CHEEROLL LTD v. PHILIP LEIGH TOSE AND OTHERS

HCA15993/1998

IN THE HIGH COURT OF THE

HONG KONG SPECIAL ADMINISTRATIVE REGION

COURT OF FIRST INSTANCE

ACTION NO.15993 OF 1998

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R U L I N G

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1. The 1st to the 4th defendants are appealing against the decision of the Master who ordered discovery by affidavit of specific documents and classes of documents, inspection and the taking of copies under the plaintiff's amended summons dated 11 March 2002.

Background

2. The background of this matter is as follows. The plaintiff was a shareholder of Peregrine Investment Holdings Limited ("Peregrine"), a public company listed in the Hong Kong Stock Exchange. The defendants were directors and/or officers of Peregrine. In late December 1997, Peregrine was in financial trouble. In early January 1998, the Securities and Futures Commission stepped in to protect the customers of the regulated business. On 13 January 1998, provisional liquidators were appointed to Peregrine. On 23 April 1999, the Financial Secretary appointed Mr Richard Farrant as Inspector under section 143(1)(a) of the Companies Ordinance (Cap. 32) to investigate the affairs of Peregrine and also its subsidiary, Peregrine Fixed Income Limited (In liquidation) ("PFIL"), with effect from 5 May 1999. On 12 February 2000, Mr Farrant delivered his report ("the Farrant Report").

The plaintiff's pleaded case

3. The plaintiff filed the Statement of Claim on 18 September 1998. It alleged that from late August to October 1997 there were persistent rumours that Peregrine and its businesses were in financial difficulties in that they had suffered huge losses in the Asian foreign exchange, fixed income and equity markets. In mid-October, the plaintiff was considering sale of its shares in Peregrine in view of the rumours. On 26 October 1997, the defendants held a board meeting of Peregrine and they issued an announcement ("Announcement") that Peregrine was not in financial difficulty and including: "Rumours of losses by Peregrine running into hundreds of millions of US dollars and of Peregrine's financial demise are completely false". And the defendants caused the Announcement to be published in the SCMP on 27 October 1997.

4. The plaintiff alleged that the defendants' intention was to ensure the shareholders to retain confidence in Peregrine and dissuade them from selling the shares. The defendants owed to the shareholders a duty of care to ensure the Announcement was true, accurate and not misleading, and they knew and ought to have known the reliance thereon by the shareholders. In reliance on the Announcement, on 12 December 1997, the plaintiff reclassified its shares in Peregrine as long term investment instead of selling them.

5. I have to look more carefully at paragraph 14 of the Statement of Claim. In paragraph 14, the plaintiff pleaded that:

"In breach of duty and/or negligently the Defendants gave misleading and false information in the Announcement and/or omitted to give information in the Announcement which made statements therein misleading.

Particulars

Pending discovery and interrogatories herein, the best particulars the Plaintiff can currently provide are that it is to be inferred from the following facts and/or matters pleaded at paragraphs 15 and 23-26 below that contrary to the facts and/or matters stated in the Announcement, rumours of losses by Peregrine running into hundreds of millions of dollars and/or Peregrine's financial demise were not completely false and/or Peregrine was in serious financial difficulty:

(1) Peregrine had a large, concentrated and disproportionate bond and debt exposure to Indonesian companies. It had for example made a substantial multimillion loan facility available to an Indonesian company called PT Steady Safe, which debt was not underwritten, the Indonesian Rupiah was suffering severe depreciation thus undermining the ability of Peregrine's Indonesian debtors to service their loans and Peregrine's bond inventory was materially different to the position in 1996 in that the inventory contained a large number of bonds which Peregrine had been unable to find buyers for.

(2) Peregrine's financial position was parlous such that within weeks of the Announcement being made (if not earlier) the Defendants were seeking substantial new investment to keep and/or make Peregrine solvent."

6. The plaintiff pleaded that the directors knew or ought to have known that at all material times that by reason of Peregrine's exposure to the PT Steady Safe transaction and other matters referred to in paragraph 14(1), that the assurances in the Announcement were unsound or misleading. In other words, the plaintiff was saying that the directors knew or ought to have known that Peregrine was in serious financial trouble by 26 October.

