MOULIN GLOBAL EYECARE HOLDINGS LTD AND OTHERS v. KPMG (a firm)

HCA 118/2007

IN THE HIGH COURT OF THE

HONG KONG SPECIAL ADMINISTRATIVE REGION

COURT OF FIRST INSTANCE

ACTION NO. 118 OF 2007

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BETWEEN

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J U D G M E N T

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Introduction

1.  By these proceedings, the Plaintiffs, all of whom are companies forming part of the now defunct Moulin Group of companies, seek damages from their former auditors, Messrs KPMG, in respect of losses said to have been caused by alleged negligence on the part of KPMG (“the Defendants”) in their audit of the Plaintiffs’ accounts for the financial years ending on 31 March 1999, 2000 and 2001 respectively.

2.  The applications before me relate to requests by the Defendants for particulars of the Statement of Claim (which has now been amended – references below will be to the Amended Statement of Claim), and for discovery.

3.  The Plaintiffs are:-

(1)  Moulin Global Eyecare Holdings Limited (formerly named Moulin International Holdings Limited) (“MIHL”), which was listed on The Stock Exchange of Hong Kong, and was the ultimate holding company of the Moulin Group.

(2)  Moulin Holdings (HK) Limited (“Moulin HK”), which was an indirect wholly-owned subsidiary of MIHL, and was the immediate holding company of the principal operating subsidiaries within the Group.

(3)  Moulin Global Eyecare Trading Limited (formerly named Moulin Optical Manufactory Limited) (“MOML”), a wholly owned subsidiary of Moulin HK, which was the largest operating subsidiary within the Group.

(4)  Leadkeen Industrial Limited (“Leadkeen”), another wholly owned subsidiary of Moulin HK, and also a significant operating subsidiary within the Group.

4.  Peace City Investment Limited, a further wholly owned subsidiary of Moulin HK whose function was to hold property, was formerly the Fifth Plaintiff in these proceedings until its removal as a party on the Statement of Claim being amended.

5.  At the relevant times, the Moulin Group carried on a business involving the design, manufacture, distribution and retail sale of eyewear products. The main operating companies within the Group were MOML and Leadkeen. MOML’s function focussed on the marketing and distribution of eyewear products designed and manufactured by the Group. Leadkeen’s function focussed on the manufacture of such products, through arrangements it had with factories in the People’s Republic of China (“the PRC”). The majority of the executive directors of MIHL during the relevant period were members of the Ma family (Ma Bo Kee, his brothers Ma Bo Fung and Ma Bo Lung, and his sons Ma Lit Kin Cary and Ma Hon Kin Dennis), who were also its main shareholders, holding some 40% of its issued shares through a family trust.

6.  The Plaintiffs’ claim is substantial – the alleged damages run to some HK$381 million. The pleadings run to well over 100 pages on each side, with extensive particulars having been sought, and (for the most part) provided. Discovery runs to many thousands of documents. The trial of the action, which is to commence at the end of February 2011, is expected to last between two and three months.

These applications

7.  The parties have sought to deal constructively with most interlocutory matters that have arisen, and have, to a very large extent, been able to do so. There remain, however, some matters on which they have been unable to agree. This resulted in summonses being issued by the Defendants seeking further and better particulars of the claim, and for further discovery, shortly before the first case management conference was held in September 2009. Both summonses were adjourned to this hearing.

8.  So far as the Defendants’ request for particulars was concerned, there were sixteen outstanding requests, falling into four broad groups, which required a ruling. As for the discovery application, which related to 17 categories of documents, in the light of further discovery and information provided (or which, it is expected, will be provided) by the Plaintiffs, the Defendants only sought orders in relation to two categories (although a third also figured briefly in the argument), and asked for the balance of their discovery application to be adjourned sine die with liberty to restore.

The Plaintiffs’ case

9.  Before dealing with the applications, it will be convenient first to outline the Plaintiffs’ case, as it appears from the Amended Statement of Claim. In doing so, I shall focus in more detail on those parts of the Amended Statement of Claim that are of particular relevance to the applications now before me.

The parties, the relevant framework and guidelines and the audit engagements

10.  Paragraphs 1 to 7 identify the parties, and paragraphs 8 to 16 provide further information in relation to the Plaintiffs, setting out the nature of their business and operations, and identifying their directors and major shareholders. Paragraphs 17 to 22 set out the various roles in which the Defendants acted on behalf of the Plaintiffs between about 1991 and 2002. Paragraphs 23 to 26 identify the statutory and regulatory framework which are said to give rise to certain duties on the part of the Defendants as the auditors of the Plaintiffs and the group of companies of which they were part. Paragraphs 27 to 33 then identify the professional guidelines and standards that the Plaintiffs contend are relevant in the circumstances of this case. Paragraphs 34 to 40 identify the relevant terms (express and implied) on which the Defendants were engaged as the Plaintiffs’ auditors. Paragraphs 41 to 52 set out information relating to the financial statements of the Plaintiffs in respect of the financial years ending on 31 March 1999, 2000 and 2001 respectively, and identify the relevant statements made and opinions expressed by the Defendants in their audit reports relating to those financial years, in particular their opinion that the accounts of the Plaintiffs gave a true and fair view of their respective state of affairs, and that such accounts had been properly prepared in accordance with accounting principles generally accepted in Hong Kong and the requirements for disclosure under the Companies Ordinance (Cap. 32).

The alleged misstatements in the audited accounts

11.  Paragraphs 53 to 79 set out the respects in which it is alleged that, contrary to the audit opinions expressed by the Defendants, the audited accounts of the Plaintiffs and the Moulin Group were deficient in that they did not give a true and fair view of their financial affairs, had not been properly audited, had not been prepared in accordance with the applicable professional guidance and did not comply with the relevant disclosure requirements under the Hong Kong Stock Exchange’s Listing Rules.

