ZIMMER SWEDEN AB v. KPN HONG KONG LTD AND ANOTHER

CACV 172/2015

IN THE HIGH COURT OF THE

HONG KONG SPECIAL ADMINISTRATIVE REGION

COURT OF APPEAL

CIVIL APPEAL NO. 172 of 2015

(ON APPEAL FROM HCA 2264 OF 2013)

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J U D G M E N T

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Hon Lam VP:

1. I have the benefit of reading the judgment of Yuen JA in draft and I agree with it. In addition, as Her Ladyship mentioned, the fraud exception had been abrogated in England since 1992. Though the wide interpretation given to that exception in Hong Kong avoids the illogicality identified by Nicholls LJ, it does not mean that in the context of the modern litigation environment in Hong Kong the continuous existence of such exception can be justified. For my part, I can see considerable force in the argument that such an exception no longer sits well with the modern litigation landscape. I will recommend to the Rules Committees of the Rules of the High Court and the Rules of the District Court to review the appropriateness of keeping this exception in our rules. A copy of this judgment will be furnished to the secretaries of those committees.

Hon Yuen JA:

2. This is the plaintiff’s appeal from a decision of Chung J given on 30 April 2015 dismissing its  application for summary judgment on the ground that the application fell within the exception to Order 14 provided by rule 1(2)(b) which states:

“ ... this rule applies to every action begun by writ other than -

(b) an action which includes a claim by the plaintiff based on an allegation of fraud”.

In the authorities, this rule has been referred to as “the fraud exception” and I will adopt this term for convenience.

Background

3.1.  The plaintiff is a Swedish company with headquarters in the USA.  Its case is as follows.

3.2. On 14 October 2013 its Finance Manager was deceived by a person posing as a senior executive of its parent company into transferring EUR487,000 (“the 1^st Transfer”) to the Lithuanian bank account of a company called “Enara UAB”.  It is the plaintiff’s case that “Enara” is also known as “Kosona”.

3.3.  At the time the 1^st Transfer sum was received, the balance in Kosona’s bank account stood at zero. 

3.4.  The next day (15 October 2013) Kosona converted EUR467,000 into US currency, of which a net sum of USD628,417.29 was remitted to a Hong Kong bank account of the 1^st defendant, KPN Hong Kong Ltd.  This sum has been referred to as “the KPN sum”.

3.5. Within a period of 10 days thereafter (15 - 25 October 2013), the 1^st defendant transferred a total of USD296,641 to a Hong Kong bank account of the 2^nd defendant, Brand Trading Ltd.  This sum has been referred to as the “the Brand Trading sum”.

3.6. On 21 October 2013, the plaintiff’s Finance Manager was again deceived in the same way into transferring a further sum (“the 2^nd Transfer”) to the Latvian bank account of another company.  The next day the deception was discovered and investigations began.

Proceedings

4.1. On 21 November 2013 the plaintiff commenced proceedings against the 1^st and 2^nd defendants.

4.2. A Statement of Claim was filed on 16 December 2013.  A Defence was filed on 10 February 2014, followed by the plaintiff’s Reply filed on 21 March 2014.

4.3.  In the meantime, the plaintiff applied for a Mareva injunction.  The papers relating to that application are not before this court, but we have been informed that although the defendants had sought to discharge it, an injunction is still in place. 

The Pleadings

5.1.  On 31 July 2014 the plaintiff filed its Amended Statement of Claim.  In summary, the following was pleaded.  (Even though the KPN sum and the Brand Trading sum came from the 1^st Transfer only, references to the 2^nd Transfer are made in a number of places). 

(A)  “The 1^st and 2^nd Transfers made under fraudulent misrepresentations and mistake”:

-  there were two sets of fraudulent misrepresentations (para. 29);

-  authorization for the 1^st and 2^nd Transfers were obtained by fraud (para. 31);

-  the 1^st and 2^nd Transfers were made as a result of a fundamental mistake as to the recipient’s identity (para. 32);

-  the plaintiff had relied on the fraudulent misrepresentations (para. 34); and

-  the plaintiff had suffered loss and damage by reason of the fraudulent misrepresentations (para. 35).

