FREEMAN SECURITIES LTD (previously known as Dynasty Securities Limited) v. IP PO KI

HCA 2368/2018

[2020] HKCFI 2994

IN THE HIGH COURT OF THE

HONG KONG SPECIAL ADMINISTRATIVE REGION

COURT OF FIRST INSTANCE

ACTION NO 2368 OF 2018

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JUDGMENT

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Introduction

1.  This is an appeal by the Defendant ("D") from the decision of Master Gary C C Lam ("the Master") giving summary judgment to the Plaintiff ("P") under RHC Order 14 rule 3.

2.  P's claim in this action, as per its Statement of Claim, is for moneys due on a margin trading securities account ("D's Account").

3.  It is common ground that the indebtedness on D's Account arose principally by reason of a loan of HK$250,000,000 granted by P to D ("the Loan") to enable D to purchase or procure the transfer to D's Account of 700m shares in P's parent company, Freeman FinTech Corp Ltd ("FFCL"), which sum was paid to Enerchina Securities Limited, as a consequence of which the 700m shares in FFCL ("the 700m Shares") were transferred from D's account with Enerchina to D's Account.

4.  In defence of this claim, D relies on an alleged oral agreement ("the Alleged Oral Agreement"), allegedly made between Zhang Yong Dong ("Zhang") and Wang Ziaodong ("Wang"), both purportedly acting on behalf of P, on the one hand, and D on the other, whereby it was allegedly agreed that, D would only be permitted to sell 700m Shares or any part thereof if the value of the shares appreciated but if the value of the 700m Shares fell, D would not be permitted to sell the shares and, in return, P would not make any margin calls on D's Account and would not seek repayment of the Loan.

5.  As regards the Alleged Oral Agreement, it is D's case that:

5.1     In early 2017, D was informed by an acquaintance, who was also an executive director of FFCL (and who knew that D had previously held a substantial number of FFCL shares in the Account - as D indeed had done), that Zhang, who was the then chairman of FFCL, (but not a director of P) was looking for an investor to purchase a significant block of FFCL shares and hold them as a long term investment and that, for this purpose, FFCL would arrange financing.

5.2     D then met with Zhang and also Wang, who was then an executive director and the CFO of FFCL and also a director of P and it was at this alleged meeting when the Alleged Oral Agreement was made.

6.  In paragraph 4.1 of P's Reply and Defence to Counterclaim the existence of the Alleged Oral Agreement is not admitted and D is put to strict proof thereof.  In this connection it is explained that neither Zhang nor Wang can be contacted by P.  However, in other paragraphs of the Reply the existence of the Alleged Oral Agreement is denied.

7.  It is further pleaded in the Reply that:

7.1     The Alleged Oral Agreement is not in any event binding on P, in particular for want of authority and that, even if Zhang or Wang did have any apparent and/or ostensible authority to enter into it (which is denied), D did not rely on the authority and/or that such reliance was not justified and was either irrational and/or dishonest [§4.3.3], and

7.2     The Alleged Oral Agreement gives rise to offences of false trading, price rigging and stock market manipulation under the SFO; has the effect of misleading and manipulating markets; it is illegal both as to its formation and performance and, accordingly, D is debarred from relying on it or enforcing it [§4.4].

JURISDICTION AND THE FRAUD EXCEPTION

8.  As a consequence of P's averments in the Reply, D argues that this case comes within "the fraud exception" contained in RHC Order 14 rule 1(2)(b) and, consequently, the court has no jurisdiction to grant summary judgment.

9.  RHC Order 14 rule 1(2)(b) excludes from the O. 14 summary judgment process "an action which includes a claim by the plaintiff based on an allegation of fraud".

10.  The scope of the "fraud exception" was explained in the judgment of Yuen JA in Zimmer Sweden AB v. KPN Hong Kong Limited and another [2016] 1 HKLRD 1016, per Yuen JA at §18 (with which Lam VP and Kwan JA agreed):

“(1)     The court should determine whether “the fraud exception” applies at the time when the application for summary judgment is heard. Therefore the court should not be restricted to a consideration of the statement of claim only, but should examine all relevant materials existing at the time of the hearing, including subsequent pleadings and the affidavits. (It would be noted that in Pacific Wire, the court even took into account the skeleton argument of the plaintiff’s counsel at first instance. With respect I tend to the view that given the nature of skeleton submissions, they should be considered only where they serve to clarify an ambiguity in the plaintiff’s case).  

(2)     Having regard to all the relevant materials, the question to be asked by the court is “does this action include a claim for which an allegation of fraud would have to be made by the plaintiff in order to establish or maintain that claim?”¹  If the answer is affirmative, “the fraud exception” is engaged and the court has no jurisdiction to hear the summary judgment application, even if the plaintiff seeks to hive off that claim from another claim (eg for dishonoured cheque) for which summary judgment would have been available.  That consequence follows from the wording of “the fraud exception” (Pacific Wire para. 19).

