ZHANG HENG v. KINGSTONE INTERNATIONAL WEALTH MANAGEMENT LTD AND OTHERS

CACV 56/2017

IN THE HIGH COURT OF THE

HONG KONG SPECIAL ADMINISTRATIVE REGION

COURT OF APPEAL

CIVIL APPEAL NO 56 OF 2017

(ON APPEAL FROM HCMP NO 1518 OF 2016)

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REASONS FOR JUDGMENT

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Hon Kwan JA (giving the reasons for judgment of the court):

1.  The plaintiff in these proceedings, Madam Zhang Heng (“Zhang”), sought leave to bring a derivative action in the name of the 1^st defendant, Kingstone International Wealth Management Limited (“Kingstone Wealth” or “the Company”) against the 2^nd, 3^rd and 4^th defendants, Madam Shum Shan Mui (“Shum”), Poon Kwok Tung Alex (“Poon”) and Kingstone International Advisors Limited (“Kingstone Advisors”) respectively, pursuant to sections 732 and 733 of the Companies Ordinance, Cap 622. In his judgment of 9 February 2017, Anthony Chan J refused leave. This is Zhang’s appeal.

2.  We have allowed the appeal at the conclusion of the hearing.  These are the reasons of the court.

Background

3.  The relevant background matters, taken largely from §§5 to 11 of the Judgment, may be stated as follows.

“5. Zhang is a resident of Shanghai. She has a share in a business there called Shanghai Kingstone Investment Management Co Ltd [“Shanghai Kingstone”], which was established in 2009. That company provides financial consultation services in the Mainland in the course of which it may recommend the purchase of financial products to its clients and for which it will be paid, inter alia, marketing fees by the product sellers.

6. Shum was a broker with Taifook Lexton Wealth Management Ltd.  Zhang got to know Shum in the course of her work.  In about April 2011, Zhang expanded her business to Shenzhen.  As a result, Zhang, Shum and Li (a friend of Zhang) established Shenzhen Kingstone Investment Management Co Ltd [“Shenzhen Kingstone”], owning respectively 30%, 30% and 40% of its shares.  Zhang and Shum developed a close personal relationship.”

4.  We pause here to mention that Zhang had co-operated with Shum when she was a broker in unit-linked insurance, which, we were given to understand, is a kind of financial product.  A part of the premium paid would be used to provide insurance cover to the policy holder, while the remaining portion would be invested in funds which may consist of various equity and bond schemes.  Zhang would refer clients to Shum in return for a percentage of commission that Shum would receive from her principal.[1]

5.  It is also pertinent to note from the business proposal of Shenzhen Kingstone (深圳景淳建立計劃書) that the intended scope of its business would appear to be wider than merely dealing in insurance products and it included funds, trust products, banking products and futures contracts.

6.  Continuing with the narrative in the Judgment:

“7. In 2012, Zhang and Shum agreed to set up a joint venture business in Hong Kong, which resulted in the incorporation of the Company on 28 December 2012 with a paid up share capital of HK$1M (million). According to the annual return of the Company made up to the end of 2015, prior to 26 June 2015, the shares of the Company were held by Zhang (47.5%), Shum (47.5%) and VP Ltd (a corporate vehicle of one Mr Pang) (5%). Shum’s shares in the Company were transferred to Kingstone Financial Group Ltd (her corporate vehicle) on 26 June 2015. That shareholding structure has remained unchanged. Shum is the sole director of the Company.

8. In March 2013, the Company obtained an insurance broker licence which entitled it to sell insurance products to its clients.

9. Kingstone Advisors was incorporated in Hong Kong on 21 August 2014 with a paid up share capital of HK$5M. The shares in that company were initially held by Shum (60%) and Poon (40%). Shum’s shares were subsequently transferred to Kingstone Financial Group Ltd on 26 June 2015. There has been no other change in the shareholding of Kingstone Advisors.