(B)  “Tracing at Common Law - [the plaintiff’s] proprietary claim against the [1^st defendant] based on retention of title”:

-  immediately before the 1^st Transfer, Kosona’s bank account had a zero balance (para. 36);

-  therefore the plaintiff’s proprietary interest in the 1^st Transfer sum can be traced into the KPN sum (para. 37);

-  neither Kosona nor the 1^st defendant had provided any consideration for the 1^st Transfer sum and the KPN sum (para. 38);

-  the 1^st defendant was liable to return the KPN sum to the plaintiff (para. 39).

(C)  “Claims on unjust enrichment and money had and received”:

-  the 1^st and 2^nd Transfers were made as the result of a fundamental mistake as to the identity of the recipient (para. 42);

-  the 1^st and 2^nd defendants “had no legitimate reason to benefit from or retain” the KPN sum or the Brand Trading sum and have been unjustly enriched (para. 43);

-  “neither UAB Kosona, [the 1^st defendant] nor [the 2^nd defendant] gave any consideration for the 1^st and the 2^nd Transfers, nor were they bona fide purchasers” (para. 44);

-  consequently the plaintiff was entitled to a claim for restitution of the KPN sum and the Brand Trading sum as unjust enrichment and money had and received (para. 45).

5.2. The relief sought included:

(1)  an order that the 1^st defendant and the 2^nd defendant pays to the plaintiff the KPN sum (or so much of it still in its hands) and the Brand Trading sum respectively;

(2)  a declaration that each defendant holds the respective sum for the plaintiff and/or is liable to account as trustee and account for all profits and/or make good all loss; 

(3)  an injunction that each defendant be restrained from disposing of the respective sums;

(4)  further or alternatively, equitable compensation.

6.1.  The defendants’ case in the Amended Defence filed on 27 August 2014 can be summarized as follows:

-  they were in the trading business; as they had a common shareholder, funds would be transferred by way of loan from the 1^st defendant to the 2^nd defendant when necessary;

-  Kosona had been introduced by a business associate;

-  Kosona wished to acquire three lots of goods;

-  the 1^st defendant then sourced the goods from three suppliers (in the USA, Israel and Turkey respectively), to whom it made part payment on 3, 9 and 10 October 2013 (pursuant to the suppliers’ invoices dated 1, 8 and 9 October 2013 respectively);

-  the 1^st defendant duly issued invoices to Kosona on 8, 10 and 11 October 2013 in a total sum of USD628,648.75;

-  the sum of USD628,417.29 (the KPN sum) which the 1^st defendant received from Kosona on 15 October 2013 was payment for the three lots of goods;

-  at the time the KPN sum was received, the 1^st defendant’s bank account had a credit balance;

-  after receiving the KPN sum, the 1^st defendant arranged for the goods to be released from the warehouses where they had been stored on 17, 21 and 24 October 2013 respectively;

-  the 1^st defendant paid its suppliers the respective balances of the price of the three lots of goods between 4 and 7 November 2013. 

6.2. The defendants pleaded that “[the 1^st defendant] had received the KPN sum in good faith and under a genuine and honest belief that the KPN sum was paid in a normal and ordinary business transaction” for payment for goods (para. 34(3)), that consideration had been provided and that they are “bona fide purchasers and/or have changed their positions in good faith” (para. 35B(3)).

7. The plaintiff’s Reply is important. In it, the plaintiff pleaded (amongst other things) that

-  the London address given for the 1^st defendant was a “derelict building awaiting demolition” (para. 6);

-  the US supplier named by the defendants was a real estate agent which did not deal in the type of goods the 1^st defendant had allegedly ordered from it (para. 8);

-  the Israeli supplier named by the defendants did not sell the product, did not issue the invoice to the 1^st defendant, and has “declared the invoice is a fake” (para. 9);

-  there was no entity in Turkey that bore the name given by the defendants for the Turkish supplier (para. 10);

-  “no transactions took place between UAB Kosona and [the 1^st defendant]” (para. 11);

-  “it is denied that [the 1^st defendant] received the funds as a bona fide purchaser for value and in good faith ... No sales transactions took place between the 3 suppliers and [the 1^st defendant].  Nor were there any sales transactions between [the 1^st defendant] and UAB Kosona” (para. 11). 

