CHAN CHUNG WAI AND OTHERS v. CHEUNG WAI PUI AND OTHERS

HCA 8721/1996

THE HIGH COURT OF THE

HONG KONG SPECIAL ADMINISTRATIVE REGION

COURT OF FIRST INSTANCE

ACTION NO. 8721 OF 1996

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J U D G M E N T

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The background

1.  This is a derivative action taken out by the plaintiffs as the minority shareholders holding 42.86% of the shareholding of Jan Nam Hong Limited, the 8^th defendant.  A judgment dated 7 March 2003 was entered by consent of the defendants.  [A102]  The judgment provides, inter alia, that there be all necessary accounts and inquiries by a Master for ascertaining what profits or sums the 1^st to 7^th defendants have made from the breach of fiduciary duties and/or the wrongful acts and that the said defendants do pay to the 8^th defendant all such profits and sums ascertained after the said inquiries with interest as the Master may decide.

The application

2.  This is the application of the plaintiffs for an inquiry and account of profits or sums the 1^st to 7^th defendants have made from their breach of fiduciary duties pursuant to the judgment.

3.  In the same application, the plaintiffs by a summons dated 20 April 2005 applied for an order of interim payment pursuant to Order 29 rule 12.  The plaintiffs will not be able to make a full inquiry in this hearing because plaintiff’s counsel complains that there are matters outstanding such as the account of loss of profits before 1990, the account of loss of profit from the 7^th defendant (Elegant View) and the account of loss of worth of the business of the 5^th defendant (Rainbow Come), the 6^th defendant (Jin Jiang) and the 7^th defendant.  All of these matters have to be cleared and counsel for the plaintiff will apply for special directions.  For these reasons, the inquiry will have to be adjourned to another date.  In the meantime, we shall deal with the plaintiffs’ application for an interim order only.

4.  In support of the plaintiff’s application for an interim payment, Chan Chung Yin, the 3^rd plaintiff has filed an affirmation, with which she has exhibited an accountant’s report.  [A1-0005]  Mr. Horace Ho, who is a certified public accountant had compiled the report, which is in bundle F [F-1-24].  He ascertained the profit of Rainbow Come and Jin Jiang, which according to the plaintiffs were the vehicles that 1^st, 2^nd and the 3^rd defendants had used to reap the profits of the 8^th defendant between the period of 1990 to 2003, the date of the writ.  He has come to the conclusion that the total profits and sums for this period is HK10,170,083, comprising of (1) accounting profits forgone HK9,465,133, (2) excess expenses HK104,950 and (3) goodwill forgone HK600,000 [F-008] Mr. Ho’s evidence is challenged by the defendants and I shall deal with his evidence in court in due course.

Grounds of objections of D1 to D7

5.  Mr. Chan, counsel acting for the 1^st to 7^th defendants appeared before this court on the first day without a skeleton argument as required by Practice Directions 5.4.  Mr. Chan told me that he had just received instructions to appear before this court a few days ago.  Given the volume of documentation, he did not have enough time to prepare the written skeleton arguments for the court.  It is therefore difficult for me and Mr. Mak to know in advance the defendants’ argument and the grounds in the first day hearing.  He submitted his skeleton argument the next day afternoon.  In his skeleton submissions, he has raised the following issues:

(a)  Order 29 rule13 provides that the interim payments are to be paid to the plaintiff whereas the order is for payment to be made to the 8^th defendant. The court has no jurisdiction to do so.

(b)  Even if the court has the jurisdiction to make the interim payment, this action being a derivative action, the plaintiffs simply have not the authority to withdraw payment from the 8^th defendant’s account.

(c)  If the plaintiffs have not the intention to withdraw money from the 8^th defendant’s account, the court should not make the interim order.

(d)  In any event, the money paid in will be subject to the decisions of the board of directors and the shareholders in accordance with the articles of the company. Since the plaintiffs are not entitled to withdraw the money from the 8^th defendant’s account, the court should not make the interim order.

(e)  The issue of quantum, which includes the question of double counting as mentioned above, the question of whether loss of goodwill of the 8^th defendant should be taken into account and the question of proper amount to be made for the interim payment, if any.

