XCHRX RE C.A. PACIFIC FINANCE LTD. (in Liquidation)

HCCW 36/98, 37/98

IN THE HIGH COURT OF THE

HONG KONG SPECIAL ADMINISTRATIVE REGION

COURT OF FIRST INSTANCE

COMPANIES (WINDING-UP) ACTIONS NO. 36 AND 37 OF 1998

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DECISION

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1. This is an application by the Liquidators of C.A. Pacific Securities Ltd ("CAPS") and CAP Finance Ltd ("CAPF") for the determination by the Court of objections raised by certain clients of CAPF to their classification by the Liquidators as "margin" clients.

Background

2. The matter arises in this way. CAPS was a stockbroker which was associated with CAPF, a finance company which provided finance to clients to enable them to trade in securities on margin. In January 1998, CAPS and CAPF collapsed. CAPS had some 11,000 clients on its books, and some 8,000 of these were also clients of CAPF. After the presentation of petitions to wind up the companies, Provisional Liquidators were appointed.

3. Most (though not all) of the clients claimed the return of shares that had been acquired by CAPS on their instructions. It turned out that there was a substantial shortfall in some shares, apparently because CAPF had charged large volumes of shares to its own lenders which had disposed of the shares.

4. It was impossible to identify exactly which clients' shares had been disposed of in this way, because the shares had been acquired by CAPS through CCASS, a computerised book-entry settlement system where unnumbered share certificates are immobilised and deposited with a central share depositary.

Title Application

5. In those circumstances, the first question that confronted the Liquidators was the title to the unnumbered shares acquired through CCASS:- were these shares the property of the clients (in which event the clients could demand the return of the shares as owners) , or not (in which event the clients could only claim as unsecured creditors against the companies' assets in liquidation)?

6. The Liquidators sought the determination of the Court on this question in proceedings in November 1998, which proceedings have been referred to as the "Title Application".

7. In December 1998, I held in a written Decision that the property in the shares belonged to the clients. I shall not repeat the reasons for the Decision here. The consequence of that Decision was that clients could demand the return of the shares as owners.

Share Application

8. However, where there was a shortfall in some shares, the next question that confronted the Liquidators was:- since the shares were unnumbered, how were the Liquidators to know which clients' shares had been charged by CAPF to their lenders and been disposed of, and which clients' shares had remained? In other words, how were the available shares to be distributed amongst the clients demanding them?

9. The Liquidators sought the determination of the Court on this question in proceedings in November 2000, which proceedings have been referred to as the "Share Application".

10. Essentially, the Court's task in the Share Application was to determine from the available evidence the intention of CAPS and CAPF as to the choice of which clients' shares were to be charged to CAPF's lenders. The evidence was that this was not done indiscriminately.

11. All clients of CAPF were clients of CAPS, but not all CAPS clients were CAPF clients. A client opening an account with CAPF would be asked to sign a document entitled "Memorandum of Deposit", the terms of which will be referred to later in this Decision. He would also be asked to sign a Letter of Authorization to transfer funds or properties among intergroup or related companies, including CAPS and CAPF, enabling shares to be withdrawn from any one of them.

12. According to the Liquidators, a signed Memorandum of Deposit has been found for 95% of CAPF clients. For convenience in the Share Application, clients who had signed the Memorandum of Deposit were referred to as "margin" clients and those who had not were referred to as "cash" clients.

13. After signing the Memorandum of Deposit, the client would be allocated an account number with a suffix "-01" in CAP's record system known as Financial Investment System ("FIS"), which the Liquidators have ascertained was kept accurately. Another mode of identifying clients was that "cash" clients had a 4-digit client number, whereas "margin" clients had a 6-digit client number or a 4-digit number starting with a letter other than "M".

14. CAP staff would check the FIS on a daily basis, and the shares of "margin" clients only (identified by the code numbers) would be considered for charging to CAPF's lenders. Even for shares so identified as belonging to "margin" clients, not all shares would be chosen for charging, as different shares had different security values. It would appear that this daily exercise of identifying only "margin" clients' shares for charging to CAPF's lenders was maintained until apparently at the last stages of the companies before their collapse.

15. In the light of this evidence as to the intention and the course of conduct of CAPS and CAPF in drawing on the shares of only "margin" clients to charge to CAPF's lenders, I held in a written Decision delivered in December 2000 that CAPS as trustee must be presumed to have first exhausted shares attributable to "margin" clients before drawing on shares attributable to "cash" clients. I shall not repeat here the legal principles applied and the reasons for the Decision.

