SHINE GRACE INVESTMENT LTD v. CITIBANK, N.A. AND ANOTHER

HCCL 28/2008

IN THE HIGH COURT OF THE

HONG KONG SPECIAL ADMINISTRATIVE REGION

COURT OF FIRST INSTANCE

COMMERICAL ACTION NO. 28 OF 2008

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DECISION

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1. This is an application by the plaintiff, by summons dated 15 October 2012, to amend the Statement of Claim in the terms of the draft Amended Statement of Claim annexed to the summons.  Mr Jin Pao, who appeared for the plaintiff, has, very helpfully, attached the draft Amended Statement of Claim as an annex to his skeleton submissions.

This shows the proposed amendments underlined in red, with certain passages highlighted in yellow to identify the specific paragraphs which have been objected to by the defendants.  I make an order in terms of the summons in respect of the proposed amendments which are not objected to, and I make an order in terms of §§2 - 6 of the plaintiff’s summons dated 15 October 2012 in respect of these amendments.

2. The proposed amendments that are in issue can be divided into two categories, the first category of amendments introduce a number of technical concepts associated with the risk of the investment product in question, and the second category of amendments concern the medical condition of Mrs Anita Chan, after her discharge from hospital in October 2007, and contain allegations that the defendants were aware of her condition.  Mr Victor Dawes, who appeared for the defendants, readily conceded that amendments to pleadings ought to be allowed “for the purpose of determining the real question in controversy between the parties to the proceedings or correcting any defect or error in any proceedings”, and that leave was readily given, in cases where the amendments were sought before trial, unless it could be demonstrated that the new claim based on the proposed amendments was bound to fail.  However, he opposed the application on the basis that the proposed amendments, highlighted in yellow, were not for the purpose of determining the real question in controversy between the parties and that, in any event, they were bound to fail. 

Background

3. This matter went before the Court of Appeal recently on an interlocutory appeal against the refusal of Reyes J to make certain orders for specific discovery.  I sat with Lunn JA on that appeal and agreed with his judgment, given on 17 August 2012, in which he set out the background to the case.  I replicate that background in this decision but I also include some additions of my own.

4. The plaintiff company was a private investment BVI company beneficially owned by Mrs Anita Chan until her death on 17 October 2007.  There is no dispute that she controlled the plaintiff, at least until the period when it is said that she became incapacitated through illness, about 10 days before her death.  She was one of the two directors of the plaintiff.  The action brought by the plaintiff is in respect of 9 accumulator contracts of Chinese companies listed on the Hong Kong Stock Exchange.  These accumulator contracts were entered into with Citibank NA, the 1^st defendant, and were made on 15 and 16 October 2007 between Ms Hailey Mak, the 2^nd defendant, acting on behalf of her employer, the 1^st defendant, and Mrs Anita Chan, acting on behalf of the plaintiff.  The plaintiff had been a customer of the 1^st defendant since 2003 and, since that date, the 2^nd defendant had acted as her employer’s relationship manager with the plaintiff.  Mrs Anita Chan had been a customer of the 1^st defendant since 1999, and had dealt with the 2^nd defendant, as her relationship manager, throughout that period. 

5. Very substantial losses were occasioned by these transactions.  Margin call notices were issued by the 1^st defendant on various dates in November and December 2007, and also in January 2008. Absent the injection of further funds pursuant to these margin calls, all open positions in the 9 accumulator contracts were closed by the 1^st defendant on or about 23 January 2008, thereby crystallizing the losses. 

6. The nub of the plaintiff’s case is that, knowing her to be incapacitated and not competent to make decisions in the best interests of the plaintiff, the 2^nd defendant had inveigled Mrs Anita Chan to enter into the 9 accumulator contracts on behalf of the plaintiff, which were “massively imprudent and contrary to the best interests” of the plaintiff, in breach of various duties owed to the plaintiff by both the 1^st and 2^nd defendants.  The amount of initial margin security required by the plaintiff was in excess of its net asset value and its liability on the contracts, many times greater than that value.  Conversely, it was contended that those contracts were “massively advantageous” to the 1^st defendant. 

7.  The relevant allegations made by the plaintiff are:

(1)  The 9 accumulator contracts were not authorised by the plaintiff, alternatively, Mrs Anita Chan was not competent to authorise the accumulator contracts.  Further, the accumulator contracts were incomplete and/or void for uncertainty.

(2)  The plaintiff was entitled to rescind and void the accumulator contracts for breach of duties, contractual, fiduciary and/or at common law, failing to provide reasonable, fair, accurate and honest advice composed with reasonable diligence and care.