(3)     In considering whether an allegation of fraud would have to be made to establish or maintain a claim, one must look at the substance, and not the mere form, of the plaintiff’s case.  If all the factual constituents of fraud are alleged and relied upon, it does not matter whether the actual word “fraud” has or has not been used (Newton p.1301).  

(4)     The court must consider whether those factual constituents of fraud are relied upon in order to establish or maintain a claim.  In Newton, the court accepted that the factual constituents of a Derry v Peek fraud had been set out in the pleadings.  However in order to establish the plaintiff’s claims of breach of contract, breach of fiduciary duty and negligence, it did not need to make any allegations of fraud.  On the facts of that case, the breach of contract, breach of fiduciary duty and negligence would still be established, even if the defendant had been completely honest, and was only mistaken (p.1302).  It would appear from the report that the defendant had not pleaded a defence which the plaintiff needed to reply to by alleging fraud on the part of the defendant.  This may be contrasted with A-1 discussed below.

(5)     It may be that originally a claim (eg breach of fiduciary duty) may be established without the plaintiff having to make an allegation of fraud (as in Newton). But the nature of the defence (whether disclosed in a pleading or an affidavit) may be such that in rebuttal (whether in a Reply or in an affidavit in reply), the plaintiff would have to allege fraud, in which case, “the fraud exception” would be engaged.  So for example, in A-1 the defence was that there was no breach of fiduciary duty because the receipt of money was pursuant to a declaration of dividend.  In reply to this defence, the plaintiff alleged that the declaration was an ex post facto fabrication.  Consequently, by the time of the hearing of the summary judgment application, the plaintiff would have to make out an allegation of fraud by the defendant in order to maintain the claim for breach of fiduciary duty.

(6)     Finally, as to what is an allegation of fraud for the purpose of “the fraud exception”, this court is bound by the judgment in Pacific Wire to adopt the wide/liberal meaning.  The rationale for adopting a wide meaning had been suggested by Kaplan J in Skink and adopted by this court in the Pacific Wire judgment.  That judgment cannot be said to be plainly wrong.  Further if the narrow meaning is adopted, the anomaly observed in Newton would arise, viz summary judgment would not be available for only one type of dishonest conduct, but available for all other types of dishonest conduct.  To conclude, “the fraud exception” would be engaged where what is alleged is an intentional or reckless dishonest act (or omission) done with the purpose of deceiving.”

11.  In Zimmer v. KPN (supra):

11.1   The plaintiff brought proceedings against the defendants alleging that it had been deceived into transferring funds to a bank account of a company, K, in Lithuania as a result of a fraudulent misrepresentation as to the recipient's identity.  The funds were then transferred to the 1st Defendant's Hong Kong bank account and the 1st Defendant then transferred part of the funds to the Hong Kong bank account of the 2nd Defendant.  The Plaintiff claimed restitution of the funds on the basis that the defendants had provided no consideration for the transfers and had no legitimate reason to benefit from or retain the moneys transferred.

11.2   The defendants' case was that the funds had been received by the 1st Defendant as payment of an invoice it issued for an allegedly bona fide transaction for goods that it had sourced from suppliers and on sold to K and that accordingly full consideration was provided for the payment.

11.3   In paragraph 19 of the judgment of Yuen JA, the learned Judge stated:

“19.1.    Applying the above principles to the present case, it seems to me that the judge was clearly right when he held that “the fraud exception” was engaged. 

19.2.    It did not matter that the statement of claim did not contain a claim for damages for fraud, or that the claim against each defendant was confined to the money it had received or remaining in its hands, because one cannot stop there.  One has to consider the subsequent pleadings and affidavits to see the substance of the plaintiff’s case at the time of the hearing of the summary judgment application.  The defence was that the defendants had received the money as proceeds of sale in a bona fide transaction where it had sourced goods from the three suppliers and on-sold them to Kosona.  Such a defence would provide a complete defence to the plaintiff’s claims.  In order to maintain its claims, the plaintiff has alleged that the 1^st defendant had not in fact sourced goods from two of the three suppliers at all, that the third supplier did not exist, and that one of the suppliers had declared that an invoice (purporting to be from that supplier and exhibited by the 1^st defendant in support of its defence) was “fake”; in other words, the plaintiff has alleged that the transaction was a sham. 

19.3.    As was rightly pointed out by Mr Jonathan Chang counsel for the defendants, even if the plaintiff has not asserted that the defendants were parties to the fraud practised in Sweden to obtain the money, it has clearly asserted that the defendants are parties to a fraud to keep the money transferred to them, which is the subject-matter of its claims.”

