AKTIESELSKABET DANSK SKIBSFINANSIERING (BODY CORPORATE) v. WHEELOCK MARDEN AND CO LTD AND OTHERS

1988, No. MP2625

IN THE SUPREME COURT OF HONG KONG

HIGH COURT

MISCELLANEOUS PROCEEDINGS

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J U D G M E N T

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1. The plaintiff is the creditor in the liquidation of Wheelock Maritime International Limited (WMI) and alleges that the business of the company was carried on with intent to defraud creditors and that the defendants, were knowingly parties to the carrying on of the business in a fraudulent manner and seeks relief under section 275 of the Companies Ordinance. By the present summonses, the defendants apply under Order 18, rule 19 of the Rules of the Supreme Court, or alternatively under the inherent jurisdiction of the Court that the statement of claim be struck out on the grounds - (a) it discloses no reasonable cause of action; (b) it may prejudice, embarrass or delay the fair trial of the proceedings; and (c) is frivolous, vexatious or otherwise an abuse of the process of the Court. For the purposes of this application I must assume that the allegations set out in the statement of claim will be proved at the trial.

2. Section 275(1) of the Companies Ordinance provides :-

" 275. (1) If in the course of the winding up of a company it appears that any business of the company has been carried on with intent to defraud creditors of the company or creditors of any other person or for any fraudulent purpose, the court, on the application of the Official Receiver, or the liquidation or any creditor or contributory of the company, may, if it thinks proper so to do, declare that any persons who were knowingly parties to the carrying on of the business in manner aforesaid shall be personally responsible, without any limitation of liability, for all or any of the debts or other liabilities of the company as the court may direct."

3. The 1st defendant Wheelock Marden & Company Limited was at all material times the general manager and secretary of WMI which was placed in voluntary liquidation on the 2nd August 1985. The other defendants were, at all material times prior to the liquidation, directors of WMI except the 7th defendant who was a director until the 3rd April 1985. The action against the 11th defendant was struck out during the course of the hearing of the present summonses. In the liquidation of WMI, the plaintiff claims to be a creditor for a sum of DKr 438,446,671.68 and £5,668.36.

4. By paragraph 4 of the statement of claim, the plaintiff alleges that :-

"The said indebtedness was incurred and/or allowed to continue at a time when, unknown to the Plaintiff, but known to all the Defendants (or which ought to have been known or in respect of which the Defendants acted with reckless disregard therefor) WMI was insolvent and unable to pay its debts as they fell due. Further and/or alternatively the said indebtedness was incurred and/or allowed to continue at a time when the Defendants knew or ought to have known that there was no reasonable prospect that the loans would ever be repaid or that the shortfall guarantees which supported them (see below) would be honoured or at a time when they had reckless disregard as to whether such prospects were reasonable."

Following this allegation, particulars of indebtedness are set out in paragraph 4.1. Under the particulars, the plaintiff contends that it provided loans on the 8th April 1983 and the 22nd March 1984 to two indirect subsidiaries of WMI viz Adleship Limited and Mastship Limited for the purchase of two ships. The loans were secured inter alia by second mortgages on the ships and by guarantees given by WMI. Re-financing of the ships took place on the 6th February 1985 when the loans were continued in favour of two other indirect subsidiaries of WMI Mayport Shipping Corporation and Cape Vincent Shipping Corporation. Default has been made under the loans and a formal demand was made of WMI, but the sums to which I have referred together with interest remain unpaid.

5. Particulars of knowledge of the 1st defendant are contained in paragraph 4.2 of the statement of claim wherein it is stated that all the meetings of the full Board of directors of WMI ware held in the Boardroom of the 1st defendant which was shared with WMI. The 1st defendant was the holding company of WMI and owned 51% of its shares. The 2nd, 3rd, 4th, 5th, 6th and 7th defendants who constituted a majority of the Board were also directors of the 1st defendant. A special committee of the Board consisting of the 3rd, 5th and 6th defendants was set up on the 28th February 1983 to deal with cashflow problems which met until about the 6th March 1985. The 1st defendant continued to act as general manager and secretary of WMI until the 31st May 1985.

