CHINA FORESTRY HOLDINGS CO LTD (IN OFFICIAL LIQUIDATION) AND OTHERS v. KPMG (a firm)

HCCL 9/2019

[2021] HKCFI 1519

IN THE HIGH COURT OF THE

HONG KONG SPECIAL ADMINISTRATIVE REGION

COURT OF FIRST INSTANCE

COMMERCIAL ACTION NO 9 OF 2019

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BETWEEN

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DECISION

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1.  This is KPMG’s Summons filed on 30 March 2021 (“Summons”) by which it seeks leave to apply for two classes of amendments to the Re-Amended Substituted Defence and Counterclaim (“RADCC”).

2.  The first relates to Section L of that pleading.  KPMG seeks to abandon its reliance on statutory relief under Hong Kong law and any equivalent relief available under Cayman Islands law. 

3.  The second relates to Section H.1.  KPMG seeks leave to plead that the indemnity contained in China Forestry’s Articles of Association[1] (“Indemnity”) covered the 2009 Audit claims against it (“Audit Claims”), in addition to the notes issuance claims (“Notes Claims”) in respect of which reliance on the Indemnity has been pleaded (“Indemnity Amendment”).

4.  Only the Indemnity Amendment is opposed.

5.  The extreme lateness of this application is demonstrated by the fact that the written Opening Submissions of the parties are due to be lodged with the court by tomorrow.  There can be no doubt that they will be very substantial documents supported by many bundles of authorities.  A 50-day trial of this action is due to start 1 month later on 28 June 2021.  The length of this trial is commensurate with its complexity and importance.  The claims against KPMG are in excess of US$117 million, plus interest.

6.  Thus far, this case has been carefully managed by the court with comprehensive directions, including a deadline for interlocutory applications, which was extended twice from 30 November 2020[2] to, ultimately, 17 December 2020.  A late application of the present type tends to undermine the efforts of the court in managing the case. 

Applicable principles

7.  In respect of the applicable principles, I have been referred to the much cited authorities of Hsu Ming Chi v Lam Shu Chit, unrep, HCCL 8/2013, 22 October 2014, at §§13-18, per Ng J and Tao Soh Ngun v HSBC International Trustee Ltd [2018] HKCFI 2543, at §5 per Wilson Chan J.

8.  In view of the lateness of this application, I shall bear in mind in particular the dicta of Mrs Justice Carr DBE in Quah Su-Ling v Goldman Sachs International [2015] EWHC 759 (Comm) at §38(b), (e) and (g) :

“where a very late application to amend is made the correct approach is not that the amendment ought, in general, to be allowed so that the real dispute between the parties can be adjudicated upon. Rather, a heavy burden lies on a party seeking a very late amendment to show the strength of the new case and why justice to him, his opponent and other court users requires him to be able to pursue it. …;

gone are the days when it was sufficient for the amending party to argue that no prejudice had been suffered, save as to costs.  In the modern era it is more readily recognised that the payment of costs may not be adequate compensation;

a much stricter view is taken nowadays of non-compliance with the Civil Procedure Rules and directions of the Court.  The achievement of justice means something different now.  Parties can no longer expect indulgence if they fail to comply with their procedural obligation because those obligations not only serve the purpose of ensuring that they conduct the litigation proportionately in order to ensure their own costs are kept within proportionate bounds but also the wider public interest of ensuring that other litigants can obtain justice efficiently and proportionately, and that the courts enable them to do so.”

9.  With respect, I fully agree with the dicta. See also Chun Wo Building Construction Ltd v Metta Resources Ltd, unrep, HCCT 29/2013, 22 March 2016, at §6. 

10.  Finally, I have been invited by the Plaintiffs to bear in mind that it is the pleadings that will “dictate the course of proceedings both before and at trial”.  Where witnesses are involved, “it will be the pleaded issues that define the scope of the evidence, not the other way round”.  It will “not be acceptable for unpleaded issues to be raised out of the evidence which is to be or has been adduced”: Kwok Chin Wing v 21 Holdings Ltd (2013) 16 HKCFAR 663 at §21.

Explanation for the delay

11.  This application has generated highly contentious evidence over, inter alia, KPMG’s explanation for the lateness of this application.  It is neither appropriate nor necessary to resolve the highly contentious evidence on paper.  In my view, the court is entitled to make an objective assessment of the evidence, especially where such evidence is uncontroversial or incontrovertible, and come to a view whether the delay has been satisfactorily explained. 

