LUEN TAT WATCH BAND MANUFACTURER LTD v. LEE SHU HANG (also known as RICHARD LEE) AND OTHERS

HCA 1952/2012

IN THE HIGH COURT OF THE

HONG KONG SPECIAL ADMINISTRATIVE REGION

COURT OF FIRST INSTANCE

ACTION NO 1952 OF 2012

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BETWEEN

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JUDGMENT

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1.  By its summons dated 31 July 2013 (“the O.14 summons”) the plaintiff applies for summary judgment against the 1^st and 2^nd defendants for payment of the sum of $6,000,000 (“the $6m claim”) and against the 1^st defendant for payment or restitution of $1,000,000 (“the $1m claim”). Interest and costs are also claimed.

Background

2.  The plaintiff is a company incorporated in Hong Kong.

3.  According to the 4^th defendant (“the Father”), he established a business of manufacturing and trading of watchbands and stainless steel accessories in the 1950s.  The business grew and the same was carried on through a group of companies (“the Group”).

4.  The plaintiff was incorporated in about 1972 as the marketing arm of the Group.  The Father owned and controlled the Group including the plaintiff.

5.  The Father is the father of the 1^st defendant (“Richard”), the 3^rd defendant (“Ken”) and Seline Li Sin Man (“Seline”).  Ken is the older sibling.

6.  According to the Father, due to a copyright dispute involving the Father personally in 1986, he transferred all his shareholdings in the plaintiff to Ken and his wife on trust for him.  Richard joined the plaintiff in 1992.  The Father directed Ken and his wife to transfer 49% shareholding in the plaintiff to Richard in or about May 1993 to be held by Richard on trust for the Father.

7.  Richard left the plaintiff in 2009.  Pursuant to the Father’s directions, Richard transferred the 49% shareholding in the plaintiff registered under Richard’s corporate vehicle Full Moon Investment Holdings Inc (“Full Moon”) to the Father’s corporate vehicle Allied Ever Holdings Ltd (“Allied Ever”).

8.  The company search records of the plaintiff show that 49% of the shareholding of the plaintiff was registered from 11 May 1995 to 18 March 2009 in the name of Full Moon.  The 49% shareholding was transferred on 18 March 2009 to Allied Ever and they are still registered in the name of Allied Ever.

9.  The 51% shareholding of the plaintiff was registered from    6 June 1995 to 25 May 2009 in the name of Joesh Overseas Ltd a corporate vehicle controlled by Ken.  The 51% shareholding was transferred on 25 May 2009 to Joseph Li (“Joseph”).  Joseph is Ken’s son.  The 51% shareholding of the plaintiff is still registered in Joseph’s name.

10.  The Father was a director of the plaintiff from 26 May 1972 to 1 April 1986.  Thereafter, he was a de facto director of the plaintiff.

11.  Richard was a director of the plaintiff from 2 November 1992 to 18 December 2007.

12.  Ken was a director of the plaintiff from 5 February 1986 to   6 July 2010.

13.  Richard left the plaintiff to start his own business in 2006 by establishing the 2^nd defendant (“Radar”).

14.  Radar is a company incorporated in Hong Kong on 5 July 2006.  Richard was previously the 90% shareholder of Radar but is currently the 100% shareholder.  Richard is the sole director of Radar.

15.  According to the Father, his children Ken, Richard and Seline had worked for him in the family business.  However, the Father was the one who exercised the ultimate control over the Group including the plaintiff.

16.  It is the Father’s case, supported by Richard and Seline, that all the shares in the plaintiff were held on trust for the Father.  The plaintiff remained a profitable company at all material times.  The Father who maintained full control of the Group including the plaintiff distributed profits as he saw fit from time to time to those of his children who were assisting him in the family business.

17.  In 2009 there was a family dispute with Ken on one side and the Father, Richard and Seline on the other side.  At that time Allied Ever held 49% of the shares in the plaintiff and Joesh Overseas Ltd, the corporate vehicle controlled by Ken, held 51% of the shares in the plaintiff.