6. Twelve sub-paragraphs are set out in paragraph 4.3 with regard to the insolvency of WMI in which it is alleged that the company was doomed to fail as at the 8th April 1983. In sub-paragraph (1) it is stated that in a report of the 1st defendant dated the 2nd September 1981 there was a sharp downturn in the freight market with no expectation of a return to levels reached six months previously. In another report dated the 22nd March 1982 reference is made to very adverse market conditions. A further report on the 16th September 1982 revealed a fall in profits of about HK$30 million and to continued adverse conditions which were unlikely to improve during that year. Based upon the state of the shipping market, the accounts of WMI and the failure of the Board to hold meetings during critical periods and the company's dependence upon third party support, it is contended by the plaintiff that the company should have been put into liquidation in February 1983. However, by the defendants' failure to do so and by procuring the loan made on the 8th April 1983, it is alleged that WMI continued to trade with intent to defraud its creditors.

7. Further particulars of insolvency are set out in paragraph 4.4. which includes details of the reports of financial advisers upon the financial requirements needed for the company to survive, the failure of the company to maintain repayment of principal and interest and a policy for a sale of its assets and lack of Board meetings. In an interim statement to shareholders for the year ending 31st December 1983, an unaudited net loss of the group for the six months ended the 30th June 1983 of HK$14,885,236 was reported and that the group was not expected to achieve a profit for that financial year. In September 1983 the 1st defendant arranged to give WMI a secured standby credit facility of US$4 million, but this amount was insufficient for the company's survival for it was in fact spent by the 22nd March 1984.

8. Other particulars of insolvency of WMI and/or that it was doomed to fail at all material times after the 22nd March 1984 are set out in paragraph 4.5. In particular, reference is made to a letter dated the 8th September 1984 from the 1st defendant to WMI inquiring whether it was trading fraudulently. WMI's reply of the 10th September 1984 was in the following terms :-

"We believe that, as General Managers, you are fully aware of the financial position and commitments of the Company, and to that extent you are able to form your own view as to this Company's current financial Position."

A similar comment was also made in another letter dated the 21st September 1984.

9. Financial advisers Schroders adverted to WMI's situation in a report dated the 21st September 1984, which where relevant reads :-

"...very careful consideration needs to be given by the Directors as to whether the Company should continue to carry on its business in the normal way and in particular incur new liabilities".

At a full Board meeting on 22nd September 1984, Schroders emphasised that in order to effect a recovery it was essential for the loans of WMI to be rescheduled, that a capital injection be made and for an upturn in the shipping market. Apart from a waiver of a dividend payment by the defendant in October 1984, WMI received no benefit from its parent company. In fact the 1st defendant expressly stated in March 1985 that it would not provide any further funds for WMI.

10. By paragraph 4.6, the plaintiff sets out particulars of knowledge of the defendants of the financial position of WMI and/or knowledge which they ought to have had and/or their recklessness as to the inevitability of WMI's collapse. The particulars refer to the attendances of the 2nd to 12th defendants at Board meetings of WMI; attendances of the 2nd 7th defendants at Board meetings of the 1st defendant; and that the 3rd, 5th and 6th defendants were members of the special committee of WMI. It is also alleged that the 2nd - 12th defendants were sent minutes of the relevant meetings and owed a duty to WMI to be fully informed about its affairs. Further by their failure to hold so few Board meetings at critical times, the defendants acted recklessly in allowing the situation to occur.

