KAN SAU LAN v. KIN LEE CONSTRUCTION CO LTD

HCMP 1611/2014

IN THE HIGH COURT OF THE

HONG KONG SPECIAL ADMINISTRATIVE REGION

COURT OF FIRST INSTANCE

MISCELLANEOUS PROCEEDINGS NO 1611 OF 2014

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REASONS FOR DECISION

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The originating summons

1.  This is the hearing of an originating summons issued under sections 733 and 737 of the Companies Ordinance (Cap 622).  The plaintiff is a shareholder and director of the defendant (the “Company”).  The originating summons seeks the following reliefs:

(1) leave to the plaintiff to bring a statutory derivative action on behalf of the Company against the following intended defendants:

i. Setrich Development Limited (“Setrich”), a former shareholder of the Company (holding 60 shares);

ii. Lam Yau Kwan (“Lam”), a current shareholder and director of the Company;

iii. Wong Chung Ngok Paul (“Wong”), a current shareholder and director of the Company; and

iv. Cheng Hoi Chuen (“Cheng”), a current shareholder and director of the Company,

relating to, concerning or arising from:

a. the 60 shares originally allotted to Setrich on 1 September 2004;

b. the 20 shares transferred by Setrich to Lam on 10 April 2007;

c. the 20 shares transferred by Setrich to Wong on 10 April 2007; and

d. the 20 shares transferred by Setrich to Cheng on 10 April 2007.

(2) an order that an independent auditor be appointed for and on behalf of the Company to investigate and report to the court on the Company’s financial position, including but not limited to:

i. the consideration (if any) for the purported allotment of shares to Setrich; and

ii. funds misappropriated, or used improperly or not in the interests of the Company by Lam, Wong and/or Cheng be it as directors or otherwise;

(3) all reasonable costs and expenses incurred by the said independent auditor be provided for; and

(4) costs of the application be provided for.

2.  The position of the Company is that it does not oppose to the plaintiff being granted leave to bring a derivative action in terms as set out in a draft Indorsement of Claim provided by the plaintiff which is attached as Annex 1 to this judgment. This is of course done without admission as to the merit or otherwise of the intended action.  The Company however opposes the appointment of an independent auditor on the ground that it is unnecessary.  On the question of costs of the application, the Company agrees that costs of and occasioned by the Originating Summons, including any indemnification costs order, be determined in the derivative action.

3.  The difference between the parties is thus solely on the necessity to appoint an independent auditor to carry out the said investigation.

Background

4.  The plaintiff is an indigenous villager in the New Territories.  She was married to the late Mr Tsang Ma Ming (“Tsang”), also an indigenous villager in the New Territories who passed away on 13 September 2004.  The plaintiff has been a housewife.  Tsang was a businessman in the development of small houses.  He incorporated a few companies for that purpose and one of which was the Company.

5.  The Company was incorporated in 1991.  The plaintiff and Tsang held one share each.  The plaintiff did not take any active part in Tsang’s businesses.  The only asset of any substantive value held by the Company is a property in Yuen Long (“the Property”) which can be developed into a cluster of approximately 30 small houses, each valued at HK$6.5 million according to the plaintiff.

6.  In 1990s, the plaintiff came to know Lam and Wong whom she understood as Tsang’s business partners.  She knew that Tsang set up Setrich together with Lam and Wong.  She also came to know Cheng and his wife in the late 1990s.  She understood Lam, Wong and Cheng to be Tsang’s friends.

7.  Tsang passed away on or about 13 September 2004 due to a traffic accident in mainland China.  During the period between 17 and 24 of September 2004, the plaintiff attended three to four meetings with Lam, Wong and Cheng at the office of Setrich.  During these meetings, the following major events took place:

(1) Lam, Wong and Cheng told the plaintiff that they had invested an amount of HK$16.2 million in the development project relating to the Property in return for a total of 60% shareholding in the Company.

(2) They showed minutes of a shareholders’ meeting and a board meeting (both held between Tsang, Lam, Wong and Cheng) recording a purported decision by Setrich to purchase 60% interest in the Company/the development project relating to the Property.

(3) Lam, Wong and Cheng claimed that they had fully paid the investment sum of HK$16.2 million but Tsang had failed to transfer 60% of shareholding in the Company to Setrich.

(4) Although they did not show any documentary proof of their investment, they assured the plaintiff that they could do so later.  They asked the plaintiff to seek confirmation from a legal executive serving Tsang before.