Application for summary judgment

8.1.  With the battle lines drawn as above, on 30 September 2014 the plaintiff issued an application for summary judgment. This was supported by a 16-page affirmation of Christopher Jefferis, a director of the plaintiff, who deposed on 26 September 2014 to the matters pleaded in the Defence, exhibited various documents in support, and contended “there were no genuine sales transactions between UAB Kosona and the Defendants” (para. 38).

8.2. The judge ordered that the issue whether “the fraud exception” was engaged should be determined as a preliminary issue.

Chung J’s Decision

9.1. In para. 5 of his Decision, Chung J noted that “in denying the defendants’ case that they were bona fide recipients for value of the claimed sum, the plaintiff would have to establish:

(1)  two of the three suppliers [the US and Israeli suppliers] averred to by the defendants did not sell to the defendants; the third supplier [the Turkish supplier] was fictitious;

(2)  an invoice [from the Israeli supplier] relied upon by the defendants is a forged document;

(3)  the 1^st defendant had used a false address [in London]”.

9.2. More importantly in para.14, the learned judge noted that the plaintiff had in para. 9 of the Reply made an allegation against the defendants of falsifying and uttering a forged document.  In that paragraph, the plaintiff had pleaded “[the Israeli supplier] did not issue the invoice to [the 1^st defendant] and has declared the invoice is a fake”. 

9.3. Following the “wider/liberal” meaning of the “fraud exception” set out in this court’s judgment in A-1 Business Ltd v Chau Cham Wong Patrick [2009] 5 HKLRD 579, the judge held that the rule did not permit a summary judgment application to be made in this action and decided the preliminary issue in the defendants’ favour.

Discussion

10. I shall first briefly set out my understanding of the difference between the “narrow” meaning and the “wide/liberal” meaning of “the fraud exception”. 

The “narrow” meaning adopted by the English courts

11.1.   Before “the fraud exception” was abrogated in England on 1 June 1992 by rule 5 of the Rules of the Supreme Court (Amendment) 1992, the English courts had interpreted the “fraud exception” in a narrow way, to mean only fraud as defined in Derry v Peek (1889) 14 App Cas 337, viz. a false representation made knowingly, or without belief in its truth, or recklessly, careless whether it be true or false.  I shall refer to this as “Derry v Peek fraud” or “fraud in the Derry v Peek sense” for convenience. 

11.2.  In Newton Chemical Ltd and others v Arsenis [1989] 1 WLR 1297,Nicholls LJ (as he then was) acknowledged that “as a matter of first impression [the fraud] exception seems apt to embrace cases where dishonesty is alleged against a defendant” (p.1300) and would thus not be confined to fraud in the narrow Derry v Peek sense. However he accepted that the narrow meaning had long been established by authorities in England and must be applied.

11.3. Nicholls LJ suggested an explanation as to why the narrow meaning had been adopted in England. 

11.4.  In Barclays Bank Ltd v Cole [1967] 2 QB 738, the English court of appeal had to construe the word “fraud” in the context of the Administration of Justice (Miscellaneous Provisions) Act 1933 which provided for jury trials if an allegation of fraud was in issue.  The court there adopted the narrow meaning of the word.  The result was that jury trials would only be required for a relatively small number of cases. 

11.5.   In E Hannibal & Co Ltd v Frost (unrep) 13 May 1987, CA (Civil Division) Transcript No.495 of 1987, the English court of appeal then held that “the fraud exception” in Order 14 should bear the same meaning as that stated in Barclays Bank v Cole, ie the narrow meaning.

11.6.  The result of that approach was that, however dishonest the conduct pleaded, the English courts have held “the fraud exception” was not engaged if the plaintiff’s claim was not based on an allegation that there has been a false representation in the Derry v Peek sense.

11.7. Unsurprisingly, this led to statements of claim being drafted in “artificial” or “contrived” terms, so that whilst allegations of dishonest conduct were being made, the claims were not based on an allegation of Derry v Peek fraud.

