CLASSROOM INVESTMENTS INC v. HK WANSHITAIPING INVESTMENT AND MANAGEMENT LTD AND OTHERS

HCMP 577/2016

IN THE HIGH COURT OF THE

HONG KONG SPECIAL ADMINISTRATIVE REGION

COURT OF FIRST INSTANCE

MISCELLANEOUS PROCEEDINGS NO 577 OF 2016

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Background

1.  On 11 March 2016, the plaintiff (“Classroom”) obtained an ex parte injunction (“Order”) against the 1^st defendant (“HKW”) and the 2^nd defendant (“BJW”), whereby they were restrained from disposing of, dealing with or diminishing the value of a deposit of a total of RMB 351.4 million (“Deposit”) held in the HKW’s accounts with the Xiamen Bank (“Bank”). The Deposit was pledged to secure a loan made by the Bank to BJW for the sum of about RMB 800 million under a loan agreement dated 13 March 2015 (“Loan”). The Order contained other provisions relating (inter alia) to the preservation of the Deposit, authorizing Classroom’s agent to negotiate with the Bank for an extension of the Loan, and for the provision of documents relating to the Loan. Some variations were made to the Order on 14 March 2016.

2.  By its summons issued on 14 March 2016 (“Summons”), Classroom seeks the continuation of the Order.

3.  These proceedings are in substance an extension of HCA 995/2015 (“HCA 995”), another set of proceedings which had been commenced by Classroom against 14 defendants, the 3 defendants in this action included.  Classroom is a wholly owned subsidiary of the Ontario Teachers’ Pension Plan Board, one of the largest single profession pension funds in the world with approximately HK$980 billion in net assets.  In HCA 995 which was commenced in May 2015, Classroom claims that it is a victim of the fraud perpetrated by the 3^rd defendant in this action (“Hu”), and companies which Hu controls.  In HCA 995, Classroom seeks rescission of various contracts it had entered into for purchase and subscription of shares in China Hospitals, Inc (“Hospitals”) (a Cayman Islands company, and 2^nd defendant in HCA 995), and damages for fraudulent misrepresentation and conspiracy. 

4.  In January 2014, Classroom had entered into a share purchase and subscription agreement (“SPA”) and a shareholders agreement (“SHA”) with Hu and his companies, the essence of which is that Classroom was to acquire 19.77% of the shareholding in Hospitals for a total consideration of US $175 million.  Part of the shares would be acquired from a BVI company of Hu (“Dragon Dosan”), and the remaining shares were to be issued by Hospitals.  The effect of the SPA and the SHA was that Hospitals would, through its subsidiaries, acquire or complete the acquisition of various hospitals on the Mainland and would, within 30 months, float its shares in an IPO.  It is not disputed that of the total consideration of US$175 million paid by Classroom under the SPA Classroom, a sum of US$156,750,000 (“Subscription Monies”) was paid by Classroom to, and received by, Hospitals.

5.  The SPA contained express warranties and representations by Hospitals, and by the other associated companies controlled by Hu, that acquisition agreements were in place between a company controlled by Hu known as BJ Dongjun Hospitals Investment and Management Co Ltd (“BJ Dongjun”) and the owners of 2 hospitals on the Mainland, Puyang Hospital (“Hospital P”) and Qingfeng Hospital (“Hospital Q”), pursuant to which BJ Dongjun had agreed to acquire, and the owners agreed to sell, the 100% equity interests in the 2 hospitals.  There were further warranties that BJ Dongjun was the 100% owner of 3 other hospitals on the Mainland.  Under the SPA, Hospitals undertook to use the Subscription Monies to complete the purchase of the 5 Mainland hospitals.  The SHA also contained provisions, that Hu would not own any interest in, manage or control any competing business, and that Hospitals would not be restructured or reorganized without Classroom’s prior approval. 