Jurisdiction point

6.  I consider that it would be more appropriate for the issues on jurisdiction to be dealt with in the beginning of the hearing before hearing evidence from the witnesses.  Since those grounds are only known after hearing of the oral evidence, I shall nevertheless deal with the issues of jurisdiction first before I evaluate the evidence of the witnesses on quantum.

7.  It is apparent that this action is a derivative action, in which the plaintiffs claim against the 1^st to 7^th defendants on behalf of the 8^th defendant.  What the plaintiffs ask for in this summons is an interim payment to be paid into the 8^th defendant’s account with them as one of the signatories.  This is obviously for the purpose of having some control over the money in the account as the controlling power rests with the majority shareholders.  Mr. Chan submits that if the plaintiffs are unable to withdraw the money from the account, there is no reason for them to ask the court to make the order and the court should not make such order.

8.  As the plaintiffs are entitled to start the action on behalf of the 8^th defendant, it follows that the court has the jurisdiction to hear the plaintiffs’ application for the interim order and has the power to make such order if it thinks appropriate to do so, having considered all the circumstances.  Mr. Chan agrees that under Order 29 rule 13, the court may order the interim payment to be paid to the plaintiff or into court.  But Mr. Chan argues that the order for payment into court should be upon the basis that the plaintiffs are able to apply to court for payment within a short time because the ultimate purpose of Order 29 is to make the interim payment to the plaintiffs.  Order 29 should not be used to provide the plaintiffs with security of the fruit of judgment.  The plaintiffs may apply for a Mareva Injunction to protect the assets of Jin Jiang and Rainbow Come if they fear that they may dissipate their assets.  I specifically request Mr. Chan to support his argument with authority and he concedes that he is unable to do so.

9.  With respect to Mr. Chan, I am unable to accept his view that Order 29 should be restricted the way he proposes.  The plaintiffs are entitled to take whatever process they consider appropriate to protect their position as the judgment creditors on behalf of the 8^th defendant.  I hold that I have the jurisdiction to deal with the plaintiffs’ application and whether or not I should make the interim order as proposed in the summons is within my discretion.  Having considered the arguments from Mr. Chan and Mr. Mak, I hold that I should exercise my discretion to make the interim order as applied for by the plaintiffs.  I shall consider the terms of the appropriate order.  I shall now deal with the issue of quantum.

Quantum

10.  I shall now deal with the evidence of the plaintiffs’ expert. In his report [F-1 to 24], Mr. Ho took into account of the following factors:

(a)  the combined sales of the Rainbow Come and Jin Jiang after 1991 was about HK$20 million, almost the same as that of the 8^th defendant before 1990;

(b)  the business activities of Rainbow Come and Jin Jiang were the same as the 8^th defendant;

(c)  the gross profit ratio to estimate the gross profit loss of the 8^th defendant; gross profit/sales ratio is 27.02%.

He arrived at different sums of loss of profit for each of the year from 1990 to 2001, in the total sum of HK$8,635,193 and from 2002 to 2003, HK$829,940, giving a total of HK$9,465,133.  In addition, Mr. Ho found that there is a loss of goodwill forgone and other excess expenses reflected in the total sum of HK$704,950, making the total sum of HK$10,170,083, which is the amount the plaintiffs seek for the interim order.

11.  The first defendant filed his affirmation the day before the hearing.  In his affirmation he said that the main contention on the plaintiffs’ expert report was that by taking into account of the sales between the Jin Jiang and Rainbow Come, the amount of the consolidation sales would be double counted. [para. 3 of affirmation filed on 27.4.05]  In this affirmation, he had exhibited his own accountant’s report, which found that the total sum payable to the 8^th defendant was HK1,035,299. [F-32].

12.  The first defendant said that the 2^nd defendant had a property worth HK2,800,000.  There should be sufficient security for the plaintiffs’ claim. In his affirmation, the 1^st defendant disclosed, sadly, that the 2^nd defendant, who is the father, had passed away on 4 April 2005 and the elder brother, the 3^rd defendant was critically ill.  There were also other events in this affirmation relating to the reasons of cease of business of Rainbow Come and Jin Jiang and the goodwill of the 8^th defendant.  On those bases, the 1^st defendant asks this court to dismiss the plaintiffs’ application with costs.

