NG YEE WAH v. LAM CHUN WAH AND ANOTHER

HCA3349/2003

IN THE HIGH COURT OF THE

HONG KONG SPECIAL ADMINISTRATIVE REGION

COURT OF FIRST INSTANCE

ACTION NO.3349 OF 2003

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D E C I S I O N

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1. This is a rather sad case. The 1st defendant and the plaintiff are former husband and wife. They were married in July 1990 and have two children. They were and still are the only two shareholders and directors of the 2nd defendant ("the Company") which was acquired by them off-the-shelf in July 1991. On 1 May 1992, the Company bought a property ("the Property") for HK$5.25 million, with a mortgage of HK$2.5 million repayable over 10 years. The Property was used as their matrimonial home.

2. In about March 2001 the couple separated and the plaintiff filed a petition for divorce on 17 March 2003. A decree nisi was granted on 8 September 2003. Ancillary relief and custody proceedings are still ongoing in the Family Court. In circumstances which I shall describe in more detail later, the Property was sold by consent of the plaintiff and the 1st defendant on August 2001 for HK$7.1 million. Since then the Company has, for all practical purposes, remained dormant.

3. On the day the divorce petition was filed, 8 September 2003, the plaintiff also commenced this action as a derivative action purportedly seeking remedies on behalf of the Company against the 1st defendant. By summons dated 11 November 2003, the plaintiff applied for :

(1) leave to continue this action as a derivative action seeking relief on behalf of the Company until its final conclusion or further order;

(2) an indemnity of her costs out of the assets of the Company.

4. On the hearing of the summons on 21 January 2004, Master de Souza gave the plaintiff leave to continue the action as a derivative action. But the Master did not make any order on the application for indemnity; he left the question of indemnity to be determined at the conclusion of the trial. Costs of the application were ordered against the 1st defendant. From that order the 1st defendant appealed to this court, seeking the dismissal of the plaintiff's summons. There is no cross appeal against the Master's refusal to give the plaintiff indemnity for her costs at this stage.

5. At the conclusion of the hearing, I allowed the appeal and set aside the order of the Master granting the plaintiff leave to continue the action as a derivative action, but declined to dismiss the plaintiff's summons in relation to the indemnity. I now give my reasons for so ruling.

Synopsis of parties' contentions

6. For reasons that will be apparent later, I will not go into the details of the parties' contentions but will simply give a brief description of the broad issues in dispute.

7. The plaintiff's pleaded case is that the company was set up as a "quasi-partnership" between herself and the 1st defendant for the sole purpose of owning the Property. It was never intended that the Company would carry on active trading business. It is alleged that contrary to such agreement, the 1st defendant without her knowledge and consent carried on trading activities through the Company and obtained banking facilities for the Company. The Property was used as security for such facilities. It is alleged that she discovered for the first time after she had separated from the 1st defendant in March 2001 that as a result of the trading activities carried out by the 1st defendant purportedly through the Company, the Company was serious indebted to the bank.

8. When the Property was eventually sold, the net proceeds remaining after paying off the bank were only about HK$260,000. As noted above, the Property was purchased in May 1992 for HK$5.25 million with a mortgage for HK$2.5 million repayable over 10 years. Hence by the time of the sale of the Property in August 2001, only a small amount was outstanding under the mortgage. Had there not been the indebtedness to the bank, the net proceeds from the sale of the Property would have been around HK$6.8 million. The plaintiff therefore contends that the Company has suffered loss of about HK$6.5 million and the 1st defendant should compensate the Company for such loss.

9. The 1st defendant denied there was ever such a limited purpose as alleged by the Plaintiff. He pointed out that the Company was acquired in July 1991, well before the Property was bought. In July 1991, the 1st defendant transferred some shares he previously had in two trading companies which he used to run with his family members to hold such shares on his behalf, and the plaintiff signed the bought and sold notes on behalf of the Company. Further, the Company bought a car in September 1991, which was used by the 1st defendant in his business, some 11 months before the Property was bought.

