LI CHI NGAI ANTHONY AND ANOTHER v. SIU TAK WA

HCA 887/2020

[2021] HKCFI 1616

IN THE HIGH COURT OF THE

HONG KONG SPECIAL ADMINISTRATIVE REGION

COURT OF FIRST INSTANCE

ACTION NO 887 OF 2020

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BETWEEN

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DECISION

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1.  This was an appeal by Li Chi Ngai Anthony (“P1”) and Lin Ho Yan Doris (“P2”) (collectively “the plaintiffs”) from the order dated 9 December 2020 of Master Phoebe Man dismissing the plaintiffs’ application for specific performance pursuant to O 86 of the Rules of the High Court (“RHC”). At the conclusion of the hearing the decision was reserved which I now give.

Background

2.  The plaintiffs and Siu Tak Wa (“the defendant”) are practising medical doctors who were the founding members of a medical business they established in October 2017 under the name Connaissance Holdings Limited (“the Company”), a company incorporated in the BVI.

3.  The issued capital of the Company comprised 816 shares.  The defendant held 26.47% of the issued shares while P1 and P2 respectively held 14.71% and 25%.  There were 3 other shareholders holding the remaining issued shares.  All 6 shareholders were directors of the Company.

4.  The Company set up a series of corporate vehicles such that the Company indirectly held the 3 operating companies, namely KPM Health Limited (“KPM Health”), KPM Holdings Limited (“KPM Holdings”) and Dr Renata Limited (“Dr Renata”) (collectively “the Group” or “Group Companies”).

5.  The defendant, the plaintiffs and one of the 3 remaining shareholders were the directors of KPM Health which provides medical services.  The defendant and another of the other shareholders were the directors of Dr Renata which provides beauty services.

6.  From the incorporation of the Company until January 2019, the defendant had been acting as CEO and managed the business administration of KPM Health.  By January 2019, when KPM Health had accumulated losses of over $60 million and was losing around $5 million per month, the defendant resigned as CEO of KPM Health in January 2019 and P1 was appointed to take over as acting CEO of KPM Health while the defendant continued to manage Dr Renata.

7.  The relationship between the plaintiffs and defendant deteriorated in the course of 2019 to the extent that by early 2020 the plaintiffs decided to leave the Group and the defendant decided to buy their shares and to acquire their loans to the Company by way of assignment.

8.  This culminated in the parties entering into a Sale and Purchase Agreement on 14 February 2020 (“the SPA”) whereby the defendant agreed to acquire (1) 324 shares in the aggregate from the plaintiffs: 120 shares from P1 and 204 shares from P2 (“the sale shares”); and (2) certain amounts the Company and/or Group Companies owed the plaintiffs immediately prior to the execution of the SPA as set out in Schedule 3 to the SPA (“the shareholders’ loans”).

9.  The aggregate consideration payable to the plaintiffs was in excess of $46 million (approximately $29.35 million for P2 and $17.3 million for P1).  Payment was to be made in 4 tranches: upon execution of the SPA, on 24 April, 10 June and 30 September 2020 respectively.

10.  The 1^st tranche was paid on 14 February 2020 and the plaintiffs resigned as directors the same day.

11.  When the defendant failed to pay the 2^nd tranche on 24 April 2020, negotiations back-and-forth between the parties ensued.  The ostensible reason the defendant gave for the default was cash flow difficulties as a result of the pandemic.  The parties finally reached agreement on 28 May 2020 for completion to take place on 30 June 2020.

12.  Under the terms of the SPA as varied, the defendant (who was under an obligation to deliver instalment cheques before the close of business on 29 May 2020) failed to do so and on 4 June 2020 the plaintiffs issued the writ.

13.  When, on 22 June 2020, the plaintiffs threatened O 86 proceedings, 2 days later, for the first time since his acquisition of the Company 4 months earlier, the defendant mentioned that there were “serious accounting issues”.

14.  As earlier noted, the O 86 application which was filed on 10 July 2020 was dismissed by the Master on 9 December 2020.

Applicable legal principles

15.  The applicable principles are well established and not controversial. Where (as in the present case) the plaintiffs have raised a prima facie sustainable case, the burden is on the defendant to satisfy the court why judgment should not be given against him: 2021 HKCP at §14/4/1.

