BASAB INC. AND ANOTHER v. SUPERB GLORY HOLDINGS LTD AND OTHERS

CACV 256/2014

IN THE HIGH COURT OF THE

HONG KONG SPECIAL ADMINISTRATIVE REGION

COURT OF APPEAL

CIVIL APPEAL NO. 256 OF 2014

(ON APPEAL FROM HCA NO. 6 OF 2014)

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REASONS FOR JUDGMENT AND DECISION ON COSTS

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Hon Cheung JA:

1.  I agree.

Hon Yuen JA:

2.  I agree with Kwan JA’s Reasons for Judgment and Decision on Costs.

Hon Kwan JA:

3.  On 22 November 2016, we dismissed the plaintiffs’ appeal against the judgment of Deputy High Court Judge Wilson Chan handed down on 4 December 2014.  By his judgment, the judge ordered the plaintiffs’ claim against the 1^st and 2^nd defendants to be struck out and this action as against those defendants be dismissed, on the basis that the plaintiffs’ claim is for losses allegedly suffered by Accufit Investments Inc (“Accufit”) and is therefore barred by the no reflective loss principle.  These are my reasons for dismissing the appeal.

Background

4.  I adopt the relevant background matters set out in the judgment below at §§5 to 18:

“5. The 1^st plaintiff owns 100% of Accufit. Accufit in turn held 161,000,000 shares in KHL [Kith Holdings Limited], a listed company. The 2^nd plaintiff was the founder and Chairman of KHL.

6. The 2^nd defendant is the sole director and shareholder of the 1^st defendant.

7. There is no dispute that:

(1) In September 2012, the 1^st defendant lent HK$140 million to Accufit and the 2^nd plaintiff provided a personal guarantee for the debt.

(2) In January 2013, the 2^nd defendant and Accufit entered into a supplemental loan agreement, varying some terms of the original HK$140 million loan and the 2^nd plaintiff signed a supplemental personal guarantee for the debt.

(3) In February 2013, the 1^st plaintiff executed a Debenture (including a floating charge) over all its assets (including its 100% shareholding in Accufit) to secure the loan.

(4) Despite repeated demands, Accufit failed to make repayment. Cheques were issued for partial repayment, but they were dishonoured. The last attempt was made on 28 March 2013.

8. Given Accufit’s default, the 1^st defendant took the following steps to protect its interests:

(1) On 12 April 2013, the 1^st defendant’s solicitors wrote to crystallise the floating charge over the 1^st plaintiff’s assets under the Debenture.

(2) On 6 May 2013, the 2^nd defendant appointed professional receivers under the Debenture, namely, Mr Fok Hei Yu and Mr John Batchelor of FTI Consulting (the “Receivers”). Under the Debenture, the Receivers appointed themselves as directors of Accufit. The Receivers are respectively the 3^rd and 4^th defendants in this action.

9. The 1^st plaintiff had full knowledge of these events but never voiced any objection thereto.

10. In the meantime, not only was Accufit in financial trouble, KHL’s financial situation also deteriorated rapidly:

(1) On 31 March 2013, KHL issued its 2012 Annual Results Announcement. Its independent auditors raised concern over bank borrowings and loans, which had become overdue and unpaid, leading to “material uncertainty which may cast significant doubt on the Group’s ability to continue as a going concern…”.

(2) On 16 April 2013, KHL disclosed the disposal of a subsidiary at a book loss of more than HK$55 million for the purpose of the repayment of liabilities.

(3) On 23 April 2013, members of the KHL Group had to provide a general fixed and floating debenture to its creditor banks.

(4) On 31 May 2013, KHL announced that its plan to issue HK$300 million of bonds could not proceed as the placing agent was unable to procure subscribers.

(5) On 1 August 2013, KHL issued a loss warning.

11. On 18 December 2013, KHL published an announcement to:

(1) suspend trading of its shares; and

(2) put its most valuable business into voluntary liquidation.