11. Under paragraph 5, an alternative allegation of fraud is set out to the effect that the plaintiff's position was worsened by the defendants in procuring the release of certain securities in respect of the two loans. By paragraph 6, a further alternative allegation of fraud is set out wherein the plaintiff alleges that the defendants misrepresented the position of WMI which resulted in the release and deferment of interest instalments at a time when they knew or ought to have known that the loans would never be repaid or acted recklessly in so doing. Specific reference is made in the particulars to the 5th defendant who negotiated the release of the securities and deferments to which I have just referred in that he misrepresented the position and did not make it plain that the true state of WMI showed that it was insolvent and was unable to pay its debts. Under paragraph 7 of the statement of claim, an alternate plea of fraud alleges that the defendants knew or ought to have known of WMI's position or acted recklessly, by their failure to inform the plaintiff of the true position which if known would have enabled the plaintiff to cover its position. In the further alternative, the defendants failed to put WMI into liquidation and thereby allowed its assets to be dissipated.

12. Paragraph 8 concludes that it can be inferred from the facts set out that the defendants were acting fraudulently whilst paragraph 9 contends that the defendants carried on the business of WMI fraudulently within the meaning of section 275 of the Companies Ordinance from at least the 9th February 1983 in that they were all knowingly parties thereto whereby the plaintiff has suffered loss and damage.

13. Under the heading of relief, the plaintiff claims payment of the amounts to which I have already referred together with a declaration that the defendants are liable for such other debts of WMI as it seems proper and payment of such other debts as the Court shall direct together with an account of the debts of WMI.

14. Counsel for the 1st defendant, Mr Ribeiro, and Mr Barma for the 2nd to 12th defendants have attacked the statement of claim on two grounds. First, that the statement of claim is not unequivocal in that it pleads rolled up allegations throughout both in the body of the pleading and in the particulars as to the defendants' states of mind, that they "knew or ought to have known or were reckless" with regard to certain facts relied on which, it is contended is a bad pleading especially as there is no alternative claim based upon negligence, while the matters pleaded do not sustain a case of fraud. Second the statement of claim is an embarrassing pleading.

15. In respect of the submissions made by counsel for the defendants on the claim based upon fraudulent trading, Mr Cullen for the plaintiff agreed with the following propositions :

1. That in order to succeed on the claim for fraudulent trading, the plaintiff must show -

(1) that certain business of WMI was being carried on with in tent to defraud creditors or for any fraudulent purpose; and

(2) the defendants were knowingly parties to the carrying on of such business in such manner.

2. Actual dishonesty is an essential element of fraudulent trading.

(1) It must be shown that the persons involved in carrying on the company's relevant business -

(a) actually intended to defraud creditors or to achieve a particular fraudulent purpose; or

(b) were reckless as to whether the carrying on of the business would result in the creditors being defrauded.

(2) Recklessness exists where the defendants actually realise that continuing the business could well result in the perpetration of fraud on the company's creditors but where they wilfully close their eyes to material facts and press on regardless.

(3) Such intent or recklessness must involve dishonesty, (i.e. real moral blame) on the defendants' part.

(4) An intent to defraud does not arise when a person who genuinely believes that the financial difficulties of the company can be overcome but misjudges negligently otherwise the prospects of recovery with a consequence that creditors suffer loss.

(5) An allegation that a person "ought to have stopped the business" since he "ought to have realised that the company might have no way to repay the credit it was thereby incurring" is an allegation of misjudgment, whether innocent or negligent, and does not amount to dishonesty.

16. It is also common ground that in a case of fraudulent trading, actual fraud is an essential ingredient in the cause of action which must be pleaded clearly and unequivocally by alleging dishonesty on the part of the defendants whilst fraud is not to be inferred from the facts, see Davy v. Garrett [1878] LR 7 Ch 473.

17. Section 275 of the Companies Act 1929 from which section 275 of the Companies Ordinance was taken was considered by Maugham J. in In re William C. Leitch Brothers, Limited [1932] 2 Ch 71 where he had this to say at 77 :-

"That leads me to the question of the true construction of s.275 of the Companies Act, 1929, a question of great difficulty. In my opinion I must hold with regard to the meaning of the phrase carrying on business 'with intent to defraud creditors' that, if a company continues to carry on business and to incur debts at a time when there is to the knowledge of the directors no reasonable prospect of the creditors ever receiving payment of those debts, it is, in general, a proper inference that the company is carrying on business with intent to defraud:"

In another case heard by the same judge dealing with the same section, In re Patrick and Lyon, Limited [1933] 1 Ch 786, he had this to say at 790 :-

"I will express the opinion that the words 'defraud' and 'fraudulent purpose', where they appear in the section in question, are words which connote actual dishonesty involving, according to current notions of fair trading among commercial men, real moral blame."

