RACP PHARMACEUTICAL HOLDINGS LTD v. LI XIAOBO

HCA 490/2007

IN THE HIGH COURT OF THE

HONG KONG SPECIAL ADMINISTRATIVE REGION

COURT OF FIRST INSTANCE

ACTION NO. 490 OF 2007

____________

____________

_____________________________

REASONS  FOR  RULING

_____________________________

1.  The plaintiff bought from the defendant the defendant’s shares in a Chinese company for US$11.125 million.  Then, according to the plaintiff, it found out that the receivables of the company had been overstated by about $20 million.  The plaintiff applied for, and obtained a world-wide Mareva injunction.

2.  The ex parte application came before me and on 9 March 2007 I made an order in respect of assets up to the value of US$6 million.  On 13 April 2007, Deputy Judge Gill increased the amount to US$10 million.  On 4 May 2007, Yam J made an order for the disclosure of the statements of the defendant’s bank accounts in Canada and Shenyang and details of incumbrances pertaining to certain properties owned by him in those places.  On 17 May 2007 the defendant appealed against this last order.

3.  The defendant now applies by summons dated 10 April 2007 to have the Mareva injunction set aside.  He also applies by summons dated 18 May 2007 to have execution of the order of 17 May 2007 stayed pending the hearing of the appeal.

Issues

4.  The defendant says that the injunction was wrongfully obtained by reason of material non-disclosure by the plaintiff of a number of important and material facts.

5.  It is necessary therefore to decide first, whether the facts relied on are relevant to the decision which had to be made at the ex parte stage.  If they were not, then that is an end of the matter.

6.  If the facts were relevant, it is then necessary to decide whether the non-disclosure was deliberate or innocent.  If deliberate, as has been noted in argument, discharge is almost inevitable; there are various judicial pronouncements to this effect.  If innocent, the court may continue the injunction or may discharge the existing injunction and, if appropriate, make a fresh order.

7.  If the existing injunction is to be continued, or discharged and a new order made, it is then necessary to consider quantum; the defendant says that in that event, the amount frozen should be restricted to the original sum of US$6 million. 

8.  If the injunction is discharged, then, necessarily, the ancillary order for disclosure must also be discharged.  The defendant argues, and I do not think there is any real opposition to this, that in the event that the injunction is continued or renewed for a lower figure, any ancillary disclosure order must be restricted to that figure.

9.  As to the application for stay, the defendant argues that he has good grounds of appeal and that if stay is not granted the appeal will be rendered nugatory.

Background

10.  The plaintiff is a BVI company, beneficially owned by a US company, China Biopharmaceuticals Holdings Inc. (“CBH”).  The defendant, a medical doctor and businessman, owned a 100% shareholding in a company called Enshi Singapore, which in turn owned Shenyang Enshi Pharmaceuticals Ltd (“Enshi”), a pharmaceutical company in Mainland China.  The defendant sold his shareholding to the plaintiff under a stock purchase agreement which was signed in Beijing on 16 May 2006 and in Hong Kong on 2 June 2006.  US$1M was placed in an escrow account and on the latter date the plaintiff transferred US$10.125 million to the defendant’s account in Hong Kong.

11.  Negotiations began in late 2005.  Mao Peng, a director and shareholder of CBH, represented the plaintiff.  In mid March 2006, one Wang Weng Xin, a financial manager with CBH and a certified public accountant, was sent to Enshi’s office in Shenyang to collate the company’s financial documents before the arrival of the auditors, Moore Stephens who were to make a financial report on Enshi.

12.  On 13 May 2006 the defendant signed a confirmation letter confirming that the information presented to Moore Stephens was true, accurate and complete.  Attached to it was a list of accounts receivable by Enshi amounting to about RMB22 million.

13.  As part of the stock purchase agreement the defendant gave a warranty that the audited net income of Enshi for the year ending 31 December 2005 was not less than US$5 million and that its audited net assets were not less than RMB82 million. 

14.  After the purchase was completed, it was found that the RMB22 million of receivables was not in fact owing to Enshi.  The figure represented receivables from two companies.  In fact Enshi owed money to one of them.

The claim and the defence

15.  The plaintiff’s claim is for damages for deceit, alternatively damages for breach of the stock purchase agreement.  The plaintiff’s case is that the defendant defrauded it by certifying an inflated value of the receivables.

16.  In brief, the defendant’s defence, as it now appears from his affirmation dated 30 April 2007 in support of the application to discharge the injunction, is that he did not defraud the plaintiff; the plaintiff’s own director, Mao did that.  Mao sent in Wang, as part of the due diligence exercise before purchase, to collate the company’s financial documents in March 2006, shortly before the arrival of the auditors who were to prepare and did prepare the report, on which the plaintiff relied in entering into the stock purchase agreement and which was confirmed by the defendant.

