TANG SIU CHOI v. MAN LUNG TEXTILES LTD AND ANOTHER

HCMP 1351/2017

[2018] HKCFI 125

IN THE HIGH COURT OF THE

HONG KONG SPECIAL ADMINISTRATIVE REGION

COURT OF FIRST INSTANCE

MISCELLANEOUS PROCEEDINGS NO 1351 OF 2017

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J U D G M E N T

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Introduction

1.  This is the application of Madam Tang Siu Choi (“Tang”) by originating summons filed on 12 June 2017 under s 732(1) of the Companies Ordinance, Cap 622 (“CO”) for leave to commence a statutory derivative action (“intended action”) in the name of the 1^st Respondent (“Man Lung”) against its director, the 2^nd Respondent Mr Tam Tak Yam (“Tam”).

2.  The application is opposed by Tam.

3.  Man Lung is a limited company incorporated in Hong Kong carrying on the business of manufacturing and trading in garments.  It is said that at all material times, Tam has been in control of its finance while Tang has been responsible for sales and operations until about July 2016.

4.  Since about February 2011, there have been 3 shareholders of Man Lung viz Tang (25% shareholding), Tam (50% shareholding) and Mr Yeung Siu Ming (“Yeung”) (25% shareholding).  According to Tang, that remains the position today.  This is disputed by Tam who claims that Yeung’s 25% shareholding in Man Lung had already been sold and transferred to Tang pursuant to a written sale and purchase agreement dated 30 January 2015 (“Agreement”).  Tang, on the other hand, says completion of the sale had not taken place — hence the shareholding structure of Man Lung remains the same.  What is not in dispute however is that Yeung had resigned as director of Man Lung on 15 May 2014 and, since then, the only two directors of Man Lung were and are Tang and Tam.

5.  Man Lung’s manufacturing arm, so to speak, is Dong Guan Wan Xi Textiles Limited (“Wan Xi”), a private company incorporated in the PRC.  Its business is to manufacture garments and Man Lung is said to be one of its “clients”.  Wan Xi is a wholly owned subsidiary of another Hong Kong company viz Man Shing Textiles Limited (“Man Shing”). Man Shing’s shareholders were at all material times Tang, Tam and Yeung.  By the Agreement, Yeung also agreed to sell his 1/3 shareholding in Man Shing to Tang and Tam.  Similarly, Tang claims completion of the sale had not taken place and hence the shareholding structure of Man Shing remains the same.  Since about September 2006, Tam has been the legal representative of Wan Xi and said to be in control of its finance and management.  Tang said she was responsible for its sale and production.

6.  By way of further background, on 25 November 2016, Yeung petitioned for the winding up of Man Lung and Man Shing pursuant to s 177(1)(f) of the Companies (Winding Up and Miscellaneous Provisions) Ordinance, Cap 32 in HCCW 425/2016 and HCCW 426/2016.  His grounds were essentially about the irregularities in the audit report on the profits and loss of Wan Xi[1] up to 20 January 2015; that he had not consented to the appointment of the auditor; that Tam refused his and Tang’s request to hold an annual general meeting to deal with the two companies’ matters and that Tam’s and Tang’s conduct has prejudicially affected his interest in the companies: In the Matter of Man Lung Textiles Limited, HCCW 425/2016 and In the Matter of Man Shing Textiles Limited, HCCW 426/2016; unrep, DHCJ To; 30 November 2017 at [4].  DHCJ To allowed Tam’s application to strike out the two petitions on the ground that Yeung had no locus standi to present the petitions, he having sold his shares in the two companies to Tam and Tang under the Agreement[2].  The judgment of DHCJ To is currently under appeal. 

Deliberation

7.  It can be seen from the draft statement of claim of the intended action (“Draft”) that Tang and Tam have completely fallen out with each other such that Man Lung does not have a functioning board of directors.  There is thus no way Man Lung could properly or would bring proceedings against Tam.

(1) At paragraph 6 of the Draft, it is alleged that in July 2016, Tam had expelled Tang from the management of Man Lung and Wan Xi.