12.  In Universal Capital Bank v. Hong Kong Heya Co Ltd [2016] 2 HKLRD 757, the plaintiff was deceived by a fraudulent email into making a transfer to a company in Hong Kong part of which was then transferred to the defendant and then onto a third party in the PRC.  The plaintiff brought proceedings for unjust enrichment against the defendant without making any allegation of fraud or dishonesty as against the defendant.  In deciding that the "fraud exception" did not apply on the facts of that case, Deputy High Court Judge Burrell stated as follows, at §18:

" The following points may be validly made:

(1)     The underlying reason for the fraud exception is to prevent summary judgment in a case where serious allegations of dishonesty are made or implied against a party to the proceedings so that such a party may have an opportunity to answer the allegations, or put in a more familiar way, “have his day in court”.

(2)     The defendant company here has no need of such protection.  First, it is a “paper” company but secondly and more importantly, no allegations of dishonesty/fraud are made against it.  Further, no similar allegations are made against its “operator” Yang.

(3)     Although, as agreed by the plaintiff and conceded by counsel for the defendant, the movement of the money out of Montenegro and into the PRC is a plain and obvious scam, the legal route being taken by the plaintiff to recover its money does not necessarily involve any party to that scam.  The plaintiff seeks recovery from the defendant, not Yang.

(4)     Whilst it is true that the Hong Kong courts have adopted a fairly wide and liberal interpretation of “fraud” when considering the application of Order 14, rule 1(2)(b), it should not be applied automatically merely because there are allegations of fraud or dishonesty in the bigger picture. The question remains, does the underlying allegation of fraud (which does exist here) on which the claim is based (which it is not in this case) constitute an allegation of fraud against the defendant?  It seems that the answer to this question in this case is in the negative.

(5)     To say otherwise would take away from a plaintiff an opportunity to utilize the Order 14 procedure in cases where it might be clearly merited."

13.  In Xiao Long v. Great Wall Securities Limited [2019] HKCFI 2769 at §166, Marlene Ng said as follows:

“ I bear in mind the guidance by the Court of Appeal discussed in paragraphs 118-120 above, and in considering the substance and not merely the form of P’s claim as well as all the pleadings and affirmation evidence, I am not persuaded the fraud exception was applicable. Whilst D’s defence might elicit issues of falsity/forgery in response when read in light of P’s Reply and affirmation evidence, as Mr Lam explained, an allegation of fraud by D was not required to establish or maintain P’s claim. There might well be some falsity or fraud, but quite simply, there was no need for P to assert D was the fraudster in order to establish or maintain his claim. In such circumstances, the fraud exception was not applicable.”

14.  In DBS Bank (Hong Kong) Limited v. Happy Grace International Limited [2019] HKCFI 2864 at §6, Deputy High Court Judge MK Liu held as follows:

“ P does not allege that D, or indeed any of the second-level recipients, were directly involved in the fraud practised on it. P is relying on unjust enrichment as a cause of action against D, which does not require any allegation of fraud[1]. That being the case, the fraud exception in Order 14 which bars summary judgment is not triggered[2]. In this Order 14 application, P is pursuing a personal claim for the value of the fund received by D, ie USD230,000, on the basis of unjust enrichment.”

“ D is precluded from relying on the 2 defences since its use of underground banking involved illegality under Mainland Chinese law.”

15.  In my view the observations made in Universal Capital Bank, Xiao Long v. Great Wall Securities Limited and DBS as set out above, correctly state the approach of the court in applying the fraud exception and are consistent with the observations of Yuen JA in Zimmer v. KPN. In this respect, the critical question is whether or not allegations of fraud are required to establish the plaintiff's claim.  If they are (as in Zimmer v. KPN, the fraud exception is engaged but if they are not (as in Universal Capital Bank, Xiao Long v. Great Wall Securities Limited and DBS), then the fraud exception does not apply.

16.  In the present case the allegations in the Reply to which I have referred in paragraph 7 above are clearly not required to establish P's claim in the action and in my view the fraud exception is not engaged.  Mr Toby Brown, counsel for D argued that the fact that the Reply contained denials as regards the existence of the Alleged Oral Agreement is tantamount to an allegation of sham and that the fraud exception is thereby engaged.  I do not accept this.  However even if it were correct to regard the denial of the existence of the Alleged Oral Agreement as an allegation of sham (which I do not accept it is), the fact remains that such an allegation is not required in order to establish P's claim in the action which is, simply, for monies due on D's margin trading account.  P does not need to advance any positive case in relation to the Alleged Oral Agreement.