17.  In fact the defendant did not check the figures; he thought they were all right, and so he signed.  As it turned out, the report was false, but it was false because Mao had procured Wang, in the course of his collation of the financial documents, to falsify the accounts of Enshi by inflating the receivables.  Mao did this in order to convince the investors in his own company, CBH to put up the money for the purchase, knowing that later, when the falsities came to light, he could procure the plaintiff to pursue the defendant and get back the purchase price; the plaintiff would be able to rely on the express warranties in the sale and purchase agreement in which the defendant had accepted responsibility for the financial statements, and guaranteed that if the receivables were not paid, he would be personally liable for the amount of them.

18.  I said to counsel appearing before me, that the defendant’s defence is obviously an improbable one.  Wang, who knew nothing about Enshi, would have had to falsify a huge amount of documents in a matter of a few days, which on the defendant’s own account was all the time he would have had.  Further, frankly, the story is far too complicated, and does not make commercial sense.  If the company was worth what was paid for it, as the defendant says it was, why would Mao, having put up the money, want to go after the defendant to get it back?  Even if he had deceived his own investors, they would have got their money’s worth.  

19.  This is not a summary judgment application, and I do not have to make the distinction between that which is not to be believed and what is unbelievable, but if it were I can imagine that many a judge of robust outlook and not given to credulity would see the “moonshine” shining through the defence case.

Non-disclosure

20.  A list of the non-disclosures relied on is set out at paragraph 19 of defence counsels’ first skeleton argument.  They relate first to an incident in November 2006 which the defendant calls Mao’s personal instigation of false accounting and false receivables by Enshi, and what Mao calls a failed attempt on the part of himself and Wang to get the defendant to incriminate himself for fraud.  Second, the defendant says that the plaintiff used one valuation to get a loan from the Bank of China, while CBH used an inflated version of the same valuation to support its statements to the Securities and Exchange Commission in the USA.  Third, the defendant says that Mao’s mother asked the defendant to lend Mao RMB20 million.  Fourth, while Wang says that the defendant beat him up to try to get from him repayment of a loan of RMB5 million to Enshi – and there is ample evidence that Wang was beaten up by someone – the plaintiff did not disclose the fact that the defendant later got judgment in a Chinese court for the same amount.  Last, the defendant relies on the allegedly unjustifiable basis for increasing the amount of claim, based on the report of its forensic accountant RGL.

Materiality

21.  Material facts are “… all facts that are relevant to the weighing operation which the court has to make in deciding the point before it.”:  per Browne-Wilkinson LJ in Thermax Ltd v Schott Industrial Glass Ltd [1981] FSR 289.  The duty is to disclose anything which casts doubt on or would have undermined the plaintiff’s case.  See Continental Mark Ltd v Verkehrs-Club de Schweiz [2001] 4 HKC 469, Hover Base Investments Ltd v Best Concept Management Ltd [2004] 4 HKC 457.

22.  The weighing operation referred to is carried out to decide first, whether there is a serious question to be tried and then, if damages are not adequate as a remedy, the balance of convenience.  In the latter connection the relative strengths of the parties’ cases may be taken into account, where the relative strengths are disproportionate.  See Fellowes & Son v Fisher [1976] 1 QB 122 at 137.

23.  It appears that in November 2006 the defendant at the request of Mao or Wang produced a receipt for a dividend which the books showed he had received, when in fact he had not.  The receipt was signed in the defendant’s name but not by himself.  Later, Wang had the defendant sign a similar receipt in his own name, but also a memorandum signed by Wang and authorised by Mao to the effect that the receipt was invalid.  Wang says that this was done to get the defendant to incriminate himself. 

24.  The defendant says that Mao instigated this matter in order to “clean up” receivables which had been adjusted upwards.  He told Mao to liaise with his own company’s finance officer, to sign the receipt in the defendant’s name.  The defendant says that Wang told him that this receipt was not acceptable to the auditors and got him to sign another one himself, also handing over the memorandum and an authorisation by Mao.  Wang denies any knowledge of the finance officer or having been sent to get a false receipt from him.

25.  The defendant says that the court should have been apprised of these facts.  The plaintiff says that they are not material in any event.

26.  I do not need to, nor should I make a finding as to who is telling the truth about these documents.  The point is that if there had been disclosure, it would have been disclosure of Wang’s story as it now appears.  As Wang’s story stands – and at the ex parte stage it would not have been subject to the forensic scrutiny now applied to it – it does not tend to cast doubt on or undermine the plaintiff’s case that the defendant committed a fraud particularly by signing off on accounts which turned out to be false.

