VERON INTERNATIONAL LTD v. RCG HOLDINGS LTD AND ANOTHER

HCMP 3210/2013

IN THE HIGH COURT OF THE

HONG KONG SPECIAL ADMINISTRATIVE REGION

COURT OF FIRST INSTANCE

MISCELLANEOUS PROCEEDINGS NO 3210 OF 2013

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J U D G M E N T

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Introduction

1.  This is the application of Veron International Limited (“Veron”) by originating summons filed on 28 November 2013 for leave under section 168BC of Companies Ordinance, Cap. 32 (“CO”) to commence proceedings (“Intended Action”) in the name of the 1^st Respondent (“Holdings”) and the 2^nd Respondent (“China”) against ten  former directors of Holdings (“Former Directors”). Among the Former Directors, five of them were also directors of China viz Chu Wai Man Raymond (“Chu”), Chau Pak Kun Anita (“Chau”), Dato Lee Boon Han (“Lee”), Ying Kan Man Lawrence (“Ying”) and Chong Khing Chung (“Chong”).

2.  The application is opposed by Holdings and China.

Background

3.  Holdings is a company incorporated in Bermuda and was first listed on the AIM (Alternative Investment Market) of the London Stock Exchange in July 2004 and on the PLUS Stock Exchange in London in June 2007. On 10 February 2009, Holdings was listed on the main board of the Hong Kong Stock Exchange by way of introduction.

4.  China is a company incorporated in the BVI and a wholly‑owned subsidiary of Holdings.

5.  Veron was at one time the single largest shareholder of Holdings.  Between 2005 and 2007, it acquired a substantial shareholding in the company, reaching more than 27%. As at 27 November 2013, Veron held 7.86% of the issued share capital of Holdings.

6.  The present application is in a sense a “continuation” of proceedings in HCMP No. 343 of 2011 and CACV No. 126 of 2012 (“Discovery Proceedings”) wherein Veron successfully obtained an order under section 152FA of CO for inspection of Holdings’ documents relating to its investments, via China, in two BVI companies viz. Vast Base Technology Limited (“VB”) and Strong Aim Limited (“SA”). VB was incorporated in the BVI on 30 July 2007 while SA was incorporated in the BVI on 16 October 2008.

7.  Both VB and SA were said to be involved in Radio Frequency Identification (“RFID”) technology, a technology for data acquisition by way of radio frequency between transponders and a host system. For ease of comprehension, the RFID technology in most common use in Hong Kong is the Octopus system.

8.  Between 5 December 2007 and 15 November 2008, China acquired 80% of the issued share capital of VB for a total cash consideration of about HK$734.8 million pursuant to three share purchase agreements:

(1) dated 5 December 2007, under which China acquired 19.9% of the issued share capital of VB for HK$120 million (“1^st VB Share Agreement”);

(2) dated 15 May 2008, under which China acquired a further 40.1% of the issued share capital of VB for HK$410.2 million (“2^nd VB Share Agreement”); and

(3) dated 15 November 2008, under which China acquired a further 20% of the issued share capital of VB for HK$204.6 million (“3^rd VB Share Agreement”).

9.  In November 2011, China disposed of all the VB shares for HK$50,000.

10.  By two share purchase agreements both dated 24 April 2010 (“SA Share Agreements”), China acquired a total of 70% of the issued share capital in SA for a consideration of HK$185 million, comprising HK$37 million in cash and the rest in Holdings shares.

11.  In March 2012, China disposed of all the SA shares for HK$3,000. 

12.  Although the two investments were acquired in the name of China, it cannot be seriously in dispute that the ultimate decision to make the investments was made by the board of Holdings. The board of China, no doubt, also approved of the investments and proceeded to implement them. In both cases, China financed its acquisitions by loans from Holdings. With the disposal of the VB and SA shares for next to nothing, these loans were effectively written off.

13.  As pointed out by the Court of Appeal in its decision in CACV No. 126 of 2012 (“CA Decision”):

“The Applicant’s case

8.1 According to [Veron], it sought inspection of [Holdings’] records relating to the acquisition of these two investments, not only because of the substantial losses made and their disposal (which came after the proceedings commenced), but also because of certain matters (discussed below) which led to a reasonable suspicion that the Company’s directors had failed to perform their duties to the Company when they decided to make these investments.

8.2 For convenience, this has been referred to as the “directors’ due diligence” point. It should however be noted that it is common ground that there is no established definition of the term “due diligence”. One must therefore be careful when using the term.

8.3 The Company says “due diligence” had been performed by a firm of Malaysian lawyers before the Company acquired VB, and by a firm of PRC lawyers before it acquired SA.