10. The 1st defendant contends that the plaintiff knew all along that the Company was engaged in business, from which the Company derived income to pay the mortgage instalments and other outgoings. She signed all the facilities letters and the financial statements of the Company over the years. She was not only a housewife as she would have this court believe, but was a wealthy woman in her own right with experience in running private companies. A cursory look at the financial statements signed by the plaintiff over the years would reveal to any person of full capacity that the Company was not merely holding the Property but was engaged in active trading. The trading business carried out by the Company was normal business and the fact that loss resulted from such activities offers no ground for relief against the 1st defendant.

11. The 1st defendant further contends that this action was brought by the plaintiff for an ulterior motive. It is said that this action, and other proceedings and endless requests for disclosure of documents from the plaintiff, were deployed to deplete his already straitened resources. All these were done with a view to pressurising him and making him bankrupt so that she could get custody of the children. These allegations are, naturally, denied by the plaintiff.

Appeal academic?

12. Against the above background, counsel for the 1st defendant, Mr E.C. Mumford SC, submitted that the plaintiff has failed to make out a prima facie case for leave to continue a derivative action. He contended that despite the absence of an express rule requiring a plaintiff in a derivative action to obtain leave of the court before the action could proceed, as in the case of Order 15, rule 12A of the former Rules of the Supreme Court in England which has no equivalent in Hong Kong, the plaintiff in a derivative action is nevertheless required to seek leave to proceed as a matter of law, and that in so doing he must demonstrate a prima facie case that the action falls within an exception to the rule in Foss v. Harbottle (1843) 2 Hare 461. He submitted that Wallersteiner v. Moir (No.2) [1975] 1 QB 373 and Smith v. Croft [1986] 1 WLR 580 are authorities for that proposition. Mr Mumford also referred me to Chung Sau Ling v. Asia Women's League Ltd [2001] 3 HKC 410, a decision of Chu J, in which a similar order as that made by Master de Souza was made.

13. Alternatively, Mr Mumford submitted that irrespective of any legal requirement to seek leave, since the plaintiff did seek and was granted leave, once such leave was set aside the plaintiff could not proceed. He submitted that since a derivative action was an exception rather than the norm, there was no difference between an application by the plaintiff for leave to continue and an application by the 1st defendant to strike out the action, because in both cases the same issue would be involved, namely, whether the plaintiff has demonstrated that she should be allowed to continue the action as a derivative action. He therefore invited me to "disregard the mechanics" and treat this hearing as his application to strike out the action.

14. In resisting the appeal, Mr Rimsky Yuen SC submitted that as a matter of law, there was no requirement for the plaintiff to obtain leave before commencing or continuing with a derivative action. In the absence of any statutory provision, the position was governed by common law : see Chu J in Chung Sau Ling at 414F-I. It was only when the derivative plaintiff wished to seek an indemnity that he had to apply to the court for leave to proceed. He relied on Wallersteiner at 405A-C where Buckley LJ recognised that the derivative plaintiff could proceed even if the court refused to give him authority :

"Upon the effective hearing of the summons the court would determine whether the plaintiff should be authorised to proceed with the action and, if so, to what stage he should be authorised to do so without further directions from the court. The plaintiff, acting under the authority of such a direction, would be secure in the knowledge that, when the costs of the action should come to be dealt with, this would be upon the basis, as between himself and the company, that he has acted reasonably and ought prima facie to be treated by the trial judge as entitled to an order that the company should pay his costs ... and should indemnify him against any costs he may be ordered to pay to the defendants. Should the court not think fit to authorise the plaintiff to proceed, he would do so at his own risk as to costs." (emphasis added)

15. On the strength of these authorities Mr Yuen submitted that since leave to continue was not required, all that the Master had done in this case was to leave the question of indemnity to the end of the trial. Hence there was nothing against which the 1st defendant could appeal. The appeal was thus academic.