8.  The plaintiff contacted the said legal executive who equally assured the plaintiff that Lam, Wong and Cheng had made the said investment.  Relying on the aforesaid representations, the plaintiff executed a series of companies documents between 27 September 2004 and December 2004 pertaining to the allotment of 98 shares of the Company (60 shares to Setrich and 38 shares to the plaintiff).[1]  The documents also resulted in Lam and Wong being appointed directors of the Company as from 1 September 2004.  It is the plaintiff’s case that the aforesaid documents though executed within this time frame were all backdated to dates prior to the demise of Tsang.  In one of such documents, Tsang was even purported to have been elected as chairman of the meeting.

9.  The plaintiff was able to obtain copies of the said documents from the Company through her alternate director Mr Wong Chi Kit Carson (“Carson”).  Carson was allowed to inspect documents of the Company in September and October 2013.  With the help of Carson, the plaintiff alleged that she discovered a number of instances of misconduct or suspected misconduct on the parts of Lam, Wong and Cheng.

10.  At the hearing, I requested Mr Vaughan, counsel for the plaintiff, to identify the alleged misconduct committed against the Company because in the Plaintiff’s Skeleton Arguments, a number of matters were said to be “misconduct” but not all of which could amount to “misconduct committed against the Company”.  Mr Vaughan identified those acts of misconduct against the Company as follows:

(1) Setrich, Lam, Wong and Cheng had paid no consideration for the allotment.  The allegation that Lam, Wong and Cheng had made a total investment of HK$16.2 million is not substantiated by evidence.  The Company was wrongly procured to make the allotment at par value of HK$1 per share when the development project is worth millions.

(2) The plaintiff was misled into executing the various company’s documents pertaining to the allotment by the fraudulent representations of Lam, Wong and Cheng who also made the same for Setrich.

(3) Furthermore, the various company’s documents pertaining to the allotment were invalid in that they were executed at a time after the death of Tsang yet backdated to dates when Tsang was still alive and purportedly made with the participation/knowledge of Tsang.  The Company was wrongfully procured to act upon those documents as if they were valid.

(4) There were various identified payments and one accounting adjustment caused by Setrich, Lam, Wong and/or Cheng to be made by the Company which were not for the benefit of the Company. They constituted misappropriation of the Company’s funds.

(5) Lam, Wong and Cheng procured the Company to agreeing to pay them exorbitant interest of 40% per annum in respect of loans allegedly owing to them.  It amounted to breach of fiduciary duties on their part.

I wish to point out that though I have summarized the above acts of misconduct in general terms for the purpose of this decision, Mr Vaughan had in fact been able to meticulously set out the details of these complaints in his Skeleton Arguments with references to various documentary exhibits and affidavit evidence filed by Lam, Wong and Cheng.[2]

11.  Mr Lam, counsel for the Company, pointed out that the Company did not oppose the application for leave to bring derivative action because it acknowledged the low threshold that was required to be crossed.  The Company’s stance was taken without admission of the plaintiff’s allegations.

12.  Despite so, Mr Vaughan submitted that it is still necessary to seek an order of appointment of independent auditor to make those investigations as set out in the Originating Summons.  He relied on Re Li Chung Shing Tong (Holdings) Ltd[3] in which Harris J held that only in exceptional circumstances where, without such appointment, the plaintiff would be “unable to satisfactorily bring proceedings against the intended defendant” would a section 737 (2)(d) order be made.  Mr Vaughan submitted that this is one such case.  Furthermore, Mr Vaughan submitted that the parties and the court trying the derivative action will eventually need to be assisted by evidence from a forensic accountant.  Rather than leaving the matter to be dealt with by possible adversarial evidence at a later stage in the derivative action, it will greatly assist the parties and the court if an independent forensic expert can be appointed now to investigate into the matters as prayed for in the originating summons.  He said it would just be expediting a step that would have to be taken in the derivative action anyway.

13.  Mr Lam submitted that the plaintiff’s submissions were both wrong in law and in principle.  He first pointed out that according to the wordings of the Originating Summons, the plaintiff is seeking an imprecisely defined, wide ranging and roving investigation into “what were the wrongs committed to the Company”.  He submitted that the court’s powers under section 737(2) are for the purposes of the two types of proceedings set out in section 737(1).  Since the present Originating Summons relates to “an application for leave to bring derivative action”, the court should only exercise the power of making appointment if it requires the assistance of such an investigation report in determining whether or not to grant leave.  Such power should not be exercised to usurp the fact finding function of the trial judge hearing the eventual derivative action.  He further submitted that in any event, there is no sufficient basis to say in this case that the plaintiff cannot satisfactorily present her case on the intended derivative action.  She is able to formulate the draft Indorsement on Writ with precision.  Her counsel is able to crystallize the complaints of misconduct or suspected misconduct.  That is because the plaintiff, as a director is entitled to and did (acting through Carson) inspect and take copies of documents of the Company.  The case of this plaintiff is to be distinguished from cases where mere shareholders are hampered in their formulation of a case of derivative action against the company due to lack of information.  Mr Lam further submitted that whether or not expert evidence would be engaged in due course would be a matter to be determined in the derivative action based on the issues identified in pleadings and the discovery made by parties.