8.4 However what the applicant means by that term in the present case is an exercise that the directors should have undertaken to assess the risks and verify matters which were material to the decision whether to acquire shares in VB and SA. The applicant says that it has a reasonable suspicion that the directors had not performed that duty…

….

28. The learned judge also held that the applicant had failed to satisfy the 2^nd condition [ie the inspection applied for is for a proper purpose] because the Listing Document had disclosed that an independent valuation had been performed prior to acquisition.

29.1 However it is clear that the valuation had been performed on the basis of various assumptions (p.74 of the Listing Document). Certain information had been reviewed by the valuers, but would not have been verified by them (p.75).

29.2 More importantly, the valuations were made on the basis of the “income approach”, ie the value of the contracted income under the contracts to which VB was party. VB itself had only been incorporated five months before the Company acquired a substantial holding. As for the income expected, the source were the distributorship agreements VB had with Bellson, Top Venture and THJ, companies with no long term track record with VB and which had been interposed between VB and the end‑users.

29.3 The risk was recognized by the Company at the time of the Listing Document, hence the following statement in the section on Risk Factors:

‘[VB] had four customers in total and had entered into long term contracts with three of them. ... If any of these customers fails to fulfil its obligations under these long term supply contracts, ... [VB’s] business may be adversely affected, and in turn, the group’s business, operating results and financial conditions may be materially and adversely affected.’

29.4 Put simply, VB’s business to a large extent would only be as good as their distributors.

29.5 The crux is whether the directors had recognized this risk before the Company acquired VB and had made a proper assessment of the risk…It is noted that according to the Company’s announcement of 19 December 2012, ‘the recoverability of trade debts owed by customers [presumably meaning the distributors] was considered doubtful and had to be fully provided for’. The Listing Document did not disclose who were the ultimate beneficial owners of these distributors, nor whether any attempts had been made to see if the distributors were backed up by substantial parent companies, or if they were not, whether personal guarantees were obtained from the ultimate beneficial owners or indeed anyone else. Not surprisingly the applicant wishes to know whether the Company assessed and verified these matters before investing $734 million in VB.

….

30.1 The Company’s case is simply that “due diligence” had been performed by a firm of Malaysian lawyers.

30.2 As noted earlier, the term “due diligence” does not have an established definition. There is no evidence before the court on the instructions given to the Malaysian lawyers. Nor is there evidence on the exercise they performed. It may, or may not, have been simply what might be called a “legal audit”, ie only checking that legal documentation is in place.

30.3 Hence that does not provide an answer to the questions posed in [29.5] above.

….

33. In conclusion I take the view that, with respect to the learned Judge, the applicant has made out a reasonable case that there was a need to investigate what had or had not been done by the directors to safeguard the interests of the Company prior to its acquisition of VB, and inspection of the Company’s records was sought for this proper purpose.

SA

34. As for SA, the applicant’s case against the Company is less strong but it was in a similar line of business, the business model was similar, the assumptions made in the valuation were similar, the same income approach was taken in the valuation, the same risk factors were present, SA was also recently incorporated before the Company’s acquisition, there is a similar dearth of information regarding its customers, nothing is known of the scope of the “due diligence” undertaken by the firm of PRC lawyers and similarly a very substantial loss was made by the Company on disposal. In my view, the application for inspection of the Company’s records on the SA acquisition was also for a proper purpose.”

14.  In summary, the Court of Appeal was of the view that there was a serious question whether the Former Directors had conducted reasonable due diligence before deciding to invest in the two BVI companies and that Veron’s application for inspection of Holdings’ records on the two acquisitions was for a proper purpose.

15.  The “due diligence” documents disclosed by Holdings consisted of (i) a lawyers’ report on VB by Messrs Hisham Yoong K.C. Lim and another one on SA by Beijing Attange Law Firm; and (ii) four valuation reports by Vigers Appraisal and Consulting Limited. As expected, the lawyers only carried out legal due diligence and did not look into the commercial aspects of the investments. The valuations by Vigers did not take the matter much further than what the Court of Appeal said in its judgment quoted above. Veron considers that the due diligence documents reveal obvious negligence and breach of duty on the part of the Former Directors in that they have failed to perform any or any reasonable due diligence on the two companies’ business before deciding to invest in them.

16.  Hence the present application.

The Law

17.  Statutory derivative actions are covered by Part IVAA of the CO.

18.  Section 168BC(1) of CO states:

“(1) A member of a specified corporation or of a related company of a specified corporation may, with the leave of the court granted under subsection (3)—

(a) bring proceedings before the court on behalf of the specified corporation …”

19.  Section 168BA is the definition section. It provides inter alia that:

“related company”, in relation to a specified corporation, means -

(a) a subsidiary of the corporation;

(b) a holding company of the corporation; or

(c) a subsidiary of a holding company of the corporation.”

