NUGAN HAND (HONG KONG) LIMITED v. SPEAKMAN AND COMPANY

CIVIL APPEAL NO. 36 OF 1986

IN THE SUPREME COURT OF HONG KONG

COURT OF APPEAL

(ON APPEAL FROM HIGH COURT ACTION)

(NO. 2757 OF 1984)

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BETWEEN

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JUDGMENT

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Clough, J.:

1. This is an interlocutory appeal from the order of Rhind J. made on the 18th March 1986 dismissing with costs the Defendants' application under Order 18 rule 19(1) to strike out the Plaintiff company's Statement of Claim and dismiss the action, or alternatively to strike out specified parts of the Statement of Claim. The dismissal of the application was qualified to the extent only that the judge ordered that two short passages in the Statement of Claim relating to the alleged capacity of the Defendant firm and its duties in relation to the Plaintiff were to be struck out as a result of concessions made on behalf of the Defendants.

2. The Plaintiff is a deposit taking company in compulsory liquidation and the action is conducted by its liquidator, the Official Receiver. The Defendants are a firm of accountants. The Plaintiff's claim is based on the alleged professional negligence of the Defendants. It was conceded before the judge and on the appeal that the Plaintiff intended to confine its claim against the Defendants to alleged breaches of duty by the Defendants as the auditors of the Plaintiff, notwithstanding allegations in the Statement of Claim that the Defendants had also been the Plaintiff's accountants, tax representatives and financial advisers. It was also conceded by the Plaintiff that none of its claims in the Statement of Claim relied on any cause of action arising out of the' Defendants' audit of the Plaintiff's accounts for the period ended the 31st December 1977.

3. The writ in the action was issued on the 25th April 1984. It was amended on the 8th February 1985 and was not served until the 12th April 1985. It was generally indorsed with claims for damages for breaches of duty by the Defendants in relation, so far as is now material, to its capacity as the Plaintiff's auditors. These claims were founded in contract and tort and also on the statutory obligations imposed upon auditors under the Companies Ordinance (Cap.32).

4. The Statement of Claim was served on the 15th April 1985. It is not a model of the pleader's art. The breaches of duty alleged therein against the Defendants stem from two matters. One matter is the alleged misappropriation of negotiable certificates of deposit ("NCDs") belonging to the Plaintiff by Nugan Hand Limited ("Nugan Hand"), an Australian company, closely associated, through common shareholders and directors, with the Plaintiff. The NCDs in question are claimed to have had a value of (A)$2,702,776.39 and the misappropriations are claimed to have occurred on various dates during 1978, 1979 and 1980 at a time when the NCD's had been released from the custody of the Australia and New Zealand Banking Group Limited to be held on the Plaintiff's behalf and to the Plaintiff's order. The Plaintiff pleads that in the annual accounts of the Plaintiff for the years ended the 31st December 1977 and 1978 its NCDs were described as "Deposits with other banks" in the sums of (US)$1,805,920 and (US)$1,533,957 respectively.

5. The other matter concerns payments amounting to (US)$92,620.58 and (US)$400,000 alleged by the Plaintiff to have been made to it by Nugan Hand Bank during the period between the 24th December 1976 and the 31st December 1977, and during the accounting year ended the 31st December 1978 respectively. The Plaintiff pleads that these payments purported to have been made to the Plaintiff in respect of business introduced to the Nugan Hand Bank by the Plaintiff and in respect of the expenses incurred by the Plaintiff in operating the representative office of Nugan Hand Bank in Hong Kong.

6. It is pleaded that the Plaintiff was not entitled to these payments, that the sum of (US)$92,620.58 was shown in the detailed profit and lose accounts in the Plaintiff's audited accounts for the above mentioned period ended the 31st December 1977 as "Commission received" and that the sum of (US)$400,000 was shown in the detailed profit and loss account in the Plaintiff's audited accounts for the year ended the 31st December 1978 as "fees and other income". The Plaintiff goes on to plead that without the abovementioned sum of $92,620.58 the Plaintiff's net profit for the abovementioned accounting period ended the 31st December 1977 would have been only (US)$31,293.71 and not (US)$123,914.29 as stated in the relevant accounts. It is also pleaded that without the abovementioned sum of (US)$400,000 the Plaintiff did not make a net profit of (US)$176,551 for the year ended the 31st December 1978 as stated in the accounts but a loss of (US)$223,449.