12.  Paragraph 53A of the Amended Statement of Claim summarises the allegations. It is said that the revenues and accounts receivable of the Moulin Group and the Plaintiffs were substantially overstated by the creation of fictitious sales in order to inflate the actual sales and profitability of the Group. These (it is said) were covered up by the use of funds sourced from trade finance and other loan facilities obtained for fictitious transactions, which (insofar as they were recorded) were not properly recorded, and were falsely accounted for with a view to disguising the true position.

13.  Paragraphs 54 to 79 set out a more detailed description of the various respects in which it is said that the accounts were false. They are divided into four main sections, respectively dealing with the North American debtors (paragraphs 54 to 61), the circular trade finance transactions (paragraphs 61A to 61L and 68), the cash advances to third parties (paragraphs 62 to 68) and Leadkeen/Ma Wu Bei (paragraphs 69 to 79). These paragraphs, and in particular the allegations at the end of each section, are (together with certain other paragraphs in the Amended Statement of Claim) the subject of the first aspect of the outstanding requests for particulars.

The North American debtors

14.  The North American debtors consist of five entities which were recorded as substantial customers of MOML in its accounts for the financial years ending on 31 March 1999, 2000 and 2001. The trade debts and bills receivable attributed to them at each year end represented a substantial proportion of the total trade debts and bills receivable recorded in the consolidated accounts of the Moulin Group as a whole (some 58.61% in 1999, 41.98% in 2000 and 61.05% in 2001), and the revenues said to have been generated from dealings with them represented significant proportions of the Moulin Group’s turnover in those years (some 26.70% in 1999, 27.29% in 2000 and 33.41% in 2001).

15.  The Plaintiffs allege that the North American debtors were wholly fictitious, did not exist, and that the Moulin Group never conducted any business with them. Accordingly, it is alleged that the revenues supposedly derived from them was fictitious, as were the debts supposedly owing by them at the relevant year ends. Paragraph 61 of the Amended Statement of Claim alleges that by recognising the supposed revenues and debts said to have arisen through dealings with them, the accounts of MOML and the consolidated accounts of the Moulin Group were overstated as to current assets by the amount of the receivables recorded as owing by the North American debtors, and as to revenue by the amount of the revenue recorded as having been received from them. This is one of the allegations of which particulars are now sought.

The circular trade finance transactions

16.  As to the circular trade finance transactions, the Plaintiffs allege that if the fictitious transactions involving the North American debtors were (as they should have been) removed from MOML and the Moulin Group’s respective financial statements, MOML and the Moulin Group were not generating sufficient income to meet their operating costs, resulting in a funding deficit that was met by increased syndicated debt and increased borrowing through the use of trade finance facilities. Funds derived from such trade finance facilities were treated as purported receipts from the North American debtors and to meet operating expenses of the Moulin Group. It is said that from 1998 onwards, MOML would apply for trade finance loans in favour of a number of suppliers, called “Friendly Suppliers”, which are said to have been controlled by Ma Lit Kin Cary and/or Ma Bo Kee. With a few exceptions, it is alleged that the Friendly Suppliers did not in fact do business with the Moulin Group, but were used only as a conduit for funds to be channelled to MOML and the Moulin Group in the following way – MOML would purport to place an order for raw materials with a Friendly Supplier and would be supplied with an invoice for the materials supposedly ordered; the invoice would be used to support an application for a trade finance loan in the invoice amount, which would be remitted by the lending bank (net of charges) to the Friendly Supplier, who would then forward the proceeds to MOML; MOML would eventually repay the loan, charges and accrued interest to the lender, having meanwhile obtained further similar advances from the lender or other lenders. The supposed underlying transactions with the Friendly Suppliers for the purchase of raw materials are, on the Plaintiffs’ case, fictitious.

17.  Some such transactions are said not to have been recorded in the accounts of MOML and the Moulin Group at all (these have been referred to as “off balance sheet” trade finance facilities). Those that were recorded were, according to the Plaintiffs, misrecorded in MOML’s Temporary Payments and Temporary Receipts ledgers, with incoming funds being described (falsely) as payments received from the North American debtors for the fictitious sales described above, and outgoing funds being described (again, falsely) as payments made to Leadkeen/Ma Wu Bei, or as loans made by MOML to third parties, as described below.

18.  The effect of the alleged false accounting was to overstate MOML’s and the Moulin Group’s accounts receivable and revenue. It is also alleged that there was an understatement of its liabilities as a result of some of the trade finance facilities remaining off balance sheet and unrecorded (see paragraph 61L). Although there is no outstanding request in respect of these allegations (which were introduced into the Statement of Claim by the amendment for which leave was given at this hearing), the allegations are of the same nature as those for which requests are outstanding, and if an order is made for the provision of the particulars sought, in the manner suggested by the Defendant, such particulars as may be needed of these allegations will, I think, be provided as well.

The third party advances

19.  The next section of the Statement of Claim makes allegations in relation to the third party advances. It is alleged that in the accounts of MOML and consolidated accounts of the Moulin Group, there was recorded, for each of the years ended 31 March 1999, 2000 and 2001, an item described as “Other Debtors, Deposits and Prepayments”, which included purported loans made by MOML to third parties in the total amounts of about HK$112 million, HK$90 million and HK$165 million in each of those years respectively. The borrowers in question are alleged all to have been persons or entities related to the Ma family, and thus with MOML and the Moulin Group. Certain common characteristics of these advances are then identified, and it is alleged that the amount of such advances was, in each year, material for audit purposes.