(2) At paragraph 15 of the Draft, it is alleged that Tam, as director, has been in breach of his fiduciary duties, duties of fidelity and duties of care, skill and diligence towards Man Lung including inter alia “misuse and misappropriation of assets of Man Lung, failure to exercise reasonable skill, care and diligence, not acting in good faith and in the interest of Man Lung, not exercising his powers for proper purposes and conflict of interest”.  Detailed incidents of the alleged breaches are set out from paragraph 16 onwards of the Draft.

8.  Statutory derivative actions are covered by Part 14, Division 4 of the CO.  The relevant parts of s 732 provide:

“Member of company or of associated company may bring or intervene in proceedings

(1) If misconduct is committed against a company, a member of the company or of an associated company of the company may, with the leave of the Court granted under section 733, bring proceedings in respect of the misconduct before the court on behalf of the company.

(2) If, because of misconduct committed against the company, a company fails to bring proceedings in respect of any matter, a member of the company or of an associated company of the company may, with the leave of the Court granted under section 733, bring proceedings in respect of the matter before the court on behalf of the company.

…

(4) The cause of action in relation to the proceedings under subsection (1) or (2) is vested in the company.  Any of those proceedings must be brought in the name of, and the relief (if any) must be sought on behalf of, the company.”

9.  Applications for leave to bring statutory derivative action are governed by s 733, the relevant parts of which provide:

“Leave of Court to bring or intervene in proceedings

(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;

…

(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).”

10.  There is no serious dispute that in order for Tang to obtain leave to bring the intended action on behalf of Man Lung, she must satisfy all the conditions set out in s 733.  For the present purpose, only the following two are material:

(1) First, it appears to be in the interest of the company that leave be granted (“Interest of the Company Requirement”).

(2) Second, there is a serious question to be tried and the company has not itself brought the proceedings (“Serious Question Requirement”).

11.  I shall consider the two requirements in reverse order.  This is because, if the Serious Question Requirement cannot be met, it is difficult to see how it can be in the interest of Man Lung to commence proceedings against Tam which ex hypothesis are doomed to fail: Re Li Chung Shing Tong (Holdings) Ltd [2011] 5 HKC 531at [31].

12.  As expected, Tam’s contention is that (1) there is no serious question to be tried; and (2) it is not in the interest of Man Lung that leave be granted.

Serious Question Requirement

13.  The Serious Question Requirement is of a “relatively low threshold”: Re F&S Express Ltd [2005] 4 HKLRD 743 at [21]; Re Grand Field Group Holdings Ltd [2009] 3 HKC 81 at [21]; Re Li Chung Shing Tong (Holdings) Ltd, supra at [32].  At [33], Harris J observed:

“…in ascertaining whether or not there is a “serious question to be tried”, the prospects of the plaintiff’s success are to be investigated only to a limited extent, and the court should be slow to find against the plaintiff unless his prospects are so slim that he cannot be said to have any expectation of success. I am reminded, in this regard, of Megarry VC’s oft‑cited explanation in Mothercare Limited v Robson Books Ltd [1979] FSR 466, in which he said, at 474:

‘… the prospects of the plaintiff’s success are to be investigated to a limited extent, but they are not to be weighed against his prospects of failure. All that has to be seen is whether the plaintiff has prospects of success which, in substance and reality, exist. Odds against success no longer defeat the plaintiff, unless they are so long that the plaintiff can have no expectation of success, but only a hope. If his prospects of success are so small that they lack substance and reality, then the plaintiff fails; for he can point to no question to be tried which can be called ‘serious’, and no prospect of success which can be called ‘real’.” (emphasis added)

14.  I agree and would gratefully adopt this approach.

15.  In considering this requirement, the most convenient starting point is the Draft which identifies the causes of action Tang seeks to bring in the name of Man Lung against Tam.  As I said earlier, detailed incidents of the alleged misconduct on the part of Tam are set out from paragraphs 16 onwards.  For ease of reference, they are set out below:

“Misappropriation of Man Lung’s Assets

16. In breach of his duties, Tam attempted and/or succeeded in various occasions to divert payments from Man Lung to himself personally or to other persons unlawfully.

17. In breach of his duties, Tam attempted to misappropriate payments due to Man Lung from Sterling & Grant Limited (“S&G”).