10. In August 2015, Kingstone Advisors obtained 3 licences (Licences) from the Securities and Futures Commission (SFC) to carry on Type 1, 4 and 9 regulated activities, ie, dealing in securities, advising on securities and asset management. Shum and Poon are the responsible officers under the Licences.

11. Poon joined the Company in around February 2015 as an associate director.  According to Zhang, her relationship with Shum broke down in around July 2015.”

7.  One further matter should be noted.  The registered office of Kingstone Advisors is the same as that of Kingstone Wealth.

Zhang’s case

8.  In summary, Zhang’s case is that contrary to the mutual understanding that she and Shum would have equal power to manage Kingstone Wealth, she was shut out by Shum from management.  Her primary complaint is that Shum and Poon wrongfully caused Kingstone Advisors (whose name in Chinese and English is very similar to Kingstone Wealth and whose registered office is the same), to apply for and obtain the Licences and to carry on a new line of business in securities, in breach of the “no conflict rule” which applied to Shum and Poon as fiduciaries of Kingstone Wealth.  This is the duty of a fiduciary not to place himself in a position where his interests would or may conflict with those of the beneficiary.

9.  As Shum is the sole director of Kingstone Wealth, no proceedings have been brought by the Company on Zhang’s complaints.

The relevant law

10.  For leave to be granted to commence a statutory derivative action, the material requirements for present purpose are: (1) on the face of the application, it appears to be in the interest of the company that leave should be granted; and (2) there is a serious question to be tried and that the company has not itself brought the proceedings.

11.  There is no dispute about the law on the correct approach regarding the exercise of discretion to grant leave.  This has been covered in a number of cases, including an earlier decision of the judge mentioned in the Judgment, namely, Hao Xioying v Green Valley Investment Ltd, HCMP 1394/2015, 10 August 2016, which quoted from relevant passages of the decision of Ng J in Re Primlak (HK) Ltd [2016] 2 HKLRD 31 and Ng J in turn drew on various decisions of judges at first instance[2].  The relevant legal propositions have been summarised by the judge in Green Valley Investment Ltd at §§10 and 11:

“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[3]. See Re Primlaks (HK) Ltd, §9.

11. As regard the interest of the company:

(a) Again, the threshold 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 Primlaks (HK) Ltd, §21.

(b) If a “serious question to be tried” has been demonstrated, in most cases it will follow that it is prima facie in the interest of the company that proceedings are pursued. See Re Primlaks (HK) Ltd, §§20-21.

(c) In assessing whether it appears to be in the interest of the company that the derivative action be pursued, the court ought to take into account whether any practical benefit is likely to result, even in circumstances where it may be clear that, eg, a director has breached his duties to the company.  This essentially involves assessing whether it appears that the company stands to gain in money or money’s worth in light of the costs which will have to be incurred.  See Swansson v RA Pratt Properties Pty Ltd (2002) 42 ACSR 313 at [56] to [60][4] per Palmer J; Pang Yong Hock v PKS Contracts Services Pte Ltd [2005] 2 LRC 72 at [21] per Tay Yong Kwang J (giving the judgment of the Singaporean Court of Appeal).”

12.  The court would usually consider the serious question requirement first, because if this requirement is not satisfied, it would be difficult to see how it could be in the company’s interest to bring a derivative action.  This was the approach adopted by the judge.

13.  On the law relating to the “no conflict rule”, it does not appear from the submissions on both sides that there is any serious dispute.  What is in dispute is the application of the law to the facts.  The relevant legal principles as taken from the submissions may be stated as follows:

(1) In examining whether a fiduciary was in breach of the “no conflict rule”, the question is whether a reasonable man looking at the relevant facts would think there to be a “real sensible possibility of conflict” (Phipps v Boardman [1967] 2 AC 46 at 124B to C, per Lord Upjohn; Poon Ka Man Jason v Cheng Wai Tao (2016) 19 HKCFAR 144 at §74, per Spigelman NPJ).