20.  It is then alleged that the advances in question, although recorded in MOML’s books, were not in fact loans to the borrowers in question, but were no more than fictitious assets created to disguise the true reason for part of the payments by MOML that had been recorded in its Temporary Payments ledger.

21.  Further allegations are made in relation to purported loans to a Mr Ulrich Fisher and a company called Filos SpA in relation to the audited accounts for the year ending March 2001. It is alleged that loans recorded in such accounts as having been made to them were never in fact made, and that the accounts misstated the position in this regard.

22.  The effect of this false accounting is said to have been to overstate the assets of MOML and the Moulin Group in each of the three relevant years by the amount of the purported loans in question, and to overstate the revenue of MOML and the Moulin Group in relation to the interest income supposedly generated by such purported loans. It is also said that MOML and the Moulin Group’s liabilities and expenses were understated by failing to record and recognise that part of the trade finance facilities which were kept off balance sheet, and by failing to record and properly charge against their true revenues the costs associated with such unrecorded facilities. There are outstanding requests for particulars in respect of these allegations also.

Leadkeen and Ma Wu Bei

23.  The final part of the allegations of false account relates to Leadkeen and Ma Wu Bei. As I have noted, Leadkeen was the company in the Moulin Group which was primarily responsible for the manufacturing operations of the Group on the Mainland. In the audit years in question, Leadkeen’s and the Moulin Group’s audited accounts recorded as assets of Leadkeen and the Group amounts purportedly held by Ma Wu Bei (a nephew of Ma Bo Kee who had responsibility for the management of Leadkeen’s PRC factories and business) on behalf of Leadkeen (and hence the Moulin Group). The total amount purportedly so held was some HK$150 million in 1999, HK$217 million in 2000 and HK$257 million in 2001. These amounts were subdivided into what were described as prepaid production expenses, investment in a China joint venture, investment in a factory known as the South Sea factory, and advances or repayments from PRC distributors.

24.  It is also alleged that no allowances were made in respect of potential PRC tax liabilities of Leadkeen in Leadkeen’s accounts, or those of the Moulin Group, on the basis that Ma Wu Bei had provided indemnities in respect of any such liabilities that might arise.

25.  The amounts supposedly held by Ma Wu Bei on behalf of Leadkeen are alleged to have represented significant proportions of Leadkeen’s current assets (between 45% and 55%), total assets (between 21% and 26%) and total equity (between 47% and 53%) in each of the years in question, and smaller, but nonetheless significant, proportions of such items in the Moulin Group’s consolidated accounts.

26.  According to the Plaintiffs, all of the amounts purportedly held by Ma Wu Bei on behalf of Leadkeen were fictitious, and were (like the loans to third parties) simply false accounting entries to disguise the balance of the payments recorded in MOML’s Temporary Payments ledger.

27.  As a result, it is said that the audited accounts of Leadkeen and the consolidated audited accounts of the Moulin Group materially overstated their respective receivables by the amounts of the Ma Wu Bei payments in each of the years ended March 1999, 2000 and 2001. Again, this allegation is the subject of an outstanding request for particulars.

The steps taken by the Defendants and allegations of breach of duty

28.  There follows from paragraphs 79A to 122A a series of allegations concerning the audit process in respect of the 1999, 2000 and 2001 financial years, the interim accounts for each of those three years, and steps taken in respect of the audit for the 2002 financial year prior to the Defendants’ resignation as auditors prior to the completion of that audit. The allegations set out the areas of concern identified by the Defendants in the course of such audits, the steps taken to address them, and communications between the companies and Group on the one hand, and the Defendants on the other, in connection with the audits under consideration.

29.  Paragraphs 123 to 178 set out the Plaintiffs’ allegations of breach of duty and/or negligence, pleading alleged shortcomings and identifying steps that it is said that should have been taken in relation to the Defendants’ approach to audit planning and assessment of audit risk, and its failures to obtain adequate or reliable audit evidence in relation to the North American debtors, the third party advances and the Leadkeen/Ma Wu Bei payments, again identifying the shortcomings, and the steps that it is said should have been taken in relation to each of these areas in all the years in question, supplemented by specific allegations applicable to specific years. It is further alleged that the Defendants failed to detect or act upon material irregularities in the Plaintiffs’ accounts in respect of alleged overstatements of cash at the end of accounting periods – an allegation which is also the subject of an outstanding request for particulars. The matters upon which it is said the Defendants should have reported (but did not) are set out in paragraphs 175 to 178.

30.  Paragraph 178 is the subject of the second aspect of the outstanding request for particulars. It alleges that, had the Defendants complied with their duties, they should, and would, have detected fraud by the executive management of the Moulin Group, and should have taken various further steps and made various further reports (which they did not do).

31.  There follows an allegation that the Defendants were in breach of duty in failing to report unresolved audit issues upon their resignation (paragraphs 179 to 183).

Causation, loss and damage

32.  Finally, paragraphs 184 to 193 set out the Plaintiffs’ case on causation, loss and damage. In summary, it is alleged that had the Defendants acted properly, the Plaintiffs’ accounts would have disclosed that they had suffered losses (rather than the profits which it purported to have earned), and were in fact insolvent, could not have paid the dividends which they did, and would not have had to pay the profits tax which they in fact paid, in any of the years 1999, 2000, 2001 and 2002. It is further alleged that had the Defendants acted properly, the true financial position of the Plaintiffs would have been revealed, resulting in their becoming unable to obtain further loans, so that they would not have incurred the interest and bank charges associated with the circular trade finance arrangements used to disguise the non-existence of the North American debtors. There are also requests for particulars outstanding arising out of allegations in these paragraphs.