14.  I largely agree with Mr Lam.  Sections 732 (1) and (2) state that “a member … may, with the leave of the Court granted under section 733, bring proceedings …”. Section 732(3) states that “a member … may … intervene in the proceedings…”.  Section 737 has a title “Court’s general powers to order and direct”.  Its provisions read:

“(1) The Court may make any order, and give any direction, that it thinks fit in respect of—

(a) any proceedings brought or intervened in under section 732(1), (2) or (3);

(b) an application for leave for the purposes of section 732(1), (2) or (3);…

(2) Without limiting subsection (1), the Court may do any or all of the following under paragraph (a) or (b) of that subsection—

(d) … make an order appointing an independent person to investigate and report to the Court on—

(i) the company’s financial position;

(ii) the facts or circumstances that gave rise to the proceedings or application; or

(iii) the costs incurred by the parties to the proceedings or application, and by the member who brought or intervened in the proceedings or who made the application.” (my emphasis)

In my view, subsection (1) refers to the court’s exercise of power in two different settings.  Subsection (1)(a) is a reference to proceedings “brought or intervened in under section 732(1), (2) or (3)”.  The use of passive voice in subsection (1)(a) is significant.  One can contra the language used in section 738(1)(a)(i) which refers to “any proceedings brought or intervened in, or to be brought or intervened in, under section 732(1), (2) or (3)”.  In my judgment, section 737(1)(a) specifically refers to the actual derivative proceedings instituted by a member after obtaining leave of the court to do so; or the proceedings (already on foot) involving the company which a member has obtained leave to intervene in.  My interpretation is supported by the Australian decision in Charlton v Baber & oths (2003) 47 ACSR 31.  In that case, the court was interpreting sections 237, 241 and 242 of the Corporation Act 2001.  Section 737 (including its precursor section 168BG) is modeled after the Australian Corporation Act 2001.  The court held that the words “proceedings brought” referred to a stage where after leave to bring proceedings on behalf of the company has been exercised, ie the applicant for leave, having been successful in obtaining it, has actually taken steps to bring on the company’s behalf the proceedings the court has allowed him to institute.

15.  On the other hand, section 737(1)(b) refers to an application for leave for the purposes of section 732(1), (2) or (3).  This is the stage which this court is now confronted with.  In my judgment, though given the same powers under section 732(2), the actual exercise of such powers by the court will depend on which type of proceedings the court is actually dealing with.  In the course of dealing with an application for leave under section 732(1) or (2), the court is primarily concerned with whether the applicant can establish the threshold set out in section 733(1).  If the court is there and then invited to exercise its power given under section 737(2)(d) to appoint an independent investigator, the court has to consider whether it is necessary at this stage to make such an order.  It will depend on whether the court considers that the obtainment of such an investigation report is:

(i) reasonably necessary to assist the court in arriving at a correct decision of either granting or refusing leave; or

(ii) reasonably necessary to enable the applicant to adequately frame at least a prima faice case in the writ to be issued if leave is granted by the court.

In Re Grand Field Group Holdings Ltd [2009] 3 HKC 81, Kwan J (as she then was) was dealing with an application for leave to bring statutory derivative action under section 168BC. After granting the applicant leave to institute derivative action, the court (at para 49) dealt with the application for appointment of independent investigator.  Kwan J said:

“I decline to make an order to appoint an independent auditor to investigate the financial position of the Company. If the Company wishes to engage such an auditor, it is at liberty to do so, without any order from the court. As for Mr. Tsang [the applicant], it seems to me that the information presently available to him is prima facie sufficient to bring proceedings. I do not see the need for investigation by an independent auditor to be appointed by the court at this stage. The appointment of an independent auditor in Re Lucky Money Limited was made on the special facts of that case, and it does not mean that an appointment is called for whenever there is a sharp conflict in the evidence file.”(my emphasis)

