SEAN ERIC MCLEAN HOTUNG v. HILLHEAD LTD AND OTHERS

HCA 1738/2006

IN THE HIGH COURT OF THE

HONG KONG SPECIAL ADMINISTRATIVE REGION

COURT OF FIRST INSTANCE

ACTION NO. 1738 OF 2006

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J U D G M E N T

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INTRODUCTION

1.  This is a strike-out application. 

2.  Sean Hotung is the assignee of beneficial interests under 2 trusts.  He claims compensation against Hillhead, the trustee of both trusts, for the diminution in value of company shares held by the trust.  Sean says that the diminution in value came about because, contrary to its fiduciary duties, Hillhead was not vigilant in protecting its beneficiaries’ interests in the relevant companies.

3.  Hillhead says that the loss claimed is purely reflective loss.  Such loss can be claimed by the companies concerned against any wrongdoers involved.  But it is not the type of loss which can legally be claimed by a beneficiary from a trustee.

4.  Sean claims compensation for the same type of loss from Ernst & Young.  It is asserted that Ernst & Young are “vicariously liable” for the fiduciary wrongs of Hillhead.

5.  Ernst & Young reply that there is no legal principle for holding them vicariously liable.

II. BACKGROUND

6.  Hillhead is the trustee of 2 trusts: one (the HEL trust) a trust of Hotung Enterprises Ltd. (HEL) shares, the other (the HICL trust) a trust of Hotung Investment (China) Ltd. (HICL) shares.  The original beneficiaries of the trusts were the 3 daughters of the settlor (Eric Hotung).  The interests of 2 of the beneficiaries have since been assigned to Sean.

7.  Ronald Ho, the 3^rd Defendant, is a nephew of the settlor.  He became a partner of Messrs. Arthur Young (which through merger became Ernst & Young) in 1981.  He retired from Ernst & Young in 2002.  He helped to set up the HEL and HICL trusts.  Sean pleads that he was responsible for the administration and management of the HEL and HICL trusts on behalf of Hillhead and Ernst & Young.

8.  Sean alleges that Ronald dishonestly assisted the settlor in diverting assets from HEL and HICL.  Sean further pleads that “[t]he breaches of fiduciary duty/trust by [Hillhead] and/or [Ernst & Young] ... were each committed with the dishonest assistance or participation of [Ronald]...”

9.  The Amended Statement of Claim prays for the following relief:-

“AND THE PLAINTIFF [SEAN] CLAIMS:-

(1)     Damages or equitable compensation for diminution in the value of the share in HEL resulting from the wrongful diversion of their assets or funds or monies from their subsidiaries;

(2)     Further or alternatively, any necessary accounts and enquiries and orders for payment thereon;

(3)     Interest pursuant to paragraph 31;

(4)     Costs;

(5)     Further or other relief.”

10.  Sean is now in control of HEL and (through HEL) HICL.

III. DISCUSSION

A. The claim against Hillhead

A.1 The reflective loss principle

11.  In principle, a shareholder (such as Hillhead) cannot normally recover a sum representing the diminution in market value of his shares. 

12.  That is because the diminution in value of the holder’s shares “merely reflects the loss suffered by the company in respect of which the company has its own cause of action”.  To allow recovery of reflective loss would entail either multiple recovery (a wrongdoer compensating both the company wronged and the shareholders of such company) or inequitable recovery (a shareholder recovering for his loss in a manner that precludes the company from recovering for its loss).  See Johnson v. Gore Wood & Co. [2002] 2 AC 1 (HL), at 62E-F (Lord Millett).

13.  The rule against recovery for reflective loss is not concerned with barring causes of action.  The rule instead bars recovery of certain types of loss.

14.  Thus, where a company can recover the original loss from a wrongdoer and such recovery would redress the diminution in share value of which a shareholder complains, the rule will apply.  In such situation, the Court will typically strike out the claim based on pure reflective loss.  See Landune International Ltd. v. Cheung Chung Lung [2006] 1 HKLRD 39 (CA), at §§24, 25, 29 and 30 (Yuen JA).

