counsel as this appeal did not involve complicated issues, as even submitted by Mr Wong himself. However, it is usual practice that a successful party in the Court of Appeal is entitled to two counsel, unless the circumstances clearly show otherwise[38]. We do not find any such circumstance in the present appeal.

61.  For all the above reasons, we further order that costs of this appeal be to the plaintiffs with certificate for two counsel, to be taxed if not agreed.