SECURITIES AND FUTURES COMMISSION v. ZHOU LING AND OTHERS

HCMP 2067/2020

[2024] HKCFI 2484

IN THE HIGH COURT OF THE

HONG KONG SPECIAL ADMINISTRATIVE REGION

COURT OF FIRST INSTANCE

MISCELLANEOUS PROCEEDINGS NO 2067 OF 2020

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J U D G M E N T

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1.  This is the trial of the petition presented on 16 November 2020 (“Petition”) by the Securities and Futures Commission (“SFC”) under s.214 of the Securities and Futures Ordinance (Cap. 571) (“SFO”) against the 1^st Respondent, Mr Zhou Ling (周凌) (“R1”), and the 2^nd Respondent, Mr Dai Haidong (戴海東) (“R2”), who were former executive directors of New Ray Medicine International Holding Limited (新銳醫藥國際控股有限公司) (“Company”).

2.  In the Petition, the SFC complains that the following transactions were conducted in a manner involving misfeasance or other misconduct towards the Company’s members; and/or resulting in its members not having been given all the information with respect to its business or affairs they might reasonably expect; and/or unfairly prejudicial to its members:

(1)  “1^st Acquisition”: During the acquisition of 50% shareholding in Saike International Medical Group Limited (“Saike”) by Major Bright Holdings Limited (“Major Bright”), a wholly-owned subsidiary of the Company, from Madam Zhao Lei (趙雷) (“Zhao”), R1-R2 failed to disclose the fact that Zhao owed monies to each of them. 

(2)  “Artificial Transactions”: The dealings in 5 pharmaceutical products were “artificial transactions” and formed part of a scheme devised or implemented to enable the companies of Mr Wang Wai (王威) (“Wang”) to obtain and retain substantial funds without having to pay any interest.  R1 negotiated and authorized the Artificial Transactions.

(3)  “2^nd Acquisition”: The Company (through Major Bright) acquired 15% shareholding in Eternal Charm International Ltd (恆雅國際有限公司), a BVI company (“Eternal BVI”), at HK$53.4 million.  R1 obtained a secret profit of HK$26 million.

3.  It is the SFC’s case that R1 was involved in all the impugned transactions while R2 was only involved in the 1^st Acquisition. 

4.  On the basis of the above conduct, the SFC seeks a disqualification order against R1-R2 and an order requiring R1 to pay HK$26 million (with interest) to the Company.   

5.  At trial:

(1)  The SFC is represented by Mr Ambrose Ho SC (leading Mr Lau Ka Kin).  R1-R2 are represented by Mr Gary CC Lam.

(2)  Ms Chau Hong Ni Connie, formerly an associate director in the enforcement division of the SFC, made a verifying affirmation dated 16 November 2020 and a witness statement (“WS”) dated 16 November 2022.  She left the employment of the SFC, and the contents of her affirmation and WS have been adopted in the WS of Ms Ling Suet Yan Elica dated 2 May 2024. Ms Ling has not been cross-examined on her WS. 

(3)  R1 makes a WS in Chinese dated 16 November 2022 (“R1 WS^”) and an undated supplemental WS in Chinese (“R1 SWS”) to correct the inaccuracies in §§57, 107-108 of his WS.   

(4)  Wang makes a WS in Chinese dated 16 November 2022 (“Wang WS”).

6.  Upon completion of opening submissions by both counsel, on day 2, Mr Lam informs the court that R1-R2 admit “liability” on the 1^st Acquisition and the facts and matters pleaded in §§1-32 of the Petition. 

A.  FACTUAL BACKGROUND

7.  Unless otherwise stated, the following facts are not in dispute or are indisputable. 

8.  The Company was incorporated in Bermuda with its headquarters in Hangzhou city in the Mainland.  The Company’s shares were listed on the GEM Board of The Stock Exchange of Hong Kong Limited (“HKEx”) until the listing was transferred to the Main Board of HKEx in June 2015[1]. 

9.  The Company and its subsidiaries (collectively “Group”) engage in the business of trading in pharmaceutical products in the Mainland[2].

10.  R1 was one of the founding members of the Group. He was the Chairman and executive director of the Company, responsible for the operation of the business and the overall sales and marketing strategies of the Group.  As of 31 December 2015, R1 together with his wife, Ms Yang Fang (楊芳) (“Yang”), were interested in 10.2% of the issued shares of the Company.  R1 retired as executive director on 27 June 2018[3].

11.  R2 was also a founding member of the Group.  Until his resignation on 5 November 2015, he was an executive director and the Chief Executive Officer (“CEO”) of the Company.  R2 was responsible for the operation of the Group’s business and the overall sales and marketing strategies of the Group[4].

12.  The other executive directors of the Company at the relevant times were[5]:

(1)  Yang was an executive director until 27 June 2018 and the CEO of the Company from 5 November 2015. 

(2)  Mr Lee Chik Yuet (李植悅) was an executive director until 20 June 2017.

B.  APPLICABLE PRINCIPLES

13.  The Petition is based on s.214(1)(b)-(d) of the SFO which provides as follows:

“(1) Where, in relation to a corporation which is or was listed, it appears to the Commission that at any relevant time the business or affairs of the corporation have been conducted in a manner—

…

(b) involving defalcation, fraud, misfeasance or other misconduct towards it or its members or any part of its members;

(c) resulting in its members or any part of its members not having been given all the information with respect to its business or affairs that they might reasonably expect; or

(d) unfairly prejudicial to its members or any part of its members,

the Commission may, subject to subsection (3), by petition apply to the Court of First Instance for an order under this section.”

14.  The applicable principles have been summarised in SFC v Zheng Dunmu [2024] 2 HKLRD 688, §§18-23:

(1)  “Misfeasance” is defined as “the performance of an otherwise lawful act in a wrongful manner” (Schedule 1 to the SFO).  The notion of misfeasance overlaps with that of breach of fiduciary duty and covers a director’s breach of his duty to exercise reasonable care and diligence in his management of the company, and to act in good faith in the best interests of the company (Zheng Dunmu §20(2)).

(2)  The words “other misconduct” connote improper or wrongful behaviour or mismanagement, or culpable neglect of duties.  This term is described as something of a “belt and braces exercise”, and is intended to cover the “widest range of possible misconduct” (Zheng Dunmu §20(3)).

(3)  As for s.214(1)(c) (i.e. members not having been given all the information with respect to its business or affairs they might reasonably expect), it can be complementary to the other subsections, and covers situations such as (a) the making of misleading or false announcements; and (b) situations requiring publication of periodic financial statements and announcements, as members are entitled to expect the listed company to provide complete and accurate information in respect of such matters (Zheng Dunmu §22).

(4)  With respect to s.214(1)(d), the conduct in question does not have to be wrongful per se; “unfairly prejudicial” conduct covers a range of conduct, from fraud at the one end to neglect or inaction on the part of those to whom the affairs of a company are entrusted at the other end.  The question to be asked in such circumstances is whether the conduct concerned is that which can be expected from the managers of the company to whom those affairs have been entrusted; it covers the case where the listed company has (a) failed to comply with the disclosure requirements and (b) made misleading or false announcements, as members are entitled to expect the listed company to provide complete and accurate information (Zheng Dunmu §23).

15.  The SFC has to satisfy 3 conditions for relief under section 214(1) of the SFO namely, (1) the corporation is or was a listed corporation; (2) the business or affairs complained of is that of the corporation; and (3) the conduct complained of falls within one or more heads of misconduct specified in s.214(1)(a)–(d) of the SFO (Zheng Dunmu §18).

C.  ASSESSMENT OF WTINESSES

16.  The principles governing the assessment of witness have been stated by Cheng J in Cheung Hon Kin v Chubb Life Insurance Company Ltd [2024] HKCFI 1313, §§81, 83:

“81. … In assessing the evidence, I have had regard to the principles summarised in Hui Cheung Fai v Daiwa Development Ltd, unreported, HCA 1734/2009, 8 April 2014 at [77] to [83], per Deputy High Court Judge Eugene Fung SC. In particular:

81.1 contemporaneous written documents and documents which came into existence before the problems in question emerged are of the greatest importance in assessing credibility;

81.2 in deciding whether to accept a witness’ account, importance should also be attached to the inherent likelihood or unlikelihood of an event having happened, or the apparent logic of events;

81.3 regard should be had to the consistency of the witness’ evidence with undisputed or indisputable evidence, and the internal consistency of the witness’ evidence;

81.4 care should be taken in drawing conclusions about truthfulness and reliability solely or mainly from the appearance of a witness or from the assessment of a witness’ character;

81.5 witnesses’ credibility should be tested by reference to the objective facts proved independently of their testimony, and regard should be had to their motives and to the overall probabilities.

…

83. The observations of DHCJ Jin Pao SC in Leung Chin Sing, Rabo v Ko Chun Hay, Kelvin in [2021] HKCFI 2242 at [42] are also relevant:

It is rare in modern commercial litigation to encounter a claim based on an agreement which is not only said to have been purely by word of mouth but of which there is no contemporaneous documentary record of any kind.  The prevalence of e-mails, text messages and other forms of electronic communication is such that most agreements or discussions which are of legal significance, even if not embodied in writing, leave some form of electronic imprint: Blue v Ashley [2017] EWHC 1928 (Comm) at [65] per Leggatt J (as he then was); Music Holdings Property HK Ltd v Ooi Lean Choo [2020] HKCFI 1312 at [58] per Ng J.  Because the value of a written record is understood by anyone with business experience, its absence may, depending on the circumstances, tend to suggest that no contract was concluded: Blue v Ashley at [49]; Wing Hing (1956) Co Ltd v Nissin Foods Co Ltd [2021] HKCFI 638 at [56] per DHCJ Abraham Chan SC.”

17.  R1 and Wang have been subject to extensive cross-examination by Mr Ho.  Both of them give evidence in a very direct, succinct and straight-forward manner.  They are ready to accept and concede to most of the questions put to them by Mr Ho even though some of the questions clearly go beyond the SFC’s pleaded case against R1.  I find that the evidence of R1 and Wang to be generally credible and I accept their evidence. 

18.  As will be explained further below, many of the criticisms made by the SFC concerning the Artificial Transactions are directed to challenging the commercial rationale (or the lack of it) of how the Group carried on its trading business in the Mainland.  However:

(1)  Issue of commercial judgement is generally not a matter for the court to review or interfere (see §72(3) below).

(2)  More importantly, in their evidence, both R1 and Wang explain the practices and rationale in paying “sincerity money”, “deposit”, “security money” or “earnest money” to secure the agency or distributorship of the pharmaceutical products in question and the importance of securing the return of the monies paid at the end of the relevant contracts.  The SFC adduces no evidence to contradict what they say.  I do not see how the SFC can criticise the evidence of R1 and Wang in this respect as incredible.