18.  The Father says at paragraphs 8 to 11 of his 1^st affirmation that

“8. In short, my relationship with Ken broke down in about 2009 following his taking a series of illegitimate steps to expel all family members from the Group, including forcing me to sign acknowledgement that all the shares of Luen Tat belonged to him beneficially (which was refused). When Seline assisted me to study the accounts of Luen Tat in June 2009, Ken Li even assaulted her, and as a result Seline Li was hospitalized. Since then, Ken Li had concealed all the books, records and ledgers of Luen Tat and the ledgers of the Group, and I had been unable to exercise any control over the affairs of Luen Tat.

9. I must stress that the 51% shareholdings registered under Joesh Overseas (which was subsequently transferred by Ken Li to his son, Joseph Li) were (and still are) held on trust for me. I am the sole beneficial owner of the shareholdings and profits in Luen Tat and the Group and decide how the profits were distributed to my children.

10. Following that saddening family dispute, and also my discovery of Ken Li’s wrongdoings to Luen Tat in August 2009 I sued Ken Li and Joseph Li in the Main Action seeking the return of the shareholdings in Luen Tat which were held on trust for me.

11. I also caused Allied Ever to take out a Petition under HCCW 497/2009 to wind-up Luen Tat on just and equitable grounds. Since I was ousted by Ken Li from the affairs of Luen Tat, it was my intention that professional liquidators could take over the affairs of Luen Tat, and investigate the wrongdoings of Ken Li. Luen Tat has been wound up by order of the Hon. Mr Justice Harris dated 6^th July 2010. Stephen Liu and David Yen of Ernst & Young Transactions Limited were appointed the joint and several liquidators of Luen Tat (the “Liquidators”).”

19.  The Main Action referred to in paragraph 10 of the Father’s 1^st affirmation is HCA 1711 of 2009 brought by the Father against Ken and Joseph.  There are a number of other actions concerning the members of the Lee family.

20.  At a global case management conference before Harris J on 25 July 2012 it was directed that the question of liability in the Main Action, namely, the question of who owns the shares and profits of the plaintiff, should be tried first.  Some of the related proceedings were directed to be tried only after the disposal of the Main Action.

21.  The trial of the Main Action has now been fixed to commence from 17 to 25 March 2014.

22.  I would observe that the plaintiff was ordered to be wound up on the just and equitable ground by the order of Harris J on 6 July 2010.  The plaintiff was at all material times a solvent company.  It was a profitable business when it was wound up.

The claims

23.  The plaintiff’s claims in this action were brought by the Liquidators against the defendants.

24.  In relation to the $6m claim, the plaintiff’s case is that Richard and/or Radar are indebted to the plaintiff in the sum of $6m being the consideration for goods supplied by the plaintiff to Radar during the period from 3 November 2006 to 27 December 2007, and which sum was recorded in the books and accounts of the plaintiff as outstanding from Richard.  There is also a claim in the alternative for damages against Richard and Ken for breach of the duty to exercise due care and skill owed by them to the plaintiff in the said sum of $6m.

25.  In relation to the $1m claim, the plaintiff’s case is that Richard is indebted or liable to the plaintiff in the sum of $1m paid by the plaintiff to Richard on or around 9 February 2007 by a cheque dated 9 February 2007, no. 234011 (“the cheque”) drawn on Hang Seng Bank and signed by the Father, on behalf of the plaintiff, without the lawful approval of the plaintiff and without any lawful justification, and for which no consideration has been provided by Richard.  There is also a claim in the alternative for damages against Richard, Ken and the Father for breach of the duty to exercise due care and skill owed by them to the plaintiff in the said sum of $1m.

26.  Summary judgment is sought against Richard and Radar by the O.14 summons.

27.  I was reminded of the oft-quoted observations of Godfrey J (as he then was) in Unic Co v Centus Development Ltd [1988] HKC 643 at 647

“The power to give summary judgment under O 14 is intended to apply only to cases where there is no reasonable doubt that the plaintiff is entitled to judgment and where therefore it is inexpedient to allow the defendant to defend for mere purposes of delay: see Jones v Stone [1894] AC 122.

As a general principle, where a defendant shows that he has a fair case for defence or reasonable grounds for setting up a defence, or even a fair probability that he has a bona fide defence, he ought to have unconditional leave to defend.  Leave to defend must be given unless it is clear that there is no real substantial question to be tried, or that there is no dispute as to the facts or law which raises a reasonable doubt that the plaintiff is entitled to judgment.  Order 14 is not intended to shut out a defendant who can show there is a triable issue applicable to the claim as a whole from laying his defence before the court, nor to make him liable in such a case to be put on terms of paying into court as a condition of leave to defend.”