The outstanding requests for particulars

33.  Turning to the outstanding requests for particulars, these fall into four main areas.

Request for restated financial statements, details of off balance sheet liabilities and overstated cash balances

34.  The first area is that covered by requests 7(2) and 8(2) under paragraph 61 of the Amended Statement of Claim, requests 22(2) and 23(5) under paragraph 68(a) of the Amended Statement of Claim, requests 25(2) and 27(2) under paragraph 68(b) of the Amended Statement of Claim, request 88 under paragraph 184 of the Amended Statement of Claim, request 97 under paragraph 188(a) of the Amended Statement of Claim and request 99 under paragraph 189 of the Amended Statement of Claim. These requests call for the identification of the changes which are required to be made to the financial statements in order to reflect the removal of the allegedly fictitious revenues and assets and the recognition of the trade finance liabilities identified by the Plaintiffs in the Amended Statement of Claim.

35.  The second area is that covered by request 24(2), which seeks details of the off balance sheet trade finance liabilities which it is said should have been included in the financial statements.

36.  The third area is that covered by requests 69, 70 and 73, all of which seek the identification of the extent of the overstatement of cash balances which is alleged to have taken place at the end of each accounting period.

37.  At the hearing, these three areas were dealt with together by both Mr Jat (appearing for the Plaintiffs) and Mr Lam (appearing for the Defendants), on the basis that they had the common feature that the provision of restated financial statements in respect of the Plaintiffs for each of the accounting years in question would in all likelihood address each of the requests. While the first group of requests identified above specifically request such restated financial statements, the second and third groups in effect seek them as well. As far as the alleged off balance sheet trade finance liabilities are concerned, the complaint is that they should have been, but were not, included as liabilities of MOML, and included on its balance sheet and the consolidated balance sheet of the Moulin Group. Thus, once such liabilities are identified, they would have to be included on restated balance sheets of MOML and the Moulin Group. As for the alleged inflated cash balances, this is also a matter that feeds through to the balance sheets of the companies concerned, as the inflated balances would result in larger than appropriate amounts of cash being recorded on such balance sheets.

38.  In his affidavit filed in opposition to these applications, Mr Sutton, one of the liquidators of each of the Plaintiffs, indicated that although the Plaintiffs did not regard these requests as legitimate requests for particulars, they would provide the restated financial statements and information relating to the off balance sheet trade finance facilities sought by the Defendants (but not, so far as appeared from his affidavit, in relation to the allegedly overstated cash balances) in advance of the main part of their expert evidence.

39.  At the hearing, Mr Jat maintained that what was sought did not form the subject of a legitimate request for particulars, so that no order should be made in respect of them, although he reiterated that the Plaintiffs would supply restated financial statements (which would now extend to the alleged overstatements of cash balances) and full details of the off balance sheet trade finance liabilities (some of which had already been provided prior to the making of Mr Sutton’s affidavit) prior to the deadline for the exchange of expert evidence. He indicated that it was hoped that this could be done by the end of January 2010 (so that they may have been provided by now).

40.  He submitted, however, that no order should be made in respect of these requests, as they were in fact requests for evidence, and that, even if he was wrong as to this, particulars should not be ordered because this was necessary neither for the saving of costs nor for the fair disposal of the proceedings, as is now required by Order 18 rule 12(3B) of the Rules of the High Court.

41.  In his affidavit filed in support of the applications, Mr Collins of the Defendants provided a number of reasons why such information was considered to be necessary.

42.  Mr Collins suggested that there was information that was missing from the Plaintiffs’ case, saying that it was necessarily the Plaintiffs’ case that the cumulative amount of the allegedly fictitious sales to the North American Debtors should, at any given date) be equal to the sum of the balances of the alleged fictitious assets (i.e. the receivables from such debtors, together with the balance allegedly held on the Ma Wu Bei account and the cash advances to third parties) and any unrecorded liabilities. This suggestion does not appear to have been dissented from by Mr Sutton.

43.  Mr Collins then pointed out that the cumulative sales to the North American debtors up to 31 March 2001 amounted to some HK$1,184 million, whereas the total of the allegedly fictitious assets as at that date amounted to only HK$707 million, resulting in a shortfall of HK$477 million. He went on to suggest that the difference must be accounted for either by unrecorded liabilities or cumulative cash settlements, or a combination of both. To the extent that there were cash settlements, this would reduce the amount of the overstatement of revenues (since the settlements would constitute real revenues), and would have an impact on the claims for loss arising out of allegedly improper dividend payments, and allegedly overpaid profits tax, since the revenue and profits of the Plaintiffs would fall to be reduced not by the full amount of HK$1,184 million, but some lesser (but as yet unspecified) amount.

44.  Mr Collins also suggested that even if the North American debtors were fictitious, this did not rule out the possibility that there were genuine sales with other entities whose identities had been disguised. Similarly, he suggested that on the basis of documents seen by the Defendants, it was possible that the Ma Wu Bei payments (or at least part of them) had some underlying basis – for example, prepaid production expenses might in fact have been applied at some later dates – and that the advances to third parties might have been recovered, in whole or in part, at some later time.

45.  He went on to suggest that insufficient information (whether in the form of particulars or documents disclosed on discovery) had been provided to enable the Defendants to ascertain whether some or all of the allegedly fictitious assets were in fact recovered in subsequent accounting periods, or could properly have been regarded at the relevant time as being recoverable – in either case, it was suggested, the alleged overstatement of profit would be reduced (either because that was the factual position, or because it would have been appropriate to regard the assets as having some value at the relevant date, and hence something that was properly recognised and included the financial statements as at that date.

