STEP BY STEP LTD AND OTHERS v. DOROTHY JANE FURNESS AND OTHERS

HCA 2712/2006

IN THE HIGH COURT OF THE

HONG KONG SPECIAL ADMINISTRATIVE REGION

COURT OF FIRST INSTANCE

ACTION NO. 2712 OF 2006

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D E C I S I O N

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1.  This is an appeal of the plaintiffs from the decision of Master Ko on 30 June 2009 on an application for specific discovery.

2.  What are at issue here are primarily the relevance of documents sought to the matters in issue in this action and if the documents sought are necessary for the fair disposal of the cause or matter or for saving costs.  There is no dispute the documents sought are in existence and that the defendants have or have had them in their possession, power or custody.  I bear in mind the legal principles, which are well established.  I have cited to me on both sides a number of authorities.  I have considered them but do not find it helpful to refer to any of them in this decision, as what was said in a case on relevance and necessity must be read in the particular context of that case.

3.  I have provided to me a transcript of the relevant part of the proceedings before the Master, who gave very detailed reasons for the orders he made.  This is helpful and should have been provided to the court from the start, particularly as the plaintiffs sought to put in further evidence in this appeal to explain why, notwithstanding the documents ordered to be disclosed by the Master, they are still inadequate for the exercise of determining the source of funds of the 3^rd defendant, which is a very important issue in this action.

4.  Under Order 58 rule 1(5) of the rule of the High Court, which is a new provision introduced under the Civil Justice Reform, “no further evidence (other than evidence as to matters which have occurred after the date on which the judgment, order or decision was given or made) may be received on the hearing of an appeal under this rule except on special grounds”.  As I have mentioned, the purpose of the additional affidavit of the plaintiffs is to demonstrate, by taking two specific expenditures as examples, why the bank statements and ledgers (which are the only supporting accounting documents allowed by the Master in the application) did not contain the necessary information to enable the plaintiffs to identify and establish the source of funds of those expenses incurred by the 3^rd defendant.  I consider this a proper case to admit further evidence on appeal.

5.  The defendants would suffer no prejudice with the admission of such further evidence.  They have filed evidence in response to the further affidavit put in by the plaintiffs.  I think it pertinent to note that they have made additional discovery to what was ordered to be disclosed by the Master in this affidavit, and also in a 3^rd supplemental list of documents filed by the 3^rd defendant on 28 August 2009.

6.  I turn to consider the summons before the Master.

7.  The discovery sought consisted of 4 broad categories:

(1)  audited accounts of the 3^rd defendant from incorporation to date;

(2)  “any supporting documents and working papers which were provided to the auditor in preparing the audited accounts of the 3^rd defendant from incorporation to date” and, “in particular”, the 18 sub-categories of documents listed thereunder;

(3)  audited accounts of the 4^th defendant from 15 March 2007 (being the date on which the 1^st and 2^nd defendants became its directors) to date; and

(4)  “any supporting documents and working papers which were provided to the auditor in preparing the audited accounts of the 4^th defendant from 15 March 2007 to date”, including but not limited to the 18 sub-categories of documents listed in (2).

8.  The Master ordered discovery of:

(1)    audited accounts of the 3^rd defendant from incorporation to the end of its financial year from 2007 to 2008;

(2)    the 3^rd defendant’s bank statements and ledgers covering the period of the audited accounts ordered in (1); and

(3)    audited accounts of the 4^th defendant for the period from 15 March 2007 to the end of its financial year from 2007 to 2008.

9.  He refused to order audited accounts of the 3^rd and 4^th defendants to be provided “to date”.  He refused discovery of any of the supporting documents and working papers in the preparation of audited accounts for the 4^th defendant, and, of the supporting accounting documents in respect of the 3^rd defendant, he only ordered to be provided the 2 items being bank statements and ledgers, limited to the end of the 3^rd defendant’s financial year from 2007 to 2008.

10.  In so doing, the Master took the view that:

(1)  although the plaintiffs have sought audited accounts beyond the year end in 2008, the relevance of these other audited accounts would depend on whether there is anything suspicious in the previous accounts;

(2)  bank statements and ledgers would contain records of the flow of assets in and out of the 3^rd defendant and should be sufficient to enable the plaintiffs to identify if any of the misappropriated funds were received by the 3^rd defendant and if they could be followed into any substituted assets;

(3)  on the pleadings and available evidence, there is nothing to connect the supporting accounting documents sought in respect of the 4^th defendant with the misappropriated funds.

11.  The Master ordered the defendants to pay the plaintiffs the costs of the application up to and including 14 May 2009 (when the defendants responded by letter to the plaintiffs’ summons agreeing to give discovery of the audited accounts) in any event and the costs of the application after 14 May to be in the cause of the proceedings, with a certificate for two counsel to the plaintiffs.

12.  The plaintiffs seek to set aside the Master’s orders.  They ask for discovery of all the documents as per their summons.