Particulars

(1) In or about February 2017, S&G terminated an order for manufacturing garments with Man Lung;

(2) Prior to the termination of the order by S&G, Man Lung had already purchased different quantities of raw materials and had delivered the same to Wan Xi for further processing;

(3) At the material times, the raw materials were the property of Man Lung;

(4) Upon the termination of the order, pursuant to two sale and purchase agreements, Man Lung agreed to sell different lots of raw materials to one 南輝 and one 中山宏豐 respectively;

(5) Pursuant to the said sale and purchase agreement and the delivery of the raw materials, Tam wrongfully caused Wan Xi to issue two invoices to 南輝 and 中山宏豐 both dated 21 February 2017 in the amounts of RMB 116,217.25 and RMB 95,708.57 demanding payments to be made to Tam’s personal bank account (China Construction Bank Account number 323-091-998-012-016-7997); and

(6) After learning the event from S&G, Tang rectified the situation by informing S&G that payments should only be made directly to Man Lung and having Man Lung issued a debit note dated 9 March 2017 to S&G.

18. On or about 18 January 2017, Tam wrongfully caused Wan Xi to issue a commercial invoice to Fred Perry Ltd. (“Fred Perry”) for a sum of US$219,355.00 in respect of an order made between Fred Perry and Man Lung. Tam requested the said sum of US$219,355.00 to be paid to an account of Wan Xi (China Construction Bank Corporation Dongguan Branch Account Number 4405-0177-6208-0914-0015) thereby misappropriating the said sum from Man Lung.

19. In order to facilitate the misappropriation of Man Lung’s account receivables, Tam unlawfully and without authority from the board of directors of Man Lung issued a written authorisation dated 30 December 2016 (“the Purported Authorisation Letter”) purportedly authorising Wan Xi to receive an amount of US$12,770.50 due to Man Lung from one Eagle State Industrial Ltd. in respect of an invoice issued by Man Lung (Invoice Number: ML16227).

20. Further, in order to misappropriate Man Lung’s account receivables, Tam had by emails dated 7 December 2016, 17 February 2017, 22 February 2017 and 28 February 2017 respectively issued to Frank & Oak, a customer of Man Lung, wrongfully requested Frank & Oak to send its payments due to Man Lung to the bank account of Wan Xi numbered 4405‑0177‑6208‑0914‑0015 at China Construction Bank Corporation Dongguan Branch.

21. On or about 4 January 2017, Man Lung issued an invoice to Modasuite Inc. for a sum of US$4,592.70 in respect of an order made between Modasuite Inc. and Man Lung. Tam wrongfully requested the said sum to be paid to an account of Wan Xi (China Construction Bank Corporation Dongguan Branch Account Number 4405-0177-6208-0914-0015) thereby misappropriated Man Lung’s account receivables.

22. On or about 13 January 2017, Man Lung issued an invoice to Modasuite Inc. for a sum of US$20,820.00 in respect of an order made between Modasuite Inc. and Man Lung. Tam wrongfully requested the said sum to be paid to an account of Wan Xi (China Construction Bank Corporation Dongguan Branch Account Number 4405‑0177‑6208‑0914‑0015) thereby misappropriated Man Lung’s account receivables.

23. On or about 23 January 2016, Man Lung issued an invoice to Doniger Fashion BV (“Doniger”) for a sum of US$32,331.00 in respect of an order made between Doniger and Man Lung. Tam wrongfully requested the said sum of US$32,331.00 to be paid to an account of Wan Xi (China Construction Bank Corporation Dongguan Branch Account Number 4405‑0177‑6208‑0914‑0015) thereby misappropriated Man Lung’s account receivables.

24. On or about 6 March 2017 and 13 March 2017 respectively, Tam unlawfully instructed S&G to settle payments due to Man Lung to the following parties:‑

(1) Intertek Testing Services Shenzen Ltd. Guangzhou GDD Branch in the amount of HK$60,257.53;

(2) 東莞市黃江永欣電腦刺繡廠 in the amount of ¥102,355.00; and

(3) 佛山市佛紡紡織有限公司 in the amount of ¥200,000.00.

None of these parties had any business dealings with Man Lung at the material time and that Man Lung was not under any legal obligation to pay any of these parties the above amounts or at all. The Plaintiff further avers that these parties were suppliers to Wan Xi and not Man Lung.