6.  Dispute arose between the parties, as Classroom claims that Hu had fraudulently concealed from Classroom that in actual fact, it was not BJ Dongjun (as represented) but instead the 2^nd defendant (“BJW”) (one of Hu’s corporate vehicles in which Classroom held no interest) which had entered into written agreements to acquire the interests in Hospital P and Hospital Q, and that BJ Dongjun had agreed with BJW to pay the acquisition price for the hospitals on behalf of BJW.  Classroom also claims that from June to October 2014, Hu had covertly established a separate group of companies (“Healthcare Group”), and had effectively stripped away assets (mainly, certain hospitals on the Mainland)  belonging to the Hospitals group, and injected such assets into the Healthcare Group instead, thereby substantially undermining the value of Classroom’s investment in Hospitals.  According to Classroom, the Healthcare Group is holding certain hospitals that had been intended to be held under the Hospitals group pursuant to the SPA.  Hu also confirmed to Classroom at a meeting in October 2014 that without consultation with and the prior approval of Classroom, he had commenced a restructuring of the Hospitals group, utilizing a Hong Kong company which he owned (namely, HKW) and a PRC company owned by his wife (BJW).

7.  Classroom accordingly issued a notice of breach under the SPA.  This was in November 2014.

8.  The defendants’ answer to Classroom’s claims is that Hu did not consider that the restructuring of the Hospitals group, and the utilisation of the Healthcare Group to acquire the Mainland hospitals, required Classroom’s prior approval under the SHA.  Hu denies any dishonest intent or fraudulent misrepresentations, suggesting that the acquisition of the Mainland hospitals by BJW was for the purpose of the SPA, and that he had offered to Classroom the same shareholding of Healthcare as the new listing vehicle, and as envisaged in the original SPA and SHA.  According to Hu, the loan facilities from the Bank were all contemplated under the SPA, although he had used the Bank instead of the Bank of China as envisaged under the SPA, since he was able to obtain better terms from the Bank.

9.  After Classroom’s service of the notice of breach under the SPA, the parties had engaged in negotiations in good faith pursuant to the provisions of clause 25 of the SPA.  When an impasse was reached, Classroom issued HCA 995 in May 2015, and obtained an injunction on 6 May 2015 (“995 Injunction”), which restrained the defendants in that action from dealing with the traceable assets of Classroom which it was then able to identify.  These included:

(1) the sum of US$98.5 million (“1^st HKDJ Sum”), which was (on 14 February 2014) transferred by Hospitals to HK Dongjun Hospitals Investment and Management Limited (“HK Dongjun”, the 10^th defendant in HCA 995), from the Subscription Monies Hospitals had received from Classroom on 29 January 2014;

(2) the sum of US$48 million (“2^nd HKDJ Sum”), which was (on 5 March 2014) transferred by Hospitals to HK Dongjun, from the Subscription Monies Hospital had received on 29 January 2014;

(3) proceeds of a loan obtained by BJ Dongjun from the Bank, in the sum of RMB 776 million, as a result of the 1^st HKDJ Sum and the 2^nd HKDJ Sum being pledged as security to the Bank; and

(4) BJW’s interests or shareholding in Hospital P and Hospital Q, which had been acquired by utilizing the loan proceeds received by BJ Dongjun.

10.  Proceedings were at the same time commenced by Classroom in the Cayman Islands.  Similar injunctive relief was obtained from the court in the Cayman proceedings. 

11.  The parties finally agreed in December 2015 that their dispute should be referred to arbitration.  HCA 995 and the Cayman proceedings were stayed for arbitration, with the injunctions continued until the determination of the arbitration proceedings.  The arbitral tribunal is in the course of being constituted. 

The orders now sought

12.  As a result of disclosure orders made by the Court against the defendants in HCA 995, Classroom has discovered that the 1^st HKDJ Sum and the 2^nd HKDJ Sum which had been transferred by Hospitals to HK Dongjun was converted into RMB in March 2014, and placed by HK Dongjun in time deposits with the Bank.  The amount converted and placed on time deposit was RMB 800 million (“HKDJ Deposit”).  Classroom also discovered that a year later, in March 2015, the Bank released the total sum of RMB 802,877,363.82, being the HKDJ Deposit and interest, into HK Dongjun’s account with the Bank.  On receipt of this sum, HK Dongjun transferred US$12.5 million and RMB 276,748,900 to HKW (“3/15 Transfer”). The 3/15 Transfer was unknown to Classroom at the time when it applied for the 995 Injunction in May 2015. 

13.  Using the funds received from the 3/15 Transfer, HKW then placed a total sum of RMB 351.4 million on deposit with the Bank on 12 and 24 March 2015 (ie the “Deposit” referred to in paragraph 1 above).  The Deposit was pledged as security for the Loan (of RMB 800 million) from the Bank to BJW.  RMB 340,858,000 of the Loan has been drawn-down by BJW. 

