C Y FOUNDATION GROUP v. CHENG CHEE TOCK & OTHERS

HCMP 680/2011

IN THE HIGH COURT OF THE

HONG KONG SPECIAL ADMINISTRATIVE REGION

COURT OF FIRST INSTANCE

MISCELLANEOUS PROCEEDINGS NO. 680 OF 2011

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BETWEEN

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J U D G M E N T

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1.  By these proceedings, the Plaintiff, C Y Foundation Group Limited (“CYF”) complains of the payment of a sum of HK$9,306,500 by CYF for the benefit of the 1^st and 2^nd Defendants, Mr Theodore Cheng Chee Tock (“Mr Cheng”) and his wife, Madam Leonora Yung (“Madam Yung”), pursuant to a resolution by which the board of directors of CYF resolved to indemnify Mr Cheng and Madam Yung in respect of legal costs incurred by them:-

(1) in defending proceedings (HCMP 702/2010) relating to CYF that were brought against them (and others) pursuant to section 168A of the Companies Ordinance (Cap. 32) by Luck Continent Ltd (“Luck Continent”); and

(2) in respect of an investigation of them by the Independent Commission Against Corruption arising out of complaints that they had defrauded the CYF in relation to a transaction (which has been called “the 17/F transaction”) by which CYF acquired its office premises, it being alleged that they were financially interested in the property acquired by CYF (Mr Cheng has now been charged with offences of dishonesty in relation to the 17/F transaction, and is due to stand trial in February 2012).

2.  The proceedings are brought against Mr Cheng, Madam Yung, and also against three of CYF’s former directors, who passed the resolution complained of.

3.  CYF contends that the resolution was passed by the board in breach of its fiduciary duties to CYF, and that the resolution is invalid.  CYF also contends that, in consequence, payments to Mr Cheng and/or Madam Yung pursuant to it (in particular, the payment of HK$9,306,500) were misapplications of its funds, and that Mr Cheng and/or Madam Yung thereby became constructive trustees of the sums received by them, as they must have been aware of the breach.  The HK$9,306,500 was in fact paid to Madam Yung, by a cheque dated 15 February 2011.

4.  On commencing these proceedings, CYF also applied by inter partes summons for an injunction to restrain Mr Cheng and Madam Yung from disposing of or dealing with this sum, and for disclosure orders to require Mr Cheng and Madam Yung to state what they had done with it, whether any of it remained with either of them, and whether any other sums paid by either of them to their legal advisers in respect of either of the matters referred to in paragraph 1 above had been funded by CYF.  This was the hearing of those applications.

5.  By way of background, CYF is a Bermuda company that is listed on the Hong Kong Stock Exchange.  Its largest shareholder is Luck Continent, which is controlled by a Mr Poh Po Lian while its second largest group of shareholders consists of various companies beneficially owned by Madam Yung.  Until 8 April 2008, Mr Cheng was the Chairman of the board of CYF and one of its Executive Directors, and Madam Yung was a Vice-President in charge of Human Resources and Administration, but not a director.

6.  The section 168A proceedings concerned various complaints by Luck Continent and Mr Poh of allegedly unfairly prejudicial conduct on the part of Mr Cheng, Madam Yung, and the shareholders beneficially owned by Madam Yung, in particular their consistent opposition to amending the constitution of CYF to enable its directors to be removed by an ordinary resolution (the articles require a special resolution to be passed for this purpose).  There were also complaints about a number of transactions entered into by CYF, although at the trial, the focus in this respect was only on the 17/F transaction.  Judgment in those proceedings has been reserved.

7.  During the course of the trial of those proceedings, CYF held an Annual General Meeting, at which Luck Continent gained control of CYF’s board.  As a result, Mr Cheng and Madam Yung were suspended from their duties.  Shortly after CYF’s new board took over, the payment was discovered by them, and these proceedings were commenced.

