SHUM WING PING v. WING TAK COMPUTER EMBROIDERY DEVELOPMENT COMPANY LTD AND ANOTHER

HCMP 1438/2014

IN THE HIGH COURT OF THE

HONG KONG SPECIAL ADMINISTRATIVE REGION

COURT OF FIRST INSTANCE

MISCELLANEOUS PROCEEDINGS NO 1438 OF 2014

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D E C I S I O N

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1. The company was established in Hong Kong on 26 February 1997.  The company acquired the business of Wing Tak Computer Embroidery Development Company which, as the name suggests, was engaged in the business of computer-directed embroidery manufacture.  The actual manufacturing process was carried out in the Mainland.  The company had its registered office and premises, which it owns, in Hong Kong. 

2. It is not necessary to go into the precise nature of the company’s business operations in any detail.  In summary, the position is this. 

3. Mr Chan ran the company in Hong Kong, and his responsibility focused on marketing and obtaining orders.  The orders that the company was able to obtain were then passed to a factory in the Mainland, which was ultimately beneficially owned by Mr Shum and Mr Chan which carried out manufacturing.

4. The manufacturing costs were, as one would expect, financed by transfers of money from the company through transfer agents into the Mainland. 

5. Towards the end of 2012, Mr Shum began to discuss with Mr Chan his retirement plans.  The upshot of these discussions was that it was agreed that the company should be dissolved and the assets of the factory, which owned the production machinery, be distributed between the two shareholders in order that they or their children had the opportunity to use them for new business ventures.

6. Mr Shum says that since early 2013 he began for the first time to look into the accounting records of the company.  He became concerned about a number of items which caused him to instruct a firm of forensic accountants, Kennic Lui & Co. CPA, to examine the company’s books and ledgers in more detail. 

7. They identified an extensive series of transactions which seemed questionable and indicated that Mr Chan had made transfers of the company’s funds to himself or entities controlled by him in circumstances which did not appear to be justified by the company’s accounts records.

8. It is a claim in respect of those items that Mr Shum seeks leave to pursue on behalf of the company against Mr Chan and ESP Enterprise Company Limited. 

9. As is normal, Mr Shum’s lawyers prepared a draft Statement of Claim setting out the claims that Mr Shum wishes on behalf of the company to be able to pursue.

10. In recent years, a number of authorities in Hong Kong have considered the correct approach by the court to applications for leave to commence a statutory derivative action. They relate to the predecessor statutory provision of section 733(3), namely section 168A of the Companies Ordinance, Cap 32.

11. Section 733(1) contains the statutory criteria which the court must be satisfied before granting leave:

“(1) On application by a member of a company or of an associated company of a company, the Court may grant leave for the purposes of section 732(1), (2) or (3) if it is satisfied that -

(a) on the face of the application it appears to be in the company’s interests that leave be granted to the member;

(b) in the case of -

(i) an application for leave to bring proceedings under section 732(1) or (2), there is a serious question to be tried and the company has not itself brought the proceedings; or

(ii) an application for leave to intervene in proceedings under section 732(3), the company has not diligently continued, discontinued or defended the proceedings; and

(c) except where leave is granted by the Court under subsection (5), the member has served a written notice on the company in accordance with subsection (3), and the notice complies with subsection (4).”

12. The principal matters that the court is therefore concerned to determine on applications of this sort are:  first, whether the proposed action is prima facie in the interests of the company; and, secondly, whether there is a serious question to be tried. 

13. As I explain in my judgment in Re Li Chung Shing Tong (Holdings) Ltd [2011] 5 HKLRD 274, the threshold in respect of both these criterion is low.  Normally the first to be considered, is whether or not there is a serious question to be tried.  If this criteria is satisfied then commonly the other will be. 

14. In Re Li Chung Shing Tong, I say this in paragraphs 32 to 34:

“32. Like the first requirement, the “serious question to be tried” criterion is “likewise of a relatively low threshold”. Re Grand Field Group Holdings Ltd, para 21. In Re F & S Express, supra, Kwan J, citing Palmer J in the Swansson RA Pratt Properties case, para 25, put the test in this way:

“21. To ascertain if there is a serious question to be tried, the court ‘will not normally enter into the merits of the proposed derivative action to any great degree’, and the Plaintiff has ‘the same relatively low threshold to surmount as in the case of an application for an interlocutory injunction’”.

