JOSE MIRANDA DA COSTA JUNIOR AND ANOTHER v. LORENZO YIH, also known as YU CHUAN YIH AND OTHERS

HCA 156/2010

IN THE HIGH COURT OF THE

HONG KONG SPECIAL ADMINISTRATIVE REGION

COURT OF FIRST INSTANCE

ACTION NO 156 OF 2010

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D E C I S I O N

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INTRODUCTION

1.  This is the application of the 1^st defendant by counterclaim (“Miranda”) to seek security for costs from the plaintiff by counterclaim (“MGHK”) for MGHK’s “counterclaim” against Miranda.  The reason for the use of the word “counterclaim” will become apparent from the quote below of the decision dated 13 May 2013 of G Lam J (“the May 2013 decision”).  Unless otherwise stated, the same abbreviations used in my decision of 8 October 2013 will be used below.

2.  The background to this application (and this action) has been concisely set out in the May 2013 decision, which I will gratefully quote and adopt:

“The background to [Miranda’s] claim was summarised by Deputy Judge Le Pichon in her decision dated 26 March 2013 in this action on an appeal relating to [Miranda’s] application for specific discovery against [Yih], which I gratefully adopt and set out as follows:

‘2. [Miranda] is a Brazilian merchant engaged in the business of supplying high end gemstones and is the founder and owner of [MGB], a Brazilian company. This action arises from [Miranda’s] claim that in or around September 2003 he and [Yih] orally agreed to jointly set up and operate in partnership a wholesale business of gemstones in Hong Kong through a Hong Kong company to be formed. [Miranda] would manage and develop the business and its goodwill by making use of his expertise and experience and [Yih] would provide financial and local support in Hong Kong including office premises and staff.

3. [Yih] is the major beneficial owner, the Chairman and CEO of LJ International Inc (“LJI”), a NASDAQ listed company engaged in the manufacture and marketing of jewellery.

4. Pursuant to the agreement, [MGHK] was incorporated in Hong Kong on 7 January 2004. Two shares were issued: one was issued to Li Fung Ying, Cam and the other to Wan Po Ming, Flora. They were employees of LJI and held the same on trust for the 1^st plaintiff and the 1st defendant.

5. On 31 December 2006, the two issued shares in the 3^rd defendant were transferred to a BVI company beneficially owned by [Yih] called Oceandrift Group Ltd (“Oceandrift”) and on 6 November 2008, Oceandrift transferred those shares to [Paraiba]. [Miranda’s] case is that those shares continued to be held on trust for [Miranda] and [Yih].

6. [Miranda] actively participated in the business of [MGHK] from 2004 onwards until his exclusion from the 3^rd defendant’s office on 5 November 2009. [Miranda] gave instructions to staff who took orders from him and was treated as one of two bosses. He was also a director from August 2007 until 10 November 2009. He and [Yih] were each paid a monthly shareholder’s bonus of $120,000 until December 2008 when [MGHK’s] cash flow situation no longer permitted that.

7. At all material times the 1st defendant controlled a company called Goldleaves Trading Ltd (“Goldleaves”) which had an office at Unit C, LG/F, Phase 3, Kaiser Estate, 18 Man Lok Street, Hunghom (“the premises”). [MGHK] operated from the premises and staff of Goldleaves was seconded to and placed under the payroll of [MGHK]. Rental for the use of the premises, office furniture and supplies were paid to a subsidiary of LJI at the request of [Yih].

8. It is [Miranda’s] case that on 5 November 2009, [Yih] repudiated the agreement. When [Miranda] returned from Shenzhen that day he found out that Mr Osorio Mendes Quintino Neto who had worked with [Yih] for many years caused [MGHK’s] office to close and compelled all staff to leave. [Miranda] was thus excluded from [MGHK’s] office. He was also denied access to [MGHK’s] computer system and was no longer able to access his e-mail accounts or [MGHK’s] server.’” (para 4 thereof);

“[MGHK] also counterclaims against [Miranda] in its existing Defence and Counterclaim (although strictly speaking “counterclaim” is a misnomer here for [Miranda] has made no claim against [MGHK]). The counterclaim consists of a series of claims based on disparate transactions. Three of these claims should be mentioned here.

(1) It is alleged that [Miranda] delivered a quantity of [MGHK’s] gemstones to a customer, Shrey International Ltd (“Shrey”) and was paid a cash advance of US$30,000 by Shrey for which [Miranda] failed to account to the 3^rd defendant.

(2) [MGHK] claims that at various times up to November 2009, it consigned various gemstones to Triangulo Gemas & Joias (“Triangulo”) with an outstanding value of US$358,707.63. In January 2010, [Miranda] wrongfully directed Triangulo to return the gemstones to himself, and had failed to account to [MGHK] for them and had converted them to his own use.

