CHAN KAM CHEUNG v. RONNIE K W CHOI & KEVIN K F LO t/a CHOI, LO & CO Certified Public Accountants (Practising) AND ANOTHER

HCA 2307/2019

[2022] HKCFI 3028

IN THE HIGH COURT OF THE

HONG KONG SPECIAL ADMINISTRATIVE REGION

COURT OF FIRST INSTANCE

ACTION NO 2307 OF 2019

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D E C I S I O N

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1.  This is an appeal by Chan Kam Cheung (“the plaintiff”) from the Decision of Master Alan Kwong dated 2 August 2021 ordering that the plaintiff’s Amended Statement of Claim (“ASoC”) as against the 2^nd defendant, Latitude CPA Limited (“the 2^nd defendant”), be struck out and the action dismissed. At the conclusion of the hearing, the decision was reserved which I now give.

Background facts

2.  The plaintiff and Wong Shiu Keung (“WSK”) were the founding members of Sun Light Elastic Limited (“the Company”), a company incorporated in Hong Kong in 1992 which manufactured plastic products. It had 2 mainland Chinese subsidiaries: Shunde Ronggang Elastic Limited (“Ronggang”) and Zhao Jin Elastic Limited (“Zhao Jin”).

3.  Since about 2011, the Company’s shareholders have been the plaintiff (35%), WSK (45%), WSK’s son Wong Shek Hang (10%) and Wong Shu Duen (“WSD”) (10%).

4.  WSK and WSD are the current directors and the plaintiff is the Company Secretary.

5.  In 2011, WSK made an offer to purchase the plaintiff’s shares in the Company for $9 million but refused the plaintiff’s request for access to the Company’s accounting records and financial statements. Disputes then arose between the plaintiff and WSK.

6.  In August 2012, the plaintiff presented an unfair prejudice petition in HCCW 302/2012 (“the petition”) seeking primarily a buyout order, and alternatively, for a winding up order. The 1^st defendant was the Company’s auditor at the time remained so until it resigned in mid-2015. The 2^nd defendant was engaged to act as the Company’s auditor in October 2015.

7.  On 27 September 2013, Harris J heard 2 summonses in the petition:

(i)  a summons dated 28 January 2013 taken out by the 1^st and 2^nd defendants (the respondents to the petition) (“the 1^st summons”) to strike out the winding up relief sought by the plaintiff petitioner; and

(ii)  the plaintiff’s (petitioner’s) summons dated 3 September 2013 to stay all further proceedings in the petition (“the 2^nd summons”) “pending the performance and execution of the Mediated Settlement Agreement dated 28 December 2012” (“the MSA”).

8.  The defendants succeeded on the 1^st summons and the winding-up relief sought was struck out.

9.  On 28 December 2012, the plaintiff and WSK entered into the MSA which set out the procedure for identifying which of 5 firms of accountants should be jointly instructed to provide an expert valuation of the Company’s shares which valuation would be binding for the purpose of negotiating a buyout price. However, the MSA did not impose any obligation on either party to buy or sell the plaintiff’s shareholding.

10.  By the time of the hearing of the 2^nd summons, the relevant firm had been identified whose engagement as expert valuer was pending.

11.  In those circumstances, Harris J was minded to stay the petition seeking a buyout order with liberty to either party to lift the stay, a course to which the defendants had no objection. Accordingly, an order to that effect was made on the 2^nd summons on 27 September 2013 (“the 2013 order”).

12.  Shortly thereafter, in October 2013, BDO Financial Services Ltd (“BDO”) was jointly engaged by the plaintiff and WSK to ascertain the value of the Company. BDO completed its report on 1 April 2014, valuing the Company at $29.7 million. However, the plaintiff and WSK failed to reach any agreement on the price for the plaintiff’s shares.

13.  Since the 2013 order, there has been no application to lift the stay of the petition.

14.  In mid-2015, the 1^st defendant resigned as auditor of the Company.

15.  In early October 2015, the 2^nd defendant’s staff met with the 2^nd defendant and his son who were informed, inter alia, of the status of the petition, the appointment of BDO to carry out an expert valuation of the Company’s shares and the fact that the plaintiff and WSK failed to reach agreement on the value of the shares for a buyout despite the BDO valuation.

16.  The 2^nd defendant was engaged by the Company in October 2015 to act as its auditors. The 2^nd defendant performed statutory audits on the financial statements of the Company for the years ended 31 March 2015 up to 31 March 2020.