(3)  Given the condition of the market on 15 and 16 October 2007, the defendants misrepresented the risks of entering into the accumulator contracts and the plaintiff was entitled to rescind and/or avoid the accumulator contracts for fraudulent, reckless and/or negligent misrepresentation and/or is entitled to damages for the same.  Further or alternatively, the defendants are also liable for the tort of deceit and/or negligence.

(4)  By reason of Mrs Anita Chan’s illness, medication, and lack of rest on 15 and 16 October 2007, she was incapable of making decisions in the best interests of the plaintiff.  The accumulator contracts were entered into by reason of the undue influence of the defendants over her.

(5)  The defendants were also in breach of various statutory duties under the code of conduct issued by the Securities and Futures Commission (“SFC”) and the Securities and Futures Ordinance, Cap 571. 

8. In respect of the plaintiff’s case that was based on the medical condition of Mrs Anita Chan, it appears to be common ground that Mrs Chan was hospitalized from 6 October to 10 October 2007 and that, between 11 and 17 October 2007, when she passed away, no accumulator contracts were entered into on 11 October 2007, which was a Friday, and that she gave instructions on Monday 15 October 2007 and Tuesday 16 October 2007 to enter into the 9 accumulator contracts.  The defendants’ case is that Ms Hailey Mak did not see Mrs Anita Chan in person since July or August 2007, and that all their communications were via the telephone and, in particular:

(i)  Mrs Anita Chan initiated contact with Ms Hailey Mak on 15 October 2007 at 9:36 am.  The conversation between them indicated that Mrs Anita Chan’s memory and cognitive abilities appeared to be the same as before. 

(ii)  The conversations that Ms Hailey Mak had with Dr Yau, a friend of Mrs Anita Chan, and with Mr Anson Chan (Mrs Anita Chan’s son) on 18 October 2007, indicated that everyone was shocked and surprised about Mrs Anita Chan’s demise.  In particular, Mr Anson Chan had said that his mother was very healthy on 16 October 2007.

9. In short, the plaintiff asserted that the 9 accumulator contracts were not authorised, alternatively that the plaintiff was able to rescind them by reason of undue influence and/or unpleasant conduct exercised over Mrs Anita Chan at the time when she was seriously ill and close to her untimely death.  She was not competent and/or not able to exercise either an independent or an informed judgment.  The plaintiff also contended that the defendants were in breach of statutory and contractual duties owed to the plaintiff and sought various reliefs, including a declaration that the 9 accumulator contracts were invalid and/or unenforceable, and claiming, alternatively, damages, or restitutionary relief, arising from the closing of the open positions and associated trading.

10. At issue between the parties is Mrs Anita Chan’s experience in investing in structured financial products, in particular, highly leveraged structured derivative products, of which accumulator contracts are but one example.  It is the defendants’ case that Mrs Anita Chan had experience in investing in various options and derivative products and was aware of the level of risk associated with accumulator contracts and that, in trading in the latter, she was highly successful.  Further, that she relied on her own investment strategy and experience.  It is the plaintiff’s case that, although Mrs Anita Chan had investment experience, in the period 2003 until her death in October 2007, including investments in Equity-Linked Notes, Exchange-traded options and warrants, she had “less experience in investing in structured financial products and, in particular, in highly leveraged structured derivative products such as accumulator contracts”.  There is no dispute that in the period 2004 to 2007, Mrs Anita Chan caused the plaintiff to enter into 271 accumulator contracts with the 1^st defendant and 50 accumulator contracts with the Bank of East Asia.

What is an Accumulator Contract?

11. I find helpful the explanation given by Deputy High Court Judge Pow SC in his recent judgment in DBS Bank (Hong Kong) Ltd v San-Hot HK Industrial Co Ltd and Anor (HCA 2279/2008, 13 March 2013) that :

“5. … An accumulator contract has the following main features:

(1) a customer who enters into such a contract has the right and obligation to purchase a set volume of listed shares (or foreign currencies) at a price (the “Strike Price” [also known as Accumulator Forward Price (‘AFP”)]) lower than the prevailing market price at the time when the contract was entered into (the “Initial Price”);

(2) the difference between the Strike Price and the Initial Price, when expressed in terms of a percentage of the Initial Price, is normally described as the “Discount”;

(3) if the price of the underlying listed shares (or foreign currencies) has arisen to or above a certain pre-agreed price (the “Knock-out Price”) at the close of a trading day, then the contract will automatically be determined, i.e. “knocked-out”. In that case, the customer will get a guaranteed amount of the shares purchased at the Strike Price;