(3)  Although the SFC contends that the impugned transactions were “artificial” and were “sham”, there is no proper basis for the contentions in light of the documentary evidence adduced by the parties, which show that the Group had carried out research in respect of each product concerned before entering into the relevant contracts, and purchases and sales of the products were actually carried out by the companies concerned with some of them generated profits for the Group.   

D.  1^st ACQUISITION

D1.  Undisputed Facts

19.  At the board meeting of the Company held on 14 February 2015, a draft memorandum of understanding between Major Bright and Zhao for the proposed acquisition of 50% in Saike (“Saike MOU”) together with a draft announcement were considered and approved.  None of the directors (including R1-R2) declared any conflict of interest in the proposed transaction[6].

20.  In the announcement made by the Company on 14 February 2015, it was stated that Zhao “is an Independent Third Party”, which was defined in the announcement as “a party … independent of the Company and its connected persons.”[7]  

21.  Saike MOU was executed on 14 February 2015.  Clause 2.5 provides that Major Bright shall pay RMB 20 million to Zhao as “sincerity money” (意向金) within one month of signing the same, and if no agreement is signed by 30 April 2015, Zhao shall repay the sincerity money (without interest) to Major Bright on or before 6 May 2015. 

22.  By a cheque dated 3 March 2015, the Company paid HK$24.7 million to Zhao.[8]

23.  By a cheque dated 17 March 2015, Zhao paid HK$4,940,000 to R1[9].

24.  At the board meeting of the Company held on 20 March 2015, the sale and purchase agreement whereby Major Bright agreed to purchase Zhao’s 50% shareholding in Saike at RMB95 million (~ HK$118.8 million) (“Saike SPA”) together with a draft announcement were approved.  None of the directors (including R1-R2) declared any conflict of interest in the transaction[10].

25.  Pursuant to the aforesaid resolution, on 20 March 2015, the Company and Zhao executed Saike SPA.  In the announcement issued on the same day, Zhao was described as an “Independent Third Party” as defined in the earlier announcement of 14 February 2015.[11]

26.  On 24 March 2015, the Company paid HK$12.5 million to Zhao.  Thereafter, by a cheque dated 2 April 2015, Zhao paid HK$2.5 million to R2, and by another cheque dated 10 April 2015, Zhao paid HK$6 million to R1[12].

27.  The 1^st Acquisition was considered at 2 further board meetings of the Company but none of the directors declared any conflict of interest[13]:

(1)  The meeting on 26 June 2015 during which a draft supplemental agreement to extend the long stop date for satisfaction of the condition precedent under Saike SPA was considered and approved. 

(2)  The meeting on 16 July 2015 at which a draft put option deed which entitled Major Bright to require Zhao to purchase the sale shares at a stated exercise price was considered and approved.

28.  The 1^st Acquisition was completed on 16 July 2015 whereupon the Company remitted HK$56,475,000 to Zhao.  On 17 July 2015, the Company remitted HK$25.1 million to Zhao[14].

29.  Shortly thereafter, Zhao made the following payments[15]:

(1)  By a cheque dated 24 July 2015, Zhao paid RMB31,375,000 to Mr Yang Qi (楊奇), R1’s brother in law, who in turn (a) transferred RMB10 million to R2 on 28 July 2015, and (b) drew a cheque of HK$1,195,000 in favour of R1 on 30 October 2015.

(2)  By a cheque dated 29 July 2015, Zhao paid HK$1.2 million to Yang.

30.  In summary[16]:

(1)  The Company paid HK$118,775,000 to Zhao in respect of the 1^st Acquisition.

(2)  From March to October 2015, Zhao paid HK$46,015,000 to R1, R2, Yang and Yang Qi of which:  

(a)  R1 received from Zhao HK$4,940,000 on 17 March 2015 and HK$6 million on 10 April 2015; and

(b)  R2 received from Zhao HK$2.5 million on 2 April 2015.

31.  As directors of the Company, R1-R2 owed to the Company the following duties (collectively “Duties”)[17]:

(1)  To avoid any actual or potential conflict of interest and disclose fully and fairly his interests in any contracts, transactions that the Company or entities within the Group would or would consider entering into; and

(2)  To declare the nature of his interest in any contracts, arrangements, transactions or proposed contracts, arrangements, transactions in which he is directly or indirectly interested at the meetings of the board at which the subject concerning such contracts, arrangements or transactions were considered or decided. 

D2.  Breach of Duties by R1

32.  The information provided by R1 and the Company to the SFC revealed that[18]:

(1)  On 16 December 2014 (before approval of Saike MOU), R1 advanced HK$3,560,000 to Zhao, which was repayable on 16 March 2015. 

(2)  On 13 March 2015 (before approval of Saike SPA), R1 and Zhao agreed that Zhao would pay RMB6 million to R1 by 30 April 2015 for investment in a venture capital fund; and

(3)  The sums received by R1 from Zhao were for repayment of the loan referred to in §(1) and the investment referred to in §(2) above. 

33.  R1 knew or ought to have known that:

(1)  When the board discussed and approved Saike MOU at the meeting on 14 February 2015, (a) his loan to Zhao would become due in a month; (b) Major Bright had to pay RMB20 million to Zhao as “sincerity money” within one month; and (c) he had a personal interest to procure the Company to approve Saike MOU so that Zhao would receive RMB20 million which, in turn, would enable her to repay the loan to R1[19].

(2)  When the board discussed and approved Saike SPA at the meeting on 20 March 2015, (a) he expected Zhao to pay RMB6 million for the investment by 30 April 2015; and (b) Zhao would be obliged to return the “sincerity money” to Major Bright unless Saike SPA was signed by 30 April 2015; and (c) he had a personal interest to procure the Company to approve Saike SPA so as to avoid any risk of jeopardizing Zhao’s contribution to the investment[20].

34.  In breach of his Duties, R1 failed[21]:

(1)  to disclose or declare the loan arrangement with Zhao, his expectation of Zhao’s payment for the investment and his personal interest in procuring the Company to approve the Saike MOU and the Saike SPA; and

(2)  to avoid the conflict of interest that has arisen and to abstain from voting on the resolutions to approve the Saike MOU and the Saike SPA. 

D3.  Breach of Duties by R2

35.  The information provided by R2 and the Company to the SFC revealed that:[22]

(1)  On 20 January 2015, (before Saike MOU), R2 advanced a loan of RMB1 million to Zhao, which was repayable by 19 April 2015.

(2)  On 28 January 2015 (before Saike MOU), R2 advanced a further loan of RMB1 million to Zhao, which was repayable by 27 April 2015.

(3)  R2’s receipt of HK$2.5 million from Zhao on 2 April 2015 was for repayment of the 2 loans owed to him.

36.  At the board meeting on 14 February 2015, R2 knew or ought to have known that Zhao was indebted to him in respect of the 2 loans[23].

37.  In breach of his Duties, R2 failed to (1) disclose or declare his loan arrangements with Zhao, and (2) avoid the conflict of interest that has arisen and to abstain from voting on the resolution to approve Saike MOU[24].

D4.  Announcements were misleading

38.  In light of the dealings and relationship between R1-R2 and Zhao, the announcements made by the Company on 14 February 2015 and 20 March 2015 were misleading, inaccurate and false in a material aspect as Zhao was not  an “Independent Third Party” and R1-R2 were connected persons.  R1-R2 were responsible for such inaccuracy and falsity[25].

39.  In conducting the 1^st Acquisition in the manner set out above, R1-R2 engaged in misconduct towards the members of the Company, which resulted in the members not having been given all the information they might reasonably expect in respect of the 1^st Acquisition, and the members were unfairly prejudiced as a result[26].

E.  ARTIFICIAL TRANSACTIONS

E1.  Undisputed facts

40.  The following entities were involved in the Artificial Transactions complained of by the SFC:

(1)  Zhejiang Xin Rui Pharmaceutical Co., Ltd (浙江新銳醫藥有限公司) (“Xin Rui”), a company established in the Mainland.  It  engages in the business of trading in pharmaceutical business and has established a sales network throughout the Mainland[27]. It is an indirect wholly owned subsidiary of the Company. 

(2)  Hongkong Victoria Health (China) Co., Ltd (香港維健 (中國)有限公司) (“Victoria”), a company incorporated in Hong Kong and was wholly owned and controlled by Wang until 22 February 2017.

(3)  Eternal BVI was until the 2^nd Acquisition wholly owned by Wang. 

(4)  Eternal HK, a company incorporated in Hong Kong, is a wholly owned subsidiary of Eternal BVI. 

(5)  Zhejiang Medical Technology Development Company Ltd (浙江醫學科技開發有限公司) (“Zhejiang Medical”), a company established in the Mainland, was wholly owned and controlled by Wang through his shareholding in Eternal BVI.[28]   

(6)  For ease of reference, in this Judgment, Eternal BVI and its subsidiary (Eternal HK) and indirect subsidiary (Zhejiang Medical) are referred to as “Eternal Group”. 

41.  According to the CBI’s company search report on Zhejiang Medical dated 12 July 2018 (“CBI Report”)[29]:

(1)  Its registered capital from 22 May 2017 was  RMB70 million.  Between 17 July 2009 and 4 November 2016, its paid-up capital was RMB5.01 million, and was increased to RMB10 million on  22 February 2017 and further increased to RMB70 million on 22 May 2017.

(2)  It engages in the business of wholesale, import and export of western and Chinese pharmaceutical products and other chemical products as well as wholesale, retail and import of medical equipment in the Mainland.

(3)  Its registered shareholders were as follows:

Period	Name (Shareholding)
11/11/2011-20/12/2015	Wang (85%) Hu Qing 胡青[30] (15%) (together “Wangs”)
21/12/2015-2/8/2016	Chen Shiwei  陳士偉 (85%) Chen Shijian (陳士劍) (15%) (together “Chens”)
3/8/2016-3/11/2016	Zhang Suju張素菊 (85%) Zhang Yuyan 張玉艷 (15%) (together “Zhangs”)
4/11/2016-18/6/2017	Eternal HK (100%)
19/6/2017-27/12/2017	Eternal HK[31]
28/12/2017-17/5/2018	寧波梅山保稅港區維苓投資管理合伙企業 (unknown) Eternal HK (unknown)
18/5/2018-	Eternal HK (100%)

42.  The Artificial Transactions concerned with dealings in 5 pharmaceutical products namely, “重塑傑[32]” (“Drug”), Tamiflu, Unasyn, Contractubex, and Coniel.