16. The consequence was that what remained in each line of stock must be returned first to the "cash" clients who had acquired that stock, with the balance of the shares in each line to be allocated to the "margin" clients who had acquired that stock. Where there was a deficiency in either class, the clients in the same class were to share pari passu.

Classification of clients

17. This decision led to the Liquidators having to distinguish between "cash" clients and "margin" clients. In light of the evidence in the Share Application, I directed that any clients who had not signed any Memorandum of Deposit in favour of CAPF would be treated as "cash" clients, and any clients who had signed a Memorandum of Deposit would be treated in the first instance as "margin" clients.

18. Any client objecting to being classified as a "margin" client notwithstanding his execution of the Memorandum of Deposit was to lodge his objection (together with reasons and supporting documentation) within 28 days of his being notified by the Liquidators of his classification as a "margin" client.

19. However, as I indicated in that Decision, no purpose would be served in permitting objections to classification based on any alleged misrepresentation at the time when the client signed the Memorandum of Deposit. Misrepresentation only renders a transaction voidable, not void. What was important, when considering the question which clients' shares had been delivered for charging to CAPF's lenders in January 1998, was the trustee CAPS' perception of the status of the client then. Any claim now made by a "margin" client of misrepresentation would not have affected CAPS' perception in 1998 that he was a "margin" client, and that his shares were eligible for charging to CAPF's lenders.

20. That does not mean of course that any client who had been the victim of a misrepresentation would be left without remedy. He would have to pursue his claim for damages by lodging a proof of debt in CAPF's liquidation.

Determination of Objections

21. The Liquidators' exercise in classification led to objections from some clients. There were a total of 408 objections, excluding one made by a "cash" client in error. Having considered the nature of the objections, the Liquidators had initially grouped the objections into 10 categories.

22. However at a directions hearing in July 2001, a further analysis showed that the objections could be distilled into 5 types, where:-

Apart from the above, there was also Mr Yue Ming's unique case [Category K], referred to below.

23. At the directions hearing in July 2001, legal representatives appeared for some clients whose objections covered types (i) to (v) above. It became apparent that by reason of such legal representation, the time and costs of making a representative order for each category of client could be saved.

24. At the hearing in September 2001, I heard those clients' legal representatives, as well as two clients in person Mr Yue Ming and Mr Yuen Charn Ming, who had filed affirmations in support of their objections.

25. This Decision deals with samples of all the types of objections, as well as Mr Yue Ming's unique case. It is hoped that when the reasons in this Decision are considered, the other clients and the Liquidators will be able to apply these reasons to individual cases and thus be spared the time and costs of having a determination by the Court of each individual objection. (For this purpose, a Chinese translation of this Decision will be made available through the Liquidators to unrepresented clients who do not read English). Should any individual client wish to pursue his objection by way of a separate determination hearing notwithstanding this Decision and the reasons expressed in it, there would be possible ramifications by way of costs orders.

(i) No Memorandum of Deposit signed

26. The first type of objection was from clients who had been classified as "margin" clients even though there was no signed Memorandum of Deposit.

27. According to the Liquidators, there were 22 clients who were in this category. Five clients were represented by counsel, these 5 clients comprising Mr David Wong Yau Kar, and 3 companies and 1 individual represented by him. By the time of the hearing however, the Liquidators had re-classified the 3 companies and the individual as "cash" clients, leaving Mr Wong's own case to be determined.

28. In respect of Mr Wong's case, the evidence was that he had previously used Peregrine Brokerage Ltd as his stockbrokers but due to concerns about Peregrine's continued operation at the beginning of 1998, he transferred his portfolio to CA Pacific for safe custody as a matter of urgency on 14/15 January 1998 (Wednesday/Thursday). It would appear that his debit balance with Peregrine had been settled with money from CAPS but CAPF provided him with an account statement on 16 January 1998 (Friday). On 18 January 1998 (Monday), CAPS and CAPF collapsed. No trading was ever done.

29. Mr Wong's case is simple. He has gone on affirmation to say that he did not sign any Memorandum of Deposit, nor indeed any account opening forms, and that he never agreed to charge his shares to CAPF.

30. The Liquidators suggest that it was likely that Mr Wong would have signed a Memorandum of Deposit, although no Memorandum of Deposit has been found. CAPF's statement of account recorded a debit entry and debit balance of the same amount paid by CAPS to settle his debit balance with Peregrine. That suggests, the Liquidators submit, that although CAPS paid Peregrine the money, it did so on behalf of CAPF and that is consistent with the companies' respective areas of operations.

