LANDUNE INTERNATIONAL LTD v. CHEUNG CHUNG LEUNG RICHARD

CACV225/2005

IN THE HIGH COURT OF THE

HONG KONG SPECIAL ADMINISTRATIVE REGION

COURT OF APPEAL

CIVIL APPEAL No. 225 OF 2005

(ON APPEAL FROM HCCW1178 /2004)

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JUDGMENT

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Hon. Yuen JA:

1.This is an appeal from a decision of Kwan J. refusing to strike out a petition presented by Mr Richard Cheung Chung Leung ("the Petitioner") for the winding up of  Landune International Ltd, a listed company formerly known as Singapore Hong Kong Properties Investment Ltd (“the Company”). 

Background

2.The Petitioner was an executive director of the Company from 1998 to 2003.  From August 2000 to July 2002 he was also a director of Kailey International Ltd, which the Company acquired in August  2000 as a vehicle for an investment which I shall refer to later and which remains the Company’s wholly-owned subsidiary (“the Subsidiary”).

The Debt

3.In April 2004, the Petitioner lodged a claim against the Company in the Labour Tribunal for a sum of more than $2.6m for arrears of wages, directors’ fees and other remuneration

4.On 4 June 2004, the Petitioner and the Company entered into a Settlement Agreement whereby the Company agreed to pay him $1,570,000 by instalments.  There was a default clause whereby the entire sum would become payable immediately if the Company failed to pay any instalment due.

5.The Company paid the 1^st instalment but failed or refused to pay the 2^nd instalment in September 2004. 

The Petition

6. The Petitioner duly presented a petition in November 2004 to wind up the Company on the ground that it was unable to pay $1,177,500, the balance due under the Settlement Agreement.

7. The Company accepted (and still accepts) that it is indebted to the Petitioner in the amount set out in the petition, but says that it has a bona fide and substantial cross-claim against him. 

8. On 2 December 2004, the Subsidiary commenced HCA 2730/2004 ("the High Court action") against four defendants, including the Petitioner, for damages. 

Summons to strike out Petition

9. On 22 December 2004, the Company issued a summons to strike out the petition on the basis that it is an abuse of process for a creditor to present a petition for a debt which is disputed in good faith on substantial grounds.  (There was an alternative application to stay the petition upon payment into court of the amount due,  but this was not pursued either before Kwan J. or on appeal).

The Company’s claim

10. In February 2005, the Company joined in the High Court action as 2^nd plaintiff.  In the Amended Statement of Claim, the Company and the Subsidiary allege that in September 2000, the Petitioner and another director of both companies (the 3^rd defendant) caused the Subsidiary to purchase shares in a company, which investment purportedly was to result ultimately in the acquisition of an interest in a hotel.  The purchase price was $120m. 

11. The amount of $120m. was paid by the Company directly to the vendor (the 1^st defendant).  It was treated in the books of both the Company and the Subsidiary as a shareholder’s loan by the Company to the Subsidiary.  A further sum of $2.4m (being 2% of the purchase price and payable apparently as commission) was also paid by the Company.  Although it was not clear before Kwan J. how this sum was treated, we were told by Mr Erik Shum counsel for the Company that this was also booked as a shareholder’s loan to the Subsidiary and he was content that this amount should be treated in the same way as the amount of $120m.

12. The Company and the Subsidiary allege that in fact the shares that the Subsidiary purchased were worthless as they did not result ultimately in the acquisition of an interest in the hotel. 

13. The Company and the Subsidiary allege against the 1^st and 2^nd defendants (the vendor company and its director) that they fraudulently, negligently or innocently made false representations to the Company and the Subsidiary that it had an interest in the hotel. 

14. In relation to the Petitioner and the 3^rd defendant, the Company and the Subsidiary have pleaded that they had fiduciary duties to the Company and the Subsidiary (para. 24) and that as directors of both companies, they were trustees of the companies’ assets and property as were in their possession or control (para. 25).  However Mr Shum accepts that there is no proprietary or trust claim against the Petitioner.