16.  The defendant has to show a bona fide defence that is believable and/or show an arguable defence in law: see Super Town Investments Ltd v Ives Developments Ltd, HCA 86/2006, unreported., 22 May 2007, §§5-6.

17.  Whether a defence is believable is to be scrutinised in the context of so much of the background as is either undisputed or beyond reasonable dispute: see Re Safe Rich Industries Ltd, CACV 81/1994, unreported, 3 November 1994 at §13.  In that regard, the plausibility of the defendant’s evidence has to be evaluated against available contemporaneous documents or other relevant matters.

The defence

18.  The defendant’s case rests on fraudulent misrepresentation.

19.  The essential elements of this defence include the following: (i) there must be a representation of fact made by words or conduct; (ii) it must be made with the intention that it should be acted upon by the defendant; and (iii) it must be proved that the claimant/defendant has acted upon the false statement: see Haifa International Finance Co Limited v Concord Strategic Investments Limited [2009] 4 HKLRD 29 at §15 (1) (3) and (4).

20.  As pleaded in §10 of his defence, the defendant relies on 2 representations which can be summarised as follows:

(1) the plaintiffs’ representation that the contents of the “Relevant Financial Statements” were true and accurate (“True and Accurate Representation”); and

(2) the plaintiffs’ representation that other than as disclosed in note 20 of the financial statements as at 31 March 2019, there were no transactions or contract of significance (“No Material Interest Representation”).

21.  The “Relevant Financial Statements” consists of (a) the final audited accounts of the operating subsidiaries for the period ended 31 March 2019 circulated by Cathy Choi, the Group Companies’ Chief Financial Officer (“CFO”) by email dated 24 December 2019 (“the 2019 audited accounts”), and (b) draft management accounts and an accounts payable list for the period from April to December 2019 (“the accounts payable list”) also circulated by the CFO by email dated 15 January 2020.

22.  The relevant backdrop to these allegations is as follows:

(i) the plaintiffs and the defendant were some of the directors of the Company and, inter alia, KPM Health[1];

(ii) on 17 December 2019, the CFO circulated the draft audited accounts of the operating subsidiaries prepared by KPMG for the period ended 31 March 2019 to the shareholders seeking comments by 20 December 2019 in view of the impending deadline of 31 December 2019 for filing the 2019 audited accounts;

(iii) on 22 December 2019, P1 sent the CFO the following email, copying all shareholders:

“As no comment has been received to-date, please proceed with finalising the documents and arrange for AGM of KPM Health and KPM Holdings by resolution asap before year end …”

(A) Whether the plaintiffs made a representation of fact

23.  There is no allegation that the plaintiffs made any oral representations. 

24.  Other than P1’s email of 22 December 2019, the only documents in writing relied on are the emails (with enclosures) which were circulated by the CFO and not the plaintiffs. Relevantly, those emails preceded the timeframe of the defendant’s decision to acquire the plaintiffs’ interests in the Company which was not made until early 2020.

25.  The defendant relies on the fact that the plaintiffs by putting their signatures to the 2019 audited accounts[2] made a representation that the accounts were true and accurate. However, that submission cannot extend to the accounts payable list since it was a draft list and unlike the 2019 audited accounts did not require the plaintiffs’ signature.

26.  The 2019 audited accounts were provided prior to January 2020 and so could not have been provided for the purposes of the SPA. The same is true of account payable list circulated by the CFO on 15 January 2020 which merely updated an earlier version circulated to board members on 24 December 2019.

27.  Mr Justin Lam, counsel for the defendant, referred to the English Court of Appeal’s decision in Webster v Liddington [2014] PNLR 26 at §46 for the proposition that when a person (X) passes information produced by another (Y) someone with whom X is hoping to contract (Z), depending on the circumstances, the court may conclude that X has adopted the information as his own or in any event represented that he believes on reasonable grounds the information supplied by Y to be correct.

28.  Webster was a case concerning whether clinicians are responsible for statements in manufacturers’ brochures for cosmetic treatment which they gave to prospective patients without any disclaimer.  In that case X was actively providing material with the view to selling services.

29.  The defendant also relied on Peek v Gurney (1873) LR 6 HL 377.  In that case, the directors were held to have made representations by putting forward a prospectus to prospective investors with a view to their investing in the company.

30.  Mr Victor Dawes SC, leading counsel for the plaintiffs, submitted that the present case is factually very different in that the defendant received the 2019 audited accounts because he was a director.  The 2019 audited accounts and the account payable list were not provided with a view to selling anything to the defendant but were circulated by the CFO to all the directors in the ordinary course of business.