20.  Section 168BA was amended to its present form in 2010.  The amendments to it and to the subsequent sections in Part IVAA were designed to expand the scope of statutory derivative actions to cover “multiple” derivative actions so that a member not of the specified corporation but of a related company e.g. the holding company of the specified corporation may also be able to commence a statutory derivative action where the cause of action is vested in, and relief is sought on behalf of, the specified corporation. The combined effect of the amendments in 2010 is to place the statutory regime in line with the common law, as recommended by the Court of Final Appeal in Waddington Ltd v Chan Chun Hoo Thomas and Ors (2008) 11 HKCFAR 370: Re Li Chung Shing Tong (Holdings) Ltd. [2011] 5 HKLRD 274 at [17].

21.  Section 168BC(3) sets out the requirements that must be satisfied before leave is to be granted:

“(3) The court may, on the application of a member of a specified corporation or on the application of a member of a related company of a specified corporation, grant leave for the purpose of subsection (1) if the court is satisfied that—

(a) it appears to be prima facie in the interest of the specified corporation that leave be granted to the applicant;

(b) if the applicant is applying for leave to bring proceedings under subsection (1)(a), there is a serious question to be tried and the specified corporation has not itself brought the proceedings;

….

(d) except where leave is granted by the court under section 168BD(4), the member has served a written notice on the specified corporation in accordance with section 168BD.”

22.  It is common ground that in order for Veron to obtain leave to bring the proposed statutory derivative action on behalf of Holdings and China, it must satisfy all the conditions in subsection (3). For the present purpose, only the following two are material:

(1) Under subsection (3)(a), it appears to be prima facie in the interest of the specified corporation that leave be granted (“Interest of the Company Requirement”); and

(2) Under subsection (3)(b), there is a serious question to be tried and the specified corporation has not itself brought the proceedings (“Serious Question Requirement”).

23.  I shall consider the two requirements in reverse order. This is because, if the Serious Question Requirement cannot be met, it is difficult to see how it can be in the interest of the company concerned to commence proceedings which ex hypothesis are liable to be struck out: Cf Re Li Chung Shing Tong (Holdings) Ltd supra at [31].

Serious Question Requirement

24.  The Serious Question Requirement is of a “relatively low threshold”: Re F&S Express Ltd [2005] 4 HKLRD 743 at [21]; Re Grand Field Group Holdings Ltd [2009] 3 HKC 81 at [21]; Re Li Chung Shing Tong (Holdings) Ltd supra at [32]. At [33], Harris J observed:

“…in ascertaining whether or not there is a “serious question to be tried”, the prospects of the plaintiff’s success are to be investigated only to a limited extent, and the court should be slow to find against the plaintiff unless his prospects are so slim that he cannot be said to have any expectation of success. I am reminded, in this regard, of Megarry VC’s oft-cited explanation in Mothercare Limited v Robson Books Ltd [1979] FSR 466, in which he said, at 474:

‘… the prospects of the plaintiff’s success are to be investigated to a limited extent, but they are not to be weighed against his prospects of failure. All that has to be seen is whether the plaintiff has prospects of success which, in substance and reality, exist. Odds against success no longer defeat the plaintiff, unless they are so long that the plaintiff can have no expectation of success, but only a hope. If his prospects of success are so small that they lack substance and reality, then the plaintiff fails; for he can point to no question to be tried which can be called ‘serious’, and no prospect of success which can be called ‘real’.” (emphasis added)

25.  I agree and would gratefully adopt this approach.

26.  In considering this requirement, a convenient starting point is the draft Statement of Claim which identifies the causes of action Veron seeks to bring in the name of Holdings and China. The draft Statement of Claim can be summarized as follows.

27.  Before deciding to enter into each of the 1^st, 2^nd, and 3^rd VB Share Agreements in 2007 and 2008, the then directors [1]owed Holdings and China a duty (“duty of due diligence”) to exercise reasonable skill and diligence to make inquiries into, obtain information about, and assess (i) the reasons, advantages, disadvantages, benefits, and risks in VB’s business model of selling through distributors and, in particular, through the VB distributors; (ii) the commercial reasonableness, prospects, and sustainability of each of the VB contracts; (iii) the business strength, distribution networks, financial conditions, and creditworthiness of each of the VB distributors; (iv) each VB distributor’s relationship with the ultimate customers, the customers’ demands and the distributor’s ability to secure and on-sell to the existing and future customers at quantities and prices above the committed quantities and prices in the long term (“VB due diligence inquiries”).

28.  Each of the 2007 and 2008 Directors was negligent and in breach of his duty of due diligence in approving the VB Share Agreements. One aspect of the alleged negligence and breach of duty was the directors’ failure to make the VB due diligence inquiries. Another aspect was their retention of a firm of Malaysia lawyers, Messrs Hisham Young K.C. Lim, to produce a due diligence report dated 8 May 2008 (which did not cover the commercial aspects of the transaction and which did not give any conclusion or opinion on matters it was to cover) and the directors’ reliance on it in approving the 2^nd and 3^rd VB Share Agreements.