17.  The financial statements for the years ended 31 March 2015 and 2016 prepared by the 2^nd defendant were tabled at the AGM held on 28 October 2016 at which accounting queries were raised by the plaintiff. Upon further investigation, the plaintiff identified 3 main problems with the accounts, namely:

a)  an amount of approximately $11.5 million said to be a payable of the Company was in fact an account receivable of Ronggang, which had been wound up in 2008 which meant that the net assets of the Company had been undervalued;

b)  the amount of loss of approximately $15.7 million recorded on disposal of the Company’s investment in Zhao Jin has not been properly investigated in that Zhao Jin’s accumulated loss was not explained and its assets were “abnormally at a low level”; and

c)  there has been a “false accounting entry” in respect of the cost of plant and machinery over the years, the gist of the plaintiff’s grievance being that it caused an undervaluation of the Company’s actual assets.

Legal principles

18.  It is common ground that the legal principles applicable in an application to strike out a claim are those set out in 2022 Hong Kong Civil Procedure (“HKCP”) at §18/19/4. For present purposes, the following are relevant: (i) the court should strike out a claim only in plain and obvious cases; (ii) disputed facts are taken in favour of the party sought to be struck out; (iii) the claim must be obviously unsustainable, the pleadings unarguably bad, and it must be impossible, not just improbable, for the claim to succeed before the court will strike it out; (iv) where the legal viability of the cause of action is sensitive to the facts, an order to strike out should not be made; and (v) the court is loath to strike out a case that involves a developing area of the law.

The issues arising

19.  3 issues arise for consideration in determining whether or not the plaintiff’s claim against the 2^nd defendant should be struck out: (A) whether the 2^nd defendant owes the plaintiff, a shareholder of the Company, a duty of care as auditor in the circumstances pleaded in §31 of the ASoC; (B) loss; and (C) causation.

(A)  Duty of care

20.  The leading authority on the scope of duty owed by auditors to a 3^rd party is Caparo Industries plc v Dickman [1990] 2 AC 605. The principles it laid down may be summarised as follows:

(i)  the purpose for which the auditors’ certificate is made and published is providing those entitled to receive the report with information to enable them to exercise their shareholders’ powers. The duty of care is one owed to the shareholders as a body and not to individual shareholders: per Lord Oliver at 654B-D;

(ii)  advice to individual shareholders in relation to present or future investment in the company is no part of the statutory purpose of the preparation and distribution of the accounts: per Lord Jauncey at 662A-B; and

(iii)  only where the auditor was aware that the individual shareholder was likely to rely on the accounts for a particular purpose would a duty of care arise: per Lord Jauncey at 662D.

21.  Ms Lydia Leung, counsel for the plaintiff, referred to the passage in the speech of Lord Bridge (at 620H-621C) distilling the “essential characteristics of a situation giving rise ... to a duty of care[1]” from case law he reviewed commencing with the decision in Hedley Byrne & Co Limited v Heller & Partners Limited [1964] AC 465 where such a duty of care was found to arise.

22.  He identified the “salient feature” of all those authorities as one in which:

“the defendant giving advice or information was fully aware of the nature of the transaction which the plaintiff had in contemplation, knew that the advice or information would be communicated to him directly or indirectly and knew that it was very likely that the plaintiff would rely on that advice or information in deciding whether or not to engage in the transaction in contemplation.”

23.  The plaintiff’s case is set out in §31 of the ASoC which reads as follows:

“At all material times the Defendants knew and ought to have known that the Plaintiff required the accounts disclosed in the financial statements of the Company for his information to conduct his financial affairs including but not limited to the provision of dividend payments, assessing the value of the shares of the Company for the purchase by the Chairperson Wong Shiu Keung or vice versa taking into account the quasi-partnership nature of the Company, long-lasting shareholder dispute resulting the HCCW 302/2012 action, the joint appointment of BDO for value assessment of the asset of the group and frequent queries by the Plaintiff in members meetings, correspondence with the solicitors and the Defendants themselves.”

24.  The issue is whether the matters pleaded in the ASoC and, in particular §31 on which the plaintiff relies as giving rise to a duty of care, satisfy the “salient feature” requirements considered in Caparo. Pausing here, I would remark that I have not found §31 readily comprehensible given its somewhat idiosyncratic syntax.

