YAN HOW YEE v. YU KIN SANG PAUL AND OTHERS

   HCA1069/2008

IN THE HIGH COURT OF THE

HONG KONG SPECIAL ADMINISTRATIVE REGION

COURT OF FIRST INSTANCE

   ACTION NO. 1069 OF 2008

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BETWEEN

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J U D G M E N T

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1.  This is a derivative action commenced by the plaintiff on behalf of the 6^th defendant. By the Order of Master Lung made on 24 April 2009, the 1^st defendant’s counterclaim against the 6^th defendant was struck out. This is the 1^st defendant’s appeal against Master Lung’s Order, which raises the question of whether a defendant in a derivative action can counterclaim against the company on whose behalf the claim is made under Order 15, rule 2 or 3.

Background

2.  Since around 1990, the plaintiff (“Madam Yan”) and the 1^st defendant (“Mr Yu”) have been business partners. They jointly own a number of companies, directly or indirectly, in Hong Kong and Mainland China. The 6^th defendant herein (“Haywood”) is one of such companies. Haywood was incorporated in Hong Kong in March 1997 and has since been carrying on trading business in respect of wood products including wood veneers and veneered plywood.

3.  Madam Yan and Mr Yu were at all material times and still are the only shareholders of Haywood, each holding 50% of its issued capital. On 15 July 2008, that is after the commencement of this action and pending the substantive hearing of an interlocutory injunction application made by Madam Yan, Mr Yu gave notice of his resignation as a director of Haywood with effect from 12 July 2008. Until then, Madam Yan and Mr Yu were the only directors of Haywood.

4.  One of the claims in this derivative action is the breach of fiduciary duty on the part of Mr Yu. According to Madam Yan, Mr Yu set up a sole proprietorship business known as Wosland Veneers & Timbers Co. in December 2007 and then the 5^th defendant in May 2008. Both the sole proprietorship business and the 5^th defendant were operated by Mr Yu while he was still a director of Haywood. Not only were their businesses the same as that of Haywood, Madam Yan avers that Mr Yu (with the assistance of the 2^nd to 4^th defendants) diverted the business of Haywood first to the sole proprietorship business and then the 5^th defendant. On this basis, Madam Yan contend that Mr Yu has acted in wrongful breach of his duty as a director of Haywood.

5.  The 2^nd to 4^th defendant are the former employees of Haywood. In short, it is Madam Yan’s case that these former employees dishonestly assisted Mr Yu in his breach of fiduciary duties and had acted in breach of the implied terms of their employment contracts made with Haywood.

6.  In addition, the Statement of Claim pleads the causes of action of passing off, procuring breaches of contract by the 3^rd defendant as well as conspiracy and unlawful interference with Haywood’s business. For the present purpose, it is not necessary to go into the details of these heads of claim. Suffice it to say that the facts relied on in support of these causes of action overlap with those relied on in support of the claims for breach of fiduciary duties.

7.  Since this is a derivative action, Haywood is only a nominal defendant. Haywood was not represented in this appeal, and rightly so.

8.  The 1^st, 2^nd, 3^rd and 5^th defendants filed a Defence and Counterclaim on 23 December 2008. They dispute the claims put forward byMadam Yan on behalf of Haywood. In addition to his defence, Mr Yu lodged a counterclaim against the Haywood (“the Counterclaim”).

9.  This Counterclaim, which is the focus of this appeal, is pleaded as follows :

“26.  By divers orders, the 6^th Defendant had ordered from Legnoquattro veneers and/or veneers related products for the total sum of Euro 170,000 (‘the said Sum’).

27.  Despite repeated requests and demands, the 6^th Defendant has failed and/or unlawfully refused to pay to Legnoquattro the said Sum or part thereof or at all.

28.  The 1^st Defendant has fully settled the said Sum with Legnoquattro from whom all of the rights of Legnoquattro against the 6^th Defendant in their capacity as its creditor were or deemed to have transferred to the 1^st Defendant.

29.  Having been informed of the matter as pleaded in paragraph 28 above, the 6^th Defendant has failed and/or refused to pay to the 1^st Defendant the said Sum or part thereof or at all.