11.8. Nicholls LJ was aware that the adoption of the narrow meaning of fraud in the “fraud exception” led to an anomaly in the approach to different forms of dishonesty, with applications for summary judgment not being available for Derry v Peek fraud, but being available for all other types of dishonest conduct.  He suggested the abrogation of the rule, so that even claims based on the narrow meaning of fraud could be made the subject of summary judgment applications.  He said (p.1303):

“As presently framed, Ord. 14 r.1(2)(b) is itself somewhat anomalous. If ‘fraud’ in that rule had been interpreted by the court as having a wide meaning, so that all cases in which a plaintiff alleged dishonest conduct by a defendant were outside the scope of the order, the argument [of the defendant’s counsel] based on artificiality and contrivance would be powerful. But once fraud is to be understood as having the strict meaning of Derry v Peek fraud, this argument is far less compelling. Once it is accepted that claims based on allegations of all forms of dishonest conduct other than Derry v Peek fraud, can, in a suitable case, be the subject of summary judgment, I confess to having difficulty in understanding why the same should not also be true of a claim based on an allegation of Derry v Peek fraud. Whatever may be the historic origin and justification for Derry v Peek fraud being outside Order 14, I do not perceive what is the principle which justifies requiring a plaintiff today to prove at trial a claim based on Derry v Peek fraud, alone of all forms of dishonesty. The rule could with profit be reconsidered by the Supreme Court Rule Committee”.

Stocker LJ also said (p.1307):

“I also agree that such a limited exception is anomalous. It may be that it was considered that since under the Act of 1933 a party to a civil action charged with fraud (in the Derry v Peek sense vide the Cole case [1967] 2 QB 738) is entitled to trial by jury that it would be inappropriate and inconsistent with that right for summary judgment to be given under Order 14. Whatever the reason there seems little logic in so limited an exception to the power to order judgment under Order 14 when other forms of dishonesty, which may be no less opprobrious, are not so excluded”.

11.9.  As mentioned earlier, the “fraud exception” was repealed in England in 1992, with the result that a plaintiff in England has since been able to apply for summary judgment, whatever the type of dishonest conduct alleged against the defendant.

The “wide/liberal” meaning adopted by the Hong Kong courts

12.1.  Unlike the Administration of Justice (Miscellaneous Provisions) Act of 1933 discussed above, in Hong Kong an allegation of fraud does not entitle a party to a trial by jury (see s.33A of the High Court Ordinance, Cap.4).  Accordingly, there was no need to apply a narrow meaning for the sake of consistency with the provision for civil trials by jury.

12.2.  As will be seen later, the courts in Hong Kong have adopted a wide or liberal meaning of the “fraud exception”.  In other words, if the action included a claim based on an allegation of fraudulent conduct, the courts have held that Order 14 did not apply.  This is consistent with Nicholls LJ’s observation in Newton that “as a matter of first impression, [the fraud] exception seems apt to embrace cases where dishonesty is alleged against a defendant”, before he held that in England, the courts were bound by authorities to adopt a narrow meaning. 

The plaintiff’s position in this case

13. In the present case, Mr Burns SC counsel for the plaintiff was content to argue the case on the basis that “the fraud exception” bears the wide meaning, even though he was reminded that if he did not argue before this court the point whether a narrow meaning should be adopted, he might not be allowed to raise it should he wish to take the matter further.

14. I shall now discuss how “the fraud exception” has been understood and applied in this jurisdiction.

Skink

15. In Skink Ltd (in liquidation) v Comtowell Ltd and another [1994] 2 HKLR 26, decided soon after Newton, Kaplan J said (p36-37):   

“I am thus faced with the stark choice between what I might refer to as the limited interpretation of fraud, apparently favoured in England, or the wider interpretation favoured by Barnett J [in Peninsula Fur Trading Ltd v George Chen Dah-shing and others HCA3550/1987, 14 March 1988, unrep.] in Hong Kong. ...

I can only think that the fraud exception to O.14 was inserted in England and maintained in Hong Kong because the O.14 jurisdiction was wholly inappropriate for cases where the Court had to consider whether a person was guilty of fraud or at the material time had an intention to defraud. Such findings have very serious consequences, and it could not have been thought right that persons should be condemned, as it were, unheard save on affidavit. I therefore favour the wider approach insofar as I am not prepared to hold that only Derry v Peek fraud comes within the exception as I am satisfied that the claim in this case [setting aside conveyances under s.60 Conveyancing and Property Ordinance, Cap.219 on the ground that the assignor intended to defraud its creditors] also comes within the exception”. (Emphasis added).

