ANTHONY ERIC RYAN HOTUNG v. HO YUEN KI AND OTHERS

HCA1216/2006

IN THE HIGH COURT OF THE

HONG KONG SPECIAL ADMINISTRATIVE REGION

COURT OF FIRST INSTANCE

ACTION NO. 1216 OF 2006

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DECISION

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1.  By summons filed on 8 September 2009 as amended at the hearing, the 1^st defendant applies to strike out the writ and the Statement of Claim and to dismiss the action against her, relying on all the grounds under Order 18, rule 19(1) of Rules of the High Court, Cap.4A and the inherent jurisdiction of the court.

The plaintiff’s case

2.  The plaintiff’s pleaded case can be briefly stated.  For the purpose of this striking out application, it is assumed that the plaintiff is able to make out his case at the trial. 

3.  Pursuant to a Declaration of Trust dated 29 November 1979, and as a result of the Judgment in HCA 571/2003, the 1^st defendant held as trustee 10,001 shares in Hotung Enterprises Ltd (“HEL”) upon trust for the plaintiff and two of his brothers.  Of the remaining 10,003 shares, one share is held on behalf of the 2^nd defendant and the other 10,002 shares were held on trust for the plaintiff’s sisters.

4.  Pursuant to another Declaration of Trust dated 1980, the 1^st defendant held as trustee three shares in Hotung Investment (China) Ltd (“HICL”) upon trust for the plaintiff and two of his brothers (“HICL Trust”).  Another three shares in HICL were held on trust for the plaintiff’s sisters.  The remaining 90 shares were held by HEL.

5.  The 2^nd defendant is the plaintiff’s father.  He is the settler of the two trusts.  He was at all material times a director of HEL and HICL.  He was and is a director of the 3^rd defendant and has a controlling beneficially interest in it.

6.  In July 1991, HICL acquired certain land plots in Kam Tsin, New Territories (“the Land”) at the price of $7,440,000.  In December 1998, HICL sold the Land to the 3^rd defendant at the price of $17,500,000, giving a unit price of $143 per square foot.  At the same time, the 2^nd defendant also sold to the 3^rd defendant several land plots registered in his personal name that are adjacent to the Land (“the Adjacent Land”).  In April 2000, the Land together with the Adjacent Land were sold by the 3^rd defendant at $204,307,510, giving a unit price of $550 per square foot.

7.  In a nutshell, the plaintiff says that there were irregularities in these sales transactions, including that the sale of the Land to the 3^rd defendant should have included a premium to reflect the enhancement in value when amalgamated with the Adjacent Land. The plaintiff also says there were irregularities in the finance and management of HICL in the form of advances made to the 2^nd and 3^rd defendants and companies owned or controlled by the 2^nd defendant.  It is said that these irregularities had potentially and adversely impacted on the value of the shares 

8.  The plaintiff pleads that the 1^st defendant was or reasonably should have been put on notice about these irregularities in the management.  It is further pleaded that the 1^st defendant failed to satisfy her duties as trustee in that she fails to act personally, to exercise diligence and care and to safeguard the value of the shares in HICL and HEL, thereby resulting in a diminution in the value of the shares.

9.  As against the 1^st defendant, the Statement of Claim seeks a declaration that she has breached her duties as trustee, an order for her removal from office and also damages for beach of trust.  The proposed Amended Statement of Claim put in at the hearing has deleted the relief for removal of the 1^st defendant from office.

10.  The 1^st defendant had filed a Defence, which was subsequently amended.  The 2^nd and 3^rd defendants have not filed any defence.  By an order dated 17 March 2009, the plaintiff had discontinued the action as against the 2^nd and 3^rd defendants.  It is said that this is without prejudice to the plaintiff’s right to reinstate the claims after April 2010.

Grounds for striking out

11.  The 1^st defendant’s application to strike out is based on two grounds.  The first is that the claim for damages is barred by the reflective loss principle.  The second is that any cause of action against the 1^st defendant in respect of losses caused by diminution in value of the shares has become time barred.

The contempt proceedings

12.  Before dealing with the 1^st defendant’s grounds for striking out, I shall deal with a preliminary objection of the plaintiff to the application. 

13.  In HCMP 2701/2005, which was brought by the plaintiff, the 1^st defendant was ordered to supply to the plaintiff ten categories of documents and information concerning HEL and HICL.  Upon the 1^st defendant’s appeal in CACV 178/2006, the Court of Appeal upheld part of the order with the result that the 1^st defendant is ordered to supply five categories of documents and information to the plaintiff: see Hotung v. Ho Yuen Ki [2007] 4 HKLRD 384.  The plaintiff says that the 1^st defendant has failed to comply with the order made in HCMP 2701/2005 as varied by CACV178/2006.  With leave granted by the Court of Appeal on 25 September 2009, the plaintiff has commenced HCMP 1956/2009 seeking an order that the 1^st defendant may be committed to prison for contempt of the order.  A direction hearing is scheduled for 10 February 2010.   The plaintiff contends that the court should not hear the 1^st defendant when she is in contempt.  Alternatively, it is said that the 1^st defendant’s application should be deferred until after the Court of Appeal has heard and disposed of the contempt proceedings.

