EVER JOINT (HOLDINGS) LTD v. NICE THEME LTD AND OTHERS

HCA 2153/2005

IN THE HIGH COURT OF THE

HONG KONG SPECIAL ADMINISTRATIVE REGION

COURT OF FIRST INSTANCE

ACTION NO. 2153 OF 2005

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J U D G M E N T

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1.  This is a derivative action.  There are a number of applications before me; the primary one is to strike out or stay the proceedings, upon the grounds that the company upon whose behalf the action was brought is now wound up.

Background

2.  The plaintiff, Ever Joint, and the 4^th defendant, Luk Wing Hung, hold 50% each of the shares in the 1^st defendant, Nice Theme.  Nice Theme owns the 2^nd and 3^rd defendants which I shall refer to as the subsidiaries.  The 4^th defendant, Mr Luk, is a director of and is or was in effective control of Nice Theme and the subsidiaries.

3.  Management of Ever Joint had cause to believe that Mr Luk was guilty of breach of fiduciary duties owed Nice Theme and the subsidiaries on what is said to be a grand scale, including the misappropriation of assets and opportunities the property of the subsidiaries.  The 5^th, 6^th and 9^th to 11^th defendants are alleged to have assisted Mr Luk, and the 7^th and 8^th defendants to have been wrongful recipients of the misappropriated assets and opportunities.

4.  Ever Joint not having control of Nice Theme brought this action on behalf of itself and all other shareholders of Nice Theme and the subsidiaries.

5.  The proceedings were filed on 2 November 2005.  The day before, Ever Joint applied for and was granted two Anton Piller orders against the two alleged recipients, the companies sued as the 7^th and 8^th defendants.

6.  In separate proceedings under HCCW 29/2006 Ever Joint by petition presented on 19 January 2006 petitioned to wind up Nice Theme for default in paying on demand a shareholder’s loan.  The petition was not opposed.  Nice Theme was wound up on 15 March 2006.  Pending appointment of a liquidator, scheduled to be due on 15 December 2006, the Official Receiver acts as the provisional liquidator.

7.  To complete the picture, by summons under HCCW 29/2006 of 23 October 2006 the Companies Judge was asked for leave for this action to be continued by Ever Joint; alternatively, by the liquidator when appointed.  That summons is scheduled to be heard after the strike out application before me.

The Derivative Action

8.  This is a remedy available to minority shareholders of a company where they are aggrieved by wrongful conduct of those in control of the company, to the detriment of the company.  The usual rule that a company wronged and no other should bring the action is relaxed in favour of the aggrieved minority, who are permitted thus to bring a minority shareholders’ action on behalf of themselves and all others.  The rationale is that, without such right, their grievance could not be aired and dealt with because the wrongdoers themselves, being in control, would not allow the company to sue; see the English Court of Appeal case Prudential Assurance Co. Ltd v Newman Industries Ltd (No. 2) [1982] Ch 204, at p.210.  This is known as the exception to the rule in Foss v Harbottle.

9.  No issue is taken with this principle, nor that Ever Joint was within its right to mount this a derivative action to protect its interests in Nice Theme and the subsidiaries.

What is contested is the right for Ever Joint to continue with the action now that Nice Theme is in liquidation, for no longer is it or are its subsidiaries under the control of a majority behaving unlawfully.

The Applications

10.  The defendants named excluding Nice Theme and the subsidiaries are separately represented.  The 4^th defendant, Mr Luk, said to be the ringleader, and the 9^th defendant, Ms Chan, said to be his personal assistant and administration’s manager of one of the subsidiaries, are in one camp.  The remaining personalities and incorporated companies, designated the 5^th to 8^th defendants, 10^th and 11^th defendants, are in another.  For the purposes of the matters being pursued before me however, they form a united front.

11.  In chronological order the summonses before me are as follows:

(a)     on 17 March 2006, by Ever Joint, for directions for a speedy trial;

(b)    on 25 and 26 April by both sets of defendants, to strike out the actions in whole or in part.  The first was upon the grounds that the order winding up Nice Theme, thus vesting control of Nice Theme and the subsidiaries away from the former management, brought the action outside the exceptional circumstances in which a derivative action is permitted.  The second, as a fallback on the merits, because certain of the paragraphs of the statement of claim alleging wrongdoing are defective for not disclosing any reasonable cause of action.  Shortly before this hearing further applications were made to amend these summonses to incorporate an alternative application to the strike out in full, namely, a stay of the action pending further order of the court.  There was no objection to these further applications being granted; indeed they were supported, and at the outset I gave leave to amend; and

(c)     on 24 October 2006, by Ever Joint, for leave to amend the statement of claim.  It is said of this that the purpose is to join a 12^th defendant and to make fresh allegations, as a result of new information gleaned from the search and seizure earlier authorized, and to remedy the so-called defects alleged by the defendants in certain paragraphs of the statement of claim.

