CHUNG KENG v. PEARL ORIENTAL OIL LTD

HCMP 1795/2018

[2018] HKCFI 2564

IN THE HIGH COURT OF THE

HONG KONG SPECIAL ADMINISTRATIVE REGION

COURT OF FIRST INSTANCE

MISCELLANEOUS PROCEEDINGS NO 1795 OF 2018

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D E C I S I O N

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1.  By Originating Summons dated 22 October 2018, the applicant, a registered shareholder of the respondent, applies for leave, under sections 732(1) and 733 of the Companies Ordinance[1], for him to commence, in the name of the respondent, a statutory derivative action against two of its directors, Ms Fan Amy Lizhen (樊麗真) and Mr Tang Yau Sing (鄧有聲) (“the prospective defendants”). They were at the material times two of the three directors of the respondent.

2.  According to the draft statement of claim exhibited to the Originating Summons, the applicant is concerned by the following acts or omissions (which I shall call “complaints”) of the prospective defendants (referred to therein as “the Defendants”), and which are said to constitute breaches of fiduciary and statutory duties owed to the respondent (referred to as “the Company” therein):

“ (a) The dubious circumstances surrounding the execution and sudden termination of the Proposed Placing (as defined below) when the Defendants failed to secure placees of their own choosing to receive the shares under the said placing exercise;

(b) The insistence on relocating the Company’s office premises in the absence of commercial justifications and despite the lack of sufficient funding;

(c) The failure to settle outstanding wages of employees;

(d) Despite the above, the refusal, for no apparent reason, to accept the proposed loan offered by [the applicant] where the Company has no reasonable alternatives to secure funding;

(e) Worse still, the reinforcement of their positions as directors by (i) refusing to convene a Special General Meeting in respect of resolutions to remove existing directors; and (ii) the appointment of directors lacking in required experience and qualifications.”

3.  An affirmation was made by the applicant on 22 October 2018 in support of his application.  It was, however, not filed or served until 9 November 2018, a few days before the hearing.

4.  On 24 September 2018, solicitors for the applicant sent a letter to the directors of the respondent, which is said to constitute a formal notice under section 733(1)(c) that the applicant intended to apply for leave to commence a statutory derivative action on behalf of the respondent against the prospective defendants (“the Notice”).  The complaint stated therein was that the prospective defendants did not acceptthe offer of a loan from the applicant, ie complaint (d) in the draft statement of claim.  The other complaints were not mentioned.  The respondent has not replied to this letter.

5.  At the first hearing of the Originating Summons before me on 14 November 2018, Mr Michael Lok, appearing for the applicant with Ms Jasmine Cheung, asks me to grant leave straight away.  He says that the threshold for the grant of leave under section 733 is low and the allegations contained in the draft statement of claim give rise to, at the very least, serious issues to be tried. 

6.  Mr Val Chow, who appears for the respondent, submits that this application should be dismissed for non-compliance with section 733(1)(c), because only one of the complaints set out in the draft statement of claim was stated in the Notice, but the requirements under section 733(4) is that the Notice must set out in full the reasons for the intention to apply for leave. 

7.  Further, if I am not minded to dismiss the Originating Summons because of the alleged defect regarding the Notice, Mr Chow submits that I should not grant substantive relief (namely leave to commence a derivative action) right away because:

(1) An independent board committee (“the Committee”) was appointed by the respondent to consider the issues raised in the draft statement of claim and what action the respondent ought to take, and should be given a chance to consider the allegations and decide what to recommend to the board, and to file evidence in opposition if it considers appropriate.  The Committee was only formed on 5 November 2018 and the evidence of the applicant in support was only served on 9 November 2018.  Mr Chow says that the respondent should respond to the evidence, rather than merely the allegations contained in the draft statement of claim;

(2) There are possibilities that the control of the respondent would change, because (i) there is an upcoming special general meeting (“SGM”) on 29 November 2018 where shareholders will consider whether to pass resolutions to remove seven of the current eight directors of the respondent; (ii) a winding-up petition and an application for provisional liquidator are pending before the Court in Bermuda (where the respondent was incorporated).  In such scenarios, Mr Chow says, the respondent would no longer be in control of the prospective defendants, and a derivative action cannot be brought or continued in relation to a company in liquidation.[2]  However, I am told that there is no hearing date fixed for the matters in Bermuda.