14.    It is within the discretion of the court whether to hear a party in contempt.  In Hadkinson v. Hadkinson [1952] 1 All ER 567, at 574-575, Denning LJ observed:

“…  It is a strong thing for a court to refuse to hear a party to a cause and it is only to be justified by grave considerations of public policy.  It is a step which a court will only take when the contempt itself impedes the course of justice and there is no other effective means of securing his compliance.  … ”

“Applying this principle, I am of the opinion that the fact that a party to a cause has disobeyed an order of the court is not of itself a bar to his being heard, but if his disobedience is such that, so long as it continues, it impedes the course of justice in the cause, by making it more difficult for the court to ascertain the truth or to enforce the orders which it may make, then the court may in its discretion refuse to hear him until the impediment is removed or good reason is shown why it should not be removed.”

This passage was referred to and applied by the Court of Appeal in Hotung v. Ho Yuen Ki, op cit, at 397 para.32.

15.  I note that while the Court of Appeal had granted leave for the commencement of committal proceedings, there is at present no finding that the 1^st defendant is guilty of contempt for non-compliance of the order made in HCMP 2701/2005 as varied in CACV 178/2006.  Assuming that the 1^st defendant has indeed failed to comply with the court order, I am not satisfied that the plaintiff has shown that the disobedience has impeded the course of justice in the present case and/or that there is no other effective means of securing the 1^st defendant’s compliance with the order in question.  I do not consider that I ought to refuse to hear the 1^st defendant on her striking out application.

The reflective loss principle

16.  In company law, the rule against recovery of reflective loss debars a shareholder from suing to recover a loss which is merely a reflection of the loss suffered by the company of which he is a shareholder: Johnson v. Gore Wood & Co (No 1) [2002] 2 AC 1; Landune International Ltd v. Cheung Chung Leung [2006] 1 HKLRD 39.

17.  In Hotung v. Hillhead Ltd [2008] 3 HKLRD 200, which concerns two other trusts over the shares in HEL and HICL, the assignee of the beneficiary interests under the trusts claimed against the trustee for compensation for diminution in market value of the shares held on trust.   Reyes J struck out the plaintiff’s claim, holding that the reflective loss principle applied.  It was pointed out that the assignee/ beneficiary’s loss was not separate and distinct from that suffered by HEL and HICL and that the loss could be made good if the companies took action against the alleged wrongdoers: see para.26.

18.  The 1^st defendant argues that insofar as the plaintiffs’ claim is based on diminution in value of the shares in HEL and HICL, it is caught by the reflective loss rule in that the companies could recover the loss from the 2^nd defendant and such recovery would redress the diminution in share value.

19.  In his affirmation opposing the application, the plaintiff said that because his brother, Sean Hotung, is now in charge of the companies and as the latter had reached a settlement with all the defendants in all matters relating to HEL and HICL, the companies would not pursue any claim for loss against the defendants in respect of the wrongdoings complained herein.

20.  However, the rule will apply where a company can recover the original loss from a wrongdoer and such recovery would redress the diminution in value of the shares.  The exception arises where the company though suffers but has no cause of action to sue to recover that loss: see Johnson v. Gore Wood & Co, op cit, at p.35E and Hotung v. Hillhead Ltd, op cit, at p.208 paras. 28 to 34.   Here, the plaintiff is not saying that HEL and/or HICL do not have a cause of action or are unable to bring a claim to recover the loss.  As Mr Yin argued, if indeed the companies have legitimate claims against the wrongdoers, Sean Hotung would be in breach of his duties as a director if he were to prevent the companies from pursuing the claims because of the settlement he had reached with the 2^nd defendant and others.  In such a case, the plaintiff might be able to have recourse by means of derivative action.  But this will not afford a justification for the plaintiff to bring a claim in his own right to recover the diminution in value of the shares in HEL and HICL.

21.  The main argument advanced by Mr Alder on this ground is that the reflective loss principle does not apply where a beneficiary is seeking relief against a trustee in the form of reconstitution of the trust assets, relying on the case of Freeman & Ors v. Ansbacher Trustees (Jersey) Limited [2009] JLR 1.  In this connection, the plaintiff seeks leave to amend the Statement of Claim to add, as an alternative to the claim for damages, the following relief against the 1^st defendant: (i) an order for replacement of such sums as are necessary to restore the value of the trust estate to its value prior to the events/ wrongdoings complained of; and (ii) an order that an account be taken of what is due to the trust estate and payment of all monies found due on taking the account.