The defences

28.  In the 1^st affirmation of the Father, in response to the claims in this action the Father says at paragraphs 28 to 34 as follows:

“28. In HCA1952, the claims made by the Liquidators were for:

(1) as against Richard and Radar, HK$6,000,000 allegedly recorded as outstanding in the books and accounts of Luen Tat, for goods supplied by Luen Tat to Radar;

(2) as against Richard, HK$1,000,000 allegedly paid by Luen Tat to Richard without lawful approval, under a cheque signed by me.

29. These claims are totally groundless. These goods supplied to Radar were profits of Luen Tat and the Group that I distributed to Richard, who started working for me in the Group and Luen Tat in about 1992 or 1993. The background of the arrangement in relation to the profits of Luen Tat and the Group was set out in paragraphs 31 to 34 of my Amended Witness Statement in the Main Action:

“F. ARRANGEMENT IN RELATION TO THE PROFITS OF LUEN TAT AND/OR THE GROUP

31. I would say that all the assets and money of the Group including Luen Tat, Yuen Hing and Shenzhen Lianda, had been controlled by me until around late October 2008 when I was excluded from the management by Ken Li and when I was no longer able to sign the cheques of Luen Tat. When both Ken Li and Richard Lee were working for Luen Tat, they received salaries from Luen Tat.

32. As regards Seline Li, she has accounting background and joined Luen Tat/Group under my invitation to handle all its account jobs in or around 1990 when she returned to Hong Kong from Australia. As an incentive to them, I did generously distribute Luen Tat’s profits to each of my 3 children.

33. All my 3 children know that the Group (and all the interests and assets therein) belongs to me.

34. Indeed, I used to maintain my own ledgers recording the profit of the Group each month.  If the profit accumulated to a certain amount and the cashflow was sufficient to meet the ordinary operation, I would consider distributing part of the profit to my children according to my own formula as hereinafter mentioned.  Each of them including Ken Li would not challenge how much I distributed to them, nor would any of them challenge my formula of distribution…”

30.  In the subsequent paragraphs of my Amended Witness Statement, I explained the 2 formulas which I adopted for distributing the profit (which are not repeated here).  Suffice to say that, as at June 2006, I decided to distribute a sum of HK$13,976,970 to Richard under the 2 formulas.  My calculation was recorded in a note dated 30^th June 2006.  There is now produced and shown to me marked Exhibit “LSN-18” a copy of the Note dated 30^th June 2006.

31.  With my permission, from time to time Radar obtained supply of goods from Luen Tat.  I treated the price of the goods supplied (including goods supplied to Radar being the subject matter of HCA 1952 between the period referred to in the Statement of Claim of HCA 1952 ending in December 2007) as part of the profits distributed to Richard and, therefore, it was unnecessary for Radar to pay.  It is my understanding that Radar continued to obtain supplies of goods from Luen Tat in 2008 and 2009 and it paid for them.

32.  As I am the founder and sole owner of the Group (including Luen Tat), I can decide how the profits of Luen Tat and the Group were to be distributed.  As advised by my legal advisers, I verily believe that under the Duomatic principle at common law, Luen Tat is not in a position to bring claim against me or overturn my decision.

33.  It is noteworthy that Ken also knew of the above arrangement for the distribution of profits to Richard.  In his draft witness statement under the Main Action provided to me for the purpose of obtaining my consent for filing, Ken stated that (at para. 127) ”… To my memory, [Richard] took his final balance in 2008.  During the period, the Group’s cash flow was still weak and there were occasions when Richard Lee, with my approval, took stock from Luen Tat in lieu of cash for his profit share…”  While I shall not be taken to have accepted any part of his witness statement (especially the suggestion that the distribution arrangement shall be subject to Ken Li’s approval), it is fair to say that Ken knew and had no objection for the supply of goods to Richard as part of the arrangement for the distribution of profits.

34.  As to the other head of claim, namely, HK$1,000,000 paid to Richard, the Liquidators were misconceived in saying that such payment was without legal approval or justification.  As I am the founder and sole owner of the Group (including Luen Tat), I decide how the funds of the Group were to be used.  I decided to pay an extra sum of HK$1,000,000 to Richard through Luen Tat and I signed the cheque to effect such payment.”