46.  Mr Sutton responds to this line of argument by pointing out that the Plaintiffs’ case does not depend on niceties such as those which Mr Collins seeks to introduce. As Mr Jat put it in his submissions at the hearing – fictitious means fictitious: the Plaintiffs’ case is that the revenues supposedly deriving from the North American debtors was wholly fictitious, or not real, in that they were completely made up. There was no underlying reality to them, and it was not a case of misrecording of real sales. Similarly with the loans to third parties, and the supposed Ma Wu Bei payments – they were not real, in the sense that there never had been any loans to the third parties capable of generating interest income, or being recovered at the end of the day, and the position in relation to the Ma Wu Bei payments was the same: they were imaginary and did not exist, otherwise than as an entry in the Plaintiffs’ accounting records.

47.  In this, I think that Mr Sutton is right. It is clear from the Amended Statement of Claim that the Plaintiffs’ case is that the sales to the North American debtors never occurred, and the revenues and receivables supposedly deriving from them should have been disregarded entirely, and that the assets created to disguise the hole in the Plaintiffs’ accounts that would otherwise have existed, consisting of the loans to the third parties and the payments to Ma Wu Bei, were likewise non-existent and had no basis in reality. I do not think, therefore, that Mr Collins’ suggestion that there might be some underlying reality to some part of these supposed assets, a suggestion which runs flatly counter to the Plaintiffs’ case, provides a basis for requiring the Plaintiffs to provide the particulars sought.

48.  However, this is not the end of the matter. As Mr Collins also pointed out, although the Plaintiffs have identified the revenues and assets which they say should be removed from their financial statements, they have not yet identified the full extent of the accounting adjustments that are required to be made in order to effect such removal. This is because, when an item is removed from the revenues recorded in a profit and loss account, the effect of doing so goes beyond the consequent reduction in the profits recorded therein – it feeds through to the balance sheet, so as to affect the level of accumulated profits (by reducing them) or losses (by increasing them). Further, any adjustment on one side of the balance sheet would necessarily imply that consequential changes will have to be made on the other side of the balance sheet, so that it remains balanced. The Defendant says that these consequential adjustments have not been identified.

49.  Mr Sutton recognises that such consequential adjustments do have to be made, and that this will have to be done in the context of establishing that the Plaintiffs would have incurred trading losses as the result of the exclusion of the fictitious revenues and assets, so as to establish the Plaintiffs’ case that they would not have paid, or been in a position to pay, the dividends and tax which they say constitute a substantial part of the losses which they suffered.

50.  Mr Sutton suggests, however, that any dispute over this is essentially an exercise in accounting, and that it is a matter for (expert) evidence rather than particularisation of the Plaintiffs’ case. He says that there can be no doubt as to the Plaintiffs’ pleaded case – whether as to the nature of the misstatements in the Plaintiffs’ audited accounts, or as to the Defendant’s negligence in failing to identify them or pick them up, or as to the consequences in terms of loss which the Plaintiffs claim to have suffered as a result. Or, as Mr Jat put it in his submissions, the precise form that the restatements to the Plaintiffs’ financial statements should have taken does not form a necessary part of the Plaintiffs’ pleaded case.

51.  With respect, I do not think that this is right. As I have noted, it is common ground that the financial statements concerned will, if the Plaintiffs are right in respect of their allegations concerning the North American debtors, the unrecorded trade finance facilities, the advances to third parties and the Leadkeen/Ma Wu Bei payments, require restatement. The question is whether such restatement is a necessary part of the Plaintiffs’ case. It seems to me that it is. In my view, the restatements are required in order to establish an essential element in the Plaintiffs’ case as to loss and damage. In order to establish that certain dividends would not have been paid, the Plaintiffs will have to demonstrate that the state of their finances, in particular in respect of their distributable reserves, was such that they would not have made the dividend payments complained of (although there may be some room for argument as to how far they will have to go in this regard – whether it will be necessary for them to show that they could not have made the distributions (because, e.g., there would have been no distributable reserves out of which to make them), or that they would not have made them (because, perhaps, it would have been imprudent to do so in the light of the available distributable reserves)) But on either basis, it would seem necessary for the Plaintiffs to make a case as to the level of distributable reserves that would have been available to them had their accounts been properly audited, and restated so as to reveal their true financial position.

52.  It seems to me that this is a necessary step in the Plaintiffs’ case, which is required in order to take them from the allegations of breach of duty by the Defendant, to the conclusion that they have thereby suffered loss and damage. As such, I think that they must be regarded as material facts, which the Plaintiffs will need to establish in order to succeed in their claims, and not merely as matters of evidence.

53.  That being so, can it be said that the provision of such information is neither necessary for the fair disposal of the proceedings, nor for the saving of costs?

54.  So far as the fair disposal of the proceedings is concerned, I think that the nature and extent of the adjustments that the Plaintiffs’ will say should have been made to their audited financial statements to properly reflect their true financial situation are matters of sufficient importance as to be necessary for the fair disposal of the proceedings. This is clearly information which needs to be provided – a matter that appears to be recognised by the Plaintiffs. It seems to me that it would be much fairer for such information to be provided to the Defendants in sufficient time for the Defendants to consider it and address it, as necessary, in their evidence, whether of fact or of expert opinion (it is more likely to be the latter).

