WONG WING TAT v. LAM HUNG CHUNG AND OTHERS

HCA18/2001

IN THE HIGH COURT OF THE

HONG KONG SPECIAL ADMINISTRATIVE REGION

COURT OF FIRST INSTANCE

CIVIL ACTION NO. HCA18 OF 2001

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J U D G M E N T

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1. This is a derivative action by the plaintiff as shareholder of the 2nd defendant, a limited company ("the company"), against the 1st defendant who is the nominee shareholder of his brother's, the 3rd defendant's shareholding. This rather grand title to the nature of the proceedings is, I am afraid, not done justice by the modesty in financial terms of the parties themselves and of the company which, as will become clear shortly, was seriously under-capitalised and in a period of a little over a year was forced to cease trading and is now dormant and insolvent. There is also a claim of $110,000 which the plaintiff says the 3rd defendant owes him being the balance of $150,000, which represents half of the company's paid up share capital on its formation.

2. This matter is concerned with the garment industry. The plaintiff has been in this business for about 18 years and for 7 or 8 of those years he has owned a small company called Tat Hing Trading Company which supplies accessories such as belts, zippers and buttons. In about 1994/95, he became acquainted with the 3rd defendant, who was then a merchandiser at one of the plaintiff's client's factories. In late 1996, the plaintiff, who was keen on starting a company that would export clothing overseas, persuaded the 3rd defendant to join him in such a venture. The plaintiff had some money but, as will emerge in a moment, not very much, agreed to largely bankroll the start-up of the business. They formed the company by purchasing a shelf company. The paid up share capital was to be $300,000, a substantial sum for this sort of venture. According to the plaintiff, they would each subscribe to half of those shares and would become directors.

3. The 3rd defendant is a person well experienced in the garment export business. He knows about letters of credit, export quotas, shipping, manufacturing, and has good connections in all aspects of the industry. It is this which made him an attractive business partner to the plaintiff who is much less conversant with these aspects of the trade. Whilst the 3rd defendant has all this know-how, what he does not have is much money. In fact, all he had was $40,000.

4. Just before the incorporation of the company, the 3rd defendant told the plaintiff that he had some outstanding and unresolved tax problems with Inland Revenue Department, which made it difficult to take up a shareholding and directorship in his own name. And so he asked whether his brother, the 1st defendant, might hold those positions as nominee on his behalf, which the plaintiff agreed to, and so this is how the 1st defendant comes to be a party in this action. Other than signing formal documents he has played no part in the operation of the company. He was employed elsewhere and the plaintiff appears to accept that position.

5. The plaintiff spent about $200,000 setting up the company's offices by paying for decorations, furniture, and all the initial costs of setting up a business. The 3rd defendant, who only had $40,000, says that he told the plaintiff that because he could not afford more he was content to be a minority shareholder. The plaintiff disagreed with that suggestion and said that they should be 50/50 partners and that he would not require the 3rd defendant to pay more. The cash shortfall in his contribution to the share capital would be more than compensated for by his expertise and labour. The plaintiff would inject the start-up capital and take a backseat, being occupied with his own accessories company, and the 3rd defendant would run the business. The plaintiff now says that this was not so. They agreed that the $110,000 would be owed to him by the 3rd defendant who would pay him when he could. This has not been paid, hence this part of his claim in the action.

6. The company started modestly enough in early 1997. A girl was employed in the office and the 3rd defendant drew a salary of $13,000 and brought in another brother of his to help out who was paid $11,000 a month. It has become clear from the evidence that almost immediately the company was short of working capital and that the plaintiff was not, or perhaps could not inject anymore into its operations.

7. A savings account and a current account were opened, and a little later two accounts were opened at HSBC for the negotiation of letters of credit. These accounts, although joint, were set up so that the 3rd defendant alone was able to operate them. It is common ground that this was done because the plaintiff knew nothing to speak of about letters of credit and, additionally, he cannot read English so he would not be able to deal with this aspect of the business.

8. It is the operation of these two accounts and the opening of three letters of credit on these accounts that has brought about this action. The purpose of these accounts was to bring about a hoped for expansion of the business. The 3rd defendant would solicit orders from overseas customers known to him, they would pay by letter of credit, and he would find suppliers of material and factories in China to make up the orders and also obtain export quotas.

9. Three letters of credit were opened. Firstly, one issued by Cambridge Trading Services Corporation to the value of US$141,360 for the purchase of garments. Of this sum, US$76,500 was transferred in favour of Zhejing South Import and Export Corporation who would manufacture the order. This company failed to deliver and the letter of credit expired, so nothing came of that. The second letter of credit, which lies at the heart of the case, was one for US$275,000 opened by G C Concept Inc. of New York City and I will leave the history of this letter of credit over until after I deal with the third one which I can dispose of quickly. The third letter of credit was one issued by Gaberdine Clothing Company of Toronto for US$20,000 for the purchase of sweaters. The company delivered partial shipment to the value of HK$90,000 (about US$11,540) and was paid this amount, and the balance of the letter of credit lapsed.