30.  By reason of the matters aforesaid, the 1^st Defendant has suffered loss and damage.”

10.  By her Summons dated 2 January 2009, Madam Yan applied for an Order that the Counterclaim be :

(1)  dismissed on the ground that there is no jurisdictional basis on which Mr Yu can lodge a counterclaim against Haywood;

(2)  struck out or stayed on the ground that it discloses no reasonable cause of action and/or that it is frivolous and vexatious and/or that it may prejudice, embarrass or delay the fair trial of this action and/or that it is an abuse of the court process; and

(3)  struck out or tried separately from Madam Yan’s claims or that all further proceedings on the Counterclaim be stayed until after the trial of Madam Yan’s claims on the ground that the subject-matter of the Counterclaim ought to be disposed of by a separate action and/or the Counterclaim may embarrass or delay the trial of Madam Yan’s claims.

11.  On 24 April 2009, Master Lung allowed Madam Yan’s application and struck out the Counterclaim. By his Notice of Appeal filed on 8 May 2009, Mr Yu lodged this appeal against Master Lung’s Order.

Jurisdictional

basis

12.  The making of a counterclaim and the court’s jurisdiction in respect of a counterclaim are governed by section 16(2) of the High Court Ordinance (Cap. 4) and Order 15, rules 2 and 3 of the Rules of the High Court (Cap. 4A). At the hearing of this appeal, Ms Rita So, counsel for Mr Yu, made it clear that Mr Yu relied on both Order 15, rules 2 and 3 in support of this appeal.

13.  Order 15, rule 2(1) reads as follows :

“Subject to rule 5(2), a defendant in any action who alleges that he has any claim or is entitled to any relief or remedy against a plaintiff in the action in respect of any matter (whenever and however arising) may, instead of bringing a separate action, make a counterclaim in respect of that matter; and where he does so he must add the counterclaim to his defence.” [emphasis added]

14.  Order 15, rule 3(1) reads as follows :

“Where a defendant to an action who makes a counterclaim against the plaintiff alleges that any other person (whether or not a party to the action) is liable to him along with the plaintiff in respect of the subject-matter of the counterclaim, or claims against such other person any relief relating to or connected with the original subject-matter of the action, then, subject to rule 5(2), he may join that other person as a party against whom the counterclaim is made.” [emphasis added]

15.  It is crystal clear from the wording of Order 15, rule 2(1) that a defendant may only make a counterclaim against the plaintiff but not a defendant in the same action. The wording of Order 15, rule 3(1) is equally clear in that it only applies where the defendant makes a counterclaim against both the plaintiff in the action as well as another party or other parties. Order 15, rule 3(1) does not apply if the defendant only intends to make a counterclaim against a co‑defendant in the action but not also the plaintiff. If the counterclaim is not also made against the plaintiff in the action, a defendant would have to have recourse to Order 16. See : Hong Kong Civil Procedure 2010, Vol. 1, para. 15/3/1 (at p. 267).

16.  In the present case, Order 16 is not invoked by Mr Yu and I make no observation as to whether Mr Yu is entitled to invoke Order 16. The Counterclaim is only made against Haywood (as the 6^th defendant). This is put beyond doubt by paragraphs 26 to 30 of the Defence and Counterclaim (quoted in paragraph 9 above) and also the prayer to the Counterclaim. The Counterclaim is not made against Madam Yan. In any event, the Counterclaim cannot be made against Madam Yan in her personal capacity or in her capacity as a shareholder of Haywood since the alleged debt (if it exists, and which I make no finding as it is not necessary to do so) was owed by Haywood to the supplier “Legnoquattro”. Accordingly, the Counterclaim is prima facie outside the scope of Order 15, rule 2 or 3.

17.  Faced with this difficulty, Ms Rita So, counsel for the 1^st defendant, argued that the present derivative action is made on behalf of Haywood and the Counterclaim is in effect a set‑off against Haywood’s claim. Ms So’s argument ran as follows. In all derivative actions, the fruit of the judgment should go to the company on whose behalf the action is brought. Hence, if this derivative action is upheld, Mr Yu would have to pay equitable damages to Haywood and not Madam Yan personally since she is only suing on behalf of Haywood. On the other hand, should the Counterclaim succeed, Mr Yu would be entitled to be reimbursed by Haywood for the sum he paid to Legnoquattro. In such a scenario, argued Ms Rita So, there could be a set-off at the end of the day (at least at the stage of enforcement).