12. On the same day, the Receivers (as directors of Accufit), after consulting independent financial advisers, decided to sell Accufit’s stake in KHL to Double Key International Limited, the 5^th defendant in this action (“Double Key”), at HK$0.38 per share.

13. As a result of the sale of the KHL shares to Double Key, Double Key was obliged to make a general offer to all shareholders of KHL at the same price of HK$0.38 per share.

14. On 9 May 2014, KHL’s Board issued a Response Document relating to Double Key’s general offer, which included a letter from an Independent Financial Adviser to KHL’s Board. The Independent Financial Adviser took the view that the price of HK$0.38 was “fair and reasonable”.

15. In the meanwhile, the 1^st defendant tried to enforce the 2^nd plaintiff’s personal guarantee, and issued a statutory demand dated 18 November 2013 against the 2^nd plaintiff. However, attempted service was unsuccessful, with the 2^nd plaintiff repeatedly giving the excuse that he was out of the jurisdiction through different solicitors.

16. On 2 January 2014, the 1^st and 2^nd plaintiffs commenced the present action against, inter alios, the 1^st and 2^nd defendants.

17. The plaintiffs’ claims are all premised upon the alleged sale at undervalue by the Receivers (as directors of Accufit) of Accufit’s KHL shares. As put in paragraph 6 of the 2^nd Affirmation of the 2^nd plaintiff:

(1) The 1^st plaintiff, as the chargor and guarantor under the Debenture, claims that the sale at undervalue by the Receivers (as directors of Accufit) means that the 1^st defendant has breached its duties owed to the 1^st plaintiff as the chargee.

(2) The 2^nd plaintiff, as the guarantor of the debt, claims that the sale at undervalue by the Receivers (as directors of Accufit) means that the 1^st defendant has breached its duties owed to the 2^nd plaintiff as the chargee.

(3) The plaintiffs claim that there is a conspiracy amongst (1) the 1^st defendant (as chargee) and the 2^nd defendant (as its director); (2) the Receivers; and (3) the purchasers (ie, Double Key and its directors) to injure the plaintiffs economically by unlawful means (ie, the sale at undervalue).

18. As a result, the plaintiffs complain that they have suffered loss, such loss being framed as follows:

(1) But for the alleged wrongdoing, Accufit would have sold the KHL shares at a price sufficient to cover Accufit’s loan obligations owed to the 1^st defendant, and the plaintiffs’ liability under their Debenture/Guarantee would be discharged.

(2) Due to the alleged wrongdoing (ie, sale at undervalue), the plaintiffs’ liability is no longer fully discharged, but only partially discharged (by the undervalue consideration).

(3) The loss is therefore the difference between full discharge (the plaintiffs are not liable at all) and partial discharge (the plaintiffs liable for the loan amount minus the undervalue consideration).”

5.  The consideration for the sale of the KHL shares to Double Key was $49,780,000.  The plaintiffs alleged that the fair value of these shares should be in the region of $312 to $389 million.

6.  I should mention that the 1^st plaintiff, Basab Inc, had applied for leave to bring a statutory derivative action in the name of Accufit, which is a company incorporated under the laws of the British Virgin Islands, to the courts of that jurisdiction.  The defendants in the proposed derivative action are basically the same as the parties in the present action.  They are the 1^st defendant in this action, the receivers who appointed themselves as directors of Accufit, and Double Key.  The proposed action was to recover loss arising out of the sale of the KHL shares to Double Key at a gross undervalue.

7.  On 22 September 2014, Bannister J refused leave to bring a statutory derivative action, holding that the claim against the various defendants was speculative, unsupported by any material evidence and without substance.  On 9 November 2015, the BVI Court of Appeal dismissed an appeal from the decision of Bannister J, having evaluated afresh the evidence adduced before the court and concluded that the appellant had failed to show on the available evidence it was more probable than not that it would succeed in proving that the KHL shares were sold to Double Key at an undervalue.

