BASAB INC AND ANOTHER v. SUPERB GLORY HOLDINGS LTD AND OTHERS

HCA 6/2014

IN THE HIGH COURT OF THE

HONG KONG SPECIAL ADMINISTRATIVE REGION

COURT OF FIRST INSTANCE

ACTION NO 6 OF 2014

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J U D G M E N T

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Introduction

1. This is the hearing of the 1^st and 2^nd defendants’ strike out application by summons dated 27 May 2014.

2. The 1^st and 2^nd defendants relied upon the following grounds under Order 18, rule 19 of the Rules of the High Court and the court’s inherent jurisdiction.  In particular:

(1) The plaintiffs’ claim is barred by the no reflective loss principle.  The plaintiffs are claiming for alleged losses suffered by one Accufit Investments Inc (“Accufit”).

(2) The 1^st defendant owes no duty to the plaintiffs as regard the sale by the Receivers of Accufit’s shares in Kith Holdings Limited (“KHL”) qua directors of Accufit.

(3) The plaintiffs’ claim discloses no reasonable cause of action, as the elements of a conspiracy claim have not been properly pleaded.

(4) The plaintiffs’ claim is in any event scandalous, frivolous and vexatious or is otherwise an abuse of the process of the court – the plaintiffs’ claim is wholly unsupported by facts and is only designed to starve‑off the 2^nd plaintiff’s bankruptcy.

3. It should be noted that at the beginning of the second day of the hearing, Mr Johnny Mok, SC (with him Mr Alexander Tang), counsel for the 1^st and 2^nd defendants, orally abandoned the above Ground (3) of the strike out application relating to the plaintiffs’ pleading of the conspiracy claim.

Factual Background

4. Very briefly, the salient facts of this case are as follows.

5. The 1^st plaintiff owns 100% of Accufit.  Accufit in turn held 161,000,000 shares in KHL, a listed company.  The 2^nd plaintiff was the founder and Chairman of KHL.

6. The 2^nd defendant is the sole director and shareholder of the 1^st defendant.

7. There is no dispute that:

(1) In September 2012, the 1^st defendant lent HK$140 million to Accufit and the 2^nd plaintiff provided a personal guarantee for the debt.

(2) In January 2013, the 2^nd defendant and Accufit entered into a supplemental loan agreement, varying some terms of the original HK$140 million loan and the 2^nd plaintiff signed a supplemental personal guarantee for the debt.

(3) In February 2013, the 1^st plaintiff executed a Debenture (including a floating charge) over all its assets (including its 100% shareholding in Accufit) to secure the loan.

(4) Despite repeated demands, Accufit failed to make repayment.  Cheques were issued for partial repayment, but they were dishonoured.  The last attempt was made on 28 March 2013.

8. Given Accufit’s default, the 1^st defendant took the following steps to protect its interests:

(1) On 12 April 2013, the 1^st defendant’s solicitors wrote to crystallise the floating charge over the 1^st plaintiff’s assets under the Debenture.

(2) On 6 May 2013, the 2^nd defendant appointed professional receivers under the Debenture, namely, Mr Fok Hei Yu and Mr John Batchelor of FTI Consulting (the “Receivers”).  Under the Debenture, the Receivers appointed themselves as directors of Accufit.  The Receivers are respectively the 3^rd and 4^th defendants in this action.

9. The 1^st plaintiff had full knowledge of these events but never voiced any objection thereto.

10. In the meantime, not only was Accufit in financial trouble, KHL’s financial situation also deteriorated rapidly:

(1) On 31 March 2013, KHL issued its 2012 Annual Results Announcement.  Its independent auditors raised concern over bank borrowings and loans, which had become overdue and unpaid, leading to “material uncertainty which may cast significant doubt on the Group’s ability to continue as a going concern…”.

(2) On 16 April 2013, KHL disclosed the disposal of a subsidiary at a book loss of more than HK$55 million for the purpose of the repayment of liabilities.

(3) On 23 April 2013, members of the KHL Group had to provide a general fixed and floating debenture to its creditor banks.

