SHIH HUA INVESTMENT CO., LTD v. ZHANG AIDONG AND OTHERS

HCA 2682/2016

IN THE HIGH COURT OF THE

HONG KONG SPECIAL ADMINISTRATIVE REGION

COURT OF FIRST INSTANCE

ACTION NO. 2682 OF 2016

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DECISION

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Introduction

1.  On the return day of the plaintiff’s summons (“the Summons”) after obtaining an ex-parte order (“the Order”) made by Lok J on 25 October 2016, both the plaintiff on the one part and the 1^st, 3^rd and 4^th defendants (collectively “the relevant defendants”) on the other part made interlocutory applications though in principle they agree on the usual directions to be given for the substantive hearing of the Summons.

2.  The plaintiff applies for an order for payment in and a disclosure order in aid of the Order. The relevant defendants ask for fortification of the undertaking as to damages given by the plaintiff under the Order.

Brief background facts

3.  I shall give a brief account of the background facts leading to these applications.

4.  The plaintiff brought this derivative action on behalf of the 6^th defendant (“the Company”) as its 50% shareholder against all the defendants. The 4^th defendant is the other 50% shareholder of the Company. Both the 4^th and 5^th defendants were incorporated in the BVI and are controlled by the 1^st defendant. The 1^st defendant is a PRC resident and he and the plaintiff are the only directors of the Company.

5.  The 2^nd defendant was the deputy general manager of the Company. The 3^rd defendant is a locally incorporated company with a Chinese trade name confusingly similar to that of the Company and is controlled by the 1^st defendant. The 1^st defendant is its sole director.  

6.  The major business of the Company is in the trade of liquefied petroleum fuel (“the Product”) and it involves back-to-back trading with its purchase of fully refrigerated propane from its suppliers and sub-sale of the same to its customers. For its trade purpose, the Company signed a few long-term contracts with its suppliers and customers approved by the plaintiff. It was a hugely profitable business having a niche market. However, the relevant defendants now allege that it is insolvent.

7.  Since mid 2014, the plaintiff has been prevented from being involved in the affairs of the Company and since May 2016, he has been totally excluded. 

8.  Owing to such exclusion, among other complaints, the plaintiff presented a petition against the 1^st defendant (“the Petition”), the 4^th defendant and the Company for a buy-out order or alternatively an order that the Company be wound up on just and equitable grounds.

9.  I should add that in the course of the Petition proceedings (HCCW198/2016), the 1^st defendant disclosed that in August 2016, termination notices had been given to Oriental Energy Co Ltd (“Oriental”) and Bohua Petroleum Co, Limited (“Bohua”) to terminate their respective long-term sales contracts. The plaintiff says that these termination notices were issued without its knowledge and detrimental to the commercial interest of the Company.

10.  In the case of Oriental, the Company had one 3-year sales contract and one 6-year sales contract whereas Bohua had one 10-year sales contract with the Company. The plaintiff challenges the authenticity and validity of these termination notices.

11.  The plaintiff’s suspicions about the 1^st defendant’s conduct prompted him to commission RSM Corporate Advisory (Hong Kong) Limited (“RSM”), a firm of forensic accountants, to conduct investigation into the affairs of the Company. There are four major areas of suspected wrongful activities.

12.  First, there were suspicious transactions whereby the business of the Company was seemingly diverted to the 3^rd and 5^th defendants. Second, there are four documents of the Company bearing a forged chop of the Company. They consisted of 2 shareholders’ resolution, 1 board resolution and the 2014 Audited Accounts of the Company dated 16 September 2015. Third, there was misappropriation of the funds of the Company in its HSBC account. Fourth, there were unauthorized loans to the 4^th defendant as its shareholder.   

13.  In its report dated 6 September 2016, RSM concluded that the first and second suspicions are reasonably established whereas the other two require further review and investigation pending more access to the records of the Company.

14.  In regard to the first suspicion, the RSM report highlighted the gravity of the wrongdoings of the 1^st and 2^nd defendants. They caused the Company to cancel a series of scheduled cargoes from its long-term suppliers such as Targa Liquids Marketing and Trade LLC and Shell International Eastern Trading Company (“Shell”) in June to August 2016 when they were ready to be delivered to its long-term customers including Oriental and Bohua. It was found that at the end the contractual interests and/or receivables of the Company were diverted to either the 3^rd defendant or the 5^th defendant on the strength of a guarantee letter signed by the Company and an addendum signed by the 3^rd defendant on behalf of the Company. In effect, the 3^rd defendant and the 5^th defendant replaced the Company to fulfill the supply obligations of the Company under the long-term sales contracts with Oriental and Bohua. RSM concluded that this may have caused millions of US dollars loss to the Company and such loss may continue.  For present purposes, I need not go into further detail of the alleged breaches of the fiduciary duties of the 1^st defendant.