10. I now return to the main letter of credit for US$275,000. When this letter of credit was opened in mid-1997, the company was for all intents and purposes insolvent. This was a substantial matter, but in order to fulfil it the company needed to purchase material, find a factory to make up that material and obtain a quota for export to the United States of America. The 3rd defendant entered into an agreement with the material supplier, Kwan Yin Trading, whereby part of the letter of credit was transferred to it in order that the material might be paid for. Kwan Yin was also short of cash and needed the letter of credit to use to persuade its own creditors of its ability to pay its way. In the meantime, the plaintiff was persuaded to pay a further HK$132,000 to the manufacturer's factory in China in part payment of the quota. Thereafter the company was unable to pay the balance of the quota. The plaintiff was not disposed to inject further capital to do that. The 3rd defendant then renegotiated the matter with Kwan Yin Trading, who, in effect, took over the entire contract. This necessitated using a Macau export quota. The goods had to be shipped there first. G C Concept Inc., the client, was persuaded to open a new letter of credit in favour of Kwan Yin for the lesser amount of US$178,750 plus a post-dated cheque for US$48,125. G C Concept Inc. was also short of money because that cheque was dishonoured on presentation. Then the goods could not be exported due to a quota embargo. Ultimately, the original letter of credit in favour of the 2nd defendant expired and so no payment was effected against that document. By then the company was, in effect, dead in the water, if I can use that expression. Nevertheless, the plaintiff, who had put in over HK$400,000 into the company with absolutely no return, had become suspicious that the 3rd defendant was making off with some of the proceeds of these letters of credit without accounting to him how these documents and any proceeds had been disposed of.

11. These two parties then agreed to have prepared for them a set of accounts to clarify the position and they jointly instructed Jetco & Company who provide general business services to do that for them. A handwritten set of accounts was prepared (see page 83 of the documents bundle) which confirmed the parlous state of the company's financial position. A further set of accounts was commissioned by the plaintiff (see pages 96 to 98) which is for all intents and purposes identical.

12. Dissatisfied with the 3rd defendant's explanations, the plaintiff reported the matter to the police who looked at the company's documents and interviewed the plaintiff and the 3rd defendant. The police came to the conclusion that the matter did not require them to take any further steps in their investigation, a fact which understandably Miss Lai for the 1st and 3rd defendants relies on as tending to show that the plaintiff's fears have been unfounded.

13. Whilst the 3rd defendant can take comfort from the outcome of the police investigation, this does not absolve me from the duty of looking at the evidence independently to determine what has come of the company's trading activities and the 1st and 3rd defendants' part in that trading.

14. Reliance is placed by Mr James Cheng for the plaintiff on the report to the accounts by Jann Plan Company Limited (page 96) who prepared the second set of accounts for the plaintiff. The material parts of the report bear repetition and are as follows:

"We find that the accounts are proper except the following:

(1) The date of transactions were not in sequential order. It is very difficult to analyse the actual financial position periodically, say, monthly;

(2) The material transaction was a sale of approximately US$275,000 which was properly booked into account, but there was no actual receipt and payment put through bank account nor any bank advice of the company bank account, Hongkong Bank, was found from the company document which can be used for tracing flow of money;

(3) There was a claim for HK$797,075 incurred re (2) above, but which was also charged back to the supplier, Kwan Yin. This made a receivable of HK$800,000 in the accounts. If the company had sufficient and supporting documentation to sue for such claims, this will be better off for the client;

(4) A payment of HK$1,740 for business registration fee was booked. We find some hints from that payment voucher in the name of that company it was marked with;

(5) We cannot make sure how many L/C transactions had been handled by the company because no L/C statement was found from the company records. How we cannot advise client to get them is very material to this case."

15. Unfortunately, both sets of accounts can carry very little weight. The authors of the accounts have not been called. I cannot tell who prepared them nor the level of competence and qualification of those persons. Without having access to what was actually used to prepare these accounts, I have no way of telling whether they are accurate. I am afraid that it is not safe to place any material reliance on them.

16. On all of the evidence I am persuaded that the 3rd defendant has provided a cogent and truthful account of the full trading history of the company with particular reference to the use to which the letters of credit were put. He has been able to account for these three letters of credit and he has satisfied me that he has acted conscientiously and honestly in relation to the company and to the plaintiff.

17. The plaintiff himself would have had access to most of these documents. He came to the company's offices on a number of days each week and he should have had a fair idea of the company's position. It is most regrettable that he should have elected to take this course by seeking to litigate in this way to no avail.

18. I am satisfied that there has been no misfeasance by the 3rd defendant. That being so, all the relief sought under paragraphs 1 to 5 of the amended statement of claim is refused. Mr Cheng has quite rightly conceded that if his client fails to prove fraud by the 3rd defendant, he is not entitled to what he has sought from the court.

19. Given this finding, it is unnecessary for me to go into the elements of a derivative action and when such an action should be brought. As a minimum, the plaintiff would need to show fraudulent activity by the 3rd defendant. In this matter he has singularly failed to demonstrate any sort of questionable behaviour, even falling well short of fraud. This is all highly regrettable when lack of funds has, in the first place, caused the collapse of the company and now the costs of this litigation can only serve to exacerbate that situation.

20. As to the second limb of the action, in respect of HK$110,000, I have no doubt that the plaintiff did not expect any further payment from the 3rd defendant. The 3rd defendant made it clear that $40,000 is all that he could afford and that he was willing to take a minority position in the company. The plaintiff decided that the 3rd defendant should have a half share simply because he was going to do all the work notwithstanding that he was to receive a salary of $13,000. It is also significant that this claim was not pursued before action and not pleaded in the original statement of claim. This is an afterthought and one without substance; it must stand dismissed. There must, therefore, be judgment to the 1st and 3rd defendants against the plaintiff. I will also hear from the parties as to what order I should make in relation to the company's position, the 2nd defendant vis-à-vis the plaintiff.

(Discussion)

21. I shall dismiss the plaintiff's claim against the 2nd defendant. There will be judgment for the 2nd defendant against the plaintiff and I suspect, inevitably, with an order for costs against the defendant.

22. There will be an order for costs against the plaintiff in favour of all the defendants.