25.  It is the plaintiff’s case that the 2^nd defendant was aware that the transaction the plaintiff had in contemplation was “a pending buy-out claim in court”, that the 2^nd defendant was aware that the plaintiff would be relying “on the upcoming audited reports of the Company for the specific purpose of contemplating and considering the price at which a buy-out is reasonable”[2].

26.  Ms Natalie So, counsel for the 2^nd defendant, submitted that for a duty of care to arise, there has to be an identifiable or specific transaction. An illustration of this can be found in the Court of Appeal’s decision in Yue Xiu Finance Company Limited and Another v Dermot Agnew and Others [1996] 1 HKLR 137, a case where the plaintiff through a holding company acquired a majority shareholding in 2 companies (“the companies”).

27.  The price for the acquisition depended on the combined profits of the companies which were also to form the basis of put and call options. The defendants were joint auditors of the companies. The issue was whether the plaintiff who was not a shareholder in either of the companies in its statement of claim had pleaded sufficient facts to establish arguably that the defendants have incurred liability to pay damages to the plaintiff for negligence in making their report as auditors.

28.  In that case, the plaintiff put its case on the duty of care thus (at p 140G-J):

“(1) Throughout the development of the restructuring proposals the defendants were kept informed thereof and consented to act as the joint auditors to the companies in certifying the combined profits … for the purposes of Clause 2.2, Schedule 2 and Clause 11 of the agreement: …

(2) Whilst carrying out the audit work leading to the reports and when signing the reports themselves, the defendants knew or ought to have known of the agreement and in particular Clause 2.2, Schedule 2 and Clause 11 and knew that the plaintiff would rely on the audited financial statements in determining whether they had a claim under the agreement and/or a right to exercise the put option provided for in the Clause 11.1: …

(3) The defendants knew or ought to have known when they consented as pleaded in paragraph 15 and/or when they audited the financial statements of the companies that the plaintiff was relying on them to exercise reasonable skill and care in carrying out the audit and, in so consenting and/or undertaking the audit, each of the defendants assumed vis-a-vis the plaintiff the responsibility of exercising such reasonable care: …

(4) In the premises each of the defendants owed to the plaintiff a duty to exercise reasonable care and skill in acting as joint auditors in respect of the financial statements of the companies for the year ended 31 March 1988: …”

29.  The Court of Appeal held that the “transaction” which the plaintiff clearly had in contemplation was the exercise of its contractual rights under Schedule 2 and Clause 11.1 of the agreement: the right to demand an adjustment of the price and a right to “put” the shares back to the vendor. On the pleadings, the defendants were aware of the nature of the transaction: they knew that the audited accounts would be communicated to the plaintiff; they had knowledge of the price adjustment mechanism and the put option and therefore knew that it was very likely that the plaintiff would rely on the audited accounts in deciding whether the price adjustment mechanism or the put option might be triggered.

30.  It is clear from Caparo that there is no duty of care owed by an auditor to potential investors, or to individual shareholders in respect of their investment decisions. For a duty of care to arise an individual shareholder as the plaintiff, it is incumbent on the plaintiff to identify and plead specific matters or circumstances that give rise to such a duty.

31.  Whilst the plaintiff submitted that there is “a pending buyout claim in court” and that there was the purpose of assessing the value of his shares for the purchase by WSK, the undeniable fact is that the petition has remained dormant since the 2013 order staying the plaintiff’s proceedings for a buy-out. It is common ground that no application to lift the stay has been made and negotiations between the plaintiff and WSK for a buyout based on the BDO report had come to nought. In other words, there was no purchase in the offing for the plaintiff’s shares.

32.  In the present case, by October 2015 when the 2^nd defendant accepted engagement as the Company’s auditors, the proceedings seeking a buyout cannot be said to be “pending”: not only had no application made by either party to lift the stay that by then had been in place for 2 years, there is also no pleading and no evidence of any ongoing discussions or negotiations between the plaintiff and WSK to effect or achieve a buyout after the failed attempt based on the BDO valuation that could have been brought to the 2^nd defendant’s attention.

33.  It is the plaintiff’s case that the contemplated transaction was the purchase of his shares by WSK. That that is his ‘desire’ or ‘wish’ is one thing; it cannot evolve into an identifiable transaction without more.

34.  One of the matters the plaintiff pleaded in §31 of the ASoC as relevant to the existence of a duty of care is the fact of “frequent queries by the Plaintiff in members’ (sic) meetings, correspondence with the solicitors and the Defendants themselves”.