25. On or about 10 March 2017, Tam unlawfully instructed S&G to settle payments due to Man Lung to, inter alia, the following parties:‑

(1) 百隆東方股份有限公司 in the amount of ¥70,783.00;

(2) 東莞市東城區下橋股份經濟聯合社 in the amount of ¥77,856.00;

(3) 富士施樂租賃(中國)有限公司 in the amount of ¥13,800.00;

(4) 富士施樂實業發展(中國)有限公司 in the amount of ¥15,733.00; and

(5) 社保機構單位 441930 in the amount of ¥60,632.00.

None of these parties had any business dealings with Man Lung at the material time and that Man Lung was not under any legal obligation to pay any of these parties the above amounts or at all. The Plaintiff further avers that these parties were suppliers to Wan Xi and not Man Lung.

26. In addition, on or around 22 March 2017 and 31 March 2017, Tam wrongfully caused Wan Xi to invoice Man Lung for the various expenses of Wan Xi, including but not limited to staff expenses of Wan Xi (全廠員工工資), society insurance fee (社會保險費) and rent (下橋村委). The Plaintiff avers that Man Lung was not under any legal obligation to pay any of these expenses or at all.

27. Further, in breach of his duties and/or for the purpose of misappropriating Man Lung’s assets, Tam had wrongfully caused the following increase in receivable owed by Man Lung to Wan Xi in the accounting documents:-

(1) According to the ledger of Man Xi prepared by Tam for the period from March 2016 to April 2017 (“Table 1”), the receivable owed by Man Lung to Wan Xi on 31 March 2017 was in the sum of HK$1,021,805.68; and

(2) However, according to a confirmation letter to be signed by Man Lung confirming the receivable owed by Man Lung to Wan Xi also prepared by Tam subsequent to Table 1 for the period from 1 January 2017 to 30 April 2017, the sum of receivable owed by Man Lung to Wan Xi on 31 March 2017 was artificially and drastically increased to the sum of HK$9,743,918.00 from HK$1,021,805.68.

28. Further, in breach of his duties and/or for the purpose of misappropriating Man Lung’s assets, Tam wrongfully caused the ledger of Man Lung to include the false entries that, on 31 October 2016, Tam had personally paid for the following staff’s monthly salary for October 2016 for and on behalf of Man Lung (“Entries for October 2016 Salaries”):

(1) Ho Woon Cheung (何渙章), in the sum of HK$22,166.68;

(2) Lung Mei Ling (龍美玲), in the sum of HK$25,650.00;

(3) Lau Hung Wing (劉紅泳), in the sum of HK$18,525.00;

(4) Ho Lok Pui (何洛佩), in the sum of HK$12,825.00; and

(5) Wong Lok Yau (黃樂悠), in the sum of HK$14,630.00.

29. The Entries for October 2016 Salaries were wrongfully made as Man Lung had itself paid for the aforementioned staff’s monthly salary for October 2016.

30. Further, in breach of his duties and/or for the purpose of misappropriating Man Lung’s assets, Tam wrongfully caused the ledger of Man Lung to include the false entries that Tam had personally paid legal fee to Messrs. Lo, Wong & Tsui (盧王徐律師事務所) for and on behalf of Man Lung on the following occasions:-

(1) Payment of HK$30,000.00 made on 9 August 2016; and

(2) Payment of HK$4,700.00 made on 28 February 2017.

31. The said entries are false in that at all material times, Man Lung has not engaged Messrs. Lo, Wong & Tsui (盧王徐律師事務所) during that period or at all and that Man Lung was not indebted thereto.

Conflict of Interest

32. In the ordinary course of business, after receiving orders from its customers for garment manufacturing, Man Lung would supply certain quantity of raw materials to and place orders with Wan Xi for cut make and trim works (“CMT Works”). The cost for CMT Works formed part of the cost of the orders from Man Lung’s customers.

33. Since in or about November 2016 subsequent to the commencement of the winding up petition HCCW 425/2016, Tam, via Wan Xi, artificially and drastically inflated the cost for CMT Works for the orders placed by Man Lung. Tam, purportedly on behalf of Man Lung, wrongfully accepted the drastically inflated cost for CMT Works with the knowledge that taking into account of the inflated cost for CMT Works, the orders from Man Lung’s customers would be performed at a loss to Man Lung.