7. The plaintiff further pleaded that on 11 December 1997, the defendants announced Peregrine's financial results for the 10 months ending 31 October 1997 ("Results"). And on 17 December 1997, the 1st defendant issued with the approval of the other defendants a letter ("Letter") and a circular ("Circular") stating that the board undertook to advise the shareholders on a proposed new investment by Zurich Centre Investment Limited and the Results were attached.

8. The Circular stated that the directors collectively and individually accept full responsibility for the accuracy of the information contained in the Circular and that the directors are not aware of any material adverse changes in the financial or trading position of Peregrine since the date of the last audited financial statement of 31 December 1996. The plaintiff alleged that the information in the Results, Letter and Circular were incorrect or misleading and the defendants were in breach of their duty of care to the shareholders.

9. The plaintiff further pleaded that in the statement of affairs furnished by the defendant to the provisional liquidators on 5 June 1998, the liabilities of Peregrine exceeded its assets by HK$4,600,000,000. The plaintiff suffered a loss of at least HK$27,375,000 in respect of its shareholdings in Peregrine.

The Farrant Report

10. I have been referred to the Farrant Report at length and I will refer to it now. The terms of reference include: to conduct examination of the books, documents, accounts, information and records in possession of the liquidators of Peregrine and PFIL; to draw conclusions as to reasons and events that led to the collapse of Peregrine and PFIL, which include: whether full, adequate and timely provisions and/or disclosure had been made in respect of losses or potential losses arising from the book, i.e. the Fixed Income Book, in the Announcement; whether full, adequate and timely disclosure has been made throughout the period, 2 July 1997 to 15 January 1998; knowledge and involvement of each director in the valuation of the book and assessment of provisions for losses and potential losses and their disclosures; whether any director had been in breach of fiduciary duties, negligent in performing duty or in breach of duties of skill, care and diligence.

11. And in Appendix A to the term of reference, the Inspector was asked to pay particular reference to the valuation of transactions involving or affecting inventory in the Fixed Income Book of PFIL between the period of 1 April 1997 and 31 January 1998 and in particular to the marking to market of positions relating to PT Steady Safe Tbk.

12. Pursuant to section 145 of the Companies Ordinance, Farrant made enquiries of the defendants, and the defendants made written responses and submissions to him. Farrant also interviewed the defendants. I hope without doing injustice to the Report, I will summarise very briefly for the present purpose the several opinions expressed in the Farrant Report:

(1) The event which triggered the insolvency of Peregrine was the unprecedented economic downturn in Asia in 1997 and early 1998;

(2) However, Peregrine was unable to survive, or at least survive for longer than it did, in that adverse environment because of corporate structural weakness in relation to fixed income business;

(3) PFIL's business was instrumental in the collapse of the Peregrine Group;

(4) Steady Safe was the straw that ultimately broke the camel's back;

(5) Too many eggs were put in one basket in that up to August the exposure in Steady Safe and another Indonesian Company, APP/Sinar Mas, were 75% of the assets of Peregrine, and even after disposal of the APP/Sinar Mas position, the Steady Safe exposure was still 35%;

(6) Provisions for losses or potential losses were inadequate and disclosure was inadequate;

(7) Bond valuation was on mark to market basis. The appropriate basis should be marking to market, i.e. the current value or the disposal value of the bonds. The so-called "mark to market" basis adopted by PFIL was in fact the historical value of the last transacted price;

(8) By the end of October 1997, earlier optimism about the Steady Safe commitment was untenable.

13. It is noted that the opinions expressed in 2000 which I have summarised above echoed the plaintiff's complaints in paragraph 14(1) of the Statement of Claim.

14. I wish to say something about Steady Safe first because it has been mentioned as crucial. Steady Safe was an Indonesian bus and taxi company. In April 1997, PFIL was approached to assist Steady Safe to purchase 21% of the shares in another Indonesian company, CMNP. The transaction was to take two stages: (1) to provide US$150 million to repay a syndicated loan; and (2) to purchase the shares. Stage 1 must take place before stage 2 because certain restrictions in the loan covenant has to be removed. On 29 May 1997, the Steady Safe mandate was committed by PFIL. It was envisaged that there would be three tranches of debt issuance on behalf of Steady Safe totalling US$350 million, maturing in up to five years.

