HONG KONG ZHIXIN FINANCIAL NEWS AGENCY LTD v. CHINA MAPLE LEAF EDUCATIONAL SYSTEMS LTD

HCA 2973/2016

[2019] HKCFI 2921

IN THE HIGH COURT OF THE

HONG KONG SPECIAL ADMINISTRATIVE REGION

COURT OF FIRST INSTANCE

ACTION NO 2973 OF 2016

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D E C I S I O N

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Introduction

1.  This is the appeal of the defendant (“D”) against the decision of Master Suen (the “Master”) made on 14 November 2018 (the “Decision”) refusing D’s application (“D’s Application for Security”) for an order that the plaintiff (“P”) shall pay security for costs of the action. 

2.  The power to order security for costs, upon proof of certain specific threshold matters, is discretionary.  The ultimate issue in this appeal boils down to how the Court should exercise its discretion having regard to the merits of the parties’ respective cases and the fact that D has pleaded a counterclaim.

P’s claim, and D’s defence

3.  P is a company incorporated under the laws of Hong Kong.  It “is…principally engaged in providing investor and media relations services” [1].

4.  D is a company incorporated in the Cayman Islands.  Its shares are listed on the Hong Kong Stock Exchange (“HKSE”).

5.  By this action, P is seeking specific performance of an agreement dated 8 June 2015 (the “Agreement”) as modified by a supplemental agreement dated 17 July 2015 (the “Supplemental Agreement”) it had entered into with D.  Pursuant to those agreements, and according to P:

 (a) P was entitled to an option (the “Option”) to subscribe for 17,500,000 shares in D (the “Option Shares”);

 (b) That Agreement to grant the Option to P was “in consideration of [P’s] services as an investor and media relations consultant to [D] for a term of three years” [2];

 (c) The Option would remain exercisable for 6 months after the relevant conditions were met [3];

 (d) The Option, when granted, would be exercisable in two tranches [4]:

 (i) 40% of the Option (the “First Batch Option”) upon the market capitalization of D reaching HK$8 billion for 15 consecutive trading days during the 18‑month period after the date of the Agreement (the “First Batch Condition”); and

 (ii) 60% (the “Second Batch Option”) upon the market capitalization of D reaching HK$10 billion for 15 consecutive trading days during the 36‑month period after the date of the Agreement (the “Second Batch Condition”);

 (e) D would grant the Option to P within 3 months of the Agreement [5];

 (f) The issue of the Option Shares would be subject to permission to deal by the Listing Committee of the HKSE to be sought by D [6];

 (g) The Option would not be affected by any early termination of the Agreement and would be irrevocable once it has been granted [7];

 (h) The Option was granted on 8 June 2015 [8];

 (i) In its June 2015 Monthly Returns on Equity Issuer on Movements in Securities submitted to the HKSE (the “06/15 Monthly Returns”), D reported that:

“ Options granted to [P] on 8 June 2015 pursuant to the general mandate granted to the Board by the shareholders of [D] on 4 February.”

It was only in 12 July 2016 when D sought to deny the grant of the Option by revising what had been reported in the 6/2015 Month Return from what it was to:

“ On 08/06/2015 [D] entered into an engagement agreement with [P], pursuant to which [D] agreed to grant options to [P]… No option has been granted under the engagement letter as at close of the month.” [9]

 (j) P and D entered into the Supplemental Agreement on 17 July 2015. They agreed upon certain additional conditions relating primarily to the convening of an extraordinary general meeting (“EGM”) to approve a Specific Mandate (the “Specific Mandate”) to the directors for the grant of the Option;

 (k) Pursuant to the Supplemental Agreement, an EGM was convened on 24 August 2015.  In its announcements and notice convening the same (“EGM Notice”), and as pleaded by P[10], the EGM was:

“ for the purpose of considering and, if though fit, passing an ordinary resolution to, inter alia, approve the Agreement (as amended by the Supplemental Agreement) and the transactions contemplated thereunder, including the Specific Mandate for the grant of the Option and the allotment and issue of the Option Shares.”

At the EGM, the Specific Mandate was approved [11];

 (l) On 30 September 2015, the HKSE granted listing approval to D [12];

 (m) In the Monthly Returns of August 2015 to May 2016 (the “08/15 to 05/16 Monthly Returns”), D reported that:

“ Options granted to [P], pursuant to the specific mandate granted to the Board by the shareholders of [D] on 24 August 2015.”