34. Further, the sum of the monthly invoices issued by Wan Xi to Man Lung (as shown by Man Lung’s ledgers) was substantially higher than the sum of those recorded by Wan Xi (as shown by Wan Xi’s ledgers) for the financial years from 2012 to 2015. The Plaintiff avers that the two sets of ledgers do not match with each other in terms of the sum of the invoices issued by Wan Xi to Man Lung.

(1) The invoices issued by Wan Xi for the following months did not match the corresponding ones in Man Lung even after taking into account the discrepancy, if any, due to exchange rates:-

(a) May to October 2012;

(b) June, October, and December 2013;

(c) January and March to December 2014;

(d) January 2015; and

(e) February 2017.

(2) The sum owed by Man Lung as shown by Man Lung’s ledger was HK$13,163,431.34 higher than the one shown by Wan Xi’s ledger for the financial years from 2012 to 2015. As such, the costs or loss of Man Lung for the said period was materially and wrongfully increased.

Mismanagement by Tam

35. Paragraph 16 of the Articles of Wan Xi states that, inter alia, a board meeting must be held every six months to be presided by the Chairman with a quorum of at least two thirds of the total number of directors.

36. In breach of paragraph 16 of the Articles of Wan Xi, Wan Xi had not conducted any board meeting since in or about end of 2011.

37. The Plaintiff avers that in accordance with the PRC laws, upon the breach of paragraph 16 of the Article, Wan Xi did not have the requisite legal capacity to conduct any business or to enter into any legal agreement.

38. Knowing full well of such incapacity of Wan Xi, Tam, as a director of Man Lung, on behalf of Man Lung and as a legal representative of Wan Xi, continued and still continues to enter into different agreements and transferred funds to Wan Xi thereby prejudicing Man Lung’s interest.

39. Further, without any justification and knowledge of the board of directors of Man Lung, Tam was in breach of his duties by employing one Jowie Wu (胡燕紅) (“Jowie Wu”) as an employee in the role of a merchandising manager by allowing her excessive remuneration under the employment contract, including a salary of about HK$28,000 per month and 2% commission on the value of all invoices from Fred Perry placed with Man Lung.

Particulars

(1) The normal market salary for such post was HK$28,000 per month with neither commission nor other substantial bonus;

(2) Man Lung had never paid any commission to any of its employees;

(3) The customer, Fred Perry, was not introduced to Man Lung by Jowie Wu;

(4) The maximum salaries paid by Man Lung to its most senior employee was HK$32,000 per month; and

(5) The 2% commission would be equivalent to about a substantial sum of HK$1.2‑1.4 million per year.

40. In the alternative, the Plaintiff further avers that Tam had personally employed Jowie Wu and wrongfully disguised the arrangement in the name and in the expense of Man Lung.  The Employment Contract was only a false instrument created for the purpose of causing monetary loss to Man Lung.”

16.  The very detailed allegations of misappropriation of assets, conflict of interest and mismanagement by Tam in the Draft are supported by Tang’s affirmations filed in this case.

17.  Not surprisingly, Tam denies these allegations.  In his written and oral submissions, Mr Cheung, for Tam, submits at length that there was no misappropriation of Man Lung’s assets, no conflict of interest on Tam’s part and no mismanagement by Tam by inter alia providing certain explanations and/or justifications for his conduct.  Those explanations and justifications may or may not be sound but it is plain and obvious to this court that there are serious disputes of fact between Tang’s case and Tam’s “defences” which can only be resolved at trial.  With respect, it is futile for Mr Cheung to seek to persuade the court at this stage that there is no serious question to be tried on the basis that his client’s explanations and justifications should be believed and accepted while Tang’s case should be rejected.

18.  Taking into account the relatively low threshold for the Serious Question Requirement and having considered all the materials before this court as well as counsel’s submissions, this court cannot conclude that the intended action’s prospects of success are so slim that Man Lung can have no expectation of success, but only a hope.