29.  The Father’s evidence is supported by the evidence of Richard and Seline.

30.  Richard and Radar in defence of the $6m claim and the $1m claim rely on the fact that the Father was the 100% beneficial owner of the Group including the plaintiff.  As such, the Father was free to make distribution of the profits he wished.

31.  As Richard says in his affirmation, the Father decided and Ken also agreed that Radar could take goods from the plaintiff in lieu of cash to the extent of $6m.  This is referred to in the evidence as the Free Payment Arrangement.  Radar purchased goods from the plaintiff but under the Free Payment Arrangement it did not have to pay the plaintiff for them.

32.  The value of goods supplied by the plaintiff to Radar under the Free Payment arrangement notionally amounted to $8,069,298.32. That amount included the costs of raw materials and parts for the manufacture of the goods which were purchased.  Radar supplied the raw materials and parts to the plaintiff and Radar issued invoices to the plaintiff for the supply of the same to the plaintiff.  The invoices from Radar to the plaintiff totalled $1,915,877.42.

33.  As Radar could take $6m worth of goods under the Free Payment Arrangement, Richard says that there was a reconciliation of the invoices issued by the plaintiff to Radar and the invoices issued by Radar to the plaintiff.  The position was that Radar had taken more than $6m worth of goods from the plaintiff to the extent of $153,420.90.  That being so, on 4 March 2008, Radar by a cheque paid the sum of $153,420.90 to the plaintiff.

34.  It was submitted by Ms Eu SC, with Ms Lam, for the plaintiff that the books and accounts of the plaintiff do not show any distribution of profits and that the accounting documents do not support the assertions of the defendants.  In my view, the fact that the books and accounts do not show the distribution of profits does not make the assertions of the defendants unbelievable.  Whether or not the defendants’ assertions will be believed is a matter to be resolved at trial.

35.  Mr Wong SC, with Ms Lok, for Richard and Radar relied on the Duomatic principle deriving its name from Re Duomatic Ltd [1969]   2 Ch 365.  As was said by Buckley J (as he then was) at 373

“where it can be shown that all shareholders who have a right to attend and vote at a general meeting of the company assent to some matter which a general meeting of the company could carry into effect, that assent is as binding as a resolution in general meeting would be”.

36.  In EIC Services Ltd v Phipps [2004] 2 BCLC 589   Neuberger J (as he then was ) when dealing with the Duomatic principle said at paragraph 122 of his judgment

“The essence of the Duomatic principle, as I see it, is that, where the articles of a company require a course to be approved by a group of shareholders at a general meeting, that requirement can be avoided if all members of the group, being aware of the relevant facts, either give their approval to that course, or so conduct themselves as to make it inequitable for them to deny that they have given their approval. Whether the approval is given in advance or after the event, whether it is characterized as agreement, ratification, waiver, or estoppel, and whether members of the group give their consent in different ways at different times, does not matter…”

37.  It was submitted that the Father, who was and is the beneficial owner of the 100% shareholding in the plaintiff, was free to make distribution of its profits.  Formal requirements to such a course was not required if members give their unanimous approval to that course.  It seems to me that, as submitted, lack of formality is not an uncommon feature in small family companies like the plaintiff.

38.  The plaintiff disputes that the Duomatic principle is applicable as there is doubt as to whether the principle applies to beneficial as opposed to registered shareholders.  In my view, this is not a matter that ought to be resolved in an application for summary judgment.  It is a matter to be resolved at trial.

39.  In Shahar v Tsitsekkos and others [2004] EWHC 2659 Mann J said at paragraph 67

“It seems to me that the point of principle relied on by Mr Tager (namely that the Duomatic principle can never apply to the consent of a beneficial but non-registered owner) is not clearly right, and it should not be determined on a summary judgment application such as this. In fact my view is that as a statement of principle it is wrong. I do not see why in an appropriate case the principle should not operate in relation to the consent or infomed participation of a beneficial owner of shares if the facts justify it.”

40.  I would also observe that as pleaded at paragraph 6 of the statement of claim the plaintiff’s case is that Richard and/or Radar are indebted to the plaintiff for $6m in respect of goods supplied by the plaintiff to Radar from 3 November 2006 to 27 December 2007.  The plaintiff’s case is that on the books and accounts of the plaintiff there was a shifting of the debt from Radar to the director’s account.  The $6m claim is against Radar for goods sold and delivered or against Richard as amount due from him in the director’s account in the books and accounts of the plaintiff.