29.  The plea in relation to SA follows a similar pattern. It is said that before deciding to enter into the SA Share Agreements in April 2010, the then directors[2] owed Holdings and China a duty of due diligence to exercise reasonable skill and diligence to make inquiries into, obtain information about, and assess the commercial reasonableness, prospects, and sustainability of each of the SA contracts and well as the business strength, financial conditions, and creditworthiness of each of the SA customers (“SA due diligence inquiries”).

30.  Each of the 2010 Directors was negligent and in breach of his duty of due diligence in approving the SA Share Agreements. One aspect of the directors’ alleged negligence and breach of duty was their failure to make the SA due diligence inquiries. Another aspect was their retention of a firm of PRC lawyers, Beijing Attange Law Firm, to produce a due diligence report dated 20 April 2010 (which did not cover the commercial aspects of the customers or the SA contracts) and their reliance on it in approving the SA Share Agreements.

31.  The draft Statement of Claim concludes by alleging Holdings and China have suffered loss and damage being the entire value of their investments in VB and SA.

32.  As I said earlier, among the Former Directors, five of them were also directors of China.  Among the five, Chu was a director of China at the time of both the VB and SA acquisitions. Chau was a director of China at the time of the VB acquisition only. Lee and Ying were directors of China at the time of the SA acquisition only. Chong was not a director of China at the time of either acquisition.

33.  Mr Joffe, on behalf of Holdings and China, made a number of criticisms of the Statement of Claim as currently drafted. While some of them are fair criticisms e.g. Veron’s reliance on directors’ fiduciary duty and the inadequate way in which it has been pleaded, they are not fatal to the present application. Paraphrasing Barma J (as he then was) in Re Myway Ltd [2008] 3 HKLRD 614 at [36], even if the current draft Statement of Claim requires further amendments before it is in a state fit for filing, so long as there is an underlying claim that appears to have prospects of success, and which it would prima facie be in the interest of the company to bring, the court should grant leave so that the applicant can take further steps to put the claim onto an appropriate footing.

34.  Two other objections made by Mr Joffe in relation to claims by Holdings are more substantial – they are the so‑called “proper plaintiff point” and the “no reflective loss point”.

35.  First, regarding the “proper plaintiff point”, Mr Joffe submitted that all the agreements for the purchase of shares in VB and SA were entered into by China and it was China which acquired the shares concerned. It follows that the loss on the “investments” in VB and SA is a loss to China and Holdings has no standing to sue for China’s loss. The fact that China is a wholly-owned subsidiary of Holdings would not make any difference. China is a separate legal entity distinct from its parent viz Holdings on the Saloman v Saloman principle, a principle which has from time to time been reaffirmed by high authorities: Gerber Garment Technology Inc v Lectra Systems Ltd. [1997] RPC 443 at 479; Johnson v Gore Wood & Co [2002] 2 AC 1 at 61G-H; Prest v Prest [2013] 2 AC 415 at [8].

36.  As observed by Hobhouse LJ (as he then was) in Gerber Garment Technology Inc v Lectra Systems Ltd supra  at 479 lines 40 to 45:

“The root principle which must be adhered to is that each company is a separate legal entity. The property of one is not the property of another. The plaintiff must prove its own financial loss in its own pocket and quantify it. Any other approach is contrary to the decided authorities and the principle in Salomon v A Saloman & Co Ltd ”.

37.  Second, Mr Joffe submitted that any loss suffered by Holdings was purely reflective of the loss suffered by China and could not be recovered by Holdings as a matter of law.

38.  In as well-known passage in Johnson v Gore Wood & Co supra at 35E to 36A, Lord Bingham of Cornhill explained the principles as follows:

“These authorities support the following propositions. (1) Where a company suffers loss caused by a breach of duty owed to it, only the company may sue in respect of that loss. No action lies at the suit of a shareholder suing in that capacity and no other to make good a diminution in the value of the shareholder's shareholding where that merely reflects the loss suffered by the company. A claim will not lie by a shareholder to make good a loss which would be made good if the company's assets were replenished through action against the party responsible for the loss, even if the company, acting through its constitutional organs, has declined or failed to make good that loss… (2) Where a company suffers loss but has no cause of action to sue to recover that loss, the shareholder in the company may sue in respect of it (if the shareholder has a cause of action to do so), even though the loss is a diminution in the value of the shareholding…. (3) Where a company suffers loss caused by a breach of duty to it, and a shareholder suffers a loss separate and distinct from that suffered by the company caused by breach of a duty independently owed to the shareholder, each may sue to recover the loss caused to it by breach of the duty owed to it but neither may recover loss caused to the other by breach of the duty owed to that other…” (emphasis added)

39.  At 62C – G, Lord Millet explained the matter further:

“Where the company suffers loss as a result of a wrong to the shareholder but has no cause of action in respect of its loss, the shareholder can sue and recover damages for his own loss, whether of a capital or income nature, measured by the diminution in the value of his shareholding. He must, of course, show that he has an independent cause of action of his own and that he has suffered personal loss caused by the defendant's actionable wrong. Since the company itself has no cause of action in respect of its loss, its assets are not depleted by the recovery of damages by the shareholder.

