SHIH HUA INVESTMENT CO., LTD (suing for and on behalf of itself as shareholder of EVERGLORY ENERTY LTD v. ZHANG AIDONG AND OTHERS

HCA 2682/2016

[2018] HKCFI 1234

IN THE HIGH COURT OF THE

HONG KONG SPECIAL ADMINISTRATIVE REGION

COURT OF FIRST INSTANCE

ACTION NO 2682 OF 2016

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REASONS FOR DECISION

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The Applications and Decisions

1.  On 25 and 26 July 2017 I heard the following applications:

(1)  A summons issued by the 1^st, 3^rd and 4^th Defendants dated 24 November 2016 (a) to discharge an ex parte injunction granted by Lok J on 25 October 2016 and a further ex parte injunction granted by DHCJ Kent Yee on 22 November 2016 (“Orders”) and (b) to strike out the Statement of Claim on the grounds that it constitutes an abuse of process and, alternatively, the Plaintiff has no authority to continue the derivative action.

(2)  Two summonses issued by the Plaintiff dated 26 October and 25 November 2016 respectively for the continuation of the injunctions.

(3)  A summons dated 16 May 2017 by the 1^st to 4^th Defendants seeking fortification of the Plaintiff’s undertakings as to damages in the two injunctions.

2.  On 26 July 2017 I set aside the two injunctions and struck out the Statement of Claim.  Consequently I also dismissed the continuation and fortifications summons.  I ordered that the Plaintiff pay the 1^st to 4^th Defendants’ costs.

3.  At the hearing the Plaintiff was represented by Mr Chua Guan Hock SC and Mr Robert Chan.  The 1^st to 4^th Defendants were represented by Mr Victor Joffe, Mr Justin Ho and Ms Astina Au.  Mr D Whitehead appeared for the directors of the 6^th Defendant, who took a neutral position in respect of the applications.

4.  These are my reasons for the orders made on 26 July 2017.

Background

5.  In the 1990s the 1^st Defendant, Zhang Aidong (“Zhang”) began trading in the petrochemical industry using companies with the name Everglory.  Mr Zhang says that in 2011 he decided to establish a new business trading liquid petroleum gas (“LPG”).  In mid 2012 he negotiated a long term LPG contract with the Tianjin Bohua Group (“Bohua”). Shortly afterwards in June 2012 Mr Zhang met Mr Zhong Jie in Shanghai.  As a result of their discussions it was agreed that Mr Zhong would join Mr Zhang in the new LPG venture.  Mr Zhang says that Mr Zhong led him to believe that he would be able to introduce both substantial customers and suppliers to the new business.  It was agreed, says Mr Zhang, that Mr Zhong would work full time for the new business although Mr Zhang would be in ultimate control of its management.

6.  Mr Zhang caused the 6^th Defendant, Everglory Energy Ltd (“Company”), to be formed on 31 August 2012.  Nineteen thousand shares were issued and allotted equally to Mr Zhang’s company Motivi Point Consultancy Ltd (“Motivi”) and Mr Zhong’s company Shih‑Hua Investment Ltd (“SH”), although Mr Zhang says that 30% of the latter shares were held by Mr Zhong on trust for Mr Zhang in the anticipation that they would in due course be allotted to important employees in the Company as its business developed.  This is in dispute.

7.  During the following four years the Company entered into a three major contracts to supply LPG to Bohua and Oriental Energy.  Despite the Company’s business apparently developing successfully Mr Zhang and Mr Zhong’s relationship deteriorated.

8.  On 20 June 2016 SH issued the unfair prejudice petition in HCCW 198/2016, which was amended on 2 February 2017 (“Petition”), seeking an order that Mr Zhang purchase SH’s shares alternatively an order for the winding up of the Company.

9.  On 15 July 2016 the Company issued a summons for a validation order.  The summons was fixed to be heard before Anthony Chan J on 20 July 2016.  On the evening of 19 July 2016 SH gave notice of its intention to apply at the hearing of the application for a validation order for the appointment of provisional liquidators.  Anthony Chan J granted the validation order, but declined to hear the application for the appointment of provisional liquidators.

10.  Following the hearing before Anthony Chan J, SH sought an urgent hearing before me for the appointment of provisional liquidators.  I read the papers over lunch and heard Mr Ronny Tong SC on behalf of SH in the afternoon.  I summarised what took place in the afternoon of 20 July and subsequently in [1–10] of a letter to counsel for the parties dated 24 July 2017 which I wrote having read the papers in preparation for the hearing commencing on 25 July 2017:

“1. On 20 July 2016 the Judge heard an application by Mr Ronny Tong SC ex parte on notice for the appointment of provisional liquidators over the Company. After reading the papers and a 2‑hour hearing the Judge declined to deal with the matter on an ex parte because he was not satisfied that the matter was sufficiently urgent. The Judge directed that an inter partes summons be issued returnable on an early date and made detailed directions for the filing of evidence and submissions for the prospective summons. The Judge also made at his own motion an injunction.

2. On 22 July 2016 the Plaintiff issued the summons required by the order of 20 July 2016. It was returnable on 8 and 9 February 2017 with 2 days reserved.

3. On 23 August 2016 the Plaintiff issued a new summons seeking the appointment of provisional liquidators to be returnable on Monday 29 August 2016 when the Petition was to come on before the Judge. It appeared from the correspondence sent to court that the basis for wishing to apply for immediate appointment of provisional liquidators was that the Petition would not be opposed and Shih-Hua wished to appoint its preferred provisional liquidators to investigate the matters, which had led to the application on 20 July 2016 as soon as possible as opposed to allowing the Official Receiver to initially play that role. The application was, however, supported by a draft 2^nd affirmation of Yang Shiheng exhibiting a draft report of RSM. I wrote on 25 and 26 August 2016 informing the parties that the summons would not be determined unless it was agreed that provisional liquidators be appointed. The reason being that the Judge had already decided that the matter was not sufficiently urgent to justify an immediate appointment of provisional liquidators.