15. The Company and the Subsidiary further pleaded that the Petitioner had conspired with the other defendants to defraud the Company and the Subsidiary (para. 26) by means of certain unlawful acts (para.27). 

16. Paragraph 28 then pleads:

“as a result of the matters set [out] in paragraphs 26 and 27 above the Plaintiffs have suffered loss and damage”.

Paragraph 29 pleads:

“by reason of the conspiracy to defraud and injure the Plaintiffs and by reason of the unlawful means as pleaded in paragraphs 26 and 27 above, the Plaintiffs have suffered loss and damages”.

17. In the prayer for relief, both plaintiffs (the Company and the Subsidiary) claimed “damages” against the Petitioner.  No further and better particulars were provided.  In answer to a question from the bench at the appeal, Mr Shum said that the damages sought were the sums of $120m. and $2.4m. - i.e. the sums paid by the Company to the vendor (the 1^st defendant) but booked as shareholder’s loans to the Subsidiary (the 1^st plaintiff).  The Amended Statement of Claim does not indicate that the Subsidiary was claiming anything less from the defendants.

Issue

18. Essentially, the issue before this court was whether Kwan J. was right to hold that the Company did not have a bona fide substantial cross-claim against the Petitioner because the Company’s loss was a reflective loss.

19. The rule against reflective loss originated in Prudential Assurance Co. Ltd v Newman Industries Ltd (No.2) [1982] Ch 204 and was authoritatively discussed by the House of Lords in Johnson v Gore Wood & Co. [2002] 2 AC 1.  Put at its simplest, the rule debars a shareholder from suing to recover a loss which is merely a reflection of the loss suffered by the company of which he is shareholder. This rule has been extended to include not only claims brought by a shareholder in his capacity as such, but also claims in his capacity as an employee or director, as well as in his capacity as a creditor (Gardner v Parker [2004] 2 BCLC 554).

Kwan J.’s judgment

20. Kwan J. considered “whether the loss claimed by [the Company] appears to be or is one which would be made good if [the Subsidiary] ... enforced its full rights against the party responsible [the  Petitioner] and whether ... the loss claimed is ‘merely a reflection of the loss suffered by [the Subsidiary]’” (para. 38 Judgment, quoting from Johnson v Gore Wood at 36D). 

21. The judge assumed that the Company had an independent cause of action against the Petitioner (para. 38 Judgment).  Although the cause of action was not identified, the judge was presumably referring to the wrong allegedly done to the Company as pleaded in the Amended Statement of Claim (paras. 26-29).  The judge held that nevertheless on the available information, the loss allegedly suffered by the Company was suffered in its capacity as a shareholder or creditor of the Subsidiary, and would be made good if the Subsidiary enforced its full rights against the Petitioner.

22. Accordingly, the judge held that the Company was debarred from recovering damages against the Petitioner.  It followed that there was no cross-claim that the Company could rely upon as a defence to the petition.  The Company’s application to strike out the petition was therefore dismissed with costs.

Appeal

23. On appeal, Mr Shum accepted that the judge had adopted the correct approach to the application and had applied the correct authorities.  He submitted however that the judge’s conclusion was incorrect on the following grounds:

(1)  the Company was the primary victim of the fraud as it had been defrauded into lending money to the Subsidiary, which otherwise would not have had the funds with which to pay the 1^st defendant vendor.  Mr Shum argued that the damages claimed were therefore not a reflective loss, but the Company’s own loss as the victim of the fraud;

(2)  the fact that the Company happened to hold shares in the Subsidiary should not prejudice its rights to recover the money as victim of the fraud; 

(3)  the Company and the Subsidiary had independent causes of action against the Petitioner which they should be allowed to bring to trial, and it would be up to the trial judge to make the appropriate order to prevent double recovery against the defendants.

Discussion

24. With respect to Mr Shum, I am of the view that the judge’s conclusion was clearly correct.  For present purposes, I assume that the Company was the primary victim of the fraud as it was an established company and the Subsidiary was originally an unfunded company acquired to hold the hotel investment only.  But on the authorities, the focus of the rule against reflective loss is not on whether a wrong had been done to the plaintiff (the Company) personally, but on the loss he is seeking to recover - if the loss can be made good if the company (the Subsidiary) enforces its rights against the defendant, the plaintiff’s loss is a reflective loss and to prevent double recovery, its claim should be struck out.  That is obviously the case here as I will discuss later.

