CHINA FORESTRY HOLDINGS CO LTD (in official liquidation) v. TOP WISDOM OVERSEAS HOLDINGS LTD AND ANOTHER

HCA 1089/2016

[2021] HKCFI 2761

IN THE HIGH COURT OF THE

HONG KONG SPECIAL ADMINISTRATIVE REGION

COURT OF FIRST INSTANCE

ACTION NO 1089 OF 2016

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J U D G M E N T

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Introduction

1.  This is the hearing of paragraph 1 of the Defendants’ summons dated 9 July 2018 (“Summons”)  seeking to strike out parts of the Statement of Claim annexed thereto underlined in red[1] as disclosing no reasonable cause of action.

Background

2.  The Plaintiff was a company incorporated in the Cayman Islands in December 2007.  At all material times, it was the holding company of the China Forestry group of companies (“Group”)  which engaged in a business involving the management and development of forests, the harvest of forest resources and the sale of logs mainly in the PRC. 

3.  In December 2009, the Plaintiff’s shares were listed on the Main Board of the Hong Kong Stock Exchange (“HKSE”)  pursuant to an initial public offering (“IPO”). 

4.  The 2^nd Defendant (“Li”)  was an executive director and CEO of the Plaintiff when it was listed in 2009.  After KPMG had identified the irregularities in the 2010 Audit referred to below, he was removed from his positions as the CEO and the executive director in February 2011 and February 2012 respectively. 

5.  Li is the sole shareholder of the 1^st Defendant (“Top Wisdom”).  Li, through Top Wisdom, was a substantial shareholder of the Plaintiff, holding approximately 6.34% of the Plaintiff’s shares up to 12 January 2011. 

6.  On 12 January 2011, Li procured Top Wisdom to enter into a placing agreement with Standard Chartered Securities (Hong Kong)  Limited to dispose of an aggregate of 119 million Plaintiff’s shares for a consideration of more than HK$398 million (“January Share Sale”).

7.  On 25 January 2011, the Plaintiff’s auditor, KPMG, reported to the Board a number of irregularities in the financial year ended 31 December 2010 (“2010 Audit”).  This led to the suspension of trading of the Plaintiff’s shares on 26 January 2011.[2] 

8.  On 2 February 2011, the SFC obtained an ex parte interim injunction freezing assets held by Top Wisdom in a UBS bank account, which represented the approximate proceeds of the January Share Sale.

9.  On 18 June 2015, the Plaintiff was wound up by the Grand Court of the Cayman Islands and liquidators were appointed (“Liquidators”).[3] 

10.  On 25 April 2016, the Plaintiff commenced the present proceedings.  The Writ was served on the Defendants in June and July 2017.  The Plaintiff subsequently served its Statement of Claim on 30 April 2018.  The deadline for service of the Defence and Counterclaim was extended by consent to 9 July 2018, the day when the Defendants issued the Summons. 

The Plaintiff’s case

11.  The Plaintiff commenced the present action on the basis that Li, in breach of his fiduciary duties owed to the Plaintiff and for his own personal benefit, orchestrated a scheme (“Scheme”)  to cause the Plaintiff and/or its subsidiaries to engage in false transactions and false accounting, resulting in

(1)  the overstatement of the assets, revenues and profitability of the Group, and

(2)  the misstatements of the Group’s expenses,

in the Plaintiff’s prospectus, the 2008 consolidated financial statements, the 2009 interim financial statements, the 2009 consolidated financial statements and the 2010 interim financial statements. 

12.  The effect of the Scheme was to create the false impression that the Group was more profitable and valuable than it actually was, thereby inflating the price of the Plaintiff’s shares. 

13.  With the knowledge of the Scheme and the inflation of the price of the Plaintiff’s shares, Li carried out the following transactions for his personal benefit:

(1)  On 25 June 2009, Li caused Top Wisdom to dispose of 130,434 of the Plaintiff’s shares prior to the Plaintiff’s IPO for US$1,499,991 (“Pre-IPO Proceeds”). 

(2)  In June 2010, Top Wisdom received dividends from the Plaintiff in the sum of RMB10,019,430 (“Top Wisdom Dividend”).

(3)  On 12 January 2011, Li caused Top Wisdom to dispose of 119,000,000 of the Plaintiff’s shares for HK$398,650,000 (“Post-IPO Proceeds”). 

14.  It is the Plaintiff’s case that Li, through Top Wisdom, obtained the Pre-IPO Proceeds, Post-IPO Proceeds and Top Wisdom Dividend as a result of his fiduciary position or pursuant to an opportunity resulting from that fiduciary position.  The Plaintiff claims that the Defendants hold the Pre-IPO Proceeds, the Post-IPO Proceeds and the Top Wisdom Dividend on constructive trust for the Plaintiff. 