E2.  Issues

43.  The SFC’s case on the Artificial Transactions is pleaded in §33 of the Petition which reads as follows:

“Since late 2015 until about mid-2018, the Group, in particular one of its subsidiaries called [Xin Rui], had entered into various transactions with [Wang]. Those transactions involved entities owned or controlled by [Wang] (collectively ‘the Wang Wei Companies’) acting, ostensibly, as supplier of pharmaceutical products to the Group. Substantial payments were made by the Group purportedly as ‘deposit’, ‘prepayment’ or ‘sincerity money’ for these artificial transactions which, the [SFC] contends, were not genuinely conducted for the commercial benefit of the Company or the Group, but were in truth and in substance a scheme devised predominately to use the funds of the Group to provide liquid capital to the Wang Wei Companies. Among the Wang Wei Companies were [Victoria] and [Zhejiang Medical].” (underlined added)

44.  In the Agreed List of Issues, counsel put forward the following issues:

(1)  SFC: Whether the purchase of the Drug from Victoria and sale of the same to Zhejiang Medical and the payments of “deposit” and “prepayment” to Victoria were genuine transactions[33] ?

(2)  R1: In respect of the transactions involving the Drug, Tamiflu, Unasyn, Contractubex and Coniel, (a) whether Wang owned and/or controlled both Victoria and Zhejiang Medical; and (b) whether these transactions were artificial, devoid of commercial purpose, and part of a scheme devised to enable Wang’s Companies to obtain liquid capital ?

(3)  Agreed: Whether the payments of “sincerity money”, “security money”, “prepayments” to Zhenjiang Medical relating to Tamiflu, Unasyn, Contractubex and Coniel were genuine transactions[34] ?

45.  There is no real difference in the formulation of the issues.  The issue is whether the Artificial Transactions (and each of them) were artificial transactions deployed by R1 to provide liquid capital to Wang’s companies (as the SFC contends) or whether they were genuine transactions conducted between Xin Rui and Wang’s companies (as R1 contends).

E3.  Dealings in Drug

E3.1  Undisputed facts 

46.  The following facts are not in dispute.

47.  By a product agency agreement (產品代理協議) dated 12 November 2015 made between Victoria and Xin Rui (with Wang as guarantor of Victoria) (“Drug Agreement”), Victoria (as authorised distributor of the Drug in the Mainland) appointed Xin Rui as the sole agent in selling the Drug within the Mainland. 

48.  Drug Agreement provides, inter alia, that:

(1)  for the purpose of securing the sole agency, the Company (qua shareholder of Xin Rui) shall pay RMB30 million to Victoria as deposit (“保證金”) (“Deposit”) in 2 tranches by 31 December 2015, and Victoria agrees that the Deposit is only to show the sincerity of Xin Rui in securing the agency and the same is not tied in with the sales performance of Xin Rui and cannot be deducted or retained by Victoria by reason of inability to reach any sales volume (cl.3);

(2)  Xin Rui shall purchase no less than 500,000 pieces of Drug each year, and if the actual quantity is less than 80% of the minimum amount, Victoria has the right to terminate the agreement but shall refund the Deposit 7 days prior to termination of the agreement (cl.4(2));

(3)  Victoria shall ensure that Xin Rui has the exclusive right to sell the Drug in the Mainland, and if a third party is able to sell the Drug in the Mainland, Xin Rui has the right to terminate the agreement whereupon Victoria shall refund the Deposit to Xin Rui within 7 days of receiving the notice of termination from Victoria (cl.10(4)); and

(4)  The agreement remains valid from 1 November 2015 to 31 October 2016 and Xin Rui has the right to renew the agreement on the same terms.  Victoria shall refund the Deposit to Xin Rui within 7 days of termination of the agreement (cl.11(1), (3)).

49.  From November 2015 to February 2016, the Company (on behalf of Xin Rui) made 5 payments to Victoria in the aggregate amount of HK$41,783,225 as follows:

Date	Amount (HK$)
16/11/2015	12,172,855
10/12/2015	5,678,400
7/1/2016	11,942,000
3/2/2016	5,990,000
26/2/2016	6,000,000

50.  From 22 April 2016 to 2 November 2016, Xin Rui purchased substantial quantity of the Drug and paid US$4,933,210 to Victoria.

51.  From 4 July 2016 to 27 February 2017, Xin Rui in turn sold the Drug to Zhejiang Medical at the total price of RMB42,721,150 (inclusive of VAT). 

52.  In the meantime, the registered shareholders of Zhejiang Medical were changed (1) from Wangs to Chens on 21 December 2015; (2) from Chens to Zhangs on 24 July 2016; and (3) from Zhangs to Eternal HK on 18 October 2016. 

53.  By a supplemental agreement dated 1 November 2016 (“Drug 1^st SA”) the parties agreed inter alia (1) to extend Drug Agreement for one year to 31 October 2017; and (2) to treat the entire amount paid by the Company as deposit[35], which shall be refunded to the Company upon expiry of Drug 1^st SA. 

54.  In early December 2016, Wang notified the Group that he had already acquired Zhejiang Medical and would use it as the authorised agent of the Drug in the Mainland and requested to terminate Drug 1^st SA[36].

55.  By another supplemental agreement dated 29 December 2016 (“Drug 2^nd SA”), Victoria and Xin Rui agreed, inter alia, to terminate Drug 1^st SA on 28 February 2017, and Victoria shall return to the Company the Deposit by paying HK$5,678,400 within 10 days and HK$36,104,855 within a month.

56.  There is no dispute that R1 was the chairman of Xin Rui[37] and he conducted the negotiations with Wang and approved Drug Agreement, Drug 1^st SA and Drug 2^nd SA (collectively “Drug Agreements”) qua executive director of the Company[38].  R1 was also responsible for negotiation with Wang on the intended acquisition of Zhejiang Medical[39].

E3.2  SFC’s case

57.  It is the SFC’s case that:

(1)  Wang continued to own and/or control both Victoria and Zhejiang Medical at all times[40].  Although the registered shareholders of Zhejiang Medical were changed (a) from Wangs to Chens on 21 December 2015, (b) from Chens to Zhangs on 24 July 2016, and (c) from Zhangs to Eternal HK on 18 October 2016, both Chens and Zhangs were nominees of Wang.

(2)  The purported purchases of the Drug from Victoria and the sales of the same to Zhejiang Medical were artificial and devoid of commercial purpose[41] in that:

(a)  they were not conducted for the commercial benefit of the Company[42];

(b)  they were in truth a scheme devised to provide liquid capital to the tune of HK$42 million to Victoria[43];

(c)  the artificial involvement of Xin Rui concealed what in substance were related parties’ transactions between 2 companies of Wang namely, Victoria and Zhejiang Medical[44]; and

(d)  they constituted misfeasance and/or misconduct, which was unfairly prejudicial to the members of the Company[45].

58.  There is no alternative plea that even if Drug Agreements and the purchases and sales were genuine, it was not in the interests of the Company/Xin Rui to enter into the same.    

E3.3  Analysis

59.  The burden is on the SFC to prove that Drug Agreements and all the purchases and sales of the Drug pursuant thereto were artificial transactions and did not have any commercial purpose and R1 acted in breach of his duties owed to the Company/Xin Rui in entering into such Agreements.  Mr Ho accepts that given the serious nature of the allegation, strong evidence is required before the court concludes that the allegation is established on the balance of probability (Re H (Minors) (Sexual Abuse: Standard of Proof) [1996] AC 563, 586E).

60.  The SFC’s case is inconsistent with or contradicted by the following evidence and falls to be rejected in limine. 

61.  First, it is the unchallenged evidence of R1 that the marketing department of the Company had conducted its research on the Drug including its components, its applications on various diseases, the prices of the successful tenders in the Mainland in 2012 and 2013, the sale volumes in the Mainland from 2012 to 2014, a SWOT[46] analysis, its market potential in the Mainland and produced a Report before Drug Agreement was entered into[47]. The Report was discussed amongst the staff of the department and formed the basis of its marketing and sales plan. 

62.  Second, Drug Agreement was entered into between Victoria and Xin Rui openly and was known to the management of the Group. 

63.  Third, the objective evidence shows that pursuant to Drug Agreement, the Company paid the Deposit and Xin Rui became the sole agent of the Drug in the Mainland for the period from April 2016 to 28 February 2017.  During the agency period, Xin Rui purchased the Drug from Victoria for US$4,933,210 and sold the Drug to Zhejiang Medical for RMB42,721,150 and made a gross profit of around RMB2,397.000[48] (see §§50-51 above).

64.  Fourth, Victoria was entitled to and did terminate Drug Agreements with effect from 28 February 2017.  Thereafter, the Deposit was returned to the Company in tranches, with HK$5,678,400 paid on 30 December 2016 and 3 January 2017 and HK$36,104,855 paid on 28 March 2017[49] (i.e. within the time limits stipulated in Drug 2^nd SA).

65.  Fifth, R1 gives consistent evidence on the market condition of pharmaceutical products in the Mainland including how competitive the market was (with over 1,000 companies engaging in similar agency business) and the practice of the industry in requiring a deposit to secure a sole agency contract:

“… firstly, in order to obtain the agency right for a famous product, this matter in itself is rather difficult. Because in Mainland China, there’re more than one thousand pharmaceutical companies. So, there’s fierce competition. So, according to the usual practice in the industry, in order to obtain the good agency right, usually, one would make use of the security deposit or sincerity money. This kind of money represented the agent’s sincerity; besides it’s a guarantee of reputation. That’s why it had to be paid.

  And after [the Company] got listed, we had abundant funds, we usually put the deposit in current account.  So why is it that we’re willing to pay considerable sum in terms of security deposit, in order to obtain a product agency right, well the consideration for us is just very low interest. Because security deposit had to be refunded in any event.  The consideration we had to pay is low interest, but we would be able to achieve a successful business.  So that’s why we place a lot of emphasis on the product agency being obtained.  That’s why we’re willing to invest this sort of resources … And in relation to this product, we’d like to seek, these are the famous brand pharmaceutical products.  Certainly obtaining the agency right is the beginning …”

66.  The SFC adduces no evidence to contradict the evidence of R1 on the market condition or the industry practice of pharmaceutical industry in the Mainland. 

67.  Sixth, R1 also gives evidence on the importance of securing the right to obtain a full refund of the Deposit at the end of the agency so as to protect Xin Rui and Company.  The evidence makes sense and shows that R1 did take into account the interests of the Company/Xin Rui when negotiating the terms of Drug Agreements. 

68.  In his Closing, Mr Ho makes many criticisms on the lack of commercial purpose of Drug Agreements from the perspective of Wang and his companies (Victoria and Zhejiang Medical), which may be summarised as follows:

(1)  At the time Drug Agreement was entered into, Wang was the “controller” of Zhejiang Medical.  R1’s and Wang’s evidence is that since the second half of 2015, they had been discussing the acquisition of a stake in Zhejiang Medical and Wang continued to have access to Zhejiang Medical’s books and financial records, it is “unreal” to assert that Chens/Zhangs were the “real owners” of Zhejiang Medical (Controller point).

(2)  It is not open to R1 to run a positive case that Chens and Zhangs were the true owners of Zhejiang Medical as he only pleads non-admission to SFC’s case (No positive case point).