(2) “The boundary of fiduciary duty is variously expressed in the authorities “the company has no concern” or “no interest” in the impugned conduct (Bell v Lever Brothers Ltd [1932] AC 161 at 194); “the fiduciary has no duties to perform in respect thereof” Boardman v Phipps [1967] 2 AC 46 at 130; “wholly without the scope of the firm’s business” Aas v Benham [1891] 2 Ch 244 at 256 (Lindley LJ); the company was “not in the business” Canberra Residential Developments Pty v Brendas (2010) 188 FCR 140 at [38].” (Poon Ka Man Jason v Cheng Wai Tao at §77, per Spigelman NPJ).

(3) Subject to the next proposition in (4), in business opportunity cases, whether the company could, would or might have taken up the opportunity itself or whether it is within or outside the scope of business of the company is not of relevance.  The point is that the existence of the opportunity is relevant for the company to know and of which the director has a duty to inform it.  The director’s duty is one of undivided loyalty and it is not for him to make his own decision that the company will not be interested and to proceed, without more, to appropriate the opportunity for himself (Re Allied Business & Financial Consultants Ltd[5] [2009] BCC 822 at §§69 to 70; Waddington Ltd v Chan Chun Hoo Thomas & Anr, CACV 10/2014, 20 May 2016 at §§69 to 70).

(4) The facts and circumstances of a particular case may be such as to circumscribe the scope of the company’s business and hence modify the fiduciary duties of a director in applying the “no conflict rule”, as long as the modification of the subject matter to which the fiduciary duties apply is binding in the corporate context (see the discussion in Poon Ka Man Jason v Cheng Wai Tao at §§83 to 87, qualifying Re Allied Business & Financial Consultants Ltd).

(5) The onus of establishing that there is agreement or acquiescence to restrict the scope of the company’s business in a particular way thereby modifying the fiduciary duties is on the fiduciary.  The fact that other directors or shareholders may not have had any basis for an expectation that the company would take up a new line of business is not the same as acquiescing or agreeing to a restriction of the scope of business (Poon Ka Man Jason v Cheng Wai Tao at §§89 and 125).

Serious question requirement

14.  The judge held that Zhang has not made out a serious issue to be tried because he found the evidence compelling: the Company has never been in a position to meet the minimum requirements set by the SFC for the grant of the Licences; Zhang and Shum had not expressly agreed that Kingstone Wealth should apply for the Licences; there was no discussion of increasing the share capital to meet the requirements for obtaining the Licences, nor the hiring of qualified staff (not until Poon was hired) to act as a responsible officer.  The judge took the view that Zhang’s evidence is vague and nebulous, it “does not answer the fragility in her case”, and her allegations “do not sit well with common/business sense or the undisputed facts, and are contrary to the weight of the contemporaneous documents”.  He concluded that this is not in truth a case of a fiduciary stealing the opportunity of his employer.  The issue is the scope of the business “as agreed” between Zhang and Shum.  And since the business conducted under the Licences was not part of the scope of the business of Kingstone Wealth as agreed, there was no breach of the “no conflict rule”.

15.  Mr Bernard Man, SC, who appeared for Zhang on appeal[6], submitted that the judge was wrong to conclude there is no serious issue to be tried (which is a low threshold) that there was a real sensible possibility of conflict, and, in so doing, had effectively conducted a mini-trial on affidavit evidence.

16.  Mr Derek Hu, who appeared for the 2^nd to 4^th defendants on appeal and below, submitted that what the judge did was merely to consider correctly the evidence before him, testing the allegations of the plaintiff in the light of objective facts and contemporaneous documents as part of his analysis.  The court cannot just accept affidavit evidence at face value, nor does it act as a rubber stamp in an application for leave to bring a statutory derivative action.

17.  In considering whether a serious issue to be tried has been made out for present purpose, the court is not obliged to accept whatever evidence the plaintiff chooses to place before it without any critical thinking.  There is no problem with the judge testing Zhang’s allegations against undisputed facts and contemporaneous documents.  The problem with his approach is three-fold.