4. On 29 August 2016 Shih-Hua were represented by Mr Maurellet SC leading Connie Lee. Mr Maurellet explained that 2 creditors of the Company had expressed concern about appointing provisional liquidators because it might constitute an event of default under long term petrochemical supply contracts that is was beneficial to the Company to retain. The way the matter was advanced before the Judge by Mr Maurellet was that Shih-Hua still wanted provisional liquidators appointed, but if the court thought there was substance in the creditors’ concerns the matter be adjourned for 7 or 14 days in order for Shih-Hua to consider reformulating its application and seeking reconstitution of the board pursuant to s725 of the Companies Ordinance, Cap. 622. The Petition and Shih-Hua’s summons was adjourned to 12 September 2016.

5. On 8 September 2016 Shih-Hua issued a summons to reconstitute the board of the Company.

6. The Petition and summons came on before the Judge on Monday 12 September 2016. It became clear during submissions that the Respondents were not prepared to agree to reconstitution of the board, although they were content to have the Petition and summons adjourned in order that discussions concerning the purchase of their shares by Shih-Hua could continue. Mr Maurellet sought the immediate determination of the application to reconstitute the board. This the Judge declined to do for various reason including the fact that he had already decided that the matter was not sufficiently urgent to justify it being heard immediately and that the Respondents position was that it was opposed to the new summons and consequently sometime would be required to address what was a novel application. Having heard the application for the immediate determination of the application to reconstitute the board the following exchange in relation to the urgency of the matter took place.

‘COURT: I accept that the discretion, or the powers in the discretion are very, very broad. My concern is making this kind of order on an interlocutory basis without having it fully argued. Now, so far as your solicitors’ enthusiasm for trying to have this matter dealt with quickly is concerned, I have already refused to deal with the, if I recall correctly, the appointment of provisional liquidators on an ex parte basis. You got the injunction and you got a date for the inter partes application.

MR MAURELLET: In February, my Lord.

COURT: In February, yes. So ...

MR MAURELLET: As your Lordship has seen, there’s some urgency in this matter. Your Lordship may have seen, very briefly, the ...

COURT: Well, there’s urgency in all kinds of matters that turn up, but the fact is I cannot have your solicitors keeping -- you know, continually dreaming up new reasons for barging into court and trying to get to the front of the queue, so you can repeat that over a cup of coffee afterwards, all right. So the position is the position.

If this is largely a commercial problem, they’re going to have to thrash the thing out commercially and I can’t be utilised as a lever for exerting pressure on people, much as it might be useful. There’s a limit to -- so I think the position is this. I think Mr Sussex is right, it shouldn’t be left in abeyance for too long, and if the position is essentially this, either your clients and Miss Chan’s clients do a deal, quickly, and as a result, I assume your client takes over the company and then they sort out whatever needs to be sorted out, including, obviously, the claims of Shell and SK.

Then things just continue in the normal way, which probably means Mr Sussex is going to say it’s now rather more straightforward; it’s an insolvent company, we’re large creditors and this is what we would like done.

MR MAURELLET: Well, just in terms of the timing, assuming we go for the three weeks which was sort of suggested by Mr Sussex, does your Lordship envisage that, on that occasion, we will be dealing substantively with the application to reconstitute the board, because obviously, what we’re trying to ...

COURT: No, because it would be a Monday morning matter. So that needs to be dealt with properly, not squeezed in. Because I’ve also got no idea what that Monday morning will look like. There may be all kinds of emergencies and people rushing into court, or a long list of petitions that have to be dealt with. So I can’t promise you that I would have time to read the papers and argue ...

MR MAURELLET: A bit like the health service where everybody goes to A & E because the general queue is too long.

COURT: Exactly, yes. But there is a danger that that is what happens if one is too accommodating. So, no, I can’t promise you I can sort it out on a Monday morning, so you should assume I can’t.’

7. The Petition and the summons were adjourned to Monday 3 October 2016.

8. It should have been quite clear to Shih-Hua’s instructing solicitors following this hearing, and it is the Judge’s recollection that Mr Liu was in court, that the Judge took the view that there was not sufficient urgency to justify the type of expedited hearings they had by this time sought on a number of occasions.

9. When the Petition and the summons came back on 3 October 2016 once again Shih-Hua’s position was that it wanted an immediate interim remedy despite it having been made quite clear that the Judge did not think that there was any justification for the immediate determination of a contested substantive application to reconstitute the board. After hearing counsel the Judge adjourned Shih-Hua’s summons for argument on the first available date, which as matters transpired was before Mr Justice Anthony Chan on 4 and 5 January 2017.

10. By 3 October 2016, the Judge had heard hearings totaling 3.5 hours in length.”

11.  The injunction that I granted supplemented the validation order and provided that only payments specified in the schedule to the order could be made and other payments in the ordinary course of business not exceeding HK$2,000,000 per month.

The Present Proceedings

12.  On 14 October 2016 SH commenced a common law derivative action, HCA 2862 of 2016 (“Action”) against Mr Zhang, Motivi and three other parties who are not respondents to the Petition, namely, Hua Xueliang, Everglory Petrochemicals and Proud Union International Ltd who it is suggested are Mr Zhang’s nominees, and filed a Statement of Claim.  The relief sought includes various pecuniary claims and an order for the appointment of special managers.  The complaints of diversion of business, breach of duty, knowing assistance and receipt by Mr Zhang and his nominees said to entitle the Company to the relief sought are pleaded in [38–75] of the Statement of Claim.  As one would expect there is a substantial overlap between the complaints in the Statement of Claim and the Petition, which invites the question why it was thought necessary to commence the Action.  The only explanation that has been advanced is set‑out in [64(3)] of SH’s skeleton submissions:

“The Defendants’ position in effect, is that the Plaintiff should be confined to relief in the HCCW, and there should be no relief in the Action, arising out of the same facts.

However, their argument is at odds with well-established principles:-

(a) A shareholder and company are separate entities in law.