8.  At the hearing, CYF was represented by Mr Douglas Lam, and Mr Cheng, Madam Yung and the 3^rd and 5^th Defendants were represented by Mr John Litton and Mr Kestrel Lam.

9.  Mr Lam explained that the injunction applied for (which is designed to prevent the sum paid to Madam Yung being dealt with) was not a Mareva injunction to prevent dissipation of assets which might otherwise be available to meet any order for payment that might be made at the end of the day.  Rather, it was premised on Mr Cheng and Madam Yung being constructive trustees of any amounts received by them pursuant to CYF’s board resolution of 10 February 2011, and was intended to preserve the proceeds of such payments in their hands.  Accordingly, it was based on proprietary claims advanced by CYF against Mr Cheng and Madam Yung.  It would therefore require CYF to identify assets of Mr Cheng and Madam Yung which can be said to represent the sums paid to them by CYF.

10.  The basis of the claims, as explained in CYF’s evidence filed in support of the application, was that CYF was under no obligation or liability to make such a payment to Mr Cheng and/or Madam Yung, that the payment was accordingly in the nature of a gift and not made bona fide in the best interests of CYF, and thus was made in breach of fiduciary duty on the part of the directors approving it.

11.  In particular:-

(1)   In the context of the funding by CYF of costs incurred in relation to HCMP 702/2010, Mr Lam pointed out that it is well recognised that a company should not expend its own funds in defending section 168A proceedings in relation to itself, and should not provide funding to its shareholders or directors who are parties to such proceedings, as section 168A proceedings are in the nature of a dispute between the shareholders of the company, which should remain neutral (see e.g. Re Hydrosan Ltd [1991] BCLC 418; Core Pacific-Yamaichi International (HK) Ltd (unreported, Barma J, HCMP 3231/2003, 17 October 2003)).

(2)   In the context of the criminal investigation and proceedings, having regard to the subject matter, it was self evident that this was not a matter for which CYF should have been providing funding for Mr Cheng and Madam Yung’s legal expenses.

12.  Mr Lam went on to submit that as Mr Cheng was and remained a director of CYF, insofar as any part of such funds could be traced into his hands, they were held by him on constructive trust for CYF, while Madam Yung was either a volunteer, or had notice (through Mr Cheng) of the source of the funds, and was on that basis likewise a constructive trustee.

13.  So far as the disclosure orders were concerned, Mr Lam explained that these were ancillary to the injunction, and were designed to enable CYF to identify the whereabouts of the funds, and to ascertain whether any other similar payments had been made which should be the subject of similar orders.

14.  Mr Litton, however, submitted that no relief should be granted as:-

(1)   CYF had failed to establish that there was a serious issue to be tried in relation to the allegation that the payment of the HK$9,306,500 to Madam Yung was a misapplication of CYF’s funds, having regard to the fact that its board had in fact obtained legal advice from CYF’s Bermudan legal advisers prior to passing the resolution of 10 February 2011.

(2)   Even if there were a serious issue to be tried, damages would be an adequate remedy, as an order for repayment of any sums wrongfully paid to Mr Cheng and/or Madam Yung would provide full compensation for any loss that CYF might have suffered, and there was nothing to suggest that Mr Cheng and Madam Yung were not in a position to pay such damages.  On the contrary, there was evidence to show that Madam Yung had a substantial net balance in her bank account in Hong Kong, and nothing to suggest that she was likely to dispose of it.

(3)   If it were necessary to go on to consider the balance of convenience, this lay in favour of refusing the injunction and sought, because:-

(a)   Having regard to Madam Yung’s financial position, it was likely that any order for payment to CYF that might be made would be honoured.

(b)   The inability to use the HK$9,306,500 for the purposes of HCMP 702/2010 or the criminal proceedings against Mr Cheng might prejudice Mr Cheng and Madam Yung in their defence of such proceedings.

(c)   The status quo was that Mr Cheng and Madam Yung had been reimbursed, and they should therefore be free to make use of the funds if they wished.