(3)  The business of Zhejiang Medical and Xin Rui was “very similar”.  In the WS of R1 and Wang, there is no explanation on why Victoria appointed Xin Rui as agent and why Drug 1^st SA and 2^nd SA were entered into.  Under cross-examination, R1 puts forwards 3 reasons for the appointment of Xin Rui as agent, but his assertions are inconsistent with his assertions about the business and operations of Zhejiang Medical (Similar business point). 

(4)  R1 can only point to a “perfunctory” research report, the provenance of which is unknown.  There was no cost-benefit analysis on the payments of the Deposit or the credit worthiness of Victoria (Research report point). 

(5)  Both the source of the Drug (Victoria) and the downstream agent (Zhejiang Medical) were in truth Wang’s companies, there is “no meaningful answer” to the SFC’s complaint that (a) the “circular transactions are artificial and not genuine”; (b) “to interpose Xin Rui and oblige Xin Rui to pay nearly HK$42m as ‘deposit’ etc was a scheme to grant interest-free loans to Victoria” when the Group was borrowing at 5-7.1% p.a.; and (c) “the interposing of Xin Rui concealed the related-party transactions between Victoria and Zhejiang Medical” (No meaningful answer point).

69.  I do not think that the criticisms are well-founded.  In any event, even if the criticisms are established, they do not support the SFC’s case that Drug Agreements were “artificial” or that they formed part of a scheme to provide capital to Wang’s companies.   

70.  The Controller point is a red herring:

(1)  As submitted by Mr Lam, there is no allegation in the Petition that when Drug Agreements were negotiated and entered into, R1 knew about the changes in registered shareholders of Zhejiang Medical.  Nor is there any allegation that R1 had any knowledge of or was part of an agreement to the alleged scheme to provide capital to Wang’s companies. 

(2)  It is not open to the SFC to run an unpleaded case that R1 had knowledge of the various matters which are only put by Mr Ho to R1 during cross-examination.  Even if the SFC were allowed to run an unpleaded case against R1, the consistent evidence of R1, which I accept, is that to his knowledge, Wang had sold Zhejiang Medical in late 2015 and acquired it back in late 2016. 

(3)  In any event, it is difficult to see why the changes in registered shareholders of Zhejiang Medical would render Drug Agreements and all the sales and purchases subsequently entered into between relevant companies to become artificial or not genuine transactions. 

(4)  Even if Zhejiang Medical was at all times owned by Wang (which is not established), it was a matter for Wang to consider whether it was in the interests of his companies to appoint Xin Rui as sole agent for the Drug.  It was not for R1 to be concerned with Wang or his companies. 

71.  The No positive case point is misconceived.  R1 does not plead any positive case that Chens/Zhangs were the true owners of Zhejiang Medical.  Nor does he seek to prove any such case.  The oral evidence of R1 which Mr Ho seeks to refute is given in response to the questions put by Mr Ho during cross-examination. 

72.  The Similar business point is wholly without merit:

(1)  It was a matter for Wang (not R1) to consider whether it was in the interests of his companies to appoint Xin Rui as the sole agent of the Drug. 

(2)  In any event, both R1 and Wang give evidence on the commercial reasons for entering into Drug Agreements, including the fact that Xin Rui had an established sales network and sales team to handle the sales and distribution of the Drug within the Mainland and the other reasons cited in §61 above.  The SFC adduces no evidence to contradict R1’s evidence in this regard.

(3)  More importantly, as Mr Lam submits, the court should be slow to interfere with the business judgment and business decisions of directors (Wong Luen Hang & anor v Chan Yuk Lung and others, CACV 112/2012, 30 October 2013, §26).  As Street CJ puts it in Re Mineral Securities Australia Ltd (in liq) [1973] 2 NSWLRD 207, 232B-C (and applied in Re A Company (Liquidators: Cowley and Lui) [2020] 3 HKLRD 96, §19):

“When the court is required to pronounce upon the commercial prudence of a transaction, it enters upon a slippery and uncertain field. Apart from the lawyer’s disclaimer of expert qualifications in matters of business prudence, the very process of litigation and the necessary limitations upon the scope of admissible evidence restrict the available material to far less than is necessary for the making of a commercial decision.”

73.  The Research report point only falls to be rejected.  It is not open to the SFC to dispute the authenticity of the research report when it has not filed any notice of non-admission or taken issue with its authenticity in the pleadings. 

74.  The No meaningful answer point is a repetition of the other points and adds nothing to the analysis.  In any event, as the SFC has not established a prima facie case of breach of fiduciary duties on the part of R1, there is no evidential burden on R1 to demonstrate the propriety of his actions or decision[50] or to provide meaningful answer to the forensic points raised by the SFC.

75.  For the above reasons, I reject the SFC’s case on the Drug.

E4.  Dealings in Tamiflu & Unasyn

E4.1  Undisputed facts

76.  On 14 December 2015, Zhejiang Medical and Xin Rui entered into a letter of intent (意向協議) in respect of Tamiflu (“Tamiflu LOI”) whereby Xin Rui shall within the next 7 days pay RMB6 million as “sincerity money” (意向金) to Zhejiang Medical in return for the right to negotiate on the authorised distributorship of Tamiflu up to 30 March 2016 (“Period”). If no agreement is reached within the Period, Zhejiang Medical shall refund the “sincerity money” in full to Xin Rui.

77.  The parties were not able to reach any agreement within the Period.  However, the “sincerity money” was not repaid to Xin Rui but was retained by Zhejiang Medical. 

78.  It is the unchallenged evidence of R1 that prior to the expiry of the Period, R1 had already been negotiating with Wang on the agreement with respect to Unasyn[51].

79.  On 28 April 2016, Zhejiang Medical (as authorised dealer of Unasyn) entered into a product agency agreement (產品代理協議) with Zhejiang Medical (“Unasyn Agreement”) whereby the parties agreed, inter alia, that:

(1)  Xin Rui shall pay RMB6 million to Zhejiang Medical as “security money” (保證金);

(2)  Zhejiang shall appoint Xin Rui as the sole distributor of Unasyn in the Mainland, responsible for all the sales and related matters from 27 April 2016 to 23 April 2017; and

(3)  Xin Rui shall purchase at least 300,000 pieces of Unasyn at RMB21.5/piece, and if the quantity purchased is less than 80%, Zhejiang Medical may terminate the Agreement whereupon the “security money” will be refunded to Xin Rui.   

80.  The sum of RMB6 million retained by Zhejiang Medical pursuant to Tamiflu LOI was treated as “security money” payable under Unasyn Agreement[52].

81.  By a supplemental agreement (補充協議) dated 29 November 2016 entered into between Xin Rui and Zhejiang Medical (“Unasyn SA”), it was agreed, inter alia, that (1) the price of Unasyn would be reduced to RMB19.63/piece; and (2) Xin Rui shall make a “prepayment” in the amount of RMB5,889,000 for 300,000 pieces of Unasyn by 5 December 2016, whereupon Unasyn Agreement shall be extended for one year to 23 April 2018.   

82.  Xin Rui only purchased 96,000 pieces of Unasyn at the total price of RMB1,884,480, which accounted for 32% of the “prepayment”.

E4.2  SFC’s case

83.  In respect of Tamiflu Agreement, Unasyn Agreement and Unasyn SA and all the sales and purchases made pursuant thereto, it is the SFC’s pleaded case that:

(1)  they were “artificial transactions” and were a scheme devised to provide liquid capital to Wang’s companies[53] (see §43 above);

(2)  there was no valid reason why Xin Rui did not demand Zhejiang Medical to return the RMB6 million “sincerity money”, which accounted for 10% of the Company’s net cash as at 31 December 2015.  Tamiflu Agreement, payment of “sincerity money” and non-recovery of the same since 30 March 2016 were part of a scheme to provide interest-free liquidity to Zhejiang Capital, and R1 was responsible for the misfeasance or misconduct[54];

(3)  Unasyn SA was not in the interest of Xin Rui or the Group, as Unasyn Agreement provided that payment for purchased products would be by remittance or letter of credit, Xin Rui was not contractually obliged to make “prepayment”.  The payment of “security money” under Unasyn Agreement and the “prepayment” under Unasyn SA totalling RMB11,889,000 to Zhejiang Medical were part of a scheme to provide liquid capital to Zhejiang Medical, and R1 was responsible for the misfeasance or misconduct [55].

84.  Except in respect of Unasyn SA, there is no alternative plea that even if Tamiflu Agreement and Unasyn Agreement and the purchases and sales were genuine, it was not in the interests of the Company/Xin Rui to enter into the same. 

E4.3  Analysis

85.  There is no allegation that R1 had any knowledge on the scheme to provide interest-free liquid capital to Zhejiang Medical, or that he agreed to any such scheme.  For this reason alone, it is difficult to see on what basis the SFC contends that R1 was responsible for the alleged misconduct concerning Tamiflu and Unasyn.    

86.  In my judgment, the SFC has not discharged the burden of proving that Tamiflu Agreement, Unasyn Agreement, Unasyn SA and the sales and purchases made pursuant thereto were “artificial transactions” or that they formed part of a scheme to provide interest-free liquid capital to Zhejiang Medical for the reasons explained below.

87.  First, it is uncontradicted evidence of R1 that Xin Rui’s market research staff had conducted a market research in respect of Tamiflu before entering into Tamiflu Agreement, and the amount of the “sincerity money” was based on and reflected the market potential of Tamiflu[56].

88.  Similarly, it is R1’s unchallenged evidence that the market research staff of Xin Rui had undertaken a research in respect of Unasyn before entering into Unasyn Agreement, and the amount of the “security money” was decided on the basis of Unasyn’s market potential and the analyses jointly prepared by the sales staff of Zhejiang Medical and Xin Rui[57].

89.  The SFC does not take issue with the authenticity of the research reports or the fact that the staff of Xin Rui and the Company were involved in discussing the reports and the amounts of the “sincerity money” and “security money” for securing the distributorship. 

90.  Second, R1’s evidence on the market condition of the pharmaceutical products, the industry practice and the importance of securing the right to obtain refund of the amount paid as “sincerity money” or “security money” (see §§65-67 above), which I accept, applies equally to Tamiflu Agreement and Unasyn Agreement (and Unasyn SA).  As regards the amount paid as “sincerity money” and “security money”, they were commercial decisions made by Xin Rui based on the market potential of Tamiflu and Unasyn and with the inputs from the staff of Xin Rui and the Company.  There is no proper basis to impugn the decisions, even if it is proper for the court to do so (which it is not, for the reasons stated in §72(3) above).   

91.  Third, Tamiflu Agreement, Unasyn Agreement and Unasyn SA were entered into between Xin Rui and Zhejiang Medical openly and was known to the staff involved in dealing with the Agreements and the subsequent sales and purchases.  During the agency period, 96,000 pieces of Unasyn were purchased by Xin Rui from Zhejiang Medical.  These objective facts militate against the SFC’s case that the Agreements were artificial or formed part of a scheme to benefit Zhejiang Medical. 