19.  In my judgment, Tang has satisfied the Serious Question Requirement.

Interest of the Company Requirement

20.  The fact that Tang has satisfied the Serious Question Requirement goes a long way in satisfying the Interest of the Company Requirement, albeit not conclusive of the matter: Re Li Chung Shing Tong (Holdings) Ltd, supra, at [26].

21.  In Re Li Chung Shing Tong (Holdings) Ltd, supra, Harris J made the following observations in respect of this requirement:

“21. It is now well‑established in Hong Kong that the threshold for the ‘interest of the company’ criterion is low. In deciding whether it is prima facie in the interest of the company for leave to be granted, the court should have regard to the fact that ‘there should not be a trial within a trial and the court should not be forced to enter into the merits of claims where there are serious disputes’: see Re Lucky Money Ltd (unrep, HCMP 505/2006 [2006] HKEC 1379), per Kwan J at para 41; see also Re My Way Ltd [2008] 3 HKLRD 614, per Barma J at para 31.

….

26. I accept that in most cases if a “serious question to be tried” has been demonstrated it will follow that it is prima facie in the interests of the company that proceedings are pursued and the converse, of course, will also be true. In this context the “serious question to be tried” criterion can be viewed as a bench mark indicating whether or not it is likely to be in the interest of the company that proceedings are pursued and, in my view, this is how Kwan J’s judgments in both Re Grand Field Group Holdings and Re F & S Express are to be read.

...

28. In cases in which the board of the company has made a bona fide commercial decision that it is not in the interests of the company that proceedings are commenced generally the court will be slow to override that decision…” (emphasis added)

22.  In the present case, there is no suggestion that an independent board of directors of Man Lung has made a bona fide commercial decision that it is not in the interest of the company to commence the intended action — Man Lung’s board of directors consists of the two protagonists in this application viz Tang and Tam and they have not made any decision, bona fide or otherwise, that it is not in the interest of Man Lung to commence the intended action.

23.  What Tam asserts is that Tang has acted in concert with Yeung and launched the present proceedings in an oppressive manner and as a collateral attack against him.  Hence, Mr Cheung, for Tam, further asserts at paragraph 32 of his written submissions that “Clearly, the alleged claim against [Tam] is not genuine.  Furthermore, it is nothing more than claims fabricated by [Tang] due to the deadlock and shareholders dispute arose between the two camp.”

24.  With respect, the submission is a complete non sequitur.  This court has concluded that on the basis of the materials available, there is a serious question to be tried.  Making a bare assertion that Tang and Yeung are acting in concert and that the alleged claim against Tam is not genuine is just another way of arguing there is no serious question to be tried.  It is not an argument in relation to the Interest of the Company Requirement.

25.  There being no credible argument from Tam on this question, and in light of the conclusion that Tang has satisfied the Serious Question Requirement, this court is of the firm view that, on the face of the application, it is in the interest of Man Lung that leave for the intended action should be granted.

Disposition and costs order nisi

26.  This court hereby grants leave to Tang to bring a statutory derivative action on behalf and in the name of Man Lung against Tam as per paragraph 1 of the originating summons.

27.  At paragraph 2 of the originating summons, Tang seeks “costs of and incidental to the application and the derivative action be indemnified by Man Lung out of its assets or, alternatively, be paid by Tam personally on an indemnity basis”.

28.  As far as costs of this application are concerned, this court is satisfied that Tang was acting in good faith and had reasonable grounds for making the application.  Given Tam’s unjustified opposition, there seems no reason why such costs should be paid out of Man Lung’s assets.  In this court’s view, ordering a company to bear the member’s costs of a proper leave application will only serve to encourage unjustified opposition by the intended defendant to the proposed derivative action in future.  There shall be an order nisi that costs of this application be borne by Tam, to be taxed if not agreed, with certificate for counsel.

29.  As to whether the Court should grant an order that the costs of the derivative action be indemnified out of the assets of Man Lung or be borne by Tam personally, even Mr Hon recognises, at paragraph 18 of his written submissions, that the Court very often would defer such determination when the outcome of the statutory derivative action is known or when the position is clearer: Re Grand Field Group Holdings Ltd unrep, HCMP 1059/2008, Kwan J (as she then was) at [50].  I agree and will defer the matter to a subsequent occasion.  There will be liberty to apply for that purpose.