(d)   CYF had failed to disclose the fact that it had received legal advice prior to the resolution being passed, and therefore was guilty of non-disclosure of a material fact, and should be denied relief because it did not come to court with clean hands.

(e)   Mr Cheng and Madam Yung had offered to deal with the matter by giving suitable undertakings, but CYF had unreasonably rejected the offer.

(4)   As for the disclosure orders, these should be refused because:-

(a)   The disclosure sought was ancillary to the injunction, and thus if the injunctions were refused the disclosure should similarly be refused.

(b)   In any event, Mr Cheng and Madam Yung had provided adequate answers to the questions posed in their affirmations in opposition to the summons.

15.  Madam Yung’s evidence (which was adopted in these respects by Mr Cheng) was that she and Mr Cheng had paid (before 10 February 2011), out of their own resources, HK$9,000,000 to Messrs Peter K S Chan & Co on account of fees in relation to HCMP 702/2010, and HK$12,000,000 to Messrs Li Wong Lam & W I Cheung on account of fees in relation to the ICAC investigation.  She said that by about February 2011, a total of HK$9,306,500 had been spent by the two law firms between them.  At that time, Messrs Peter K S Chan & Co were also asking for a further HK$10,000,000 to cover fees for the upcoming trial of the proceedings.  In those circumstances, as it was thought that Mr Cheng and Madam Yung’s involvement in the proceedings was due to their role in relation to the management of CYF, and as it was thought that the complaints of Luck Continent were unjustified, it was thought to be appropriate that they should be indemnified in respect of their legal expenses.  As the amount already expended on legal representation was HK$9,306,500, payment of that amount was sought, together with a further payment of HK$10,000,000 to cover the costs on account being asked for by Messrs Peter K S Chan & Co.

16.  Madam Yung says that only the one payment of HK$9,306,500 had in fact been made pursuant to the resolution, and that there had been no other payments made to them by CYF in respect of their legal expenses.  She said that the cheque by which the payment was made was deposited into her bank account with the Hang Seng Bank Limited (“Hang Seng”), and that she had thereafter paid HK$5,000,000 on 22 February 2011 to Messrs Peter K S Chan & Co (as the amount of further costs required for HCMP 702/2010 had been reduced as a result of a decision not to retain senior counsel for the trial).

17.  Madam Yung exhibited to her affirmation copies of her bank statements covering the period in which these payments were received and made.  The statements are in respect of an integrated account numbered 378-180822-888.  That account appears to have had two components, a statement savings account with a balance of HK$100 throughout the relevant period, and a current account, which was just prior to the payment in of CYF’s cheque overdrawn to the extent of HK$11,554,854.29.  The crediting of the cheque proceeds reduced the overdraft to HK$2,461,991.89 (there were some other debits the same day).  The account remained overdrawn throughout the relevant period.

18.  The statement also set out the balances at the statement date of a number of other accounts maintained by Madam Yung with Hang Seng Bank.  These other accounts included two other integrated accounts, which appear to have comprised savings, current and investment accounts, and a number of savings accounts (some in foreign currencies).  There were also a number of credit card accounts, a mortgage loan and a number of insurance policies.  On the first page of each statement, there was a summary of Madam Yung’s financial position, in which the net position was arrived at after taking account of all deposits, investments, personal loans and overdrafts and credit card balances across the various accounts.  The net position did not include the outstanding mortgage loan, which was shown as a separate liability, or the insurance policies.  As at 19 February 2011 (the date of the first of the two statements covering the period from the payment in of the CYF cheque until the payment of HK$5,000,000 to Messrs Peter K S Chan & Co), the net position showed a positive balance of some HK$8,446,002.83, while the mortgage loan (not taken into account in the net position) stood at HK$5,329,175.20.