Pacific Wire

16.1.  That wider interpretation of “the fraud exception” was also adopted by this court (Rogers VP and Le Pichon JA) in Pacific Electric Wire & Cable Ltd v Harmutty Ltd [2009] 3 HKLRD 94.

16.2.  In that case, a company commenced three actions against its directors and officers for misappropriating money to invest in properties and securities.  Allegations of false accounting were made in the statements of claim.  In the skeleton submission before the first instance judge, the plaintiff accused the defendants of “a massive accounting fraud”.

16.3.   However there were no express claims for damages for fraud, the claims being breach of fiduciary duty, constructive trust, resulting trust and money had and received.

16.4.  The court of appeal held that so long as one claim in the action was based on an allegation of fraud, “the fraud exception” precluded summary judgment proceedings (para. 29).  And in considering whether there was a claim based on an allegation of fraud, it did not matter that there was no claim for damages for fraud.  What was excluded was any action where there was a claim in respect of which the underlying allegations on which the claim was based constituted an allegation of fraud (para. 19). 

16.5.   In that case the court held that although the relief was framed in respect of constructive trust, resulting trust and money had and received, the claims were nevertheless based on allegations of deliberate dishonesty including false accounting, active concealment of the beneficial ownership of investments, and connivance at the preparation of false financial statements and accounts (para. 31).

16.6.  It is interesting to note that an application for leave to appeal to the Court of Final Appeal was made in FAMV28/2009.  Although the CFA considered that the scope of “the fraud exception” was a reasonably arguable point and of importance, leave was refused on the merits.

A-1

17.1.  In A-1, a judgment of this court (Cheung and Yuen JJA) which Chung J followed, the plaintiff company sued a director for breach of fiduciary duties for using company money to repay a personal debt.  In defence, the defendant claimed that the money had been paid to a subsidiary as a dividend, which the plaintiff had directed to pay over to him.  In its reply, the plaintiff pleaded that the declaration of dividend had been fabricated after the event.

17.2. The first instance judge held that “the fraud exception” applied and dismissed the summary judgment application. He held that since the plaintiff was alleging that the defendant had falsified documents after the event to create a fictitious declaration of dividend, it was implicit in the plaintiff’s case that the defendant had acted fraudulently. 

17.3.  On appeal, the plaintiff argued that the claim for breach of fiduciary duties did not have to be based on an allegation of fraud, and that it was the claim that mattered, not its response to the defence.

17.4. The court of appeal upheld the first instance judgment.  It accepted that a claim for breach of fiduciary duties may not necessarily involve dishonesty, but each case must be based on its own facts (para. 18).  In that case the plaintiff’s claim based on misappropriation could not be viewed in isolation and divorced from its response to the defence that the transfer was for a legitimate purpose.  The plaintiff had to address the defence, and in doing so, an allegation of dishonesty (the fabrication of an after the event declaration of dividend) was involved (para. 15). 

17.5. Finally, at para. 20, the court said that “even if” the case was viewed strictly from the plaintiff’s claim, allegations of dishonesty and hence fraudulent acts were also involved in that it had pleaded that the director had used the company’s money for an improper purpose, viz to benefit himself personally, and had concealed various security documents.  However it is clear from the way this judgment was set out that this paragraph was obiter.

Principles

18. In my view, having regard to the cases discussed above, the following points are clear.

(1)  The court should determine whether “the fraud exception” applies at the time when the application for summary judgment is heard.  Therefore the court should not be restricted to a consideration of the statement of claim only, but should examine all relevant materials existing at the time of the hearing, including subsequent pleadings and the affidavits.  (It would be noted that in Pacific Wire, the court even took into account the skeleton argument of the plaintiff’s counsel at first instance.  With respect I tend to the view that given the nature of skeleton submissions, they should be considered only where they serve to clarify an ambiguity in the plaintiff’s case). 