31. However the fact remains that Mr Wong has deposed on affirmation that he did not sign a Memorandum of Deposit and there is no evidence to contradict it. He has also deposed on affirmation that concern at the time was to effect the transfer of his shares from Peregrine to the safe custody of the CA Pacific group and that he was not concerned about opening a new trading account. Having just retrieved his shares from a brokerage which was about to collapse, it is certainly plausible that he would not wish to risk them by charging them to a finance company.

32. The fact that CAPF might have arranged for CAPS to settle Mr Wong's debit balance with Peregrine is not consistent only with his having agreed to charge the shares to CAPF pursuant to the sort of transaction contemplated in the Memorandum of Deposit. The transaction could just as possibly have been only in the form of a loan from CAPF. Mr Wong's case of an urgent transfer from another broker was unusual; indeed it would appear interest was not even charged before the CA Pacific companies themselves collapsed.

33. In my view, a client cannot be presumed to have agreed to charge his shares to CAPF when there was no contemporaneous documentary evidence (in the form of a signed Memorandum of Deposit or otherwise) showing that he had agreed to do so, when he has deposed on affirmation that he had made no such agreement orally, and when the available evidence is consistent with some other arrangement such as a loan.

34. By reason of the above, I would direct that the Liquidators re-classify Mr Wong as a "cash" client.

35. As for the other clients in this group of 22 clients for whom no signed Memoranda of Deposit have been located by the Liquidators, apparently 13 had never used margin facilities and did not owe a debt to CAPF at liquidation. However, there have been no affirmations from these clients as to whether they had in fact signed Memoranda of Deposit. Should affirmations to that effect be provided and assuming the Liquidators find no evidence consistent only with a charge of shares to CAPF, it would be in order for the Liquidators to re-classify them as "cash" clients.

36. As for those remaining in this group who had used margin facilities or had a debt owing to CAPF as at liquidation, again there have been no affirmations from these clients as to whether they had in fact signed Memoranda of Deposit, and if they say they had not, explaining under what arrangement they were allowed to use margin facilities. These clients and the Liquidators should have liberty to restore the hearing, and I will leave it to the Liquidators to fix a date for the restored hearing, allowing a reasonable time for the clients to file evidence if they so wish.

(ii)(a) Margin facilities never used

37. The second type of objection was from clients who had been classified as "margin" clients even though they had not used their margin facilities.

38. One of these clients was Mrs Tiffany Hung Pui Yee Vaswani. She had signed the Memorandum of Deposit even though she asserts she had no intention of trading on margin. Mr Cotterell, who appeared for Mrs Vaswani, accepted however that she cannot rely on the doctrine of non est factum to disavow her execution of the Memorandum of Deposit, and this case seems to be typical of the many cases where the clients' failure to read the Memorandum of Deposit before signing it has resulted in an unfortunate state of affairs. There was a brief reference in the written submissions that the Unconscionable Contracts Ordinance cap. 458 was "relevant". Under that Ordinance, the burden is on a party claiming that a contract was unconscionable to prove that it was, but this argument was not pursued at the hearing.

39. Mrs Vaswani's evidence was that she had not used the margin facilities and that out of 20 transactions, she had only once failed to settle on T+2. On that occasion, she settled shortly thereafter. Mrs Vaswani also relied on the statements from CAPF which showed that the margin value of the shares that she held was "0".

40. Mr Cotterell submitted that it was inequitable in these circumstances for Mrs Vaswani to be classified as a "margin" client. It was suggested that the Court should adopt the criteria set out in the schedule to his written submissions as being more equitable.

41. However, in this classification exercise, the Liquidators are not dividing up the remaining shares in vacuuo according to notions of equity. What the Liquidators are doing, in accordance with the Decision in the Share Application, is to list those clients who CAPS and CAPF understood in January 1998 to have agreed to charge their shares to CAPF's lenders.

42. The language of the Memorandum of Deposit was wide enough to make a charge of a client's shares valid even though she did not actually use margin facilities. Clause 1 provided that in consideration of CAPF continuing to grant advances or credit to the client from time to time at its sole discretion, the client expressly charged all stocks which at any time thereafter were deposited with CAPF "as a continuing security for the payment or satisfaction ... of all monies and liabilities which now are or at any time hereafter may be due owing or incurred ...". Mr Cotterell submitted that this clause meant that the client's shares could only be subject to a charge when there was an amount actually due and owing. I am not persuaded that that is so.