Again, it was only in 12 July 2016 when D sought to deny the grant of the Option by revising what had been reported in the 08/15 to 05/16 Monthly Returns to:

“ Specific mandate to the Board to grant the options to [P] was given by the shareholders of [D] on 24/8/2015. No option has been granted under the specific mandate as at close of the month” [13]

 (n) By 15 June 2016[14] and 4 October 2017[15], the First and Second Batch Conditions had been satisfied;

 (o) P exercised the First Batch Option and Second Batch Option by letters dated 5 October 2016 [16] and 21 November 2017 [17];

 (p) D refused to acknowledge P’s exercise of the Option or to issue and allot the Option Shares.

6.  In its Re‑Re‑Amended Defence and Counterclaim “RRAD&C”):

 (a) D has raised a number of defences.  As summarized in his written submissions [18] by Mr Tony Ko, Counsel for D (with bundle references omitted):

“ The defences advanced by D against P’s claim were as follows:

a. The services provided by P were far from satisfactory, to an extent that it amounted to a total failure of consideration (‘Unsatisfactory Services Defence’);

b. The grant of Option is subject to the approval of HKSE which was conditional upon various factors, inter alia, no violation of Listing Rules and/or the Securities and Futures Ordinance (‘SFO’) on the part of P when it was referring services to D (‘Conditional Approval Defence’);

c. Ms Chen Yuhong (‘Ms Chen’) the sole director and 100% owner of P, had engaged in insider dealing (defined under s.245 of the SFO) in D’s listed shares, breaching a condition of the Agreement (‘Insider Dealing Defence’); and

   d. P induced D to enter into the Agreement and Supplemental Agreement by misrepresenting it had the capability to introduce and procure Mainland investors to make substantial investments in D (the ‘Misrepresentation’)… which was over‑priced when compared with another provider of the same services, but for P’s misrepresentation (‘Misrepresentation Defence’) [19] ”

 (b) I will come back to those defences;

 (c) Repeating and relying primarily on the matters pleaded in the Defence, D counterclaims for the following relief:

“ I. damages to be assessed;

II. a declaration that the Option had not been granted, and had lapsed or been cancelled upon [P’s] breaches and/or its repudiation of the Agreement;

III. in the alternative to (II), a declaration that [P] is not entitled to exercise the Option, by reason of its breaches and/or repudiation of the Agreement;

   IV.    in the further alternative, restitution in respect of any Option granted be made by the [P] to [D], such that the right to exercise any rights under the Option is to be deemed to have lapsed or been cancelled.”

Whether P “is ordinarily resident out of the jurisdiction”

7.  D’s Application for Security is made pursuant to Order 23 rule 1. Whether P “is ordinarily resident out of the jurisdiction” is the threshold issue.  It is only where it appears to the Court that P is ordinarily resident out of the jurisdiction when the Court may exercise its discretion and order it to give security.

8.  On the legal approach to adopt when considering whether a limited company is ordinarily resident out of Hong Kong, I have considered Hui Yin Sang v Tsoi Ping Kwan [2012] 2 HKLRD 1085, where Fok JA (as his Lordship then was) referred to Re Little Olympian Each Ways Ltd [1995] 1 WLR 560 and Charter View Holdings (BVI) Ltd v Corona Investments Ltd [1998] 1 HKLRD 469 and summarized the position at §14, that:

“ (1) The mere assertion of where the company’s central management and control is located is unsatisfactory. What is needed are the primary facts on which that assertion is based.

(2) All the circumstances in which the company carries on its business should be taken into account, though the weight to be applied to each factor will differ from case to case. Those factors include:

(a) the provisions of the company’s objects clause,

(b) the place of incorporation,

(c) the place where the company’s real trade and business is carried on,

(d) the place where the company’s books are kept,

(e) the place where the company’s administration is carried out,

(f) the place where the directors with power to disapprove of local steps or to require different ones to be taken themselves meet or are resident,

(g) the place where its chief office is or where the company secretary is to be found, and

(h) the place where its most significant assets are.

(3)   In applying the test to a non‑trading company, it may be more important to have regard to the nature of the company’s corporate activities.”

