XCHRX CENTRALING LTD. v. QUANFORD ENTERPRISES LTD.

IN THE HIGH COURT OF THE

HONG KONG SPECIAL ADMINISTRATIVE REGION

COURT OF FIRST INSTANCE

1998 No. A646

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J U D G M E N T

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1. The defendant appeals against the Order made by Master Poon on 16th March dismissing its application for security for costs pursuant to section 357 of the Companies Ordinance, Cap. 32 of the Laws of Hong Kong. The brief background in this case is that the defendant as vendor and the plaintiff as purchaser entered into a written provisional agreement for the sale and purchase of Flat 38H, Goldwin Heights, No.2 Seymour Road, Hong Kong dated 17th October 1997. Completion was to have been the 5th December 1997. The agreement expressly provided that the property was sold subject to a tenancy, the term of which was to be from 15th November 1996 to 14th November 1998. This is clause 18 of the Agreement. The existing tenant, referred to as "BHP" in these proceedings, had apparently wished to extend its tenancy only up to 31st March 1998 and not up to 14th November 1998. The plaintiff says, if that be so, the defendant was simply not able to complete as agreed namely, with an existing tenancy subsisting up to 14th November 1998 and it therefore terminated the agreement on 29th October 1997.

2. The defendant, however, says that this termination was premature in that it had another five weeks or so to put things right. This, very briefly, is the necessary background to understand the factual issues in this case.

3. The plaintiff then issued its writ on 14th January 1998 asking for the return of a deposit it had paid and other relief. After the writ which is endorsed with a statement of claim, was issued on 14th January of this year, the defendant applied for an extension of time to file its defence. The application was granted but before the time was due for its defence, the plaintiff took out a summons under Order 86 of the Rules of the High Court on 18th February 1998. On 23rd February 1998, the defendant's solicitors wrote seeking security for costs and a summons for security was issued on 10th March 1998.

4. Section 357 of the Companies Ordinance provides as follows:

"Where a limited company is plaintiff in any action or other legal proceeding, any judge having jurisdiction in the matter may, if it appears by credible testimony that there is reason to believe that the company will be unable to pay the costs of the defendant if successful in his defence, require sufficient security to be given for those costs, and may stay all proceedings until the security is given."

5. Mr Mok for the defendant relies on a number of factors in seeking to persuade me that I have such reason to believe that the Plaintiff company would be unable to pay those costs. First of all, he says, the plaintiff was only incorporated on 27th August 1997, in other words, shortly before the Provisional Sale and Purchase Agreement was signed, secondly, it only has an authorised capital of HK$10,000 and a paid up capital of $2; thirdly, the plaintiff is probably a shell company; fourthly, it does not have telephone or fax listings which he submits, is an extremely rare occurrence if a company was actively involved in business; fifthly, the plaintiff's registered address is Shop 2A of the Hong Kong Computer Centre and its name was not on display at these premises and then next, the deposit paid pursuant to the agreement was not paid by the plaintiff but by way of a cheque issued by a company called Lam Yuk Fai Production Limited. There are other factors to which Mr Mok has referred, but I do not believe that they add a great deal to be factors already enumerated. Mr Mok goes on to say and this is summarised in his written skeleton argument as follows:

"All the above tend to show that the plaintiff is a shell company with $2 paid up capital acquired for the specific purpose of entering into the Agreement to purchase the Property. The deposit was paid by someone else. Other than having entered into the Agreement, the plaintiff appears to have no other activities whatsoever."

6. Mr Chow's retort on behalf of the plaintiff is that, first, it is exceedingly common in Hong Kong for people to use shell or shelf companies to hold properties. Secondary, the size of the paid up capital of the plaintiff is no indication of the lack of means. I do not think Mr Mok seriously disputed either of these observations. Mr Chow goes on to say that the fact that the registered office of the plaintiff was occupied by a connected company is neutral and lastly, he says the fact that the initial deposit was paid by Lam Yuk Fai Production Limited shows that the plaintiff had some financial support behind it.

7. Mr Mok disputed this last point. He says that while the plaintiff may have financial support to support its purchase and its participation in these proceedings, there is nothing by way of assets that the defendant can lay its hands on in case the plaintiff loses these proceedings, and I think that is force in that argument.