7. Having pleaded these matters the Statement of Claim alleges four heads of breaches of duty by the Defendants which are alleged to have caused loss to the Plaintiff. They are as follows:

(1)    Failure to satisfy themselves that Nugan Hand were "proper custodians" of NCDs

8. By paragraphs 16 and 22 it is pleaded inter alia that at the date of the Defendants' appointment as the Plaintiff's auditors (the appointment is alleged in paragraph 4 to have been confirmed by the Defendants on the 14th of May 1978) and thereafter the Defendants were in breach of their duty as the Plaintiff's auditors in failing to satisfy themselves that Nugan Hand were "proper custodians" of the NCDs in circumstances where the Defendants knew or ought to have known that it was necessary so to satisfy themselves. This allegation is the basis for a claim in paragraph 23(1) in respect of consequential loss sustained by the Plaintiff amounting to (A)$2,702,776.39 representing the value of the NCDs allegedly misappropriated by Nugan Hand after the appointment of the Defendants as the Plaintiff's auditors.

9. By paragraphs 17 and 22 it is pleaded further or in the alternative that the Defendants were in breach of their duty as the Plaintiff's auditors in failing to satisfy themselves, when they carried out the Plaintiff's audit for the year ended the 31st December 1978, "as to the Plaintiff's entitlement to the NCDs and the proceeds thereof and Nugan Hand's lack of entitlement thereto". This allegation is the basis for an alternative claim in paragraph 23(2) in respect of the Plaintiff's alleged consequential loss amounting to (A)$2,200,000 representing the value of the NCDs allegedly misappropriated by Nugan Hand after the 31st December 1978.

10. By paragraphs 18, 19 and 22 it is pleaded further or in the alternative that the Defendants were in breach of their duty as the Plaintiff's auditors when carrying out the Plaintiff's audit for the year ended the 31st December 1978 by failing to establish the true financial position of the Plaintiffs which was one of insolvency. This allegation was particularised by reference to the commissions and fees allegedly wrongly entered as income of the Plaintiff in the audited accounts and by reference to the alleged misappropriation of the Plaintiff's NCDs and their proceeds up to the 31st December 1978.

11. It is also alleged that if the Defendants had established the true financial position of the Plaintiff at the time of their audit the Plaintiff would have ceased trading shortly thereafter or the Commissioner of Deposit-taking Companies would have suspended or revoked the Plaintiff's registration. This allegation is also the basis for the alternative claim in paragraph 23(2) in respect of the Plaintiff's alleged consequential loss amounting to (A)$2,200,000.

(4)    Failure to qualify the Plaintiff's audited accounts for the year ended the 31st December 1978

12. By paragraphs 20, 21 and 22 the Plaintiff pleads further or in the alternative that the Defendants were in breach of their duty as the Plaintiff's auditors in that, in breach of paragraph 29 of the Hong Kong Society of Accountants' Statement No. 108 and of section 141(3)(a) and paragraph 2 of the Tenth Schedule of the Companies Ordinance (Cap. 32), the Defendants had failed to indicate, in the Plaintiff's audited accounts for the year ended the 31st December 1978, the general nature of the NCDs and their limited inquiries concerning them, and inter alia had failed to qualify their report by stating that they had been unable to satisfy themselves regarding the ownership of the NCDs due to lack of account records.

13. It is also alleged that had the Defendants not been in breach of the abovementioned provisions the Plaintiff would have ceased trading shortly thereafter or the Commissioner of Deposit taking Companies would have made inquiries into the affairs of the Plaintiff which would have led to the suspension or revocation of the Plaintiff's registration. These allegations are also the basis for the alternative claim in paragraph 23(2) in respect of the Plaintiff's alleged consequential loss amounting to (A)$2,200,000.

14. On the 31st October 1985 the Plaintiff served Further and Better Particulars of the Statement of Claim which served to clarify or, in effect, amend a number of allegations in the Statement of Claim. The particulars of paragraph 16 made it clear that the Plaintiff was alleging the breaches by the Defendant, summarised at (1) above, to have been committed by the Defendant in its capacity as auditors only and not as accountants, tax advisers or financial advisers of the Plaintiff.

15. Before the judge it was contended on behalf of the Defendant that the Statement of Claim should be struck out under Order 18 rule 19 on the grounds that it disclosed no cause of action, was embarrassing and also that it was an abuse of the process of the court. It was also contended in the alternative that a substantial number of specified parts of the pleadings should be struck out for reasons specified in the summons.

16. The judge adopted a broad approach to the Statement of Claim and identified the gist of the Plaintiff's cause of action against the Defendants as a common place action for professional negligence against a firm of auditors. He mentioned that the Plaintiff's officers were alleged to have engaged in what he called a "window dressing" exercise which allowed non-existent profits to appear in the accounts due to "Imaginary commissions and fees" shown as income accruing to the Plaintiff, with the result that the Plaintiff was able to continue in business as a deposit taking company when in reality it was insolvent. He went on to mention the Plaintiff's allegation that if the audited accounts had shown the true position the Plaintiff's registration and licence as a deposit taking company would have been suspended before its assets had been misappropriated.