(4) unless the contract is knocked-out, i.e. the price of shares (or foreign currencies) fluctuates below the Knock-out Price, the customer’s right and obligation to purchase the fixed volume of listed shares (or foreign currencies) per trading day will continue until the expiry of the entire term of the contract (1 year in the case before Deputy High Court Judge Pow SC). In other words, the customer will be accumulating the said listed shares (or foreign currencies). This is however a slight misnomer because the customer can always choose to sell the listed shares (or foreign currencies) back into the market at any time he sees fit. He may do so when there is a profit arising or he may do so to limit loss and to keep his cash-flow healthy;

(5) a contract may simply require a customer to purchase a fixed volume of listed shares (or foreign currencies) when the closing price for any trading day falls below the Strike Price. In that case, the contract is described as a “1X contract”. A contract will be described as a “2X contract” if it requires a customer to purchase twice the fixed volume of listed shares (or foreign currencies) under the same circumstances. For the same listed share (or foreign currency), a “2X contract” will customarily offer a higher Discount as compared to a “1X contract”);

(6)  an accumulator contract may be a product structured and devised by a bank and offered to its own customers.  It may also be a product structured and devised by a third party issuer and marketed by a bank to its customers.”

12. In the present case, each accumulator contract was accompanied by an 8-page “Tailored Investment Proposal” (“TIP”) setting out the risk and reward profile of the accumulator contract in question. 

The proposed amendments

13. Before dealing with the proposed amendments, I should state, at the outset, that whilst the underlying objectives set out in Order 1A of the Rules of the High Court (“RHC”) must be taken into account in exercising my discretion whether or not to grant the leave that has been sought to make these amendments, the current application is not one which is made at a late stage of the proceedings, nor does it jeopardise a milestone date.  The amendments relate to the risk factors arising from accumulator contracts and the medical condition of Mrs Anita Chan.

Risk factors

14. The disputed proposed amendments appear in §§21A-C, 22A-C, 22E and 24A-C.  These proposed amendments introduce a number of new risk factors such as “Hold to maturity risk” (“HTM Risk”) and “Mark-to-Market risk” (“MTM Risk”).  These risks are introduced in §§21A-C.  §22A introduces the concept of “implied volatility” as a key risk factor.  §22D, which is a proposed amendment that is not disputed, pleads the effect of margin calls and consequent increased exposure to various risks.  It is pleaded, in §22E, that the defendants ought to have explained and disclosed these risk factors to the plaintiff and, in §24A, that disclosure contained in the TIP was inadequate and/or incomplete, and did not identify these newly pleaded risks. 

15. The amendments are objected to on the ground that they are being introduced solely for the purpose of complicating relevant issues, and to pave the way for an application to introduce expert evidence.  The latter point is not something that affects the exercise on my discretion on these applications.  If, and when, an application for expert evidence is made, that application will be dealt with on its merits.  So far as HTM Risks and MTM Risks are concerned, it is submitted these are risks associated with the credit risk arising from the use of margins and, as explained by the defendants, the risks are not specific to accumulator contracts but apply to all investment undertakings.  It is submitted that these risks are irrelevant in the context of accumulator contracts.  Further, it is submitted that the concept of implied volatility is theoretical, and that it is neither practical nor realistic in the assessment of risks arising from accumulator contracts. 

16. I am not persuaded, on these submissions, that the purpose of the proposed amendments, introducing these new risk concepts, is not to enable the real question in controversy to be determined but to muddy the waters, so to speak; and that they are bound to fail.  I find substance in the submissions of the plaintiff that whether it was, in fact, necessary, meaningful or possible to disclose the risks identified in the proposed amendments, is clearly a matter for trial.  The plaintiff’s case is that there was an over-emphasis on HTM Risk, with the corresponding emphasis on absolute price movements, and that MTM Risk was not dealt with, either sufficiently or at all.  I am not prepared, on the submissions I received from the defendants, to shut the plaintiff out from raising these allegations at trial.  Whether or not the TIP sheets supplied to the plaintiff in respect of the 9 accumulator contracts were adequate is clearly a matter for trial.  Much will depend on evidence of the prevailing practice of banks and financial institutions dealing with these products.  I, therefore, grant leave to the plaintiff to amend the Statement of Claim to include the disputed amendments relating to the alleged risks arising from accumulator contracts. 