27.  The other matters relating to the alleged approach by Mao’s mother for a loan, or the matter of the RMB5 million loans are not relevant to the case of fraud.

28.  On these points I conclude that there was no material non-disclosure.  I will deal separately with the quantum issue.

Deliberate or innocent non-disclosure

29.  In case I am wrong in finding that there was no material non-disclosure, I would still have no hesitation in saying that if there was non-disclosure it was innocent.  The defendant’s improbable story, that it was he who had been a kind of innocent accessory –he could hardly be a victim, since he got the money – to a fraud on CBH’s investors had not yet come to light.  The undisclosed matters could support the defendant’s story, if the conclusions he draws from them turn out to be true.  But in a situation where the plaintiff could not as yet have known what the defence would be I cannot see that there would have been a duty on it to disclose matters which might support that defence.  If there was material non-disclosure, therefore, it was innocent.

30.  In this case someone has been defrauded.  There is obviously a real question to be tried, and equally obviously the balance of convenience lies in favour of the Mareva injunction.  The money is the proceeds of fraud, whether the defendant’s or the plaintiff’s.  He has taken the money out of Hong Kong.  If there is no injunction there is obviously a serious risk of dissipation.

31.  In cases of substantial fraud, innocent, albeit careless non-disclosure may not result in discharge: Gee on Commercial Injunctions para. 9.018.  This is a substantial fraud.  If there was innocent non-disclosure, I cannot see that the injunction should be set aside and there is no point at all in setting it aside and granting a new injunction.  The injunction must stand.

Quantum

32.  The defendant says that the order of Deputy Judge Gill increasing the sum frozen to US$10 million should be varied because it was based on the forensic accountant’s report, which takes into account matters in respect of which there are no claims in the Writ.

33.  This argument does not appear in the affidavit of Mr Bedford, the defendant’s then solicitor.  We do not know if it was advanced before Deputy Judge Gill but the point was there to be argued, and nothing has changed since then.

34.  The case of Chu Hung Ching v Chan Kam Ming & Ors [2001] 1 HKC 396 is authority for the proposition that the rules of res judicata and issue estoppel do not apply in interlocutory motions.  However it may be unjust and unreasonable to permit the same issue to be litigated afresh.

35.  It is true that I have the discretion to reconsider the quantum.  My original order was based on the claim as it then stood, i.e. the difference between the price and the value assessed in Eric Wei’s affirmations.  However, the plaintiff has a contractual claim, the amount of which is yet to be ascertained.  Perhaps the figures in the forensic accountant’s report take into account matters not covered by the Writ, but the Writ can be amended if need be, and so far we have seen no Statement of Claim assessing the contractual damages sought.  In the light of this and the fact that the argument could have been advanced before Deputy Judge Gill, but was not, and that nothing has changed since then, I think it would be unjust to vary the amount restricted.

Stay

36.  It is true that the disclosure order is not my order and it would have been better for Yam J to hear the application for stay.  But he is not hearing it, and, unfortunately, I am.  I cannot say that the particular grounds of appeal relied on by Mr Huggins SC are not good.  No doubt if stay is not granted the appeal will be nugatory.  I think the stay has to be granted.

Conclusion

37.  The injunction will stand, as varied by Deputy Judge Gill.  However there will be a stay of execution of the disclosure order.

Costs

38.  The plaintiff seeks its costs of the discharge application.  The defendant says that they should be in the cause but if they are ordered now, he should have costs up to the time of filing the affidavit evidence to make good the alleged deficiency in admissibility.

39.  Applying the reasoning in Kickers International SA v Paul Kettle Agencies Ltd & Anor [1990] SFR 436 – would it be unfair for the plaintiff to have the costs if it loses at trial – I do not think that it would, although at the same time, on what is before me, it seems unlikely that the plaintiff will lose.

40.  Costs of both the applications will be in the cause.

41.  As to the directions: having heard further argument, I accept that in the circumstances of this case discovery and inspection will take a long time.  Parties will have to go through a huge amount of documents to ascertain which are false.  Then they will have to try to find out what indication there is as to who falsified them.

42.  That said, this is a Mareva injunction.  It is in both parties’ interest to bring the trial on as soon as possible.  I will make this order:

Directions:

Plaintiff to file Statement of Claim within 7 days from today’s date.

Defendant have 28 days thereafter to file and serve Defence.

Plaintiff to have 14 days thereafter to file Reply if so advised.

Mutual discovery within 28 days from close of pleadings.

Inspection within 28 days thereafter.

Witness statements to be exchanged within 28 days thereafter.

Case to be listed for speedy trial.