12.  Despite the submissions made on behalf of KPMG, I reject any suggestion that the Indemnity Amendment is somehow technical in nature because the existing plea (RADCC, §§197-199) is sufficiently wide to cover the claim of indemnity over the 2009 Audit.  Any reading of the plea will dispel such contention. 

13.  In my view, an objective assessment of the evidence relied upon by KPMG leaves little doubt that the issue whether the Indemnity would cover the 2009 Audit was considered by KPMG (a well-resourced multinational enterprise) with their legal advisors and not adopted as part of its defence after such consideration.  The following evidence of KPMG is telling :

(1) 4^th Affivadit of Ms Wong, §18

“KPMG pleads reliance on the Indemnity at paragraphs 197 to 199 of the Defence. These paragraphs have not been amended since the Defence was filed on 1 June 2020. At that time, KPMG considered the Indemnity may well not be a viable defence to the 2009 Audit claim and accordingly intended to rely on the Indemnity principally in relation to the notes issue engagement and otherwise to rely on the Court’s discretion under section 903 of the Companies Ordinance.”

(2) 6^th Affidavit of Ms Wong, §16

“Put shortly, and without waiver of privilege in any advice received by KPMG, at the time the Defence was filed on 1 June 2020, KPMG and its legal team recognised that the existence of the Indemnity was not consistent with Hong Kong practice and proceeded on the basis that the way in which any liability of Hong Kong auditors in the position of KPMG could be mitigated in respect of audit engagements would be through section 903 of the Companies Ordinance and/or the inherent jurisdiction of the Court to grant relief as a matter of Cayman Islands law (Defence, §209-211).”

14.  Although there is no specific evidence on whether Cayman Islands legal advice was obtained when the decision was made by KPMG, it was at all material times well-advised by a reputable team of lawyers, not to mention KPMG’s own international experience. 

15.  Any doubt over KPMG’s awareness of the difference between Hong Kong law and that of the Cayman Islands in that the former prohibits the limitation of liability by auditors[3] but not the latter must have dissipated when it was confirmed by the DARTS recording[4] that the court was informed of such difference by KPMG’s counsel at the hearing of the application for expert evidence on 24 September 2020. 

16.  This brings me to the evidence of the single joint expert (“SJE”) on Cayman Islands law.  KPMG relies heavily on the Final Report of Mr Lowe QC as an impetus for the Indemnity Amendment.  With respect, I have considerable misgivings about it. 

17.  Firstly, the relevant Order only permitted Cayman Islands law on 2 issues, namely, (a) Is relief akin to section 903 of the Companies Ordinance (Cap 622) available under the laws of the Cayman Islands?  (b) In what circumstances can the indemnity provisions contained in the Company’s 2007 and 2009 Articles of Association be enforced by KPMG under the laws of the Cayman Islands?

18.  Although the 2^nd issue was formulated in wide terms, there was no room to doubt that it was confined to the existing plea of reliance on the Indemnity as an implied term of the Notes Issue Engagement.  That was perfectly plain from the KPMG’s Skeleton Submissions put before the court on the expert evidence application.  In particular, section E of the Table attached to the Submissions stated KPMG’s comments against the 2^nd issue as follows:

“KPMG relies on a provision in P1’s Articles of Association that every auditor shall be indemnified out of P1’s assets and profits in respect of any act or omission in the execution of the auditor’s duty, other than in respect of fraud or dishonesty: Defence §§197-199 [A/3/158]. Expert evidence is necessary to determine the interpretation of the Articles, which is a matter of Cayman law.”

19.  Under the disguise of clarification[5], the SJE was led into expanding his report to cover an unpleaded issue, ie, whether the Indemnity might be incorporated into the 2009 Audit Engagement.  It was against the Order of this court on the scope of the evidence, and fundamentally against the principles summarised by the CFA in Kwok Chin Wing v 21 Holdings Ltd.

20.  It should be added that the correspondence exchanged between the parties in the course of agreeing the instructions to the SJE, to which the court was taken to by the Plaintiffs, suggest that KPMG was making tactical manoeuvre to try to expand the scope of the expert evidence to its advantage. 

21.  I am unable to accept that KPMG is entitled to springboard the Indemnity Amendment by acting in breach of an Order of the court.

22.  In the premises, I do not consider that the delay has been properly or satisfactorily explained.  On this ground alone, in light of the lateness of this application, I would decline this application. 

Prejudice to the Plaintiffs

23.  First of all, in my view the burden on the Plaintiffs to show prejudice (see Hsu Ming Chi, §17) is not a heavy one to discharge in light of the prevailing circumstances.  It must be accepted that in a case of this complexity and magnitude, the resources of the Plaintiffs’ team of lawyers are extremely stretched with the trial preparation in compliance with the directions of the court. 