15.  The plaintiff relies on the RSM report in both the Petition proceedings and the present action, which was commenced on 16 October 2016.

16.  In the Statement of Claim, the plaintiff, among other things, seeks a declaration that each of the 3^rd defendant and the 5^th defendant holds proceeds of their sale of the Product to Oriental and Bohua as constructive trustee for the Company on the ground of knowing receipt and an order against each of them for taking of an account and making of all necessary inquiries.

17.  It should be noted that the plaintiff’s allegation is that for the January and May 2016 diversion to the 3^rd defendant and the 5^th defendant, the Product supplied by them to Oriental in the stead of Company was actually purchased by the Company from Shell. It is however unknown whether the 3^rd and the 5^th defendants ever paid consideration to the Company for the Product they sold to Oriental due to the lack of records.

18.  The triggering event leading to the ex-parte application is that the plaintiff had recently received information that the 3^rd defendant or another company associated with the 1^st and 2^nd defendants would soon make deliveries of a total of 91,252.47 MT of the Product to Bohua in two batches and the 1^st and 2^nd defendants had already purchased such product from 3 suppliers to complete the transactions.

19.  The plaintiff contends, as accepted at the ex-parte hearing, that there is a serious question to be tried as to whether as a result of the alleged breach of their fiduciary duties by the 1^st and 2^nd defendants, there has been a wrongful diversion of the Company’s rights and interests under its long-term contracts with Oriental and Bohua to companies associated with or controlled by the 1^st defendant and/or the 2^nd defendant such as the 3^rd and 5^th defendants, Everglory Macau and Decen.

20.  The injunctive part of the Order (“the Injunction”) provides that all the defendants except the Company shall be until trial or further order restrained from in any way disposing of, dealing with or diminishing the value of any proceeds of sale unpaid or yet to be paid by the Company’s customers (collectively “the Funds”) including Bohua and Oriental in respect of the supply of the Product supplied by the 3^rd defendant, the 5^th defendant, Everglory (Macau) International Co., Limited (“Everglory Macau”) or Decen International Limited (“Decen”). The 1^st defendant is one of the directors and shareholders of Everglory Macau whereas the 2^nd defendant’s wife owns Decen.  

21.  It should be noted that the Funds are confined to the receivables not yet paid and to be paid by the Company’s customers.

The plaintiff’s applications

22.  By the Summons, the plaintiff applies firstly an order that the Funds be paid into court. It further seeks a disclosure order to compel the defendants to disclose to the plaintiff in writing at once when any of the Funds shall become payable, giving the value and corresponding cargo information (including the price and quantity of the Product being delivered, the location of the delivery and the relevant contract in question) in respect of such amount.

Payment in order

23.  Mr Chua SC, together with Mr Chan appearing for the plaintiff[1], argues that payment into court the Funds is just, appropriate and necessary for three reasons. First, he points out that the Order was applied for and granted ex parte by reason of secrecy. Second, he submits that cash has been acquired by the defendants as a result of their alleged wrongdoings. Third, it is inappropriate to permit the defendants to retain control of any sale proceeds in light of the plaintiff’s good arguable case against them and the serious risk of dissipation of the Funds.

24.  Both Mr Chua and Mr Joffe, appearing for the relevant defendants together with Mr Ho, refer to this court the guiding principles relating to the making of orders for the delivery up of chattels laid down by the English Court of Appeal in C.B.S. United Kingdom Ltd. v Lambert [1983] 1 Ch.37 (C.A.). They are not controversial. Of particular relevance to this application is the requirement that there should be clear evidence that the defendant is likely, unless restrained by order, to dispose of or otherwise deal with his chattels in order to deprive the plaintiff the fruits of any judgment he may obtain.

25.  This requirement poses a difficult hurdle for the plaintiff in the present application. At the ex-parte hearing, the plaintiff did not apply for an order for payment in. Now, the Order is already in place to restrain the defendants to deal with or dispose of the Funds. There is no new evidence to suggest that notwithstanding the Order, the Funds are likely to be dissipated by any of the defendants already enjoined. In the circumstances, I do not find it just and convenient to order a delivery up of the Fund at this stage. I refuse to accede to this application.

26.  That being my conclusion, I need only deal with the major arguments of Mr Joffe briefly. First, he also argues that a delivery up order would cause additional hardship to the relevant defendants since the Funds frozen are actually required for satisfaction of the genuine needs of the relevant defendants. I cannot agree with him given the clear effect of the Order.

27.  Mr Joffe further argues that there is insufficient evidence to link the 1^st defendant with some other entities receiving the Funds from the Company’s customers. Some of them such as Everglory Macau and Decen are not even party to these proceedings.

