SHIH HUA INVESTMENT CO., LTD v. ZHANG AIDONG AND OTHERS

HCCW 198/2016

[2022] HKCFI 567

IN THE HIGH COURT OF THE

HONG KONG SPECIAL ADMINISTRATIVE REGION

COURT OF FIRST INSTANCE

COMPANIES WINDING-UP PROCEEDINGS NO 198 OF 2016

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D E C I S I O N

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1.  On 20 June 2016 the Petitioner, Shih-Hua Investment Co. Ltd (“Shih-Hua”), issued the present unfair prejudice petition seeking an order that the 2^nd Respondent to purchase its shares in the Company, alternatively that the Company be wound up. The Petition was amended on 2 February 2017 (“Petition Proceedings”). On 4 and 5 January 2017 Anthony Chan J (“Chan J”) heard an application by the Petitioner to reconstitute the Board of the Company and replace the existing two directors with two suitably qualified independent professionals or alternative relief, which included continuing an injunction granted by me on 20 July 2016 restraining disposal by the 2^nd Respondent of the Company’s money other than in accordance with the normal course of business and not exceeding HK$2 million each month. Chan J made an order on 19 January 2017 reconstituting the Board, removing the existing directors and replacing them with David Bennett of Grant Thornton Recovery & Reorganisation Limited and Tong Piu of Grant Thornton Advisory Services Limited. Chan J ordered the costs of the reconstitution summons be paid by the 1^st and 2^nd Respondents with a certificate for two counsel (“Reconstitution Order”).

2.  The 1^st and 2^nd Respondents (“Respondents”) issued a notice of appeal on 8 March 2017.  On 31 March 2017 the Respondents’ solicitors Jun He wrote to the Court of Appeal stating:

“Since the appointment of the New Directors to the Board, our clients have met with them on numerous occasions in order to provide assistance to them for the purposes of advancing the interests of the Company. Notwithstanding ad clients’ initial (and considerable) concerns relating to their appointment, our clients are presently satisfied with the New Directors’ performance and believe they have a genuine desire to act in the Company's best interests.

In the premises, we are instructed that the 1^st and 2^nd Respondents do not desire to proceed with the hearing of the Appeal.”

3.  Jun He requested that the appeal be dismissed and that their clients pay the Petitioner’s costs of the appeal.  On 5 April 2017 the Court of Appeal made an order that the appeal be dismissed and the Respondents pay the Petitioner’s costs of the appeal.  There were no further steps taken by the Parties in the present petition.

4.  On 29 August 2018 Master Lai made an order winding up the Company on the Petition of a creditor, Shell Eastern Trading (PTE) Ltd, issued on 25 June 2018 in HCCW 173/2018.  The Petition was not contested when it came on before Master Lai.

5.  In these circumstances it might be thought strange that on 24 November 2020 the Respondents and two interveners, Everglory Petrochemical Limited and Everglory (Macau) International Co., Limited, issued a summons (“24 November 2020 Summons”) seeking an order that the Petitioner’s undertaking as to damages given to Chan J (as contained in Schedule 1 to his order dated 19 January 2017) should be enforced.  The reason why the application was made has to do with the progress of an associated High Court Action: HCA 2682/2016 (“Action”).

6.  The Action was a common law derivative action issued on 14 October 2016.  It is not necessary for me to discuss in any detail the background to the Petition proceedings and the Action as this has been explained in Chan J’s judgment and my reasons for decision in the Action dated 4 June 2018, to which I refer later in this paragraph.  In short, the Petition proceedings and the Action sought relief in respect of the same complaints.  In the Action Shih-Hua obtained an ex parte injunction dated 25 October 2016 from Lok J and a further ex parte injunction from DHCJ Kent Yee on 22 November 2016.  On 25 and 26 July 2017 I heard an application by the Respondents (the 1^st and 4^th Defendants in the Action) to strike out the Statement of Claim in the Action and discharge the injunctions.  I did strike out the Statement of Claim and discharge the injunctions.  The primary ground for doing the former was that Shih-Hua could not bring itself within the exceptions to the Rule in Foss v Harbottle because as a consequence of the reconstitution of the Board the 1^st Respondent was no longer in control of the Company.  This disposed of the application to discharge the injunctions, but in case I was wrong in my finding on the strike out application I found, in the alternative, that I would have set aside the injunctions on the grounds of material      non-disclosure and would not have re-granted them.  Of particular relevance to this application are my findings in [57] and [61]:

“57. In the evidence before me was a report prepared by Briscoe Wong Advisory Ltd (‘BW’) dated 24 November 2016 which was not before Lok J, DHCJ Yee or Anthony Chan J. This report analyses the conclusion reached in the RSM Report…

61. On the basis of the evidence that I have read I consider it doubtful whether SH is able to demonstrate a prima facie case of a material breach of duty by Mr Zhang let alone any scheme to defraud the Company, which is the import of SH’s claim. However, assuming for present purposes that a prima facie case has been demonstrated:

(1) I am not satisfied that the evidence shows that unless enjoined Mr Zhang and the entities he controls will divert future payments. I am made more confident in reaching this conclusion by the appointment of independent directors. There is nothing to suggest that Mr Zhang currently intends to divert any monies due to the Company to his own entities now the directors have been appointed and they have obtained control of the Company’s bank accounts.

(2) I am certainly not satisfied that there is sufficient risk of loss to the Company and consequently to SH to make it unjust to refuse to re-grant the Orders as a penalty for what I have found to be a serious failure to make full and frank disclosure of material matters before Lok J and DHCJ Yee.”

7.  The reference in [57] to the report not being before Chan J, was a reference to the hearing before him on 4 and 5 January 2017 not a reference to the only other hearing before him referred to in my decision, namely, the application for a validation order, which was heard on 20 July 2016 and is referred to in [9].  As can be seen from [9]–[10]  Shih-Hua also sought to make an application for appointment of provisional liquidators on 19 July 2016, but Chan J declined to hear it.  Shih-Hua then sought to make an urgent ex parte application before me, which is described in detail in [10] of my decision.  It has become clear to me on reading the papers and hearing counsel that I probably proceeded on the mistaken assumption that Chan J did not have the 24 November 2016 BW Report.  It appears that for all practical purposes we had the same evidence before us.  I simply reached a different conclusion on some of the factual matters common to both applications[1].

8.  Shih-Hua appealed my decision.  The appeal was dismissed on 21 January 2021.  In her judgment with which the other members of the court agreed, Yuen JA says this at [11.1]:

“On 25 and 26 July 2017, Harris J heard (amongst other applications) a summons issued by the defendants to strike-out the CLDA. It should be noted that by this time, there was available to the judge a forensic report by Briscoe Wong Advisory Ltd dated 24 November 2016 which post-dated the applications before Lok J or DHCJ Yee, but which had also not been placed before Anthony Chan J in January 2017. This report analyzed and rebutted a number of matters set out in a report from RSM Corporate Advisory (Hong Kong) Ltd on which SH had relied[2].

9.  Yuen JA understandably assumed that what I had stated in [57] was correct.  It appears that I was wrong.

10.  On 24 November 2020, the Respondents and the Interveners issued a summons seeking an inquiry as to the amount of damages suffered by them as a result of the granting of the two injunctions in the Autumn of 2016 to which I have referred.  On 10 September 2021 I ordered an inquiry before a Master into what loss resulted from granting the two injunctions.

11.  In their skeleton argument, the Respondents and the Interveners argue that it follows from the findings in the Action that (1) the Reconstitution Order was wrongly granted; (2) that it is probable that loss resulted; (3) consequently, the court should order an inquiry into what that loss should be and that (4) the inquiry should take place at the same time as the inquiry in the Action before the same Master.