13.  However, I find that those matters above do not constitute valid objections to the present application.

14.  In another affirmation made by Mr. Tam Kwok Liang on behalf of the 5^th defendant [B1-111], Mr. Tam confirmed that he agreed to adopt the gross profit ratio of 27.02% for the period from 1990 to 1998 as set out in the plaintiffs’ expert report and he agreed that the actual trading results per audited accounts of Jin Jiang be adopted for years 1999 to 2003 [B1-113].  But he raised objection that in consolidating the sale between Rainbow Come and Jin Jiang for computation of the consolidated net profits for years 1990 to 2003, the inter companies sales for each year should be eliminated as this would lead to double computation. [para. 10]

15.  From all the evidence before me, the 1^st to 7^th defendants only raise the issue of double computation in their objection to this application. For this purpose, the defendants have caused their accountant, Messrs. M.B. Lee & Co. to file a report [F-025].  In this report, the sum accountable to the plaintiffs is HK1,035,229 only. It is clear that there is a very wide discrepancy between the results of the plaintiffs’ expert and those of the defendants.

The expert evidence

16.  Mr. Horace Ho, the accountant who compiled the report for the plaintiffs has given evidence in court. He explained that the accounts were the combined accounts of Jin Jiang and Rainbow Come, not a consolidated account.  He disagreed that his first report with the profits made by Jin Jiang from the sales to Rainbow Come was a double computation of the profits accountable to the 8^th defendant.  If those sales between Jin Jiang and Rainbow were discarded, then the accounting profit forgone would be $5,011,772, to be added by the expenses rejected by the Inland Revenue Department in the sum of $2,294,809 [Exh.P1-1], the directors’ inflated remuneration in the sum of $1,387,668 [Exh.P1-2], the excessive expenses incurred by Rainbow Come for $104,950 and the goodwill forgone for $600,000 [Exh.P2-1]. The total amount was $9,399,199.  Mr. Ho reaffirmed that the first way of calculating the gross profit by adopting the agreed 27.02% on the gross sales of the companies, including sales between Jin Jiang and Rainbow Come should be preferable because to adopt the alternative method of assessment, there were various reasons for those additional expenses and amounts, which he could not account for and were only known to the 1^st to 7^th defendants.

17.  Mr. Yu Yu Kin of Messrs. M.B. Lee & Co., the expert for the 1^st to 7^th defendants gave evidence and said it very clearly at the outset that his instructions to prepare the report [F-25 to 33] and to give evidence in court were only to show double computation in the expert report of Mr. Ho. That’s all.  Therefore when he was cross-examined by Mr. Mak on other aspects of the accounts of Jin Jiang and Rainbow Come, he said that he had no instructions to prepare for the answers.  According to Mr. Yu, he worked on the basis that if the 8^th defendant were to sell all the goods itself instead of through Jin Jiang and Rainbow Come, how much profits that 8^th defendant should be able to obtain during the period of 1990 to 2003.  He said that in accordance with the practice and procedure under the Statement of Standard Accounting Practice 32 (SSAP 32 para. 31) issued by the Hong Kong Institute of Certified Public Accounts, paragraph 31 states “Intragroup balances and intragroup transactions and resulting unrealised profits should be eliminated in full. Unrealized losses resulting from intrgroup transactions should also be eliminated unless cost cannot be recovered. He regarded the transactions between Jin Jiang and Rainbow Come being done between different departments of the 8^th defendant.  As such, the transactions between these departments could not be counted separately.  He said that by applying 27.02% on the gross sales between Jin Jiang and Rainbow Come and again on the sale of Rainbow Come to the ultimate customers, it was an obvious double computation of the gross profits.

18.  Mr. Chan, counsel for the 1^st to 7^th defendants has followed this line of argument.  He gives an example that if Jin Jiang sold goods to Rainbow Come for $100 and Rainbow Come then sold the same goods to the ultimate customers for $120, the profit is $20.  By applying the agreed 27.02% to this gross sale, the gross profit is $32.42.  But according to Mr. Ho’s assessment, the gross profit would be 27.02% on the sale between Jin Jiang and Rainbow Come, which is $27.02 plus the profit of Rainbow Come, which is $32.42 (120x27.10%), making a total of $59.44.  This, according to Mr. Chan, would be quite impossible for the 8^th defendant to make such a profit if the goods were sold by itself alone.