55.  As for savings in costs, I would think that the provision of the information in advance of the exchange of evidence, and particularly the exchange of expert evidence, is likely to result in such savings. If the information were not provided at this stage, the Defendants would have to prepare their evidence on the basis of their best assessment of the adjustments to the financial statements that would be needed – in the event that this assessment proves incorrect, there would almost certainly be a need for them to go back on this part of their evidence and reconsider it in the light of what is revealed in the Plaintiffs’ expert evidence in respect of the appearance of the restated accounts. This would simply add to costs, in a way that would seem avoidable if the information is supplied in advance. On the other hand, from the Plaintiffs’ point of view, the information is something that will have to be provided at some stage – the only question being when. It does not seem to me that the provision of the information at a slightly earlier time than it otherwise would have been is likely to result in any significant costs wastage from the Plaintiffs’ point of view, as such work would have to be done in preparing their expert evidence in any case.

56.  I have therefore come to the view that the provision of restated financial statements is a matter for proper particularisation of the Plaintiffs’ claim, and that these requests for particulars are justified. Given that the Plaintiffs have indicated that they will provide such information (and may already have done so), the main effect of my decision will probably be reflected in the incidence of costs in respect of the application. However, in case the information has not yet been provided, I would direct that it should be provided within two weeks from the date of this judgment, by close of business on 24 February 2010.

Requests for details of fraud

57.  This leaves two requests for particulars outstanding. Both relate to paragraph 178 of the Amended Statement of Claim, and in particular the allegation that the Defendants “should, and had it exercised reasonable care would, have detected or suspected fraud and financial mismanagement by certain members of the executive management of the Moulin Group”.

58.  The relevant requests are requests 82 and 83. Request 82 asks for identification of the members of the Group’s executive management in respect of whom the Defendants should have detected or suspected fraud and financial mismanagement. Request 83 seeks a statement of the nature of the alleged fraud and financial mismanagement.

59.  The Plaintiffs have provided a response to each of these requests. In respect of request 82, they have stated that the members of the executive management in question included five named persons (the five members of the Ma family mentioned in paragraph 5 above. In respect of request 83, they have indicated that the alleged fraud and financial mismanagement “includes false accounting and the intentional misstatement in accounting records and/or financial statements, the intentional falsification of documents, misrepresentations to financial institutions and other stakeholders, destruction of records and general laundering of funds”.

60.  In pursuing these requests, the Defendants seek details of the identities of any other members of the Moulin Group’s executive management whom the Plaintiffs say were party to the alleged fraud, and whether there are any other as yet unspecified forms of fraud alleged, together with the particular respects of what is intended to be included in the general allegations of fraud mentioned in the answer that has been given so far.

61.  Dealing first with request 82, Mr Jat contended that identification of the persons responsible for the fraud was not a necessary part of the Plaintiffs’ case. At one stage, he suggested, I think, that the allegation of fraud was not itself a necessary part of that case. While that may be right in the sense that it may not strictly be necessary for the Plaintiffs to contend that the misstatements in their financial statements were brought about by fraud, or by fraud of a particular kind perpetrated by particular persons, it remains the case that the Plaintiffs have, in paragraph 178 alleged in effect that the misstatements were due to fraud on the part of members of their executive management. Moreover, on being asked for particulars of the identities of such persons, their response was not that the identification of such persons did not form part of their case, but was to identify five named persons as being persons who were included in those responsible for the fraud.

62.  It seems to me that having regard to the fact that the Plaintiffs have chosen to identify, in an apparently non-exhaustive way, certain persons as party to the fraud said to have been perpetrated on them, it is proper for the Defendants to seek to establish whether or not the Plaintiffs say that any other persons were party to the fraud. This information may be relevant in a number of respects identified by the Defendants – for example, it may have some impact on questions of contributory fault and causation which the Defendants have raised in their defence; or it may impinge on questions of what acts or knowledge on the part of members of its executive management are to be attributed to the Plaintiffs, another matter raised by the Defendants’ defence; or it may have some impact on issues of whether or not the Defendants could or should have relied on information or representations allegedly provided to them by particular members of the Plaintiffs’ executive management.

63.  In the course of his submissions, Mr Jat made reference to the indictment which has been laid in criminal proceedings for false accounting and conspiracy to defraud in which the five members of the Ma family identified by the Plaintiffs, along with a number of other senior employees of the Moulin Group, have been charged as providing some indication of the persons involved. However, as Mr Lam pointed out, those charges relate to a different time frame to the matters in question in this litigation, and in any event, it does not seem to me that this excuses the Plaintiffs from having to identify those persons whom they wish to allege were part of the executive management of the Plaintiffs who were involved in the alleged fraud.

64.  Insofar as the Plaintiffs seek to allege that any persons, other than the five already named, were persons whom the Defendants should have suspected of fraud, or concluded were involved in a fraud on the Plaintiffs, they must, I think, inform the Defendants of this. I would therefore order that the particulars sought should be given, within the same time frame as has been ordered in respect of the other requests, namely by close of business on 24 February 2010.

65.  As for request 83, it seems to me that the position is similar. Although it may not have been strictly necessary for the Plaintiffs to have alleged that the misstatements were due to a fraud, they have chosen, no doubt for good reasons, to do so. Further, they have provided an apparently non-exhaustive description of the nature of the fraud. In these circumstances, it seems to me that it is open to the Defendants to seek to pin the Plaintiffs down as to whether or not there are any other relevant aspects of the fraud.