The position is, however, different where the company suffers loss caused by the breach of a duty owed both to the company and to the shareholder. In such a case the shareholder's loss, in so far as this is measured by the diminution in value of his shareholding or the loss of dividends, merely reflects the loss suffered by the company in respect of which the company has its own cause of action. If the shareholder is allowed to recover in respect of such loss, then either there will be double recovery at the expense of the defendant or the shareholder will recover at the expense of the company and its creditors and other shareholders. Neither course can be permitted. This is a matter of principle; there is no discretion involved. Justice to the defendant requires the exclusion of one claim or the other; protection of the interests of the company's creditors requires that it is the company which is allowed to recover to the exclusion of the shareholder.” (emphasis added)

40.  In Day v Cook [2002] 1 BCLC 1 at [38] – [39], Arden LJ said:

“[38] It will thus be seen from the speeches in Johnson v Gore Wood & Co [2001] 1 BCLC 313, [2001] 2 WLR 72 that where there is a breach of duty to both the shareholder and the company and the loss which the shareholder suffers is merely a reflection of the company’s loss there is now a clear rule that the shareholder cannot recover. That follows from the graphic example of the shareholder who is led to part with the key to the company’s money box and the theft of the company’s money from that box. It is not simply the case that double recovery will not be allowed, so that, for instance if the company’s claim is not pursued or there is some defence to the company’s claim, the shareholder can pursue his claim. The company’s claim, if it exists, will always trump that of the shareholder.

[39] Accordingly the court has no discretion. The claim cannot be entertained…” (emphasis added)

41.  At [41], Arden LJ explained the limits to the application of the no reflective loss principle as follows:

“[41] However, it is apparent that there are limits to the application of the no reflective loss principle. The principal limit is that the no reflective loss principle does not apply where the company has no claim and hence the only duty is the duty owed to the shareholder (Lord Bingham’s proposition (2)). Likewise it does not apply where the loss which the shareholder suffers is additional to and different from that which the company suffers and a duty is also owed to the shareholder: see Lord Bingham’s proposition (3) and see Heron International Ltd v Lord Grade [1983] BCLC 244, as explained by Lord Millett in Johnson v Gore Wood. There may well be other limits.” (emphasis added)

42.  I do not agree with Mr Joffe’s “proper plaintiff point”, but I do agree with him that the “no reflective loss point” bars Holdings’ claim in the present case.

43.  On the “proper plaintiff point”, it is true that the loss currently pleaded in the draft Statement of Claim is the value of the investments in VB, in the sum of HK$734.8 million, and SA, in the sum of HK$185 million. Since these were China’s investments, it is China who has suffered the loss of them. The proper plaintiff to claim for such a loss should therefore be China, and not Holdings.

44.  However, it cannot be denied that Holdings has also suffered a loss as a result of the “ill-fated” investments in VB and SA since it was the financier of China, by way of shareholder’s loans, for the purpose of the investments. Given the disposal of the shares in VB and SA at nominal consideration, the shareholder’s loans were effectively written off in its entirety. This is a loss suffered by Holdings itself, caused, on Veron’s case, by the negligence and breach of duty on the part of the relevant Former Directors. As I said earlier, although the two investments were made in the name of China, the ultimate decision was made by the board of Holdings. So was the decision to extend the shareholder’s loans to China in order to fund the investments.  As far as this loss is concerned, the proper plaintiff should be Holdings, not China.

45.  Regarding the “no reflective loss point”, the focus is not so much on whether Holdings has a cause of action based on the negligence or breach of duty of the Former Directors, but on the type of loss it has suffered.

46.  In my judgment, the loss suffered by Holdings is in substance one and the same as that suffered by China ie the HK$920 million paid for the shares in VB and SA. Legally speaking, it was China who paid for and acquired the shares and it was China who should make a claim for the loss of the HK$920 million. Of course Holdings has also suffered a loss in that it had to write off its loans to China ie the same HK$920 million paid for the shares in question. But if China has a viable claim against some of the Former Directors and recovers this HK$920 million from them, its assets will be replenished and Holdings’ loss of the same amount will be made good. If so, the loss suffered by Holdings is only reflective of the loss to China and is not recoverable in law. As Arden LJ put it in Day v Cook supra, China’s claim, if it exists, will always trump that of Holdings. 