16. Mr Yuen further reminded me of the distinction between the Wallersteiner line of cases (including Smith v. Croft and Chung Sau Ling) which were cases concerning whether a derivative plaintiff should be given an indemnity for costs, and the Prudential Assurance Co. Ltd v. Newman Industries Ltd (No.2) [1982] 1 Ch 204 line of cases (including Daniels v. Daniels [1978] Ch 406; Estmanco (Kilner House) Ltd v. GLC [1982] 1 WLR 2; Hurley v. BGH Nominees Pty Ltd (1982) 1 ACLC 387, Eromanga Hydrocarbons NL v. Australis Mining NL (1988) 6 ACLC 906 and Dempster v. Biala Pty Ltd (1989) 7 ACLC 552) which were concerned with the question of the plaintiff's standing to sue. The proper way of challenging the plaintiff's standing to sue, he submitted, was by way of an application properly made to strike out the claim or for the determination of a preliminary issue, rather than an appeal against an order for leave which was not required. Therefore, in addition to being academic, this appeal was also procedurally wrong.

17. Mr Yuen, however, went on to submit that although leave to continue was not necessary, the plaintiff would suffer prejudice if I were to set aside such leave. He submitted that if the plaintiff's summons was dismissed (which was what the 1st defendant sought in his Notice of Appeal), it would deprive her of an opportunity to seek indemnity from the Company. This would be a fetter on the trial judge's discretion which was contrary to the court's established practice : see Wallersteiner at 403C-D per Buckley LJ. On the other hand, he submitted that leaving the Master's order intact would cause no prejudice to the 1st defendant because the question of indemnity remained at large. Mr Yuen, however, realistically accepted that if I were to set aside the leave granted without dismissing the plaintiff's summons, there would be no prejudice to her.

18. In my judgment, Mr Yuen is correct in his submission that as a matter of law prevailing in Hong Kong, there is no requirement for a derivative plaintiff to seek leave to continue. I cannot detect such a requirement from the authorities relied on by Mr Mumford. In contrast, I consider that the judgment of Buckley LJ in Wallersteiner cited above to be authority against such a proposition. It must be remembered that in Wallersteiner, the court was concerned with the question of Mr Moir's costs and it was in that context that the members of that court drew the analogy with a trustee's application for indemnity (the so-called Beddoe order). A trustee does not need the court's authority to commence or continue an action; he only needs to seek the court's direction or sanction in order to safeguard his costs position. In my judgment, the same applies to a derivative plaintiff. In this connection there is no practical difference between a trustee and a derivative plaintiff: in the case of a trustee, he is the only person entitled to sue on behalf of the trust; whereas in a (true) derivative case, by reason of the obstruction of the majority shareholder the only person who could bring the action on behalf of the company is the minority plaintiff.

19. I do not derive much assistance from the Chung Sau Ling case. Although in that case the Master also gave the plaintiff leave without the indemnity, the appeal was against the refusal to give the indemnity and the question of leave was not in issue.

20. In England, the law was changed by statute after the Wallersteiner case by the addition of Order 15, rule 12A in 1975 which introduced the leave requirement. The requirement was retained in the new Civil Procedure Rules. There is no equivalent rule in Hong Kong. It may be noted that the Chief Justice's Working Party on Civil Justice Reform in its Interim Report and Consultative Paper raised for consideration whether a similar rule should be introduced : see para.403 and Proposal 24. That proposal was not further considered in the Final Report of the Working Party because of the introduction to LegCo in June 2003 of the Companies (Amendment) Ordinance 2003 which contained provisions relating to "statutory derivative actions" : see paras.467-468 of the Final Report and sections 168BA to 168BI of the Bill. The Bill is now in the committee stage. I understand that committee stage amendments have been proposed to introduce a leave requirement for a shareholder before he can bring proceedings on behalf of the companies. However, under the proposal currently being discussed, the common law right of a shareholder to bring proceedings on behalf of the company is not affected and will co-exist with the statutory derivative action. It is, of course, not possible to predict what form the eventual legislation will take.

21. Accordingly, unless there is any sound doctrinal basis to impose a leave requirement as a matter of law, I am not prepared to accept that a derivative plaintiff has to seek leave from the court before continuing with the action. Mr Mumford submitted that such doctrinal basis could be found in the rule that in order to obtain the court's sanction in respect of costs, a derivative plaintiff must satisfy the court that the case is a suitable one to grant leave. That, however, begs the question whether leave is independently required in the first place. The fact that if a derivative plaintiff wants an indemnity from the court he must satisfy the court that there is a prima facie case for derivation action does not lead to the conclusion that a derivative plaintiff must get leave to continue irrespective of whether he seeks an indemnity.