17. The judge was here identifying the claim summarised at (3) above. It was contended by Mr. Barlow for the Defendants on the appeal that the judge fell into error by his reference to "Imaginary" commissions and fees. Mr. Barlow stressed that the relevant amounts had actually been alleged to have been received by the Plaintiff and so they had to be entered in its accounts.  Moreover it was not alleged by the Plaintiff that the relevant amounts had been paid back or recovered from the Plaintiff.

18. Whilst we accept that the payments of the amounts in question were clearly not imaginary we consider that the judge demonstrated by his subsequent observations, referred to above, that he apprehended correctly the nature of the Plaintiff's claim as summarised at (3) above. That claim is based on the allegation of failure by the Defendants as auditors of the Plaintiff to ascertain the true position in relation to the commissions and fees and the alleged consequential insolvency of the Plaintiff, when auditing the Plaintiff's accounts for the year ended the 31st December 1978. It is a claim which may well prove difficult to establish but it is not plain and obvious to us that, as pleaded, the claim does not raise a reasonable cause of action.

19. The judge had the following to say about the gist of the Plaintiff's claims pleaded in the Statement of Claim concerning the NCDs:-

"The second way in which the defendant is alleged to have failed in its duty as accountants and/or auditors is that it failed to detect or do anything about a system whereby the plaintiff's principal asset, namely negotiable certificates of deposit, were allowed into the hands of a company (Nugan Hand Limited) with which the plaintiff was associated.  Nugan Hand Limited was not the sort of company which should have been used as custodian or trustee of the plaintiff's asset. Nugan Hand Limited misappropriated the plaintiff's negotiable certificates of deposits. If the defendants had blown the whistle on the unbusiness-like arrangement of Nugan Hand Limited holding the plaintiff's negotiable certificates of deposit, the misappropriation would not have occurred."

His subsequent conclusion that the Statement of Claim disclosed a reasonable cause of action was challenged by Mr. Barlow on the appeal. He further contended that the Plaintiff's claims in relation to the NCDs were embarrassing by reason of obscurity and irrelevance and incapable of re-formulation to plead a reasonable cause of action.

20. In our judgment the judge was right as regards the claims summarised at (2) and (4) above to hold that a reasonable cause of action had been pleaded. These claims relate to alleged breaches by the Defendants in and about their conduct of the audit of the Plaintiff's accounts for the year ended the 31st December 1978 and we consider that in relation to these claims the judge rightly held that, whilst there were obviously difficult questions of causation to be determined, this was not a plain and obvious case for striking out the pleading.

21. However, we accept Mr. Barlow's contention that the claim summarised at (1) above, based on the alleged failure of the Defendants to satisfy themselves that Nugan Hand were "proper custodians" of the NCDs is not only obscure and therefore embarrassing but also fails to disclose a reasonable cause of action. Part of the confusion in the pleading stems from the fact that, as originally pleaded in paragraphs 16 and 22, by reference to paragraphs 2 to 5 of the Statement of Claim, this claim is expressed to be based on an alleged breach by the Defendants of their duties as auditors, accountants, tax representatives and financial advisers.

22. The particulars of the Statement of Claim contain substantial matter concerning the alleged duties of the Defendants in their capacities other than as the Plaintiff's auditors but the particulars given in relation to paragraph 16 of the Statement of Claim and the concessions mentioned above make it clear that the Plaintiff is in fact pursuing its claim under paragraph 16 against the Defendants only in its capacity as the Plaintiff's auditors. This leaves much dead .wood in the Statement of Claim and in the further and better particulars of that pleading. Furthermore, in the particulars given by the Plaintiff under paragraph 4 of the Statement of Claim, the work required to be undertaken by the Defendants in their capacity as auditors is alleged to have been:-

"................ the forming of an opinion as to whether the financial statements of the Plaintiffs being reported upon complied with the Hong Kong Companies Ordinance and gave a true and fair view of the Plaintiffs' state of affairs for the accounting period in question."

23. In the light of these pleadings there is a complete absence of any material averment of fact or law to provide the basis for any reasonable cause of action founding the claim under paragraph 16 of the Statement of Claim.

24. The Plaintiff has pleaded in paragraph 4, as particularised in the Further and Better Particulars of the Statement of Claim, that the Defendants were appointed to be the Plaintiff's auditors "on a date be about the 15th November 1977 and 1st February 1978 (and, in all probability, between about 29th November 1977 and 1st February 1978)". Paragraph 16 makes no allegation in relation to the conduct of any audit for the accounting period ended on the 31st December 1977 and Mr. Neoh for the-Plaintiff informed us that the Plaintiff's causes of action were not concerned with allegations of alleged misfeasance by the Defendants in the course of the 1977 audit.

