A O SMITH HOLDINGS (BARBADOS) SRL v. ZHANG DACHENG

HCMP 1132/2011

IN THE HIGH COURT OF THE

HONG KONG SPECIAL ADMINISTRATIVE REGION

COURT OF FIRST INSTANCE

MISCELLANEOUS PROCEEDINGS NO 1132 OF 2011

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J U D G M E N T

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A. INTRODUCTION

1.  This is the plaintiff’s application to commit the defendant for contempt of court for breaching a worldwide Mareva injunction in dealing with his assets.

2.  The Mareva injunction (“the injunction order”) was granted ex parte on 26 April 2011 prohibiting the defendant from, amongst others, dealing with his assets anywhere in the world up to the value of US$26,000,000.  The injunction was continued by an order (“the continuation order”) of Recorder A Chow SC on 29 April 2011 in default of the defendant’s appearance.

3.  The defendant has not disputed that he was aware of the injunction order.  The continuation order was also served on him.

4.  It is also common ground that, notwithstanding the injunction order, the defendant transferred all his shares in a Mainland company known as Shanghai Chanitex Industrial Co Ltd (“Chanitex”) to his daughter (“the daughter”), Zhang Xiaoheng in May 2011.

5.  On 16 June 2011, leave was granted to the plaintiff to apply for an order for committal of the defendant for his contempt of court.  The plaintiff issued the Originating Summons on 17 June 2011 in these proceedings for an order that the defendant be committed to prison.

B.   BACKGROUND

6.  The plaintiff is an indirect subsidiary of AO Smith Corporation (“AOS”), a manufacturer of residential and commercial water heating equipment in the US.

7.  In January 2009, AOS entered into a letter of intent with the defendant for the potential purchase of the majority share of a water treatment business in the Mainland operated and owned by the defendant and his wife.

8.  On 17 September 2009, the plaintiff entered into a share purchase agreement (“SPA”) with Tianlong Holding CO (“Tianlong”), a company controlled by the defendant, for the purchase of 80% shareholding in a company called A O Smith (HK) Ltd for RMB 524 million.  By way of the SPA, AOS though P would acquire the majority of that water treatment business.

9.  For the purpose of the SPA, the defendant further entered into a guarantee agreement with the plaintiff, guaranteeing the performance of the SPA.

10.  It is the plaintiff’s contention that Tianlong was in breach of the terms of the PSA and alternatively liable for fraudulent misrepresentation by falsifying and providing false financial information to the plaintiff prior to completion. 

11.  The plaintiff thus claims against the defendant under the guarantee agreement.  It also claims against the defendant for breach of a non-competition agreement by engaging direct competition with the plaintiff’s business and using similar trademarks through Chanitex. 

12.  These claims were to be referred to and be resolved by ICC arbitration pursuant to the terms of the relevant agreements.  The plaintiff estimated its damages for these claims in the region of US$26,000,000.00. 

13.  As mentioned above, on 26 April 2011, the plaintiff obtained the injunction order in aid of its claims against the defendant in the arbitration.  On 29 April, the injunction order was continued by the continuation order.

14.  Then, on 10 May 2011 (ie, after the injunction order), the defendant transferred the shares in Chanitex (which were at that time registered in the defendant’s name) to the daughter.

C.   THE PRESENT COMMITTAL FOR CONTEMPT

C1.   Applicable principles

15.  In committal for civil contempt, the following general legal principles apply.

16.  Court orders are made to be obeyed and litigations who intentionally breach orders do so at the risk of being in contempt of court:  Hong Kong White Book 2012, paragraph 52/1/4; RACP Pharmaceutical Holdings Ltd v Li Xiaobo (unreported, HCA 490/2007, 14 April 2008, Deputy High Court Judge Gill) at paragraph 2.

17.  In hearing a committal for contempt, it is necessary to (a) construe the court’s orders to ascertain their meaning and operation; (b) determine whether the defendant has in fact complied with the orders, and (c) finally consider whether any failure to comply was accompanied with the state of mind necessary to establish punishable contempt: Kao Lee & Yip v Donald Koo Hoi Yan (2009) 12 HKCFAR 830 at paragraph 21 per Brennan NPJ.

18.  The burden is on the plaintiff to prove the defendant’s contempt beyond reasonable doubt: Kao Lee & Yip, supra, paragraphs 6 and 30 per Brennan NPJ; RACP, supra, paragraph 3.

19.  In order to establish the necessary state of mind, the plaintiff needs to prove that the act constituting breach was made intentionally, not casually, accidentally or unintentionally.  However, it is not necessary to prove a deliberate intention to breach the order, although this is relevant to sentencing: Kao Lee & Yip, supra, paragraphs 45-46 per Brennan NPJ. 