(3) [MGHK] claims that it consigned various gemstones to Azizi Enterprises Co Ltd (“Azizi”) with an outstanding value of US$32,887. Azizi had returned the consigned stock to [Miranda], who had failed to account for them and converted them to his own use” (para 10 thereof).

THIS APPLICATION

3.  Relying on s 357, Companies Ordinance (Cap 32) (now succeeded by s 905, new Companies Ordinance (Cap 622)); see also s 921 (Cap 622) and RHC Ord 23, Miranda brings this application, contending that there is credible testimony that there is reason to believe that MGHK will be unable to pay its costs if successful in his defence, and thus asks MGHK to give security for the costs.

(a) MGHK’s inability to pay costs

4.  Miranda’s said contention is based principally on:

(a) MGHK’s audited accounts;

(b) statements made in the affirmation of MGHK’s solicitors;

(c) statements made in the affidavit of Yih.

5.  The figures in the said accounts on which particular emphasis has been laid are in the accounts ending 31 December 2011 (“the 2011 a/c”):

(1) net liabilities of about $81.7 million (p 6 thereof (balance sheet));

(2) loss of about $10.8 million (p 5 thereof (income statement));

(3) the 2011 a/c also states that “[MGHK] has been inactive subsequent to the balance sheet date.  In addition, the management plans to cease operations in future” (p 3 thereof (para 4, basis for disclaimer of opinion)).

Further, MGHK’s solicitors affirmed that:

“[MGHK] no longer maintains any employees” (para 20, Brown’s 2^nd affirmation dated 16 August 2012).

Finally, Yih (who Miranda alleges to be the person in control of MGHK) affirmed that:

“[MGHK] is insolvent and any prudent businessman would therefore think carefully before wasting time and money on lawyers to the detriment of the ultimate beneficiaries” (para 96, Yih’s 4^th affidavit dated 19 November 2013).

6.  On the other hand, MGHK argues that:

(a) the said accounts do not constitute credible evidence;

(b) in any event, MGHK has sufficient assets of about $7.5 million to meet Miranda’s costs (p 11, the 2011 a/c (inventories));

(c) further, or in the alternative, to sub-para (b) above, Miranda holds assets belonging to MGHK which can constitute sufficient security.

7.  In relation to para 6(a) above, MGHK observes that:

(1) in relation to MGHK’s 2009 financial report (“the 2009 a/c”), Miranda has made a serious allegation to the effect that the books and records of MGHK had been “created” by Yih to make MGHK appear to be financially unwell (para 9 to 12, Miranda’s 3^rd affidavit dated 18 July 2012).  If so, then those inaccuracies would have “tainted” the subsequent financial reports, including the 2011 a/c;

(2) Miranda also alleges that, even when he was MGHK’s director, MGHK’s accounts were being manipulated for tax avoidance purpose (para 15(b), Miranda’s 10^th affidavit dated 13 February 2014);

(3) expenses related to Miranda’s own personal projects have been included in the 2009 a/c (appendix II thereof).  This totalled about $34 million;

(4) in MGHK’s accounts ending 31 December 2012 (“the 2012 a/c”), out of MGHK’s net liabilities of about $83 million, about $75 million was in fact the entry for Yih’s current account with MGHK (which reflects funding provided by Yih to MGHK) (p 6 thereof (balance sheet));

(5) the 2012 a/c was heavily qualified by its auditors (p 3 thereof (disclaimer of opinion)) such that the said accounts are for all intents and purposes meaningless;

(6) Yih’s statement that MGHK was insolvent could well have been based on the said accounts.

8.  When considering the above points of dispute between the parties, which are essentially factual in nature, several matters should be (and have been) borne in mind.

9.  First, the burden to adduce evidence of the requisite “credible evidence” of an inability to pay costs obviously lies with the applicant (in this application, Miranda): Brand Farrar Buxbaum LLP v Samuel-Rozenbaum Diamond Ltd and Another [2003] 1 HKLRD 600.  But an applicant may do so by indirect evidence, such as the respondent is a shelf company with a nominal amount of paid-up capital, or it does not have an actual registered address, or it was a one-transaction company which does not ordinarily carry on business: Hong Kong Civil Procedure 2014, Vol 1, para 23/3/14 (p 528).

10.  Secondly, bearing in mind para 9 above, the affirmation filed on MGHK’s behalf in this application was not made by its officers, or anyone who has direct knowledge of the matters deposed to. Instead, it was made by its solicitors.  Because:

(a) the solicitors could only have deposed to those matters from MGHK’s business records;

(b) some of the matters deposed to by solicitors are inaccurate (as will be elaborated below),

I consider it inappropriate to attach any weight to the solicitors’ statements (independently of the records on which those were based) (see also UES International (HK) Ltd (formerly known as Grand View Development (HK) Ltd) v Maritima Maruba SA (formerly known as Maruba SCA), HCA 632/2011 (19 November 2013), para 13 to 17)).