15. It was originally envisaged that stage 1 was to be completed by July 1997, and for stage 2, between August to December 1997. PFIL was to extend bridging finance against the pledge of CMNP shares by Steady Safe until the long term debt structure was in place. It is noted by Farrant that there was no get-out clause and it was unusual for PFIL to be committed to supply funds over several months.

16. As far as stage 1 was concerned, out of the US$150 million, PFIL managed to issue promissory notes for US$100 million and there was no problem in disposing of them in the market. However, by 31 July (i.e. the deadline for stage 1) the originally envisaged floating rates notes issue was not ready because there was nervousness in the international investment market about the condition in Indonesia, and hence the US$100 million promissory notes were rolled over with interest at US$107 million maturing on 31 October 1997. These rolled over promissory notes were fully sold by 14 August.

17. To bring about stage 2 and partly stage 1, three more bridging loans were arranged, all on short term promissory notes: the first issue, 8 August, US40 million maturing 6 November 1997; the second issue, 12 August, US$50 million maturing 30 September 1997; and the third issue, 19 August, US$65 million maturing also 30 September 1997. There was no difficulty in selling the first two issues of promissory notes, but PFIL encountered difficulty in the third issue of US$65 million. On 30 September, US$115 million worth of promissory notes from the second and third issues matured and were rolled over at US$121 million by new promissory notes maturing on 31 March 1998.

18. Between August and September, Steady Safe bought 274 million CMNP shares at US$166 million. They were pledged to PFIL but the documentation was not ready due to administrative difficulties. In the meantime, the Indonesian stock market weakened and by the end of September, the CMNP shares dropped from US$121 million to US$80 million, and by the end of October, they further dropped to US$62 million.

19. On 31 October, some of the stage 1 promissory notes matured and they were rolled over to 1 December 1997, but PFIL was unable to sell them.

20. Farrant commented that by 6 November 1997, all the bridging finance were rolled over, some twice, and PFIL's exposure was $269 million. PFIL believed the business was still fundamentally sound, notwithstanding that it has difficulty in selling some of the promissory notes.

21. I have also been referred to the opinions expressed by Farrant on the directors.

22. The 1st defendant was the chairman of Peregrine and together with Andre Lee he was the key player behind the PFIL fixed income operation. It was commented that Andre Lee fell below the standard of competence in respect of the Steady Safe transaction. It was a fundamental mistake due to its magnitude and open ended obligation with no escape and the 1st defendant was hazardous and foolhardy to agree with Andre Lee. The 1st defendant was aware of the Steady Safe transaction and he approved it. He took the lead with regular reports on the ageing and pricing of the position, but he took no steps to periodically check that all was well. He assumed that John Lee, Financial Controller of Peregrine, would take care of the provisions for losses of the position, but in fact John Lee did not do so and the provisions before 26 October were not justified. Mr Farrant said the 1st defendant fell below the standard of competence and breached the duty of care, skill and diligence.

23. The 3rd defendant was the internal auditor before 1997 and the person in charge of finance, IT and personnel, i.e. the administrative side, in 1997. It was said that he had failed to develop a Group Credit Risk Management Procedure and had little supervision on the credit risk management. His performance also fell below the standard of competence and he breached the duty of skill, care and diligence as directors of Peregrine as well as PFIL.

24. The 4th defendant was the internal auditor of Peregrine since early 1997. By October, he knew the SFC inspector had questioned the valuations of the fixed income and he took no steps in making the provisions before the Results were out, and he had not alerted the external auditors of the inadequacy of the provisions. He was also negligent.

25. The 2nd defendant was a director of Peregrine and also a non-executive director of PFIL. He was co-chief executive of Peregrine with the 1st defendant, but he was in charge of the equity side of Peregrine. He was not criticised by Farrant.

26. I now look at the summons. It has been divided into two lots of documents: (1) those called the documents relating to the inquiry in paragraphs 1(1), (2), (3), (4) and (6) of the amended summons; and (2) paragraph 1(5) are the pre-existing documents.