19.  During the hearing, I raised with counsel the question of what impact the payment of the CYF cheque into an overdrawn account had on the ability of CYF to trace the proceeds of the cheque into some asset held by Madam Yung.  As neither party was in a position to deal with this question immediately, I directed that written submissions limited to this question should be lodged after the hearing concluded.  Such submissions were lodged on 4, 9, 12 and 13 May 2011.

20.  I shall deal with this point first, as it is, in my view, determinative of this application.

21.  There are a number of authorities which state that where funds are paid into an overdrawn account, the right to trace such funds is lost.  In Re Diplock [1948] Ch 465 at 521, Lord Greene M R stated that:-

“The equitable remedies presuppose the continued existence of the money either as a separate fund or as part of a mixed fund or as latent in property acquired by means of such a fund. If, on the facts of any individual case, such continued existence is not established, equity is as helpless as the common law itself.”

22.  This principle has been applied to the position in relation to overdrawn accounts on many occasions.  See, for example, Re Bishopsgate Investment Management Ltd v Holman [1995] 1 Ch 211 at 218-220, Re Goldcorp Exchange Ltd [1995] 1 AC 74 at 104-105, Shalson v Russo [2005] Ch 281 at paras 136-140 of the judgment, Director of Serious Fraud Office v Lexi Holdings plc [1009] QB 376 at para 50 of the judgment and Re B A Peters plc [2010] 1 BCLC 142 at para 15 of the judgment.

23.  In the last of these cases, Lord Neuberger said (in the passage referred to):-

“The problem which the appellants’ case has to confront is that, because the money in issue was paid by the company into the current account (which was always in debit), it was effectively used to reduce the company’s liability with the bank and it effectively disappeared so that there was never any fund on which a proprietary claim could operate …”

24.  However, Mr Lam submitted that notwithstanding that CYF’s cheque was paid into an overdrawn bank account of Madam Yung’s, CYF’s proprietary right to trace its funds of which it was wrongfully deprived was not lost, because:-

(1)   Such funds could be traced through the overdrawn bank account and into the payment of HK$5,000,000 made to Messrs Peter K S Chan & Co because on being paid into the bank account, they could be traced into an enhanced right of Madam Yung to draw on the overdraft facility extended to her by her bankers, and thereafter into the client account of Messrs Peter K S Chan & Co; or alternatively,

(2)   The court should not simply look at the position in relation to the overdrawn bank account into which the funds were paid, but should have regard to the overall relationship between Madam Yung and Hang Seng Bank, which was one in which Madam Yung had a net positive balance.

25.  In support of the first of these points, Mr Lam suggested that the vital distinguishing feature in the present case was that Madam Yung had an agreed secured overdraft facility with the bank with a limit of HK$11,640,000, whereas there did not appear to be anything in the earlier authorities to suggest that the overdrafts in those cases were pursuant to an agreed facility.  Mr Lam suggested that in this case, the right to draw under the agreed facility was an asset of Madam Yung’s, the value of which was increased by the payment into her account of the HK$9,306,500, since that payment reduced the amount outstanding and made it possible for further drawings to be made.  That right was then utilised to make the payment of HK$5,000,000 into the client account with Messrs Peter K S Chan & Co.  In this way, Mr Lam suggested, there was (at least arguably) an entitlement to trace the cheque paid by CYF into the funds standing to the credit of the client account, and thus to enjoin the further use of those funds by Madam Yung.

26.  I do not think that this is right.  In my view, the fact that the overdraft facility granted to Madam Yung on the account in question was an agreed facility does not provide a relevant basis for distinguishing the many cases in which it has been held that the ability to trace is lost when the funds being traced are paid into an overdrawn account.