(4) On 31 May 2013, KHL announced that its plan to issue HK$300 million of bonds could not proceed as the placing agent was unable to procure subscribers.

(5) On 1 August 2013, KHL issued a loss warning.

11. On 18 December 2013, KHL published an announcement to:

(1) suspend trading of its shares; and

(2) put its most valuable business into voluntary liquidation.

12. On the same day, the Receivers (as directors of Accufit), after consulting independent financial advisers, decided to sell Accufit’s stake in KHL to Double Key International Limited, the 5^th defendant in this action (“Double Key”), at HK$0.38 per share.

13. As a result of the sale of the KHL shares to Double Key, Double Key was obliged to make a general offer to all shareholders of KHL at the same price of HK$0.38 per share.

14. On 9 May 2014, KHL’s Board issued a Response Document relating to Double Key’s general offer, which included a letter from an Independent Financial Adviser to KHL’s Board.  The Independent Financial Adviser took the view that the price of HK$0.38 was “fair and reasonable”.

15. In the meanwhile, the 1^st defendant tried to enforce the 2^nd plaintiff’s personal guarantee, and issued a statutory demand dated 18 November 2013 against the 2^nd plaintiff.  However, attempted service was unsuccessful, with the 2^nd plaintiff repeatedly giving the excuse that he was out of the jurisdiction through different solicitors.

16. On 2 January 2014, the 1^st and 2^nd plaintiffs commenced the present action against, inter alios, the 1^st and 2^nd defendants.

17. The plaintiffs’ claims are all premised upon the alleged sale at undervalue by the Receivers (as directors of Accufit) of Accufit’s KHL shares.  As put in paragraph 6 of the 2^nd Affirmation of the 2^nd plaintiff:

(1) The 1^st plaintiff, as the chargor and guarantor under the Debenture, claims that the sale at undervalue by the Receivers (as directors of Accufit) means that the 1^st defendant has breached its duties owed to the 1^st plaintiff as the chargee.

(2) The 2^nd plaintiff, as the guarantor of the debt, claims that the sale at undervalue by the Receivers (as directors of Accufit) means that the 1^st defendant has breached its duties owed to the 2^nd plaintiff as the chargee.

(3) The plaintiffs claim that there is a conspiracy amongst (1) the 1^st defendant (as chargee) and the 2^nd defendant (as its director); (2) the Receivers; and (3) the purchasers (ie, Double Key and its directors) to injure the plaintiffs economically by unlawful means (ie, the sale at undervalue).

18. As a result, the plaintiffs complain that they have suffered loss, such loss being framed as follows:

(1) But for the alleged wrongdoing, Accufit would have sold the KHL shares at a price sufficient to cover Accufit’s loan obligations owed to the 1^st defendant, and the plaintiffs’ liability under their Debenture/Guarantee would be discharged.

(2) Due to the alleged wrongdoing (ie, sale at undervalue), the plaintiffs’ liability is no longer fully discharged, but only partially discharged (by the undervalue consideration).

(3) The loss is therefore the difference between full discharge (the plaintiffs are not liable at all) and partial discharge (the plaintiffs liable for the loan amount minus the undervalue consideration).

Ground (1): The Reflective Loss Principle

19. Mr Mok SC points out that the only loss claimed by the plaintiffs is loss resulting from the sale of KHL shares allegedly at an undervalue.  The shares were held by Accufit, not by the 1^st plaintiff or the 2^nd plaintiff.  The sale was made by Accufit (with the Receivers being its directors).  The alleged loss was suffered by Accufit.  In the premises, any loss allegedly suffered by the 1^st plaintiff (as the chargor and guarantor under the Debenture) or the 2^nd plaintiff (as the guarantor of the debt) is reflective loss of Accufit.