9.  Mr Ko submits that on the evidence, P is ordinarily resident out of Hong Kong.  He highlights the evidence that P has no physical business presence in Hong Kong (in the sense that the sole director and 100% shareholder of P resides in Shenzhen, and that the registered address of P is the same as its company secretary), that P has provided no means of contact within Hong Kong, that under the Agreement P was primarily to provide services in relation to Investors based in the Mainland, that most of P’s related companies primarily operated in the Mainland, and that P has no substantial fixed assets in Hong Kong.

10.  Whilst not conceded, the contrary has not been pressed hard by Mr Li.

11.  On the evidence, I am of the view that P is ordinarily resident out of Hong Kong. 

The discretion

The law

12.  Upon proof of the threshold, the Court’s discretion is engaged.  That is “a real discretion”.  As explained in §23/3/3 of the Hong Kong Civil Procedure 2020:

“ Rule 1(1) provides that the court may order security for costs ‘if, having regard to all the circumstances of the case, the court thinks it just to do so’. These words have the effect of conferring upon the court a real discretion, and indeed the court is bound, by virtue thereof, to consider the circumstances of each case, and in the light thereof to determine whether and to what extent or for what amount a plaintiff (or the defendant as the case may be) may be ordered to provide security for costs. It is not an inflexible or rigid rule that a plaintiff resident abroad should provide security for costs…

In exercising its discretion under r.1(1) the court will have regard to all the circumstances of the case. Security cannot now be ordered as of course from a foreign plaintiff, but only if the court thinks it just to order such security in the circumstances of the case…

A major matter for consideration is the likelihood of the plaintiff succeeding. In exercising its discretion, the court may take into account the merits of the plaintiff’s claim. If the case of the plaintiff is genuine and strong, no order for security would be granted… On the other hand, an order for security would usually be granted if the plaintiff cannot clearly demonstrate that it has a high degree of probability of success at trial… The court will also have to consider the defendant’s prospects of success; in other words, whether it has an arguable defence. This is to be approached in a broad‑brush manner, and the court is not to embark on an assessment exercise as though it were considering an application for summary judgment under O.14 (Wai Shun Construction Company Limited (in Liquidation) v Fitzroya Finance Company Limited (unrep., HCA 2051/2004, [2007] H.K.E.C.1302)…

This is not to say that every application for security for costs should be made the occasion for a detailed examination of the merits of the case.  It is not the function of the court, when faced with an application for security for costs, to make a ‘preliminary run’ at deciding the ultimate success or failure of the claim (Sunchase International Group (China) Ltd v Vincor Group of Companies (Investment) Ltd [2004] 1 H.K.L.R.D. 731.  The strength of a plaintiff’s case is only a material consideration in simple cases.  The court will not embark on determining whether a case is ‘genuine and strong’ if that case is not straightforward and not amenable to ready assessment of the prospects of a party’s case being made out at trial…”

13.  That the applying defendant has pleaded a counterclaim is a relevant consideration.  The question is whether the defendant is as much an “attacker” as the plaintiff:

 (a) As commented upon also in §23/3/3 of the Hong Kong Civil Procedure 2020:

“ …Additional principles apply in cases where security for costs is sought against a plaintiff against whom the defendant has made a counterclaim. These principles are conveniently summarised in Ai Zhong v Metrofond Ltd [2010] 1 HKLRD 213, 221…”

 (b) In Ai Zhong, Yam J at §22 summarized as follows the considerations:

“ 22. It has been said that when a defendant counterclaims, there is a chance that an application by the defendant for security of costs against the plaintiff would be refused. It is useful to set out the various rules concerning the importance of who is the ‘real attacker’ in a proceeding before I consider the arguments from counsel of both sides:

(a) The Court has a discretion in all applications for security for costs, and it is not a question of merely considering whether the claim and counterclaim arise out of the same issue of fact but a question of ‘what is fair and just in all the circumstances’. (Hutchison Telephone (UK) Ltd v Ultimate Response Ltd [1993] BCLC 307, per Dillon LJ.)

(b) Application for security for cost should be refused if it will prevent the plaintiff from pursuing its claim but in the course of defending the counterclaim all the same matters would be canvassed as would be canvassed if the plaintiff were to pursue its claim. (Goal Setting Consulting Co Ltd v Unigraphics Solutions Asia/Pacific Inc (unrep., HCA 994/2003, [2005] HKEC 20), citing BJ Crabtree (Insulation) Ltd v GPT Communications Systems (1993) 59 BLR 43.)