41.  Mr Wong referred to the plaintiff’s Reports and Financial Statements for the year ended 31 March 2010.  The independent auditors KL Poon & Co reported to the Liquidators by their report dated 17 December 2010.  As regards the debit entry in relation to sales of $6m and a corresponding entry in amount due from a related party, the independent auditors expressed their view as follows

“c. Amount due to a director

During the year, a debit entry in relation to the sales of HK$6,000,000 and a corresponding entry in amount due from a related party were accounted for with reference to last year’s sales.  We have not been provided with documentary evidence of such reallocation to substantiate the validity of the entries.  There were no other satisfactory audit procedures that we could adopt to verify the validity and accuracy of the transaction of HK$6,000,000 thereof.”

42.  It was submitted on behalf of the plaintiff that the books and accounts show that the indebtedness of Radar for $6m was transferred to the director’s current account of Richard.  However, as was pointed out by Mr Wong, in support of this, the Liquidators also rely on 2 vouchers which apparently were not contemporaneous documents but were created after the breakdown of the relationship between Ken and the Father.  The 2 vouchers are:

(a) No. 09100136 dated 31 October 2009 for $3,866,208.35; and

(b) No. 10030056 dated 31 March 2010 for $2,133,791.65.

43.  The amounts in the 2 vouchers total $6m.

44.  There is no information recorded in the 2 vouchers as to who approved, received, or created the vouchers.  The information to be filled in was left blank in the 2 vouchers.  Not surprisingly, the authenticity of the 2 vouchers is disputed.

45.  It seems to me that triable issues of fact and law have been raised.  It is not appropriate to conduct a mini-trial on affidavit evidence.

The jurisdiction ground

46.  It was submitted by Mr Wong that the Court had no jurisdiction to grant summary judgment to the plaintiff.

47.  An application by a plaintiff for summary judgment is governed by O.14, r.1 RHC.  By O.14, r.1(2) it is provided that

“Subject to paragraph (3) this rule applies to every action begun by writ other than-

(a) …………….,

(b) an action which includes a claim by the plaintiff based on an allegation of fraud,……..’

48.  O.14, r.1 (2)(b) was considered by the Court of Appeal (Rogers VP and Le Pichon JA) in Pacific Electric Wire & Cable Co Ltd v Harmutty Ltd [2009] 3 HKLRD 94.  It was held that O.14, r.1 (2)(b) excluded from summary judgment proceedings an action where one claim included in the writ was based on an allegation of fraud.  So first, O.14, r.1 (2)(b) applied to exclude summary judgment proceedings where one claim but not another was based on an allegation of fraud.  Second, the rule was not confined to excluding actions in which there was a claim for damages for fraud; what was excluded was any action where there was a claim in respect of which the underlying allegations on which the claim was based constituted an allegation of fraud.

49.  At paragraph 19 of his judgment Rogers VP said

“19. The wording of O.14 r.1(2)(b) makes quite clear that what is excluded is an action where there is a claim which is based on an allegation of fraud. Two matters are clear from that. The first is that there may be one or more claims in the action and the rule envisages that one of the claims may not be based on an allegation of fraud but another may be. In those circumstances it is clear that an application for summary judgment under O.14 will not lie. Secondly, the rule is not confined to excluding actions in which one of the claims is a claim for damages for fraud, what is excluded is any action where there is a claim in respect of which the underlying allegations on which the claim is based constitute an allegation of fraud. It is clear that if r.1(2)(b) applies there is no jurisdiction for the court to entertain an application for summary judgment.”

50.  And at paragraph 31 Rogers VP said

“31. In my view, consideration not only of the skeleton argument put forward on behalf of the plaintiff but, importantly, also of the judgment of 18 January demonstrates quite clearly that, although the claims made in the case may be framed in respect of constructive trust, resulting trust and money had and received, the claims in the action are based on allegations of fraud that include deliberate dishonesty. As is pointed out in Bullen & Leake & Jacob’s Precedents of Pleadings (16th ed., 2008) Vol.2, p.841, an action in fraud will usually include one or more of a number of distinct causes of action amongst which are listed “money had and received” and “constructive trusts: knowing receipt and dishonest assistance”. Furthermore, as Mr Whitehead SC, who appeared for Mr Hu, pointed out, in paras.18-07 and 18-08 of Clerk & Lindsell on Torts (19th ed., 2006) and the third supplement thereto, it is made quite clear that active non-verbal conduct can amount to deceit. In this case, the allegations of the concealment of facts from the plaintiff when there was a duty to disclose, and the connivance at the preparation of false financial statements and accounts would be clear allegations of fraud.”