8.  Mr Lok submits that the Notice is adequate.  The applicant has stated the reason for the intention to apply for leave, namely that the prospective directors had been acting in breach of their duties owed to the respondent.  The complaints are merely grounds or particulars.  He cites a judgment of Belinda Ang Saw Ean J of the High Court of Singapore, Teo Seng Hoe (alias Tew Seng Hoe) v IDV Concepts Pte Ltd [3], which in turn cited a judgment of Nemetz CJBC of the British Columbia Court of Appeal in Bellman v Western Approaches Ltd [4] in support of the proposition that a failure to specify each and every cause of action in such a notice does not invalidate the notice as a whole, if the directors are reasonably notified of the intention to apply for leave.  If necessary, he asks for a dispensation under section 733(5).

9.  Mr Lok also suggests that the respondent, who is still under the control of the prospective directors and those they appointed, is employing delaying tactics, in particular the appointment of the Committee. Having been served with the draft statement of claim on 23 October 2018, the respondent ought to, but has failed to, plead or respond to it, and only appointed the Committee on 5 November 2018.  It has not suggested that the allegations in the draft statement of claim have no prospect of success. He also queries the independence, expertise and qualifications of the members of the Committee.  He emphasises that their very appointment as directors is a subject of complaint (see complaint (e) above).  He also suggests that there is no reason to wait to see if the possibilities for change of control happen.

10.  I shall deal with the question of the adequacy of the Notice first.

11.  Section 733 provides as follows:

“ (1) On application by a member of a company or of an associated company of a company, the Court may grant leave for the purposes of section 732(1), (2) or (3) if it is satisfied that—

(a) on the face of the application, it appears to be in the company’s interests that leave be granted to the member;

(b) in the case of—

(i) an application for leave to bring proceedings under section 732(1) or (2), there is a serious question to be tried and the company has not itself brought the proceedings; or

(ii) an application for leave to intervene in proceedingsunder section 732(3), the company has not diligentlycontinued, discontinued or defended the proceedings; and

(c) except where leave is granted by the Court under subsection (5), the member has served a written notice on the company in accordance with subsection (3), and the notice complies with subsection (4).

(2) The Court may refuse to grant leave if it is satisfied that—

(a) in the case of an application for leave to bring proceedings under section 732(1) or (2), the member has, in the exercise of any common law right, brought proceedings on behalf of the company in respect of the same cause or matter; or

(b) in the case of an application for leave to intervene in proceedings under section 732(3), the member has, in the exercise of any common law right, intervened in theproceedings in question to which the company is a party.

(3) The written notice must be served on the company, at least 14 days before the member applies for leave in respect of the company—

(a) in the case of a company as defined by section 2(1), by leaving the notice at, or by sending the notice by post to, its registered office; or

(b) in the case of a non-Hong Kong company, in a manner that the notice is sufficiently served on the company by virtue of section 803.

(4) The written notice must state—

(a) the member’s intention to apply for leave for the purposes of section 732(1), (2) or (3) in respect of the company; and

(b) the reasons for that intention.

(5) The Court may grant leave to dispense with the service of a written notice for the purposes of subsection (1)(c).”

12.  As Mr Chow points out, the legislation in Singapore, ie section 216A(3) of the Companies Act[5], only requires the complainant to give notice to the directors of the company of his intention to apply to the court for leave to bring a derivative action, but there is no requirement (like section 733(4)(b)) to give reasons for the intention.  I therefore do not find Teo Seng Hoe or Bellman to be of assistance in considering the scope and requirements of section 733(4)(b).

13.  In Re Up Profit Limited [6], Harris J said:

“ As I explained in paragraph 9(d) of Yu Yuchuan v China ShanshuiInvestment Company Limited, the purpose of the written notice isto allow the company to consider whether to contest or acquiesce to the application.”

14.  In Fong Wai Lyn Carolyn v Airtrust (Singapore) Pte Ltd [7], Judith Prakash J said:

“ Counsel for Ms Kao, Mr Davinder Singh SC, contended that this notice requirement served to give the directors a chance to consider a response to the complaint provided in the notice. I accepted Mr Singh’s suggested rationale as it provided both practical and commercial sense. If the company would be willing to pursue the complaint on its own, the leave application would become redundant, and no further legal costs would be incurred or wasted in dealing with the issue of whether leave ought to be granted.”