Deliberation

15.  The present application concerns only the alleged constructive trust over the Pre-IPO Proceeds and the Post-IPO Proceeds (“Proceeds”). 

16.  According to the Defendants, central to the present application is a distinct legal question viz whether proprietary relief by way of a constructive trust in the proceeds of a director’s sale of his own shares in the company is available to the company on the ground that fraud was committed by that director in order to enhance the apparent value of the shares. The Defendants submit that the alleged constructive trust over the Proceeds is entirely misconceived as a matter of law.

Principles on striking out

17.  The applicable legal principles are uncontroversial: the Court would only exercise the power to strike out the plaintiff’s Statement of Claim for disclosing no reasonable cause of action in a plain and obvious case, where the claim must be obviously unsustainable, the pleadings must be unarguably bad and it must be impossible, not just improbable, for the claim to succeed.

18.  In Ha Francesca v Tsai Kut Kan & Ors (No 1) [1982] HKC 382 at 392F-H, Silke JA observed:

“ … striking out should only be done in plain and obvious cases, there should be no trial upon affidavit. Disputed facts are to be taken in favour of the party sought to be struck out. The claim must be obviously unsustainable, the pleadings unarguably bad and that it be impossible, not just improbable, for the case to succeed before a court will strike out. If the court does not think the matter to be clear beyond doubt or if it fails to be satisfied that there is no reasonable cause of action or that the proceedings are frivolous or vexatious, then, there should be no striking out. One must be careful not to drive a plaintiff from the judgment seat nor should the court decide difficult points of law in proceedings such as this.” (emphasis added)

Proprietary relief by way of a constructive trust

19.  Mr Manzoni SC submits and this court agrees that, in this area of law, the leading authority is undoubtedly the seminal decision of FHR European Ventures LLP v Cedar Capital Partners LLC [2015] AC 250. 

20.  In that case, the second defendant was acting for the purchasers in the negotiation for the purchase of a hotel and successfully concluded the purchase.  Unknown to the purchasers, the second defendant was contractually entitled to receive and did receive a commission from the owner of the hotel.  On discovering that the commission had been paid, the purchasers/claimants issued proceedings seeking recovery of that sum, alleging that it constituted a secret profit.  At issue was whether the claimants were entitled to a declaration that the second defendant had received the commission on constructive trust for the claimants absolutely.  The Supreme Court held that where an agent acquired a benefit which came to his notice as a result of his fiduciary position, or through an opportunity resulting from that position, the general equitable rule was that he was to be treated as having acquired the benefit on behalf of his principal, so that the benefit was owned by the principal who had a proprietary as well as personal remedy against the agent.

21.  At [7], Lord Neuberger of Abbotsbury PSC formulated the general equitable rule as follows:

“ … The agent’s duty to account for the bribe or secret commission represents a personal remedy for the principal against the agent. However, the centrally relevant point for present purposes is that, at least in some cases where an agent acquires a benefit which came to his notice as a result of his fiduciary position, or pursuant to an opportunity which results from his fiduciary position, the equitable rule (‘the rule’)  is that he is to be treated as having acquired the benefit on behalf of his principal, so that it is beneficially owned by the principal. In such cases, the principal has a proprietary remedy in addition to his personal remedy against the agent, and the principal can elect between the two remedies.” (emphasis added)

22.  The rationale of the rule can be gleaned from [30] of the judgment. 

“ 30 The respondents’ formulation of the rule, namely that it applies to all benefits received by an agent in breach of his fiduciary duty to his principal, is explained on the basis that an agent ought to account in specie to his principal for any benefit he has obtained from his agency in breach of his fiduciary duty, as the benefit should be treated as the property of the principal, as supported by many judicial dicta including those in para 19 above, and can be seen to be reflected in Jonathan Parker LJ’s observations in para 14 above. More subtly, it is justified on the basis that equity does not permit an agent to rely on his own wrong to justify retaining the benefit: in effect, he must accept that, as he received the benefit as a result of his agency, he acquired it for his principal. Support for that approach may be found in Mellish LJ’s judgment in McKay’s Case 2 Ch D 1, 6, and Bowen J’s judgment in Whaley Bridge 5 QBD 109, 113.”

23.  At [10], Lord Neuberger recited a contention by counsel for the second defendant which did not find favour with his Lordship. 