The judgment below

8.  As mentioned earlier, the 1^st plaintiff’s claim against the 1^st defendant in respect of the sale at undervalue was brought on the basis that the 1^st plaintiff was the chargor and guarantor under the Debenture and that the 1^st defendant as the chargee had breached its duties to the 1^st plaintiff. The KHL shares, allegedly sold at undervalue, were not held by the 1^st or 2^nd plaintiff but by Accufit.  The loss which resulted from the sale of the shares at undervalue was a loss suffered by Accufit.  The judge held that the no reflective loss principle is engaged as the loss claimed by the 1^st plaintiff is merely reflective of the loss suffered by Accufit (Judgment, §§19 and 20).

9.  The judge held the principle applies to guarantor claimants claiming that a defendant has wrongfully impoverished the company, and thereby increasing the chance that the guarantee would be relied upon, having referred to English and Australian authorities (Gardner v Parker [2004] 2 BCLC 554 at §70; Erridge v Coole & Haddock (a firm), 2000 WL 1274094, unreported, Ferris J; and Heedes v Telstra Corp Ltd [2001] WASC 297 at §21).  Thus, it would make no difference that the loss allegedly suffered by the plaintiffs did not arise from the diminution in the value of the 1^st plaintiff’s shareholding in Accufit, but arose out of the plaintiffs’ role as guarantor for Accufit’s debt (Judgment, §§22 to 26).

10.  In respect of the conspiracy claim (mentioned in §17(3) of the Judgment), the same remedy must be available to Accufit as well as the plaintiffs.  The plaintiffs’ claim for conspiracy must be struck out based on the rule against reflective loss.  And as the only claim made by the plaintiffs against the 2^nd defendant is premised on the tort of conspiracy, the plaintiffs’ claim against the 2^nd defendant must be struck out entirely (Judgment, §§32 and 33).  There is no complaint in this appeal against those parts of the Judgment.

11.  In respect of the plaintiffs’ claims against the 1^st defendant for breach of duties under the Debenture (mentioned in §§17(1) and (2) of the Judgment), the plaintiffs submitted that the principle should not be engaged as Accufit had no cause of action against the 1^st defendant under the Debenture, entered into between the 1^st defendant and the 1^st plaintiff in respect of the charged assets, which included the 1^st plaintiff’s 100% shareholding in Accufit, and the 1^st defendant did not owe any duties to Accufit under the Debenture.  The judge rejected that submission.

12.  He relied on the decision of Fok JA (as he then was) in Pico North Asia Holdings Ltd v Cheung Yuk Ting Linda [2011] HKCU 256 at §37, where it was stated that the application of the principle was not affected by the fact that the defendants may owe different fiduciary duties to the plaintiff, to those owed by them as directors to the company, and, similarly, the reliance by the plaintiff on breaches of contractual duties or duties in tort on the part of the defendants did not affect the application of the principle.  As, ultimately, the question is whether the loss allegedly suffered by the plaintiff by reason of the breaches asserted in the action is merely reflective of the company’s loss.

13.  On the plaintiffs’ case as pleaded, the facts and matters relied on regarding the 1^st defendant’s breach of duties under the Debenture were also relied upon in support of the conspiracy claim, which the judge had held was a cause of action available to Accufit.  The same conduct on the part of the 1^st defendant forms the basis of both claims, just as noted by Fok JA at §§39 and 40 in applying the observation of Lord Millett in Johnson v Gore Wood & Co [2002] 2 AC 1 at 64A to B.  As the same conduct was relied on for both claims, the plaintiffs’ own loss would be made good if Accufit had enforced its rights against the defendants.  The loss claimed by the plaintiffs was reflective of Accufit’s loss and so the claims for breach of duties under the Debenture should also be struck out (Judgment, §§36 to 39).