22.  In Freeman v. Ansbacher, the plaintiffs were the beneficiaries of a discretionary trust and the defendant was the former trustee.  Part of the initial trust fund was used to subscribe for the entire share capital of a company.  At all material times, the shares were the sole significant asset of the trust; all the underlying assets were owned by the company or its subsidiaries.  The day-to-day administration of the trust was carried out by the defendant’s employee, who was also a director of the company.  Other employees of the defendant also served as co-directors of the company. The plaintiffs brought the action against the defendant, alleging various breaches of trust and mismanagement of the company’s affairs resulting in a diminution of the value of the trust fund.  The defendant applied to strike out the claim on a number of grounds.  The 1^st and 2^nd plaintiffs conceded that their claim was time-barred.  As against the remaining plaintiff, one of the grounds relied on for the striking out was that the losses claimed were merely reflective of losses sustained by the company so that the claim was barred by the rule against reflective loss.  The Royal Court of Jersey refused to strike out, holding that it was strongly arguable that the reflective loss principle did not apply. 

23.  In coming to this conclusion, the Court first considered the rationales and policy reasons underlying the reflective loss rule: The first is that if a shareholder is allowed to claim for such loss, there is a risk of double recovery from the defendant.  The second is that such a claim may prejudice the creditors and other shareholders of the company in that the recovered money will be paid directly to the claimant and will not be returned to the company’s coffers.   The Court noted that the plaintiff in that case was a beneficiary of a discretionary trust with no entitlement to the trust fund and she was merely seeking reconstitution of the trust fund.  The Court considered it could arguably order the trustee to reconstitute the trust fund either by reimbursing the company or by reimbursing the trust fund itself with a direction that the funds be used to acquire new shares in the company.  Either course was considered to have the effect of restoring the value of the shares and the financial position of the company back to what they had been.  Hence, the Court concluded that if either of the courses were followed, the reasons for the reflective loss rule would not apply.  First, with the company being reimbursed, it no longer suffered any loss and could no longer bring any claim, thus no risk of double recovery. Second, with the moneys being replaced in the company, there would be no prejudice to the creditors as they would be in the same position as before: see pp.37-38.

24.  The fact that the company in question is wholly owned by the trust, which is a discretionary trust, is an important aspect underlying the reasoning in Freeman v. Ansbacher.  The Jersey Court had pointed out that: “Such remedies may not be available in all cases but it seems … strongly arguable that they are available where the company in question is wholly owned by a discretionary trust”: para. 97(iv) at p.38; see also the discussions at para. 97(x) at p. 40 and para. 97(xiv) at p.42. 

25.  Unlike Freeman v. Ansbacher, the trusts in the present case do not own all the shares in HEL and HICL.  The shares held on trust by the 1^st defendant do not even amount to a majority shareholding.  Further, the 1^st defendant was merely given specific property to hold on trust and she was not given power to invest or manage the trust property.  Another distinguishing feature in Freeman v. Ansbacher is that the company was managed by the trustee’s employees and they, in their capacity as directors, were responsible for the wrongdoings that caused the losses.  Here, the plaintiff’s complaint of wrongdoings is primarily directed against the 2^nd defendant.  His complaint against the 1^st defendant is in essence a failure to act and to safeguard the trust against the wrongdoings of the 2^nd defendant.  

26.  The alternative relief that the plaintiff seeks against the 1^st defendant by way of amendment to the Statement of Claim is an order for replacement of moneys to restore the value of the trust estate.  Mr Alder submits that it will have the same effect as the claim for reconstitution of the trust fund in Freeman v. Ansbacher and will not infringe the reasons underlying the rule against recovery of reflective loss.  

27.  Plainly, the loss that the plaintiff claims to have suffered, namely, a diminution of the value of the shares held on trust for him, is reflective of the loss suffered by HEL and HICL.  An order for replacement of moneys to restore the value of the trust estate is compensatory in nature and is no different from the order for damages for breach of trust initially claimed in the Statement of claim.  Unlike in Freeman v. Ansbacher, the trusts here do not own all the shares in HEL and HICL.  It is not possible to think of a remedy that will result in everyone being restored to the same position as that before the occurrence of the alleged wrongdoings.  Mr Alder has not come up with any suggestion in this regard. 

28.  Further, as the trusts do not own all the shares in the two companies and because the primary complaint of wrongdoings that caused the diminution of value is not made against the trustee, it will not be that once a replacement of moneys is made by the 1^st defendant (no matter in what way), HEL and HICL will not or cannot have a second claim against the 2^nd defendant.  In addition, with the trusts not having a majority shareholding in the companies, the 1^st defendant will not be in a position to influence the companies into waiving claims against the 2^nd defendant: see Lewin on Trusts (18^th edition, 2008) para.39-41.  That aside, the other shareholders in HEL and HICL cannot be prejudiced by being prevented from claiming on the wrongdoings that cause a diminution of the value of the shares of the companies. 