“ 10 On the one hand, Mr Collings QC contends for the appellant, Cedar, that the rule should not apply to a bribe or secret commission paid to an agent, because it is not a benefit which can properly be said to be the property of the principal. This has the support of Professor Sir Roy Goode, who has suggested that no proprietary interest arises where an agent obtains a benefit in breach of his duty unless the benefit either (i)  flows from an asset which was (a)  beneficially owned by the principal, or (b)  intended for the principal, or (ii)  was derived from an activity of the agent which, if he chose to undertake it, he was under an equitable duty to undertake for the principal. Sir Roy suggested that ‘to treat [a principal] as having a restitutionary proprietary right to money or property not derived from any asset of [the principal] results in an involuntary grant by [the agent] to [the principal] from [the agent’s] pre-existing estate’: ‘Proprietary Restitutionary Claims’ in Restitution: Past, Present and Future (1998)  ed Cornish, p 69 and see more recently (2011)  127 LQR 493. …” (emphasis added)

24.  That contention, in particularly the suggestion of Professor Sir Roy Goode, is strikingly similar to the Defendants’ 1^st Ground for striking out at section E1 of their skeleton submissions.  In section E1, the Defendants submit that (i)  Li, through Top Wisdom, acquired the relevant Plaintiff’s shares from Kingfly Capital Limited on 31 March 2008 for a consideration of US$32 million, (ii)  there is nothing in the Statement of Claim which contains a legitimate basis for the Plaintiff to assert a constructive trust over those shares, (iii)  hence, Top Wisdom held the relevant Plaintiff’s shares in its own right as full beneficial owner, and (iv)  absent any legitimate claim of proprietary interest over those shares, there is no basis for the Plaintiff to mount a proprietary claim over the sale proceeds of the shares.

25.  No authority has been cited by the Defendants in support of proposition (iv)  above which is just a bare assertion of the law by them.  However, as can be seen from [10] of the FHR judgment quoted above, it has the support of Professor Sir Roy Goode who suggested that no proprietary interest arises where an agent obtains a benefit in breach of his duty unless inter alia the benefit flows from an asset which was beneficially owned by the principal.  That suggestion was not accepted by Lord Neuberger.

26.  Specifically, proposition (iv)  is contrary to what Anderson Chow J (as he then was)  has ruled in Tang Ying Loi v Tang Ying Ip [2015] 1 HKLRD 712 at [100 (3)] at which his Lordship endorsed the view that FHR shows that a constructive trust may be imposed even though the benefit (i) does not flow from an asset which was (a) beneficially owned by the principal, or (b) intended for the principal, or (ii) was not derived from an activity of the agent which, if he chose to undertake it, he was under an equitable duty to undertake for the principal.

27.  In view of the above, this court is not persuaded that the Defendants’ submission based on proposition (iv)  renders the Plaintiff’s proprietary claim over the Proceeds plainly unsustainable and obviously bad.  The Defendants’ 1^st Ground for striking out must be rejected.

28.  On the facts, FHR was a case about secret commission, a point heavily and repeatedly emphasised by the Defendants in seeking to distinguish FHR from the present case.  However, if one examines the judgment of FHR carefully, there is no indication that Lord Neuberger intended the general equitable rule to be restricted to cases of secret commission (or bribes for that matter).  On the contrary, there are indications all over the judgment which suggest the general equitable rule applies to all kind of unauthorised benefits received by a fiduciary.

29.  At [13], his Lordship referred to a number of decided cases without any hint of disapproval:

“ 13 There is a number of 19^th century cases not involving bribes or secret commissions, where an agent or other fiduciary makes an unauthorised profit by taking advantage of an opportunity which came to his attention as a result of his agency and judges have reached the conclusion that the rule applied. Examples include Carter v Palmer (1842)  8 Cl & Fin 657, where a barrister who purchased his client’s bills at a discount was held by Lord Cottenham to have acquired them for his client. The Privy Council in Bowes v City of Toronto (1858)  11 Moo PC 463 concluded that the mayor of a city who bought discounted debentures issued by the city was in the same position as an agent vis-à-vis the city, and was to be treated as holding the debentures on trust for the city. …” (emphasis added)

30.  Similarly, at [18] and [19], Lord Neuberger made the observation that many of the cases his Lordship referred to support the contention that the general rule applies to all benefits which are received by an agent in breach of his fiduciary duty:

“ 18 It is fair to say that in the majority of the cases identified in the previous five paragraphs it does not appear to have been in dispute that, if the recipient of the benefit had received it in breach of his fiduciary duty to the plaintiff, then he held it on trust for the plaintiff …