92.  Fourth, it is not in dispute that Tamiflu Agreement was terminated following negotiations between the parties as the market demand for Tamiflu was not as Xin Rui had expected[58].  Far from supporting the SFC’s case, this shows that R1 did act in the interests of Xin Rui and negotiated for a termination of Tamiflu Agreement. 

93.  Fifth, the SFC contends that the “sincerity money” paid should be returned immediately as it accounted for 10% of the Company’s cash as at 31 December 2015. 

(1)  I am unable to see why the fact that the “sincerity money” represented 10% of the cash held by the Company would render Tamiflu Agreement (or for that matter, Unasyn Agreement and Unasyn SA) to become artificial transactions or transactions not in the interests of Xin Rui/the Company.  This is particularly so when there is no suggestion that the Company was in need of fund or that there was another business or project to which RMB6 million could be deployed. 

(2)  In any event, as R1 explains, at the time of termination of Tamiflu Agreement, Xin Rui and Zhejiang Medical were about to reach agreement on the terms of Unasyn Agreement, and given the fact that the parties and the amount was the same, the RMB6 million held by Zhejiang Medical was treated as “security money” payable under Unasyn Agreement.  In addition, at around the time, R1 was aware of the changes in registered shareholders of Zhejiang Medical and thought that there might be resistance in obtaining repayment[59]. The evidence is consistent with the objective facts and makes sense. 

(3)  Under cross-examination, Mr Ho asks R1 to provide details of the difficulty and criticises him for not providing such details in his WS, I do not think that the criticism is valid.  It is clear from R1 WS that the difficulty was something which he himself thought of, it was not something which actually happened.

94.  Sixth, the “prepayment” was a commercial decision made following negotiations between the parties.  On its face, it cannot be said that the “prepayment” or Unasyn SA were artificial or not in the interests of Xin Rui.

95.  Lastly, I do not think that the criticisms on Unasyn SA are fair or justified:

(1)  the “prepayment” was a commercial decision made following negotiations between the parties;

(2)  it cannot be said that the “prepayment” or Unasyn SA are artificial or not in the interests of Xin Rui given that, in return for the agreement to make the “prepayment”, the price of Unasyn was reduced from RMB21.5 to RMB19.63 (a reduction of 8.7%) and the right to distribute Unasyn was extended for one year;

(3)  it is the unchallenged evidence of R1 that the sales of Unasyn was not satisfactory as Xin Rui had expected, in part owing to the Mainland government’s order on restriction of antibiotics; and

(4)  upon termination of Unasyn Agreement (as extended by Unasyn SA), the prepayment (less the price of the products purchased) and the “security money” were fully refunded to Xin Rui on 27 June 2017 and 3 May 2018 respectively[60].

96.  In his Closing, Mr Ho raises a number of new points which have not been pleaded in the Petition[61]: (1) as chairman of Xin Rui, R1 should have but failed to demand the return of “Tamiflu money”; (2) there was “no cost-benefit analysis whatsoever” in respect of Unasyn SA; (3) there was no internal discussion or negotiation with Zhejiang Medical; and (4) as of 31 December 2016, Zhejiang Medical held cash of less than RMB9 million, Xin Rui’s RMB12 million purportedly paid for Unasyn provided essential liquidity to Zhejiang Medical.   

97.  It is not open to the SFC to expand its case in this way.  Even if, contrary to my view, the SFC should be allowed to raise the points in Closing, I do not think that they take the complaint any further.    

E5.  Contractubex

E5.1  Undisputed facts

98.  By a 產品代理意向協議dated 9 January 2017 (“Contractubex Agreement”), Zhejiang Medical (as authorised dealer of Contractubex in the Mainland) agreed with Xin Rui that:

(1)  they will negotiate on the terms of appointing Xin Rui as the sole distributor of Contractubex in Zhejiang Province upon the latter paying RMB5 million as “sincerity money” (合作意向金);

(2)  if Contractubex is listed on Zhejiang Province’s “2017 procurement tender list” (浙江省2017年採購招標目錄) (“Procurement List”), the parties will sign a formal distribution agreement and the RMB5 million will be treated as deposit; and

(3)  if Contractubex is not listed in the Procurement List, Zhejiang Medical shall refund RMB5 million to Xin Rui.   

99.  The “sincerity money” was returned to Xin Rui on 3 May 2018.

E5.2  SFC’s Case

100.  The SFC contends that:

(1)  the Contractubex Agreement and the payment of “sincerity money” were artificial transactions, and were not genuinely conducted for the commercial benefit of the Company or the Group, but were part of a scheme devised or implemented by R1 to provide liquid capital to Zhejiang Medical.  There was no reasonable or genuine basis for payment of the “sincerity money”[62]; and

(2)  in any event, by late 2017, the supposed condition precedent to the signing of formal distribution agreement could not be met.  There was no valid or genuine reason why Xin Rui did not demand the return of RMB5 million[63].

E5.3  Analysis

101.  The allegation that Contractubex Agreement and payment of “sincerity money” were artificial transactions is unsustainable in light of the following facts and evidence:

(1)  Xin Rui’s market research staff carried out market research and produced a report in respect of Contractubex before entering into the Contractubex Agreement, and the amount of “sincerity money” was based on the market potential of Contractubex and the joint analysis of the staff of Zhejiang Medical and Xin Rui[64]. Mr Ho criticizes the research report as “perfunctory” and “has no substance at all”.  I do not accept the criticism, which does not form part of the SFC’s pleaded case and is not supported by any evidence.

(2)  Mr Ho also raises the point that there was no “cost-benefit analysis” or assessment on the chance of getting the product listed in the Procurement List. These are new points not pleaded in the Petition.  In any event, it ignores the fact that the purpose of Contractubex Agreement was to secure the opportunity to enter into a distributorship agreement if Contracetubex was able to get onto the Procurement List. 

(3)  R1’s evidence on the market condition and industry practice for securing agency and distributorship explains why “sincerity money” was negotiated and paid. 

(4)  Contractubex Agreement and the payment of “sincerity money” were made openly and was known to the staff involved in compiling the research report and the sales staff involved in analysing the market potential and coming up with the amount of the “sincerity money”. 

(5)  As soon as it became clear that Contractubex did not get onto the Procurement List, Zhejiang Medical did refund RMB5 million to Xin Rui on 3 May 2018.

102.  As regards the complaint that there was no valid or genuine reason why Xin Rui did not demand the return of RMB5 million in late 2017, it is equally without merit.

(1)  As R1 explains, Contractubex was a product with good potential, both parties decided not to end Contractubex Agreement but to wait until the end of the procurement / tendering process.  The process was not concluded by the end of 2017 as there might be supplemental purchases for the year 2017 even after the end of 2017[65].  R1’s evidence is corroborated by the evidence of Wang[66]. 

(2)  When he is asked to explain why Xin Rui did not demand refund of the “sincerity money” in late 2017 during cross-examination, R1 explains that Contractubex was a product which the Group placed some importance and the public relationship department of the Company continued to liaise with Zhejiang Province Government to see if it could be listed on the Procurement List. The tendering of pharmaceutical products at the provincial level was a very complicated process, and the reference to “2017” represents the tendering cycle for that year and as a matter of fact, the process only completed in the first half of 2018 when the result of the tender was published.  It was only until then that Xin Rui gave up on the product and asked for a refund of RMB5 million. 

(3)  The SFC adduces no evidence to contradict R1’s or Wang’s evidence, and I accept their evidence.

E6.  Coniel

E6.1  Undisputed facts

103.  By a 產品配送分銷協議dated 19 May 2017, Zhejiang Medical (as authorised dealer of Coniel in the Mainland) appointed Xin Rui as distributor of Coniel within the Mainland (except those regions where “two-invoice system” (兩票制) (“System”) applies), responsible for delivery, distribution and other related matters (“Coniel Agreement”).  The parties agreed, inter alia, that:

(1)  within 10 business days thereof, Xin Rui shall pay HK$44 million as “security  money” (保證金) to show its sincerity in obtaining the distribution right, and the Company shall on behalf of Xin Rui pay HK$22 million as prepayment for the products;

(2)  the Agreement takes effect from 19 May 2017 to 18 May 2018 and Xin Rui has the right to renew the Agreement on the same terms; and

(3)  either party may terminate the Agreement by giving 90 days prior notice whereupon the “security money” shall be refunded in full, and Wang as guarantor shall bear unlimited liability  in this respect.

104.  Pursuant to Coniel Agreement, on 23 May 2017, the Company paid HK$66.14 million to Eternal HK[67].   

105.  By a 補充協議dated 26 June 2017 (“Coniel 1^st SA”), the parties referred to the nationwide implementation of the System which would render Xin Rui unable to distribute Coniel, and agreed that Zhejiang Medical may distribute Coniel directly to its customers but shall pay commission at RMB2.5/box (for 8mg) or RMB1.25 (for 4 mg) to Xin Rui, and if the selling price of Coniel falls below 10% of the lowest selling price (at RMB54.57/box (for 8mg) and RMB32.29/box (for 4mg)), the parties will re-negotiate the commission rate.

106.  Pursuant to contracts with dates ranging from 31 July 2017 to 27 December 2017, various quantities of Coniel were sold to pharmaceutical companies in the Mainland[68].  Xin Rui received commissions in the amount of RMB1,096,403 in 2017 and RMB2,099,133 in 2018[69].   

107.  By an agreement dated 12 May 2018, Xin Rui and Zhejiang Medical agreed to extend Coniel Agreement for 3 months to 18 August 2018 during which Xin Rui continued to have the right to receive commission but the parties would re-negotiate the amount of deposit and the commission rate within the next 3 months (“Coniel 2^nd SA”).

108.  It was not until 18 October 2018 that Zhejiang Medical refunded HK$66 million to the Company.

E6.2  SFC’s case

109.  In respect of Coniel Agreement, Coniel 1^st SA and Coniel 2^nd SA and the transactions made pursuant thereto, it is the SFC’s pleaded case that:

(1)  they were “artificial transactions” and were a scheme devised to provide liquid capital to Zhejiang Medical[70] (see §43 above);

(2)  at the time of Coniel Agreement, R1 was fully aware of the implementation of the System across the Mainland; there would be no place where Xin Rui could act as a distributor of Coniel, evidenced by the Chairman’s statement dated 30 March 2017 in the Company’s 2016 Annual Report (“Chairman’s Statement”)[71];

(3)  there was no reasonable or genuine basis for paying HK$66 million to Zhejiang Medical, which was more than the net cash of HK$54.8 million of the Company as at 31 December 2016[72];

(4)  Coniel SA was “not genuinely entered into for the commercial benefit of [Xin Rui]” as there would not be any prospect of Xin Rui receiving any commission[73];

(5)  as Xin Rui would not purchase Coniel from Zhejiang Medical, there was no reason why Zhejiang Medical did not return HK$22 million prepayment to Xin Rui[74]; and

(6)  in light of the full implementation of the System, there was no valid or commercial reason for Coniel 2^nd SA extending Coniel Agreement for 3 months under Coniel 2^nd SA and failing to obtain return of HK$66 million[75].