20. I agree.  In this regard, it makes no difference that the loss alleged by the plaintiffs does not arise from the diminution in the value of the 1^st plaintiff’s shareholding in Accufit.  In Landune International Ltd v Cheung Chung Leung [2006] 1 HKLRD 39, Yuen JA held at paragraph 24 as follows:

“24 the focus of the rule against reflective loss is not on whether a wrong had been done to the plaintiff… personally, but on the loss he is seeking to recover – if the loss can be made good if the company… enforces its rights against the defendant, the plaintiff’s loss is a reflective loss and to prevent double recovery, its claim should be struck out.” (emphasis supplied)

21. Further, at paragraph 31, Yuen JA made it clear that the principle of reflective loss is not limited to cases where shareholders sue on the diminution of the value of its shareholding due to a wrong done to the company:

“31 The principle debarring reflective loss is not based on the relationship of the plaintiff to the company, whether it be shareholder‑company, or employee‑employer, or creditor‑debtor. The common thread is that the plaintiff’s loss would be made good if the company, employer or debtor, recovers from the defendant.”

22. In fact, the reflective loss principle applies to (1) non‑shareholder claimants; and (2) guarantor claimants claiming that a defendant has wrongfully impoverished the company, and thereby increasing the chance that the guarantee would be called upon.

23. Insofar as non-shareholder claimants are concerned, Neuberger LJ (as he then was) in Gardner v Parker [2004] 2 BCLC 554 held as follows at paragraph 70:

“[70] …the rule against reflective loss is not limited to claims brought by a shareholder in his capacity as such; it would also apply to him in his capacity as an employee of the company with a right (or even an expectation) of receiving contributions to his pension fund. On that basis, there is no logical reason why it should not apply to a shareholder in his capacity as a creditor of the company expecting repayment of his debt. Indeed, it is hard to see why the rule should not apply to claim brought by a creditor (or indeed, an employee) of the company concerned, even if he is not a shareholder…” (emphasis supplied)

24. More pertinent to the present case, both the English and the Australian courts have held that guarantors of a company’s debts cannot sue a defendant on the basis that the defendant has wrongfully impoverished the company, and thereby increasing the chance that the guarantee would be called upon.

25. In  Erridge v Coole & Haddock (a firm) (2000 WL 1274094, unreported), Ferris J held as follows:

“… This was to the effect that the only possible impact of Coole & Haddock’s conduct in relation to the EGH guarantee was that, EGH was unable to satisfy its liabilities as principal debtor to the Bank because it had been impoverished by, in effect, taking an interest which proved to be of only nominal value in new Premier in substitution for its valuable interest in old Premier. But Mr Johnson argued that, assuming this to be the case, the principle of Prudential Assurance prevents Mr Erridge from recovering from Coole & Haddock whatever he may have to pay under the EGH guarantee. This is simply another way in which Mr Erridge’s loss under the guarantee reflects EGH’s own loss.

I think that this submission is well-founded. I do not think that, in relation to the Prudential Assurance principle, there is a difference of kind between loss in the form of a diminution in the value of Mr Erridge’s shares in EGH and loss in the form of an increased risk of Mr Erridge’s guarantee being called upon…” (emphasis supplied)

26. A similar conclusion was reached by the Supreme Court of Western Australia in Heedes v Telstra Corp Ltd [2001] WASC 297.  At paragraph 21, it was held as follows:

“[21] … These are personal liabilities incurred by the plaintiff. But they have been incurred as a consequence of his guaranteeing debts of Toolwise Pty Ltd. If Toolwise Pty Ltd recovered from the defendant in an action for breach of contract or otherwise, then the damages would allow Toolwise Pty Ltd to meet its creditors and the plaintiff would not have been called upon under the provisions of various guarantees. Look at in this way, the losses claimed are reflective and the claim cannot be sustained.” (emphasis supplied)

27. As pointed out by Mr Mok SC, it appears that the plaintiffs are well aware of this principle.  The 1^st plaintiff had applied to the BVI court for leave to commence a statutory derivative action in the name of Accufit against basically the same parties as in this action, and in respect of the same loss, namely, loss arising out of the alleged sale at undervalue of Accufit’s KHL shares.