66.  That said, I do not think that it would be either appropriate or necessary to require the Plaintiffs to descend to the level of detail suggested in, for example, paragraph 70 of Mr Collins’ affidavit, in which he argues that the Defendants should be given what he describes as “full particulars” of the allegedly fraudulent scheme by identifying the particular documents said to have been falsified, those said to have been concealed from the Defendants and those said to have been destroyed. Although the Plaintiffs have chosen to allege that a fraud on them underlay the misstatements in their financial statements, I do not think that the precise details as to how that fraud was carried out forms (or needs to be) part of the Plaintiffs’ case. It is not suggested that the Defendants should have discovered that particular documents (other than the relevant ledgers) were falsified, let alone concealed or destroyed. What the Plaintiffs allege is that their financial statements were misstated in the various respects pleaded in paragraphs 53 to 79 of the Amended Statement of Claim. In the course of argument, Mr Jat indicated that that was the extent of their allegations of fraud.

67.  In these circumstances, I think that although the Defendants are entitled to know whether there are any other forms of fraudulent conduct beyond those mentioned in the Plaintiffs’ answer to this request on which the Plaintiffs will rely, I do not think that, beyond this, further particularisation of the answer given is necessary. I shall therefore order only that the Plaintiffs should specify any further forms of fraudulent activity beyond those identified in the Amended Statement of Claim and the answer to request 83 upon which they seek to rely in these proceedings, such particulars also to be provided by close of business on 24 February 2010.

Discovery

68.  Turning to the discovery application, I shall deal below with items 9 and 15, which were the subject of the main part of the argument at the hearing, and then deal with item 11, which was also discussed. So far as the other items are concerned, the summons will be adjourned sine die, with liberty to restore if necessary.

Item 9 – Ernst & Young working papers

69.  This part of the application for discovery seeks disclosure of “all documents concerning the balances and transactions with the North American debtors, cash advances to third parties and amounts held by Ma Wu Bei on behalf of Leadkeen and the Moulin Group … which the Liquidators would have obtained from their order under section 221 of the Companies Ordinance requiring Ernst & Young to produce documents relating to its audit of the Plaintiffs”. The documents sought are then further detailed as follows:-

(1)  Those relating to sales to and settlements received from each of the North American debtors for the financial years after that ending on 31 March 2001;

(2)  Those relating to manufacturing operations in the PRC (such as production and expense records and inventory records) for each of the audit years 1999, 2000 and 2001 and thereafter;

(3)  Those relating to the amount of cash advances made to third parties, repayments thereof and interest charged thereon for each of the audit years 1999, 2000 and 2001 and thereafter;

(4)  Those relating to year end balances of cash advances to third parties for each of the audit years 1999, 2000 and 2001 and thereafter;

(5)  Those relating to year end balances, and movements during the year, of amounts held by Ma Wu Bei on behalf of Leadkeen and the Moulin Group, showing the balances of individual components thereof, for each of the audit years 1999, 2000 and 2001 and thereafter;

(6)  Those relating to the balances of each of the North American debtors at the year end of each financial year after that ending on 31 March 2001; and

(7)  Those relating to the balances of the circular trade finance transactions at the end of each of the audit years 1999, 2000 and 2001 and thereafter, including a detailed listing by banks, and classifying the balances as on or off balance sheet.

70.  Mr Lam submitted that these documents are clearly relevant to the issues in question in these proceedings. In relation to the audit years that are the subject of these proceedings, I would accept that this would be likely to be the case. I do not think that Mr Jat disagreed with this.

71.  However, Mr Jat submitted that there was no need for such discovery to be ordered, whether for the fair disposal of the action, or for the saving of costs. He pointed out that substantial discovery had already been made in respect of documentation relating to the audit years in question, and submitted that there was therefore no significant benefit to be obtained from requiring the Plaintiffs to search through the considerable volume of material obtained from Messrs Ernst & Young, who were the Plaintiffs’ auditors after the Defendants’ resignation, to locate documents containing the information sought, an exercise which would be time consuming and costly.

72.  Mr Lam submitted that insofar as these audit years are concerned, Ernst & Young’s working papers would be likely to conveniently summarise information relating to these matters, which would save the parties the expense of having to trawl through the underlying documents for the information.

73.  At the end of the day, I do not think that the benefit (such as it may be) of having these documents produced is such as would justify the additional expenditure of time and cost involved in requiring the Plaintiffs’ to give discovery of them. The underlying documentation having already been disclosed, it seems to me that such original material, which would presumably have been seen by, or at least available to, the Defendants, would be the best source of information rather than the work product of another firm of auditors, which would, after all, record their own summaries and understandings of the material which they had seen. Such summaries may or may not be of particular value in the context of these proceedings, but they are, I think unlikely to be much more useful than the original material which has, as I understand it, been disclosed.

74.  Turning to the audit years subsequent to those for which the Defendant was the Plaintiffs’ auditor, Mr Lam submitted that the material that might be expected to be contained in them was relevant for the reasons given by Mr Collins in his affidavit, where he dealt with the alleged relevance of events after the involvement of the Defendant – this relates to the alleged relevance of potential settlements of indebtedness by the North American debtors or the third party borrowers and the possible use of funds held by Ma Wu Bei for production in the PRC, after March 2001.

75.  However, as I have explained above, in the context of the request for particulars in the form of restated financial statements, the suggestion that there might have been relevant economic benefits received at a later time flowing from the allegedly fictitious transactions (quite apart from being a notion which is disputed by the Plaintiffs) is not something that appears to flow from their case, which is simply that the transactions in question had no foundation in reality. As Mr Jat put it, the transactions never happened, and were purely imaginary, so that there could be no question of benefits of any sort flowing from them in later accounting periods.

76.  In these circumstances, I see no justification for requiring the Plaintiffs to give the discovery sought under this category of documents in relation to audit years after that ending on 31 March 2001 either.

77.  I therefore do not propose to make any order in respect of item 9 in the Schedule to the Defendant’s summons for discovery.