(b) A shareholder’s petition seeking just and equitable winding up, and relief for unfair prejudice, has different functions from a derivative action for wrongs done to a company by fraud on the minority, and a company’s entitlement to relief for such wrongs.

(c) A shareholder and company are entitled to different relief, arising from the same facts.

Moreover, there is no credible suggestion that the relief in both proceedings is in the alternative. Or that a winding-up order or buy out order is equivalent to relief in the Action, whether proprietary, or personal, e.g. an account of profits and/or damages.

Further, the conclusions of Anthony Chan J on the claim for ‘buy-out’ relief in the Petition are important (Decision §70):-

‘… there is no evidence on the ability on the part of Zhang or Motivi to buy-out [the Plaintiff ’s] shares in the Company. I note that the suggestions of buy out have so far led to nothing of substance. Secondly, there is evidence of stripping of the Company’s assets by Zhang (and his agents). That must give rise to real doubt whether he is interested to buy-out [the Plaintiff’s] shares in the Company. Further, a buy out order made against Zhang’s wish may be difficult to enforce against him (his roots are apparently in the Mainland) or Motivi, which is a BVI entity.’ (emphasis added)

Winding-up relief was thus preserved, and the Plaintiff amended the Petition to plead why winding-up relief may be the only practical and/or appropriate relief in the HCCW: Amended Petition §105.”

13.  This does not, however, explain why it was thought necessary to commence the Action.  In so far as this passage suggests that it was required to preserve the right to seek a winding-up order, something I had been expressly told by Mr Tong SC on 20 July 2016 SH did not intend to pursue, it makes little sense.  In my view it is a fairly compelling inference that the Action was issued in order to provide a platform for what SH did next.

14.  On 25 October 2017 SH applied ex parte not on notice for an injunction from Lok J.  The order sought and granted was against the 1^st to 5^th Defendants and restrained them from “disposing of, dealing with or diminishing the value of any of the proceeds of sale unpaid or yet to be paid by the Company’s ” customers.

Forum Shopping and the Duty of Full and Frank Disclosure

15.  The application was made by Robert Chan, who had not appeared for SH in any of the applications in the Petition proceedings.  There is only one reference to the Petition proceedings in Mr Chan’s skeleton argument.

“P has since May/June 2016 discovered that whilst in control of D6, D1 (with D2’s assistance) has mismanaged D6 and committed various acts of misconduct to the detriment of D6. This has led to P bringing a petition against D1 and D4 (HCCW 198/2016) on the ‘just and equitable ground’ and, subsequently, the present action.”

16.  I deal with Mr Chan’s oral submissions in detail in [20–21].  However, Mr Chan did not explain to Lok J what had transpired before me at the hearings between 20 July and 3 October 2016.  The Judge was not given or shown a copy of the injunction, which I had granted on 20 July 2016.

17.  The application was supported by a draft affirmation of Yang Shiheng, which was subsequently deposed.  Mr Yang refers to the applications before me in [73] and [77]:

“73. Shortly thereafter, still in the morning of 20 July 2016, the Injunction Order was made by the Hon. Mr Justice Harris, which essentially limited the disposition of Everglory Energy’s funds for ‘ordinary course of business’ payments, to an amount not exceeding HKD2,000,000 each calendar month. The Injunction Order also permitted the making of the payments set out in Schedule 2 thereto (being a ‘cash flow projection’, apparently of ‘ordinary course of business’ payments, listed up to 12 October 2016).

…

77. Following several further hearings, namely on 24 August 2016 (before Master R Lai), 29 August 2016, 12 September 2016 and 3 October 2016 (all before the Hon. Mr Justice Harris), the Petition is now adjourned, and is to be heard on 8 February 2017.”

18.  Mr Yang’s evidence substantially repeats complaints, which were amongst those made in the evidence in the applications before me, which included a report prepared by RSM dated 6 September 2016, which had been before me in a nearly identical form by 24 August and I refer to in [3] of my letter of 24 July 2017.  Given my familiarity with the subject matter of the application one would have expected SH’s solicitors to have approached my Clerk to see if I was available to hear the application.  An additional reason for doing so is the requirement of PD 11.1 that applications concerning the internal management of companies should be made so far as practicable to the Companies Judge. 

19.  Although not directly applicable given the terms of the order sought, it is another reason why I would have expected SH’s legal team to have thought it sensible to have approached my Clerk.  It has not been suggested that they were unaware of PD 11.1.  Mr Chua submitted that PD 11.1 did not restrict a Duty Judge from hearing an application that came within the Practice Direction.  That is, however, not the point as Kwan J (as she then was) observes in [6] of her judgment in The New China Highway Limited.[1] The obligation is “squarely on those making an urgent application to apply to a Companies Judge.  The fact that the Duty Judge has discretion to hear them in a very urgent situation is immaterial”.  The reason for this goes to the purpose for having PD 11.1 and specialist judges.  Applications can be addressed with greater efficiency and confidence by a judge familiar with the subject matter of an application and the relevant principles than one who is not.  For this reason I would have expected SH’s lawyers to have approached my Clerk in the first instance for a hearing.  Even if they had doubts as to the application of PD 11.1 I would have expected them to want the matter to be heard by me as I was already familiar with the case and to have asked my Clerk if I would do so.  No explanation has been advanced for them not taking this obvious course.

20.  In his oral submissions before Lok J Mr Chan said this:

“MR CHAN: My Lord, I need to explain some more of the procedural background for you, because it might not have been clear from my skeleton, but it’s certainly set out in the affirmation preamble, and that is that the HCCW proceedings. In those proceedings, there has been, in the past several months, applications made by our side for the appointment of, at first, provisional liquidators, and then later, we tried to reconstitute the board, as an alternative option, because there is some arguments to be made, that it would constitute an event to default…

COURT: Have you made those applications?

MR CHAN: Those applications have been made, summons have been taken out, and they are going to be heard, my Lord, in January, February. February of next year, which in our submission is just too long to wait, because the diversions…

COURT: Well, if that is the case, that is exactly why you should go before the -- I mean, you cannot -- what you should have done is that you should speed up or for some reason persuade the judge to give an early date.