13.  Before even going into the specific issues which are said to be relevant to the discovery, it seems to me the documents sought in respect of categories (2) and (4) are much too wide.  These categories are non-exhaustive and open-ended.  They comprised “any supporting documents and working papers” provided to the auditor in preparing audited accounts and included 18 sub-categories “in particular”.  Item 2.5(c) of the sub-categories was “all supporting documents not listed above”.  As the Master had correctly observed, documents that were required for the audit of the accounts of the 3^rd and 4^th defendants were not the same as the documents relevant to the matters in issue in this action.

14.  Besides, it is unfortunate that the request for documents was framed in that manner, as this would give the impression that the discovery was designed to check the accuracy of the audited accounts, which was not the plaintiffs’ objective at all.

15.  I do not propose to state the background of the dispute or give an overview of the issues and reliefs sought in this action.  I go straight to the important issues in this action for which discovery is sought.

16.  It is alleged by the plaintiffs that substantial cash takings from the plaintiffs’ bar restaurants were misappropriated by the 1^st defendant between July 2004 and April 2006.  Pending further discovery, the best particulars the plaintiffs are able to give are set out in a schedule to the amended statement of claim.  The misappropriations are alleged to be carried out by the 1^st defendant to put the 1^st and 2^nd defendants in funds to apply them for private purposes, which included the establishment, operation and management of two bar restaurants operated by the 3^rd and 4^th defendants respectively, known as Sticky Fingers and Spicy Fingers.

17.  The 1^st and 2^nd defendants were de facto directors of the plaintiffs at the material time.  The 1^st defendant admitted to “tardy banking” of some of the cash takings and to the taking of “unauthorised loans”.  The 1^st and 2^nd defendants however denied that the funds allegedly misappropriated were used in connection with the 3^rd and 4^th defendants.  The defendants have commissioned a report from Baker Tilly in February 2007 to verify the sources of funds received by the 3^rd defendant from incorporation up to May 2005, being the period during which the 3^rd defendant received various advances for the operation of its business according to the 1^st defendant.

18.  The plaintiffs do not accept the Baker Tilly report provided probative evidence of the source of funds for the 3^rd defendant.  In support of their allegation that misappropriations were made to fund operations of the 3^rd defendant, the plaintiffs have relied on circumstantial matters including the following:

(1)  the timing of the commencement of Sticky Fingers in August 2004 coincided with the initial misappropriation by the 1^st defendant in July 2004 and the misappropriation had continued in secret for two years;

(2)  the frequency in the delay in banking the cash takings increased with the continued operation of Sticky Fingers;

(3)  Sticky Fingers was engaged in directly competitive business to the bar restaurants operated by the plaintiffs;

(4)  declarations of trust were entered into between the 1^st defendant and the two shareholders and directors of the 3^rd defendant that they hold their shares on trust for her, to conceal her beneficial ownership of Sticky Fingers.

19.  By the discovery application, the plaintiffs’ objective is to seek direct evidence to prove its case that funds misappropriated were used for the purpose of the 3^rd defendant.

20.  This is clearly a relevant issue in this action.  The next question is whether the documents sought are necessary for the fair disposal of this issue or for saving costs.  It is for the party resisting the application to satisfy the court discovery is not necessary.

21.  Mr Strachan for the defendants made a number of points.

22.  Firstly, he said that the defendants have already made sufficient discovery of a number of financial documents and records of the 3^rd defendant.  They are:

(1)  monthly financial statements from May 2003 to October 2006;

(2)  bank statements from November 2003 to September 2008;

(3)  the table of deposits in and the table of withdrawals from the 3^rd defendant’s HSBC account;

(4)  ledgers from May 2003 to September 2008;

(5)  audited accounts from May 2003 to September 2007, and audited accounts for the year to September 2008 would be provided when they are available.

23.  Item (3) are the tables prepared by the 3^rd defendant’s accountants and disclosed voluntarily by the 3^rd defendant after the Master’s orders.  These tables provided more information regarding the nature of the deposits and withdrawals recorded in the bank statements and set out the source of the monies deposited and to whom the sums withdrawn were paid.

24.  I am satisfied on the additional affidavit filed by the plaintiffs after the Master’s hearing that the documents ordered to be disclosed by the Master are not sufficient to enable the plaintiffs to establish the source of funds used for the purpose of the 3^rd defendant.  The further discovery given by the defendants after the hearing should give further assistance to the plaintiffs to piece together relevant information in the attempt to establish the source of funds and the trail of money, but I do not think they are sufficient.  I understand the 1^st defendant has twenty known bank accounts in Hong Kong and New Zealand.  The table of deposits disclosed voluntarily in August 2009 merely stated that certain sums deposited into the 3^rd defendant’s HSBC account were loans from the 1^st defendant.  I do think primary or original transactional documents are needed for this exercise, just as they were required in the preparation of the Baker Tilly report.