20.  Committal orders however are remedies of last resort.  Whenever there is a reasonable alternative to committal proceedings available in aid of execution of a civil process, that alternative should be taken: G v S (2001) 4 HKCFAR 419 at 427F-G; Hong Kong White Book 2012, paragraph 52/1/8.

C2.   The defendant’s grounds of opposition

21.  As mentioned above, it is not disputed that (a) the defendant was aware of and served with the injunction order, and (b) he had transferred his shares in Chanitex to the daughters after the injunction order. The defendant is also not suggesting that the terms of the injunction order are unclear or that he did not understand them.  Thus, prima facie, the defendant was in breach of the injunction order in transferring those shares to the daughter.

22.  In opposing this application, the defendant however says there was no breach of the injunction order or contempt because (in gist):

(1)  The shares are not his assets because they belong beneficially to the daughter not him. 

(2)  Further and in any event, he had no intention to breach the injunction as he made the transfer because he understood from his legal advisers that the transfer was allowed, which advice was given under certain miscommunication.

23.  Further, even if there is contempt, Mr Manzoni for the defendant submits that a sentence of imprisonment is inappropriate, as the defendant has offered to restore the position.

24.  The defendant has filed an affirmation dated 29 July 2011 (“the defendant’s affirmation”) in support of these grounds.  His evidence has been helpfully summarized in Mr Manzoni’s skeleton submissions, which I largely adopt as follows.

25.  When Chanitex was incorporated in April 2004 with registered capital of RMB 1 million, and its initial shareholders were Shao Jun and Zhang Yanhua as the defendant’s nominees.  Its legal representative and executive director was Shao Jun.

26.  In October 2008, a shareholders resolution was passed for Shao Jun and Zhang Yanhua to transfer their shares to the defendant. The defendant also replaced Shao as the legal representative and executive director of Chanitex.  Since then, Chanitex was transformed to be a one‑person limited liability company.

27.  In December 2009, shortly after the plaintiff’s acquisition of his water treatment business, the daughter came from Beijing and started living and working with him.  The defendant then decided in January 2010 to give Chanitex to her as a gift.  He further says that before January 2010, Chanitex was never in operation. 

28.  In this regard, on 10 January 2010, a shareholders resolution was passed for the transfer.  The change in shareholding was approved on 5 February 2010.  As a result, the daughter replaced the defendant as the legal representative and executive director of Chanitex.

29.  The defendant therefore transferred Chanitex to the daughter in January 2010 as a gift.

30.  From then, the daughter started running Chanitex and conducting the sale of AOS’ water treatment products until AOS relocated out of Shanghai in December 2010. 

31.  However, the daughter gave birth to a baby on 13 December 2010 and was unable to manage the daily operations of Chanitex.  The defendant agreed that he would run the company temporarily for her until she was able to get back to work.

32.  He believed that in order to do so, he needed to become both the shareholder and legal representative.  As a result, the daughter transferred the shares to the defendant in December 2010 and he became Chanitex’s legal representative and executive director.

33.  In early May 2011, the defendant was getting ready to issue divorce proceedings against his wife.  As advised by his divorce lawyers in the Mainland, he took steps to separate his own assets from those of his family members (including the daughter).  It was therefore necessary to transfer the daughter’s shares in Chanitex back to her.

34.  The defendant further asked his then Hong Kong solicitors, Boughton Peterson Yang Anderson (“BPYA”) whether he could change the legal representative back to his daughter.  At the time (and consistently with what had happened when he became legal representative in December 2010) he thought that the position of legal representative and that of shareholder went together. The defendant says BPYA did not know of the defendant’s misunderstanding of the legal position, and this led to a genuine miscommunication between them.  They advised him that he could change the legal representative without any breach of the injunction.  He understood that to mean that he should also change the shareholding back to his daughter.  

35.  It was in these circumstances that the defendant transferred the shares in Chanitex back to his daughter in May 2011.  She also became its legal representative and executive director again. 

36.  I would now deal with each of these grounds in detail below.

C3.   Discussion

C3.1 The chanitex shares are not the defendant’s

37.  The defendant was the registered owner of these shares before he transferred them to the daughter in May 2011. Prima facie, these shares were thus part of his assets before this transfer.  It is for him to show that they did not beneficially belong to him at the time of the transfer.

