CHUNG KENG v. PEARL ORIENTAL OIL LTD

HCMP 1795/2018

[2019] HKCFI 1743

IN THE HIGH COURT OF THE

HONG KONG SPECIAL ADMINISTRATIVE REGION

COURT OF FIRST INSTANCE

MISCELLANEOUS PROCEEDINGS NO 1795 OF 2018

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D E C I S I O N

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The Application

1.  I have before me an Originating Summons issued on 22 October 2018 by Mr Chung Keng (“Mr Chung”), a shareholder in the respondent company Pearl Oriental Oil Limited (“the Company”).    The Company is listed on the main board of the Stock Exchange of        Hong Kong Limited (“HKEx”).  By the Originating Summons, Mr Chung seeks leave pursuant to section 732(1) and 733 of the Companies Ordinance (Cap 622), for leave to commence in the name of the Company a statutory derivative action against two of its directors, namely Ms Fan Amy Lizhen (“Ms Fan”) and Mr Tang Yau Sing (“Mr Tang”).

2.  The claims that Mr Chung wishes the Company through the statutory derivative action to pursue is described in a draft statement of the claim, exhibited to the Originating Summons.  That draft has subsequently been amended in a number of respects and the revised draft exhibited to one of the Mr Chung’s affirmations.

3.  The relief sought in the statement of claim is for a declaration that the two defendants breached their duties in respect of         six claims which I shall describe later, damages in respect of those  

(1)   A proposed placement considered in June 2018 was abandoned.

(2)   The relocation of the Company’s office.

(3)   The failure to settle employees outstanding wages.

(4)   Unjustified refusal of a proposed loan by Mr Chung in the absence of reasonable alternatives.

(5)   Refusal to convene a special general meeting (“SGM”) in respect of resolutions to remove directors.

(6)   The appointment of Directors lacking the requisite experience.

4.  The Company has appointed an Independent Board Committee (“IBC”).  The IBC has filed an affirmation of Ms Lyn Jialian (“Ms Lyn”) on behalf of the IBC.  The IBC opposes leave in respect of the first three claims.  It adopts a neutral position in respect of the last three, although it has provided quite detailed observations on them.

5.  The principles by reference to which the court determines application of this sort are largely uncontroversial.  They have most recently been summarised by Court of Appeal in [11] and part of [18] of the decision in Zhang Heng v Kingstone International Wealth Management Ltd [1]:

“11. There is no dispute about the law on the correct approach regarding the exercise of discretion to grant leave. This has been covered in a number of cases, including an earlier decision of the judge mentioned in the Judgment, namely, Hao Xioying v Green Valley Investment Ltd, HCMP 1394/2015, 10 August 2016, which quoted from relevant passages of the decision of Ng J in Re Primlak (HK) Ltd [2016] 2 HKLRD 31 and Ng J in turn drew on various decisions of judges at first instance[2]. The relevant legal propositions have been summarised by the judge in Green Valley Investment Ltd at §§10 and 11:

‘10. On serious question to be tried:

(a) The threshold is relatively low. The prospects of the company’s success are to be investigated only to a limited extent, and the court should be slow to find against the applicant unless such prospects are so slim that the company cannot be said to have any expectation of success. See Re Primlaks (HK) Ltd, HCMP 1789/2015, unrep, 28 January 2016, §§7-8 per Ng J.

(b) At the leave stage, it is not the court’s function to try to resolve conflicts of evidence or difficult questions of law which require substantial argument and deliberation. In practice, if the applicant is able to produce a draft pleading that sets out a case with some prospect of success when only the allegations contained in the pleading are considered, the criteria will be satisfied unless the respondent can demonstrate fairly readily that there is a serious flaw in the claim and that it has no real substance[3]. See Re Primlaks (HK) Ltd, §9.

11. As regard the interest of the company:

(a) Again, the threshold is low. In deciding whether it is prima facie in the interest of the company for leave to be granted, the court should have regard to the fact that “there should not be a trial within a trial and the court should not be forced to enter into the merits of claims where there are serious disputes”. See Re Primlaks (HK) Ltd, §21.

(b) If a “serious question to be tried” has been demonstrated, in most cases it will follow that it is prima facie in the interest of the company that proceedings are pursued. See Re Primlaks (HK) Ltd, §§20-21.