25.  Next, Mr Strachan submitted certain items of documents in category (2) cannot be relevant for this exercise.  He pointed to these:

Item 2.3(a)    –    quotations; credit notes for returned goods

Item 2.4(a)    –    quotations of purchases and sales (including equipment, furniture & fixtures etc)

Item 2.4(b)   –    maintenance/service agreements

Item 2.5(b)   –    all working papers for preparing the accounts

Item 2.5(c)    –    all supporting documents not listed above

Item 2.5(d)    –    all correspondence and notes of meetings between the 3^rd defendant, F&B Accountancy Limited and the auditor in preparing the audited accounts

26.  I am inclined to agree.  As mentioned earlier, supporting documents to the auditor for the purpose of auditing the accounts was different from the present exercise which is to establish the source of funds of the 3^rd defendant.  All the items listed above would not be required to be disclosed.

27.  The discovery to be ordered would be restricted to the classes of documents specified.  They would not be non-exhaustive and open-ended.

28.  Mr Strachan urged the court to exercise discretion to refuse discovery as the financial records of the 3^rd defendant are voluminous.  The 1^st defendant deposed that since Sticky Fingers opened for business in December 2004, the 3^rd defendant has sent approximately two lever arch folders to its accountants at the end of each month.  So from incorporation to September 2008, it is likely to involve over 90 lever arch files.

29.  I have a discretion to exercise.  The 3^rd defendant is not required to disclose all of its financial records.  I will limit the classes of documents to those that are necessary to the exercise of tracing the source of the 3^rd defendant’s funds.  I appreciate the documents to be disclosed would still be substantial but they are no more than is necessary to dispose fairly of the matter in issue.

30.  The documents in category (2) for which discovery is ordered are the following classes of documents from incorporation of the 3^rd defendant to September 2008:

 (i)  banking records being cheque books and cheque book stubs; cash and/or cheque deposit slips; account withdrawn slips; cash books; telegraphic transfer application forms; and confirmations regarding inward telegraphic transfers;

(ii)  records of income being deposit records for daily sales income; and daily records of sales receipts;

(iii)  records of purchases and expenses being records of purchases such as: contracts, agreements, invoices, goods receipt notes, receipts issued for payments; diaries or documents recording any expenditure claimed; and petty cash books; and

(iv)  records of assets being copies of contracts and agreements.

31.  I do not propose to vary the Master’s orders about the date to which audited accounts are to be provided in categories (1) and (3).  So audited accounts would be limited to the end of its financial year from 2007 to 2008.  Mr Chua, SC submitted for the plaintiffs that discovery is required for the plaintiffs to decide whether to pursue remedies which are proprietary, or personal and/or to enforce legal or equitable rights, and the plaintiffs can only decide on the basis of fully informed choice, after full discovery is given.  However, before one comes to remedies, the plaintiffs must first establish an entitlement to trace misappropriated funds into assets of the 3^rd and 4^th defendants.

32.  If the plaintiffs were not able to prove some of the funds that were used for the purpose of the 3^rd and 4^th defendants had come from the misappropriated funds, the equitable remedies envisaged to enforce the plaintiffs’ proprietary rights in respect of substituted assets, such as the 3^rd and 4^th defendants’ businesses and assets, do not arise.  I think it would be premature and wasteful to order discovery for the plaintiffs to decide on their remedies before their entitlement to the remedies is established.

33.  As for the continued existence of the money as a separate fund or as part of a mixed fund or as latent in property acquired by means of such a fund that would enable equity to grant relief, the businesses of the 3^rd and 4^th defendants are continuing in operation, assuming they were set up with funds misappropriated from the plaintiffs or with mixed funds including the plaintiffs’ funds.  That would be sufficient for present purpose.  Further discovery could be ordered at a later stage to establish precisely the current actual or notional substituted assets in the 3^rd and 4^th defendants acquired with or derived from the misappropriated funds, after the plaintiffs’ entitlement to relief is made out.

34.  That leaves category (4), being the supporting accounting documents sought in respect of the 4^th defendant.  As mentioned earlier, the 1^st and 2^nd defendants became directors of the 4^th defendant only on 15 March 2007, and Spicy Fingers was operated by the 4^th defendant only in late September 2007.  This was 16 months after the 1^st defendant was summarily dismissed by the plaintiffs.

35.  Unlike the case of the 3^rd defendant, the plaintiffs could not point to any circumstantial matter in support of its allegation that funds misappropriated were used for the 4^th defendant’s purpose.  There is merely an assertion in the amended statement of claim that the 4^th defendant received the funds derived from the plaintiffs’ monies.  Mr Chua submitted that monies generated or used by the 3^rd defendant’s business was re-invested or used in the 4^th defendant.  This was not expressly pleaded in the amended statement of claim, nor was this alleged in the plaintiffs’ supporting affidavits in this application.

36.  To allow discovery of supporting accounting documents of the 4^th defendant in these circumstances would be to give the plaintiffs an opportunity to fish for evidence.  This is not justified.

37.  I agree with the Master it is not appropriate to order discovery of documents in category (4).

38.  The appeal is allowed to the extent that the orders of the Master are varied in that discovery is to be given for those specified classes of documents in category (2) as indicated above, to be verified on affidavit.

39.  I will hear counsel on the time required for discovery to be made and on costs.