27.  The reason for this is to be found in an analysis of the nature of tracing.  In Foskett v McKeown [2001] 1 AC 102, Lord Millett explained this (at pages 127-128), saying:-

“Tracing is … neither a claim nor a remedy. It is merely the process by which a claimant demonstrates what has happened to his property, identifies its proceeds and the persons who have handled or received them, and justifies his claim that the proceeds can properly be regarded as representing his property. Tracing is also distinct from claiming. It identifies the traceable proceeds of the claimant’s property. It enables the claimant to substitute the traceable proceeds for the original asset as the subject matter of his claim. … He will normally be able to maintain the same claim to the substituted asset as he could have maintained to the original asset. … But his claim may also be exposed to potential defences as a result of intervening transactions. Even if the plaintiffs could demonstrate what the bank had done with their money, for example, and could thus identify its traceable proceeds in the hands of the bank, any claim by them to assert ownership of those proceeds would be defeated by the bona fide purchaser defence.

“… We … speak of tracing one asset into another, but this … is inaccurate.  The original asset still exists in the hands of the new owner, or it may have become untraceable.  The claimant claims the new asset because it was acquired in whole or in part with the original asset.  What he traces, therefore, is not the physical asset itself but the value inherent in it.”

28.  In this case, when one looks to see what has happened to CYF’s HK$9,306,500, one sees that it has been paid into Madam Yung’s overdrawn account.  Having been paid into that account, it resulted in a reduction in Madam Yung’s overdraft with Hang Seng Bank.  This was the reduction of a liability, and not the acquisition of an asset, so far as Madam Yung was concerned.  No new asset was acquired by Madam Yung, and there is therefore nothing in her hands into which CYF’s funds can be traced.  The position is the same as that posited by Lord Greene in Re Diplock (supra), where in the passage immediately following that cited above, he said:-

“If the fund, mixed or unmixed, is spent upon a dinner, equity, which dealt only in specific relief and not in damages, could do nothing. If the case was one which at common law involved breach of contract the common law could, of course, aware damages but specific relief would be out of the question. It is, therefore, a necessary matter for consideration in each case where it is sought to trace money in equity, whether it has such a continued existence, actual or notional, as will enable equity to grant specific relief.”

29.  Just as spending misapplied money on a meal would result in its being consumed with no new asset being acquired into which the misapplied money could be traced, so too, where misapplied assets are used simply to reduce a liability, they are consumed, and are no longer traceable.

30.  CYF’s money was, of course, received by Hang Seng Bank, but even if it was identifiable in the bank’s hands, this does not assist CYF, since the bank, when receiving the money from Madam Yung, was a bona fide purchaser for value without notice, as it gave value to Madam Yung by treating her liability to it as being reduced, without notice of any possible impediment to the receipt of the money by her.

31.  I do not think that it is possible to regard Madam Yung’s right to draw on the agreed overdraft facility as an asset into which the payment from CYF can be traced.  While the overdraft facility agreement was a chose in action, it was not one which is readily capable of being valued – each drawing on the facility would give rise to an asset (the funds received) which would be counterbalanced by the increased liability to the bank.  The value to Madam Yung of the ability to make further drawings is not the same thing as the amount of the drawings that could be made.

32.  A further problem with the analysis proposed by Mr Lam is that if one were to work backwards from the funds paid into the client account with Messrs Peter K S Chan & Co, and seek to identify the source of those funds, it is clear that the source of those funds is Hang Seng Bank, which, when allowing a fresh drawing on the facility to be made, for example by honouring the HK$5,000,000 cheque paid by Madam Yung to her solicitors, was advancing its own money to Madam Yung, rather than returning to Madam Yung any money that could be regarded as belonging to her.  For this reason also, it is not possible to regard the funds standing to the credit of the client account as representing the traceable proceeds of CYF’s funds.

33.  This leaves Mr Lam’s second argument, which is that Madam Yung’s overall position with Hang Seng Bank should be taken into account, rather than viewing the matter in terms of the position on her overdrawn current account taken in isolation.  As to this, there are also a number of authorities against the argument advanced by Mr Lam – see Box v Barclays Bank [1998] Lloyds Rep Banking 185 at 202 and Shalson v Russo (supra) at paragraphs 137 to 139 of the judgment. 