15.  Despite the difference between the Companies Ordinance and the Singapore legislation as I pointed out above, I find this explanation of the rationale by Judith Prakash J also apposite in Hong Kong, and is consistent with what Harris J said.

16.  The purpose of a notice under section 733(4) being to allow the company concerned to consider what to do with the complaints, in my judgment the notice, when giving the reasons for the intention to apply for leave, must include sufficient details and particulars of each of the complaints.  Such details are part and parcel of the reasons to be given.  What constitutes sufficient details and particulars must be a question of fact in each case, the test being whether the directors as reasonable commercial persons, with their knowledge of the company’s affairs, would be in a position, when reading the notice, to make a proper informed decision on how to respond.  Otherwise, I do not see how such a notice can fulfill its intended purpose.

17.  I do not accept Mr Lok’s submission that the reason is the alleged breach of fiduciary and statutory duties, with the details being outside the scope ofthe reason and need not be included.  If he is right, then a bare allegation of breach of fiduciary duty arguably suffices, which cannot be correct, as the company would not be in a position to consider how to respond at all.

18.  I would therefore hold that the Notice is inadequate in so far as the applicant is seeking leave to commence a derivative action for any of the complaints, save for complaint (d).  The Notice is adequate for complaint (d).

19.  Mr Chow asks me to dismiss this application on this ground.  I do not see how I can do so in so far as the applicant is seeking leave for the respondent to sue on complaint (d). 

20.  Regarding the other complaints, in my judgment I should accede to Mr Lok’s application and grant a dispensation under section 733(5).  Such dispensation is not required to be obtained before the application for leave is made: see Re China Shanshui Investment Co Ltd [8]. Even though Harris J in that case gave urgency as the reason for not making the application for dispensation before the applicationfor leave, I do not read the section, or his decision, as restricting the grant of dispensation in such circumstances to cases of urgency.  Section 733(1)(c) in its terms allow the dispensation to be granted any time before leave to commence a derivative action is granted.  In my judgment, the question is whether in all the circumstances, including in particular the intended purpose of a notice under section 733(4), and any likely prejudice or wastage of costs one way or another in granting or refusing dispensation, it is just to grant dispensation, whenever the application for dispensation is made before grant of leave to commence a derivative action.

21.  I am of the view that a dispensation ought to be granted in this case for the other complaints, and I so order:

(1) As I said above, the notice is adequate for complaint (d);

(2) Under section 733(3), the respondent is given 14 days to consider whatever complaints the applicant has.  It is not the respondent’s case had such a notice been given, it would have agreed to take action against the prospective defendants itself rendering a leave application unnecessary. Rather, having been served with the draft statement of claim containing details of all the complaints on 23 October 2018, at the hearing on 14 November 2018 before me, 22 days later, the respondent has not, according to Mr Chow, decided what to do.  It would therefore have made no difference whether the original letter mentions and contains full details of all the complaints – it is unlikely that the respondent would have responded by the time of the issue of the Originating Summons. The failure to mention and to give full details of the other complaints is therefore in this sense immaterial.  It would be quite pointless, and a complete waste of time and costs, for me to dismiss the leave application for the other complaints (while preserving it for complaint (d)), for the whole process of giving notice for the other complaints to start afresh.  In the meantime, it is still open to the respondent to agree to take action on the complaints itself directly and if it does, the question of costs of this application can be addressed accordingly.

(3) I see no prejudice to the respondent in granting dispensation.  The prejudice alleged by Mr Chow in his skeleton relates, in my judgment, to the attempt by the applicant to obtain substantive relief at this hearing, rather than to a grant of dispensation;

(4) Mr Chow says that an application for dispensation ought to be made properly, supported by an affidavit.  However, I see no such requirements under section 733(5).  The question is whether there are already sufficient materials before the court to consider the exercise of its discretion under section 733(5).  If there is no, or no sufficient, materials then of course the application will fail.  But if there are already sufficient materials for me to exercise my discretion properly, then I can and should do so, provided there is no injustice to the company concerned. I can see no such injustice as I am able to decide the question of dispensation on undisputed facts.

22.  I therefore exercise my discretion under section 733(5) to grant leave to dispense with the service of a notice for the complaints stated in the draft statement of claim for the purpose of section 733(1)(c). 