19 However, many of those cases contain observations which specifically support the contention that the rule applies to all benefits which are received by an agent in breach of his fiduciary duty. In Sugden 3 Sm & G 192, 194, Stuart V-C said that ‘it is a well-settled principle that, if a trustee make a profit of his trusteeship, it shall enure to the benefit of his cestui que trusts’. And in McKay’s Case2 Ch D 1, 5, Mellish LJ said that it was ‘quite clear that, according to the principles of a Court of Equity, all the benefit which the agent of the purchaser receives under such circumstances from the vendor must be treated as received for the benefit of the purchaser’. …” (emphasis added)

31.  Lastly, at [33], Lord Neuberger expressly approved the proposition adopted by the claimants as follows:

“ 33 The position adopted by the respondents, namely that the rule applies to all unauthorised benefits which an agent receives, is consistent with the fundamental principles of the law of agency. The agent owes a duty of undivided loyalty to the principal, unless the latter has given his informed consent to some less demanding standard of duty. The principal is thus entitled to the entire benefit of the agent’s acts in the course of his agency. …” (emphasis added)

32.  The Defendants’ 2^nd Ground for striking out is set out in section E2 of their skeleton submissions at paragraph 25 ie the Plaintiff’s claim for a proprietary interest over the Proceeds is unsupported by established principles in equity.  In support of that submission, at paragraph 29, the Defendants refer to the English Court of Appeal decision in Sinclair Investments (UK)  Ltd v Versailles Trade Finance Ltd[2012] Ch 453, in particular what Lord Neuberger expressed in [88] & [89]:

“ 88 In my view, Lewison J was right to reject TPL’s proprietary claim to the proceeds of sale of the shares. It is true that the decisions in the Reid case [1994] 1 AC 324, Sugden v Crossland 3 Sm & G 192 and (at least arguably)  Pearson’s Case5 Ch D 336 go the other way. However, there is a consistent line of reasoned decisions of this court (two of which were decided within the last ten years)  stretching back into the late 19^th century, and one decision of the House of Lords 150 years ago, which appear to establish that a beneficiary of a fiduciary’s duties cannot claim a proprietary interest, but is entitled to an equitable account, in respect of any money or asset acquired by a fiduciary in breach of his duties to the beneficiary, unless the asset or money is or has been beneficially the property of the beneficiary or the trustee acquired the asset or money by taking advantage of an opportunity or right which was properly that of the beneficiary.

89 For the reasons I have given, previous decisions of this court establish that a claimant cannot claim proprietary ownership of an asset purchased by the defaulting fiduciary with funds which, although they could not have been obtained if he had not enjoyed his fiduciary status, were not beneficially owned by the claimant or derived from opportunities beneficially owned by the claimant. …” (emphasis added)

33.  At paragraphs 31, 33 and 35, the Defendants submit that (i)  Sinclair was only partially overruled by the UK Supreme Court in FHR insofar as bribes or secret commissions were concerned, (ii)  the discussion in FHR of the “rule” in equity was confined to the question of the availability of a proprietary remedy specifically over the bribe or secret commission taken by an agent when exploiting an opportunity arising from his fiduciary position, and (iii)  Sinclair remains a sound authority for the principle that a fiduciary’s gain/profit from criminal activities (except for bribe or secret commission)  is not held on trust for the principal, because such gain/profit does not arise from opportunities beneficially owned by the principal.

34.  With respect, for reasons already explained in paragraphs 28 to 31 above, this court does not agree that the discussion in FHR of the “rule” in equity was confined to cases of bribe or secret commission.  At least, it is arguable that the discussion in FHR of the “rule” was not so restrictive as the Defendants submit.  Further, if one compares the formulation of the “rule” at [7] of FHR with the formulation of the principle at [88] and [89] of Sinclair, one can see that the two formulations cannot both be right, or at least it is arguable that they cannot both be right. 

35.  Lastly, as Mr Manzoni SC points out, the Court of Appeal in Sinclair have dealt with the case as though it were concerned with bribes.  At [55] and [56], Lord Neuberger observed:

“ 55 Both the judgment below and the arguments before us focused on cases where the courts have had to consider whether, where an agent or employee accepts a bribe or secret commission or the like, his principal or employer beneficially owns the bribe. As in the present case, the money in such cases was received by a fiduciary and, although its receipt derived from his fiduciary position and was a plain breach of his fiduciary duties, it was not money which was part of the assets subject to his duties, or derived from such assets.