14.  For completeness, the judge made clear he would not have struck out the plaintiffs’ claim against the 1^st defendant on the ground that the 1^st defendant owed no duty to the plaintiffs as regards the sale of the KHL shares by the Receivers, as there is an arguable case the 1^st defendant might have played an active role in the sale and that would be a matter for trial (Judgment, §§40 to 43).  Nor would he have struck out the plaintiffs’ claims against the defendants on the ground that they were frivolous or vexatious or an abuse of the process of the court as he should not enter into a detailed examination of the merits of the allegations in the application for striking out (Judgment, §§44 to 45).

This appeal

15.  A notice of appeal was filed on 17 December 2014.  For reasons not necessary to go into, the Court of Appeal (Kwan JA, Chu JA and Harris J) made an order on 26 February 2016 that unless the plaintiffs lodge the appeal bundle for approval by 8 April 2016 with their skeleton submissions, the appeal would stand dismissed without a hearing.  The plaintiffs complied with this order, and lodged a submission for the appeal dated 7 April 2016 prepared by their counsel, Mr Colin Leung. Mr Leung served a revised skeleton argument dated 4 November 2016, in which he made minor amendments deleting the page references to those documents which have since been removed from the appeal bundle.

16.  In the skeleton argument, Mr Leung advanced three grounds in support of his proposition that the no reflective loss principle should not be applied in the present case.  In a reply submission served the day before the hearing of the appeal, he indicated he would abandon the third ground covered in §§39 to 43 of his skeleton argument.

17.  It is regrettable that in the notice of appeal, the grounds of appeal did not specify with any clarity the arguments on the points of law advanced in Mr Leung’s skeleton argument, in particular his second ground.

18.  The grounds of appeal in a notice of appeal are not required to be detailed, they are not meant to take the place of skeleton arguments to be served in due course. As stated in the Hong Kong Civil Procedure 2017, vol 1 at §59/3/8, the object of the rule in Order 59 rule 3(3)[1] is “in all cases to narrow the issues on appeal, shorten the hearing and reduce costs, by a statement in the notice of appeal of points of law, and the questions of fact, which will be in issue on the appeal”.

19.  It is not sufficient to state in the grounds of appeal that the judge was wrong in law to hold that the plaintiffs’ claims were precluded by the no reflective loss principle or just to assert that the plaintiffs’ loss was not necessarily reflective of the loss of Accufit.  The grounds of appeal should state in what manner the judge had misdirected himself on the law and what specifically was the error that had been made in point of law, whether the point was raised in the court below or not (Hong Kong Civil Procedure 2017, vol 1 at §59/3/8).

20.  I do not consider the grounds of appeal in the notice of appeal have given fair indication of the points of law which will be in issue on the appeal.  If it had not been for the fact that the skeleton argument was served in April 2016 pursuant to a court order and the defendants had more than six months’ notice of the arguments to be advanced and could not have been taken by surprise, I would not have been prepared to allow the plaintiffs to argue the second ground in Mr Leung’s skeleton argument without an amendment of the notice of appeal.

21.  Two grounds of appeal were advanced.  In the first ground, Mr Leung contended that the no reflective loss principle would have no application to secured creditors, that loss in secured assets is not a reflective loss, and that the same consideration should apply to the claims of the plaintiffs as chargor and guarantors vis-à-vis the 1^st defendant.  In the second ground, he argued that as chargor and guarantors the plaintiffs have an equity of redemption which is separate from the general assets of Accufit held in trust for the discharge of its liabilities to unsecured creditors.  Because of this separation of funds, the plaintiffs can pursue their claims against the 1^st defendant and will not be caught by the no reflective loss principle.  These are new arguments not raised before the judge.

The first ground of appeal

22.  Mr Leung started with the proposition that the principle of no reflective loss would not apply to secured creditors.  This is because the primary entitlement to the loss is that of the secured creditor and the secured creditor is the person to whom the primary duties are owed.  In support of this, he cited the judgment of Edward Bartley Jones, QC sitting as a deputy High Court judge in International Leisure Ltd v First National Trustee Co UK Ltd [2013] Ch 346 at §§36, 38, 40, 45 and 46.  Hence, the principle would not apply to the 1^st defendant, which is a secured creditor.