18.  First, the judge erroneously approached the case on the narrow basis whether the business undertaken by Kingstone Advisors fell within the original scope of business of Kingstone Wealth as agreed between Zhang and Shum, in effect treating the agreement on the original scope of business as an agreement to restrict the scope of business of Kingstone Wealth without any possibility of expansion.  Second, the evidence is not all one way, as Mr Hu had contended.  Third, in light of the evidence which suggest the contrary, as pointed out by Mr Man, one is driven to think that the judge could not have applied the correct test, namely, that the threshold is relatively low, that one has to bear in mind the prospects of the company’s success are investigated only to a limited extent, and that the court should be slow to find against the applicant unless his prospects are so slim that the company cannot be said to have any expectation of success.

19.  The words of Megarry V-C in Mothercare Ltd v Robson Books Ltd [1979] FSR 466 at 474 quoted by Harris J in Re Li Chung Shing Tong (Holdings) Ltd at §33 bear special mention:

“… 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’.”

20.  Mr Hu emphasised these matters in the evidence which found favour with the judge: prior to the formation of Kingstone Wealth, the co‑operation between Zhang and Shum was limited to insurance products; the business of Kingstone Wealth has always been solely in insurance; Kingstone Wealth has never met the minimum requirements of the SFC to obtain the Licences; there had never been any discussion to increase the issued share capital of Kingstone Wealth to meet the SFC requirements or to hire qualified staff to be a responsible officer; there is no contemporaneous document to substantiate Zhang’s assertion if she had been told about the share capital requirement, she would have used her financial means to prepare sufficient capital for this purpose; despite Zhang’s knowledge that the Licences were obtained by Kingstone Advisors, she made no complaint when the parties had fallen out; the value of the Licences was not included in the valuation of Kingstone Wealth in the buy-out negotiation of the parties; the natural inference from all the above must be that there was never any agreement for Kingstone Wealth to obtain the Licences and the agreed scope of business of Kingstone Wealth was limited to insurance products.  Hence, there could not be any “real sensible possibility of conflict” to engage the “no conflict rule”.

21.  Mr Man argued to the contrary.  He submitted that on a proper assessment of the available evidence, there is plainly a serious issue to be tried that there was a “real sensible possibility of conflict”, or that it cannot possibly be said that Kingstone Wealth could have “no concern” or “no interest” in obtaining the Licences and carrying on a business thereunder.  He pointed to the following matters:

(1) The background and experience of Zhang and Shum are significant.  Prior to the establishment of Kingstone Wealth, Zhang was carrying on business via Shanghai Kingstone, which not only dealt in insurance products but also financial products and provided consultation services relating thereto.  Shum worked as a broker in Taifook Lexton, and this entity dealt in and advised on all sorts of financial products.  The unit-linked insurance in which Zhang and Shum co-operated on was in essence a financial product.

(2) The scope of business of Shenzhen Kingstone, which Zhang and Shum set up prior to Kingstone Wealth, was not restricted to insurance products and clearly covered financial products.

(3) The name of Kingstone Wealth chosen for the Company was not restricted to dealing in insurance products.  It could be extended to cover financial products.  Shum and Poon chose to adopt the Kingstone name for Kingstone Advisors to obtain the Licences and operate its business.  This would suggest they had apparently regarded Kingstone Advisors as being in a line of business similar to the existing Kingstone entities.

(4) Kingstone Advisors conducted its business from the premises rented by Kingstone Wealth, for which Shum and Poon were plainly in breach of the “no self-dealing rule”.

(5) Zhang had, on behalf of Kingstone Wealth, explored with a fund manager, Han Po Ching, the possibility of co-operation on setting up a private equity fund whereby customers would be sourced to invest in the fund and Han would act as the fund manager to manage the fund.  This demonstrated that Kingstone Wealth could have gone into the business of financial products.  After Shum took over the negotiation, Han became the Chief Investment Officer of the fund, named Alphasmart China Strategic Fund SP, to which Kingstone Advisors acted as the financial advisor.