MR CHAN: We tried that.”

21.  What Mr Chan did not tell Lok J was that the applications before me had been made relying on similar evidence and sought interim relief, albeit in a different form, directed to, amongst other things, the complaints said to justify the urgent application for an injunction before Lok J.  In my view Mr Chan’s explanation of the extent of the overlap between the Petition and the Action was clearly inadequate.  I think it understandable that Lok J, who was not familiar with the background to the matter and was hearing the application at short notice would not have appreciated that the application was being made before him rather than before me because SH’s lawyers, in particular its solicitors, anticipated that I would see the application as an attempt to repackage SH’s previous interlocutory application and decline to deal with it on an urgent basis.

22.  In my view SH and its legal team were guilty of impermissible forum shopping and failed in their duty of full frank disclosure.  In my view it is also a compelling inference that this was not the result of inadvertence.  It resulted from a conscious decision by SH’s solicitor, Alvan Liu, to reformulate SH’s claim with a view to obtaining an interim injunction having failed to obtain in the proceeding months immediate appointment of provisional liquidators or reconstitution of the board and to provide only limited information about how I had dealt with the earlier interlocutory applications to Lok J to minimise the possibility of the Judge referring the application to me.  The subsequent application before DHCJ Yee was, unsurprisingly, subject to the same flaws.

23.  There was, however, a further specific respect in which Mr Chan’s submissions misled Lok J.  Lok J had queried why if there was renewed urgency SH did not renew its application before the Companies Judge in view of the fact that, as Mr Chan accepted, the application was based on the same complaints as those advanced to support the application to appoint provisional liquidators.  Mr Chan said this in response:

“MR CHAN: And also at that time, my Lord should also know that we went to get the forensics, because we had SCs on board, and the advice was to get forensics to accountants, to look at the information, to see whether or not this was -- this is something which could be brought.

COURT: The application …

MR CHAN: And we ended up with a report.

COURT: … to remove D1 as director would be heard in January 2017, and the application for PL would be heard in February 2017.

MR CHAN: Yes. And we got the RSN report which now says that diversion is reasonably established, so now we’ve got the evidence to bring before the court to say that there is substance in those past diversions, and now we are seeking to injunct or restrain further diversions on basis of breach of fiduciary duties, my Lord.  So it’s slightly different.”

24.  Slightly later in the application in answer to a question from Lok J, Mr Chan again relied on what he speaks of as being a new report as justifying the application:

“MR CHAN: So we want a freezing of all the proceeds which come from each cargo..

COURT: Do you have -- then my question is, why didn’t you do it earlier?

MR CHAN: The straightforward and direct answer for my Lord is that we were waiting for the forensics, we didn’t have the evidence to say -- to build our case, my Lord, and of course, at the same time, we were going for PLs, so we’re looking at different directions in a HCCW action, and a derivative action, in that sense, so the angle was completely different.”

25.  The report referred to was prepared by RSM and is dated 6 September 2016.  I have referred to it in [18].  As I have explained the September report is nearly identical to the version I had before me by 24 August 2016.  The impression that Mr Chan gave, namely, that SH has obtained a report, which says something new and which caused SH to decide that it was necessary to issue an action and seek an injunction, was in my view false and misleading.  It appears to have been said by Mr Chan with a view to deflecting Lok J’s concern that if the evidence before him was substantially the same as that which had been before me, which it was, he should decline to hear the application and refer it to me. 

26.  It is critical that in making ex parte applications without notice to the respondent that the applicant gives full and frank disclosure and proceeds with the highest good faith[2]. There is no room for gaming the process by presenting relevant facts in a way which is calculated to obscure their significance.  An applicant cannot, for example, fulfill his obligation by including relevant documents in voluminous exhibits and leaving the judge to identify them[3]. Consequently, in discharging this duty it will commonly be necessary for counsel to ensure in his address that the court properly understands the application and its background[4] particularly if during counsel’s dialogue with the court it becomes apparent the court may not fully understand facets of it.

27.  For the reasons explained in [15–21] in my view SH (1) clearly failed in its obligation adequately to explain to Lok J the applications made in the Petition proceedings and their relationship to the application for an interim injunction and the reasons why the application was not made to me and (2) this failure arose not from in advertence, but was intentional.

28.  The way in which Mr Zhang puts his case in respect of this omission is two-fold.  First, he argues it was an abuse of process to commence the Action and apply for the Orders before the Duty Judge rather than the Companies Judge.  Secondly, the failure to properly inform Lok J of the previous applications and how I had dealt with them was material non-disclosure, although not the only material non-disclosure, and this also justifies discharging the Order.

29.  I agree with Mr Joffe’s submissions that the application before Lok J was an abuse of process.  I reach this conclusion, because of my finding in [22] that the applications to Lok J and DHCJ Yee involved conscious and impermissible forum shopping.  It does not seem to me necessary to consider whether or not issue of the Action in October 2016 was of itself an abuse of process in light of my findings:

(1)  that the Action should be struck out as the alleged wrong doer is no longer in control of the Board, which has been successfully reconstituted on SH’s application (see [30–39]); and

(2)  the failure properly and adequately to inform Lok J of the applications before me, their outcome and my comments constituted serious material non-disclosure.  It was not the only material non-disclosure (see [44–53]). It seems to me that certainly taken cumulatively the material non-disclosure and the abusive nature of the application justify discharging the Orders and refusing to re-grant them.

Re-constitution of the Board

30.  On 4 January 2017 SH’s Anthony Chan J heard four applications:

(1)  An application by SH to reconstitute the Board of the Company by removing Mr Zhang and SH and replacing them with 2 independent professionals.

(2)  SH’s summonses for the appointment of provisional liquidators.

(3)  SH’s application to continue the injunction that I had granted on 20 July 2016.

(4)  An application by Mr Zhang and Motivi Point to strike out the winding-up relief.