23.  Mr Leung then argued that since the 1^st defendant as the chargee and secured creditor owed its duties exclusively to the 1^st plaintiff as the chargor and guarantor and to the 2^nd plaintiff as the guarantor, the principle of no reflective loss would also not apply to the plaintiffs when they sued the 1^st defendant for breach of duties under the Debenture.  From the premise that the principle has no application to the 1^st defendant as the debenture holder or secured creditor, he sought to argue that the plaintiffs could directly claim against the 1^st defendant for breach of duties under the Debenture, by some process of subrogation.

24.  He contended there was policy consideration for his proposition above.  He prayed in aid International Leisure Ltd at §42, in which it was stated that the rule against reflective loss should not apply to claims by a secured creditor, as otherwise the person who has the benefit of the primary duty, and who has the primary entitlement to the loss, would be disabled from pursuing his claims directly and under his own control.  He also invoked the statement of Lord Bingham of Cornhill in Johnson v Gore Wood at 36C that “the court must be astute to ensure that the party who has in fact suffered loss is not arbitrarily denied fair compensation”.

25.  He argued that a claim for loss in secured assets is not a reflective loss, but is a claim for diminution in the value of the security of the loan.  Looked at in this way, he contended there is a change in the fundamental nature of the plaintiffs’ claims.  In support of his argument, he cited Fortress Value Recovery Fund I LLC & Ors v Blue Skye Special Opportunities Fund LP & Ors [2013] EWHC 14 (Comm) at §82.

26.  I am unimpressed with the above arguments to circumvent the application of the no reflective loss principle in the present situation.

27.  The present case is a classic situation in which loss was allegedly suffered by the claimants (the plaintiffs) as the shareholders of a company (Accufit).  There is no change in the fundamental nature of the plaintiffs’ claim.  As Mr Leung chose to put it, the plaintiffs’ claim is diminution in the value of the security for the loan.  The security is the shares of Accufit held by the 1^st plaintiff. Because of the sale of Accufit’s assets (the KHL shares) at undervalue, there was reduction in the value of the shares of Accufit, and hence diminution in the value of the security for the loan.  The loss arising out of the sale of Accufit’s assets was primarily suffered by and belongs to Accufit, for which Accufit had applied for leave in the BVI courts to bring a statutory derivative action, but was rejected on the merits.

28.  The argument as to subrogation must be rejected.  The plaintiffs are precluded from bringing their claims against the 1^st defendant as their loss is merely reflective of the loss primarily suffered by Accufit.  To allow some form of subrogation, as contended by Mr Leung, is to permit them is to get through the back door when they cannot do so by the front door.  But more importantly, it is difficult to see (nor has Mr Leung attempted to make clear), in the claims of the plaintiff against the 1^st defendant, what rights of the 1^st defendant as secured creditor and chargee that the plaintiffs may be subrogated to.  The argument of subrogation just makes no sense.

29.  The paragraphs in International Leisure Ltd cited by Mr Leung do provide support for the proposition that the principle of no reflective loss has no application in respect of a claim brought by a secured creditor for breaches of duty owed to him by an administrative receiver, who was appointed by the secured creditor and not by the company, as the secured creditor is the party primarily entitled to obtain and retain all damages awarded for the breaches alleged and the party to whom the primary duties were owed.  The judge in International Leisure Ltd refused to strike out such a claim holding that it is arguable.  But that is as far as it goes.  So if the 1^st defendant, as the holder of the Debenture and a secured creditor, should wish to claim against the Receivers for breach of duties owed to it, the principle of no reflective loss would not apply to preclude the 1^st defendant from bringing such a claim.

30.  But the plaintiffs are not secured creditors.  And they are not bringing their claims against the defendants as such.  The paragraphs in International Leisure Ltd relied on by Mr Leung would have no bearing to the present situation.  As stated in §38 of International Leisure Ltd, there is a fundamental distinction between the situation in which the primary entitlement to the loss is that of the debenture holder and the case where the loss is primarily suffered by and belongs to the company (Accufit).  Plainly, the claims of the plaintiffs against the 1^st defendant for breach of duties under the Debenture arising from sale of the company’s assets at an undervalue fall within the latter situation, and are caught by the no reflective loss principle.