33. In other words, in ascertaining whether or not there is a ‘serious question to be tried’ the prospects of the Plaintiff’s success are to be investigated only to a limited extent, and the court should be slow to find against the Plaintiff unless his prospects are so slim that he cannot be said to have any expectation of success. I am reminded, in this regard, of Megarry VC’s oft-cited explanation in Mothercare Limited v Robson Books Limited [1979] FSR 466, in which he said, at 474:

“...the prospects of the plaintiff’s success are to be investigated to a limited extent, but they are not to be weighed against his prospects of failure.  All that has to be seen is whether the plaintiff has prospects of success which, in substance and reality, exist.  Odds against success no longer defeat the plaintiff, unless they are so long that the plaintiff can have no expectation of success, but only a hope.  If his prospects of success are so small that they lack substance and reality, then the plaintiff fails; for he can point to no question to be tried which can be called ‘serious’, and no prospect of success which can be called ‘real’”

34. I agree with this approach, and accordingly adopt it.

15. In practice, what this means is that if an applicant is able to produce a draft Statement of Claim which sets out a prima facie case, the first criteria will be satisfied unless the respondent is able to demonstrate fairly readily that there is a serious flaw in the claim and that it has no real substance.

16. In the present case, 154 pages of affirmations have been filed setting out, as that number would suggest, a significantamount of evidence concerning the transactions which form the subject of the prospective action.

17. It should be said in fairness to both parties that as a result of the evidence that Mr Chan has filed, fairly significant amendments were made to the original draft Statement of Claim reducing the number of transactions which Mr Shum impugns.  However, this particular case has developed in a way which has not, in my view, given as much weight to the observations in the authorities which I have referred to in my decision in the Li Chung Shing Tong, as well as my own, and that it has become factually more complicated, at least so far as the evidence is concerned, than was necessary.

18. It seems to me to be fairly clear that Mr Shum has demonstrated that there is a serious question to be tried, and that on the face of the matter it would appear to be in the interests of the company that the claims are pursued.  That is not, of course, to suggest that any action will be successful simply that the statutory criteria are satisfied and Mr Shum should have the opportunity to progress the proceedings on behalf of the company.

19. Much of the objection to the application by Mr Chan has focused on peripheral matters.  First it has been said that the parties have agreed to put the company into liquidation and that it would be more sensible if a liquidator was left to examine the books and records of the company and decide whether there are any claims which should properly be pursued on its behalf.

20. It has also been suggested that Mr Chan has not had the opportunity to examine the financial records of the factory and to determine whether the very considerable sums of money that were transferred to Mr Shum by the company, on the face of it to finance the factory’s operations, had been properly used.  In other words, what Mr Chan seems to be suggesting is that whatever criticisms it might be possible to make of his conduct of the financial affairs of the company, much the same kind of criticisms can probably be made in respect of the way Mr Shum has dealt with the finances of the factory.

21. So far as the former matter is concerned, the parties have not agreed to put the company into voluntary liquidation.  A petition was issued in October by Mr Chan seeking a compulsory winding up on the just and equitable ground, but that has not yet come on before me, and Miss Zabrina Lau, who appeared for Mr Shum, explained that Mr Shum intended to oppose the petition on the grounds that this could not possibly be a proper case to put the company into compulsory liquidation, the reasons being that it is solvent and it could be wound up most cost effectively and efficiently by members voluntarily winding up once its remaining assets, it no longer continues its business, consisting of office premises and cross-border driving licences, have been realised. 

22. So far as the second issue is concerned, there is at present no evidence before me to suggest that Mr Chan has got similar claims which he can properly seek to pursue on behalf of the company against Mr Shum, although I understand that he is considering, when he has had the opportunity to thoroughly inspect the books and records of the factory, applying for leave to commence a similar statutory derivative action against Mr Shum.  Be that as it may, that has not happened yet and it does not seem to me that the prospect of it happening is any reason to deflect me from making the order that is sought.

23. In conclusion, it seems to me that despite the submissions of Miss Lorinda Lau on behalf of the Mr Chan, this is in fact quite a straightforward case and I will grant the leave sought by Mr Shum.  I will adjourn the paragraph of the originating summons seeking an order that the costs of the derivative action are indemnified out of the assets of the company.  That I will adjourn sine die in order that at an appropriate time Mr Shum can make an application, that will be when he has had an opportunity to have had prepared an assessment of the likely costs of the proceedings, and also an explanation of how it would be financed out of the available assets of the company. 

24. So far as the costs of this application are concerned, it seems to me that they should follow the event.