LIU CHUN KAU ANDY v. HUNG LEE CONSTRUCTION ENGINEERING LTD

HCMP 527/2019

[2019] HKCFI 1269

IN THE HIGH COURT OF THE

HONG KONG SPECIAL ADMINISTRATIVE REGION

COURT OF FIRST INSTANCE

MISCELLANEOUS PROCEEDINGS NO 527 OF 2019

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D E C I S I O N

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1.  This is an application made by the plaintiff, Liu Chun Kau Andy, under section 732 of the Companies Ordinance (Cap 622) for leave to bring a statutory derivative action in the name of Hung Lee Construction Engineering Limited (“Company”) against Chan Hop Loi Nelson (“Chan”).

2.  The Originating Summons and the affirmation in support of the application were served on the Company and sent to Chan.  Messrs Wong & Lawyers (“WL”) purported to file an acknowledgement of service on behalf of the Company on 24 April 2019.  This is surprising given that the plaintiff and Chan are the only directors and shareholders of the Company such that there has been a complete deadlock at the board and shareholders’meeting level.

3.  In his submissions, Mr Justin Ho, counsel for the plaintiff, takesissue with the authority of WL to act for the Company.  In their letter to the court dated 9 May 2019, WL accept (rightly) that they have no authority to actfor the Company and have applied for leave to cease to act for the Company. The Company is thus unrepresented at the hearing.  Mr Paul Lee appears on behalf of Chan to make submissions on the question of costs.

Background

4.  The Company carries on business in construction work which includes building, civil engineering and drainage works.  The Company hasnever declared or paid any dividend to the shareholders.  The only paymentsreceived by the plaintiff and Chan were the monthly directors’ remunerationwhich was initially at HK$20,000 and subsequently increased to HK$40,000.

5.  According to the plaintiff, since the incorporation of the Company, Chan has been responsible for handling all administrative and accounting affairs while the plaintiff has been in charge of supervising the construction projects undertaken by the Company.  In late March 2017, the plaintiff began to enquire into the financial position of the Company.  Upon further investigation, it appears from the Company’s statements of bank accounts and ledgers that Chan had, without the knowledge and consent of the plaintiff:

(1)  transferred or withdrawn an aggregate amount of HK$16,541,000 from the Company’s bank accounts to himself during the period from July 2010 to September 2017; and

(2)  used an aggregate sum of HK$131,349 for his personal purposes including making payments to his son, the elderly home of his mother and discharging his liability to pay tax during the period from 13 April 2015 to 22 September 2016.

6.  The plaintiff claims that of the aforesaid amounts withdrawn or used by Chan, a total sum of HK$7,099,087.50 appears to have been applied for the purpose of the Company and, therefore, the net amount misappropriated or misused by the plaintiff is HK$9,573,261.50 (“Subject Sum”).  Despite the plaintiff’s demands, Chan failed to provide any proper explanation to justify his use of the Subject Sum. 

7.  The plaintiff says that of the Subject Sum, Chan admitted to have withdrawn HK$2,000,000 from the Company’s bank account in order to “stakehold the same for the Company” which, according to Chan, was in response to an unauthorised withdrawal of HK$80,000 from the Company’saccount.  The plaintiff on the other hand says that this withdrawal was for his remuneration for two months.  There is no dispute that this HK$2,000,000 belongs to the Company and is currently held in the client’s account of WL.

8.  The plaintiff also claims that in September 2017, Chan set up a competing business in the name of Hung Wei Construction Engineering Limited (“Hung Wei”) to engage in the same construction engineering business.  Chan was (and still is) the sole shareholder and director of Hung Wei and used the same registered office and company secretary as those of the Company.  Hung Wei employed 5 – 6 of the former employees of the Company and has solicited work from the former clients of the Company.