A Pre-hearing Proposal

12.  The filing by both sets of defendants to incorporate into their applications for a striking out the alternative of a stay brought an open proposal from the those representing Ever Joint that this court be invited to stay the action, pending determination of the summons in HCCW 29/2006 before the Companies Judge for leave to Ever Joint to continue the action or that it be continued by the liquidator.  The proposal was further to the effect that the recently filed application to amend the statement of claim, answering the complaints of defects, be agreed with costs to the defendants.

13.  These proposals having been rejected, before me Mr Smith, SC representing Ever Joint repeated them, save that he accepted that if there was to be a stay, that stay should include a stay of the applications for directions and to amend the statement of claim.

The Stance of the Defendants

14.  The defendants rejected the proposals made both pre-hearing and before me.  Messrs Suen (for the 4^th and 9^th defendants) and Ng (for the remaining defendants) told me their primary goal was a striking out of the action, and if in the event the court were to order a stay, a dismissal of the plaintiff’s summonses for directions and to amend.

15.  I come to their grounds next.

The Grounds to Strike out

16.  The derivative action was no longer viable once the company in question had been wound up.  Yet Ever Joint’s representatives, having orchestrated the winding up of Nice Theme on its petition, then proceeded to seek directions for a speedy trial without consent of a liquidator, just two days after the winding-up order was made.  This overt act to continue the action on behalf of a company in liquidation was to offend the rule that to bring or continue a derivative action the plaintiff must establish that the alleged fraudsters are in control.

17.  The author, Victor Jaffe QC, of the text Minority Shareholders: Law Practice and Procedure (2^nd edition, 2004) was quoted at para.1.48:

“The onus is thus on the claimant minority shareholder who seeks to bring a derivative action to allege in his particulars of claim, and then to prove, that those who are implicated in the fraud are in control of the company and will not permit its name to be used as claimant in the action.  If the minority shareholder cannot demonstrate control on the part of those implicated in the fraud, the action will be dismissed.”

18.  The Privy Council was asked to adjudicate on the point in Ferguson v Wallbridge [1935] 3 DLR 66, where, as here, the company formerly in control of alleged wrongdoers fell into liquidation.  Lord Blanesburgh said at page 83:

“… in their Lordships’ judgment, [the present action] could have been so maintained if the company were not in liquidation.  Cook v Deeks [1916] 1 AC 554) is clear authority for this.  But could it be so maintained now that the company is assumed to be in liquidation?  And the answer must again, as their Lordships think, be in the negative … The form of action so authorised is necessitated by the fact that in the case of such a claim … justice would be denied to him if the mere possession of the company’s seal in the hands of his opponents were to prevent the assertion at his instance of the corporate rights of the company as against them … So as soon as the company goes into liquidation the necessity for any such expedient in procedure disappears.  Passing over the superficial difficulty that a company in compulsory liquidation cannot be proceeded against without the leave of the Court, the real complainants, the minority shareholders, are no longer at the mercy of the majority, wrongly retaining the property of the company by the strength of their votes.”

19.  In Fagro Ltd v Godfroy [1986] BCLC, 370 Walton J said at p.372 on the point:

“But once the company goes into liquidation the situation is completely changed, because one no longer has a board, or indeed a shareholders’ meeting, which is in any sense in control of the activities of the company of any description, let alone its litigation.  Here, what has happened is that the liquidator is the person in whom that right is vested.”

Further, after citing Ferguson v Wallbridge, Walton J commented at p.374:

“So there is clear authority in the Privy Council as to the vast distinction that there is between the position where the company is a going concern and the minority shareholders’ action can be brought, and a case where when it goes into liquidation where there is no longer any necessity for bringing a minority shareholders’ action.  Because, subject if necessary to obtaining the directions of the court, which is in itself an excellent thing as acting as a filter against any totally wrong-headed action, the action can be brought directly in the name of the company as it should be so brought.”

20.  There are other authorities on the point.  These and recognised texts serve to provide for the following procedural propositions:

(1)     A derivative claim may not be brought where a company is in liquidation.  This is because the company is no longer in the control of the alleged wrongdoers, in which event the reason for any exception to the rule in Foss v Harbottle disappears.

(2)     Where a company is in liquidation, it is the liquidator, if necessary with the sanction of the liquidation committee or the court, who has the power to initiate proceedings on behalf of the company.

(3)     This is the case even if the company was not in liquidation at the time the derivative action was commenced.  Once a company goes into liquidation, there is no wrongdoers’ control and the decision whether to continue with the action should best be left to the judgment of an independent liquidator.

(4)     Hence, pending any consent by the liquidator or any order by the court for the liquidator to take over or continue with a derivative action, a plaintiff shall have no authority to take any further steps or issue any further applications in the derivative action.

21.  Ever Joint provided no evidence (nor is there even a hint or suggestion) that it sought or obtained any authorisation from the Official Receiver (being the provisional liquidator of Nice Theme) before pressing ahead with its derivative direction.  Thus the court should now dismiss the applications for directions and amendments and strike out the action; this is the primary stance of the defendants.