47.  My view that the “no reflective loss principle” is apt to bar a claim brought by Holdings in the present case is reinforced by two decisions subsequent to Johnson v Gore Wood & Co supra.

48.  In Garder v Parker [2004] 2 BCLC 554 at [68], [70] and [71], Neuberger LJ (as he then was) said:

“[68] In my view, the rule against reflected loss bars any claim by BDC for the loss of its ability to recover on the loan, just as much as any loss it suffered in respect of its shares in Scoutvale, in light of the reasoning of the House of Lords, in particular that of Lord Millett, in Johnson’s case…

….

[70] It is clear from those observations, and indeed from that aspect of the decision, in Johnson’s case that the rule against reflective loss is not limited to claims brought by a shareholder in his capacity as such; it would also apply to him in his capacity as an employee of the company with a right (or even an expectation) of receiving contributions to his pension fund. On that basis, there is no logical reason why it should not apply to a shareholder in his capacity as a creditor of the company expecting repayment of his debt. Indeed, it is hard to see why the rule should not apply to a claim brought by a creditor (or indeed, an employee) of the company concerned, even if he is not a shareholder…

[71] There are observations, which I have quoted, in the speech of Lord Millett in Johnson’s case which appear to me strongly to reinforce the conclusion that the rule against reflective loss does indeed bar BDC’s claim again Mr Parker in so far as it is based on the loan. Thus, in the passage from his speech I have quoted at [30] above, Lord Millett does not merely refer to ‘shareholders’ but also to ‘creditors’. Secondly, in the passage cited at [31] above, Lord Millett emphasised that reflective loss does not only extend to ‘diminution of the value of the shares’ and ‘loss of dividends’, but also to ‘all other payments which the shareholder might have obtained from the company if it had not been deprived of its funds’. Similarly, he said in terms that the fact that Mr Johnson was claiming, as it were, qua employee, rather than qua shareholder, made no difference (see [2001] 1 BCLC 313 at 370, [2002] 2 AC 1 at 67). I can see no basis whatever in logic or principle as to why, if a claim qua employee is barred by the rule, a claim made qua creditor is not similarly so barred. In most cases where an employee’s claim is barred by the rule against reflective loss, the employee will be a creditor of the company. It is hard to see why a creditor who is an employee should be treated differently from any other creditor of the company when it comes to applying the rule against reflective loss.” (emphasis added)

49.  In Landune International Ltd v Cheung Chung Leung [2006] 1 HKLRD 39, Yuen JA said:

“19. The rule against reflective loss originated in Prudential Assurance Co. Ltd v Newman Industries Ltd (No.2) [1982] Ch 204 and was authoritatively discussed by the House of Lords in Johnson v Gore Wood & Co. (No 1) [2002] 2 AC 1. Put at its simplest, the rule debars a shareholder from suing to recover a loss which is merely a reflection of the loss suffered by the company of which he is shareholder. This rule has been extended to include not only claims brought by a shareholder in his capacity as such, but also claims in his capacity as an employee or director, as well as in his capacity as a creditor (Gardner v Parker [2004] 2 BCLC 554).

….

24. … For present purposes, I assume that the Company was the primary victim of the fraud as it was an established company and the Subsidiary was originally an unfunded company acquired to hold the hotel investment only. But on the authorities, the focus of the rule against reflective loss is not on whether a wrong had been done to the plaintiff (the Company) personally, but on the loss he is seeking to recover - if the loss can be made good if the company (the Subsidiary) enforces its rights against the defendant, the plaintiff’s loss is a reflective loss …

25. There are a number of passages in Johnson v Gore Wood which make it clear that the rule against reflective loss focuses on what loss the plaintiff has suffered, not on what cause of action the plaintiff may have independently of the company...

….

27. Lord Millett emphasised that the example of the cash box was to show that the shareholder had personally been deceived by the defendant, but that was not enough to allow him personally to sue the defendant for the money stolen from the company (at 63F):

‘The only reason [for ‘the somewhat strained business of the key’ in the example of the cash box] is to demonstrate that the principle applies even where the loss is caused by a wrong actionable at the suit of the shareholder personally’.

28. The alleged facts in the present case are similar to those in the illustration save that here the cash box was initially empty, and the shareholder (in this case, the Company) was persuaded to first deposit cash into it and then to part with the key. Does that make a difference to the result? In my view, it does not - because the money lost is still the company’s (the Subsidiary’s) money and the amount lost is still one and the same amount.