18.  Although not in so many words, Ms So in effect argued that the Counterclaim should be treated as having been made against the real plaintiff since Madam Yan is suing on behalf of Haywood.

19.  At the hearing, I was informed by both counsel that there does not appear to be any direct authority on the question that calls for determination in this appeal. Nor could their research reveal any decided cases where a defendant in a derivative action lodged a counterclaim against the company on whose behalf the claim was made. In the circumstances, I would start from the fundamental principles, viz., what is the nature of derivative action and why is the procedure of derivative action allowed by the court.

20.  In the classic authority of Wallersteiner v Moir (No. 2) [1975] 1 QB 373, Lord Denning MR expounded as follows (at pp. 390A-391B) :

“  It is a fundamental principle of our law that a company is a legal person, with its own corporate identity, separate and distinct from the directors or shareholders, and with its own property rights and interests to which alone it is entitled.  If it is defrauded by a wrongdoer, the company itself is the one person to sue for the damage.  Such is the rule in Foss v Harbottle (1843) 2 Hare 461.  The rule is easy enough to apply when the company is defrauded by outsiders.  The company itself is the only person who can sue.  Likewise, when it is defrauded by insiders of a minor kind, once again the company is the only person who can sue.  But suppose it is defrauded by insiders who control its affairs – by directors who hold a majority of the shares – who then can sue for damages? Those directors are themselves the wrongdoers.  .… Yet the company is the one person who is damnified.  It is the one person who should sue.  In one way or another some means must be found for the company to sue.  Otherwise the law would fail in its purpose.  Injustice would be done without redress.  ….

… The form of the action is always ‘A.B. (a minority shareholder) on behalf of himself and all other shareholders of the company’ against the wrongdoing directors and the company.  That form of action was …. a ‘mere matter of procedure in order to give a remedy for a wrong which otherwise would escape redress’ …. Stripped of mere procedure, the principle is that, where the wrongdoers themselves control the company, an action can be brought on behalf of the company by the minority shareholders on the footing that they are its representatives to obtain redress on its behalf.” [emphasis added]

21.  It is clear from the above passages that a derivative action is no more than a procedure created to enable a shareholder to bring an action against the wrongdoing majority. The rationale of this procedure is to enable the plaintiff shareholder to obtain redress on behalf of the company so as to prevent injustice to the company. See also : Prudential Assurance Co. Ltd v Newman Industries Ltd (No. 2) [1982] 1 Ch. 204 (at p. 211A-B).

22.  That being the rationale, I cannot see any legal justifications for allowing a defendant in a derivative action to make a counterclaim against the company on whose behalf the derivative claim is made. On the contrary, to allow such a counterclaim by treating the company as effectively the plaintiff (despite it is joined as a nominal defendant) will be inconsistent with the very nature of a derivative action.

23.  It is trite that a party cannot be both a plaintiff and a defendant in the same action. See : Hong Kong Civil Procedure 2010, Vol. 1, para. 15/1/3 (p. 262). In a derivative action, it is well established that the company on whose behalf the claim is made should be joined as a defendant (albeit a nominal one) so as to ensure that it is bound by the judgment (thereby preventing it from bringing a subsequent action for the same relief) and that it enjoys the fruit of the judgment. See : Joffe Q.C., Drake, Richardson & Lightman, Minority Shareholders : Law, Practice and Procedure (OUP) (3^rd edn), para. 1.36 (p. 12). Since the company has to be joined as a defendant in a derivative action, it cannot be treated at the same time as the plaintiff simply because the claim is brought on its behalf.

24.  It is necessary to bear in mind that a derivative action is only allowed when the company itself cannot sue as a plaintiff. Hence, putting aside the fact that the company is joined as a defendant, conceptually it is difficult to treat the company as the plaintiff in a derivative action.

25.  For these reasons, I agree with the Order made by Master Lung and rule that Mr Yu could not rely on Order 15, rules 2 or 3 to lodge the Counterclaim. Accordingly, this appeal must be dismissed.