11.  Thirdly, because MGHK has not adduced any adequate affidavit evidence (as stated above, the solicitors’ affirmation carries no weight), some of the arguments it advances are either in the nature of submissions, or inferences to be drawn from documents placed before the court.

12.  As stated above, Miranda’s main source for contending that there is credible evidence MGHK will not be able to pay his costs is the 2011 a/c.  The parties’ respective arguments about MGHK’s accounts are discussed below:

(1)   in response to MGHK’s net liability of about 81.7 million (para 5(1) above), MGHK refers to its assets worth about $7.5 million (para 6(b) above).  However, those assets have already been considered when arriving at the net liability in the 2011 a/c.  Although a net liability does not necessarily imply an inability to pay costs, it is a factor unfavourable to MGHK;

(2)   further to sub-para (1) above, MGHK draws attention to a substantial portion of its liability being in fact an entry of its current account with Yih (about $75 million) (para 7(4) above).  Miranda (correctly) replies that, even if that portion is ignored, MGHK’s account payable still totalled about $16 million (p 6, the 2011 a/c);

(3)   in response to MGHK’s net loss of about $10.8 million (para 5(2) above), MBHK refers to the expenses in the 2009 a/c, and claims that no less than $34 million of the expenses there were expenses for Miranda’s personal projects (para 7(3) above).  But even if that sum was reversed, the amount of “administrative and general expenses” would still be about $79 million (appendix II, the 2009 a/c), resulting in a loss of about $42.5 million (instead of the present $76.5 million in appendix I and p 5, the 2009 a/c).

By reason of the matters set out above, none of the above contentions of MGHK is a sufficient answer to the points made by Miranda.

13.  As regards para 6(a) and para 7(1) and (2) above, whether the accounts of MGHK can constitute credible evidence of its inability to pay costs has to be looked at this way.

14.  Declarations against interest are often given full (or a lot of) weight (whereas previous consistent statements are sometimes given less, or even no, weight) because common experience shows that, unless the declarations are true and correct, they would not be made.  Having said so, whether a statement is against one’s interest of course depends on the circumstances under which it is made.  For example, a statement that debts are owed by a business may be a declaration in its favour in a tax return (because this may result in less tax exposure); on the other hand, such a statement may properly be a declaration against interest in some other context.  In relation to this application, I consider the matters referred to in para 5 above (especially para 5(1) and (2) above) to be proper declarations against interest.  This is because they can properly be considered as matters unfavourable to MGHK in the context of this application.

15.  Despite this, MGHK in effect asks me not to place weight on those declarations because of the matters set out in para 7(1) and (2) above.

16.  In relation to para 7(1) above, Miranda’s statements were made in an affidavit filed in his application for specific discovery.  The doubts he cast upon the 2009 a/c (or its draft to be more precise) were put forth as one of the reasons for seeking specific discovery (the true financial position of MGHK up to and as at 5 November 2009). Further, Miranda’s doubts were put forth in the absence of documents which he wanted to inspect.  Understood in such context, MGHK’s assertion that:

“Miranda has under oath … made serious allegations that the books and records of MGHK have been deliberately ‘created’ by [Yih]” (para 27a, MGHK’s skeleton submission), is an over-statement.

17.  Similarly, for para 7(2) above, the relevant part of Miranda’s affidavit focused on his case that debts in MGHK’s accounts supposedly owed by him ought not be accepted as true (para 13 to 16, Miranda’s 10^th affidavit).  But Miranda claims no personal knowledge of whether there was in fact “tax-avoidance accounting”. Thus, the statement that:

“Miranda has suggested … the accounts were being manipulated to avoid tax liabilities” (para 27b, MGHK’s skeleton submission),

is also an over-statement.  It should also be noted that it is factually inaccurate to say any such manipulation occurred when Miranda was MGHK’s director.

18.  As regards the assertion that Miranda holds MGHK’s assets (para 6(c) above), 3 sums are involved:

(a)   loans from MGHK to Miranda of about $24.7 million (p 13, the 2009 a/c, p 12, the 2011 a/c and p 11, the 2012 a/c), alternatively, of about $2 million (p 13, the 2009 a/c);

(b)   personal loan of US$292,500 owed by Miranda to MGHK;

(c)   personal loan of US$150,000 owed by Miranda to MGHK.