31.  The Judges’s decision was handed down on 19 January 2017.  Anthony Chan J ordered that Mr Zhang and SH should be removed from the Board and replaced with two nominees of the opposing creditors, namely, Mr David Bennett and Mr Tong Piu of Grant Thornton Advisory Services Limited and an injunction granted restraining Mr Zhang from exercising director’s powers.  The summons to appoint provisional liquidators was withdrawn, the injunction discontinued and the summons to strike out the winding up relief dismissed.

32.  The consequence of this decision was that Mr Zhang ceased to have any control over the Company.

The Rule in Foss v Harbottle

33.  The Action is a common law derivative action.  The circumstances in which it is permissible for a shareholder to bring such an action are summarised in the judgment of Ribeiro PJ in Waddington Ltd v Chan Chun Hoo:[5]

“11. It is a fundamental principle of company law, expressed as part of the rule in Foss v Harbottle, that where a wrong has been done to a company, it is the company itself which is the proper plaintiff. That principle does, of course, admit of exceptions, the exception generally relevant to derivative actions being the ‘fraud on the minority’ exception. Jenkins LJ explained the position in Edwards v Halliwell,[6]as follows:

… where what has been done amounts to what is generally called in these cases a fraud on the minority and the wrongdoers are themselves in control of the company, the rule is relaxed in favour of the aggrieved minority who are allowed to bring what is known as a minority shareholders’ action on behalf of themselves and all others. The reason for this is that, if they were denied that right, their grievance could never reach the court because the wrongdoers themselves, being in control, would not allow the company to sue.

12. It follows that where a wrong is alleged to have been done to a company and a minority shareholder purports to bring a derivative action on the company's behalf, it is incumbent on the shareholder to show that the general ‘proper plaintiff’ rule is displaced and that the case falls within the relevant exception.

13. The derivative action is a procedural device invented by the courts to afford protection to the minority. Procedurally, there is no requirement at common law for a person seeking to sue derivatively first to obtain the leave of the court. But it does not follow from this that there is no threshold requirement to be met by the plaintiff. Substantively, such an action is only permitted where it can prima facie be shown that there exists a viable cause of action or equitable claim vested in the company which, if made good, would establish a fraud on the minority; as well as control of the company by the alleged wrongdoers such as to enable them to stifle any proposed action against themselves.

14. The time-honoured practice at common law is for the plaintiff to issue proceedings ‘on behalf of himself and the other shareholders other than the defendants’, naming the company on whose behalf the proceedings are brought as one of the defendants. A challenge to the plaintiff's locus generally takes the form of an application by the relevant defendants 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. The issue of standing can also arise in other procedural contexts, such as an application to add a party or to amend a pleading so as to introduce a derivative action. It is in such a context that the court has to consider whether the self-appointed derivative plaintiff should be permitted to proceed with the action by way of exception to the proper plaintiff rule.”

34.  The exception to the principle that the proper plaintiff to a claim to remedy a wrong done to a company is the company is permitted when the wrong would otherwise go uncorrected commonly, because the wrong-doers are directors who are in control of the Company.  It is for this reason that in [29] and [30] of the Statement of Claim it is pleaded that:

“29. By reason of the matters pleaded in paragraphs 1 to 25 above, the Plaintiff has no or no reasonable prospect of obtaining the consent of the Company to the institution of this action in the name of the Company for its own benefit, whether at a meeting at the Board of Directors or at a general meeting. If and insofar as is necessary, the Plaintiff also relies on the following particulars:-

Particulars

(1) The Plaintiff and the 1^st Defendant are the only two directors of the Company and the 1^st Defendant is the nominated director of the 4^th Defendant.

(2) According to Article 23(b) of the Company’s Articles of Association, two directors shall constitute a quorum for board meetings.

(3) By reason of the matters pleaded in paragraph 25 above, the Board of Directors has been deadlocked since mid‑2014.

(4) The 4^th Defendant as an alter ego controlled by the 1^st Defendant and the Plaintiff are the only two equal shareholders of the Company.

(5) In view of the shareholding structure of the Company, there is also a complete deadlock as between the Plaintiff on one side and the 4^th Defendant on the other side.

30. According, this action is brought by the Plaintiff as shareholder of the Company for the benefit of the Company.”

35.  If the Board of a company is independent of the wrong-doers and able to take an informed view of the alleged claim and decide whether or not the company should pursue the claim it is not permissible for a shareholder to commence a common law derivative action.  There is no suggestion in the present case that the Board is not impartial and thus, submitted Mr Joffe, the Action infringes the principal described by Ribeiro PJ and should be struck out.  Mr Joffe was not able to produce an authority directly on point, perhaps because the law and its application is sufficiently clear that it has never been disputed.  He did, however, illustrate its application in the insolvency context.  In Ever Joint (Holdings) Ltd v Nice Theme Ltd [7] DHCJ Gill held, in my view correctly, that once a company had been wound up continuation of the action could only be continued by the liquidator.  The reason is explained in a passage from the judgment of Lord Blanesburgh, quoted by the Deputy Judge, in Ferguson v Wallbridge:[8]

“... in their Lordships’ judgment, [the present action] could have been so maintained if the company were not in liquidation. Cook v Deeks [1916] 1 AC 554 is clear authority for this. But could it be so maintained now that the company is assumed to be in liquidation? And the answer must again, as their Lordships think, be in the negative ... The form of action so authorised is necessitated by the fact that in the case of such a claim ... justice would be denied to him if the mere possession of the company's seal in the hands of his opponents were to prevent the assertion at his instance of the corporate rights of the company as against them ... So as soon as the company goes into liquidation the necessity for any such expedient in procedure disappears. Passing over the superficial difficulty that a company in compulsory liquidation cannot be proceeded against without the leave of the Court, the real complainants, the minority shareholders, are no longer at the mercy of the majority, wrongly retaining the property of the company by the strength of their votes.”