E6.3  Analysis

110.  The SFC’s case on the alleged scheme is demurrable.  There is no allegation that R1 had any knowledge on the scheme to provide liquid capital to Zhejiang Medical or that he agreed to any such scheme.  There is therefore no basis for the SFC to suggest that R1 was “responsible” for the misfeasance and/or misconduct[76].

111.  In any event, the SFC’s case is so contradicted by the evidence and must be rejected.

112.  First, there was a market research in respect of Coniel which included its market potential, a sales plan for 2017 and a marketing plan to sell the products within the Mainland[77]. I do not accept Mr Ho’s suggestion that the research report was “perfunctory”. No such allegation has been pleaded in the Petition.  Nor has the SFC adduced any factual or expert evidence in support of the suggestion.   

113.  Second, the suggestion that there was no valid basis for paying “security money” or “prepayments” is unjustified, having regard to the market condition and the practice of pharmaceutical industry (see §§65-67 above). 

114.  Third, the SFC’s case is based on an assertion that the System had been implemented throughout the Mainland at the time Coniel Agreement was made, which is not established by the evidence:

(1)  As R1 explains, at the time Coniel Agreement was entered into, the System was still a suggestion and had not been implemented.  There was therefore opportunity for Xin Rui to act as distributor of Coniel.  Having regard to the possibility of its implementation, the distributorship was confined to those regions where the System was not implemented[78].  There is nothing to contradict R1’s evidence and I accept his evidence. 

(2)  I do not think that the Chairman’s Statement supports the SFC’s case.  The Chairman’s Statement reads as follows:

“Looking ahead, the ‘Two Invoice’ System (兩票制) will be implemented in the PRC within a year, which aims to reduce the drug circulation chain and layers between drug manufacturers and end user medical institutions…..The Group will closely monitor the guidelines of the national policy and adapt to the market changes. The Group will endeavour to maximise return for shareholders by focusing on proprietary drugs with outstanding marketing and sales performance and looking out for new opportunity to acquire new distribution right, with the aforesaid Group is poised to benefit from this development”. (underlined added)

(3)  In the Chairman’s Statement, R1 was expressing his view as to when the System would be implemented.  He was not stating this as a fact for the obvious reason that the System was something new and the Group could only monitor the situation and adapt to changes.  Under cross-examination, R1 further explains that Zhejiang Province was one of the first regions where the System was implemented, which triggered the need to enter into Coniel SA so as to protect Xin Rui’s interests.  The implementation of the System on a nationwide basis took more than 5 years to complete.  R1’s evidence is corroborated by the Chairman’s statement in the Company’s 2017 Annual Report dated 26 April 2018, which stated that the System “had been implemented in most of the provinces in the PRC during the Year”.

(4)  More importantly, in the Chairman’s Statement, R1 also mentioned that the Group would look for opportunity to acquire new distribution right.  This statement was entirely consistent with Xin Rui’s acts in (a) acquiring distribution right of a new drug by entering into Coniel Agreement; and (b) entering into Coniel SA when the System had been implemented in Zhejiang Province so as to adapt to the changes in business environment[79].   

115.  Fourth, the assertions that Coniel Agreement, Coniel 1^st SA and Coniel 2^nd SA and the transactions made pursuant thereto were “artificial transactions” and there would not be any prospect of Xin Rui receiving any commission are wholly without basis, as Xin Rui did provide services to Zhejiang Medical (see next paragraph) and receive commissions in excess of RMB3 million in 2017 and 2018 (see §106 above).

116.  Fifth, the suggestion that there was no valid or commercial reason for Coniel 2^nd SA is based on an erroneous assumption that the System had been implemented throughout the Mainland.  It also ignores the fact that during the extended period of distributorship, Xin Rui continued to provide marketing and logistics services to Zhejiang Medical and was remunerated in the form of the commissions paid by Zhejiang Medical[80].   

117.  Lastly, the decision to enter into Coniel Agreement (and the 1^st and 2^nd SA) including the need to pay “security money” and “prepayments” were commercial decisions which R1 was entitled to make, taking into account the market condition and the need to acquire new distribution rights in line with the business of the Group.  It is meaningless to compare the net cash of the Company or the Group as at 31 December 2016 (HK$ 72 million[81]) with the amounts paid under Coniel Agreement given that (1) there was a space of 5 months between the year end date and the date of Coniel Agreement; and (2) there is no evidence to suggest that the Company/Group would be better off by leaving the cash/bank balances idle. 

E7.  Conclusion on Artificial Transactions

118.  For the reasons stated in Sections E3 – E6 above, I hold that the agreements in respect of the Drug, Tamiflu, Unasyn, Contractubex and Coniel and the transactions carried out pursuant thereto, including the monies paid by Xin Rui/the Company as “deposit”, “sincerity money”, “security money” or “prepayments” were genuine commercial transactions.  Although R1 was involved in negotiating and approving the relevant agreements, his conduct do not constitute misfeasance or misconduct under s.214(1)(b)(d). 

F.  2^nd ACQUISITION

F1.  Undisputed facts

119.  At the trade fair held in Zhejiang Province in the second half of 2015, Wang came to know that the Company was listed in Hong Kong and asked R1 if the Company would be interested in investing in “Eternal” of which Zhejiang Medical formed part[82]. 

120.  In 2016, Wang contacted R1 for the first time regarding the potential acquisition of Eternal, whereupon R1 began to research into and obtain some understanding of Eternal Group including Zhejiang Medical.  R1 considered that the acquisition of an interest in Eternal Group would address the impact of the pharmaceutical industry’s transition to the System and, at the same time, the Company could leverage on Zhejiang Medical’s sales revenue (which exceeded RMB200 million in 2014 and 2015) and Eternal Group’s experience in importing pharmaceutical products.  Most of the negotiations were conducted between R1 and Wang through meetings and phone calls[83].

121.  R1 and Wang initially agreed that the Company would acquire 12% equity in Eternal Group as Wang did not want to sell too much and  wanted to learn from the Company/Xin Rui’s experience in listing in Hong Kong[84].

122.  At the board of directors’ meeting held on 5 December 2016, (with R1 as chairman), the directors:

(1)  considered and discussed (a) the terms of the sale and purchase agreement between Major Bright (as purchaser) and Wang (as vendor) in respect of the conditional acquisition of 12% of the issued share capital of Eternal BVI at RMB37.8 million (~HK$42.7 million), with obligation for Wang to repay in cash the adjusted amounts if the net profits for FY2017 and FY2018 fall below RMB35 million and RMB38.5 million respectively (“SPA”); (b) the information about Eternal Group; the reasons and benefits of the 2^nd Acquisition; (c) the implications under the Listing Rules and (d) the draft announcement which described details of the SPA and the 2^nd Acquisition including the fact that according to the unaudited financial statements of Zhejiang Medical for the 10 months in 2016, its net profits after taxation was RMB1,070,000; and

(2)  resolved, inter alia, that the terms of the SPA are fair and reasonable and the 2^nd Acquisition is in the interest of the Company and its shareholders as a whole, and any one director be authorised to the execute the SPA.  None of the directors declared any conflict of interest in relation to the transaction.

123.  On 5 December 2016, the SPA was signed and the announcement was published.  In the announcement, it was stated that Wang “is an Independent Party”. 

124.  By an agreement dated 3 February 2017 made between Eternal HK and First Credit Ltd (“First Credit”), Eternal HK obtained a HK$40 million revolving loan facility at 11% p.a. interest, with Wang and R1 as guarantors (“Revolving Facility”).

125.  By an agreement dated 10 March 2017, Eternal HK advanced a HK$40 million loan to Wang repayable on 20 August 2017 (“$40m Loan”).   

126.  At the board meeting of the Company held on 14 March 2017 (chaired by R1), a draft supplemental agreement between Major Bright and Wang to acquire an additional 3% shareholding in Eternal BVI (“SSPA”) together with the announcement to be made by the Company on the SSPA were considered and approved.  None of the directors declared any conflict of interest in relation to the transaction.

127.  The SSPA was considered and approved by a written resolution of the directors of Major Bright (signed by R1 and Lee Chik Yuet) on 14 March 2017.   

128.  The SSPA provides, inter alia, that the total consideration was increased to RMB47.25 million, subject to adjustments if the net operating profits of Eternal BVI was less than RMB35 million in FY2017, RMB38.5 million in FY 2018, and RMB42.35 million in FY 2019.   

129.  On 17 March 2017:

(1)  The Company paid HK$53,392,500 to Wang as consideration for acquiring 15% shares in Eternal BVI (“Consideration”) and the 2^nd Acquisition was completed.  The Consideration was deposited into Wang’s account at HSBC.

(2)  R1 was due to repay HK$26,591,833.97 to E Finance Ltd (“E Finance”) in respect of a HK$24 million advanced to him in December 2015. 

(3)  R1 issued a cheque to repay the amount due to E Finance, and the amount was transferred to E Finance on 31 March 2017.

130.  On 18 March 2017, Wang obtained a HK$2 million loan from First Credit at 11% p.a. interest, which was repayable on 21 August 2017 (“$2m Loan”).

131.  On 28 March 2017, Wang made 2 payments:

(1)  HK$26 million to R1 (which was applied by R1 to repay the amount owed to E Finance[85]); and

(2)  HK$36,104,855 to the Company as repayment of the remaining deposit payable under Drug 2^nd SA.   

132.  On 21 August 2017:

(1)  Wang borrowed HK$2 million from First Credit at 11% p.a. interest and used it to repay the $2m Loan, with maturity date on 21 August 2018 (“Renewed $2m Loan”).

(2)  Eternal HK obtained a HK$40 million revolving credit facility from First Credit at 11% p.a. interest and applied it to  repay the Revolving Facility, which was also guaranteed by Wang and R1 (“Renewed Revolving Facility”).   

(3)  Eternal HK entered into a supplemental agreement with Wang whereby it agreed to extend the term of $40m Loan from 20 August 2017 to 21 August 2018 at the same interest of 11% p.a. (“Renewed $40m Loan”).   

133.  On 24 August 2017, the SFC directed the Company to produce documents and answer questions in respect of, inter alia, the 2^nd Acquisition.  On 31 August 2017, the Company replied and provided documents and information.

134.  On 4 October 2017, the SFC informed the Company in the absence of satisfactory explanation, “with reliable supporting documents”, in respect of Wang’s payment of HK$26 million to R1 on 28 March 2017,  it intended to direct HKEx to suspend trading of the Company’s shares on 6 October 2017[86].