(6) Zhang’s evidence was that Shum had all along asked her to prepare sufficient capital for the purpose of applying for the Licences but Shum had never requested the increase of share capital and Zhang had no idea about the mandatory requirement of the amount of paid-up or liquid capital imposed by the SFC.  In disbelieving this evidence, the judge failed to consider the degree of trust Zhang had reposed in Shum at the material times.  Zhang’s trust could be seen from the fact that she did not question Shum’s arrangement of making Shum’s mother and later Shum the sole director in Kingstone Wealth.

(7) Zhang’s evidence that she would have no difficulty of injecting the necessary capital into Kingstone Wealth was not contradicted.  She was able to increase the share capital of Shanghai Kingstone from RMB 2.2 million in 2012 to RMB 5 million in 2015.

(8) There were work charts showing that there was a plan for Kingstone Wealth to provide consultation services which would have required a Type 4 licence from the SFC.  And there was a record of “WeChat” exchange in which Zhang enquired about what licence was held by Kingstone Wealth.  The judge took the view whilst these contemporaneous documents “lend some support to Zhang’s case”, “they are by no means unequivocal”, thereby erroneously setting the standard too high.

(9) The alleged lack of complaint about the Licences and the omission to include the Licenses in the valuation of Kingstone Wealth in the buy-out negotiation are factual disputes which should not be resolved in the present proceedings but in the trial proper.  It would appear from Zhang’s email to Shum dated 4 August 2015 there was in fact complaint about the Licences, contrary to Mr Hu’s submission.  The judge’s remark that Zhang’s complaints were “mainly directed at a trademark issue” may not be a fair reading of the exchanges between the parties, as it would appear from some of the documents that it was Shum who had repeatedly raised the trademark issue and Zhang was responding thereto. The fact that Zhang had specifically mentioned in the email dated 16 July 2015 the valuation did not include the Licences might serve to demonstrate that the Licences were not of no concern to her.  Further, Zhang was unable to address these matters in evidence, as they were raised only in argument before the judge.

22.  We agree with Mr Man that insofar as the case against Shum is concerned, the decision of the judge is so plainly wrong that it must have been reached by a faulty assessment of the weights of the different factors which have to be taken into account (Tai Fook Futures Limited v Cheung Moon Hoi Jeff, CACV 103/2005, §15).  Looking at the available evidence that the parties have drawn to our attention, it could not be said there is no serious issue to be tried that there was an agreement Kingstone Wealth would only deal in insurance products and nothing else, or that it could never have engaged in the line of business of Kingstone Advisors, so as to modify the fiduciary duties of the director in applying the “no conflict rule”.  To the contrary, there is plainly a serious issue to be tried that there was a “real sensible possibility of conflict” of Shum and Poon in causing Kingstone Advisors, instead of Kingstone Wealth, to apply for and obtain the Licences and carry on a business thereunder.

23.  For the case against Poon, the judge refused leave having taken the view that there is no merit in the claim against him as he joined Kingstone Wealth “well after the establishment of Kingstone Advisors” and it was not suggested that “Poon knew about the agreement between Zhang and Shum”.

24.  Poon joined Kingstone Wealth as an associate director in February 2015.  The Licences were obtained in August 2015.  He and Shum are the responsible officers of Kingstone Advisors under the Licences.  He is a director and shareholder of Kingstone Advisors since its incorporation in August 2014, holding 40% of the shares.  It is alleged that he was the right-hand man of Shum, assisting her in the day-to-day management of Kingstone Wealth.  Mr Man submitted that by using the Kingstone name and office address of Kingstone Wealth to incorporate Kingstone Advisors and operating its businesses under the Licences, there is at least a serious issue to be tried that Poon should have known that the scope of business of Kingstone Wealth had not been restricted to dealing in insurance products.  We agree.