15.  In stating the rule, I have used words of qualification such as “normally” and “typically”. 

16.  The reason for this is that there may be cases where, for some reason, a company is unable to pursue its claim against a wrongdoer.  In that situation the rationale for the rule would not apply.  The contrary might be the case.  If (say) a shareholder in that situation were barred from seeking relief, far from there being multiple or inequitable recovery, the wrong done to the company will not be rectified and the wrongdoer may go unpunished. 

17.  In such case, depending on the nature of the impediment preventing the company from pursuing its cause of action, the Court may allow a shareholder’s claim to proceed, rather than strike it out.  See Neuberger’s summary of the rule against claims for reflective loss in Gardner v. Parker [2004] 2 BCLC 554 (CA), at §33.

A.2 Sean’s case

18.  Mr. James Thomson (appearing for Sean) submits that the rule against claims for reflective loss should not be applied here.

19.  Mr. Thomson first suggests that the rule is not applicable because the defendants to a claim by the company and to a claim by Sean would be different.  A claim by HEL or HICL would be against the settlor and other persons who allegedly diverted assets belonging to HEL or HICL.  In contrast, Sean’s claim as beneficiary is against Hillhead as trustee for breach of fiduciary duty.

20.  This first submission by Mr. Thomson does not seem a good reason for departing from the reflective loss principle.

21.  In support of his contention Mr. Thomson relies on Lewin on Trusts (18th ed.).  But it appears to me that the authority is against his contentions.  I shall quote the passage at length to demonstrate this.

22.  Lewin states:-

“Breach of duties in relation to companies in which the trust has an interest - reflective loss

§39-37:-

The scope of duties of trustees in relation to companies in which the trust has an interest, and the effect of a provision in the trust instrument limiting those duties, ... have been considered elsewhere.  We are here concerned with the measure of loss for which the trustees are accountable if a breach of duty by the trustees is established.  Prima facie, the loss is the diminution in the value of the shares in the company comprised in the trust fund caused by the trustees’ breach of duty in relation to that company or of a direct or indirect subsidiary of that company.  Questions arise, however, whether recovery of the loss in an action against the trustees is barred by the rules against recovery of reflective loss if the loss is one in respect of which the company has, or has had, a cause of action and the loss is reflected in the diminution in the value of the trust shareholding.

§39-38:-

The Court of Appeal held in Walker v. Stones [[2001] QB 902, at 927] that the reflective loss principle does not prevent a beneficiary from bringing a claim against trustees, even though the company has a claim in respect of the subject matter of the loss, if (a) the claimant can establish that the defendant’s conduct has constituted a breach of some legal duty owed to him personally [and] (b) on its assessment of the facts, the court is satisfied that such breach of duty has caused him personal loss, separate and distinct from any loss that may have been occasioned to any corporate body in which he may be interested.  This statement of principle is entirely consistent with the later decision of the House of Lords in Johnson v. Gore-Wood & Co. which is the leading authority on reflective loss.  Reflective loss in itself has nothing to do with point (a) upon which the claimant may rely upon a breach of duty [by the trustee]...  The fact that the beneficiaries’ claim may be a claim for breach of fiduciary duty is not a reason why the reflective loss principle should not apply.  It is in relation to point (b) that the reflective loss principle causes difficulty.  Although the Court of Appeal held that the loss claimed by the beneficiaries did satisfy the requirement of being separate and distinct from the loss incurred by the underlying company comprised in the trust fund, the reasoning by which this conclusion was reached does not fit easily with the reasoning of the majority in the House of Lords’ decision.  It appears that the loss suffered by the beneficiaries in Walker v. Stones was in respect of the diminution in the value of the trust’s shareholding caused by the alleged plundering of the assets of a subsidiary of the company in which the trust held shares, though was nevertheless regarded as a separate and distinct loss.  It should not necessarily be assumed that on similar facts a similar conclusion would be reached today.  Hence the reflective loss principle normally does prevent the beneficiaries from recovering the diminution in value of the trust shareholding in a breach of trust action caused by a breach of duty by the trustee as a director of the company concerned for which the company has a claim against the director.