8. Mr Chow goes on to say that the burden is on the defendant to prove the plaintiff's inability to pay costs and not the other way round, and he submits that the defendant has failed to discharge the initial burden.

9. At this stage, it is necessary for me to refer to a judgment of the Court of Appeal in Tufnell Investment Limited & Others v. Thosowin Properties Limited & another, [1995] 2 HKC 14. I note in parenthesis Mr Chow's reminder that it is never very helpful to compare facts of cases in order to extract principles from them. I agree, of course, that is not the purpose of the citation of the authority. But the effect of the judgment in Tufnell, especially the judgments of the Vice-President Sir Allan Huggins and Justice of Appeal Fuad, although in the context of the facts of the particular case, would seem to suggest that when you are dealing with shell companies with an inadequate paid up capital or authorised capital, with the further facts that they have done no business other than to enter into the contracts in question with no income and no anticipation of income, are all factors to be taken into account in considering whether there is evidence of impecuniosity. I note again Mr Mok's submission that at this stage, the threshold stage, all that I have to be satisfied is that there is reason to believe that the plaintiff company would be unable to pay the costs of the defendant if successful in its defence. I do not have to be satisfied on any other basis.

10. Tufnell was not referred to in the subsequent decision of Mrs Justice Le Pichon in Gladson China Ltd v. Lam Alexander Chun June & Lam Judith Ann in MP 3602, 1995, judgment delivered on 9th May 1996 where her Ladyship considered a similar issue on principle, and came to a somewhat different conclusion on the facts.

11. Had I been left entirely to my own devices and had I not been constrained by the weight of the Court of Appeal authority in Tufnell, I would have found the reasoning of Mrs Justice Le Pichon persuasive. I note that Mr Mok does not go so far as to say that security follows whenever one is dealing with a $2 company as plaintiff, and I agree with him that I need to take into account all the relevant circumstances. Certainly, for the purposes of these proceedings, I am proceeding on the basis that the Court of Appeal in Tufnell laid down the law correctly and I am bound to follow the principle which can be extracted from that case so that, as to the threshold argument, I am satisfied that Mr Mok has persuaded me there is requisite reason to believe that the plaintiff may be unable to pay the defendant's costs of these proceedings. That then brings me to discretion.

12. Mr Mok referred to dicta of Sir Robert Megarry, the Vice-Chancellor in Pearson v. Naydler [1977] 1 WLR 899, at p. 906-7 as follows:

"Doing the best that I can to assess the relevant factors, and considering in particular the matters mentioned in the Parkinson case, I come back to the words of section 447. It seems plain enough that the inability of the plaintiff company to pay the defendants' costs is a matter which not only opens the jurisdiction but also provides a substantial factor in the decision whether to exercise it. It is inherent in the whole concept of the section that the court is to have power to order the company to do what it is likely to find difficulty in doing, namely, to provide security for the costs which ex hypothesi it is likely to be unable to pay. At the same time, the court must not allow the section to be used as an instrument of oppression, as by shutting out a small company from making a genuine claim against a large company. For this reason, Mars-Jones, J. was not prepared in the Parkinson case to make an order for security for costs for more than the (1,500 that the master had ordered: see [1973] QB 609, 617. As against that, the court must not show such a reluctance to order security for costs that this becomes a weapon whereby the impecunious company can use its inability to pay costs as a means of putting unfair pressure on a more prosperous company. Litigation in which the defendant will be seriously out-of-pocket even if the action fails is not to be encouraged. While I fully accept that there is no burden of proof one way or the other, I think that the court ought not to be unduly reluctant to exercise its power to order security for costs in cases that fall squarely within the section."

13. Mr Chow submitted that the only point on discretion argued for on behalf of the defendant is the plaintiff's inability to pay costs. He further submitted that the Vice-Chancellor's dicta in the Pearson is wrong in principle, and he referred me to dicta in Sir Lindsay Parkinson & Co. Ltd. v. Triplan Ltd., [1973] 1Q.B. 609. The first passage that he asked me to look at is to be found at p. 626 beginning at just about the letter D from the judgment of Lord Denning M.R. where his lordship says:

"Turning now to the words of the statute, the important word is "may." That gives the judge a discretion whether to order security or not. There is no burden one way or the other. It is a discretion to be exercised in all the circumstances of the case. Mars-Jones, J., in a full and careful judgment, took that view. He upset the master's order. He refused to order security for costs."