34.  Although Mr Lam sought to deal with these cases by pointing out, correctly, that in Shalson v Russo, the accounts sought to be consolidated appeared to be with different entities, and suggesting that the view expressed by Ferris J in Box v Barclays Bank was not the result of detailed analysis, I am of the view that it would not be correct to accept the proposal that the various accounts maintained with Hang Seng Bank by Madam Yung should be consolidated.

35.  This is because, in my view, the analysis set out above in relation to the question of tracing through an overdrawn account provides the answer to this argument also.  Notwithstanding that Madam Yung had a number of accounts with Hang Seng Bank, some in debit and others in credit, the fact is that CYF’s funds were paid into an account which was overdrawn, with the effect of reducing the overdraft and thereby reducing Madam Yung’s liability to the bank on that account.  The effect of the payment in on the overdraft was a real one.  Having received the payment into the overdrawn account, the bank would seem thereafter to have charged interest on the overdraft on the basis of the reduced balance.  In these circumstances, the position is that having been paid into the overdrawn account so as to reduce the liability under it, CYF’s funds have been consumed, and are therefore no longer traceable.  The fact that the bank could almost certainly have had recourse to other assets of Madam Yung’s (the credit balances on her other accounts with it, or other assets of hers deposited with it) to set off Madam Yung’s liability on the overdraft (but did not need to do so) does not make any difference.

36.  I am therefore satisfied that it is no longer possible for CYF to trace its funds into any asset now in the hands of Madam Yung.  That being so, there is no good arguable case for the granting of the injunction sought, which seeks to protect CYF’s proprietary rights in respect of the allegedly misapplied funds, as there can be no such rights capable of protection after the funds were paid into Madam Yung’s overdrawn account, and the injunction and ancillary relief applied for must be refused.

37.  It is therefore not necessary to consider the other points which were argued in opposition to the application.  However, for completeness, I would say that had I been of the view that it was possible to identify assets of Madam Yung’s that could arguably be regarded as being the traceable proceeds of the HK$9,306,500 paid to her by CYF, I would have accepted that there was otherwise a good arguable case for granting the relief sought in this application.  Briefly, my reasons for taking this view are as follows:-

(1)   I am of the view that there is, notwithstanding the fact that the independent board committee of CYF which resolved to make the payment had obtained legal advice, a good arguable case that the payment made was a misapplication of CYF’s funds.  In this regard, it is to be noted that the terms of the advice obtained were inconclusive.  The advice merely pointed out that article 166 of CYF’s by-laws did provide for an indemnity to be provided to directors and officers of CYF in respect of any costs and expenses that they might incur as a result of any act done by them in connection with the execution of their duty or supposed duty qua director or officer of the company.  The advice does not seem to have been directed specifically to the factual situation that had arisen, and it seems to me that it is at least arguable that the provision in CYF’s by-laws would not cover this payment, as there would appear to be a basis for contending that Madam Yung is not an officer of the company, that she and Mr Cheng were, or may not have been, acting in relation to the company’s affairs in defending the section 168A proceedings, and that so far as the 17/F transaction is concerned, if found guilty in the criminal proceedings, Mr Cheng would be unlikely to be able to rely on the indemnity, since he would not have acted without dishonesty in relation to it.

(2)   Questions of balance of convenience and preservation of the status quo ante are not of much relevance in the context of a claim for an interlocutory proprietary injunction such as this.

(3)   Questions of non-disclosure are not of particular relevance where the application is made inter partes, as it was here, as the defendant is able to bring the attention of the court to any matters which it considers relevant.

38.  In the result, however, the application is dismissed.  So far as costs are concerned, I see no reason why these should not follow the event, and I shall therefore make an order nisi that the Plaintiff should pay to the Defendants the costs of this application, to be taxed on the party and party basis if not agreed.