17.  I therefore conclude that, in this case, the fraud exception is not engaged.  That being the case it is not necessary for me to address the question as to whether or not, in order for the fraud exception to apply, the allegations of fraud on which the claim is based must be made against the defendant or the argument that it is not engaged if the allegations are made solely against third parties.  Whilst the judgments in such cases as Universal Capital Bank (supra), DBS (supra) and Ferrari North America Inc v. Changhon International Energy Co Ltd [2019] HKCFI 2864, [2029] HKEC 3809 suggest that this is the case, the soundness of these decisions is doubted in obiter observations made by Deputy High Court Judge Hall-Jones in R. Stahl Inc. v. AJ Development Ltd [2020] HKCFI 816.  As it is not necessary for me to resolve this issue on the present application, I will refrain from expressing any views on it.

THE ALLEGED ORAL AGREEMENT

18.  D's case on the Alleged Oral Agreement is not supported by any documentary evidence.  This is all the more remarkable, given the size of the transaction and the very large sum involved.  The absence of any documentary evidence casts considerable doubt on the veracity of D's case.

19.  Moreover, D's case is not corroborated by the evidence of either of the other parties to the Alleged Oral Agreement, namely Zhang and Wang, who, D says, he has been unable to contact, albeit that D does not explain what steps he has taken to locate them.

20.  Further, it seems to me that the terms of the Alleged Oral Agreement are contrary to all common and commercial sense - the notion that, on the one hand, a stockbroker would agree to advance a loan of this magnitude with restricted rights to seek repayment or to call for margin payments in the event of a fall in value of the shares provided as security and, on the other hand, that a professional investor, like D, would agree not to sell the shares in question unless they increased in value seems to me to be inherently unlikely.

21.  Then there is the lack of response to D's repeated demands for payment of the sum due on the account for which there is no satisfactory explanation.

22.  D has also not provided a satisfactory, convincing or credible reason for the payment by him of HK$70 million to P in February 2018 which was credited to the Margin Account.  The evidence shows that this sum was borrowed by D from a moneylender.  D sought to explain this by saying that it was a loan by him to P to assist in relieving alleged financial difficulties then allegedly being suffered by P.  There is however no evidence of any such financial difficulties and no evidence supporting the case put forward by D in respect of this payment.  I find that D's explanation for the payment is inherently incredible and is inconsistent with D's case on the Alleged Oral Agreement.

DECISION

23.  Summary judgment is of course only appropriate in clear cases when the court is satisfied not only that there is no defence but no fairly arguable point to be argued on behalf of the defendant.

24.  On the other hand, to adopt the words of Deputy High Court Judge Lisa Wong SC (as she then was) in Ontone Co. Ltd v. Leung Siu Kee (unreported), HCA 408/2011, 28 February 2012, at §23:

" In assessing the credibility of the defendants' factual case, while the court will not embark on a mini-trial on affidavit evidence, the court is not obliged to suspend its critical faculties and assume that the defendant's defence is accurate.  If having regards to inherent plausibility, inconsistency and contemporaneous documents and other compelling evidence, the defence is not credible, the court must say so.  If the defendant's defence is incredible in any material respect, it cannot be said that there is a fair or reasonable probability that the defendant has a real or bona fide defence."

25.  This is a case where I am left with real doubt as to the veracity of the case put forward by D and my first inclination therefore was to affirm the decision of the Master and dismiss this appeal and I have been very close to doing so.  In this respect, it would seem unlikely that D can improve his case if the matter were to go to trial.  In particular, if he has been unable to locate Zhang and Wang and obtain their assistance for the purposes of the application for summary judgment, there would appear to be no good reason to suppose that he will be able to do so for the purposes of any trial.  However, in case I am wrong about this and D is able to obtain corroboration for his case on the Alleged Oral Agreement, I think it is right to give leave to D to defend these proceedings, albeit only on a conditional basis.

26.  I have not heard the parties as to the conditions which it would be appropriate to impose on granting D leave to defend the proceedings and there is no evidence or other material before the court as to D's means or resources.  The usual terms on which conditional leave to defend is given are to require the defendant to bring into court within a specified time a sum equivalent to the whole or part of the claim, in default of which the plaintiff is at liberty to sign final judgment.  I am however conscious of the fact that the quantum of P's claim is very substantial and that I should not make a conditional order with which, in practice, it will be impossible for D to comply.

27.  In the circumstances, I will make an order that D shall have leave to defend these proceedings conditional upon him paying into court the sum of HK$85 million (which is a little less than half of the amount of P's claim) within 14 days of the handing down of this judgment.  If this condition is complied with the costs of P's application including the costs before the Master will be costs in the cause.  However, if this condition is not complied P shall be at liberty to sign judgment for the full amount of the claim, interest and the costs of the action including the costs of this application both here and before the Master.

28.  As I have not heard the parties as to the conditions which it would be appropriate to impose on granting D leave to defend the proceedings and there is no evidence or other material before the court as to D's means or resources, I will give the parties liberty to apply within 14 days of the handing down of this judgment to vary the order I have made as to the condition for granting D leave to defend these proceedings. In the event that such an application is made within this time, the time for complying with the condition will be extended for 14 days from the determination of that application.