Walton J is to similar affect in Fargo Ltd v Godfroy:[9]

“But once the company goes into liquidation the situation is completely changed, because one no longer has a board, or indeed a shareholders’ meeting, which is in any sense in control of the activities of the company of any description, let alone its litigation. Here, what has happened is that the liquidator is the person in whom that right is vested.”

36.  It is quite clear in the present case that in no sense is Mr Zhang in control of the Company or able to influence the decisions of the Board.  It follows in my view that unless the Board wishes to continue the Action it should be struck out.  Various authorities recognize that in the insolvency context the appropriate course may be stay the proceedings and give the liquidator the opportunity to decide whether or not to continue with the action.[10] Mr Joffe accepted that the same was true in the present circumstances, although he argued that as the Board has expressly declined to continue with the Action I should strike it out.

37.  Mr Chua argued that the decisions made in the insolvency context are not relevant and, if I understood him correctly, the reconstitution of the Board and thus the removal of control from the wrong doer from control of the Company did not cause the derivative action to infringe the Rule in Foss v Harbottle.  Mr Chua did not refer me to any authorities to support his submission.  In my view it is wrong.  The only question is whether the Board should be given the opportunity to continue later the Action.

38.  It is necessary to consider how the Board has proceeded to deal with the Action after its reconstitution.  Mr Bennett and Mr Tong were appointed on the basis that their fees for acting as directors would be paid by SH.  As is clear from Mr Bennett’s email to Karen Luk of SH’s solicitors of 22 February 2017 SH did not, as it would appear Mr Bennett and Mr Tong expected, proceed after their appointment to promptly agree commercial terms with them.  This remained the case in the middle of June according to an email from Alvan Liu to Mr Bennett and Mr Tong dated 16 June 2017, although SH had on 9 June 2017 finally made a contribution to their costs of US$150,000.  It would appear the opposing creditors had also provided some finance intended, I get the impression from the correspondence, to fund restructuring efforts.  The new Board was represented at the hearing before me by Mr Damien Whitehead of White & Case.  Mr Whitehead took me to Mr Bennett’s email to Karen Luk of 27 June 2017 in which amongst other complaints directed at SH, Mr Bennett reminds Ms Luk that SH has still not provided the indemnity in respect of the new directors liabilities that it had undertaken to Anthony Chan J to provide.  Mr Whitehead told me that the Board’s position is that the Company is insolvent and that as SH had not provided the funding Mr Bennett and Mr Tong had understood would be forthcoming when they were appointed, they had not been able properly to investigate the claims in the Action and did not intend to pursue them.  SH has provided no explanation as to why it has not funded the conduct of the Action by the Board to date or proposed a scheme for doing so in the future.

39.  It would seem to me that SH has dealt with this matter in a disingenuous way.  It would appear that its application to reconstitute the Board was directed more to ousting Mr Zhang rather than putting in management that could take over the running of the Company’s affairs including the prosecution of the Action.  It appears that SH wishes to retain control of the Action, but in my view this is not an option for them having successfully reconstituted the Board.  In my view the prosecution of the Action by SH as a common law derivative action now clearly infringes the principles described in [33–35] above and [29–30] of the Statement of Claim are unsustainable.  The Action should, therefore, be struck out.

Material Non-disclosure

40.  Mr Chua summarised the principles by reference to which the court assesses whether or not material non-disclosure is sufficiently serious to justify complete discharge of an order in [44(2)] and [44(3)] of his skeleton argument:

“(2) Whether a fact not disclosed is of sufficient materiality to justify immediate discharge of an order without examining the merits depends on the importance of the fact to the issues to be decided by the Court on the application.

(3) The Court considers all relevant circumstances in deciding whether there should be the ‘serious sanction’ of complete discharge of an order including:-

(a) whether the non-disclosure was deliberate;

(b) the excuse or reason for any material non-disclosure;

(c) the importance of the omitted fact to the issues to be decided by the judge, in particular whether the non‑disclosure would have resulted in the original order not being made in the first place, or would only affect the form of the order;

(d) whether the injunction could properly be granted had proper disclosure been made;

(e) the substantial merits of the case, and the balance of convenience;

(f) above all, whether discharge would be out of all proportion or risk a ‘serious potential injustice’ to a plaintiff. For instance, when a plaintiff makes serious allegations of fraud.

Hong Kong 2017 White Book (Vol 1) 29/1/51;
Brink’s Mat v. Elcombe[1988] 1 WLR 1350 (C.A.) (at 1357C–F, 1358D–F, 1359E–F, H);
Memory Corporation v. Sidhu[2000] 1 WLR 1443 (C.A.) (at 1455F–G, 1456A, 1458H).”

41.  Although, in considering whether to discharge an order for material non-disclosure the court weighs the relative significance of the above factors it is apparent from the authorities that considerable weight it attached to the fact of serious material non-disclosure and that where it has taken place as a general rule the order will be set aside and not renewed until trial.[11] As Kwan JA explains in Excel Courage Holdings[12]there is a tension inherent in the assessment of competing considerations: between the need to deal firmly with serious material non-disclosure in order to discourage malpractice which has a deleterious effect on the administration of justice and the risk of setting aside an order and refusing a re-grant causing injustice.  However, in order to tip the scales in favour of a re-grant it cannot be enough for an applicant to show that if the material matters had been disclosed he would still have been entitled to an order.  What is generally necessary is for the applicant to show that the refusal of interlocutory protection would have such a serious adverse effect on the value of any remedy obtained at trial that depriving him of it would be to impose a sanction out of proportion to the wrong done in failing to make proper disclosure.  This is a materially higher threshold than the balance of convenience test applied when considering an application for an interim injunction.

42.  I have already addressed the failure adequately to disclose to Lok J and subsequently DHCJ Yee, the interim applications made in the Petition proceedings.  Although in earlier parts of this decision I have characterised this failure as involving forum shopping the way in which it was perpetrated involved serious material non-disclosure.  Mr Zhang argues that there was also further substantial material non-disclosure in both applications. 