(para 14(c), para 33 to 35 and para 37 to 43, MGHK’s skeleton submission)

19.  I agree with Miranda concerning these sums:

(1)   the alleged loan of about $24.7 million was never brought up as a claim by MGHK despite the parties’ adversities.  Further, there was an item for unspecified “impairment loss” in the accounts the amount of which exactly matched Miranda’s alleged loan;

(2)   the alleged loan of US$292,500 was shown by the contemporaneous documents to be in truth a loan taken out by Miranda from a Brasil Color Gems Corporation (“BCGC”), and not MGHK;

(3)   MGHK’s own contemporaneous documents show that the alleged loan of US$150,000 has either been repaid, or secured by gemstones.

20.  Further to the above, I find the following matters advanced by MGHK to have no merits:

(a)   the auditors’ heavily qualified opinion renders MGHK’s account to be meaningless for all intents and purposes (para 7(5) above).  There is no valid reason for so concluding.  Insofar as may be necessary, I will repeat what was said in para 14 above.  In fact, in face of such an unsatisfactory state of MGHK’s accounts, any explanation which MGHK wishes to give therefore ought to be put forth by its responsible officer(s), rather than its solicitors;

(b)   regarding Yih’s statement about MGHK’s insolvency could have been based on MGHK’s accounts (para 7(6) above), neither Yih nor MGHK has adduced evidence to support this point.

21.  Thus, I agree with Miranda that MGHK’s accounts show a generally precarious financial ability.  Coupled with undisputed matters such as:

(1)   MGHK has been inactive since at least 2011;

(2)   its management has planned to cease operation;

(3)   it no longer maintains any employees (the unexplained absence of affidavit evidence from MGHK’s responsible personnel is consistent with this);

(4)   Yih’s statement that MGHK was insolvent;

(5)   subsisting judgment debt (for costs) has not been paid,

it is proper to conclude that there is credible evidence MGHK will not be able to pay Miranda’s costs.

22.  There is no valid reason for my discretion to be exercised against the making of an order to require security for costs to be provided by MGHK.

(b) Merits of “counterclaim”

23.  The parties again disagree about this.

24.  The part of the “counterclaim” relied on by MGHK in this application is that US$292,500 lent to MGHK by BCGC has been used by Miranda personally.

25.  While Miranda admits that the sum has been put to personal use, he denies that MGHK was the borrower, or that MGHK should otherwise be liable to BCGC for the loan.  Miranda also claims that gemstones (valued at US$800,000), which were held by BCGC as security, belong to him.

26.  I agree with Miranda that these are not matters which are fit for determination at this stage.  The settled approach in this regard is that, in an application such as this, a preliminary inquiry to decide the ultimate success or failure of the claim should only be undertaken in a simple case: PT Graha Multimulia Cemerlang v Silver Tech Enterprise Ltd, HCCW 883/2004 (1 March 2005), para 6; DEX Asia Ltd v DBS Bank (HK) Ltd, CACV 245/2007 (6 December 2007), para 27.  This application does not involve such a simple case.

(c) Quantum

27.  Miranda’s skeleton bill (with a detailed breakdown of the cost items) seeks a security amounting about $2.69 million. This is security up to the discovery of documents.

28.  The reasons put forth to justify such an amount are:

(a)   the “counterclaim” was commenced some 4 years ago and has been expanded to multiple defendants;

(b)   there have been earlier substantial interlocutory applications;

(c)   a substantial number of documents have been discovered by the parties;

(d)   MGHK earlier attempted to seek a security for costs of about $4.45 million and Yih attempted to seek $4.2 million or so for the same reason.

29.  On the other hand, MGHK points out that the amount of security up to the trial of this action ordered by the court was only $1.3 million.  MGHK argues that the proper amount of security should be no more than $500,000.

30.  As with the merits of the parties’ respective claim and “counterclaim”, it is not easy for the court to assess with a high degree of accuracy the degree of complexity of the same.  Doing the best I can on presently available materials, while the “counterclaim” may be more complicated than the original claim in this action, this application is concerned with security up to the discovery of documents only.

31.  Bearing the above in mind, the appropriate amount of security should be the sum of $1.5 million.  No submissions have been made as regards the provision of security by way of payment into court.

(d) Conclusion

32.  There will be an order in terms of Miranda’s summons save that the amount of security should be $1.5 million instead.

Other matters

33.  Miranda also refers to earlier interlocutory judgments handed down in this action where the court has been critical of some of the conduct of Yih/MGHK.  I have not taken these into account in this application.

Costs order nisi

34.  There is no apparent reason to depart from the usual rule that costs should follow the event.  There will accordingly be a costs order nisi pursuant to Ord 42 r 5B(6) that the costs of this application be paid by MGHK to Miranda.

35.  I consider summary assessment of costs to be appropriate.  The above costs shall thus be so assessed if not agreed.  For this purpose:

(1)   Miranda be at liberty to lodge with court and serve a statement of costs within 14 days from today;

(2)   MGHK be at liberty to lodge with court and serve a statement of objections within 14 days thereafter.