12.  The Respondents and Interveners argue that if an injunction is found to be wrongly granted the enjoined party is entitled to, subject to what I say in the next paragraph, an inquiry into damages.  It is not necessary for the order to have been set aside or for a trial to have taken place.  The undertaking given by the Petitioner is in general terms: “If the Court later finds that paragraph 1 and/or paragraph of this Order has caused loss to the 1^st and/or 2^nd Respondents or any other party and decides that the 1^st and/or 2^nd Respondents or that other party should be compensated for the loss, the Petitioner will abide by any order which the Court may make as to damages.”  As Richards J states in Abbey Forwarding Ltd (in liquidation) v Revenue and Customs Commissioners[3] this form of wording gives the court a discretion to order an inquiry when it is of the opinion that it has caused loss.  I agree with Richards J view in [100] that “Whether an inquiry as to damages should be ordered would be an issue independent of the result at trial and could well be a matter to be decided at a separate hearing either before or after the trial”.

13.  It is common ground between the Parties that the determination by the court has two stages.  The first which I have just explained concerns whether or not an order was wrongly granted.  The second is whether it caused loss.  Issues of causation and quantum are normally to be dealt with by a Master.  At the present stage of the process what is required is that the Respondents and the Interveners adduce some evidence to show an arguable case that they have sustained loss falling within the undertaking.  The court should not allow a protracted argument on whether the suggested loss will be recoverable[4]. The court is concerned to determine whether there is evidence which demonstrates that an inquiry will serve some purpose and would not be an exercise in futility[5].

14.  Shih-Hua frames the first issue thus:  the relevant question is whether the Respondents and Interveners are entitled to an inquiry as to damages.  They refer to the judgment of Neill LJ in Cheltenham & Gloucester Building Society v Ricketts and Others[6]:

“The undertaking, though described as an undertaking in damages, does not found any cause of action. It does, however, enable a party enjoined to apply to the court for compensation if it is subsequently established that the interlocutory injunction should not have been granted”

“It is important to underline the fact that the question whether the undertaking should be enforced is a separate question from the question whether the injunction should be discharged or continued”.

15.  Shih-Hua argued in its skeleton argue that:

(1)  It has not been established that the Reconstitution Order was wrongly granted.

(2)  The Respondents had the opportunity to establish that the Reconstitution Order had been wrongly granted in the appeal that they commenced, but they chose to abandon it.

(3)  The finding in my decision that had I not struck out the Statement of Claim I would not have ordered a regrant, cannot constitute a finding that the Reconstitution Order was wrong granted.

16.  Having read the skeleton arguments and the papers to establish whether or not I had been wrong about my understanding that Chan J and I did not have the same evidence before us, when the hearing commenced I informed Mr Wong that I did not think that I could properly proceed on the basis, which had been assumed in his skeleton argument (I should note that the Respondents and Interveners team of counsel for this application had no previous involvement with either the Petition Proceedings or the Action and were, therefore, unfamiliar with what had taken place at earlier hearings), namely, that I had reached a different conclusion to Chan J because I had additional expert evidence.  As a consequence Mr Wong stream-lined his case.  He made the following five submissions in support of his Clients’ case that an inquiry should be ordered:

(1)  As I explain in [38]–[39] of my decision having procured the appointment of independent directors to manage the affairs of the Company Shih-Hua failed to put them in funds to do so and, in particular, proceed with the claims against the Respondents advanced in the Action.  No explanation has ever been provided for this.  In [39] I conclude that “It would seem to me that SH has dealt with this matter in a disingenuous way.  It would appear that its application to reconstitute the Board was directed more to ousting Mr Zhang rather than putting in management that could take over the running of the Company’s affairs including the prosecution of the Action.”  Mr Wong argued that if Chan J had been told this he would have been unlikely to have made the order.  As Chan J recognises in his decision it is unusual for the court to make such an order as the court is slow to interfere in the management of a company: see [32] of Chan J’s judgment.

(2)  It is clear from [57]–[61] of my decision that I had concluded having read the evidence that it did not support Shih-Hua’s case that there had been diversion of assets.