§39-39:-

There are two features in trust cases which are not normally present in cases where questions of reflective loss arise in other circumstances.  One is that the claimants will not be shareholders in the company concerned (or in its parent company), but will be beneficiaries with a beneficial interest in a trust find comprising those shares.  This is not, however, in itself a reason why the reflective loss principle should not apply.  The other is that the defendants will not be necessarily ... the same as those against whom the company has a claim.  The beneficiaries’ claim will be against the trustees while the company’s claim will usually be against one or more of its directors.  It is only where the trustees are also the directors against whom the company has a claim that the defendants to both claims will be the same.  It is not, however, clear that the reflective loss principle can apply only in a case where the defendants to both claims are the same.  The purpose of the reflective loss principle is to ensure, first, that double recovery is not achieved and secondly, that the company’s assets are preserved in the interests of its creditors so that its claim takes precedence over the claims of persons interested in them.  It is arguable that this purpose is engaged in the trust context irrespective of whether or not the trustees are the same as those against whom the company has a claim.”

23.  I agree with the thrust of the passage just cited from Lewin. 

24.  In particular, given Landune, in Hong Kong a similar fact situation as that in Walker v. Stones would not lead to a similar outcome as in that case.  The loss complained of in Walker, the diminution in value of a trust’s shares, plainly constituted reflective loss.  Consequently, if one applies Johnson v. Gore-Wood, the loss alleged by the beneficiaries in Walker could not have been a loss which was separate and distinct from that suffered by the corporate body.

25.  Further, Landune pointed out that the Court’s focus must be on the type of loss claimed as opposed to the cause of action being asserted.  Accordingly, it cannot be a valid distinction that the defendants in an action by the beneficiary and one by the company may be different. 

26.  The simple fact is that the loss being asserted by Sean in this action could be made good if HEL or HICL took action against the alleged wrongdoers.  That fact is not affected by any difference in defendants in this action in contrast to any actions by the companies.

27.  I am thus not persuaded that Mr. Thomson’s first argument is a good ground for resisting a strike-out.

28.  Mr. Thomson next relies on a passage from the speech of Lord Bingham in Johnson v. Gore-Wood (at 35E).  There Lord Bingham stated that:-

“Where a company suffers loss but has no cause of action to sue to recover that loss, the shareholder in the company may sue in respect of it (if the shareholder has a cause of action to do so), even though the loss is a diminution in the value of the shareholding.”

29.  The burden is on Hillhead (Mr. Thomson argues) to show that HEL and HICL have causes of action in respect of the diversions of assets being alleged.  Hillhead (Mr. Thomson says) has not discharged that onus. 

30.  Indeed, the likely lack of any cause of action by the company may be inferred (Mr. Thomson suggests) from the fact that, while in control, Hillhead made no attempt to cause the companies to sue the wrongdoers.

31.  Mr. Thomson adds that HEL or HICL may not have any claims because Hillhead arguably authorised them to enter into the prejudicial transactions.  He cites the following passage from Lewin in support:-

Ҥ39-41:-

Two further points are to be noted, which may assist the beneficiaries.... Secondly, in a case where the company is wholly owned by the trust, and the trustees as sole shareholders in the company authorise the company to enter into a transaction which the prejudices the company and which, apart from such authority would have generated a claim by the company against the directors or others.  The beneficiaries may, in our view, maintain an action against the trustees since the company never had a claim at all.”

32.  I am unable to accept that HEL and HICL have no cause of action in the situation posited in the Amended Statement of Claim.

33.  Sean’s allegation is essentially that Hillhead stood by and allowed HEL and HICL to be plundered by the settlor and “his minions”.  As a result of Hillhead’s inaction, it is contended that the settlor had a free rein in mismanaging the companies and diverting their assets.

34.  If Sean is right, it would be surprising if HEL and HICL had no cause of action whatsoever against the settlor and others for mismanagement of the company’s affairs and finances. 

35.  As far as shareholding is concerned, Hillhead held 50% of the issued share capital of HEL and 3.125% of the issued share capital of HICL.  I therefore do not see the relevance of the passage cited from Lewin which deals with the situation where companies are wholly owned by trusts.

36.  I reject Mr. Thomson’s second argument as a basis for resisting a strike-out.

37.  Mr. Thomson finally relies on an exception to the reflective loss principle identified in Giles v. Rhind [2003] Ch 618 (CA). 