(c) In assessing whether it appears to be in the interest of the company that the derivative action be pursued, the court ought to take into account whether any practical benefit is likely to result, even in circumstances where it may be clear that, eg, a director has breached his duties to the company. This essentially involves assessing whether it appears that the company stands to gain in money or money’s worth in light of the costs which will have to be incurred. See Swansson v RA Pratt Properties Pty Ltd (2002) 42 ACSR 313 at [56] to [60][4] per Palmer J; Pang Yong Hock v PKS Contracts Services Pte Ltd [2005] 2 LRC 72 at [21] per Tay Yong Kwang J (giving the judgment of the Singaporean Court of Appeal).’

…

18. First, the judge erroneously approached the case on the narrow basis whether the business undertaken by Kingstone Advisors fell within the original scope of business of Kingstone Wealth as agreed between Zhang and Shum,   in effect treating the agreement on the original scope of business as an agreement to restrict the scope of business of Kingstone Wealth without any possibility of expansion.  Second, the evidence is not all one way, as Mr Hu had contended.  Third, in light of the evidence which suggest the contrary, as pointed out by Mr Man, one is driven to think that the judge could not have applied the correct test, namely, that the threshold is relatively low, that one has to bear in mind the prospects of the company’s success are investigated only to a limited extent, and that the court should be slow to find against the applicant unless his prospects are so slim that the company cannot be said to have any expectation of success.”

6.  I would emphasise these criteria mean exactly how they are described.  Unless the statement of the claim is demurrable or it can be demonstrated quickly that the proposed claim or claims are based on fundamental mistakes, the serious question criteria will be satisfied.  The court should not be faced, as in the present case, with 100 pages of affirmation evidence.  The applicant needs to do little more than briefly summarise the background to the application and confirm that he or she believes the draft statement of claim to be true.  The evidence filed by the company should be limited to identifying errors, not arguing the claim.

7.  Given the position taken by the IBC on behalf of the company, it is only necessary to address the first three claims.

8.  The first of these relates to the non-payment of wages and the alleged failure of the directors to address the payment issue and the need to raise finance in order to make the outstanding payments.

9.  It seems to me that the allegation of breach of duty reaches the necessary threshold and Mr Dawes did not actively dispute this.     The Company’s objection falls under the second criteria, namely whether it is in the interests of the company to pursue the claim given that there is currently no evidence of tangible financial benefit in so doing.

10.  Mr Wong on behalf of Mr Chung fairly accepted that this might be correct if this was the only claim that was being pursued.    He argued, however that the action will proceed in any event, the issue has to be accessed in the broader contact of the entire action.     If he submitted, the claim is capable of bolstering the other claims it has a sufficiently tangible potential benefit to make it in the Company’s interests to allow this claim to be advanced, I agree.

11.  The next contentious claim relates to the relocation of the office.  The Company says this is purely a matter of commercial judgement.  The Company has given its reasons for incurring the costs of moving at about HK$5 million at a time when it faced acute financial problems.  The reasons for the move apparently was a request by a potential investor in the Company that the Company’s office be moved closer to his own location.  That investment did not materialise, but that argues Mr Dawes, does not alter the character of the decision under attack.

12.  Although this is an unusual claim to wish to pursue, I agree with Mr Wong that it cannot be ruled out at this stage that the decision was so poor that is passes from that category of decisions with which the Court will not interfere into that category of gross-mismanagement that constitutes a breach of section 465(1) of the Companies Ordinance (Cap 622).

13.  The final claim is more complicated because it concerns a prospective private placement, which commenced in June 2018 and was abandoned in early August, following a special general meeting on 27 June at which the shareholders failed to approve an extension of   the general mandate.  The Company says that this was subsequently followed by a decision of HKEx on 1 August 2018 indicating that in the circumstances HKEx would not approve the listing of new shares.

14.  Mr Chung says that this is a misleading description of what took place.  He explains in his evidence that Ms Fan continued with her attempt to find a placing after the SGM and those attempts ceased before the Exchange wrote with its decision on 1 August 2018.

15.  Mr Chung’s characterization of the complaint is that Ms Fan was trying to procure a placement to friends and when this fell through she used the mandate issue and subsequently the Exchange’s decision, as an excuse for not entertaining Mr Chung’s offer to subscribe for shares which might have affected her control of the Company.  Given the Company’s financial difficulties, there is no reason why, says Mr Chung, negotiation could not have progressed in tandem with steps to obtain shareholder and HKEx approval to a firm offer from an independent third party to invest.

16.  It seems to me that this claim is at least arguable.  Mr Dawes argued as he had in a case of the claim in respect of non-payment of wages, that even if I took this view, there was no tangible benefit to the Company, other than possibly recovering wasted costs.  In my view this in conjunction with the support the claim tends to lend to the other claims based on breach of duty is sufficient to satisfy the second criteria.