25. There are a number of passages in  Johnson v Gore Wood which make it clear that the rule against reflective loss focuses on what loss the plaintiff has suffered, not on what cause of action the plaintiff may have independently of the company.  In fact, Lord Millett spent nearly 5 pages on this aspect in  Johnson v Gore Wood (62E - 67C) which I will not reproduce here. 

26. As for Mr Shum’s 1^st submission that the fraud was allegedly practised on the Company as "primary victim", it is helpful to refer to the illustration of the cash box given in Prudential v Newman (222-3) which was quoted by Lord Millett in Johnson v Gore Wood     (63): 

“Suppose that the sole asset of a company is a cash box containing £100,000.  The company has an issued share capital of 100 shares, 99 of which are held by the plaintiff.  The plaintiff holds the key of the cash box.  The defendant by a fraudulent misrepresentation persuades the plaintiff to part with the key.  The defendant then robs the company of all its money. The effect of the fraud and the subsequent robbery, assuming that the defendant successfully flees with the money, is (i) to denude the company of all its assets; and (ii) to reduce the sale value of the plaintiff’s shares from a figure approaching £100,000 to nil.  There are two wrongs, the deceit practised on the plaintiff and the robbery of the company.  But the deceit on the plaintiff causes the plaintiff no loss which is separate and distinct from the loss to the company.  The deceit was merely a step in the robbery.  The plaintiff obviously cannot recover personally some £100,000 damages in addition to the  £100,000 damages recoverable by the company". (Emphasis added).

27. Lord Millett emphasised that the example of the cash box was to show that the shareholder had personally been deceived by the defendant, but that was not enough to allow him personally to sue the defendant for the money stolen from the company (63F):

“The only reason [for ‘the somewhat strained business of the key’ in the example of the cash box] is to demonstrate that the principle applies even where the loss is caused by a wrong actionable at the suit of the shareholder personally”. 

28. The alleged facts in the present case are similar to those in the illustration save that here the cash box was initially empty, and the shareholder (in this case, the Company) was persuaded to first deposit cash into it and then to part with the key.  Does that make a difference to the result?  In my view, it does not - because the money lost is still the company’s (the Subsidiary’s) money and the amount lost is still one and the same amount.

29. It matters not that the Company has its own independent cause(s) of action against the Petitioner.  In Gardner v Parker, a decision of the English Court of Appeal, it was held that as the rule against reflective loss is not concerned with barring causes of action as such, but with barring recovery of types of loss, the rule applied whether the cause of action lay in common law or equity and whether the remedy lay in damages or even restitution (§49).

30. What is important is that the Company’s loss would be made good if the Subsidiary recovers from the defendants.  In the present case, the Subsidiary is actively pursuing the defendants in the High Court action.  Mr Shum confirms that the Subsidiary remains in the Company’s control and that it has no other creditors.   It follows that if the Subsidiary recovers damages from the defendants, the Company could call in its shareholder’s loans and it would suffer no other loss.  The rule against reflective loss therefore clearly applies - in my view, with greater force in this case than in many others because of the features that I have just discussed (cf Gardner v Parker §75).  In the present case, it is plain that the Company has suffered no personal loss separate or distinct from the Subsidiary’s loss. 

31. As for Mr Shum’s 2^nd submission that the fact that the Company owned shares in the Subsidiary should not be allowed to prejudice its claim, with respect that ignores the principle (or at least one of the principles) behind the rule against reflective loss - the prevention of  double recovery.  The principle debarring reflective loss is not based on the relationship of the plaintiff to the company, whether it be  shareholder-company, or employee-employer, or creditor-debtor.  The common thread is that the plaintiff’s loss would be made good if the company, employer or debtor, recovers from the defendant.