29. It matters not that the Company has its own independent cause(s) of action against the Petitioner. In Gardner v Parker [2004] 2 BCLC 554, a decision of the English Court of Appeal, it was held that as the rule against reflective loss is not concerned with barring causes of action as such, but with barring recovery of types of loss, the rule applied whether the cause of action lay in common law or equity and whether the remedy lay in damages or even restitution (at §49).

30. What is important is that the Company’s loss would be made good if the Subsidiary recovers from the defendants. …” (emphasis added)

50.  It follows from the discussion above that Holdings’ claim for the HK$920 million lost is barred by the “no reflective loss principle”. While the Applicant, in its skeleton submissions, hints at the possibility of adding to the draft Statement of Claim Holdings’ claims for loss of use of capital and financial costs, the truth is, on the materials available, it is unclear what these losses are or how they allegedly arose. If Holdings had indeed suffered such losses over and above the HK$920 million, there is no explanation why they were left out of the draft Statement of Claim and the evidence in support of the originating summons in the first place. As Mr Joffe submitted, one simply cannot see the shape of the claims or reach an informed decision about their viability.

51.  In these circumstances, this court is of the view that there is no serious question to be tried in the Intended Action to be brought in the name of Holdings - no leave should be given to Veron to pursue the claim in Holdings’ name.

52.  It also follows from the discussion above that China has a prima facie claim to recover its lost investments, at least against its own directors. This much is not disputed by Mr Joffe, advisedly. In my view, the materials before this court do disclose serious questions to be tried as to whether China’s then directors have been negligent and/or in breach of duty in approving and proceeding with the two investments which resulted in substantial losses. In these circumstances, Veron has satisfied the Serious Question Requirement in so far as it seeks to pursue a claim in China’s name against China’s then directors.

53.  As a general proposition, directors’ duties are of course owed only to the company of which they are directors: Percival v Wright [1902] 2 Ch 421. Regarding those Former Directors who were not directors of China at the material time, the Applicant appears to accept that China does not have a cause of action against them: paragraph 11.8 skeleton submissions of the Applicant. In any case, the fact remains there is nothing in the draft Statement of Claim which clearly states that China also has a claim against those Former Directors who were not its own directors and what that claim may be. In the originating summons as well as the draft Statement of Claim, Holdings and China are treated as if they were one and the same and collectively referred to as “RCG”. The duties of the Former Directors were said to be owed to Holdings and China, as the case may be.

54.  In these circumstances, this court is not satisfied that there is a serious question to be tried regarding the liability of the non‑China directors and no leave can be granted to Veron to pursue a claim in China’s name against them.

Interest of the Company Requirement

55.  The fact that Veron has satisfied the Serious Question Requirement goes some way in surmounting the hurdle presented by this Interest of the Company Requirement, but is not conclusive of the matter.

56.  In Re Li Chung Shing Tong (Holdings) Ltd supra, Harris J made the following observations in respect of this requirement:

“21. It is now well-established in Hong Kong that the threshold for the ‘interest of the company’ criterion 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 Lucky Money Ltd (unrep., HCMP 505/2006 [2006] HKEC 1379), per Kwan J at para. 41; see also Re MyWay Ltd [2008] 3 HKLRD 614, per Barma J at para. 31.

….

26. I accept that in most cases if a “serious question to be tried” has been demonstrated it will follow that it is prima facie in the interests of the company that proceedings are pursued and the converse, of course, will also be true. In this context the “serious question to be tried” criterion can be viewed as a bench mark indicating whether or not it is likely to be in the interests of the company that proceedings are pursued and, in my view, this is how Kwan J’s judgments in both Re Grand Field Group Holdings and Re F & S Express are to be read.

27. There will, however, be cases in which a serious question to be tried is established, but it may not be in the interest of the company that proceedings are commenced…

28. In cases in which the board of the company has made a bona fide commercial decision that it is not in the interests of the company that proceedings are commenced generally the court will be slow to override that decision…” (emphasis added)

57.  As this court is concerned with the exercise of a discretion and since the exercise is fact-sensitive, no useful purpose can be served in examining the facts of cases in which this requirement has been held to have been satisfied or otherwise, or the weight that should be attached to a particular relevant factor - for instance, the opinion, impartial or otherwise, of the board of directors of the company involved.  

58.  Mr Joffe submitted to this court that Veron had failed to meet the Interest of the Company Requirement primarily on the ground that the current directors of the two companies, who are independent of the Former Directors and are not implicated in the draft Statement of Claim, had taken a bona fide commercial decision not to pursue the claims proposed by Veron in the Intended Action. In support of this submission, he relied on three board resolutions of Holdings.