18. In a later decision In the matter of White & Osmond (Parkstone) Limited (unreported) 1960, Buckley J. alluded to the position of directors incurring credit when they knew the company was insolvent when he had this to say at p.11 of his judgment:-

"In my judgment, there is nothing wrong in the fact that directors incur credit at a time when, to their knowledge, the company is not able to meet all its liabilities as they fall due. What is manifestly wrong is if directors allow a company to incur credit at a time when the business is being carried on in such circumstances that it is clear the company will never be able to satisfy its creditors. However, there is nothing to say that directors who genuinely believe that the clouds will roll away and the sunshine of prosperity will shine upon them again and disperse the fog of their depression are not entitled to incur credit to help them to get over the bad time."

This passage was considered by the Court of Appeal in R. v. Grantham [1984] 1 QB 675 when the court disagreed with Buckley J.'s statement that it is never dishonest or fraudulent for directors to incur credit at a time when to their knowledge the company is not able to meet all its liabilities as they fall due. In this case the court held that for a prosecution under section 332 of the Companies Act 1948 the successor to section 275 of the Companies Act 1929, an intent to defraud was established on proof of an intention dishonestly to prejudice the creditors in receiving payment of their debts.

19. In respect of his submission that the pleading is defective on the grounds of a rolled up plea, Mr Ribeiro places reliance upon a Court of Appeal decision Belmont Finance Corp. Ltd. v. Williams Furniture Ltd. [1979] 1 Ch 250 a case involving a constructive trust where it was held at 251 :-

"2. That before the defendants could be held to be liable as constructive trustees, they had to assist with knowledge a dishonest and fraudulent design on the part of the company's directors; that 'dishonest' and 'fraudulent' in that context had the same meaning and, although neither word needed to be specifically pleaded, the pleadings had to disclose with particularity the allegation that the defendants had knowledge of dishonesty; that the only knowledge pleaded was that they were aware or ought to have been aware of the facts that constituted a breach of section 54 of the Companies Act 1948, and, in the absence of an unequivocal plea that the defendants had been dishonest, the plaintiff company could not rely on a breach of a constructive trust without being granted leave to amend the pleadings."

20. Mr Ribeiro also relied upon Lipkin Gorman v. Karpnale Ltd. and Lloyds Bank Plc (1989) FLR 137 in which it was held that a pleading is not bad where it is alleged that a defendant knew or ought to have known that transactions were part of a fraudulent or dishonest design if followed by proper and sufficient particulars that the defendant knew of the matters complained of. In particular he referred to the judgment of May L.J. where he had this to say at 147 :-

"Secondly, where an element in the alleged fraud or dishonesty relied on is the other party's knowledge of a given fact or state of affairs, this must be explicitly pleaded. It is ambiguous and thus demurrable, if fraud is relied on, to use the common 'rolled-up plea' that a defendant knew or ought to have known a given fact. If it is desired to allege and plead fraud and, in the alternative, negligence based upon similar contentions, then the former must be pleaded first and clearly and the relevant part of the plea confined to the fraud. The allegation in negligence can then be pleaded separately and as a true alternative contention."

However, in the instant case there is no alternative plea in negligence for the whole of the claim is based upon fraudulent trading. In the same case at 175 Parker L.J. referred to the decisions in Belmont Finance Corp Ltd. v. Williams Furniture Ltd. and Nihill v. Nihi11 (1983 unreported) and said : "Neither of those cases in my view establish that a pleading that a defendant knew or ought to have known that transactions were part of a fraudulent or dishonest design is a bad pleading if followed by proper and sufficient particulars."