(c) Application should also be refused when the cost incurred by the defendant for the purposes of the defence might equally and perhaps preferably be regarded as costs necessary to prosecute the counterclaim. (Goal Setting Consulting Co Ltd v Unigraphics Solutions Asia/Pacific Inc, citing BJ Crabtree (Insulation) Ltd v GPT Communications Systems.)

(d) The existence of a counterclaim arising out of the same matters as that in the plaintiff’s claim per se does not affect the Court’s ability to order security for costs against the plaintiff. (Winghing Investments Ltd v Lee Hoi Wing (unrep., CACV 378/2005, [2006] HKEC 378).)

(e) It is pertinent to ask whether in the particular case the counterclaim is a cross‑action or operates as a defence, that is to say merely operates as a defence. (Hutchison Telephone (UK) Ltd v Ultimate Response Ltd, per Dillon LJ.)

(f) In determining the question in (e), the most important factor to consider is whether ‘the claim by the plaintiffs and the cross‑claim by the defendants — raise essentially the same issues and are going to be fully litigated anyway so far as one can tell’. (BJ Crabtree (Insulation) Ltd v GPT Communications Systems, per Bingham LJ at p.54.)

(g) In determining the question in (e), the marked discrepancy in size between the amount claimed in the action and the very much greater amount claimed by the cross‑claim is also a relevant factor. (Hutchison Telephone (UK) Ltd v Ultimate Response Ltd, per Dillon LJ.)

(h) A defendant should not be required to give security for costs if he is only defending himself from the plaintiff’s claim. (Hutchison Telephone (UK) Ltd v Ultimate Response Ltd, per Bingham LJ.)

(i) When both the plaintiff and defendant can be viewed as attackers, the treatment of both parties in security for costs should be the same.  (Samuel J Cohl Co v Eastern Mediterranean Maritime Ltd [1980] 1 Lloyd’s Rep 371, cited with approval by Ma J in Brand Farrar Buxbaum LLP v Samuel‑Rozenbaum Diamond Ltd [2003] 1 HKLRD 600.)”

P’s case genuine and strong

14.  I consider first of all the merits of the parties’ respective cases. I necessarily have to adopt a broad brush approach when doing so [20]. After all, at this stage, the pleadings are primarily all that the Court has.

15.  P’s claim is a relatively straight‑forward one.  On the face of pleadings, the existence of the Agreement and Supplemental Agreement is not in dispute.  The EGM was convened on 24 August 2015.  The Specific Mandate was approved during the EGM.  The HKSE granted listing approval to D on 30 September 2015.  That approval must have been sought by D pursuant to Clause 2(1)(I)(ii)(F) of the Agreement.  The First and Second Batch Conditions had been met.  P exercised the First Batch Option and Second Batch Option by letters dated 5 October 2016 and 21 November 2017.  D had not however issued or allotted any Option Shares to P.

16.  I note that it is D’s case that the grant of the Option was conditional, and that none had been granted [21].

17.  I have set out the relevant original contents of the 06/15 Monthly Returns and the 08/15 to 05/16 Monthly Returns.  The contemporaneous reporting by D of the grant of the Option supports P’s pleaded case that the Option has been granted.

18.  I have also considered the contents of the EGM Notice:

 (a) I deal first of all with its admissibility:

 (i) The EGM Notice, albeit pleaded in the RASoC, was not produced before the Master during the hearing.  Mr Li now seeks to place it before me as an annexure to his supplemental submissions;

 (ii) Mr Ko objects to its production on that basis that P could not satisfy the Ladd v Marshall conditions;

 (iii) Mr Li informed me that the EGM Notice was not placed before the Master because at the time of the hearing, the parts of the Amended Statement of Claim (not yet re‑amended at that stage) which pleaded the EGM Notice [22] had been unreservedly admitted by the D[23].  In the light of the admission, it was deemed not necessary to produce the EGM Notice.  Subsequently in May 2019, D in its RRAD&C by amendments subjected the admissions to certain reservations.  That change of circumstances, in Mr Li’s submissions, justifies the production of the EGM Notice;

 (iv) Given the change of circumstances, and given the fact that the EGM Notice is a public document, I allow D to produce it for the purpose of this appeal;

 (b) At p 7 of the EGM Notice, it was specifically stated that the “Date of Grant” of the Option was “8 June 2015”.  This again supports P’s claim that the Option has been granted.