38.  In Giles Waller LJ observed (at §34) as follows:-

“One situation which is not addressed [in Johnson v. Gore-Wood] is the situation in which the wrongdoer by the breach of duty owed to the shareholder has actually disabled the company from pursuing such cause of action as the company had.  It seems hardly right that the wrongdoer who is in breach of contract to a shareholder can answer the shareholder by saying, ‘the company had a cause of action which it is true I prevented it from bringing, but that fact alone means that I the wrongdoer do not have to pay anybody.’”

39.  In Giles X was found to have diverted a lucrative contract from company A (of which he was a director) to company B (in which he had an interest).  As a result, A was put into administrative receivership.  A sued X, but had to discontinue its action when it could not pay security for the defendant’s costs.  Thus, X’s act of diverting the lucrative contract meant that in practical terms A was unable to pursue its action against X.  The Court of Appeal held that, in such case, although some of the damage being claimed by a plaintiff P against X was reflective loss, P should be entitled to recover that reflective loss.

40.  Mr. Thomson says that HEL and HICL shares are now worthless due to wrongs in which Hillhead played a part.  Mr. Thomson argues that this means that HEL and HICL are technically insolvent and (like the company in Giles) not in a position to sue Hillhead.

41.  I am not persuaded by this third argument.

42.  There is no cogent evidence that HEL and HICL are unable to pursue claims against their alleged wrongdoers.

43.  On the contrary, on 21 February 2008, in a bid to stave off this strike-out application, Sean’s solicitors (Stevenson Wong) wrote to the solicitors of Hillhead and Ernst & Young (Simmons & Simmons) as follows:-

“We are instructed that, entirely without admission as to the merits of your application, Hotung Enterprises Limited (‘HEL’) and Hotung Investment (China) Limited (‘HICL’) will apply to be joined in as Plaintiffs in the action and have appointed Mr. Sean Hotung to prosecute the action upon their behalf.  We are further instructed that HEL and HICL will be claiming the entirety of the losses suffered during the material period and not just the proportion thereof claimed by Mr. Sean Hotung in his capacity as beneficiary.

In the light of the above, please advise as soon as possible whether your clients are prepared to withdraw their summons.  We reserve the right to draw a copy of this letter to the attention of the Court on the question of costs.”

44.  Mr. Thomson submits that I should ignore this letter sent by his own solicitors because Stevenson Wong does not act for HEL and HICL and the letter “does not show that the companies are in a position to enforce the rights”.

45.  But Stevenson Wong and Sean must have satisfied themselves that there was substance in the statement that HEL and HICL would be intervening in this action.  Otherwise, why was it being proposed that the strike-out application be withdrawn in light of an impending application for joinder by HEL and HICL? 

46.  I therefore do not think that I can simply ignore Stevenson Wong’s letter as Mr. Thomson invites me to do. 

47.  Nor do I think that Order 18 Rule 19(2) prevents me from looking at the letter. 

48.  Mr. Thomson suggests that, by that rule, this strike-out application being premised on Order 18 Rule 19(1)(a), I cannot look at any material other than the pleadings in determining whether there is a reasonable cause of action against Hillhead or Ernst & Young.

49.  That may be the case insofar as deciding whether there is a viable cause of action on the pleadings.  Here on the Amended Statement of Claim, there is plainly no viable cause of action because the only loss being alleged is reflective loss.

50.  I do not think that Order 18 Rule 19(2) prevents Sean from adducing such evidence as may be appropriate to demonstrate that, despite the inadequacy of the pleadings, there is some good reason why Sean should be allowed to proceed with his actions.

51.  In Giles P’s allegations had actually gone to trial.  The Court had found in P’s favour.  It was only during the assessment of damages that, following the then recent decision in Johnson v. Gore-Wood, X belatedly argued that P should not be compensated for merely reflective loss.  Thus, in Giles, there had not just been evidence but express findings that X had disabled the company by rendering it impecunious.

52.  Here in contrast there is nothing apart from Mr. Thomson’s assertion that HEL and HICL have become so impoverished as to be unable to bring an action.  There is a mere pleaded allegation that assets have been diverted from the companies. 

53.  If it is being suggested that any diversion of assets has now rendered it impossible for HEL or HICL to take action, more needs to be done.  One would have expected evidence (such as affidavits from the companies themselves) confirming that fact.