43.  I do not understand it to be in dispute that it was the responsibility of SH and its legal team to ensure that they put before the court all matters that Mr Zhang might argue was relevant whether it be possible defences to the claims or matters such as SH’s financial state that would be relevant to its ability to give a valuable undertaking in damages.  It was not for SH or its legal team to assess how material were such matters.  That was a matter for the court.[13]

44.  Mr Joffe submitted that SH had failed to disclose matters, which were both relevant to the substance of the application and the terms upon which any order should be granted.

45.  First, Mr Joffe argued that SH failed to disclose its own conduct which demonstrated that it was SH’s actions that had brought the Company’s business to a halt.  This was relevant to the assessment of SH’s claim that it was the diversion of the Company’s business by Mr Zhang that had interfered with its ability to carry on business and justified an injunction in order to prevent any further stripping of the Company’s assets and business opportunities.  Mr Joffe relied on the following matters:

(1)  On 1 June 2016 (one month before the Petition was presented), SH wrote to all banks of the Company causing seven of its nine bank accounts to be frozen, thus rendering it unable to meet its ongoing contractual obligations.

(2)  Without any or any legitimate reason, SH refused to give consent to Mr Zhang’s request that the Company be allowed to use its funds to discharge its obligations in the ordinary course of business.  The Defendants as a result had to apply to court for a validation order, which was granted on 20 July 2016.

46.  Mr Joffe argued that these matters were plainly relevant and SH’s legal team must have been aware of them because they had been raised in the Petition proceedings.  It was not for them to decide their substance and relevance.  It was plainly their duty to draw the court’s attention to them, as it was an argument which the Defendants would have made if they had the opportunity of being heard.

47.  Secondly, Mr Joffe argued that SH failed to make sufficient disclosure of its financial status and ability to honour its undertaking as to damages by not drawing attention to the following material facts and, instead, representing to Lok J that it is a “substantial company … involved in the investment holding business for the past 20 years [and …] is able to give the usual undertaking as to damages”. Mr Joffe relied on the following matters:

(1)  SH failed to disclose the fact that SH owed a total of US$5,953,339.03 to the Company including a shareholder’s loan of US$3,000,000 admitted to be owed by SH and an unpaid allotment of US$2,939,752.21).

(2)  SH failed to disclose the fact that it had, shortly prior to the 1st Injunction Order, diverted substantial assets owned by it to Huaxing Gas Ltd, a company incorporated only on 19 July 2016 which has the same shareholder and director as SH, and Stargas Investment Ltd.

(3)  On 30 August 2016 SH transferred its shareholding in Stargas Limited to Stargas Investment Ltd.

(4)  On 21 September 2016, SH transferred all of its shareholding in Quanzhou Huaxing Gas Co Ltd (worth RMB90,000,000) to HGL.

(5)  On 23 September 2016, SH transferred all of its shareholding in Fujian Huaxing Co Ltd (worth US$14,900,000) to HGL.

48.  Mr Joffe submitted that these matters were plainly material to the question of whether SH was good for its undertaking and its duty of full and frank disclosure required SH to inform Lok J of them in order that he could assess what fortification was required if he was satisfied that an injunction should be granted. 

49.  In respect of the 2^nd Order, in particular the alleged proprietary injunction in [2] of the Order against Motivi in respect of of US$7,362,202, Mr Joffe submitted that SH failed to disclose material that would have directly countered its claim that Motivi owed the Company US$7,362,202:

(1)  SH was aware since as early as 3 October 2016 from evidence filed by Mr Zhang in the Petition proceedings that the extract from the Company’s ledger “loan due from shareholders” as at 30 June 2016 prepared by F. S. Li Associates Ltd (“Extracted Ledger”) showed that there was no outstanding liability due from Motivi to the Company, yet failed to bring this to the court’s attention whether in its evidence or in Mr Chan’s skeleton.

(2)  Even assuming that SH justifiably proceeded on the basis that there had been no repayment by Motivi, it was still misleading for SH to inform the court, as it did in 33(f) of Mr Yang’s 2^nd affirmation, that the injuncted amount included a shareholder’s loan to Motivi in the amount of US$5,310,000.  US$5,310,000 is the aggregate amount of the seven tranches of the shareholder’s loan shown in the Extracted Ledger in US$.  However, the aggregate of the seven tranches shown there in HK$ is HK$20,237,205 , the equivalent of about US$2,594,513.  The discrepancy is explained by an obvious error in the statement of the loan tranche dated 17 December 2015 whereby the amount of HK$2,325,300 was mistakenly stated to be US$3,000,000 rather than US$300,000.  This caused the total amount of the loan to be overstated in the accounts of the Company as at 30 June 2016 prepared by F. S. Li Associates Ltd, exhibited to Mr Zhang’s evidence filed in the Petition proceedings. This was re‑exhibited to Mr Zhang’s 1^st affirmation in response to the 1^st Injunction Order.  Mr Yang only exhibited to his 2^nd affirmation those parts of the Accounts which do not show the repayment of the loan by Motivi.

50.  F. S. Li Associates Ltd has confirmed in a letter dated 25 October 2016 that there was a typo in the description of the transaction dated 17 December 2015 stating the loan as “US$3,000,000” instead of “US$300,000”. Consequently, the total amount of the loan was only about US$2,610,000 or HK$20,237,205.

51.  Mr Joffe submitted that this error was so obvious that it should have been picked up by someone making proper inquiry, bearing in mind that SH was looking at the Extracted Ledger with a view to determining the appropriate amount to be injuncted. SH was aware of this because the discrepancy between the HK$ entry and the US$ entry was specifically mentioned on page 4 of the 1^st RSM Report.

52.  It seems to me that even if SH was not sure whether the HK$ figure or the US$ figure was the correct one, it ought to have at least disclosed the possibility of there being an error and that the total value of the loan was only US$2,610,000. For it to simply turn a blind eye to this possibility and pick the figure that gave it a higher injuncted amount was contrary to its obligation to give full and frank disclosure.