38.  As set out above, the fundamental basis of the defendant’s case that these shares are not his asset is that he already transferred the shares to the daughter back in January 2010 as a gift.  He then explains that all these shares were subsequently transferred back to him by the daughter in December 2010 because he needed to run the company for her during the time when the daughter was pregnant and of his then understanding (albeit a mistaken one) that the legal representative needed to be vested with the shareholding of the company as well.  For the purpose of his case, what the defendant must have meant by this is that these shares were transferred to him in December 2010 not beneficially but only as a nominee.

39.  I reject the defendant’s case as clearly incredible. My reasons are as follows.

40.  First, the defendant’s allegations that he transferred the shares to the daughter as a gift in January 2010 and that he as her nominee transferred them back to the daughter in May 2011 are inconsistent with and directly contradicted by the following documentary evidence which shows that these transfers were made for valuable consideration:

(1) Under a sale and purchase agreement dated 10 January 2010[1], the shares were transferred to the daughter for a consideration of RMB 1 million.

(2) Pursuant to a share transfer agreement dated 4 May 2011 between the defendant and the daughter[2], the shares were transferred to the daughter by the defendant for a consideration of RMB 1 million.

41.  Mr Manzoni for the defendant submits that even though the shares were transferred for RMB 1 million, the defendant’s description of the transfer as a gift “may be realistic”.  I have difficulty in understanding this, especially when the defendant has not sought to explain why the alleged transfer of the shares as a gift had to be made under a sale and purchase agreement for a significant consideration. 

42.  I therefore reject this submission and reject the defendant’s case on gift as clearly incredible. 

43.  Second, apparently to bolster this allegation of gift, the defendant also said in his affirmation that before the share transfer in January 2010, Chanitex was never in business[3].  But as pointed out by the plaintiff, this is also directly contradicted by the documentary evidence that between 2004 and 2009, there were reported turnover and post-tax profits of Chanitex[4]. Again, in the absence of any explanation (let alone a reasonable one) as to why he deposed that the company was never in business at the time he transferred the shareholding in Chanitex to the daughter, with the evidence at it presently stands, I am of the clear view that the defendant’s said assertion that Chanitex was never in business is simply made up to support the “gift” allegation.

44.  For these reasons, with all the evidence before me, there is no doubt in my mind that:

(1)  The defendant has not shown that the shares had been transferred to the daughter as a gift in January 2010 as alleged, which is the only case advanced by the defendant. 

(2)  The defendant has also failed to show that the shares were transferred to him in effect only as a nominee by the daughter in December 2010.  This is particularly so as these shares were then transferred by him to the daughter in May 2011 for a consideration of RMB 1 million.  If he were only transferring the shares as a nominee back to the daughter as suggested, there is no reason why this was done for such a consideration.

45.  Given that the plaintiff was the registered owner of these shares at the time when he transferred them to the daughter in May 2011 for a valuable consideration, and that I have rejected the defendant’s above case and evidence, in the totality of the evidence, the plaintiff has shown beyond reasonable doubt that (a) these shares were part of the plaintiff’s assets at the time of May 2011 transfer, and (b) the transfer was made intentionally and in breach of the injunction order.

C3.2 The breach was excusable as the defendant relied on a mistake of fact in making the transfer

46.  The defendant says the reason for the transfer was to separate his assets from those of his family members in light of his pending divorce, and this was based on the advice from his Mainland lawyers. 

47.  He further says that after receiving the notice of the injunction order, he had sought advice from his then Hong Kong solicitors, BPYA, relating to the intended transfer of the Chanitex shares to the daughter.  The defendant however says that the advice given was made on a “miscommunication” between him and BPYA of the question he asked.

48.  The defendant’s evidence on the said seeking of advice from BPYA and the “miscommunication” is set out at paragraphs 16 to 18 of the defendant’s affirmation as follows:

“16. On 4 May 2011, a shareholders resolution was passed for me to transfer my shareholding in Chanitex Industrial back to my daughter. The change in shareholding was approved on 10 May 2011. As a result, my daughter became the legal representative and executive director of Chanitex Industrial again.

17. Prior to transferring Chanitex Industrial back to my daughter, I asked [BPYA], my then solicitors, whether it was permissible, and whether it would cause any problems given the Injunction Order. I was told that I could do so, and it was on the basis of that comfort given to me by my Hong Kong lawyers that I proceeded with the transfer.

18.   I now realize that there was in fact a miscommunication between myself and BPYA.  The question which I asked BPYA was whether I could change the legal representative of Chanitex Industrial back to my daughter.  At that time, I had no understanding of company law, and I thought the position of legal representative and the position of shareholder meant the same thing.  I only now realize, having been advised so, that there is a significant difference as a matter of Hong Kong law, between a person occupying the position of legal representative of a company and a person being a shareholder of a company.  BPYA did not appreciate at the time that I was referring also to a change of shareholding of Chanitex Industrial and this led to the miscommunication.  Had I know, in December 2010, that I could hold the position of legal representative of Chanitex Industrial without being the shareholder of Chanitex Industrial at the same time, I would never have asked my daughter to transfer the shareholding to me.”