54.  I stress that I am not saying that the Court requires findings of fact along the lines of what happened in Giles, before the Court will apply the exception discerned by Waller LJ.  But the Court does need some evidence that the exception is applicable.  Mere assertion by counsel cannot be enough.

55.  Mr. Thomson has drawn my attention to recent litigation among Hillhead, members of the Hotung family (including Sean), HEL and HICL (HCMP No. 2757 of 2005, 30 March 2007).  There Deputy Judge Muttrie observed (at §8) that “[i]t is not disputed that the shares [of HEL and HICL] are now worthless”. 

56.  But it does not follow from such observation (even if correct) that HEL and HICL cannot bring any action.  For instance, if Sean is right in his allegations of massive and systematic diversion, the companies’ claims against the settlor and others must have significant economic value.  The claims are themselves assets.  On the strength of that value, the companies may well be able to raise the necessary financial backing (from directors, shareholders or even creditors) to embark upon litigation.

57.  If Sean has the financial resources to fund this litigation, it is hard to see why he could not apply the same funds to support direct actions by HEL and HICL (both companies effectively controlled by him) against any wrongdoers.

58.  For those reasons, I do not accept Mr. Thomson’s contention that the position here is analogous to that in Giles.

59.  The end result is that I have rejected all of Mr. Thomson’s submissions.  The reflective loss principle should apply and the claim against Hillhead should be struck out accordingly.

B. The claim against Ernst & Young

60.  It is apparent from the Prayer to the Amended Statement of Claim that the loss sought to be recovered against Ernst & Young is also reflective loss.  Insofar as the claim against Hillhead fails because it is a claim for reflective loss, the claim against Ernst & Young must equally fail.  The claim against Ernst & Young should thus also be struck out.

61.  Nonetheless, Mr. Thomson has also put forward a case of vicarious liability on the part of Ernst & Young.  He says that Ernst & Young are vicariously liable by virtue of their “providing ... trustee services through Hillhead”.  He elaborates that Ernst & Young are liable for Ronald’s acts as a partner in Ernst & Young, being acts “in the ordinary course of business of [Ernst & Young] and/or with the authority of [Ronald’s] co-partners”.

62.  In his support, Mr. Thomson cites Partnership Ordinance (Cap.38) (PO) s.12 and Dubai Aluminium Co. Ltd. v. Salaam [2003] AC 366 (HL).

63.  PO s.12 provides:-

“Where, by any wrongful act or omission of any partner acting in the ordinary course of the business of the firm or with the authority of his co-partners, loss or injury is caused to any person not being a partner in the firm or any penalty is incurred, the firm is liable therefore to the same extent as the partner so acting or omitting to act.”

64.  Dubai is said to be authority for the proposition that the expression “wrongful acts” in s.12 includes equitable wrong as well as tortious liability. 

65.  Thus, Mr. Thomson’s case runs:-

(1)     Ronald dishonestly assisted the settlor to dissipate the companies’ assets.

(2)     In managing Hillhead’s affairs Ronald acted fraudulently in consciously preferring the interests of the settlor as opposed to interests of the beneficiaries under the HEL and HICL trusts.

(3)     Ernst & Young did not authorise Ronald to act fraudulently.  But Ronald’s wrongful activities were so closely connected with what he was authorised to do as an Ernst & Young partner (namely, to manage professional trustee companies such as Hillhead set up by Ernst & Young for their clients) that his fraudulent activities may fairly be regarded as reasonably incidental to the ordinary type of business conducted by the Ernst & Young partnership.

(4)     Accordingly, the partnership may be treated as vicariously liable to the beneficiaries of the HEL and HICL trusts for Ronald’s equitable wrongs.

66.  Mr. Benjamin Yu SC (appearing for Hillhead and Ernst & Young) accepts that, if he failed to strike out on reflective loss, the vicarious liability case advanced by Mr. Thomson could not be summarily disposed of in a strike-out application.

67.  Given my conclusions in relation to reflective loss, I do not propose to say any more about Mr. Thomson’s contention of vicarious liability.

IV. CONCLUSION

68.  The pleadings against Hillhead and Ernst & Young are struck out.  The actions against both are consequently dismissed.  I shall now hear counsel on costs and other orders.