In Re Lucky Money Limited, (unreported) HCMP 505/2006, the court was dealing with an application by a member to intervene in proceedings instituted against the company.  The complaint of the applicant was that the company (controlled by delinquent directors siding with the plaintiff in those proceedings) was allowing a default judgment to be entered against it when it had a viable defence to the claim.  The applicant thus applied to intervene in those proceedings and to take up the conduct of the defence of the company.  Before coming to a conclusion as to whether or not to grant leave, the court ordered an independent auditor to investigate and provide opinion on specific matters relevant to whether the company had an arguable defence to the claim.  After obtaining such assistance from the investigation report, Kwan J concluded that the applicant was able to establish that it appeared to be prima facie in the interest of the company to defend against the claim.

16.  I regard Re Lucky Money Limited as an example of exercise of power under situation (i) above.  I regard Re Grand Field Group Holdings Ltd as an example of refusal to exercise the power under situation (ii) above.

17.  Mr Vaughan relied on the dictum of Harris J in Re Li Chung Shing Tong (Holdings) Ltd.  In my view, when the dictum of Harris J is read in its proper context, it is not at all inconsistent with the principles I have set out above.  In that case, the court was equally dealing with an application for leave to institute derivative action.  After concluding that the applicant had demonstrated serious questions to be tried and that it was in the best interest of the company that the proposed proceedings were pursued, Harris J dealt with the application for appointment of independent professional accountant to investigate and report to the court on the facts or circumstances that gave rise to the proposed derivative action.  Harris J (at para 59) agreed with the approach of Kwan J in Re Grand Field Group Holdings Ltd and continued to say:

“… The Court, in my view, should only exercise its discretion to appoint independent accountants in exceptional circumstances where, without such an appointment, the plaintiff would be unable to satisfactorily bring proceedings against the intended defendant. That is not to say, as Kwan J was quick to emphasize, that the plaintiff may not engage an auditor without an order from Court—it is free to do so of its own accord.”

Harris J concluded, on the facts of that case, that it was not necessary at that stage to appoint an independent professional accountant.  Having quoted and endorsed the approach of Kwan J in Re Grand Field Group Holdings Ltd, what Harris J must have meant by saying “the plaintiff would be unable to satisfactorily bring proceedings against the intended defendant” was a situation where without the investigation, the applicant could not adequately frame a prima facie case in the writ of the derivative action for which leave had been granted.  I certainly agree with Harris J that only in exceptional circumstances would the court exercise the power of appointment after deciding to grant leave but before derivative action is actually on foot.

18.  In the present case, the plaintiff is clearly able to frame her case with reasonable precision as seen both in the draft Indorsement of Claim and the Plaintiff’s Skeleton Arguments.  I do not see any necessity at this stage to appoint an independent auditor to make the wide ranging investigation prayed for in the originating summons. Mr Vaughan argued that as the derivative action progresses, a forensic accountant would in any event be required.  He described his current application as expediting an event that would have to take place anyway in the course of the derivative action.  With respect, this approach is wrong in principle.  The derivative action is yet to be instituted.  We are currently still at the stage of section 737(1)(b). Once a derivative action is properly instituted pursuant to the leave granted, then we will arrive at the situation envisaged in section 737(1)(a).  When the plaintiff of the derivative action then apply to seek the court’s exercise of power under section 737(2)(d), the court would have to consider whether it is just and convenient for the fair disposal of the derivative action to order such an investigation.  The court would have to assess the merit of the application on the basis of the issues as defined in the pleadings; the state of discovery and the witness statements filed by the parties etc.

19.  In the circumstances, I refused to exercise the power under section 737(2)(d) at this stage and had so ordered at the conclusion of the hearing on 15 January 2015.  The above are the reasons for my decision.

ANNEXURE 1

[Intended Statutory Derivative Action]

IN THE HIGH COURT OF THE

HONG KONG SPECIAL ADMINISTRATIVE REGION

COURT OF FIRST INSTANCE

ACTION NO     OF

___________

(Draft) INDORSEMENT OF CLAIM

The plaintiff’s claim is for the following:

(1) A declaration that the purported allotment of 98 shares of the plaintiff, comprising 60 shares allotted to the 1^st defendant, and 38 shares allotted to Madam Kan Sai Lan (簡秀蘭) on 1 September 2004 (“the Allotment”), was void and invalid, and an order that the Allotment be set aside and the corresponding shares be cancelled, by reason that the Allotment was procured by the fraud of or fraudulent misrepresentations made by the 2^nd to 4^th defendants on their own behalf and/or on behalf of the 1^st defendant and by forged documentation;

(2) By reason of and consequent upon paragraph (1) above, a declaration that the subsequent transfers of the shares respectively set out below were void and invalid, and an order that the said transfer be set aside:

(a) 20 shares of the plaintiff transferred to the 2^nd defendant by the 1^st defendant on 10 April 2007;

(b) 20 shares of the plaintiff transferred to the 3^rd defendant by the 1^st defendant on 10 April 2007;

(c) 20 shares of the plaintiff transferred to the 4^th defendant by the 1^st defendant on 10 April 2007.