56 I am prepared to accept for present purposes that, if a claimant beneficially owns a bribe received by a fiduciary, it follows that TPL’s proprietary claim to the proceeds of sale of the shares must succeed. None the less it is worth pointing out that a fiduciary who accepts a bribe receives it directly because of his fiduciary function, e g as the principal’s agent, in order to induce him to place a contract for the principal with the bribe payer. Not only did Mr Cushnie not acquire the shares with, or as a result of, his breach of duty as director of TPL, but the profit which he made on the shares was as a shareholder in VTFL (indirectly through VGP)  not as a director of TPL. Having pointed out that distinction I can well see that, for practical as well as principled reasons, the proceeds of sale of the shares, as an unauthorised secret profit, should be treated for present purposes in the same way as a bribe.” (emphasis added)

36.  Hence, for the sake of argument, even if the “rule” laid down in FHR is only confined to cases of bribe, it is at least arguable that Sinclair can no longer be regarded as a sound authority, in light of FHR. 

37.  For the above reasons, the Defendants’ 2^nd Ground for striking out is also rejected.  This court is of the view that, on the present state of the law, the Plaintiff has at the very least an arguable proprietary claim over the Proceeds.

38.  The Defendants’ 3^rd Ground for striking out can be found in section E3 of their skeleton submissions.  At paragraphs 37 and 38, the Defendants submit that (i)  if the Plaintiff’s assertions in the Statement of Claim were to be established, Top Wisdom/Li’s disposal of the relevant Plaintiff’s shares after the IPO would constitute insider dealing for the purpose of section 270 of the Securities and Futures Ordinance, Cap 571 (“SFO”), (ii)  the SFC can apply under section 213(2)(b)  of the SFO for a restoration order against the insider dealer/fiduciary to restore the parties to the relevant transactions to the position before they were entered into, (iii)  the Market Misconduct Tribunal (“MMT”), upon the finding of insider dealing, can order disgorgement of profit pursuant to section 257(d)  of the SFO, and (iv)  other persons who have sustained pecuniary loss as a result of the insider dealing are entitled to seek compensation under section 281 of the SFO. 

39.  On the basis of the above, the Defendants submit at paragraph 41 that, in the present case, to declare a constructive trust over the Proceeds in favour of the Plaintiff would unjustly elevate its interest to a level above those purchasers of the relevant shares or other persons who have sustained pecuniary loss and are entitled to claim compensation under section 281 of the SFO.  The Defendants conclude at paragraph 42 that:

“… The injustice so occasioned is itself a cogent illustration of the obvious fallacy in P’s claim of a proprietary interest over the Post-IPO proceeds.”

40.  With respect, the Defendants’ submission at paragraph 41 of their skeleton submissions is irrelevant for the purpose of deciding whether the Plaintiff’s proprietary claim over the Post-IPO proceeds should be struck out.  The submission, taken to its highest, is a factor to be considered in determining the Plaintiff’s proprietary claim over the Post-IPO proceeds.  The Defendants’ conclusion at paragraph 42 is a non sequitur. 

41.  In this Action, this court is only concerned with the rights and liabilities between the Plaintiff and the Defendants inter se.  This court is not concerned with the yet to be established liabilities of the Defendants under the SFO or the yet to be established remedies available to the SFC, the MMT or any other persons as a result of the alleged insider dealing.  The time may or may not come when, for instance, the SFC will assert a competing claim over the Proceeds vis-a-vis the Plaintiff.  It is clearly premature at this stage to conjecture that that time will definitely come and the SFC’s competing claim must prevail over the Plaintiff’s asserted proprietary claim over the Proceeds.

42.  For these reasons, this court is not satisfied that the so-called “injustice” illustrates the obvious fallacy of the Plaintiff’s claim of a proprietary interest over the Post-IPO proceeds.  The Defendants’ 3^rd Ground for striking out must also be rejected.

43.  To conclude, this court is not satisfied that the Plaintiff’s proprietary claim over the Proceeds is so obviously unsustainable that it is impossible to succeed.

Disposition and costs order nisi

44.  Paragraph 1 of the Summons is hereby dismissed.

45.  There shall be an order nisi that costs of and occasioned by the application be to the Plaintiff, to be taxed if not agreed, and paid by the Defendants forthwith, certificate for Leading Counsel.

46.  Since Mr Melwani is not a counsel, it is inappropriate to give certificate for counsel for his assistance in this case. In accordance with the practice endorsed in China Forestry Holdings Co Ltd (in Official Liquidation)  & Ors v KPMG unrep, HCCL 9 of 2019, 27 May 2021, Anthony Chan J, this court hereby certifies that the attendance of Mr Melwani together with Mr Manzoni SC at the hearing was justified for the purpose of taxation.