25.  The judge did not appear to have considered Kingstone Advisors separately.  We agree with Mr Man that liability on the part of Shum and Poon would also give rise to at least serious issues to be tried against Kingstone Advisors, to which knowledge of Shum and Poon is attributable, and which retains the benefit from the breaches of Shum and Poon (Employment Covenants and Confidential Information (3^rd ed, 2009) by Brearley and Bloch, §§4.170 to 4.172).

Interest of the company requirement

26.  The judge recognised that if a serious issue to be tried is demonstrated, in most cases it would follow that it is prima facie in the interest of the company to bring proceedings to recover its loss and damage.  He would have regard to the practical benefit to the Company in bringing proceedings.  If he had found there is a serious issue to be tried, he would “although not without reluctance” have been satisfied that it is in the interest of the Company to bring derivative action against the 2^nd to 4^th defendants.

27.  There is no respondent’s notice seeking to argue that the judge was in error in so deciding.

28.  We will deal with Mr Hu’s arguments briefly for completeness.

29.  Mr Hu repeated his submissions before the judge that the Company is unable to fund this litigation, the costs of which he estimated to be in the region of $1.5 million.  Shum has exhibited what was described as the Company’s financial records “for management purposes only” as at 31 July 2016, showing an available bank balance of under $300,000.  He contended that the costs of the litigation would outweigh any potential benefit to be gained.  Litigation would be harmful to the reputation of the Company and may put in jeopardy the commitment of its key personnel, being Shum and Poon, to work for the Company.

30.  It is not necessary to form a view on the financial resources of the Company on the scanty information placed before the court.  The court can make an order allowing an applicant to bring a statutory derivative action if he is prepared to bear the costs in the first instance and if the proceedings prove successful he may then be granted an indemnity.  The judge apparently had this in mind when he indicated that had he granted leave, he would have deferred the decision on whether Zhang’s costs in bringing the derivative action should be indemnified by the Company.  This being the case, the ability of the Company to bear the costs of the litigation is not directly relevant to whether or not it is in its interests to grant leave, it is relevant to the terms on which leave is granted (Re Li Chung Shing Tong (Holdings) Ltd, §42).

31.  It is well established that the threshold for the interest of the company requirement is low.  There is nothing on the evidence to suggest that the potential wrongdoers are not worth suing.  We do not think it is demonstrated on the available evidence that the costs of the litigation would outweigh any potential benefit to be gained.  The fact remains there is a serious issue to be tried on the case advanced by Zhang.  At this stage, the court is not required to make an assessment of the strength of the defences that may be advanced by the putative defendants.  It is prima facie in the interest of the Company that the wrong done to it should be redressed.  We agree with the judge that the interest of the company requirement is satisfied.

Conclusion and orders

32.  For the above reasons, we have allowed the appeal and set aside the judgment and the costs order below.  We have substituted this with an order granting leave to Zhang to bring a derivative action on behalf of Kingstone Wealth against Shum, Poon and Kingstone Advisors upon terms that Zhang is to bear the costs of bringing such proceedings in the first instance, and that her application for an indemnity of her costs by Kingstone Wealth is adjourned sine die with liberty to restore.

33.  For the costs below, the costs of issuing the originating summons and the affirmation in support were necessarily incurred by Zhang in making this application, for which she may seek to be indemnified by Kingstone Wealth, and the other defendants should not be liable for those costs.  The remaining costs of Zhang are attributable to the opposition of the application by Shum, Poon and Kingstone Advisors, which turned out to be unsuccessful.  There is no reason why costs should not follow the event.  We decline to grant a certificate for two counsel for the hearing below.

34.  The order we made is that apart from the costs of making the application, which are reserved to the court dealing with Zhang’s application for an indemnity of her costs by Kingstone Wealth, Zhang’s costs in the proceedings below would be borne jointly and severally by Shum, Poon and Kingstone Advisors, to be paid forthwith.

35.  The costs of the appeal should follow the event. We have made an order that Zhang’s costs on appeal be paid by Shum, Poon and Kingstone Advisors, jointly and severally, with a certificate for two counsel.