26.  During the hearing of this appeal, both counsel had also briefly dealt with the procedural issues or difficulties that might arise if the Counterclaim were to be allowed to proceed. Mr Alan Ng stressed that Haywood is only a nominal defendant and is not represented in this action. On the other hand, Ms Rita So argued that section 114B of the Companies Ordinance (Cap. 32) can be invoked to resolve the question of who should conduct the defence on behalf of Haywood. Further, there is the possibility of a shareholder (such as Madam Yan) applying for leave to intervene under sections 168BB(1)(c), 168BC(1)(b) and 168BC(3)(c) of the Companies Ordinance.

27.  In my view, my conclusion that Haywood is not and cannot be treated as a plaintiff (and thus no counterclaim can be made against it under Order 15, rule 2 or 3) is sufficient to dispose of the jurisdictional issue. In the absence of an opportunity to properly consider the effect of the said provisions in sections 168BB and 168BC of the Companies Ordinance in detail, I do not find it desirable to express any views on the procedural issues that might arise.

No reasonable cause of action

28.  In addition to the jurisdictional difficulty discussed above, I am also of the view that the Counterclaim as is now pleaded does not disclose any reasonable cause of action.

29.  In law, a person who makes a voluntary payment to settle another person’s debt will only discharge that debt if he acts with that other person’s authority or that other person has subsequently ratified the payment. Hence, if a person pays the creditor without the debtor’s authority and if his payment is not subsequently ratified by the debtor, the person who makes the payment generally has no direct redress against the debtor. There is of course the exception to this general rule, viz., the payment was made under compulsion of law, provided the facts justify the application of this exception. See : Goff & Jones, The Law of Restitution (7^th edn), para. 13-001 to 13-006 (at pp. 379-383).

30.  As can be seen from the quotation set out in paragraph 9 above, the Counterclaim as it is currently pleaded does not contain any averment that the payment said to have been made by Mr Yu was made with Haywood’s consent or authority. Nor is there any plea that Haywood has subsequently ratified the payment. Further, there is no plea that the payment was made by Mr Yu under compulsion of law. In any event, on the evidence placed before this Court, it is difficult to see how Mr Yu can suggest that he made the payment to Legnoquattro under compulsion of law.

31.  At the hearing of this appeal, Ms Rita So confirmed that there would not be any application to amend the Counterclaim. Nor is there any evidential basis to suggest that any amendments can be made to improve this Counterclaim.

32.  In the circumstances, the Counterclaim as it is now pleaded does not disclose any reasonable cause of action. Hence, for this reason as well, this appeal should be dismissed.

Order 15, Rule 5(2)

33.  Lastly, there is the question of whether the Counterclaim, if it could be maintained, should be tried separately or together with the derivative claims made by Madam Yan. This question is raised in paragraph 3 of Madam Yan’s Summons and is governed by Order 15, rule 5(2).

34.  Order 15, rule 5(2) reads as follows :

“If it appears on the application of any party against whom a counterclaim is made that the subject-matter of the counterclaim ought for any reason to be disposed of by a separate action, the Court may order the counterclaim to be struck out or may order it to be tried separately or make such other order as may be expedient.”

35.  Due to the conclusions I have reached above, the question of whether the jurisdiction under Order 15, rule 5(2) should be exercised does not call for determination. Further, in view of what I have said in paragraphs 26 and 27 above, I would prefer not to express any view on this issue. In my view, the question of whether the Counterclaim (if it could be maintained) can be conveniently tried together with Madam Yan’s derivative claim or whether it should be tried separately depends, to a certain extent, on who should be given the conduct of the defence of the Counterclaim.

Conclusion

36.  For the reasons given above, I make an Order that this appeal be dismissed. I would also make an Order nisi that the 1^st defendant (Mr Yu) do forthwith pay the plaintiff (Madam Yan) all the costs of and occasioned by this appeal to be taxed if not agreed. Since the present dispute is separate and distinct from the rest of the parties’ disputes in this derivative action, I find it justified to order the costs of this appeal to be paid forthwith.

37.  Lastly, I wish to express my gratitude to both counsel for their assistance.