28.  I note that in the affirmation of the 1^st defendant just filed (“D1’s Affirmation”), he does not conceal his ties with the 3^rd defendant and Everglory Macau with his disclosure of their trade information.

29.  As regards the 5^th defendant, in D1’s Affirmation, the 1^st defendant does not expressly deny any association. On the other hand, the plaintiff asks this court to draw the inference of the association between the 1^st defendant and the 5^th defendant by reason of the inexplicable diversion of business from the former to the latter. Nothing has been heard from the 5^th defendant though I am aware that service on the 5^th defendant was only effected by DHL Express at its BVI address after 26 October 2016.[2]

30.  In regard to Everglory Macau and Decen, and indeed any other unnamed companies with which the 1^st and/or 2^nd defendants are associated, they are not yet joined as parties in these proceedings but the plaintiff seeks to enjoin them from dealing with or disposing of the Funds by the Order by reason of the plaintiff’s allegation that they are constructive trustees. I accept the submission of Mr Joffe that this is an unsatisfactory aspect of the Order.

31.  Another valid point made by Mr Joffe is that the plaintiff is asking too much to have the entire amount of the Funds to be paid into court. I have doubt too as to whether the entire amount without deduction of any costs incurred in the course of generating these incomes could be the subject matter of the constructive trust even if all the allegations of the plaintiff are accepted.

Disclosure order

32.  Now I turn to the plaintiff’s application for a disclosure order. Mr Chua makes this application on the basis that the defendants (except the 6^th defendant) are sued as constructive trustees and the Funds in equity belong to the Company. He submits that the disclosure order sought is both necessary and ancillary to the Injunction so as to ensure and/or enhance its effectiveness.

33.  It is imperative for me to first identify the nature of the Injunction and then to consider whether the disclosure order sought is appropriate. On the first issue, the following passage in Snell’s Equity (23^rd Ed., 2015) at §26-006 is apposite:

“If the principal is to have a claim under a constructive trust, the fiduciary must have received a specific fund of property that is identifiable as the profit arising from his breach. Otherwise, the principal is limited to a personal claim for the monetary value of the fiduciary’s profit. Once the principal has established that the specific fund is held for him on a constructive trust, he may also enforce proprietary claims to its traceable proceeds.

The constructive trust may attach to two kinds of profit. It may derive from the fiduciary’s unauthorized dealings with a fund of property that was previously treated as the principal’s equitable property. Alternatively, the constructive trust may attach to a fund of property that the fiduciary received from a third party, and for which he was liable to account to the principal by specifically delivering it up to him.”

34.  The Injunction is hence proprietary in nature and is not an ordinary Mareva injunction. Mr Chua draws my attention to the following oft-cited dictum of Templeman L.J. quoted by Ackner L.J. in Bekhor Ltd v Bilton [1981] 1 QB 923 (CA) at 937H-939A:

“A court of equity has never hesitated to use the strongest powers to protect and preserve a trust fund in interlocutory proceedings on the basis, if the trust fund disappears by the time the action comes to trial, equity we will have been invoked in vain.”

35.  I would I accept that it is an established principle that a court should not be slow to protect a trust property, especially when there is credible evidence that the defendant is untrustworthy and dishonest. However, I am not convinced that the disclosure order sought is really necessary and ancillary to the Injunction.

36.  In the first place, the Funds are clearly defined in the Injunction. They are to be paid by the Company’s customers to fulfill their payment obligations under their respective sales contracts placed with the defendants or their associated companies. Even without the disclosure now demanded by the plaintiff, there should be no difficulties in identifying all such sale proceeds in due course.  

37.  Nor should there be any difficulties in locating the Funds in light of the Injunction. They are the receivables of the defendants which the defendants cannot deal with or dispose of in view of the Injunction. In the absence of any evidence of their imminent breach of the Injunction, even bearing in mind the alleged dishonesty of the 1^st defendant and the 2^nd defendant, I do not find it necessary to order disclosure at this stage.

38.  Furthermore, the information now sought to be disclosed by the plaintiff can hardly be said to be ancillary to the Injunction. First, it is irrelevant as to when the Funds are to be paid to the defendants. In any event, they must remain intact under the Injunction. As regards cargo information and the terms of the sale contracts entered into between the Company’s customers and the defendants, I fail to see how such information is necessary to ensure the effectiveness of the Injunction and to preserve the Funds at all. On the other hand, the plaintiff may obtain such information by proper means in due course in these proceedings.

39.  I am then driven to the conclusion that I should not exercise my discretion to order disclosure as applied for by the plaintiff at this stage.

The relevant defendants’ application for fortification

40.  In the Order, the plaintiff gives the usual undertaking as to damages, as volunteered in its supporting affirmation. The relevant defendants now rely on D1’s Affirmation to apply for fortification of the plaintiff’s undertaking.