Item 15 – documents relating to loans made to members of the Ma Family and/or private companies owned by them

78.  This aspect of the discovery application seeks disclosure of all pleadings and other documents (including affidavits) in relation to the Plaintiffs’ claim against Cary Ma Lit Kin and Anthony P Dichiara in HCA 1037 of 2006, and similar documents in relation to the claim made by Active Base Limited against the Liquidators in HCCW 470A of 2005 and CACV 279 of 2008.

79.  The former proceedings sought to set aside certain agreements and recover payments made to Dichiara as part of a remuneration package – there was reference in the Statement of Claim in those proceedings to Cary Ma and other members of the Ma Family (or their private companies) having borrowed substantial amounts from unlicensed moneylenders for the purposes of the Moulin Group.

80.  Mr Sutton has pointed out that these proceedings related to transactions and loans in 2004 and 2005, some considerable time after the resignation of the Defendants as the Plaintiffs’ auditors. In these circumstances, the Plaintiffs contend that such documentation is not relevant to the issues arising in the proceedings.

81.  Mr Lam submitted that documents in these proceedings would cast light on the modus operandi of the Ma family in relation to the use of borrowed funds to influence (or inflate) cash balances – with respect, it seems to me that given that the transactions covered by these proceedings do not fall within the period during which the Defendants were the Plaintiffs’ auditors, the relevance if any of documents relating to them is tenuous, at best, and I do not think that discovery of them is necessary either for the fair conduct of this action, or for the saving of costs.

82.  The position in relation to the other proceedings (the Active Base claim) is similar. The claim related to loans said to have been made by Active Base, a moneylender, to MIHL. In the course of the proceedings, there was reference to three very short term loans made by Active Base close to and straddling the year end of the Group at the end of the 31 March 1998 and 2002 and 31 December 2003 financial years – in each case the loans were made just before the year end, with repayment scheduled shortly after the start of the next financial period. The loans were apparently made to Ma Bo Kee or Ma family private companies, with the proceeds (at least in respect of the two later loans) being channelled to companies in the Moulin Group.

83.  Again, the suggestion is that documents relating to these proceedings would cast light on the modus operandi in relation to the inflated cash balances.

84.  For the reasons I have given in relation to the Cary Ma/Anthony Dichiara proceedings, I do not think that it would be appropriate to require discovery in relation to the loans that fall outside the financial periods with which these proceedings are concerned. So far as the remaining loan, which fell to be repaid early in the financial year ending 31 March 1999, is concerned, Mr Sutton has stated (and Mr Jat confirmed) that the Plaintiffs have provided disclosure of documentation relating to this loan to the Defendants. In these circumstances, it does not seem to me to be appropriate to make an order requiring discovery of these documents either.

85.  In the result, I decline to order the discovery sought under this heading also.

Item 11 – report produced by Ferrier Hodgson for creditor banks of the Group

86.  This relates to a report apparently produced by Messrs Ferrier Hodgson (the firm of which the liquidators are partners) for certain creditor banks of the Moulin Group in 2005, as to the financial position of the Group.

87.  The Defendants suggest that this document is likely to be relevant, and that it is likely to be in the possession, custody or control of the liquidators, in their capacity as such, having regard to the fact that it was produced by their firm on the instructions of the Group’s creditor banks, who form the majority of its creditors.

88.  Mr Jat submitted that the mere fact that such a report may have been produced by the liquidators’ firm for the banking creditors of the Group does not mean that it is ipso facto in the Liquidators’ possession – he submitted that one had to have regard to the capacity in which the liquidators’ firm held the documents in question.

89.  I think that that is correct, insofar as it goes. Merely because the document may be in the possession of the liquidators’ firm (as the producers of it) does not mean that it is in the liquidator’s possession. In order for the document to be discoverable, I agree that it should be in the liquidators’ possession in their capacity as liquidators.

90.  That said, however, as I understood Mr Lam’s submission, it was that the court should conclude that there was (at least) a prima facie case for possession, as it was inherently likely that the document would have been released by the creditor banks to the liquidators in their capacity as such, given that it would throw light on the condition of the Moulin Group prior to its liquidation, and might well throw light on the false accounting that is said to have taken place. To this, Mr Jat responded that Mr Sutton had made it clear that it was not in the possession of the liquidators in their capacity as such. But with respect, that is not clear from Mr Sutton’s affidavit. All that Mr Sutton said on this point was that “documents produced for creditor banks are not documents in the possession, custody or control of the Plaintiffs”. While I would accept that the document would not necessarily, or inevitably, be in the possession of the Plaintiffs, or be in their possession simply because the liquidators’ firm had produced the document in some other capacity, it seems to me that there is nonetheless a prima facie case for suggesting that it is in their possesion, having regard to the circumstances referred to at the beginning of this paragraph. It seems to me that there is a reasonable likelihood of the document having been made available to the liquidators in their capacity as liquidators, and in my view, Mr Suttons’ statement does not deal expressly with that situation.

91.  I therefore think, on balance, that the Plaintiffs should state whether or not this document is in their possession, custody or control, by being in the possession of the liquidators of the Plaintiffs in their capacity as liquidators, so that it is a document in the possession, custody or control of the Plaintiffs. To confirm this one way or another is not likely to be an onerous task, and I shall therefore order that this should also be done within 14 days from the date of this judgment, by close of business on 24 February 2010.

Costs

92.  So far as costs are concerned, having regard to the fact that a substantial portion of the discovery application was not proceeded with, and the fact that the evidence filed in relation to the applications dealt with both applications, I shall direct that the question of the costs of these applications should be dealt with by oral submissions on 25 February 2010, when the Plaintiffs’ application for discovery from the Defendant is due to be heard.