19.  In my view, the facts pleaded by P and the contemporaneous conduct of D amply support P’s pleaded case.

20.  I next consider D’s main pleaded defences as summarized by Mr Ko.

21.  In so far as the Unsatisfactory Services Defence is concerned, it should be noted that D has not in its RRAD&C sought any rescission of the Agreement.  Whilst Mr Ko in his written submissions adopts the stance that the “services provided by P were far from satisfactory, to an extent that it amounted to a total failure of consideration”, he fairly informs me in the course of his oral submissions that he is not pushing total failure of consideration, and that this limb of D’s case at best grounds only a monetary counterclaim. 

22.  In relation to the Conditional Approval Defence, Mr Ko relies heavily on the clause in the Agreement[24] to the effect that P, in the performance of its duties under the same, should not breach any HKSE rules on insider dealing or committed any market misconduct stipulated in s 245 of the Securities and Futures Ordinance, Cap 571 (“SFO”).

23.  There is in my view a lot of force in Mr Li’s submission that that clause in the Agreement related only to D’s obligations in the performance of its contractual duties under the Agreement.  It did not otherwise impose any condition upon the grant of the Option.

24.  In any event, even assuming that there had been such a condition, D would still have to plead and prove in due cause the breach thereof.  It is in this regard where D seeks to rely on the Insider Dealing Defence.

25.  In §21 of the RRAD&C, D pleads that:

“ By virtue of its position under the Agreement, [P] (and as a result Chen [25]) have and did may have, from time to time, come into possession and/or had access to ‘inside information’ as defined by s.245 of the SFO e.g. information in relation to [D’s] business development plans, performance market promotion, and other information.”

26.  The first point I note is D’s use of the words “may have” (amended from “have and did ”).  That is hardly a sufficient basis to support a serious allegation of insider dealing.

27.  When considering an allegation of insider dealing, the starting point has to be the identification of the “inside information” concerned. According to the definition set out at s 245 of the SFO, “inside information” has to be “specific information”. 

28.  Paragraphs 26 to 29 of D’s RRAD&C is under the heading of “Inside information during the Trading Period”:

 (a) In §26 thereof, D refers to certain unspecified “favourable and positive and positive research reports in relation to [D]”.  In my view, specificity is wanting;

 (b) In §28 thereof, D refers to “an important strategic agreement with China Merchants Bank regarding the bank’s arrangement to assist [D’s] business expansion” that was signed on 14 August 2015.  Particulars of that agreement are lacking.  Even assuming that this information passes the specificity test, one notes from section D of the Chronology prepared by Mr Ko (which is meant to set out the Trading of Ms Chen on the shares in D) that Ms Chen had not traded in any shares in D during the approximately one and a half months before and after the signing of that “strategic agreement”.

29.  On the pleadings before me, the Insider Dealing Defence is vague, lacks specificity, and is verged on being contrived.

30.  In relation to the Misrepresentation Defence, Mr Ko submits that it is inherently likely that P had made the Misrepresentation, otherwise, D would not have granted it the Option, which was valuable.

31.  Whether the grant of the Option was a term unduly favourable to P would be dependent upon whether the Option was in the or out of the money when granted.  In any event, in relation to the rationales behind and reasons for the grant, Mr Li has drawn to my attention §5(b) of the EGM Notice, that:

“ The Options are subject to the Conditions that are tied to the market capitalization of the [D], which was designed to motivate [P] so that they can provide the best services possible to [D] and ensure that their interests are in line with the interest of the Shareholders of [D].”

32.  More importantly, Mr Ko accepts that the Misrepresentation Defence is extraneous to the Agreement and the Supplemental Agreement.  I repeat that no rescission of the Agreement is being sought.

33.  This is not an application for a summary judgment.  The question is not whether there is any triable issue.  The purpose of the exercise is to consider the pleadings as a whole to gauge the likelihood of P succeeding so as to assist me in deciding how the discretion has to be exercised.  Mr Ko submits that this is a complicated case with voluminous amount of documents. But on the pleadings presented to me, for the reasons set out above, and applying a broad brush approach, I find myself able to form the view that D’s pleaded defences are far from strong, and despite the contents of D’s RRAD&C, P’s case is and remains genuine and strong.