27. I am not going to refer to everything in the summons save that there is a definition of the scope of the discovery and inspection sought by reference to this formula: "insofar as those documents concern the financial affairs and conditions of Peregrine and PFIL between 1 April 1997 and 18 December 1997, in particular the bond and finance exposure of PFIL and Peregrine to Indonesian companies including Steady Safe, PFIL's unsold bond inventory and its valuation, and the provisions to be made therefore in the books and accounts of PFIL and Peregrine between those dates." This formula has been used throughout all the different sub-paragraphs in respect of the different types of documents sought.

28. I will first deal with the inquiry documents. There is no dispute by Mr Harris for the defendants that these documents did come into existence, as there were enquiries from Farrant and responses from the defendants. He is not claiming any public interest immunity or any privilege against self-incrimination. I have been referred to the case of HKSAR v. Lee Ming Tee & anor [2001] 4 HKCFAR 133 which held that documents obtained from inspectors in enquiries would be permitted for derivative use. Section 145(3A) of the Companies Ordinance controls the use of such enquiries documents: there is an express provision against admissibility in proceedings once self-incrimination is claimed, and by inference, it will be permitted for derivative use. But Mr Harris did say that such kind of documents which has been taken under compulsion are treated as confidential materials and there are certain considerations of necessity that the court has to follow before ordering production. I shall return to this later, because I will first deal with the point on relevance raised by Mr Harris.

29. The test for relevance is in The Compagnie Financiere et Commerciale du Pacifique v. The Peruvian Guano Company [1882] 11 QBD 55, i.e. document which may enable the party either to advance his own case or to damages that of his adversary, or a document which may fairly lead to a train of enquiry which may have either of those two consequences.

30. Mr Harris, in addressing me on relevance, made certain observations. He said the claim was against the defendants as directors of Peregrine, not as directors of PFIL. It is not a claim for breach of fiduciary duty arising from the poor management of Peregrine. It is not a claim that the Announcement should have been made but was not made. But the case is that the defendants, having decided to issue the Announcement in October and the Results, Letter and Circular in December, were under a duty to ensure that those documents were accurate. And it is alleged that they were not accurate and the defendants knew or ought to have known that they were not accurate. This is the cause of action. And with this cause of action, the issues in question between the parties are: (1) what was the financial situation of Peregrine on 26 October 1997 and until mid-December 1997; (2) whether what was said in the Announcement and the other three documents were inaccurate; and (3) did the defendants know that they were inaccurate, and if not, should they have known? It is submitted that it is not relevant as to why Peregrine was in the financial condition it was in from October to December. Sweeping submissions by reference to the Farrant Report by Mr Kat for the plaintiff as to the Steady Safe mandate was not relevant at all because it only had to do with why Peregrine's financial condition got to what it was in October 1997. Mr Harris said the issue was the state, not the cause. Mr Harris referred me to Molnlycke AB v. Procter & Gamble Ltd & anor (No. 3) [1990] RPC 498, per Mummery J, at p.505, lines 40 to 45:

"I reject the defendants' application for specific discovery of documents on the issue of commercial success for three reasons. First, the discovery sought, even in the form modified at the hearing, is far too wide. It embraces numerous documents which, though they may relate in a general way to the subject matter of the action, that is the plaintiffs' 'Superfit Band' disposable nappies, they do not relate to the matters in question between the parties in this action."

His point was that relevance is not to be judged generally by the subject matter alone, it is judged as to the question in issue between the parties.

31. I find that Mr Harris's submission on relevance is too narrow. When one looks at the financial position of Peregrine, one has to look at its financial position as a whole, taking into account the impact of the bond finance exposure, especially those in Indonesia as well as Steady Safe as that was prima facie the cause which led to the serious financial troubles of Peregrine. The terms of reference of the inquiry is in fact directly in issue as has been pleaded in paragraph 14(1) of the Statement of Claim. Looking at paragraph 14(1) in its entirety, I must say it is highly relevant to look into all the matters I have just mentioned.

32. I will now deal with this confidential point before I deal with the point on the period of disclosure, and also the description or specification of the documents under the terms of the order or summons.