24.  It is an unfair distraction and quite oppressive for the Plaintiffs’ team to have to deal with a new case on the Indemnity Amendment when they are due to lodge the written Opening for the trial by tomorrow.  Indeed, there are merits in the Plaintiffs’ submission that they are already prejudiced by having to divert their resources to deal with the present application whilst having to prepare for the trial. 

25.  The importance of considering and dealing with the new case is underlined by the fact that KPMG says that it is a complete answer to the Plaintiffs’ claims. 

26.  I have not lost sight of the fact that some of the arguments which may be deployed against the new case by the Plaintiffs may overlap with the arguments on the existing plea of Indemnity on the Notes Claims. 

27.  However, it is accepted by the KPMG that the Plaintiffs will be entitled to respond to the new case with argument(s) based on waiver or estoppel premised on the proposition that the parties acted on the assumption that KPMG owed an enforceable duty of care to the Plaintiffs throughout the audit.  For that purpose, the Plaintiffs will be entitled to consider the available evidence (the discovery in this case runs to nearly 200,000 documents) and the legal issues. 

28.  Further, the Plaintiffs submitted that, if the Indemnity Amendment is allowed, it will be entitled to consider evidence of, eg, accounting practice[6] and practice of the Stock Exchange which may impact upon the incorporation of the Indemnity into the 2009 Audit Engagement.  Further expert evidence may be required.  I see no reason to agree with the submission.

29.  KPMG complains that the Plaintiffs’ case on prejudice is not specific in terms of identifying relevant witness(es) or points for investigation.  I do not believe that the criticism is justified in light of the stage of development of this case and the fact that the Plaintiffs are preoccupied with the preparation for the trial.  `

30.  Putting the Plaintiffs to meeting a new case in conjunction with the trial preparation (on expert evidence alone, there are going to be 4 SJE on 4 disciplines and 2 separate experts on audit issues) is, in my view, serious prejudice.  This constitutes another reason for declining this application. 

Merits of the Indemnity Amendment

31.  Given that this court will have to adjudicate on the merits of the Indemnity on the Notes Claims, I will keep my comments here in succinct terms.  It is not readily apparent why the Indemnity was incorporated into the 2009 Audit Engagement, whether expressly or impliedly as alleged in the proposed amendments[7].

32.  In particular, the 2009 Audit Engagement Letter stated in clause 11.1 that it was subject to and governed by Hong Kong law.  It is common ground that Hong Kong law prohibits any indemnity over auditor’s liabilities.  There was also an entire agreement clause contained in clause 12.2 of the Engagement Letter which militates against the express or implied incorporation of the Indemnity.    

33.  The only particular provided in the proposed amendment which had anything to do with the Articles of China Forestry referred to clause 1.1 of the Engagement Letter.  The reliance on clause 1.1 is misplaced because it dealt with China Forestry’s obligations to prepare proper financial statements.

34.  At the hearing, KPMG placed emphasis on the proposition that the incorporation of the Indemnity was a collateral agreement.  The reference to collateral agreement was made in a half-hearted manner.  It was only referred to in one of the particulars (para 198.7) to support the allegation of express or implied incorporation of the Indemnity :

“In the circumstances, under the law of the Cayman Islands or, alternatively, under Hong Kong law, the Indemnity was an express term of each of the 2009 Audit and the notes issue engagement by way of incorporation into the 2009 Audit engagement letter and notes issue engagement letter and/or as a contract collateral thereto entered into between the 1^st Plaintiff and the Defendant on or around the time of the Defendant’s acceptance of its respective appointments.”

35.  I am unable to see any additional force in the collateral agreement point.  It was not adequately explained why the issue of collateral agreement may turn upon Cayman Islands law when the 2009 Audit Engagement was governed by Hong Kong law. 

36.  I am unable to see strength in the Indemnity Amendment which may justify this late application (see para 8 above).

Disposition

37.  For these reasons, I dismiss the Summons, save that the unopposed amendment is allowed.  The costs of and occasioned by the Summons, including the costs thrown away by the unopposed amendment, together with the costs of and occasioned by 2 Summonses for additional evidence filed on 14 and 25 May 2012, be to the Plaintiffs.  I certify that the attendance by both Mr Karas and Ms Au at the hearing was justified.

38.  I decline the Plaintiffs’ application that the costs be paid on indemnity basis.  Whilst the lateness of the Summons and the pressure which it had placed on the Plaintiffs are regrettable, I have to bring into the balance the importance of the application to KPMG as well as the size of the claims against it.