Applicable principles

9.  The principles governing application under section 732 of the Companies Ordinance are well established and have been conveniently summarised in Re Primlaks (HK) Ltd [2016] 2 HKLRD 31 at §§7 – 9 per Ng J and Lam Kin Chung v Soka Gakkai International of Hong Kong Ltd (No 2) [2018] 2 HKLRD 769 at §5 per Harris J.  In short, the plaintiff has to satisfy the court that:

(1)  it appears to be in the company’s interests that leave be granted to the member.  In this regard, if a serious issue to be tried is shown, it will normally be in the interest of the company to pursue the proceedings as the fruit of any judgment to be obtained will be paid to the company;

(2)  there is a serious question to be tried.  This is a low threshold.  In considering the prospect of the company’s success, the court will consider the allegations set out in the draft statement of claim.  It is only if the defendant can demonstrate fairly readilythat there is a serious flaw in the claim or that the claim has noreal substance such that the company cannot be said to have anyexpectation of success that the court will find against the plaintiff;

(3)  the company has not itself brought the proceedings; and

(4)  a written notice has been served on the company in accordancewith section 733(3) and the notice complies with section 733(4).

Discussion

10.  I first consider whether there is a serious issue to be tried.

11.  In the draft statement of claim, two causes of actions for breach of fiduciary duties are pleaded.

12.  First, it is alleged that the withdrawal and use of the Subject Sum by Chan for his personal purposes constituted a breach of his fiduciary duties.  This is reinforced by the fact that despite repeated requests, Chan has not been able to show that the Subject Sum has been used for the purpose of the Company.

13.  It is well settled that a director owes a duty to act bona fide in the interests of the company.  He must exercise his power solely for the purpose for which it was conferred.  If a director gave away the company’s asset for no consideration or to his personal account, it was prima facie an abuse of his powers as a director for an improper purpose.  The burden is on the director to demonstrate the propriety of the transaction.  If no grounds have been put forward upon which it could honestly have been thought that the transactions were for the benefit of the company, the director will be liableto compensate the company for the transfer of assets (Bishopsgate Investment Management Ltd v Maxwell [1993] BCC 120 (CA) at 139H – 140E, per Hoffmann LJ (as he then was)).

14.  Applying the above principle, it seems to me that there is a serious issue to be tried in respect of the claim for return or account of the Subject Sum.

15.  Second, the plaintiff alleges that in setting up Hung Wei to carry on the same business as the Company, employing the former employees of the Company and soliciting business from the former customers of the Company, Chan acted in breach of his fiduciary duties.

16.  Mr Ho submits that where, as here, a fiduciary has taken advantage of an opportunity made available to him in the course of his fiduciary relationship, he will be liable to account for any profits he has made, citing Kao Lee & Yip v Koo Hoi Yan [2003] 3 HKLRD 296 at §66 per Ma J (as he then was).  I agree.

17.  I am satisfied that on the evidence presently available, there is a serious issue to be tried in respect of a claim for breach of fiduciary dutieson the part of Chan in carrying out a competing business through Hung Wei.  

18.  As the above causes of action, if successful, will result in either an account of profit or payment made to the Company, it seems to me that the second condition viz, that it appears to be in the interest of the Company for leave to be granted to the plaintiff to bring the derivative action, is also satisfied.

19.  As for the third condition, there is no dispute that the Company has not brought proceedings against Chan in respect of the alleged causes of action.  In light of the complete deadlock at the board and shareholders’meeting level and the fact that Chan is the defendant in the proposed action,it is unlikely that a resolution can be passed to authorise the Company to commence the proposed action against Chan.

20.  Lastly, the requisite notice prescribed by section 733(3) – (4) has been served on the Company.

21.  As for costs, the plaintiff asks for an order requiring the Company to indemnify, out of its assets, the costs of the application incurredand the costs to be incurred in the derivative action.  Section 738(3) providesthat the court may only make an order about costs including the requirement as to indemnification in favour of the member if it is satisfied that the member was acting in good faith in, and had reasonable grounds for, making the application and bringing the derivative action.

22.  Mr Ho submits that the requirements are satisfied, in light of the strength of the case against Chan and the severe financial detriment which has been suffered by the plaintiff.  In my view, for the reasons set out in §§12 – 17 above, there are reasonable grounds for the plaintiff to bring the derivative action against Chan.  As a 50% shareholder of the Company, the plaintiff has a legitimate interest in the Company which justifies his act in taking step to recover assets from a director who has prima facie acted in breach of his fiduciary duties.  I am satisfied that the plaintiff has acted in good faith in making the application and bringing the derivative action against Chan.