(3)  In the appeal from my decision Yuen JA makes the following findings with which Lam VP and Kwan JA agree:

“21.1. The crucial point is that whatever alleged claims there are in the Action, they are the Company’s (not SH’s) claims. In normal circumstances, it is for the board of directors of the Company to decide whether there is any substance in them, and even if there is substance, whether to pursue them or not. A board may properly decline to pursue claims if it thinks it is in the best interests (legal or financial) of the Company not to do so.

21.2. The CLDA was commenced by SH on the ground that the then board was not able or willing to protect the Company’s interests because ZAD was in control. But it transpired that even when independent professional persons (who were appointed to fulfil the duty to protect those interests) were placed in charge of the Company, they did not consider it appropriate to prosecute the claims in the Action.

21.3. In the case of the Reconstituted Board, its solicitor appeared before Harris J on 25- 26 July 2017, informing the court that as SH had not put it in funds, the Board was not in a position to continue with the Action[7]. That was a proper reason for the Board ’s decision not to pursue the claims in the Action. SH has not explained why it did not put the Company in funds so that the Board could investigate and pursue whatever claims it (the Board) considered the Company had. SH was apparently only prepared to expend funds to pursue the claims by itself, when the alleged claims are clearly claims belonging to the Company which was now in the hands of professional independent persons.

…

22. In the present case, it is significant that the Liquidators had said in their report that they do not intend to pursue the claims for 2 reasons: not only because of insufficient funds, but also as they have not been able to gather relevant information regarding the claims because the books and records of the Company are incomplete and allegedly false.

23. In other words, both sets of independent professionals controlling the Company at different times have decided not to pursue the claims in the Action. In this respect, it is important to note that the Liquidators are officers of the Court, and the reasons for their decision is not only financial, but also because of a lack of objective materials to substantiate the alleged claims. It is pertinent that SH has not complained that it has in fact provided sufficient materials to the Liquidators, but that the latter have refused, neglected or failed to appreciate the effect of such materials. If that were the case, SH could have applied to court under s.200(5) Companies (Winding Up and Miscellaneous Provisions) Ordinance Cap 32, as a person aggrieved by an act or decision of liquidators. It has not done so.

24. That being the case, the appeal should not be allowed just because SH, a contributory, wished to pursue it contrary to the Liquidators’ decision not to do so.  Even if the request in SH’s submissions is treated as an application by summons for the court to grant it leave to pursue the appeal (and presumably the Action, if successful), the Court would have refused it. As noted earlier, whatever alleged claims there were in the Action, they were the Company’s claims, not SH’s claims, and the Liquidators have decided, without challenge, that these claims are not objectively substantiated by reason of the lack of proper documentary evidence. For that reason, the court ‘acting as a filter against any totally wrong-headed action’ (Fargro p.374) would not have directed SH to pursue the Action for the Company.  To allow a contributory to pursue the appeal (and the Action), in the light of the Liquidators’ views that there is no sufficient and reliable documentary evidence in support, would be tantamount to permitting an abuse of process.”

This clearly indicates that the Reconstitution Order was unnecessary.

(4)  In so far as Shih-Hua argues that the application cannot properly be advanced until the Reconstitution Order has been set-aside or discharged, this was the substantive effect of the winding up order.

(5)  In so far as Shih-Hua argues that the Petition is academic, it is only academic, because it has chosen not to prosecute it.  The primary relief sought by Shih-Hua was a buy-out order and this it could still seek if its wished to despite the Company being wound up[8]. Shih-Hua has chosen not to prosecute the Petition or withdraw it.  That cannot be a reason not to determine whether the Reconstitution Order was wrongly grant and, if so concluded, order an inquiry as to damages.