(2)  Having regard to all the relevant materials, the question to be asked by the court is “does this action include a claim for which an allegation of fraud would have to be made by the plaintiff in order to establish or maintain that claim?”¹  If the answer is affirmative, “the fraud exception” is engaged and the court has no jurisdiction to hear the summary judgment application, even if the plaintiff seeks to hive off that claim from another claim (eg for dishonoured cheque) for which summary judgment would have been available.  That consequence follows from the wording of “the fraud exception” (Pacific Wire para. 19).

(3)  In considering whether an allegation of fraud would have to be made to establish or maintain a claim, one must look at thesubstance, and not the mere form, of the plaintiff’s case.  If all the factual constituents of fraud are alleged and relied upon, it does not matter whether the actual word “fraud” has or has not been used (Newton p.1301).

(4)  The court must consider whether those factual constituents of fraud are relied upon in order to establish or maintain a claim.  In Newton, the court accepted that the factual constituents of a Derry v Peek fraud had been set out in the pleadings. However in order to establish the plaintiff’s claims of breach of contract, breach of fiduciary duty and negligence, it did not need to make any allegations of fraud.  On the facts of that case, the breach of contract, breach of fiduciary duty and negligence would still be established, even if the defendant had been completely honest, and was only mistaken (p.1302).  It would appear from the report that the defendant had not pleaded a defence which the plaintiff needed to reply to by alleging fraud on the part of the defendant.  This may be contrasted with A-1 discussed below.

(5)  It may be that originally a claim (eg breach of fiduciary duty) may be established without the plaintiff having to make an allegation of fraud (as in Newton).  But the nature of the defence (whether disclosed in a pleading or an affidavit) may be such that in rebuttal (whether in a Reply or in an affidavit in reply), the plaintiff would have to allege fraud, in which case, “the fraud exception” would be engaged.  So for example, in A-1 the defence was that there was no breach of fiduciary duty because the receipt of money was pursuant to a declaration of dividend.  In reply to this defence, the plaintiff alleged that the declaration was an ex post facto fabrication.  Consequently, by the time of the hearing of the summary judgment application, the plaintiff would have to make out an allegation of fraud by the defendant in order to maintain the claim for breach of fiduciary duty.

(6)  Finally, as to what is an allegation of fraud for the purpose of “the fraud exception”, this court is bound by the judgment in Pacific Wire to adopt the wide/liberal meaning.  The rationale for adopting a wide meaning had been suggested by Kaplan J in Skink and adopted by this court in the Pacific Wire judgment. That judgment cannot be said to be plainly wrong.  Further if the narrow meaning is adopted, the anomaly observed in Newton would arise, viz summary judgment would not be available for only one type of dishonest conduct, but available for all other types of dishonest conduct.  To conclude, “the fraud exception” would be engaged where what is alleged is an intentional or reckless dishonest act (or omission) done with the purpose of deceiving.  

This case

19.1.  Applying the above principles to the present case, it seems to me that the judge was clearly right when he held that “the fraud exception” was engaged. 

19.2.  It did not matter that the statement of claim did not contain a claim for damages for fraud, or that the claim against each defendant was confined to the money it had received or remaining in its hands, because one cannot stop there.  One has to consider the subsequent pleadings and affidavits to see the substance of the plaintiff’s case at the time of the hearing of the summary judgment application.  The defence was that the defendants had received the money as proceeds of sale in a bona fide transaction where it had sourced goods from the three suppliers and on-sold them to Kosona.  Such a defence would provide a complete defence to the plaintiff’s claims.  In order to maintain its claims, the plaintiff has alleged that the 1^st defendant had not in fact sourced goods from two of the three suppliers at all, that the third supplier did not exist, and that one of the suppliers had declared that an invoice (purporting to be from that supplier and exhibited by the 1^st defendant in support of its defence) was “fake”; in other words, the plaintiff has alleged that the transaction was a sham. 

19.3.   As was rightly pointed out by Mr Jonathan Chang counsel for the defendants, even if the plaintiff has not asserted that the defendants were parties to the fraud practised in Sweden to obtain the money, it has clearly asserted that the defendants are parties to a fraud to keep the money transferred to them, which is the subject-matter of its claims. 

Order

20. I would therefore dismiss the appeal with costs to be paid by the plaintiff to the defendants.

Hon Kwan JA:

21. I agree with the judgment of Yuen JA.