33. In British and Commonwealth Holdings plc (in administration) v. Barclays de Zoete Wedd Ltd and others [1999] 1 ECLC 86, Neuberger J had to deal with a situation similar to what is before me, i.e. documents arising from Department of Trade inspectors' inquiry under section 432 of the Companies Act 1985, which is in pari materia with our section 145, and at p.95i:

"Even though not the subject of PII, the transcripts of which disclosure is sought by Rothschilds, contain material which was obtained by witnesses in circumstances which were confidential, and pursuant to compulsion: in light of the provisions of ss 433 to 436 of the Companies Act 1985 any person who is lawfully required by inspectors to assist them by providing documents or other evidence to them must do so, and failure to comply with such an obligation amounts to contempt of court.

In those circumstances, one can see a powerful argument for saying that the court should not, save in exceptional circumstances, order disclosure of the transcripts in connection with civil proceedings, even where the requirements of various provisions in Ord 24 to which I have referred have been satisfied."

34. Mr Harris submitted that the test to follow is in Wallace Smith Trust Co. Ltd (in liq) v. Deloitte Haskins & Sells (a firm) and anor [1996] 4 All ER 403, per Simon Brown LJ, at p.418b:

"(5) Disclosure will be necessary if: (a) it will give 'litigious advantage' to the party seeking inspection; (b) the information sought is not otherwise available to the party by, for example, admissions, or some other form of proceeding (e.g. interrogatories) or from some other source; and (c) such order for disclosure would not be oppressive, perhaps because of the sheer volume of the documents."

And further at p.419d to f:

"... As stated, once it is recognised that inspection of the documents may give 'litigious advantage' to the party seeking it, then, assuming, as is here plain, that the information they contain is not otherwise going to be available to that party, and that disclosure would not be oppressive, the threshold test for inspection is made out and the court can only properly refuse disclosure if, having itself first inspected the documents, it concludes that they will not after all assist him. Confidentiality at this point is frankly immaterial (save as to possible partial blanking out or limiting inspection to legal advisers), unless only 'the probative value of [the] documents [is]... clearly... so slight as to render unjustifiable an order for their inspection'. (see Nasse [1979] 3 All ER 673 at 688, [1980] AC 1028 at 1076 per Lord Edmund-Davies). 'Probative value' in this context, having regard to the Peruvian Guano principle, must refer to the documents' overall use in the proceedings. Nothing short of such a finding one which in effect destroys the contended for 'litigious advantage' would justify a refusal to order inspection."

35. As to the point (a), i.e. litigious advantage, it has been conceded by Mr Harris in this case it is wide enough to cover the inquiry documents, and there is also no issue as to (c), i.e. oppression. The complaint is (b), i.e. the information sought is not otherwise available to the party. Mr Harris submitted that the information sought would otherwise be available.

36. I put to Mr Harris that the inquiry documents would not be available from anywhere without breach of confidence, so wherever it was obtained from would entail the same consideration. Mr Harris submitted that was not the point because the information sought could be available by first obtaining the source documents from the liquidators, and then to administer interrogatories and/or notice to admit facts on the defendants. And after that, if it were still thought that further litigious advantage could be obtained from the inquiry papers, there could then be an application.

37. I do not agree. The enquiry documents are highly relevant, and it is admitted to be of litigious advantage, then prima facie, it should be available on production unless I form the view that they are of little probative value, which at this stage I cannot see they are. The otherwise not available point would be a wholly unnecessary roundabout, which is not necessary for the fair disposal of the case, nor is it for saving costs.

38. Hence, I find that it is necessary to have the inquiry documents before the court, which are highly relevant for the determination of the issues in question, not to mention the point of contemporaneity in that inquiry was much closer to October 1997 and they would be helpful in the sense that now we are much further away from that date.

39. Another point Mr Harris made was that the period of 1 April to 18 December 1997 was too long. Mr Harris said even if I found that the inquiry documents should be disclosed and produced, I should cut it down to begin on 3 September, which was the date on which Peregrine's first interim half yearly report ending 30 June 1997 was published. And as there was an obligation in the interim report to take into account known contingencies up to the date of publication as there was no such disclosure in the report, and there was no criticism by Farrant of such non-disclosure, prima facie, those interim statements would be good as at 30 June and tying over to 3 September, 1997.