And then further down, his lordship continues as follows:

"If there is reason to believe that the company cannot pay the costs, then security may be ordered, but not must be ordered. The court has a discretion which it will exercise. The court has a discretion which it will exercise considering all the circumstances of the particular case. So I turn to consider the circumstances. Mr Levy helpfully suggests some of the matters which the court might take into account, such as whether the company's claim is bona fide and not a sham and whether the company has a reasonably good prospect of success."

14. Lawton, L.J. at p. 628 agreed with the judgment of Lord Denning as follows:

"I agree with Lord Denning M.R. that the effect of section 447 is that once it is established by credible evidence that there is reason to believe that the plaintiff company will be unable to pay the costs of the defendants if they are successful in their defence, the court has a discretion, and that discretion ought not to be hampered by any special rules or regulations, nor ought it to be put into a straitjacket by considerations of burden of proof. It is a discretion which the court will exercise having regard to all the circumstances of the case."

15. Those two judgments adopt a position perhaps slightly different from that adopted by Cairns L.J. at p. 627 where his lordship says :

"In my view the highest at which it can be put in favour of the applicants for security is the way in which it was put in the Irish case to which Lord Denning M.R. has referred - Peppard and Co. Ltd. v. Bogoff [1962] I.R. 180, 188, where it was said that there remains a discretion in the court which may be exercised in special circumstances; and assuming that that is a correct statement of the law, I am quite satisfied that there were special circumstances here."

16. Mr Chow also referred to the judgment of the Court of Appeal in Hong Kong in BBMB Finance (Hong Kong) Ltd. v. China Underwriters Life and General Insurance Co. Ltd. [1991]1 HKLR 617, where at p. 624, the Vice-President, Fuad, first of all, summarised the relevant principles of law which was agreed by the parties. I only need to read the first of the sub-paragraphs

"Section 357 of the Companies Ordinance (which is almost identical in terms to s. 736(1) of the UK Companies Act 1985, replacing s. 447 of the Companies Act of 1948) gives the court power to make an order for security when the conditions it contains are satisfied, if it thinks fit, but the power is discretionary or not mandatory, a discretion to be exercised having regard to all the circumstances of the particular case. There is no burden one way or the other:"

and he refers to Sir Lindsay Parkinson & Co. Ltd. v. Triplan Ltd. Then further down, after his lordship had referred to the passage I have already quoted from Pearson v. Naydler, the learned Vice-President continued at p. 625 just below the letter E as follows:

"While in my respectful opinion the Vice-Chancellor's observations are most helpful, I do not think that they support Mr. Evans-Lombe's proposition. In the very sentence upon which reliance is placed, Megarry, V.-C. was at pains to emphasise that there was no burden of proof either way. The proposition we are invited to accept seems to me to be rather close to the dissenting views of Cairns, L.J. in the Parkinson case where, at p. 627, he held that the jurisdiction to order security should be exercised once the statutory conditions are satisfied, but "there remains a discretion in the court [to refuse an order] which may be exercised in special circumstances." As perhaps sufficiently indicated earlier, we were not invited to adopt an approach different from that of the majority in Parkinson."

17. I accept that even after the threshold has been reached, there is no burden as such for the plaintiff to discharge. There is then a general discretion to be exercised in accordance with the principles laid down in Sir Lindsay Parkinson & Co. Ltd. v. Triplan Ltd. and usefully summarised on p. 413 of the Supreme Court Practice, 1997,Vol 1. I do not believe it is necessary for me to recite the passages in the Supreme Court Practice as they are very well-known.

18. Mr Chow submits that the discretion should not be exercised in favour of ordering security. He refers to the strength of the plaintiff's case and submitted that, on the undisputed evidence, the plaintiff has a good case and later on, he referred to the words used in the judgment of Lord Denning in Sir Lindsay Parkinson, that the Plaintiff had a reasonably good prospect of success.