31.  I agree with the plaintiffs’ submission that those cases do not assist where, as here, one is concerned with audited accounts and draft accounts payable being circulated to directors in the course of business.  Those cases are also distinguishable, not least because the present case concerns an insider buying out other insiders as distinct from a purchase by an outsider with no knowledge of the Company and its business.

32.  Mr Lam, while accepting that the defendant as a director had access to financial information, put considerable emphasis on the fact that since January 2019, the plaintiffs were in sole control of the Company’s managerial affairs and of its finances.  

33.  The defendant submitted that in fact certain financial information was not available to him, highlighting an email dated 26 February 2019 from P2 to the HR manager requesting that P2’s information and service contract be kept strictly confidential, limited to “HR and CE[3] use and reference[4]”.  

34.  It was said that, arguably, that information was withheld from the defendant.  That email is said to be critical to one of two complaints (considered below) the defendant makes in relation to the representations set out in §20 above said to have been made by the plaintiffs.

35.  I turn to consider the defendant’s complaints.

36.  They relate to 2 matters only: (a) an unauthorised service fee paid to Seren Investment Limited (“Seren”) (the company through which P2 provided her services as chief radiographer) totalling a little over $1 million; and (b) unrecorded expenses incurred before 1 April 2020 totalling approximately $0.55 million[5].

(a) the Seren payments

37.  It is the defendant’s case that it was the common understanding among the shareholders that for as long as KPM Health remained unprofitable, none of the shareholders would be paid for his/her services notwithstanding any service contract.  

38.  The defendant submitted that the Seren contract was objectionable because it disguised the fact that the real recipient of the payments was P2 who should not have been paid because of that common understanding.

39.  In support, the defendant has adduced evidence from the other 3 shareholders to the effect, inter alia, that no shareholders’ resolution was passed to approve the Seren contract.

40.  The plaintiffs submitted that the real question is whether the defendant knew about the payments to Seren/P2.  The court was referred to item 4 of the board minutes of 24 February 2019:

“4. Company Management

d. Service contracts for Siu/Lin/Sit/Li

It was agreed to provide a lump sum of Directors’ emoluments for Siu/Lin/Sit/Li but at a later stage.

Dr Li would suggest his salary scheme later for discussion.

It was agreed to sign an employment/service contract with Ms Lin for her work being a Radiographer [in charge] (with date back).”

41.  There is also an extract from the accounts payable list circulated on 24 December 2019[6] and exhibited by the defendant showing a payment of $50,000 to Seren for:

“radiology service 1/6/2018 to 30/6/18 - Doris”

pursuant to a service agreement dated 22 February 2019[7]. There followed monthly payments of the same amount until December 2019.

42.  The board minutes mentioned above show an agreement (to which the defendant was privy) to sign an employment contract with P2 and is inconsistent with the defendant’s evidence that he had no knowledge of the contract.

43.  The relevant entry in the accounts payable extract[8] is as follows:

Invoice Date	Company Name	Credit Terms	Invoice No.	Description	Total Amount	Classification	Rec’d Date	Chq Date	Remark
...
30/06/2018	Seren Investment Limited	COD	Service agreement dated 22/2/2019	Radiology service 1/6/2018 to 30/6/2018 - Doris	50,000.00	Doctor Fee		31-Jul

44.  This extract contradicts the defendant’s case that payments to Seren/P2 were hidden from him and is inconsistent with any suggestion that the plaintiffs made a conscious attempt to conceal those payments.

45.  It is to be noted that the accounts payable list did not emanate from the plaintiffs but was prepared by the CFO in the ordinary course. No evidence has been put forward to show that the plaintiffs and the CFO had acted in “collusion” to defraud the plaintiff.

46.  The nub of the Seren complaint is that note 20 to the financial statements as at 31 March 2019 made no mention of that contract, rendering false the no material interest representation. But KPMG clearly knew of the Seren payments since it issued an audit confirmation of $550,000 for Seren.  In any case, its omission from note 20 can hardly be said to mislead given the clear disclosure set out in §41 and §43 above.

47.  This is not the occasion for resolving the conflict of evidence concerning knowledge of the Seren contract. In so far as the payments made to Seren were unauthorised, it is open to KPM Health to recover them from the recipient. Were such an action to be brought, the conflict of evidence will have to be resolved.