28. Faced with the above authorities, Mr Douglas Lam, counsel for the plaintiffs, submitted that the principle against reflective loss is not engaged for the simple reason that Accufit, the company, has no cause of action against the 1^st defendant (as opposed to the Receivers as its directors) under the Debenture.  Mr Lam submitted that:

(1) The Debenture was entered into between the 1^st defendant and the 1^st plaintiff in respect of the charged assets, which includes the 1^st plaintiff’s 100% shareholding in Accufit.

(2) The complaint by the 1^st plaintiff is that the 1^st defendant breached its equitable duties owed to the 1^st plaintiff by instructing or directing the Receivers to act in breach of their equitable duties as receivers of the charged assets.

(3) The 1^st defendant does not owe any duties to Accufit under the Debenture and cannot be liable to Accufit for the sale at an undervalue.

29. Mr Lam, however, accepted that in the application to the BVI court for leave to commence a derivative action in the name of Accufit, the intended action did in fact include a proposed claim by Accufit against the 1^st defendant for dishonestly assisting the Receivers in their breach of duties.  But Mr Lam submitted that the nature of that claim was very different from that in these proceedings and the threshold for establishing liability would be very much higher.

30. Mr Lam went on to submit that, for the purpose of a strike out application, not only must the defendants show that the company has a claim as such, but it must be shown also that the company’s claim is available on the facts [see: Shaker v Al-Bedrawi [2003] 1 BCLC 157 at paragraph 83].

31. Mr Lam further submitted that in considering this question, the court “must at least be satisfied on the evidence whether or not the company had a claim which was likely to succeed, an exercise which involves considering not just the case which the company could have made, but the defences which could have been raised to it” [see: Perry v Day [2004] EWHC 1398 (Ch), per Rimer J at paragraph 65]. 

32. In reply, Mr Mok SC submits that Mr Lam’s above argument cannot possibly assist the plaintiffs regarding their conspiracy claim against the defendants (see paragraph 17(3) above). In respect of the conspiracy claim, based on the facts and matters pleaded in the Statement of Claim, the same remedy must be available to Accufit, the company, as well as the plaintiffs.  For this reason, the plaintiffs’ claim for conspiracy must be struck out, based on the rule against reflective loss.  I agree.  Indeed, Mr Lam has been quite unable to advance any argument against the striking out of the plaintiffs’ conspiracy claim against the defendants.

33. In this regard, it is important to note that the only claim made by the plaintiffs against the 2^nd defendant in this action is for the tort of conspiracy.  It follows that the plaintiffs’ claim against the 2^nd defendant must be struck out entirely.

34. In respect of the plaintiffs’ claims against the 1^st defendant for breach of duties under the Debenture (see paragraph 17(1) and (2) above), Mr Mok SC made the important point that when the English Court of Appeal in Shaker v Al-Bedrawi, Supra, spoke of the company’s claim being “available on the facts”, the court is not being asked to assess the likelihood of such claim being established.  Mr Mok SC referred to the judgment of Judge Rich QC in Perry v Day [2005] 2 BCLC 406, where at paragraph 25 it was held as follows:

“[25] I agree with Mr De Waal that that reference to availability on the facts in the context of that judgment is a reference to whether, on the facts, the company had a cause of action, not the likelihood of such claim being successfully pursued…”. (emphasis supplied)

35.  DHCJ Marlene Ng held to the similar effect in Lee Sai Nam v Li Shu Chung [2014] HKCU 335, at paragraph 39:

“[39] I am also unable to accept Mr Wong SC’s submission that one looks to the alleged wrongdoer’s defence allegations to determine whether the shareholder’s claim falls foul of the no reflective loss principle. If that were the case, the no reflective loss principle can be easily circumvented whenever the wrongdoer denies liability or wrongdoing. In my view, it is only when the alleged reflective loss claim itself inherently causes some anxiety or when the issue of whether or not the alleged loss is reflective loss depends on how the evidence turns out that one may argue against the applicability of the no reflective loss principle. If the defence merely denies wrongdoing without alleging any factual underpinning that goes to the question of whether or not the loss claimed is reflective of the loss said to be suffered by the company, its relevance to the issue is doubtful”. (emphasis supplied)