(3) An order that the share register of the plaintiff be rectified accordingly, pursuant to section 633 of the Companies Ordinance, Cap 622;

(4) By reason of and consequent upon paragraphs (1) and (2) above, a declaration that the respective appointments of the 2^nd to 4^th defendants as directors of the plaintiff were void and invalid;

(5) An injunction, pending rectification of the share register of the plaintiff, that the 2^nd to 4^th defendant to be restrained from exercising any power as directors or shareholders of the plaintiff, including any dealing in or with any landed property held in the name of the plaintiff;

(6) An order that all necessary accounts be taken from the defendants and enquiries be made in respect of any misappropriation of funds or other assets of the plaintiff, instances of breaches of fiduciary duty or duty as trustee, conversion of funds or other assets of the plaintiff, from the time of the Allotment to the date of the taking of such accounts and enquiries as aforesaid, which shall include but are not limited to the following matters:

(a) The transfer of HK$5,670,000 on 27 July 2005 from the plaintiff to the 1^st defendant.  Such transfer was related to an agreement dated 25 July 2005 purportedly signed by the 2^nd defendant on behalf of the plaintiff and one Kwok Wai Ming (郭偉明) (“Mr Kwok”), whereby: (i) Mr Kwok purportedly agreed to deposit HK$6,000,000 with the plaintiff for the purpose of assisting the plaintiff in erecting 26 small houses on various sections in the Property, and (ii) the plaintiff agreed to return the said deposit of HK$6,000,000 to Mr Kwok upon completion of the sale and purchase of 17 of the small houses.  Despite the said agreement, the 2^nd defendant purportedly also signed a different version of an agreement also dated 25 July 2005 carrying similar terms of the said agreement except there was no mention of a deposit of HK$6,000,000.  Further, the 2^nd to 4^th defendants had, by virtue of a purported loan agreement also dated 25 July 2005 signed between them and Mr Kwok, agreed to borrow an interest‑free loan of HK$6,000,000 from Mr Kwok, whilst on the other hand they procured a corresponding accounting entry to be made in the books of the plaintiff to the effect that a total sum of HK$6,000,000 was owned by the plaintiff to the 2^nd to 4^th defendants which carried interest at the rate of 10% pa;

(b) The alleged entry in the books and accounts of the plaintiff for the year ended 31 March 2000 recording an interest free unsecured amount of HK$18,768,000 due from “Sundries Creditors” (being the 2^nd to 4^th defendants), part of which (HK$12,712,000) was subsequently changed to an interest bearing amount (without specifying the interest rate) due to directors (namely the 2^nd and 3^rd defendant), whilst the remaining HK$6,266,000 (due to the 4^th defendant) remained non‑interest bearing.  Subsequently on 25 October 2013, the 2^nd to 4^th defendants procured the passing of a board resolution of the plaintiff to increase the interest rate for the amount due to the 4^th defendant to 40% pa.  From 2005 to 2013, the plaintiff incurred a total amount of interest of HK$18,000,000 to the 2^nd to 4^th defendants;

(c) On 23 January 2014, the 2^nd to 4^th defendants procured the passing of a board resolution for adjustments to be made, without any justification, to the financial statements of the plaintiff for the year ended 31 March 2010 in respect of a sum of HK$4,848,097 forming part of the original cost of acquisition of the Property in 1992.  As a result of the adjustment, this amount was credited to the current accounts of the 2^nd to 4^th defendants held with the plaintiff as sums due from the plaintiff.

(7) An order that the defendants, or any of them, shall pay the plaintiff any sums found due after the accounts and enquiries as referred to in paragraph (6) above have been undertaken;

(8) Alternatively, damages for fraud or fraudulent misrepresentation to be assessed;

(9) Further or in the further alternative, damages for conversion to be assessed;

(10) Any other relief as the court shall deem fit;

(11) Costs;

(12) Interest on any sums found due pursuant to section 48 of the High Court Ordinance, and/or compound interest for breach of trust.