48.  However, the existence or possibility of such a claim does not and cannot give rise to or constitute any representation that is actionable by the defendant.

(b) Unrecorded expenses incurred prior to 1 April 2020

49.  The defendant’s second complaint relates to unrecorded expenses incurred prior to 1 April 2020 shown in the list compiled by the defendant’s accountant in or around 24 June 2020 and exhibited to Siu 1^st. While 41 items with an aggregate value of approximately $2.2 million[9] appear on the list, the date the expenses were incurred is not shown.

50.  Siu 2^nd §13 (pages 4-6 of STW-2) provides a breakdown of expenses with invoice dates.  The relevant entries itemised in the defendant’s written submissions at §15 are the items that fall within the period (April to December 2019) covered by the accounts payable list (“relevant unrecorded expenses”).

51.  The entries itemised do not have a value of about $2.2 million as originally alleged. Rather, they total about $0.55 million representing less than 1.2% of the total consideration of $46.65 million odd.

(B) Reliance

52.  The plaintiffs submitted that in a typical case where the financial condition of the Company matters, a purchaser would normally require the vendor to confirm the state of the particular account and obtain the relevant assurance by way of representations and warranties.  Schedule 2 to the SPA (which sets out representations, warranties and undertakings) is a half-page document and, relevantly, contains no express statement concerning the precise financial position of the Company.  The parties who were all board members knew that the business was losing money.  

53.  The defendant’s evidence in (Siu 1^st §14) is that the amount of consideration was broadly based on the value of the shareholders’ loans and a discount rate applied based on the financial state of the Group as revealed by the Relevant Financial Statements.  

54.  A great deal of reliance was placed on the plaintiffs’ signatures to the 2019 audited accounts. Those accounts constitute but one of two components constituting the Relevant Financial Statements, the other being the accounts payable list. As earlier noted, that was a draft circulated on 15 January 2020 by the CFO updating the earlier version circulated on 24 December 2019. It was neither prepared nor circulated by the plaintiffs and bore no signatures.  

55.  Mr Lam submitted that the correct test is that set out by the English Court of Appeal in BV Nederlandse Industrie v Rembrandt Enterprises Inc [2019] 1 Lloyds L R 491 at §32: the representee had to prove he had been “materially influenced” by the representations in the sense that it was “actively present to his mind”.

56.  A mere assertion by a party that a particular document materially influenced his decision as to the appropriate discount rate is not sufficient. If the accuracy of the account payable list had been material, one would have expected Schedule 2 to have made provision for it.  The question of reliance will not arise unless there is a representation made by the plaintiffs in the first place: this is addressed in §60 below.

57.  On the defendant’s case that an implied representation was made as to their accuracy when the Relevant Financial Statements were circulated, what inaccuracies have been shown? How would have they have caused the defendant to apply a different discount rate?

58.  The complaints relate to the Seren payments and the relevant unrecorded expenses. The fact that KPM Health may have a cause of action against the recipient to recover unauthorised payments does not render the Relevant Financial Statements inaccurate. The defendant has not shown that the 2019 audited accounts are arguably impeachable.

59.  So far as the relevant unrecorded expenses are concerned, the defendant cannot seriously be suggesting that the omission of relevant unrecorded expenses representing 1.2% of the overall consideration would have been material in determining the appropriate discount rate to be applied.

Conclusion

60.  I do not accept that the circulation by the CFO of the Relevant Financial Statements in the circumstances described in §22 in the ordinary course of business and prior to the defendant’s decision to purchase the plaintiffs’ shares and interests in the Company can arguably constitute a representation on the part of the plaintiffs.

61.  In the absence of any such representation, the other elements do not even arise for consideration.

Order

62.  Accordingly, I make the following order:

(1) the plaintiffs’ appeal be allowed and the order dated 9 December 2020 be set aside; and

(2) the O 86 application be granted in favour of the plaintiffs.

63.  There is to be an order nisi that the costs of and incidental to the plaintiffs’ summons dated 9 July 2020 (with certificate for counsel) and the costs of and incidental to this appeal and the hearing below (with certificate for 2 counsel) be paid by the defendant to the plaintiffs, such costs to be summarily assessed and paid by the defendant to the plaintiffs forthwith. Directions for summary assessment will be given separately.