36. Mr Mok SC further relied on the decision of Fok JA (as he then was) in Pico North Asia Holdings Ltd (formerly known as Pico North Asia Ltd) v Cheung Yuk Ting Linda [2011] HKCU 256, where at paragraphs 37 to 40, it was held that the application of the no reflective loss principle was not affected by the fact that the defendants in that action might owe different duties to the plaintiff, to those owed by them as directors to the companies.  Similarly, the reliance by the plaintiff on breaches of contractual duties or duties in tort on the part of the defendants did not affect its application.  Ultimately, the question is whether the loss allegedly suffered by the plaintiff by reason of the breaches asserted in the action is merely reflective of the companies’ loss.

37. Mr Mok SC went on to submit that, on the pleadings in this action, the facts and matters pleaded by the plaintiffs regarding the 1^st defendant’s breach of duties under the Debenture were also relied upon by the plaintiffs in support of their conspiracy claim.  In other words, the same conduct on the part of the 1^st defendant forms the basis of both claims.

38. I entirely agree with Mr Mok SC.  The position is indeed abundantly clear under paragraph 37 of the Statement of Claim, where the plaintiffs aver that they will rely on paragraphs 1 to 36 thereinabove (dealing with the 1^st defendant’s breach of duties under the Debenture) in support of their conspiracy claim (which, as I have already held in paragraph 32 above, is a cause of action equally available to Accufit, the company, on the facts).

39. In the premises, I hold that the plaintiffs’ claims against the 1^st defendant for breach of duties under the Debenture should also be struck out under the no reflective loss principle.

Ground (2): No duties owed by the 1^st defendant to the plaintiffs

40. I can briefly deal with this by saying that I would not have struck out the plaintiffs’ claims against the 1^st defendant on this ground alone.

41. It is the plaintiffs’ case, as pleaded in the Statement of Claim, that the Receivers were in fact acting under the directions or instructions of the 1^st defendant.

42. I agree with Mr Lam that the precise role played by the 1^st defendant in the sale, the nature and particulars of any directions and instructions given by the 1^st defendant to the Receivers, will be matters for trial and cross‑examination, after full discovery and any administration of interrogatories.  On the basis of the matters pleaded, it cannot be said that such a claim cannot succeed.

43. Once it is shown that there is an arguable case that the 1^st defendant played an active role in the sale, including giving directions and instructions to the Receivers, then there is no reason why it should not be under the duties to the 1^st plaintiff and the 2^nd plaintiff as pleaded in, inter alia, paragraphs 22 and 23 of the Statement of Claim.  This is in addition to the separate claim against the 1^st and 2^nd defendants for conspiracy using unlawful means.

Ground (4): Frivolous, Vexatious or Abuse of process of the court

44. I can also deal with this briefly by holding that I would not have struck out the plaintiffs’ claims against the 1^st and 2^nd defendants on this ground alone.

45. In short, I agree with Mr Lam that this ground is little more than an attempt to conduct a mini‑trial on affidavits in a striking out application.  Such an approach has been deprecated by the courts on numerous occasions, including in Ha Francesca v Tsai Kut Kan (No 1) [1982] HKC 382 (CA).  I agree that it is unnecessary for the plaintiffs to enter into a detailed debate on the merits at this early stage, particularly when the defendants have not yet filed a defence and discovery has not yet taken place.

Conclusion and Disposition

46. For the reasons stated above, I order that:

(1)    the plaintiffs’ Statement of Claim filed herein on 18 March 2014 as against the 1^st and 2^nd defendants be struck out; and

(2)    this action, as against the 1^st and 2^nd defendants, be dismissed.

47. I make a costs order nisi that the plaintiffs do pay to the 1^st and 2^nd defendants the costs of the 1^st and 2^nd defendants’ summons dated 27 May 2014 and their costs of this action (with a certificate for 2 counsel for the hearing on 22 and 23 October 2014), such costs to be taxed if not agreed and paid forthwith.  The costs order nisi shall become absolute in the absence of application to vary within 14 days. 

48. Lastly, I thank counsel for their helpful assistance in this matter.