31.  The policy consideration mentioned in §42 of International Leisure Ltd as to why the no reflective loss principle should not apply to claims by secured creditors does not apply to the present situation.  We are not concerned with a case in which the parties suing have the benefit of the primary duty and have the primary entitlement to the loss.  The loss claimed in this action, arising out of the sale of the KHL shares held by Accufit, was primarily suffered by and belongs to Accufit.

32.  The statement in Fortress Value Recovery Fund at §82 (“when properly analysed, the claim for the ZBS loss … is not a claim for reflective loss but for diminution in the value of the security for the ZBS loan”) does not assist the plaintiffs.  That statement was made in the context of ZBS being a secured creditor and the view taken by the court was that it was arguable the rule against reflective loss should not apply to the claim of a secured creditor.  This has no application to the present case, as already explained.

The second ground of appeal

33.  Mr Leung mounted a somewhat convoluted argument invoking the equity of redemption which he contended makes the plaintiffs’ loss separate and distinct from that of Accufit.  He argued that as chargors the plaintiffs have an equity of redemption and this was a proprietary interest over the charged asset.  The charged asset formed a separate fund from the general unsecured assets of Accufit and this is consistent with the proposition that the principle of no reflective loss does not apply to secured creditors.  As the plaintiffs’ equity of redemption was held as a separate fund from the assets of Accufit, the loss of the plaintiffs could not be said to be reflective of the loss of Accufit.  He contended that the onus is on the defendants to prove that the no reflective loss principle applies to the claims and a trial is required to establish this.

34.  I would approach his arguments on the basis of first principles, and not be side-tracked by various dicta in the cases cited by Mr Leung.

35.  The 1^st plaintiff charged its own asset to the 1^st defendant under the Debenture, and that is its shareholding in Accufit.  It did not and could not charge the KHL shares.  As a shareholder of Accufit, the 1^st plaintiff has no proprietary interest over the assets of Accufit.  It is the sale of the KHL shares at an undervalue which gave rise to the loss, and that was a loss suffered primarily by Accufit.  The argument about separate funds arising out of the equity of redemption is a red herring.  It does not follow from the proposition that the equity of redemption is held as a separate fund of Accufit that the loss of the plaintiffs in this instance could not be said to be reflective of the loss of Accufit.  As a matter of substance, the plaintiffs’ claim would be made good if Accufit should recover from the defendants.  This is where the no reflective loss principle comes in, to prevent double recovery.

36.  As stated in Gardner v Parker at §49 and quoted in Pico North Asia Holdings at §35, “the rule against reflective loss is not concerned with barring causes of action as such, but with barring recovery of certain types of loss.”  So the principle applies “where the loss claimed by the shareholder is merely reflective of the company’s loss, even though the defendant may owe wholly different duties to the company and to the shareholder” (Pico North Asia Holdings, §36).

37.  The argument about equity of redemption cannot avail the 2^nd plaintiff at all, as he did not charge any asset, he only provided a personal guarantee.

38.  The second ground of appeal is wholly without merit.

Costs

39.  We have heard arguments on costs.  There is no dispute that costs should follow the event.  Mr Leung has no objection that this court should give a certificate for two counsel, just as the judge had ordered in the hearing below. I would order accordingly.

40.  Mr Johnny Mok, SC sought costs on an indemnity basis.  The factor that carries most weight with me is whether the arguments are so patently bad that one can say this appeal should not have been brought.  Although the two new arguments are rejected, it requires consideration of the arguments advanced on both sides and some analysis.  In the end, I am not persuaded to award costs on a higher scale.

41.  I would also order that the amount remaining in court as security for costs be paid out to the 1^st and 2^nd defendants after the costs of the appeal are taxed on a party and party basis, unless they are agreed.