43. Clause 16 provided that "this is to be a continuing security notwithstanding any intermediate payment or settlement of account or satisfaction of the whole or any part of any sum or sums of money owing as aforesaid or otherwise". This shows that the parties intended to secure margin facilities made available by CAPF (at its discretion) by a charge over shares acquired by the client from time to time. Whilst it is well-established that in construing a document which was drafted by one party, the agreement should be construed contra proferentem in the case of any ambiguity, Mr Cotterell was unable to proffer any submissions that suggested that this clause was otherwise than clear. In any event, to the world, the charge remained valid whether margin facilities were used or not. It was also the case in practice, according to Mr Karliner, that a client's balance was not considered when shares were charged by CAPF to its lenders.

44. As for the "security value", the Liquidators' evidence is that that was CAPF's assessment of those shares as security. The assessment varied according to the type of shares and was used to ascertain the interest rate to be charged for any margin facilities used. Therefore, the fact that the security value of Mrs Vaswani's shares was "0" meant simply that that was CAPF's assessment of those shares as security. It did not mean that there was no valid charge over those shares.

45. By reason of the above, I would confirm the Liquidators' classification of Mrs Vaswani as a "margin" client in light of her having agreed, by signing the Memorandum of Deposit, to charge her shares as a continuing security in consideration for CAPF making margin facilities available, even though she had not actually used those facilities.

46. If Mrs Vaswani had been the victim of any misrepresentation by CAPF staff, she has her remedies in damages against the estate of that company.

47. The same would apply to the account which Mr Yuen Charn Ming claimed was beneficially owned by him, though opened in the name of his wife Madam Kam Chun Fong. A Memorandum of Deposit was signed and indeed Mr Yuen's cheques were expressly made out in favour of CAPF in compliance with the printed instructions on statements of account which stated, amongst other things, "security transactions are conducted through CA Pacific Securities Ltd., CA Pacific Finance auto transfers in/out shares and funds to settle these transactions. Client settles with CA Pacific Finance Ltd".

(ii)(b) Account in credit at liquidation

48. The next type of objection was from clients who had been classified as "margin" clients even though their account was in credit at the time of liquidation.

49. One of these clients was Mrs Katija Chuang. She had signed the Memorandum of Deposit although she asserts that she was not aware that she had done so and she had not asked for margin facilities. In this respect, I would repeat the observations made regarding Mrs Vaswani's case.

50. Mr Cotterell, who also appeared for Mrs Chuang, has done an analysis of Mrs Chuang's trading which showed that of 54 trading transactions, she had paid the full amount for the shares in 36 transactions within T+2, 13 transactions within T+3, and only 5 transactions within a longer period than T+3 but in any event no later than T+6. It was submitted on her behalf that this analysis showed that she was not a "genuine margin trader".

51. I have dealt with issues regarding the construction of the Memorandum of Deposit and the validity of the charge above and need not repeat them here. If anything, Mrs Chuang's case is less strong than Mrs Vaswani's, the latter having never used margin facilities to settle her trading transactions. For the same reasons, I would confirm the Liquidators' classification of Mrs Chuang as a "margin" client even though her account was in credit at the time of liquidation.

(iii) Objections on basis of misrepresentation

52. I have in my Decision in the Share Application explained why it is thought that any misrepresentation at the time an account with CAPF was opened would only afford a client a right to claim against its assets in liquidation.

53. Although Mr Cotterell's clients did allege that they were victims of misrepresentation, he did not seek to pursue any arguments contrary to the above view.

54. I would therefore confirm that allegations of misrepresentation should be disregarded by the Liquidators in their exercise in classification.

(iv) Objections on ground that compensation paid by SFC

55. A number of clients have apparently objected to being classified as "margin" clients on the ground that they had been paid compensation by the Securities and Futures Commission ("SFC"). It is not known whether the rationale for this objection is (a) that the SFC had accepted that these clients were "cash" clients, and so should the Liquidators, or (b) that the Court should adopt the same "flexible" approach as the SFC. I shall consider both arguments below.

56. In January 1998, the SFC and the Stock Exchange of Hong Kong announced a policy decision regarding compensation arrangements for CAPS clients. The policy decision was to effect payment of compensation not only to cash clients, but also to clients of CAPS who had signed margin agreements with CAPF and had not used the facilities under the agreements (see Joint Press Release dated 10 June 1998). It was expressly stated that this was a relaxation of the statutory compensation rules, and it was announced that "as there might be cases where clients of CA Pacific had been led to open margin account[s] without their consent or under misrepresentation, the authorities considered that a more flexible approach should be adopted in assessing their claims against the Compensation Fund" (see Press Release dated 25 January 1998).