The Medical Condition of Mrs Anita Chan

17. The defendants assert that Ms Hailey Mak and Mrs Anita Chan did not meet each other between July to August 2007 and 17 October 2007.  They also assert that the communications between Mrs Anita Chan and Ms Hailey Mak, after Mrs Anita Chan was discharged from hospital, which were all recorded and have been transcribed, showed that Mrs Anita Chan was intelligent, coherent, articulate, logical, and gave very clear instructions and that, contrary to the plaintiff’s suggestions, an objective bystander listening into those conversations would not detect anything wrong with Mrs Anita Chan.  They also rely on the reactions of Dr Yau and of her son, Mr Anson Chan, which clearly showed that they were shocked by her sudden death.  Accordingly, the defendants submitted that the averment in §30, that Mrs Anita Chan’s illness and impairment in memory and cognitive abilities on 15 and 16 October 2007 were known and/or should have been known to the defendants, did not have any evidence to support it.  This would have been a strong submission to advance to oppose the proposed amendments on the ground that they were bound to fail.  However, the proposed amendments to §30 are no more than a paraphrase of the original pleading in the same paragraph that “Citibank’s Hailey Mak knew that Mrs Chan was grievously ill, and that her memory and cognitive abilities were significantly impaired to the degree that she was not competent to make decisions in the best interests of SGIL”.  The proposed change to §30 is no more than cosmetic, and I allow the proposed amendments.  I also allow the proposed amendments to §30(6) because they plead the following material facts:

(1)  that Ms Hailey Mak spoke with Dr Yau on or around 10 October 2007 and on 15 October 2007;

(2)  that Dr Yau treated Mrs Anita Chan from 6 October to 10 October 2007;

(3)  that Dr Yau knew the state of Mrs Anita Chan’s health and the effects of the drugs that had been prescribed to her;

(4)  that Dr Yau was a client of Citibank and dealt with Ms Hailey Mak, and that Mrs Anita Chan had placed investments with Citibank, through Ms Hailey Mak, on behalf of Dr Yau and that she did so on 16 October 2007 (this latter averment suggests to me that Dr Yau was of the view that Mrs Anita Chan was mentally fit to place an investment on his behalf on 16 October 2007);

(5)  that Dr Yau was very close to Mrs Anita Chan; and

(6)  that Dr Yau was the first person who informed Ms Hailey Mak of Mrs Anita Chan’s death when they spoke on 18 October 2007.

However, I do not allow the proposed amendment to the final paragraph of §30(6) which pleaded:

“In the above circumstances, it is to be inferred that Hailey Mak and Dr Yau discussed Mrs Chan’s state of health during their conversations on or around 10 October 2007 and 15 October 2007 (and/or any such further conversations that took place between 6 October 2007 and 17 October 2007 inclusive).”

The preceding facts, which I have permitted to be pleaded, do not support such an inference, particularly in the absence of any further specific averment(s) to support a plea that Dr Yau breached doctor-patient confidentiality by discussing Mrs Anita Chan’s illness with Ms Hailey Mak.

18. §30A introduces the allegation that, given her illness and medical condition, Ms Hailey Mak ought to have taken particular care to ensure that Mrs Anita Chan fully understood the risk of any transactions marketed and/or sold; and §31 contains the allegation of the failure to take reasonable care in the marketing and/or sale of these products and/or in the provision of advice on these products.  These amendments were introduced to replace the original plea, contained in §31, that:

“On 15 and 16 October 2007, Citibank and Hailey Mak knowingly breached their duties to SGIL by exploiting the grievous illness, need for rest and significantly impaired memory and cognitive functions of SGIL’s Mrs Chan, through their use of unethical high pressure sales and solicitation techniques, and including the provision of investment advice which was known to be inaccurate, misleading, unfair and contrary to the best interests of SGIL in order to attempt to induce SGIL, through Mrs Chan, to enter into 9 purported “Accumulator Contracts” (namely those pleaded in paragraph 33 below).”

19. I accept the submission of the plaintiff that this was a refinement of the existing pleading.  I, therefore, allow the proposed amendments contained in §§30A and 31.

Consequential orders and Costs

20. I also make an order in terms of §§2 - 6 of the plaintiff’s summons dated 15 October 2012 in respect of the proposed amendments which I have allowed.

21. Whilst the costs of and occasioned by the amendments are awarded to the defendants, in any event, I award the costs of the hearing to the plaintiff, in any event, for the reason that the plaintiff was substantially successful in its application for leave to amend the Statement of Claim.  Although I had sought, and have obtained, statements of costs from both parties, given the very substantial amount of costs being claimed, I decline to make a summary assessment of these costs and would leave them in the good hands of the taxing master who will deal with them in due course.