22.  Alternatively, if the court is minded to stay the proceedings, the applications of Ever Joint having nevertheless been wrongly made should be dismissed in any event.

The Case Against Striking out

23.  Mr Smith did not seek to argue against the proposition that the action was no longer in the category of a derivative action, but drew a distinction between a derivative action that was issued before the company’s liquidation, and was thus already on foot at that point, and the situation where the action post-dated the liquidation.  He accepted that at and after the order for winding up, the alleged wrongdoers could no longer be said to be in control.  But he made the point that the action having begun it should be the liquidator who should thereafter take charge and if warranted continue the action in modified form.  This in fact is dicta found in a Hong Kong case produced by the defence:  Akira Sugiyana v Kosei Securities Co. (Asia) Ltd [1992] 1 HKC 261.  Bokhary J as he then was found statutory support for the proposition that a liquidator could bring or defend without sanction any action or legal proceedings in the name of and on behalf of the company in liquidation.  He held ‘bring’ meant where appropriate ‘continue’.

24.  This decision must also serve to support the proposition that a liquidator may continue a derivative action brought by a disadvantaged shareholder before liquidation.

25.  Mr Smith argued further that to strike out the action would mean that there would be no action for the liquidator to takeover; the proceedings would have to begin de novo.  Quite apart from the waste of resources there would be the issue of unfinished interlocutory activity, for instance the incidence of costs in the Anton Piller applications and orders.

The Official Receiver

26.  Ms McKenna appeared on behalf of the Official Receiver to confirm that a liquidator is scheduled to be appointed on 15 December 2006.  She was able to say that it appears that Nice Theme is insolvent, but that the creditors are limited to shareholders (Ever Joint and the 4^th defendant, Mr Luk, and an associate company).

27.  She said that the OR is neutral on the strike out application but that if the action is not struck out then the proceedings should be adjourned or stayed pending the appointment of the liquidator.

Decision

28.  It is clear to me that the derivative action as presently constituted cannot move forward.  This is now a matter for the liquidator and his appointment and involvement is not now far away.  Whether the proceedings are to continue and if so the funding and in what form will be a matter for him. 

29.  Should the present proceedings be struck out?

30.  This was proposed in a case heard in the Supreme Court of South Australia called Zempilas & Ors v JN Taylor Holdings Ltd (in liquidation) and Ors (No. 6) [1991] 5 ACSR 28.  In that case a derivative action was before the court, where following the action having been brought the company was wound up and liquidators had been appointed.  They applied to be substituted as plaintiff.  The present plaintiff consented to that course.  The defendants alleged to be liable in damages did not oppose.  But it was argued on their behalf by counsel called Mr Rydon that the existing proceedings be struck out and that the liquidator should initiate a fresh action.  Debelle J said of this at p.31:

“I do not think it is appropriate to accede to Mr Rydon’s argument.  The effect of this argument is that it would be necessary for the applicants [the liquidators] to institute a fresh action merely for the purpose of filing and delivering an amended statement of claim.  I think that it is an unnecessary procedural step.  It is plain that the liquidators seek to pursue the same relief as against the former directors as did the original plaintiffs.  If an order is made substituting the applicants as plaintiffs, there might be some minor consequential changes to the pleadings, but the facts and circumstances upon which the cause of action is said to exist will not change in any material way.

The defendants whom Mr Rydon represents will not be put to any additional costs apart from the costs occasioned by having to amend their defence in consequence of the amendments to the statement of claim.  At the end of the day the fact remains that these defendants have sought to challenge the relief the existing plaintiffs seek in all respects including the application to wind up the company.  They have been heard on those … If an order is made substituting the applicants for the existing plaintiffs, the defendants will not be put to any substantial additional costs.”

31.  It seems to me that there is no need to strike out the action.  That presupposes that it was bad de novo and it was not.  There are also practical matters to consider.  To strike out would leave at large the not finally determined Anton Piller applications and orders, with live undertakings given by Ever Joint as a condition of those orders.

32.  I conclude that the action should be stayed instead and so order, pending further order of the court and the decision of the liquidator as to whether it should continue and in what form, and how it should be funded.

33.  I regard the application for directions for a speedy trial to have been wrongfully pursued and dismiss it.  But the application to amend the pleadings introducing a prospective additional defendant and further cause of action and seeking to remedy defects in the existing pleadings should be adjourned sine die.

Costs

34.  The order is nisi.  But my preliminary order is affected by the lately pursued application for a stay and the plaintiff’s acceding to this cause disclosed before the hearing and again at the outset of the hearing.

35.  Costs consequential upon the dismissal of the plaintiff’s directions application are to the defendants taxed and paid forthwith. 

36.  Costs on the plaintiff’s application to amend the statement of claim are in the cause of that application.

37.  On the application for strike out or stay there is no order as to costs.

38.  Costs on the defendant’s application to strike out specified paragraphs of the statement of claim are in the cause of that application.