The analysis

19.  The judgment requires that there be all necessary accounts for ascertaining what profits or sums the 1^st to 7^th defendants have made from the breach of fiduciary duties and that the said defendants have to pay to the 8^th defendant all such profits and sums ascertained with interest.  This falls upon this court to inquire the profits made by Jin Jiang and Rainbow Come, which they have to account to the 8^th defendant under the judgment.

20.  Mr. Yu said that he had checked the accounts of Jin Jiang and discovered that Jin Jiang had made some profits in the dealings with Rainbow Come, though the profits were small.  There is, however, no evidence before me what those profits were and their amounts.  The example  raised by Mr. Chan above has not taken into account the cost of the goods Jin Jiang sold to Rainbow Come.  In fact, there is no information as to how much the cost should be.  It will therefore be not possible to ascertain the profit that Jin Jiang had obtained in its sale of the goods to Rainbow Come.  If, for example, the cost of the goods were $50 and Jin Jiang sold it to Rainbow for $100 and then Rainbow Come sold it to the customer for $120, the total profit made by Jin Jiang and Rainbow Come would be $70.  The burden of proof of the profits lies on the 1^st to 7^th defendants.  Without the information of the cost of the goods, it will not be possible to determine the ultimate gross profits made by Jin Jiang and Rainbow Come respectively.

21.  Since Jin Jiang did make profit from the sale to Rainbow Come, I find that the transactions were not intra-companies transaction.  On this basis, I consider that there is no double counting in Mr. Ho’s recommended assessment of the profits accountable to the 8^th defendant. 

22.  The next question is whether it is reasonable for Mr. Ho to adopt 27.02% as the factor for calculating the profit made by Jin Jiang in the sales of the goods to Rainbow Come.  The 1^st to 7^th defendants agreed to calculate the gross profit by applying 27.02% on the gross sales made by Rainbow Come to the customers.  This figure was agreed for the reason of convenience since the 1^st to 7^thdefendants did not want to produce all the past sales and accounts records.  Absent evidence from the 1^st to 7^th defendants to account for the profit of Jin Jiang from the sales of the goods to Rainbow Come, coupled with the absence of evidence of the cost of the goods that Jin Jiang had sold to Rainbow Come, all such evidence being within the control of the 1^st to 7^th defendants only, I do not consider it unreasonable for Mr. Ho to apply the same gross profit ratio of 27.02% on the gross sales by Jin Jiang to Rainbow Come for the calculation of the profits of Jin Jiang.

23.  Mr. Chan asks me to consider that according to the audited accounts of Jin Jiang, there were losses after 1990, which indicates that it would not be possible for it to have made 27.02% gross profits.  It remains the burden of the 1^st to 7^th defendants to account for the profit of Jin Jiang.  Without evidence from these defendants, I have to speculate on the reasons for the losses, which I do not consider to be appropriate to do so.

24.  I also accept that Mr. Ho prefers to use 27.02% for calculating the gross profits between Jin Jiang and Rainbow Come instead of discarding it but taking into account other factors that he is only able to speculate. The loss of the 8^th defendant’s goodwill is relevant to the assessment of the loss to the 8^th defendant, I consider it appropriate to take the value of the goodwill of the 8^th defendant into account.

Conclusion

25.  I therefore accept Mr. Ho’s recommendation to adopt HK$10,170,083 as the sum for the interim payment from 1990 to 2003. 

The order

26.  Mr. Mak has drafted the order for this amount as the interim payment together with other directions as to the way the sum should be paid and other documents to be disclosed by the 1^st to 7^th defendants for the assessment of other accounts in accordance with the order dated 7 March 2003.  Mr. Chan has helpfully made comments on it. I therefore approve the draft order submitted as amended.

27.  Finally, I wish to thank Mr. Mak and Mr. Chan for their assistance in this hearing.