21. In another case of constructive trust Baden, Delvaux and Lecuit and others v. Societe General pour Favoriser le Developpement du Commerce et de I'Industrie en France SA (1983) BCLC 325 Peter Gibson J. at 407 summarised five categories of knowledge which are relevant for the purposes of constructive trusteeship as follows : "(i) actual knowledge; (ii) wilfully shutting one's eyes to the obvious; (iii) wilfully and recklessly failing to make such inquiries as an honest and reasonable man would make; (iv) knowledge of circumstances which would indicate the facts to an honest and reasonable man; (v) knowledge of circumstances which would put an honest and reasonable man on inquiry."

22. There is no dispute that the first three categories propounded by Peter Gibson J. constitute knowledge of fraud, but issue is taken upon categories (iv) and (v) although it appears that only category (iv) is challenged in the present proceedings. On the question of knowledge, Buckley L.J. had this to say in Belmont Finance Corp. Ltd. v. Williams Furniture Ltd. at 267 by way of obiter dicta which was approved by the other two judges Orr and Goff L..JJ. :-

"The knowledge of that design on the part of the parties sought to be made liable may be actual knowledge. If he wilfully shuts his eyes to dishonesty, or wilfully or recklessly fails to make such inquiries as an honest and reasonable man would make, he may be found to have involved himself in the fraudulent character of the design, or at any rate to be disentitled to rely on lack of actual knowledge of the design as a defence. But otherwise, as it seems to me, he should not be held to be affected by constructive notice."

Megarry V.-C. in In re Montagu's Settlement Trusts [1987] 1 Ch 264, observed that categories (iv) and (v) referred to by Peter Gibson J. in Baden did not amount to want of probity.

23. Mr Ribeiro submitted that the cases of constructive trust and the dicta in the last two cases where the allegation is one of "ought to know" can admit of a result that is consistent with innocence although I understood Mr Barma to contend that where the result could equally admit of innocence as well as of fraud, the pleading should be struck out. If the evidence at the trial enables such an inference to be drawn, dishonesty will not have been established. However, such submission does not justify an order to strike out the statement of claim. There is no doubt and it is not challenged that the allegations of actual knowledge and recklessness on their own cannot be criticised, but it is argued that when coupled with the words "ought to know" or "should have known", the pleading is bad. Indeed, fraud can be established if a person obtains credit when he knows that there is no good reason to believe that funds would become available to pay a debt when it becomes due or shortly afterwards or in the words of Templeman J. in In re Gerald Cooper Chemicals Limited [1976] 1 Ch 262 that there was no prospect or no reasonable prospect of paying the debts when they became due.

24. A director of a company acts in a fidiciary capacity and is required to carry out his duties in the best interests of the company. He must act honestly in the conduct of the affairs of the company. Provided that the directors in this action have acted honestly and in good faith, they will have a good defence to the present action. For the plaintiff to succeed, it must be proved that the defendants made decisions that were not in the interests of the company with knowledge that at the time the loans were incurred, the company was insolvent and knew that it would be unable to pay its debts when they fell due or had no prospect of paying the debts. Whether or not the defendants were guilty of fraud or dishonesty can be established by inference from the facts that have been proved and it will be essential in the case to ascertain what was in the minds of the defendants and their motives behind any decisions that were made.

25. Some of the directors should have had actual knowledge of the facts whilst the others upon the facts alleged ought to have known or should have known. These are however matters of evidence for determination at the trial. On the other hand, if the defendants are only guilty of negligence in the management of the company's affairs, fraud will not have been established. The nub of the attack upon the pleading is related to the allegation that the defendants ought to have known that the company could not avoid going into liquidation. The facts reveal that the company was for two and a half years insolvent and that despite its financial state, it incurred two loans during that period of time which were later refinanced at a time of adverse conditions in the shipping market when reports from financial advisers confirmed the parlous position of WMI and even drew the attention of the company as to whether it was trading fraudulently.