57. It would thus be seen that the SFC was not only paying compensation to "cash" clients, and thus the receipt of compensation provides no support for argument (a) above.

58. As for argument (b), whilst it may have been open to an executive body, administering a solvent fund established, funded and administered by itself, to adopt a discretionary "flexible approach" in the payment of compensation, those policy considerations cannot apply to the return of the shares, which belong to clients and which are deficient. It is a matter of property law in which the sort of discretion that the SFC exercised plays no part.

59. Accordingly, objection (iv) cannot be a valid ground of objection.

(v) Objection based on alleged "internal error"

60. The fact that a client has signed a Memorandum of Deposit is evidence of the objective intention, on the part of CAPF to make margin facilities available at its discretion, and on the part of the client to charge his shares to CAPF. The question is whether the Memorandum of Deposit should be regarded as conclusive evidence.

61. The Liquidators have ascertained that 95% of CAPF clients had signed Memoranda of Deposit and that clients who had signed Memoranda of Deposit would have had appropriate coding in their account numbers to identify them as such. However it would appear that there were some cases where clients who had signed Memoranda of Deposit had coding that nevertheless identified them as "cash" clients only, with the result that these clients' shares would not have been considered for charging to CAPF lenders. These cases are considered below. Given that such cases existed, I am not persuaded that the mere fact that Memoranda of Deposit had been signed per se, where the clients were coded as "cash" clients, could be regarded as conclusive and irrebuttable evidence that those clients should in all cases be regarded as "margin" clients.

62. The account of Ng Chun Hoi and Chau Wai Fong (Mr and Mrs Ng) was an account which was coded as "cash" even though they had signed a Memorandum of Deposit. Although in their supplemental affirmation they accepted that they had signed a Memorandum of Deposit, they said in their affirmation that they had not asked for margin facilities and no margin facilities were ever used. Significantly their account was designated an "-02" account, and no "-01" account of Mr and Mrs Ng has been referred to in any documents of CA Pacific.

63. No explanation has been found by the Liquidators as to why, if the intention was to open a "margin" account, a code for "cash" accounts was then used, and the account operated and treated as a "cash" account. The Liquidators dispute that there were any "internal errors" in CAP's record-keeping, which apparently was accurate to a high degree.

64. The fact that the "cash" code was used for Mr and Mrs Ng's account and their account was treated as a "cash" account is consistent with a variation of an initial arrangement, with the original intention to open a "margin" account (as shown by the signing of the Memorandum of Deposit) being changed to a "cash" account (as shown by the use of the "cash" client code and treatment of the account as a "cash" client account).

65. Given the contemporaneous documentary evidence emanating from CAP, I am satisfied that the common objective intention of the Ngs and CAP was that theirs was a "cash" account only, and I would direct that the Liquidators should re-classify them as such.

66. The same considerations apply to Cheuk Mei Yuk and Lo Chi Wai, whose factual situations were identical to that of Mr and Mrs Ng.

Mr Yue Man's case

67. Finally, there is Mr Yue Man's unique factual situation. Mr Yue had accounts with CAP Futures and CAPS with an "02" suffix although a signed Memorandum of Deposit has also been located.

68. In January 1998, he was in funds and instructed CAP Futures to use those funds to acquire certain shares which were to be deposited with Sun Hung Kai Securities. He exhibited a deposit slip.

69. Mr Yue explained that he did not wish the shares to be deposited with CAPS as he had heard rumours that the SFC was investigating it. Thereafter CAP Futures, acting on his instructions, acquired the shares through CAPS but before the shares could be deposited with Sun Hung Kai Securities, the transaction was interrupted by the CCASS close-out procedures. There is no evidence to contradict Mr Yue's evidence of his instructions to CAP Futures, even though it is not in liquidation.

70. In the circumstances, I am satisfied that CAP Futures and CAPS would have been holding the shares as a bare custodian before their deposit with Sun Hung Kai Securities, and as such Mr Yue should not be classified as a "margin" client.

Costs

71. Finally there is the question of costs. The Liquidators' reasonable fees, costs and expenses in the classification process (including their attendance at the hearings) and their legal advisers' fees for the present application (subject to taxation) should be borne by the trust estate in the first instance.

72. As for the costs of the represented clients, I see no reason why they should be borne by the trust estate or by the Liquidators. I would therefore make no order as to their costs.

Liberty to restore

73. I will also give liberty to restore to the Liquidators and those of the remaining clients who wish to have their individual objections determined by the Court, save that any applications to restore should be made within 28 days from the date of this Decision and subject to costs ramifications as stated above.