29.  Thus analysed, the very reasons underlying the reflective loss rule apply with full force to the present case, even with the proposed amendment to the relief claimed.

Limitation

30.  I turn next to the 1^st defendant’s second ground for the application out.  The 1^st defendant’s argument is that the plaintiff’s claim for damages for breach of trust is effectively the equitable counterpart of a common law claim in negligence.  As such, the cause of action falls to be governed by section 4(1) of the Limitation Ordinance, cap. 347.  Since the alleged wrongdoings, which are the sales transactions of the Land and the Adjacent Land, took place more than six years before the commencement of the present action, the claim has become time-barred. 

31.  In support of the argument, Mr Yin refers to an article written by Lord Millett, Equity’s Place in the Law Commerce, (1998) 114 LQR 214.  In the article (at p.225-226), Lord Millett pointed out that a claim for breach of trust is not compensatory, but should be restitutory in nature, and that it is wrong to assume a trustee is under a primary obligation to perform the trust with a secondary obligation to pay equitable compensation if he does not.  Instead, the primary obligation of a trustee is to account for his stewardship and the primary remedy of a beneficiary is to have the account taken, to surcharge and falsify the account, and to require the trustee to restore to the trust estate any deficiency that appears when the account is taken.  Specifically, Lord Millett said that:

“If the beneficiary is dissatisfied with the way in which the trustee has carried out his trust – if, for example, he considers that the trustee has negligently failed to obtain all that he should have done for the benefit of the trust estate, then he may surcharge the account.  He does this by requiring the account to be taken on the footing of wilful default.  In this context “wilful default” bears a special and unusual meaning; it means merely lack of ordinary prudence or due diligence. 47 The trustee is made to account, not only for what he has in fact received, but also for what he might with due diligence have received.  Since the trustee is, in effect, charged with negligence, and the amount by which the account is surcharged is measured by the loss occasioned by his want of skill and care, the analogy with common law damages for negligence is almost exact.48  Although he is a fiduciary, his duty of care is not a fiduciary duty.49  In this context it must be right to adopt the common rules of causation and remoteness of damage to their fullest extent.  The trustee’s liability is enforced in the course of taking the trust account rather than by an action for damages, but the obligation of skill and care is identical to the common law duty of care.”  

32.  Mr Alder does not disagree with what was said in the article.  He, however, says that the nature of the trustee’s duties is a matter for trial.  He referred to the Court of Appeal’s Judgment in Hotung v. Ho Yuen Ki at p.401 where it was pointed out that the 1^st defendant could not simply sit back and refrain from making any enquiries. This, however, is beside the point because for the purpose of this striking out application, the 1^st defendant has to proceed on the basis that the plaintiff will be able to make good his allegations and complaints against the defendants, and Mr Yin’s arguments have proceeded on this basis.

33.  Mr Alder also argues that the problem with limitation is resolved by the proposed amendment seeking a relief for taking of account.  It is also said that the 1^st defendant has a continuous duty to take action in respect of the transactions. 

34.  It is correct that the relief of taking of account per se will not be caught by section 4(1) of the Limitation Ordinance.  The plaintiff’s claim, as appeared by the proposed Amended Statement of Claim, is not a mere claim to have the account taken.  As noted in Lord Millett’s article, the liability to account is strict.  If the plaintiff’s claim is merely to have the account taken, the allegations of breach of duties or breach of trust will not be necessary.  It will appear that the plaintiff is seeking also to surcharge the account, viz. to have the account taken on the footing of what the 1^st defendant might have received had she exercised care and due diligence.  This, however, is impermissible by reason of the reflective loss principle. 

Conclusion

35.    For the reasons indicated above, the Statement of Claim is liable to be struck out.  I do not consider the proposed amendments are capable of redressing the problems in the claim.  The application to amend is therefore refused.  I am further not convinced that the plaintiff has demonstrated that his claim against the 1^st defendant is capable of being salvaged. It should be dismissed as well. 

36.  Accordingly, I make an order striking out the Statement of Claim and dismissing the claim against the 1^st defendant. 

37.  Applying the normal rule of costs follow event, there is an order nisi that the plaintiff pays the 1^st defendant’s costs of this action, including the costs of this application, to be taxed if not agreed.

47   See, e.g. Re Chapman [1896] 2 Ch 763.

48   See Henderson v. Merrett Syndicates Ltd [1995] 2 A.C. 145 at p.205 per Lord Brown-Wilkinson.

49   See Permanent Building Society v. Wheeler (1994) 14 A.C.S.R. 109 at 00.157-158 per Ipp J approved in Bristol & West B.S. v. Mothew [1997] 2 W.L.R. 436 at pp.448-449.