41.  Mr Joffe helpfully refers to the following passage in Gee’s Commercial Injunctions (6^th Edn., 2016) at§11-027 for the governing principles:

“Whether fortification of a cross-undertaking is appropriate, and if so for how much, is a matter of discretion for the court. As a general proposition, the enjoined party must show a good arguable case in support of its application for fortification, and does not have to prove the need for fortification on a balance of probabilities. This involves taking into account:

(i) an intelligent estimate, being informed and realistic although not necessarily entirely scientific, of the likely amount of any loss which might be suffered by the applicant for fortification by reason of making the interim order;

(ii) that the applicant has shown a sufficient level of risk of loss to require fortification, which involves showing good at arguable case to that effect; and

(iii) that the making of the interim order is or was a cause without which the relevant loss would not be or would not have been suffered.

All three items involve proof of some risk that loss will be suffered as a result of the injunction. Assertion of risk is insufficient, there must be some real evidence, which objectively establishes that risk.

... The court may consider it appropriate not to require fortification when arguably the claimant is unable to provide security by reason of the very conduct of which complaint is made in the proceedings and in respect of which he has a good arguable case for redress.” (emphasis supplied)

42.  Mr Chua underscores the highlighted part of the passage to this court.

43.  With these principles in mind, I examine D1’s Affirmation. On the issue of loss and hardship caused or likely to be caused by the Injunction, he claims that the trade activities of the 3^rd defendant and Everglory Macau will be seriously hampered if the Funds are frozen. He asserts that they have to paid US$10 million to US$20 million for each transaction to purchase the Product from their suppliers. If they are restrained from using the Funds, they would lack sufficient working capital to carry on their trade in the Product.

44.  Moreover, the 1^st defendant alleges to have received calls from the bankers of the 3^rd defendant and Everglory Macau whom were notified by the plaintiff of the Order. They told the 1^st defendant that the credit rating and the existing credit facilities of the 3^rd defendant and Everglory Macau would be adversely affected. Hence, the 1^st defendant concludes that the Order has a devastating effect on the business of the 3^rd defendant and Everglory Macau.

45.  With regard to the inability of the plaintiff to honour its undertaking, the 1^st defendant points out that the plaintiff is a foreign company and its only asset within the jurisdiction is its shares in the Company.  Now that the Company is insolvent, the plaintiff can have no valuable asset in Hong Kong to honour its undertaking.

46.  The plaintiff is also said to be heavily in debt and the Company has presented a winding up petition in the BVI against the plaintiff.

47.  Mr Chua submits that as a matter of fairness, the plaintiff should be allowed to put in an affirmation to deal with the allegations in D1’s Affirmation and so the fortification application should be adjourned for full argument.

48.  I agree with Mr Chua but I do not think there should be a separate hearing to determine the fortification application. There are already many interlocutory applications in the Petition proceedings to be resolved between the parties. I am minded to direct that the fortification application to be disposed of together with the remaining part of the Summons. 

49.  Mr Joffe agrees to this course but he nevertheless presses for an order for fortification for the interim period in view of the dire financial consequences flowing from the Injunction.

50.  On the available evidence, I am unable to accept the relevant defendants’ application for interim fortification. I am not impressed with the evidence of the 1^st defendant, which in my view consists of mere assertions not supported by solid evidence. 

51.  There is no credible evidence as to how much working capital that the 3^rd defendant and Everglory Macau presently have. The 1^st defendant does not disclose the quantum of the Funds as well. I am not satisfied on the evidence that they are unable to carry on their trade without the Funds. In addition, the bankers’ alleged advice is not supported by independent evidence and lacks cogency. I cannot be satisfied that the relevant defendants have shown a sufficient level of risk of real loss to order interim fortification.

52.  I therefore refuse to order fortification in the interim. The plaintiff should have 14 days from the date hereof to file and serve its affirmation in opposition to the relevant defendants’ fortification application and the relevant defendants should within 14 days thereafter file and serve their evidence in reply, if any. There shall be no further affirmation without leave and the fortification application is to be determined together with the Summons and the relevant defendants’ application to discharge the Order if it is made.

Conclusion

53.  To sum up, I dismiss the plaintiff’s applications for an order for payment into court and a disclosure order. I further dismiss the relevant defendants’ application for interim fortification of the undertaking.

54.  I am minded to take a broad-brush approach to deal with the costs of these three applications. Since neither parties succeeds in their application(s) and the time spent in the plaintiff’s applications and the relevant defendants’ application was more or less the same, I believe that the fairest order is that there be no order as to costs.  I shall make an order nisi to this effect.

55.  Lastly, I thank counsel on both sides for their helpful assistance.