17.  This leaves the question of the costs of the action. Mr Wong invited me to order that the costs be indemnified by the Company. In my view before doing so, it is desirable given the Company’s financial statement for the Court to be provided with information about its current financial position.  I will therefore adjourn this issue with liberty to apply. I direct that the Company file and serve evidence within 28 days of its current financial position and its projected financial position for the period from the 1 July 2018 to 30 June 2020.  Mr Chung can consider whether to seek an indemnity.  If follows from what I have said that       I will order that the derivative action be commenced in the form of the most recent draft of the statement of the claim.

18.  There is one further tangential matter that I wish to address.  As I have already indicated one of the claims concerns the suitability of three new independent non-executive directors.  One of these is the deponent to the principle affirmation filed by the Company in opposition to these claims that I have described.

19.  The deponent is Ms Lyn.  The only information the Company or the Court has about Ms Lyn is that set out in a draft pleading which is taken from a public announcement produced by the Company in a circular dated the 3 October 2018, concerning the appointment of both a new executive director and new independent non-executive directors.  This announcement states that “Ms Lyn, aged 20, graduated from The University of California−Irvine”. Putting to one side the obvious question whether given her age Ms Lyn had graduated from the University at the date of the announcement, it is entirely unclear from the information contained in the announcement that Ms Lyn had requisite experience to be appointed as an independent non-executive director of a company listed on the main board of the Exchange.  The announcement goes on to tell shareholders that a formal service agreement has been entered into between Ms Lyn and the Company and she will receive a directors’ fee of HK$120,000 per annum.  It also informs the reader that she has been appointed as a member of the audit committee of the Company.

20.  This suggests that Ms Lyn has met the criteria set out in Rule 3.13 of the Listing Rules.

21.  Section 465 of the Companies Ordinance (Cap 622), imposes statutory duties of care on directors. Sub-section (2) provides “reasonable care, skill and diligence mean the care, skill and diligence that would be exercised by a reasonably diligent person with−the general knowledge, skill and experience that may reasonably be expected of a person carrying out the functions carried out by the director in relation to the company; and the general knowledge, skill and experience that the director has”.  These are similar to these duties at common law and one would expect the directors of a Hong Kong listed company to meet them regardless of where the Company is incorporated in Bermuda.

22.  It seems not unreasonable to assume that the general knowledge and experience that Ms Lyn is likely to have is negligible and she could not realistically be expected to meet the standard imposed on a director by statute and common law.

23.  The Listing Rules also deal expressly with what is expected by the Exchange of directors of a listed company in Hong Kong.      I quote from Rule 3.09:

“Directors of the listed issuer must satisfy the Exchange that they have the character, experience and integrity and are able to demonstrate the standard of competence commensurate with their position as directors of the listed issuer. The Exchange may request further information regarding the background, experience, other business interests or character of any director or proposed director of a listed issuer.”

24.  The implication is that the Exchange must have approved the appointment of Ms Lyn.  It will be appreciated that it is of some concern to me as the High Court judge responsible for the portfolio of cases involving corporate governance that it could possibly be thought that a 20 years old with no work experience could satisfy these criteria and reasonably be expected to contribute to the maintenance of the standard of corporate governance to be expected of a listed company and which I would expect the investing public to expect.  If it is possible for a company to obtain from the Exchange approval of the appointment of Ms Lyn it goes some way to explain why the Companies Court rather too frequently encounters examples of inadequate corporate governance by Hong Kong listed companies.

25.  I will be sending a copy of this decision to HKEx and           I would hope that it will look into this matter.

Costs

26.  So far as costs are concerned it is not in dispute that the Applicants’ costs should be paid by the company with a certificate for two counsel.  Mr Lok on behalf of the applicant asked that I order that the costs be assessed on a higher than normal standard.  His reasons for doing so fall into two parts.  First that despite at the first hearing of the originating summons before Recorder Wong, which resulted in a reported decision which records quite clearly the Recorder as explaining to the Company, the relevant tests when giving the Company leave to file evidence in response to the application, the Company filed substantial evidence which served to increase significantly Mr Chung’s costs.

27.  It does seem to me that the evidence that has been filed by the Company demonstrates that proper regard has not been given to the Recorder’s guidance concerning what need to be said or not said about the merits of the application and that to some degree this will have increased the Applicants’ costs as it made the application unnecessarily complicated and invited more substantial evidence in reply than might otherwise has been served.  I think the issue is whether or not it is likely that the impact on costs is such as to justify of itself that the costs be taxed on a common fund basis or on an indemnity basis.

28.  It seems to me that on balance it does not.  To the extent that the costs has been increased they will be recoverable by the Applicant from the Company on taxation in any event.