23.  In WL’s letter of 9 May 2019 they submitted, on behalf of Chan, that the “usual court order” is that the costs of the derivative action should be reserved, citing Yuen Tak Sung v Sea Dragon Food Limited [2018] HKCFI 2471 and Tang Siu Choi v Man Lung Textiles Limited [2018] HKCFI 125.  They do not object to an order that the costs of the application be paid out of the assets of the Company.  Nevertheless, at the hearing Mr Paul Lee cited two authorities namely, Re Lucky Money Limited HCMP 505/2006, 18 July 2006, §§58–59 and Re Nice & Well Limited HCMP 2148/2008, 11 December 2008, §10 as examples in support of his submission that, despite granting leave to the member to bring the derivative action, the costs of the application were reserved.  He asks this court to likewise reserve the costs of the application.  The submission is misconceived.  As is clear from the passages cited by Mr Lee, in both cases, there was a dispute on whether the applicant acted in good faith and the court was unable to resolve the issue at the time leave was granted.  Here, there is no dispute that the plaintiff acted in good faith in making the present application.

24.  I have considered the authorities cited by Mr Ho and WL, it seems to me that in deciding whether to make an order to indemnify the plaintiff of the costs to be incurred in bringing the derivative action out of the assets of the Company, the court may take into account the following factors:

(1)  The amount of costs to be incurred and the ability of the company to pay such costs (Re F&S Express Ltd [2005] 4 HKLRD 743 at §28, citing Swansson v R A Pratt Properties Pty Ltd & Another (2002) 42 ACSR 313 at §75).

(2)  If the person in control of the company is responsible for the lack of evidence on the ability of the company to pay the costs of the derivative action, the court may make a limited order forindemnification up to the specified stage (Re Hang Heung Cake Shop Company Limited HCMP 527/2012, 13 November 2012,§§74 – 75).

(3)  The court may defer the question of indemnification until the outcome of the derivative action is known or when the position is clearer (Tang Siu Choi, supra, §29, citing Re Grand Field Group Holdings Limited HCMP 1059/2008, 26 February 2009, §50).

25.  In the present case, the evidence shows that the Company has HK$2,000,000 currently held by WL.  This is in addition to the cash deposits of approximately HK$1,000,000 kept in the bank accounts of the Company as at May 2019.  As the plaintiff is bringing the action on behalf and for the benefit of the Company, it seems to me that as a matter of fairness,the plaintiff should be entitled to the protection of an order to indemnify him of the costs incurred and to be incurred in the derivative action up to and including the close of pleadings.  Upon close of pleadings, the court would be in a better position to decide whether the indemnification should be further extended.

26.  I consider that it is appropriate to give liberty to the parties to apply for an order that the costs paid out of the Company’s assets should be paid by Chan.  This is because the costs of the present application were incurred as a result of the inability of the Company to pass any resolution to authorise the commencement of an action against Chan.  In that sense, the costs of the application may be treated as part of the costs of commencing the action against Chan.  There may be an argument that if the Company succeeds in the derivative action, it should be entitled to recover all the costs incurred in commencing such action against Chan.

27.  I therefore make the following order:

(1)  leave to the plaintiff to commence, in the name of the Company, a derivative action against Chan in respect of the matters described in the statement of claim exhibited as “LCKA-20” to the Affirmation of Liu Chun Kau Andy filed herein on 9 April 2019 (“Derivative Action”) with amendments indicated by Mr Ho at the hearing;

(2)  the costs of and occasioned by the Originating Summons be paid to the plaintiff out of the assets of the Company in the first instance.  The costs are assessed at HK$345,488;

(3)  the costs incurred and to be incurred by the plaintiff in bringingthe Derivative Action up to and including the close of pleadings be indemnified out of the assets of the Company in the first instance (such costs to be taxed as between the plaintiff and theCompany if not agreed), with liberty to the plaintiff to apply for further indemnification of costs; and

(4)  the plaintiff and the Company have liberty to apply for an orderthat the costs paid out of the Company’s assets should be borne by Chan.