14.  The Loan was due to expire on 15 March 2016, and it was only on 8 March 2016 that Classroom learned, for the first time, that the defendants were likely to default in making repayment, such that the Bank would be entitled to enforce its rights against the Deposit.  It was in these circumstances that Classroom made its urgent ex parte application for the injunction Order, and to preserve the Deposit.

15.  After the grant of the Order and its variation on 14 March 2016, Hu signed an authorization letter on behalf of HKW, authorizing Borrelli Walsh to participate on behalf of Classroom in negotiations with the Bank for an extension of the Loan.  As a result of various meetings held, the repayment date of the Loan has been extended for a year, until March 2017. 

16.  The issue for determination on the Summons is whether the Order should be continued, until further order or the determination of the arbitration, and full compliance by the defendants with such orders or awards as may be made by the tribunal.

Whether the Order should be continued

17.  On the evidence, Classroom has established that there is at least a serious issue to be tried, that the Deposit is derived from and constitutes traceable assets or proceeds from the Subscription Monies which are already part of the 995 Injunction, and a part of Classroom’s proprietary claim asserted against Hu, Hospitals and the various companies under Hu’s control which are parties to HCA 995 now referred to arbitration. 

18.  A court of equity has never hesitated to use the strongest powers to protect and preserve a trust fund in interlocutory proceedings.  This is on the basis that if the trust fund disappears by the time the action comes to trial, equity will have been invoked in vain (Bankers Trust Co v Shapira [1980] 1 WLR 1274 at 1280H-1281D, per Lord Denning MR).  I agree with Mr Joffe, Counsel for Classroom, that there are no merits to the objections raised on behalf of the defendants against the continuation of the Order.

19.  It was argued on behalf of the defendants that the Deposit is not a positive sum, and there is no “positive equity” in the Deposit capable of forming the subject matter of the Order, until the Loan is repaid and the Deposit is released. 

20.  On the available evidence, the Deposit is pledged by HKW (a Hong Kong company) to the Bank in Beijing.  I have not been referred to any evidence on the applicable law governing the relevant pledge, and even if that should be PRC law, in the absence of evidence to the contrary, it will be assumed that it is the same as Hong Kong law.  Under Hong Kong law, HKW whether as chargor, pledgor or mortgagor retains a beneficial interest in the Deposit, and Mr Joffe highlighted that on mortgage principles, HKW retains the equity of redemption in respect of the Deposit (Fisher and Lightwood’s Law of Mortgage (14^th ed) at para 6.8), which is an asset capable of forming the subject matter of an injunction (SA Development Ltd v Wing Hang Bank Ltd [1997] 1 HKLRD 167 at 169G).  I accept Classroom’s case, that the Order restrains HKW and BJW from dealing with or otherwise disposing of HKW’s equity of redemption in respect of and its beneficial interest in the Deposit, and in the event that the Loan is repaid and that Deposit is released, the Order would restrain HKW and BJW from dealing with or otherwise disposing of the Deposit itself. 

21.  On behalf of the defendants, Mr Harry argued that Classroom should not be allowed effectively to compel the defendants to use their own funds to repay the Loan, in order to create a “positive equity” in the Deposit.  It was also argued that the Deposit should be released from the Order, to enable BJW to repay the Loan.

22.  As HKW has a positive equity in the Deposit which is capable of being protected by the Order, the defendants are not required to take further steps to create the positive equity referred to by the defendants.  In any event, there is clear evidence that the Deposit represents traceable proceeds of the Subscription Monies, which Classroom claims belongs to it in equity.  I agree with Mr Joffe that the defendants should demonstrate by full and frank disclosure that they have no alternative funds which can be used to repay the Loan, before the Court should consider whether to exercise its discretion to allow the defendants to use the Deposit, either as security or for repayment.  In this respect, Mr Joffe relies on the principles established in Ostrich Farming Corporation Ltd v Ketchell [1997] EWCA Civ 2953 (10 December 1997), and in Wharf Ltd v Lau Yuen How [2010] 3 HKC 108. 