26. Mr Cullen relies upon Baden for the proposition which I accept that a director of a company who owes a duty to use the assets of the company in what he honestly believes to be in the best interests of the company is fraudulent if he takes a risk in using the assets which risk no director could honestly believe to be taken in the interests of the company which is to the prejudice of the rights of others. The statement of claim sets out clearly the factual basis from which an inference of fraud can be drawn if it is established that the defendants acted in the manner alleged. The rolled-up plea to which objection was taken relates to an allegation of dishonesty which has been properly particularised. The first ground that was submitted on behalf of the defendants is therefore rejected.

27. In respect of the second ground that the statement of claim is embarrassing Mr Ribeiro made the following submissions :-

(1) The particulars are couched in such vague and imprecise language that the plaintiff's case is not discernible.

(2) Particulars are pleaded which do not actually particularise the allegations of which they purport to be particulars.

(3) Matters are pleaded in the guise of particulars which are not particulars at all, but which at the highest are possible matters of evidence, see Davy v. Garrett (1878) LR 7 Ch 473.

(4) Unfounded conclusions are pleaded as purported particulars.

(5) Necessary particulars are not supplied on the untenable ground that further particulars will be a matter of expert evidence.

(6) Reference is made in the pleadings and particulars to other parts of the pleadings or particulars which cannot be identified.

(7) Large sections after pleadings are repeated without particularity and without indicating why the repetition of such sections is material

A further contention by the defendants that the allegation of misrepresentation was wholly unparticularised and cannot form the basis for any of the reliefs claimed is misconceived for the allegation is an instance of fraud by virtue of the defendant's failure to disclose the true position of WMI at the material time. Any inadequacy in the further and better particulars of the statement of claim that have already been delivered by the plaintiff can be the subject of a renewed request. However, the pleading, in my judgment, does not justify the strictures that have been addressed to me for I am of the opinion that the case of fraud has been pleaded clearly and that the defendants should not be embarrassed in the way that has been contended. A further submission that paragraph 7 of the statement of claim discloses no known cause of action is irrelevant for it is not meant to be a cause of action, but part of the plaintiff's case of fraud.

28. I have therefore come to the conclusion that the plaintiff's case is not embarrassing so that the second ground for striking out the statement of claim fails.

29. A final submission that there is no basis for the reliefs sought in paragraphs 2 and 3 of the prayer on the grounds that the plaintiff has no locus to make such claims is without foundation for section 275 of the Companies Ordinance is a section to be considered in the public interest and should be construed in wide terms see In re Cyona Distributors Ltd. [1967] 1 Ch 889 where Lord Denning M.R. at 902 had this to say after reading section 332(1) of the Companies Act 1948 :-

" In my judgment, that section is deliberately framed in wide terms so as to enable the court to bring fraudulent persons to book. If a man has carried on the business of a company fraudulently, the court can make an order against him for the payment of a fixed sum: see In re William C. Leitch Bros. Ltd. An order can be made either at the suit of the liquidator, etc., or of a creditor. The sum may be compensatory. Or it may be punitive. The court has full power to direct its destination. The words are quite general: `all or any of the debts or other liabilities of the company as the court shall direct.' By virtue of these words the court can order the sum to go in discharge of the debt of any particular creditor; or that it shall go to a particular class of creditors; or to the liquidator so as to go into the general assets of the company, so long as it does not exceed the total of the debts or liabilities. Of course, when an application is made by a liquidator, the court will usually order the sum to go into the general assets, as Eve J. did in In re William C. Leitch Bros. Ltd. (No. 2), but I do not think it is bound to do so. Certainly when an application is made by a creditor who has been defrauded, the court has power, I think, to order the sum to be paid to that creditor. In short, I think the words of the section are to be given their full width. When a creditor applies, as the commissioners did here, he applies on his own account. He does not apply as being under a trust for the other creditors or for anyone else. He is the master of his own application. He can discontinue his application, if he likes, without getting the sanction of the liquidator. But no doubt the liquidator should always be made a party to the proceedings, so that the interests of the other creditors can be safeguarded."

Accordingly, I am quite satisfied that the reliefs claimed are well founded.

30. The summonses will therefore be dismissed and there will be an order nisi for costs with a certificate for two counsel.