D equally an attacker

34.  I have set out above D’s case.  Some factual issues raised by the RRAD&C are common to those framed by the RASoC.  Some go beyond.  One specific example concerns the quality of the services P had provided.  A 6‑page table is annexed to the RRAD&C in relation to that.  The issue of Insider Dealing is another.  The allegations made in that regard are serious, and can ground criminal liabilities.  The Misrepresentation Defence is extraneous to the Agreement.  D counterclaims against P “damages for deceit or misrepresentation”.  D is, borrowing the words of Ma J (as the Chief Justice then was) in Brand Farrar Buxbaum (at §26), D is “at least also as much an attacker or plaintiff ”.

35.  Mr Ko submits that the Master, rather than dismissing D’s Application for Security, ought to have, like Ma J did in Brand Farrar Buxbaum, considered ordering both P and D to give security.  I reject that submission.  D is listed on HKSE.  D has a “Principal Place of Business in Hong Kong” — see the EGM Notice.  The evidence suggests that it is not ordinarily resident out of the jurisdiction.  There is no question of it being ordered to pay security under Order 23.  Mr Ko then points to s 905 of the Companies Ordinance, Cap 622.  But the application of that section is dependent upon “credible testimony…that there is reason to believe the company will be unable to pay the defendant’s costs if the defendant succeeds in the defence”.  There was no such evidence before the Master.  Nor is there any before me.  Quite the contrary, it is Mr Ko’s submissions that D is financially sound.

36.  Mr Ko then relies on an undertaking that D has given (the “Undertaking”). I have not been shown any formal documents showing when, by whom and to whom the Undertaking was given, or its exact terms.  Mr Ko points me to §43 of his written submissions, which records the Undertaking in the following terms, that “D would not pursue its counterclaim if P’s claim is stayed/dismissed for failure to put up the security for costs ordered ”.

37.  As accepted by Mr Ko, the Undertaking will only bites if (1) P is ordered to give security, (2) P fails to put up the security ordered, and (3) P’s claim is stayed or dismissed as a result.  But if P is ordered to put up security but is able to do so, both the claim and the counterclaim will proceed.  I agree with Mr Li that it will be unfair in that scenario to order only P to put up security when D is “at least as much also an attacker or plaintiff ” which has raised issues common to those framed by the RASoC and beyond. 

P having no fixed assets in Hong Kong

38.  Mr Ko accepts that P has certain assets in Hong Kong [26]. His real complaint is that those assets, comprising securities and cash, are not fixed, and can easily be liquidated or otherwise transferred out of Hong Kong.  He submits that if D succeeds in his defence, and in the absence of any security, D will face significant risk of not being able to recover and enforce any cost order made in D’s favour.

39.  I do not accept that that constitutes sufficient basis for the Court to order security.  There is no rule or practice that a defendant who has no fixed assets within the jurisdiction should be ordered to put up security. In fact, even the insolvency or poverty of a plaintiff is no ground for requiring him to give security under Order 23 — See Hong Kong Civil Procedure 2020, §23/3/13.  I add that D’s Application for Security is not made pursuant to s 905 of the Companies Ordinance, and if it were, different issues would have had to be addressed.

40.  I would however take this factor into account when considering the overall justice of the order to be made.

Overall justice

41.  My duty is to have regard of all the circumstances of the case and decide, in my discretion, whether it is just to order P to give security. Given my view that P’s claim is genuine and strong, that D has pleaded a Counterclaim which in the light of its scope and nature renders D at least as much also an attacker or plaintiff, for the reasons and analysis set out above, and despite P’s apparent lack of fixed assets in Hong Kong, I form the view that it is not just to order P to give security. 

Conclusion

42.  For the above reason, I dismiss D’s appeal.

Costs

43.  I make a costs order nisi that the costs of the appeal be to P.  I am minded to order summary assessment.  I am not minded to grant certificate for 2 counsel, but only 1 covering Mr Li.  Any party who seeks any variation or summary assessment should lodge their submissions within 14 days from the date hereof, response within 14 days upon receipt, and reply within 7 days thereafter.