23.  In Ostrich Farming Corporation Ltd v Ketchell [1997] EWCA Civ 2953 (10 December 1997) (Lexis Transcript p5), where a proprietary claim is asserted by the plaintiffs, Millett LJ referred to Fitzgerald v Williams [1996] 2 All ER 171, and Sir Thomas Bingham’s judgment:

“A defendant should not be entitled to draw on a fund which may belong to a plaintiff until he shows that there is no fund of his own on which he can draw.... The plaintiffs are my view right to contend that unless and until the 1^st defendant can establish on proper evidence that there are no funds or assets available to him to be utilized for payment of his legal fees and other legitimate expenses, other than assets to which the plaintiffs maintain an arguable proprietary claim, he should not be allowed to draw on the latter type of assets.”

24.  Millett LJ further explained the proposition in the following terms (at Lexis Transcript p6):

“The plaintiff has put forward a strongly arguable case for saying that the money belongs beneficially to the plaintiff. The defendants ought not to have access to those monies for the purposes of their legal costs unless they establish, first, that they have no other funds out of which to pay those costs, and secondly, that they have an arguable case for denying that the money belongs to the plaintiff company. For that purpose they must put in evidence and condescend to particulars.”

25.  In the present case, the defendants have not claimed (nor given particulars to substantiate any such claim) that they have no other funds to repay the Loan, other than the Deposit which is the subject of Classroom’s proprietary claim.  Hu only asserts that it is not right to require the defendants to “inject further sums” for Classroom’s benefit.

26.  I accept Mr Joffe’s submissions, that absent any full and frank disclosure by the defendants as to the resources open to them, HKW and BJW should have no right to use the Deposit for their own purposes, to secure and use the Loan extended to BJW (which is not a company within the Hospitals group) to acquire assets, or to use the traceable proceeds of the Subscription Monies other than for the purposes of Classroom and Hospitals, and as agreed under the SHA and SPA. 

27.  Finally, the defendants claim that the Order already extends to and restrains the defendants from disposing of BJW’s interests or shareholding in Hospital P and Hospital Q, and that this should provide sufficient protection to Classroom.  It was argued that to extend the Injunction to the Deposit would be conferring “double protection” to Classroom. 

28.  First, there is no reliable and independent evidence as to the value of the defendants’ interests in Hospital P and Hospital Q.  Although Classroom will not be entitled (as it accepts), ultimately, to obtain judgment on claims for both the hospitals on the Mainland and the Deposit (to the extent that the same funds have been used to constitute the Deposit and to acquire the Mainland hospitals), Classroom is entitled at this interlocutory stage to pursue its alternative claims for the Mainland hospitals and the Deposit, and to preserve these assets by interim injunction orders.  Classroom is only required to make an election as to which assets it seeks to recover, when judgment is eventually given in its favor (Personal Representative of Tang Man Sit v Capacious Investments Ltd [1996] 1 HKLR 16 at 20C per Lord Nicholls). 

29.  In any event, there is no evidence whatsoever to support the assertion made by Hu, that the value of Hospital P and Hospital Q provides adequate protection to Classroom.  Classroom cannot be expected to make an election between remedies unless and until it is able to make an informed choice, on the basis of fully particularized information and evidence, which is totally absent at this stage (Island Records Ltd v Tring International PLC (1996) 1 WLR 1256, 1258).

30.  Classroom has pointed out that at least US$12.5 million of the Deposit does not overlap with the funds used to acquire the Mainland hospitals.  The defendants do not seriously challenge this proposition, and there can be no double recovery in respect of this amount. 

31.  On the balance of convenience, I consider that it is just and convenient to continue the injunction in paragraph 1 of the Order in relation to the Deposit, and also to continue the revised paragraphs 2 and 3 of the Order for the extension and rollover of the Loan. 

32.  In accordance with the principles set out in paragraphs 22 to 24 above, and bearing in mind the nature of the proprietary claim asserted by Classroom, I agree that paragraph 4.1 of the Order should continue.  In the event that the defendants claim that they are unable to repay the Loan in full, and the Deposit is at risk of the Bank’s enforcement action, the defendants will have to file an affidavit “by 5pm at least 14 days prior to any anticipated default on the Loan, to explain why they are unable to repay the Loan, with full supporting documentation including but not limited to giving detailed disclosure of the latest audited and management accounts of the defendants and each of their subsidiaries, and a detailed explanation of the source of the funds used for any interest or principal repayments on the Loan to date”.

Orders made

33.  The Order (as varied on 14 March 2016) will be continued in terms of the Summons issued on 14 March 2016, with the amendments sought by Classroom, and costs in the cause (with certificate for 2 counsel).