19. In my judgment, it would be inappropriate and dangerous to embark upon what may constitute a detailed examination of the facts and merits and this I do not do, but Mr Chow's cogent marshalling of the evidence, and by and large the undisputed evidence, does suggest a more than respectable case based on misrepresentation of the date that the renewed tenancy was going to expire in 1998. Since at the date of the provisional sale and purchase agreement on 17th October 1997, the defendant had already realised that BHP, the then existing tenant, had only expressed the wish to continue up to March 1998, it should not have led the Plaintiff to believe that BHP was going to stay on until the 14th November, 1998. The defendant's inability, says Mr Chow, to persuade BHP to continue up to 14th November 1998 persisted certainly until 27th October 1997 when a draft sale and purchase agreement was sent by the defendant's then solicitors, Messrs. Ho & Wong to the plaintiff's solicitors and, as Mr Chow submitted, Clause 24(a) of that draft agreement expressly recognised the defendant's inability to convey in accordance with the agreement of 17th October 1997.

20. As to the possible defence based on an estoppel, indicated in paragraph 14 of Mr Samson Wong's affirmation of 16th March 1998 by reference to a supposed conversation with the representative of the plaintiff's, Mr Chow correctly points out that that was the first time any such suggestion had been made and is nowhere referred to in the contemporaneous correspondence and documents put before me. I was also urged to take into account, which I do, the fact that the plaintiff has issued a summons for judgment under Order 86, and a date for the hearing of the summons would be fixed, I think I was told, tomorrow. Mr Chow's submission is that this is a matter of importance and that if the plaintiff should fail on the Order 86 application, that is the time for the defendant to re-visit a security for costs application if it deems fit.

21. Mr Mok's submission on this point is that it would be unfair not to order some amount by way of security even if I were not minded to order security in the whole amount. He submitted that I should order security up to the end of the Order 86 hearing, and perhaps allow general liberty for the defendant to apply for further security in respect of costs to be incurred after that hearing if the Plaintiff should prove unsuccessful.

22. I have not found the balancing exercise straightforward. I take into account Mr Mok's submissions on the merits and his gentle criticism of Mr Chow's embarking on what Mr Mok referred to as a Murjani type examination of the facts. Mr Mok was, of course, referring to the well-known judgment of the Court of Appeal in Bhagwandas Kewalerem Murjani & ors. v. Bank of India, [1990] 1 HKLR 586. Speaking for myself, I do not believe that that was what Mr Chow was doing and, in any event, I do not do so. I have a general discretion to exercise and I do not ignore the fact that the plaintiff's possible inability to pay has been established so that I have requisite reason so to believe in accordance with section 357 of the Companies Ordinance. At the same time, on the undisputed factual material, the plaintiff has apparently a good case on the merits or if it amounts to a different test, at least a reasonably good prospect of success, and this is something that I also have to take into account. Whether the plaintiff will get judgment or not on the Order 86 application is not for me to say. The fact that the Order 86 application is likely to be heard in the next few months is material although it is just one aspect of the prospects of the Plaintiff's case. If the plaintiff should fail on that application, it would then be far more convenient all round for the defendant to re-apply for security, if it deems fit. The plaintiff's reply evidence in the Order 86 application has not yet been filed and the defence may also be subject to further amendments as Mr Mok told us earlier, so that the complexion of the case may or may not be different from what it is now. In the end, on the material as I have it, the fact that the defendant has overcome the so-called impecuniosity threshold in section 337 of the Companies Ordinance is not sufficient to justify my exercising discretion to order security in the defendant's favour.

23. Last, but certainly not least, I have been greatly assisted by the oral and written submissions of counsel to both of whom I am grateful.

[Submissions on costs]

24. Mr Chow asked for the appeal to be dismissed with costs. Mr Mok submitted that since I have not, as it were, decided that the defendant is not entitled to security for costs, I should either make no order or at the very least reserve costs to the subsequent tribunal who may or may not be asked to consider a further application for security. I agree with Mr Mok that I have made no finding on the merits, and I did not decide that the defendant should never be entitled to security in this case. What I did decide, and it follows from my judgment, is that the application for security at this stage is not justified, and therefore, in my judgment, the normal order for costs must follow and the appeal is dismissed with costs.

(R G Kotewall)

Recorder of the Court of First Instance