22. For these reasons, I conclude that there is no legal requirement imposed on the derivative plaintiff to obtain leave to continue the action. As in other cases commenced in accordance with the rules of the court, it is up to the defendant to challenge the plaintiff's standing to sue if he so wishes.

23. That, however, does not mean that the appeal is academic. Far from it. In my judgment, precisely because the plaintiff did not need leave, there was no reason why she should have obtained such leave from the Master separately from the indemnity which, as confirmed by Mr Yuen, was the real object of her application. The plaintiff's summons, in separating the leave and indemnity into distinct paragraphs might have misled the Master into thinking that these were independent relief when in fact the indemnity was what the plaintiff really wanted, and the leave was only a necessary step in order for the plaintiff to get the indemnity.

24. In the circumstances, the Master should not have been asked to make a separate order for leave. Since the Master did not regard it right to give the plaintiff the indemnity that she sought, there was no reason why he should have granted the plaintiff an unnecessary leave to proceed. It was an order that should not have been made in the first place and should not be allowed to remain on the record. Absence of prejudice to either party (even if that be the case, which I do not necessarily agree) is not an answer.

25. Accordingly, I would set aside paragraph 1 of the Master's order granting the plaintiff leave to continue this action.

Dismissal of plaintiff's summons and the action?

26. However, I am not prepared to dismiss the plaintiff's summons. As pointed out by Mr Yuen, dismissal of the summons may prejudice the plaintiff on the question of indemnity. If, therefore, the action is allowed to proceed, I should not fetter the trial judge's discretion.

27. That leads me to whether I should dismiss the action as Mr Mumford has impressed upon me. While on the basis of the materials now placed before me I am inclined to agree with Mr Mumford's submissions that the plaintiff has not made out a prima facie case for derivative action and that the case was brought with ulterior motive, there was no cross application properly made to strike out the action or for the determination of a preliminary issue. I am not prepared to accept the invitation to treat this hearing as an application to strike out because, as Mr Yuen quite rightly submitted, the complexion of the case would have been different and he might (I put it no higher than that) wish to place further materials before the court to meet such an application. The burden of proof and the requisite threshold might also be different. In all fairness I did not think it would be right to deprive the plaintiff of that opportunity. For similar considerations I did not think it right to stay the action of my own motion, even though counsel accepted that the court has inherent jurisdiction to do so in an appropriate case : see, for example, Heyting v. Dupont [1963] 1 WLR 1192, affd [1964] 1 WLR 843.

28. I would therefore not disturb paragraph 2 of Master de Souza's order. The plaintiff could proceed with the action (at least for the time being anyway) at her own risks as to costs, but without prejudice to the 1st defendant taking out any further application or proceedings as he may be advised. For this reason, I refrained from going into the details of the plaintiff's contentions and the merits.

Order

29. Accordingly, the order I made on the 1st defendant's appeal was that paragraph 1 of the order of Master de Souza would be set aside. The appeal was successful to that extent.

30. Having heard counsel on costs, I considered that since the plaintiff failed to obtain the indemnity which was the real object of her application, the 1st defendant should have his costs of the hearing before the Master. In relation to the costs of the appeal, the 1st defendant was successful to the extent stated earlier. While he did not succeed in having the plaintiff's summons dismissed, he was nevertheless substantially successful. Therefore in the exercise of my discretion I awarded the costs of the appeal to the 1st defendant. Both sets of costs to be taxed if not agreed and to be paid forthwith, with certificate for two counsel.

31. I would remind practitioners that care should be taken in framing the relief sought in similar cases so as to make it clear that if the object of the application is for an indemnity for costs, no independent leave to proceed is being sought. At the very least, the position must be made absolutely clear to the court at the hearing.

32. Lastly, it remains for me to thank counsel for their considerable assistance.