59.  First, a directors’ circular resolution dated 27 January 2014 recording their discussion in a meeting (by tele-conference) on 21 January 2014 (“1^st Resolution”). The 1^st Resolution recorded the board of Holdings had reached the conclusion that it was not in the best commercial interests of the company to pursue the Intended Action. The reasons were:

(1) Veron’s proposed claims were not strong enough to justify pursuing the Intended Action;

(2) even if judgments could be obtained against some or all of the Intended Defendants, enforcement against them might well prove difficult, if not impossible, and, for those Intended Defendants residing outside Hong Kong[3], would be time‑consuming and costly;

(3) if the Intended Action were proceeded with, reputational damage would be caused to Holdings;

(4) the interests of Holdings would be better served by the management concentrating on present and future business activities of the group, without being distracted by time‑consuming litigation where the chances of a successful outcome appeared doubtful;

(5)     the potential costs burden to Holdings would likely be substantial and appeared difficult to justify when weighing up against the chances of success and recovery.

60.  There were two further discussions by the board of directors of Holdings on the present application on 27 June 2014 and 10 October 2014. The causes for and the details of these further discussions are set out in the affidavit evidence but need not be repeated here. Suffice it to say that two further resolutions were passed by Holdings’ directors in the same terms as, and in effect confirming, the 1^st Resolution, and for substantially the same reasons.

61.  Mr Li, in his submissions, was highly critical of the reasons put forward by Holdings’ directors. In my judgment, there is considerable force in those criticisms. But that is water under the bridge, so to speak. For reasons given above, this court is of the view that Veron has failed to satisfy the Serious Question Requirement with regard to the claim proposed to be made in Holdings’ name. However unconvincing some of the reasons might be, Holdings’ directors rightly concluded the company did not have a strong enough claim to recoup the loss of the investments in VB and SA.

62.  The same cannot be said of the proposed claim in China’s name.

63.  With regard to the Interest of the Company Requirement as applied to China, all that this court has been presented with is (i) one paragraph in Mr Mark Pierrepont’s 2^nd affidavit - according to paragraph 15, Mr Sim Kay Wah Kenny, the sole director of China (and the Chief Financial Officer of Holdings), informed Mr Pierrepont “China’s position with respect to the Intended Action and [Veron’s application] mirrors that of RCG Holdings”; and (ii) one paragraph in Mr Mark Pierrepont’s 3^rd affidavit - according to paragraph 20, Mr Sim informed Mr Pierrepont that “China’s position with respect to [Veron’s application] is the same as that of RCG Holdings”.

64.  There is nothing in Mr Pierrepont’s affidavits to explain (i) why Mr Sim came to the conclusion that the proposed claim in China’s name was not strong enough to justify the Intended Action, (ii) in what way enforcement of judgment obtained against the relevant directors of China would be difficult, time-consuming and costly, (iii) what reputational damage would be caused to China, (iv) what are the present or future business activities China has or may wish to concentrate on, (v) why the interest of China will be better served by allowing it to concentrate on such activities without being distracted by the Intended Action, (vi) whether Mr Sim has carried out a meaningful exercise in weighing up the potential costs burden against the chances of success and recovery from China’s then directors. Given that Mr Sim, albeit the sole director of China, was also a staff of Holdings, it is not inconceivable that he felt obliged to toe the line of Holding’s board of directors. Indeed, the absence of evidence on Mr Sim’s line of thoughts on the above tends to suggest he might simply be adopting Holdings’ position, without separately considering the position of China itself.

65.  Be that as it may, given the lack of reasoning, this court is of the view that little weight can be placed on Mr Sim’s conclusion that it is not in the interest of China to pursue the Intended Action.

66.  What this court is left with is that there is a serious issue to be tried concerning China’s claim to recover its lost investments from its own directors who approved of them. The amount at stake runs into hundreds of millions. Among China’s five relevant directors, Chu, Chau and Ying are within the jurisdiction so difficulty in enforcement of any judgment obtained should not be a serious concern. Chu and Chau are known to the Applicant to have had substantial assets. Little weight should be attached to the so-called reputational damage – in this regard, this court agrees with Mr Li that refusal to take action against former directors for a total loss of its substantial investments cannot be good for a company’s present or future reputation. Similarly, the reference to management time is unconvincing – if leave is granted, Veron will have the carriage of the Intended Action.

67.  To conclude, this court is of the view that it is prima facie in China’s interest to pursue the Intended Action against its former directors for the loss of the investments in VB and SA.

Conclusion and Disposition

68.  For the above reasons, this court hereby grants leave to Veron to bring a statutory derivative action in the name of China against its then directors at the time of its investments in VB in December 2007, May and November 2008 and in SA in April 2010, with liberty to apply.

69.  In the absence of agreement on costs within 14 days from today, the parties are at liberty to set the case down before this court for oral submissions on costs and all outstanding matters, if any.

70.  Lastly, I like to thank counsel for their detailed and helpful submissions.