35.  At the hearing, Ms Leung agreed that the relevant meeting at which the 2^nd defendant was present was the adjourned AGM that took place in March 2017 and all correspondence postdated the adjourned AGM. Hence, the events relied on took place after the submission of the audit reports.

36.  In the circumstances, the relevance of those events escapes me. Given the timeline, they cannot possibly be relevant to the existence of a duty of care for it would be a case of putting the cart before the horse.

37.  It was then submitted that the 2^nd defendant must have viewed this shareholder (i.e. the plaintiff) independently “if the shareholder would go and speak to them independently.” But that is tantamount to the plaintiff pulling himself up by his own bootstraps.

38.  The plaintiff asserts that the auditors “ought to have known” allegedly because the auditors knew that their audit report would be used to value the shares for purchase by WSK. But no basis has been established for the auditors’ knowledge when, as earlier explained, there was no specific transaction such as could give rise to a duty of care. The assertion is misconceived.

39.  By way of contrast, in the Yue Xiu case, the composite valuation of the companies certified by the auditors would affect the actual purchase price as well as the right to exercise the put option because of the relevant clauses in the shareholder agreement.

40.  The plaintiff’s case appears to consider the audit reports relevant in determining the price of any ‘prospective’ buyout of the plaintiff’s shares. It is not suggested that the audit report would be determinative in that regard since even an expert valuation such as the BDO report was insufficient without an agreement or order for a buyout. On any view, there was simply no buyout on the horizon when the 2^nd defendant accepted its engagement in October 2015.

41.  In those circumstances, a duty of care cannot possibly be made out.

42.  The plaintiff’s position is that his case stands or falls with the duty of care point. On that basis, the 2^nd defendant must succeed in its strikeout summons.

(B)  Loss and causation

43.  Ms So’s stance is different in that if any of the 3 elements of duty of care, loss and causation is defective, the ASoC is defective and should be struck out.

44.  At 651F of Caparo, Lord Oliver observed that

“the duty of care is inseparable from the damage which the plaintiff claims to have suffered from its breach. It is … a duty to avoid causing to the particular plaintiff damage of the particular kind which he has in fact sustained.”

45.  The 2^nd defendant submitted that the fact that ASoC does not plead the damage suffered (for example, loss sustained as a result of the sale at an undervalue) reinforces the fact that there was no sale and no purchase and none was contemplated for a duty of care to arise.

46.  Ms So clarified that she does not rely on the principle of reflective loss which was an argument pursued before the Master. The point is that no one suffered any loss. In so far as there is any understatement in the financial statements, the assets remain in the Company.

47.  As regards the plaintiff’s complaint that as a result of the 2^nd defendant’s negligence he has received fewer dividends or even none at all, there is then the issue of causation.

48.  The declaration and distribution of dividends requires a board resolution. That is a supervening event about which the ASoC is silent. The ASoC does not plead how the 2^nd defendant caused the alleged loss. There is no linkage between the alleged negligence and the loss of dividends.

49.  On the issue of loss, Ms Leung submitted that loss to the plaintiff is not necessarily pegged to whether there is a loss caused to the Company and that the plaintiff has a specific loss because he was not issued dividends. It was submitted that whether the directors issue dividends must be influenced by, if not entirely based on, the audit report. If, as a result of deficiencies in the audit report a loss is shown, the directors would naturally decide not to distribute dividends. That, it was said, would be the shareholder’s loss.

50.  It is not entirely clear but the plaintiff’s position appears to be that if there is a breach of duty in the preparation and submission of the audit report, that must cause loss to him as a shareholder but what the loss is was left at large.

51.  However, the “loss” cannot be specific or unique to the plaintiff since it is in the nature of dividends that it applies to all the shareholders of the Company.

52.  The plaintiff further submitted that if the audit reports are deficient, the plaintiff cannot proceed with the buyout and that is another type of loss caused to him by the irregularities and that it would be pointless for the plaintiff to seek relief from the court. I can only say that the explanation as to why that is so was obscure.

Conclusion

53.  As I am satisfied that a duty of care has not been made out, this appeal must be dismissed.

54.  So far as the issues of loss and causation are concerned, I am inclined to agree with the 2^nd defendant that the ASoC is deficient in that regard.

Order

55.  There is to be an order that the plaintiff’s appeal be dismissed with an ordinary nisi of costs with certificate for counsel in favour of the 2^nd defendant, such costs to be summarily assessed in accordance with the directions separately given.