49.  As a result, the defendant says he transferred the shares to the daughter thinking that it was legitimate and permissible to do so.  He therefore had no intention to breach the injunction order based on this advice, which is in effect (submitted by Mr Manzoni) a mistake of fact.

50.  I find this explanation similarly incredible and reject the same.  

51.  First, the defendant’s further case that he caused the transfer of the shares as he was advised to separate his own asset from his family members’ in light of the pending divorce is premised fundamentally on the allegation that the shares belonged to the daughter. However, given my above rejection of the defendant’s case and my conclusion that that the shares were in fact part of the plaintiff’s assets and did not belong to the daughter at the time of the May 2011 transfer, this further case simply cannot stand and is clearly incredible, which should also be rejected.

52.  Second and in any event, I also reject the defendant’s evidence that he had in fact sought the advice from BPYA as alleged.  My reasons are as follows:

(1)  It is entirely illogical and thus incredible that the defendant had sought the alleged advice from BPYA:  It is the defendant’s own case that the shares belonged beneficially to the daughter after he gave them to her as a gift in January 2010.  It is also the defendant’s own case that, in light of the divorce, he had been advised by his lawyers in the Mainland to separate his assets from those of his family members.  That was the reason why he wanted to transfer the shares back to the daughter.  Thus, in the defendant’s own case, he would have no doubt that the shares were the daughter’s and not his assets. In the premises, it must be clear to him that the intended transfer would not (in his own case) infringe the injunction order.  There was therefore simply no reason and no need for him to further consult BPYA (which is a firm of Hong Kong lawyers) as to whether he could transfer those shares to the daughter in light of the injunction order.  It must be noted that it is not the defendant’s case or evidence that he could not understand that the injunction order relates only to his assets. The illogicality is even more so when the defendant says what he asked BPYA was whether he could transfer the position of the legal representative of Chanitex (but not the shareholding) to the daughter, which has nothing to do with his assets and thus unrelated to the injunction. 

(2)  The incredibility of the defendant’s case is further underlined by (a) the vagueness of the defendant’s allegation on seeking the advice.  It is pertinent to note that the defendant has not even identified in his affirmation the name of the solicitor of BPYA who had allegedly given him the advice and whether the advice was given orally or in writing, and (b) the lack of any supporting evidence[5] from BYPA to confirm that such an advice had been given.  It is difficult to understand why no such supporting evidence has been adduced if such an advice had in fact been given by a solicitor from BPYA. 

53.  Moreover, even if (which I have already rejected above) the defendant had received such an advice, I further accept the plaintiff’s submissions that no weight should be attached to it.  In my view, in light of the evidence before me, in particular, given the lack of any written record or evidence in support of the content of the advice, and the wholly unnecessary convoluted and indirect way the question was asked in relation to the advice (ie, whether it was permissible to change the legal representative of Chanitex instead of whether it was permissible to transfer the shares), I have no doubt that this was done by the defendant solely to create an excuse to transfer the shares despite of the injunction order.  As said by Lawrence Collins QC (sitting as a deputy High Court Judge) in Parker v Rasalingham[6] (a case where the defendant in breach of an injunction claimed by mitigation that they had acted upon legal advice) that:

“…no weight should be attached to [the legal advice] since the advice was nowhere recorded, it was based upon instructions which had no factual basis and it was not a case where the defendant had a genuine belief in the correctness of legal advice which later turned out to be untrue.”

54.  For the above reasons, I reject this ground and do not find the defendant’s breach of the injunction order excusable.

C3.3 Is the defendant guilty of contempt

55.  In the premises, I am satisfied that it has been proved beyond reasonable doubt that the defendant has breached the injunction order and is guilty of contempt.

C3.4 Penalty

56.  The plaintiff has asked the defendant be committed to prison for his contempt. 

57.  Contempt of civil court orders is a serious matter. As observed by Chu J (as Her Ladyship then was) in Questnet Ltd v Wilfred Royce Lane[7] at paragraph 4, the primary consideration in sentencing contempt is the signal importance of demonstrating to litigants that orders of the Court are to be obeyed.