25. That being so the Plaintiff, having identified the alleged duties of the Defendants as auditors as relating to the forming of opinions regarding the sufficiency of "the financial statements of the Plaintiffs being reported upon", has made no allegation of any breach of such duty. Instead there is merely a vacuous allegation of failure by the Defendants, on and after their appointment as the Plaintiff's auditors, to satisfy themselves that Nugan Hand were the "proper custodians" of the NCDs. This allegation, which is particularised, (in such a way as to include evidence and further pleadings), by reference to the alleged knowledge of circumstances which should have put the Defendants on their guard, leads nowhere. Furthermore, we are satisfied that this claim is incapable of reformulation to establish a reasonable cause of action, having regard to the fact that the Plaintiff has conceded that its claims are made against the Defendants in their capacity as auditors only.

26. It is clear from the Plaintiff's pleading that it is alleging a close connection, through common directors and shareholders, between the Plaintiff and its associated Australian Companies. It is alleged, in effect, that one or more of the directors of the Plaintiff and its associated companies were dishonest and that assets of the Plaintiff were wrongly being put in jeopardy by the Plaintiff's management. Assuming without deciding that the Defendants as auditors of the Plaintiff were alerted, before conducting the audit of the 1978 accounts, to the risk of the Plaintiff's assets being put in jeopardy by its management, we fail to see how it became their duty to intervene in the management of the Plaintiff company and usurp or supervise the functions of the directors. The duties and functions of the auditors of a company relate, as the Plaintiff itself alleges in the particulars of paragraph 4 of the Statement of Claim, to the scrutiny and certification or otherwise of the company's accounts in the light of the relevant statutory and other requirements. It is their duty to draw attention to irregularities ascertainable by reference to the accounts. They are not under a wider duty as auditors to intervene in the manage-ment of the company.

27. We therefore consider that the judge should have struck out paragraph 16 and the claim for (A)$2,702,776.39 in paragraph 23(1) of the Statement of Claim.

28. We heard argument at some length from Mr. Barlow on the appeal in support of the contention that the Statement of Claim should be struck out under Order 18 rule 19(1)(c) for embarrass-ment, or that all or part of the pleading should be ordered to be amended. He relied on Davy v. Garrett (1878) 7 Ch. D. 473 for the proposition that the Defendants were entitled ex debito justitiae to have the opposite party's case presented in an intelligible form so that they may not be embarrassed in meeting it.

29. Mr. Barlow complained that the judge had not dealt with the embarrassment issue which had taken up much of the time of the hearing below. Although the judge did not expressly deal with this issue we consider that he made it clear by implication that he was rejecting it, because, in a careful reserved judgment, he set out the numerous parts of the Statement of Claim which the Plaintiff  sought to have struck out for reasons of alleged embarrassment or otherwise, and gave his reasons for declining to strike out any of those parts save for those which had been the subject of the Defendants' concessions mentioned above.

30. Mr. Neoh resisted the contentions that the Statement of Claim was embarrassing and yielded to them only to the extent of applying for and obtaining leave to make a number of minor amendments which were substantially cosmetic in their effect.

31. Although we consider that the judge should have struck out paragraphs 16 and 23(l), we think he was otherwise right in declining to exercise his discretion to strike out more of the Statement of Claim than he did on the ground of embarrassment. We mean no disrespect to counsel on both sides by not dealing seriatim with all the detailed arguments advanced on the issue of embarrassment. Having discerned triable issues in the pleading, as the judge did, we consider that notwithstanding the undoubted blemishes in the Statement of Claim and the further and better particulars of that pleading, those blemishes are not sufficiently grave to justify the striking out of any part of the pleading other than the parts struck out by the judge and paragraphs 16 and 23(1) which we have dealt with above.

32. Accordingly we will allow this appeal to the extent of ordering that paragraphs 16 and 23(1) of the Statement of Claim be struck out.

33. As regards costs, a substantial amount of hearing time below and on appeal was taken up with three claims which have not been struck out and with the issue of embarrassment; and below the question of abuse of the process was raised unsuccessfully. On the other hand the Defendants have succeeded on appeal in striking out an alternative claim for (A)$2,702,776.39, thereby reducing the Plaintiff's overall claim for special damages by (A)$502,776.39 to (A)$2,200,000. The Plaintiff has also been induced to apply for and obtain a number of minor amendments.

34. The Statement of Claim leaves much to be desired as a pleading. It has been substantially amended indirectly by further and better particulars and concessions and it appears from para graph 9 of the affidavit of Mr. Hartley, the Defendants' solicitor, that on the 13th January 1986 Mr. Robertson, who has had the conduct of the Plaintiff's action, took a firm stand on his pleadings and refused to consider amending the Statement of Claim until after a Defence had been served.

35. In our judgment the proceedings in the court below could have been avoided if the Plaintiff had re-considered its pleadings and made the amendments that have now resulted from this appeal.  We consider that under the circumstances the Defendants were justified in making their application and pursuing it on appeal. We will therefore make an order nisi awarding the Defendants the costs below and of this appeal in any event.