17.  Mr Sherry’s response to these submissions focused on the fact that there had been no determination as to the correctness of the Reconstitution Order in the Petition Proceedings and, so he argued, the views of the new Board not to prosecute the Action should be given little weight because they had not been given the funds fully to investigate the matters of which Shih-Hua complains.  I would note that despite Mr Wong emphasising in his oral submissions (A) that at no stage has Shih-Hua explained why it had not funded the new Board as it had agreed and (B) Shih-Hua could prosecute the Petition and seek a buy-out order despite the winding up order, Mr Sherry did not address either issue. I infer that is because the answer would be unhelpful to Shih-Hua and support what I say in [39] of my decision.  This in itself would suggest that the Reconstitution Order was improperly obtained.

18.  Mr Sherry referred to a report to the court prepared by the liquidators, Duff & Phelps, dated 18 December 2020.  Mr Sherry submitted on the basis of section 2 of the Report that the new Board’s position was most accurately characterised as being unable to take an informed view on what potential claims might be available due to the limited funds at their disposal to investigate them and they had not been provided with a complete set of the Company’s documents by the Respondents.  The latter point is disputed as can be seen from page 4 of the Report.  However, presumably Shih-Hua was not inhibited in anyway in providing such assistance as the new Board needed.  The position is that the liquidators do not appear to have been provided with any information from which they felt able to support the claims made by Shih-Hua.

19.  It seems to me that there is considerable force in Mr Wong’s argument.  I think that I can properly conclude that on the evidence now before the court the Reconstitution Order was wrongly granted and was sought not for the reasons advanced, but as a tactical device.

20.  Shih-Hua argues that the Respondents and the Interveners have not filed evidence that demonstrates that they have suffered loss.  I disagree.  All that is required at this stage is evidence that suggests a sufficient possibility of loss having been caused as to justify an inquiry and that it is unlikely to prove a futile waste of the parties’ and the court’s resources.  At this stage the court is not concerned to deal with questions of causation or the adequacy of the evidence.  In my view this test has been met.  I can deal with this issue quickly.  Part of the claim that concerns the Interveners is the alleged loss of profit from the reselling of ethylene and propylene, the 1^st Intervener being unable to proceed with its deals with Strong Hero and Trust Bridge to purchase the same from them following the termination of funding by the Company to the 1^st Intervener. Shih-Hua takes issue with this claim contending that no such funding arrangement had been agreed by the Company and the 1^st Intervener or, if I understand Shih-Hua’s case correctly, in the alternative any such agreement was not properly authorised by the Board.

21.  The Respondents have ledgers produced by F.S. Li & Co., (a firm of accountants) in 2016, which show that the Company advanced significant sums to both the Interveners during 2016 and received payments from them.  The ledger ends with an advance to the 1^st Intervener dated 26 June 2016 of US$9,746,578.65. The total debits and credits for the period shown in the ledgers (which commences with an advance to the 2^nd Intervener of US$520,000 on 6 January 2016) is US$122,826,766.81 and US$145,926,161.82 respectively showing a net amount owed to the Company of US$304,673.12.  Cleary the Company was advancing considerable amounts to the Interveners until Shih-Hua took action, which brought it to a halt.  I am not concerned to determine whether or not either the advances were properly authorised, the consequences if they were not or whether there were any other profitable transactions of which the Interveners were prevented concluding because of the impact of the Reconstitution Order.  That is a matter for a Master.  The position is the same in respect of the other objections raised by   Shih-Hua. They may need to be addressed before a Master and Shih-Hua may prevail on some or all of them.  That is not a matter for me to determine.

22.  I will, therefore, order an inquiry.  It is common ground that if I do so it should take place at the same time as the inquiry in the Action and also that the release of security summons dated 3 July 2020 should be adjourned sine die until after that inquiry.  I will reserve the costs of the 3 July 2020 summons.  I will make a costs order nisi that the costs of the 24 November 2020 Summons be the Respondents’ and the Interveners’ costs in the inquiry as to damages with a certificate for two counsel.  So far as the summons issued on 23 December 2021 by the Shih-Hua to adduce further evidence, which was withdrawn, is concerned, I order that it be withdrawn and that Shih-Hua pays the Respondents’ and the Interveners’ costs in any event.