58.  Further, the purpose of a Mareva injunction is to protect the integrity of the Court’s processes and flagrant breaches of it should be met with an immediate term of imprisonment.  In this respect, the English Court of Appeal in Pospichal v Phillips[8] has emphasised the importance in ensuring that the public and the litigating parties are made to be aware of the seriousness of obeying court orders and in particular Mareva junctions:

“…the plaintiff is not the only interested party. The public is an interested party, because it is and it should be known that it is of the highest importance that orders as serious as Mareva injunctions made by the court are there to be obeyed and not flouted…”

59.  Further, in JSC BTA Bank v Solodchenko [2012] 1 WLR 350 after reviewing a line of first instance authorities, Jackson LJ said at paragraphs 51 and 55 that normally a custodial sentence measured in months should be imposed for a deliberate breach of disclosure provision of a freezing order:

“51. … any deliberate and substantial breach of the restraint provisions or the disclosure provisions of a freezing order is a serious matter. Such a breach normally attracts an immediate custodial sentence which is measured in months rather than weeks and may well exceed a year.”

“55…

(i) Freezing orders are made for good reason and in order to prevent the dissipation or spiriting away of assets. Any substantial breach of such an order is a serious matter, which merits condign punishment.

(ii) Condign punishment for such contempt normally means a prison sentence. However, there may be circumstances in which a substantial fine is sufficient: for example, if the contempt has been purged and the relevant assets recovered.

(iii)  …”

60.  In my view, Jackson LJ’s above observations on sentence for contempt apply equally if not with greater force in relation to breaches of a freezing or injunction order itself.

61.  Hong Kong authorities have also shown that the normal penalty for breaches of injunction orders is imprisonment measured in months: Banca Popolare di Vicenza Soc Coop v Alutech (Far East) Co Ltd[9] (the contemnor was sentenced to 6 months of imprisonment for breach a Mareva injunction and Questnet Ltd, supra (where the contemnor was sentenced to 3 months for breaching a Mareva injunction).

62.  I accept the above principles.  In my view, subject to any mitigating factors, the primary and starting penalty for the defendant’s contempt of court in breaching the injunction order in the present case is custodial sentence.

63.  Are there any mitigating factors in the present case?

64.  Mr Manzoni for the defendant submits that there should be no imprisonment since the defendant has offered to restore the position.

65.  The “offer” to restore the position by the defendant is set out at paragraphs 22 and 23 of the defendant’s affirmation as follows:

“22. As matters presently stand, my daughter is currently the sole shareholder of Chanitex Industrial, and will remain so. My daughter is willing to provide an undertaking to this Honourable Court not to transfer her shareholding ofChanitex Industrial pending the resolution of AOS’ arbitration claim against me.

23. Alternatively, if this Honourable Court were to so direct, my daughter is willing to transfer the shareholding of Chanitex Industrial back to me, and I shall undertake not to further transfer the shareholding of Chanitex Industrial pending the resolution of AOS’ arbitration claim against me.”

66.  In my view, the said offer does not amount to a mitigating factor:

(1)  The offer itself does not amount to purging the contempt as nothing has been done to restore the breach.

(2)  Further, there is no evidence from the daughter to suggest or confirm that she is willing to so transfer the shares.  In fact, the offer, in requiring the court to make an order directing the daughter to do so, suggests that she is not prepared to transfer the shares back to the defendant voluntarily and willingly.  Without the daughter’s willingness to do so, it makes the effectiveness of any such court order also doubtful as she is not a party to these proceedings and is not residing in this jurisdiction.

(3)  If, however, it is the defendant’s case that the daughter is willing to do so herself, then the offer comes too late at this stage, as it would then have been fully within the defendant’s power to act earlier to purge the contempt if he seriously and genuinely intended to do so. 

67.  I therefore do not find any mitigating factors in this case that justify imposing a non-custodial sentence instead of imprisonment.

68.  In other words, paying regard to the principles I have set out above, I find a prison sentence appropriate for the defendant’s contempt in breaching the injunction order.

69.  After taking into account of the circumstances of the present case, in particular that the defendant’s flagrant breach of the injunction, his lack of remorse and failure to purge the contempt despite the length of the time between the initial breach (May 2011) and this hearing (March 2012), I am of the view that the appropriate sentence would be a term of imprisonment of 3 months.

D.   CONCLUSION

70.  I find that the defendant is guilty of contempt for dealing with his assets in breach of the injunction order, and I further order that he be committed to prison for 3 months.

71.  There is no reason why costs should not follow the event.  I would further make an order nisi that costs of this committal be to the plaintiff on an indemnity basis, which is the usual order in a successful committal procedure[10].  Unless any of the parties applies to vary it, the order shall be made absolute 14 days from today.