32. Thus in Gardner v Parker, Neuburger L.J. held (§70):

" ... the rule against reflective loss is not limited to claims brought by a shareholder in his capacity as such; it would also apply to him in his capacity as an employee of the company with a right (or even an expectation) of receiving contributions to his pension fund.  On that basis, there is no logical reason why it should not apply to a shareholder in his capacity as creditor of the company expecting repayment of his debt.  Indeed it is hard to see why the rule should not apply to a claim brought by a creditor (or indeed an employee) of the company concerned, even if he is not a shareholder." (Emphasis added).

This conclusion is supported by a passage in Lord Millett’s speech in Johnson v Gore Wood (66):

"If the company chooses not to exercise its remedy, the loss to the shareholder is caused by the company’s decision not to pursue its remedy and not by the defendant’s wrongdoing.  By parity of reasoning, the same applies if the company settles for less than it might have done.  Shareholders (and creditors) who are aggrieved by the liquidator’s  proposals are not without a remedy; they can have recourse to the Companies’ Court, or sue the liquidator for negligence".   (Emphasis added).

33. Finally as to Mr Shum’s 3^rd submission that the Company’s claim should be left to go to trial where the judge could be expected to make suitable orders to prevent double recovery, it is quite clear that the rule against reflective loss can apply at the outset of proceedings in a strike-out situation and not necessarily only after trial.  Lord Millett said in Johnson v Gore Wood (62E-G):

“If the shareholder is allowed to recover such loss, then either there will be double recovery at the expense of the defendant or the shareholder will recover at the expense of the company and its creditors and other shareholders.  Neither course can be permitted.  This is a matter of principle ; there is no discretion involved.  Justice to the defendant requires the exclusion of one claim or the other; protection of the interests of the company’s creditors requires that it is the company which is allowed to recover to the exclusion of the shareholder”. (Emphasis added).

Lord Hutton also said (55E-G): 

“I further consider that the principle has the advantage that, rather than leaving the protection of creditors and other shareholders of the company to be given by the trial judge in the complexities of a trial to determine the validity of the claim made by the plaintiff against the defendant, where conflicts of interests may arise between directors and some shareholders, or between the liquidator and some shareholders, the principle ensures at the outset of proceedings that where the loss suffered by the plaintiff [the Company] is sustained because of loss to the coffers of the company [the Subsidiary], there will be no double recovery at the expense of the defendant nor loss to creditors of the company and other shareholders”.   (Emphasis added).

34. In Gardner v Parker, the Court of Appeal approved the following passage from Blackburne J.’s judgment in Giles v Rhind [2001] 2 BCLC 582 with the qualifications added by the Court of Appeal in the appeal from Blackburne J. in square brackets (§33):

"(1) a loss claimed by a shareholder which is merely reflective of a loss suffered by a company - i.e. a loss which would be made good if the company had enforced in full its rights against the defendant wrongdoer - is not recoverable by the shareholder  [save in a case where, by reason of the wrong done to it, the company is unable to pursue its claim against the wrongdoer]; (2) where there is no reasonable doubt that that is the case, the court can properly act, in advance of trial, to strike out the offending heads of claim; ...” (Emphasis added).

35. In the present case, I agree with the judge that there is no reasonable doubt that the Company’s loss is a reflective loss.  It would be made good if the Subsidiary succeeds in recovering the money from the defendants.  Mr Shum submits that there are no competing interests in the form of other shareholders or creditors, which was the mischief that Lord Hutton was dealing with in the passage I have quoted.  However it is clear that the Subsidiary had sued the defendants to assert its rights to recover the money which the Company had paid "on behalf of [the Subsidiary]" (§13, 16 Amended Statement of Claim).  The addition of the Company as a party to the High Court action suggests that it is nothing more than a manoeuvre in response to the petition, as the Company’s claim for the same amounts is clearly an exercise in double recovery.  The Company should not be allowed to set up a claim of reflective loss as a cross-claim against the petition and its application to strike out the petition was rightly dismissed.

Order

36. I would dismiss the appeal with costs to be paid by the Company (the Appellant) to the Petitioner (the Respondent).

Burrell J.:

37. I agree.