23.  The next question is whether I should decide whether to grant leave to the applicant to commence the derivative action now, as Mr Lok contends.

24.  In Re China Shanshui Investment Co Ltd, Harris J said:

“ 7. In determining whether or not to grant leave under section 733, the principal matters that the court is concerned with are:

(1) whether the proposed action appears to be in the interests of the company; and

(2) whether there is a serious question to be tried.

8. The threshold in respect of both these criteria is low.  As Lord Millett notes at paragraph 55 of his judgment in Waddington Ltd v Chan Chun Hoo ‘in applying for leave the plaintiff is not required to establish a prima facie case but only that there is a serious question to be tried.’  Consistent with this in assessing applications for leave the prospects of success are to be investigated only to a limited extent; and the court should beslow to find against the applicant unless his prospects are so slim that he cannot be said to have any expectation of success.  At this stage it is not the court’s function to try to resolve conflicts of evidence or difficult questions of law, which require substantial argument and deliberation.  In practice, if the applicant is able to produce a draft pleading that sets out a case with some prospect of success when only the allegations contained in the pleading are considered, the criteria will be satisfied unless the respondent can demonstrate fairly readily that there is a serious flaw in the claim and that it has no real substance.  In most cases, if a ‘serious question to be tried’ has been demonstrated, it is likely to appear to be in the company’s interests to bring proceedings.”   

25.  Citing Ng J in Re Primlaks (HK) Ltd [9], Anthony Chan J said in Re Green Valley Investment Limited [10] :

“ On serious question to be tried:

(a) The threshold is relatively low. The prospects of the company’s success are to be investigated only to a limited extent, and the court should be slow to find against the applicant unless such prospects are so slim that the company cannot be said to have any expectation of success. See Re Primlaks (HK) Ltd, HCMP 1789/2015, unrep, 28 January 2016, §§7–8 per Ng J.

(b) At the leave stage, it is not the court’s function to try to resolve conflicts of evidence or difficult questions of law which require substantial argument and deliberation.  In practice, if the applicant is able to produce a draft pleading that sets out a case with some prospect of success when only the allegations contained in the pleading are considered, the criteria will be satisfied unless the respondent can demonstrate fairly readily that there is a serious flaw in the claim and that it has no real substance. See Re Primlaks (HK) Ltd, §9.”

26.  The existence of a threshold, no matter how low, does mean that it is possible in a given case for the company to show that it is below the threshold.  As stated in the above judgments, if a company can demonstrate fairly readily that there is a serious flaw in the claim and that it has no realsubstance, or it cannot be said to have any expectation of success, then no leave should be granted.  I do not think that I can deny the respondent the opportunity to so demonstrate, if it so desires, with proper evidence, even with the limited extent to which a court should examine the evidence, and given that the evidence of the applicant was only served on 9 November 2018.  I agree with Mr Chow that the respondent should be allowed to respond to the evidence, rather than merely the allegations contained in the draft statement of claim.  If, as I direct below, the respondent is given 28 days to file evidence, that wouldbe sufficient for it to decide how to respond to this application as well (see §7(1) above).  I regard the 42 days asked for by Mr Chow to be too long. 

27.  Mr Lok is not able to show me any urgency in dealing with this application substantively now, which can or may be addressed by an immediate grant of leave.  He says that because of the alleged mismanagement the listing status of the respondent may be endangered, butthis is not a matter which can be addressed by grant of leave to commence a derivative action.

28.  I should add that I do not accept Mr Chow’s argument based on possible change of control of the respondent (§7(2) above).  These are mere possibilities which may or may not happen, in particular for the Bermudan proceedings which have no dates yet.  No doubt if leave is granted and then control of the respondent changes, appropriate arrangements can be made of the future conduct of the derivative action.

29.  I therefore give the following directions:

(1) The respondent do have leave to file and serve evidence in opposition within 28 days from the date of this Order;

(2) The applicant do have leave to file and serve evidence in reply within 21 days thereafter;

(3) No further evidence be filed without leave of the Court;

(4) The Originating Summons be adjourned for substantive argument with one day reserved, in consultation with one counsel’s diaries on each side;

(5) Costs (including costs of the hearing on 14 November 2018) be reserved.

30.  I thank counsel for assistance.