135.  On 6 October 2017, the SFC directed suspension of trading of the Company’s shares.

136.  By letter dated 20 December 2017, the Company through its solicitors (Leung & Lau), responded to the SFC’s questions and provided a 借款合同made between R1 and Wang for HK$26 million (“Loan” and “Loan Agreement”).  The Loan Agreement stated, inter alia, that:

(1)  it was signed by the parties on 18 March 2017;

(2)  the Loan was advanced for one year and was repayable on 17 March 2018;

(3)  interest at 11% p.a.; and

(4)  if R1 failed to repay the Loan and interest on the due date, Wang had the right to charge default interest at 0.1% of the principal per day. 

F2.  Issues

137.  The SFC’s pleaded in respect of the 2^nd Acquisition is as follows:

(1)  The payment of HK$26 million from Wang to R1 on 28 March 2017 (“Payment”) was a secret profit made by R1 out of the 2^nd Acquisition[87];

(2)  Although during the SFC’s investigation, R1 asserted that the Payment was a loan for one year with interest at 11% p.a. and the parties had signed the Loan Agreement, the SFC contends that the Loan Agreement was not in fact genuine given that[88]:

(a)  Wang had to borrow $2m Loan from First Credit at 11% p.a. on 18 March 2017 and another HK$36.1 million from Eternal HK on 21 March 2017 (“$36.1m Loan”).  It could not have been a genuine commercial transaction for Wang to borrow HK$38 million at 11% p.a. and then “onward lend” HK$26 million to R1 at the same interest;

(b)  R1 failed to disclose to the board or in the announcements made on 5 December 2016 and 14 March 2017 his personal interest in the 2^nd Acquisition;

(3)  Alternatively, if the HK$26 million was a genuine loan granted by Wang, the SFC contends that[89]:

(a)  R1 failed to discharge his duties (i) to avoid conflict of interest and (ii) declare to the board his personal interest in the 2^nd Acquisition and the Company’s payment to Wang;

(b)  R1 (as debtor) had actual or potential conflict of interest in not procuring Xin Rui to recover the “sincerity money” paid under Contractubex transaction from Zhejiang Medical, despite the fact that Contractubex was not listed on the Procurement List.   

138.  R1 denies that the Payment (or any part thereof) was secret profit made by him out of the 2^nd Acquisition[90]. His pleaded case is that:

(1)  The Payment was a loan advanced by Wang to him pursuant to the Loan Agreement, which was repayable on 17 March 2018 and subsequently extended to 17 March 2019 by a supplemental agreement dated 15 March 2018 (“Supp Loan Agreement”)[91].

(2)  The circumstances leading to the Loan Agreement and the Supp Loan Agreement were as follows[92]:

(a)  After payment of the Consideration on 17 March 2017, Wang asked R1 whether there was any good way to invest rather than to leave the money in a bank account at low interest rate;

(b)  R1 proposed that Wang could lend him HK$26 million at 11% p.a. interest, which rate both parties perceived to be the approximate general prevailing rate available from finance companies;

(c)  The Loan Agreement was beneficial to R1 and Wang as (i) R1 would have money to repay the loan due to E Finance; and (ii) Wang would be able to earn a higher interest rate rather than the low interest rate from bank.

(3)  The Loan and interest accrued thereon were repaid by R1 to Wang as follows[93] (collectively “Repayments”):

(a)  On 15 March 2018, HK$500,000 as interest;

(b)  On 13 April 2018, RMB1.88 million (~HK$2.36 million) as interest;

(c)  On 17 September 2018, HK$16 million as partial payment of principal;

(d)  On 22 October 2018, RMB8.8 million (~HK$10 million) as remaining principal; and

(e)  On 30 October 2018, RMB1,258,400 as remaining interest.

(4)  HK$36.1 million from Eternal HK was transferred from Wang’s account (on 21 March 2017) before he transferred HK$26 million to R1 on 28 March 2017[94].

(5)  The Loan Agreement was entered into by R1 and Wang after completion of the 2^nd Acquisition[95].

(6)  The parties would like to see if there would be any bidding plans for Contractubex irrespective of any loan to R1[96].   

139.  In its Reply, the SFC pleads that:

(1)  the Payment was not a loan, and the Supp Loan Agreement was “not genuine”[97];

(2)  it could have not have a genuine commercial transaction for Wang to borrow from Eternal HK and First Credit at 11% p.a. interest, and extend the repayment date of the Loan to R1 at the same interest rate[98]; and

(3)  the Repayments were not genuine repayments of principal and interest as they were paid after the SFC had discovered the Payment to R1[99]. 

140.  The parties agree that the issues which the court has to decide are: (1) whether the Payment was a genuine loan to R1 or a secret profit out of the 2^nd Acquisition; and (2) if the Payment was a loan, whether R1 was in breach of his duties to avoid conflict of interests and to declare his interests. 

F3.  Analysis

141.  Mr Ho submits that the burden is on R1 to prove that the Payment was a loan and the Loan Agreement and Supp Loan Agreements were genuine.  Reliance is place on Pacific Electric Wire & Cable Company Limited v Texan Management Limited, CACV 90/2012, 17 September 2013, §§60-61.

142.  On the other hand, Mr Lam submits that where, as here, the court is faced with 2 conflicting versions of event, the standard of proof remains one of balance of probabilities but the more serious the allegation, the more cogent the evidence should be.  The version of event puts forward by the SFC involves serious allegations of bribery, fraud and intentional fabrication, all of which have to be supported by cogent evidence.

143.  In my view, in deciding whether to accept the version of events put forward by the SFC or by R1, the court should consider and assess all the evidence against the inherent probability of the respective allegations made by the SFC and R1, and bear in mind that the more serious the allegation, the less likely that it occurred and the stronger should be the evidence before the allegation is established.  This accords with the principle expounded in Re H (Minors), 586D-H:

“The balance of probability standard means that a court is satisfied an event occurred if the considers that, on the evidence, the occurrence of the event was more likely than not. When assessing the probabilities the court will have in mind as a factor, to whatever extent is appropriate in the particular case, that the more serious the allegation the less likely it is that the event occurred and, hence, the stronger should be the evidence before the court concludes that the allegation is established on the balance of probability. Fraud is usually less likely than negligence. Deliberate physical injury is usually less likely than accidental physical injury….Built into the preponderance of probability standard is a generous degree of flexibility in respect of the seriousness of the allegation.

  Although the result is much the same, this does not mean that where a serious allegation is in issue the standard of proof required is higher.  It means only that the inherent probability or improbability of an event is itself a matter to be taken into account when weighing the probabilities and deciding whether, on balance, the event occurred. The more improbable the event, the stronger must be the evidence that it did occur before, on the balance of probability, its occurrence will be established. Ungoed-Thomas J expressed this neatly in In re Dellow’s Will Trusts [1964] 1 WLR 451, 455: ‘The more serious the allegation the more cogent is the evidence required to overcome the unlikelihood of what is alleged and thus to prove it.”

144.  For the reasons set out in §§145-152 below, I find that the Payment was a loan advanced by Wang to R1, rather than a secret profit made by R1 out of the 2^nd Acquisition. 

145.  First, the SFC’s case that the Payment was a secret profit is based solely on the impossibility for Wang to have agreed to lend HK$26 million to R1 when he had to borrow the $2m Loan and $36.1m Loan.  The allegation is inherently unlikely or improbable, having regard to the following facts and matters:

(1)  The 2^nd Acquisition was a genuine transaction whereby the Company acquired 15% interest in Eternal Group, which engages in the same business as the Group and had a solid track record in importing, distributing and selling pharmaceutical products in the Mainland. 

(2)  The commercial justifications for both parties to enter into the 2^nd Acquisition, as explained in R1 WS[100] and Wang WS, have not been challenged.  These include:

(a)  The Company would like to acquire Eternal Group to develop its import business in the light of the System[101];

(b)  Eternal Group is a reputable importer from foreign renowned drug manufacturers such as Pfizer and Roche and had a good relationship with them[102];

(c)  The business of Eternal Group was satisfactory and would further improve in the light of the social and economic situation in the Mainland[103];

(d)  Wang was experienced in importing pharmaceutical products[104];

(e)  Wang would like to leverage on the Company’s status as a listed company and to improve its corporate governance[105]; and

(f)  Wang agreed to guarantee the minimum profits of Eternal Group for 2017 to 2019[106].

(3)  The Consideration was based on a PE ratio of 9 times the estimated net profits of Eternal Group for 2017.  The commercial justifications for adopting the profit estimate and PE are explained in R1 WS and Wang WS[107], which have not been challenged. 

(4)  There is no allegation, whether in pleadings or evidence, that the Consideration did not reflect the market value of 15% shareholding in Eternal BVI or that the Consideration was inflated in any way. 

(5)  To the contrary, under the SPA/SSPA, there were adjustments mechanism to ensure that the adjusted net profits of Eternal Group would not be less than RMB35 million in FY2017, RMB38.5 million in FY 2018, and RMB42.35 million in FY 2019.  If the net profits fall below these amounts, Wang would be personally liable to pay the adjusted amounts in cash to the Company.  There was no reason (none has been articulated by the SFC) for Wang to have agreed to sell 15% stake in Eternal Group at about 50% of the Consideration (if, as the SFC alleges, the Payment was a secret profit paid to R1) and assumed the risk and corresponding obligation to pay the adjusted amount in cash to the Company for 3 years. 

(6)  The 2^nd Acquisition was approved by the board.  It was not a transaction which could have been decided by R1 alone.  There is no allegation or evidence to suggest that but for R1’s influence or instructions whatsoever, the board would not have approved the 2^nd Acquisition. 

146.  Second, since October 2017 when the SFC raised question about the nature of the Payment, it has been the consistent response of R1 that it was a loan advanced to him by Wang after completion of the 2^nd Acquisition:

(1)  The SFC began to investigate the nature of the Payment in its letter to the Company dated 4 October 2017.

(2)  During the interview of R1 on 29 November 2017, the interviewer asked R1 to describe the nature of the Payment.  In reply, R1 said that it was a personal loan advanced by Wang to him after completion of the 2^nd Acquisition and the parties had signed a loan agreement for that purpose[108].  When being asked about the circumstances under which the Loan was advanced, R1 said that after Wang had received the Consideration, he asked R1 about avenues for investing the money in Hong Kong as he thought that R1 was more familiar with Hong Kong and the interest for keeping money at the bank was rather low.  R1 said to Wang that he needed HK$26 million and asked if Wang could lend him the amount for one year and he would pay interest at 11% p.a. on the Loan[109]. 

(3)  A copy of the Loan Agreement, alongside with the answers  and the supporting documents in response to the questions raised in the SFC’s letter of 4 October 2017, were provided by the Company to the SFC on 20 December 2017. 