40. Mr Harris referred to the Steady Safe case. Up to late August PFIL was able to dispose of virtually all the promissory notes without difficulty, and Farrant only said that the Steady Safe commitment was only untenable by October 1997.

41. Mr Harris submitted that Farrant said that in the beginning it was reasonable to assume that the Steady Safe commitment was viable and Farrant must have been referring to August in respect of the ability to dispose of the promissory notes. Mr Harris submitted that any date would involve some arbitrariness and he commended to me the course their Lordships took in the case of Commerzebank Aktiengesellschaft v. Peregrine Fixed Income Ltd (In Liquidation), CACV 875/01, i.e. to take a rough and ready approach, and five to six weeks would be sufficient for the purpose.

42. On the other hand Mr Kat gave reasons as to why it should be 1 April: (1) it was the period of investigation by Farrant and the terms of the Farrant investigation and the results actually corresponded to paragraph 14(1) of the Statement of Claim; (2) the first interim half year report was only drawn up to 30 June 1997; (3) the Steady Safe/CMNP deal was hatched in April and was committed on 29 May 1997.

43. As to the selling of all the promissory notes in late August, Mr Kat submitted that it was misleading to take it at face value in that stage 1 of the Steady Safe commitment was delayed because it was difficult to get the floating rate notes ready by 31 July due to nervousness in the international investment market about the Indonesian economy, and by late August, there were further warning bells in that there were difficulties in selling the other promissory notes. By 19 August, the promissory notes were worth $262 million and PFIL was committed to roll them over without any final debt structure in place. The potential exposure was 262 million and, the collateral has dropped substantially.

44. I agree with the reasons submitted by Mr Kat and that the date should be 1 April in that it was the relevant period in determining the demise of Peregrine by reason of the opinion of Farrant that Steady Safe and in turn PFIL was the cause of the demise of Peregrine.

45. The third point is about the width of the order. Mr Harris submitted that the formula "insofar as those documents concern the financial affairs and conditions of Peregrine and PFIL" was too wide and too general, and in specific discovery it must be specific and not general so that the parties under obligation would not be prejudiced by swearing to a false affidavit.

46. Mr Harris has made the point about the state of affairs as at the date of the Announcement and I have already rejected that point. Mr Harris made the further point that if one were looking at the financial affairs and conditions of Peregrine, one would necessarily bring in irrelevant matters such as the business of the equities division which was no subject of criticism in the Farrant Report. If irrelevant matters were brought into being by the scope of the summons, then, in the absence of any reduced formula by Mr Kat, I should dismiss it right away. The Molnlycke case was referred to in support of this point of sheer generality.

47. I look at the formula: it is not merely the financial affairs and conditions of Peregrine and PEIL, but it has been successively defined and specified: (1) by virtue of the period, 1 April to 18 December, which I have held to be a valid and reasonable period; (2) it was focused in particular to the bond and finance exposure. The particulars have actually drawn our attention to the financial affairs and conditions of Peregrine and PEIL as a whole, taking into account of the impact of the bond and financial exposure which was said to be the cause of the demise in the Farrant Report. Bearing in mind that the defendants have undergone the inquiry and they have been provided with the Report, I am satisfied that this description is sufficiently specified and defined, and is not too wide.

48. Mr Harris also made the point in relation to Mr Francis Leung, the 2nd defendant, in that he was not criticised to be negligent or in breach of duty by the Farrant Report. He was in charge of the equities division, and it is not fair to subject him to the order of discovery.

49. The issue is the financial affairs and conditions of Peregrine, and the 2nd defendant is a director of Peregrine. He was party to the board meeting on 26 October and he was party to the issuance of the Announcement. As such, I think it is right that he should be subject to the order when one is enquiring into the accuracy or otherwise of the contents of the Announcement on 26 October.

50. As to the pre-existing documents: (1) they are qualified by the same formula of paragraph 1(1); and (2) they are also qualified by the fact that they are documents retained by the directors themselves or obtained from the liquidators, which is admittedly not too voluminous. Having relevance defined, and having the scope of order defined, I do not find it too wide an order to make by adopting the paragraph 1(1) formulation.

51. Hence, I will dismiss the appeal against the Master and affirm the order made by her.

[Plaintiff asks for costs]

52. Costs here and below be to the plaintiff.