51.  Le Pichon JA agreed with the judgment of Rogers VP.

52.  Harmutty Ltd was also considered and approved by the Court of Appeal (Cheung JA and Yuen JA) in A-1 Business Ltd v Chau Cham Wong Patrick [2009] 5 HKLRD 580.

53.  In A-1 Business it was held that the plaintiff’s claim was caught by the exclusion rule in O.14, r.1 (2)(b).  It was held that what was excluded was any action where there was a claim in respect of which the underlying allegations on which the claim was based constituted an allegation of fraud.  Regarding the plaintiff’s claim, although a claim based on breach of fiduciary duty resulting in a duty to account might not necessarily involve dishonesty, each case depended on its own facts.  It was held that the plaintiff’s claim based on misappropriation and its response to the defence that the transfer was for a legitimate purpose involved allegations of dishonesty and fraudulent conduct.

54.  I would observe that the O.14 summons was issued on 31 July 2013.  This was done after the indorsement of claim was amended also on 31 July 2013 and the statement of claim dated 31 July 2013 was filed and served.

55.  By the amendments made to paragraph 6(2) of the indorsement of claim in respect of the $1m claim the words “the misappropriation by [Richard] of” the $1m belonging to the plaintiff were deleted.  Also, allegations of dishonest assistance and conspiracy to injure the plaintiff in other parts of the indorsement of claim were also deleted by the amendments made to the indorsement of claim.

56.  It was submitted by Ms Eu that the claims against Richard and Radar were no longer based on allegations of fraud and that the exclusionary rule did not apply to the O.14 summons.

57.  I am unable to accept Ms Eu’s submissions.

58.  It seems to me that although the amended indorsement of claim and the statement of claim do not expressly allege that in respect of the $1m claim there was a misappropriation of the assets of the plaintiff by Richard, it seems to me to be implicit in the allegations made that it was in effect a misappropriation of the $1m belonging to the plaintiff by Richard at a time when he was a director of the plaintiff.

59.  Paragraph 11 of the statement of claim pleads that the payment of the $1m to Richard on or about 9 February 2007 was made “without the lawful approval of the Plaintiff and without any lawful justification, and for which no consideration has been provided by [Richard]”. In my view, this is in effect saying that Richard has wrongfully misappropriated $1m belonging to the plaintiff.  That in substance is an allegation of dishonesty and fraudulent conduct on the part of Richard, in my view.  As the Father was the one who signed the cheque on behalf of the plaintiff, this was done with his connivance.

60.  As was said by Cheung JA in A-1 Business at paragraph 15

“15. I agree with the Judge that the plaintiff’s claim based on misappropriation cannot be viewed in isolation and divorced from the plaintiff’s response to the defence that the transfer was for a legitimate purpose. In order to establish that the transfer was a misappropriation of the plaintiff’s assets, the plaintiff clearly has to address the defence and this clearly will involve an allegation of dishonesty on the part of the defendants. In substance, allegations of fraudulent conduct are involved in the plaintiff’s claim and this is caught by the exclusion rule.”

61.  Bishopsgate Investment Management Ltd v Maxwell [1993] BCC 120 does not, in my view, assist the plaintiff.  It is distinguishable.

62.  Also, as Cheung JA observed in A-1 Business at paragraph 17 of his judgment, no jurisdictional challenge was raised in Bishopsgate.  The application for summary judgment was issued after the English exclusion rule was abrogated on 1 June 1992.

63.  In my judgment as the $1m claim is caught by the exclusion rule under O.14, r.1 (2)(b), the O.14 summons should be dismissed.

Conclusion

64.  I dismiss the O.14 summons.

65.  I also make an order nisi that the costs of the O.14 summons be costs to Richard and Radar, such costs to be taxed if not agreed, with a certificate for two counsel.