(4)  When R1 was interviewed by CSRC[110] on 21 November 2018, he was asked about the Payment and why he only repaid the loan owed to E Finance on 31 March 2017, instead of its due date (17 March 2017).  R1 said that it was after he had borrowed the Loan from Wang that he repaid the amount owed to E Finance and he could not remember whether he had applied for extension of time to make the payment. 

147.  At trial, R1 has been subject to extensive cross-examination on the Payment and his case on the Loan.  His evidence is consistent with what he said at the interview in November 2017:

(1)  When being pressed as to why he had to borrow $26 million from Wang, R1 explains that before expiry of the HK$24 million loan advanced by E Finance (on 17 March 2017), he had been negotiating with E Finance for another extension but the indicative interest rate would be between 11-12% p.a..  He was not able to obtain any loan from banks in Hong Kong and if he were to remit any funds from the Mainland to Hong Kong, he would incur handling expenses owing to the restrictions on remittance of funds.  His evidence is consistent with contemporaneous documents which show that he owed HK$26.5 million to E Finance which had fallen due on 17 March 2017, and the amount was repaid in full on 31 March 2017. 

(2)  When he is asked about when he started discussing with Wang on the Loan, R1 says that he began discussing the matter with Wang during the celebratory event after completion of the 2^nd Acquisition and they came to an agreement on 18 March 2017, and the Loan Agreement was signed on the same day.

(3)  Although it is put to R1 that he must have knowledge about the financial position of Wang and the fact that Wang had borrowed $36.1m Loan from Eternal HK during the due diligence of Eternal Group, R1’s consistent evidence is that he was not aware of this matter.  There is no evidence to contradict his evidence in this respect.  In any event, the $36.1m Loan was a loan granted by Eternal HK (of which Wang held 85% indirect shareholding) to Wang himself, it is difficult to see why its existence would render Wang to become unable or unwilling to advance any loan to R1.

(4)  When R1 is asked about the fact that Eternal HK had on 10 February 2017 obtained the Revolving Facility from First Credit at 11% p.a. interest, he readily accepts that he was aware of the Revolving Facility as he was one of the guarantors.  R1 also explains that it was because of his knowledge on the interest rate under the Revolving Facility that he could not propose a rate lower than 11% p.a. for the Loan. 

(5)  Although it is put to R1 that there was no reason for Wang to have agreed to advance the Loan when Wang had to borrow the $36.1m Loan and $2m Loan, I do not think that it is inherently unlikely or improbable for Wang to have agreed to advance the Loan to R1 at 11% p.a. interest given that (a) R1 had done a favour to Wang by agreeing to become a guarantor (alongside with Wang) of the Revolving Facility; (b) the $36.1m Loan and $2m Loan were not due for repayment; (c) the interest on the Revolving Facility, the $36.1m Loan and the $2m Loan was the same, such that Wang would not be worse off by agreeing to advance the Loan to R1; and (d) borrowing and advancing personal loan was common amongst businessmen in Zhejiang (where both he and R1 came from) as they very much value their reputation and would decide on such matter within a very short time.

(6)  As to Mr Ho’s suggestion that Wang should have used the Consideration to repay the $36.1m Loan and $2m Loan, rather than agreeing to advance the Loan to R1, the objective fact show that Wang did not in fact use the remaining Consideration to repay either of the loans.  This fact militates against the SFC’s allegation that it was inherently improbable for Wang to have agreed to advance the Loan to R1.

148.  Third, the fact that the Payment was in a loan advanced by Wang to R1 is consistent with and corroborated by the Repayments. Although the SFC alleges that the Repayments were not genuine repayments of principal and interest, I do not think that the allegation is well-founded for the following reasons:

(1)  Except the last payment of RMB1,258,400, all the Repayments are supported by contemporaneous documents including bank remittance slips the authentic of which have never been challenged by the SFC. 

(2)  Apart from the bare assertion that the Repayments were not genuine repayments of principal and interest, the SFC has not been able to point to any matter, let alone adduce any evidence, to show that the Repayments (or any of them) were made for any other purpose or that the amounts were not in fact paid to Wang.

(3)  At trial, Mr Ho criticises R1 for not producing the bank statements which, he contends, will show whether the Repayments were in fact paid to Wang. I do not think it is open to the SFC to raise the point only at trial, when no notice of non-admission has ever been filed in respect of the contemporaneous documents produced by R1 in support of the Repayments. 

149.  Fourth, Mr Ho contends that in March 2018, Wang and R1 agreed to extend the repayment deadline for one year is incredible, given that (1) in August 2017, Wang had personally borrowed HK$42 million at 11% interest for another year[111]; (2) since 6 October 2017, trading of the Company’s shares had been suspended; (3) R1 defaulted in March 2018 and was not able to pay interest of HK$2.86 million on the Loan; (4) both Wang and R1 were not aware of the default interest clause in the Loan Agreement, the rate of 0.1% per day amounted to HK$9.49 million a year but nobody cared.  There was no request for some form of security or increase in interest rate and no negotiations at all; and (5) there was a complete absence of “electronic imprint” in view of the SFC’s investigation[112].

150.  Except the point stated in §149(1) above which may be said to have been pleaded in the Reply, the other points have not been pleaded.  I do not think that the SFC should be allowed to expand its allegations in this way.  In any event, the points are put to R1 and Wang during their cross-examination and they provide their answers to the effect that the extension was something which was agreed by R1 and Wang, and neither of them was aware of the default interest provision in the Loan Agreement and Supp Loan Agreement and Wang was contented with receiving interest at 11%.  It is not inherently incredible for businessmen to have acted in the way they did and I accept their evidence.

151.  Lastly, Mr Ho makes a number of points concerning Wang namely, (1) there was no attempt to explain why Wang personally borrowed HK$38 million[113] and yet allegedly sitting on idle funds; (2) why Wang was happy with 11% offered by R1 when he had to pay 11% interest to First Credit and Eternal HK; (3) the explanations offered by Wang during cross-examination are “convoluted and inconsistent”, in particular the alleged separation of his “personal” money and “business” money is “utterly incredible”[114]; and (4) Wang’s evidence on the purposes of his own borrowings (i.e. $2m Loan and $36.1m) have been inconsistent over the years[115]. 

152.  I do not see why R1 has to explain or speculate on the financial position of Wang or why Wang chose to use the funds in the way he did.  Nor do I see why the fact that Wang has provided different explanations to the SFC as to why he borrowed the $2m Loan or $36.1m Loan would render R1’s case on the Loan to become incredible or improbable.   

153.  Mr Ho also raises a number of forensic points to attack R1’s case on the Loan, none of which have been pleaded. In any event,  the points are not well founded.

154.  First, Mr Ho criticises R1’s attempt to “fill the evidential lacuna” by putting forward a completely new case on his “two options” to repay E Finance loan as incredible.  The criticism is not justified. The evidence on the various avenues to raise funds for repayment of the loan owed to E Finance is given in response to the specific questions put by Mr Ho to R1 during cross-examination.  The questions were not asked by the SFC or the CSRC in the past.  It would not be fair to criticise R1 for answering the questions put to him only at cross-examination.

155.  Second, it is said that there is a complete absence of objective evidence on the signing of the Loan Agreement on 18 March 2017[116]. However, the SFC’s pleaded case is based solely on the impossibility of Wang having agreed to advance the Loan to R1 when he had borrowed the $2m Loan and $36.1m Loan.  No notice of non-admission has been filed in respect of the Loan Agreement.  It is difficult to see how R1 can be criticised for not adducing evidence to deal with a point which does not form part of the SFC’s pleaded case. 

156.  For the above reasons, I find that the Payment was a loan advanced by Wang to R1 pursuant to the Loan Agreement made on 18 March 2017. 

157.  As the Loan Agreement was made after completion of the 2^nd Acquisition, there is no basis for the SFC to contend that R1 acted in breach of his duties in failing to avoid any conflict of interests or to declare his interests at the time the board considered and approved the 2^nd Acquisition on 5 December 2016 and 14 March 2017. 

G.  RELIEF AND COSTS

158.  It is common ground that the failure on the part of R1 and R2 in disclosing their interests in the 1^st Acquisition was sufficiently serious and warrants the court making a disqualification order against them. 

159.  Mr Ho informs the court that as far as counsel’s research goes, there is no precedent on the period of disqualification where the only breach was concerned with a failure to disclose the director’s interests in a transaction approved by the board and which the company does not seek to avoid or set aside. 

160.  Mr Lam submits that the breach is “purely technical in nature” and falls within “the slightest category” and warrants a disqualification period of 1.5 years given that (1) the Company suffers no loss and has in fact made a gain from the 1^st Acquisition; (2) it was the board’s decision to approve the 1^st Acquisition; and (3) neither R1 nor R2 have made any gain from the transaction. 

161.  I consider that the appropriate period of disqualification for R1 and R2 is one year.  Apart from the points submitted by Mr Lam (which I agree), I also take into account the fact that both R1 and R2 have since June 2018 and November 2015 respectively ceased to be involved in the management of the Company; and on day 2 of the trial, R1-R2 admit liability and all the facts pleaded in §§1-32 of the Petition, which saves some time and costs for all parties. 

162.  I make a disqualification order that R1 and R2 and each of them shall not, without leave of the court (1) be a director, liquidator, or receiver or manager of the property or business of any company in Hong Kong including the Company or any of its subsidiaries or affiliates; or (2) in any way, whether directly or indirectly, be concerned, or take part, in the management of any company in Hong Kong including the Company or any of its subsidiaries or affiliates for a period of 12 months from the date of this Judgment.

163.  As for costs, I make a costs order nisi that:

(1)  the SFC shall pay R1 62.5% of the costs of and occasioned by the Petition including all costs reserved, to be taxed if not agreed;

(2)  R2 shall pay the SFC 12.5% of the costs of and occasioned by the Petition including all costs reserved, to be taxed if not agreed;

(3)  the SFC shall pay the Company 75% of the costs of and occasioned by the Petition including all costs reserved, to be taxed if not agreed; and

(4)  R1-R2 shall pay the Company 25% of the costs of and occasioned by the Petition including all costs reserved, to be taxed if not agreed.

164.  The above costs order:

(1)  represents a rough and ready apportionment of the costs incurred by the parties in dealing with the 3 complaints made by the SFC in the Petition, which I assess at 25% for the 1^st Acquisition, 50% for the Artificial Transactions and 25% for the 2^nd Acquisition;

(2)  R1-R2 fail in the 1^st Acquisition and should pay 25% of the proceedings to the SFC, and as between R1 and R2, each of them shall bear 12.5% of such costs; and

(3)  the SFC fails in the 2 complaints and should pay 75% of the costs to R1 and the Company.  After netting off the 12.5% costs payable by R1 to the SFC, the net amount payable by the SFC to R1 is 62.5%.