53.  SH’s response to these criticisms is largely that the issues are contentious and the court is not concerned at this stage to determine disputed questions of fact.  This misses the point.  It seems to me that the matters to which I have referred, particularly the question of the amount of Motivi’s loan, was not dealt with properly by SH and its legal team.  A pattern emerges, which suggests either an indifference to the obligation to consider conscientiously what needs to be disclosed to the court or on occasions a conscious omission of unhelpful evidence.  It seems to me that SH and its legal team manifestly failed in their obligations to make full and frank disclosure in a number of aspects and that the Orders should be set aside.  As I have determined that the Action should be struck out the question of re-granting the Orders does not arise.  If I had not struck out the Action I would have approached an application to grant new orders on the basis that this was a serious case of material non-disclosure. 

Should the Order be re-granted?

54.  Lok J granted an injunction to restrain the Defendants, other than the Company, from “in any way disposing of, dealing with or diminishing the value of proceeds of sale unpaid or yet to be paid by the” Company’s customers including Bohua and Oriental Energy Co Ltd (“Oriental”) in respect of the supply of any LPG or propane supplied to them by the Everglory Petrochemical Ltd.  (3^rd Defendant), Proud Union International Ltd (“PUI”) (5^th Defendant), Everglory (Macau) International Co Ltd or Decen International Ltd.

55.  SH makes the following claims in the Action, which it relied on as showing that it had a prima facie case and that there was a need for an urgent injunction to restrain in particular Mr Zhang from diverting the Company’s interests under two long-term gas contracts.  First, that Mr Zhang controlled PUI and that he caused the Company’s interest in transactions carried out pursuant to a long term sales contract with Oriental to be diverted to PUI.  The transaction was for the sale of propane with a value of US$18,703,065.60. Secondly, that Mr Zhang had caused the Company to “book out” (as it is described in the Statement of Claim) scheduled shipments of cargos from Shell to companies controlled by Mr Zhang rather than the Company’s end buyers, in particular Bohua.

56.  I have already referred to the RSM Report.  As I understand it, this evidence was heavily relied on by SH both in the applications before Lok J and DHCJ Yee and also before Anthony Chan J.  The Report suggests that on the basis of, what RSM acknowledge was the limited documents provided to them, PUI was controlled by Mr Zhang and PUI invoiced Oriental for a cargo of LPG delivered to Oriental.  In addition RSM suggest that there is evidence that Mr Zhang caused certain purchases from Shell (its supplier) to be cancelled for no apparent reason with consequent compensation being paid to Shell.

57.  In the evidence before me was a report prepared by Briscoe Wong Advisory Ltd (“BW”) dated 24 November 2016 which was not before Lok J, DHCJ Yee or Anthony Chan J.  This report analyses the conclusion reached in the RSM Report.  In short, BW who had access both to more documents than RSM and also Mr Zhang, explain that on the basis of the material with which they had been provided they consider that RSM’s report contains a number of mistaken critical assumptions.  First, there is no evidence to suggest that PUI is controlled by Mr Zhang, rather PUI was a customer of Oriental and paid for the cargo rather than invoiced Oriental for it.  BW have seen one invoice from EPL marked “For Customs Purpose Only” amongst the papers, but nothing to suggest that either PUI or EPL sought payment for the cargo from Oriental.  BW also consider in detail a 2^nd transaction for a cargo of 46,805,692MT of LPG purchased from Shell.  The order was placed pursuant to a long term contract with Zhejiang Shaoxing Sanyuan Petrochemical Co Ltd (“Sanyuan”).  The Company issued a prepayment invoice to a Lee Fung, which was nominated as the buyer by Sanyuan.  EPL issued three invoices to Oriental again marked “For Customs Purposes Only”.  The Company, however, received US$16,147,963.74 from Lee Fung and has issued two further debit notes to Lee Fung, which at the time of preparation of the Report had not been settled.

58.  BW opine that in neither case does the information available to them support the conclusion that these transactions involved the diversion of monies to entities controlled by Mr Zhang. 

59.  So far as the book-outs are concerned RSM conclude that these took place as a result of the Company informing Shell of the closure of some of its bank accounts and the presentation of the Petition, which called into question its ability to pay for any cargo that was shipped.  In these circumstances the Company anticipated that it could not take delivery.  Shell then arranged the book-outs.

60.  BW also address a number of other criticisms and concerns identified by RSM explaining that they also do not support the suggestion that Mr Zhang was diverting business and monies away from the Company.

61.  On the basis of the evidence that I have read I consider it doubtful whether SH is able to demonstrate a prima facie case of a material breach of duty by Mr Zhang let alone any scheme to defraud the Company, which is the import of SH’s claim.  However, assuming for present purposes that a prima facie case has been demonstrated:

(1)  I am not satisfied that the evidence shows that unless enjoined Mr Zhang and the entities he controls will divert future payments.  I am made more confident in reaching this conclusion by the appointment of independent directors.  There is nothing to suggest that Mr Zhang currently intends to divert any monies due to the Company to his own entities now the directors have been appointed and they have obtained control of the Company’s bank accounts.

(2)  I am certainly not satisfied that there is sufficient risk of loss to the Company and consequently to SH to make it unjust to refuse to re-grant the Orders as a penalty for what I have found to be a serious failure to make full and frank disclosure of material matters before Lok J and DHCJ Yee.

Conclusion

62.  I shall make the following orders:

(1)  The Orders of 24 November 2016 and 22 November 2016 be discharged.

(2)  The Action be struck out.

(3)  The summonses of 26 October and 25 November 2016 be dismissed.

(4)  I make no order save as to costs in respect of the summons dated 16 May 2017 seeking fortification.

(5)  A costs order nisi that the costs of each summons be paid forthwith by the Plaintiff to the 1^st to 6^th Defendants to be taxed if not agreed.  In respect of the costs of the 1^st to 4^th Defendants there be a certificate for two counsel and the costs of the applications to discharge the Orders of 24 November 2016 and 22 November 2016 be taxed on an indemnity basis.