CHONG KAI MAN v. FU MAN HUNG, WILLIAM

HCA 357/2017

IN THE HIGH COURT OF THE

HONG KONG SPECIAL ADMINISTRATIVE REGION

COURT OF FIRST INSTANCE

ACTION NO.357 OF 2017

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REASONS FOR DECISION

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1.  The central question before me is whether the sum of HK$1.5 million (“the Fund”) deposited for the investment of a 3D Smart Phone Prototype Project (“the Project”) was subject to a Quistclose trust in favour of the plaintiff.

2.  There is no dispute that if there was a Quistclose trust, the defendant, who received the Fund, has a duty to account to the plaintiff the movements of the Fund.  An order for an account is the relief essentially sought by the plaintiff at this hearing.  Although the Summons contained other matters including striking out the defence and determination of questions of law summarily, these other matters were abandoned by the plaintiff shortly before this hearing.

QUISTCLOSE TRUST

3.  A Quistclose trust[1] commonly arises in situation where a loan is advanced to a borrower for a specific purpose and the borrower is not free to apply the money to any other purpose.  This gives rise to a fiduciary obligation on the borrower which a court of equity will enforce.  (Twinsectra Ltd v Yardly [2002] 2 AC 164 at 184C).  The lender acquires a right enforceable in equity when the money is advanced.  This right is to see that the money is applied for the stated purpose, or to prevent its application for any other purpose.  (Twinsectra at 184E)

4.  A Quistclose trust is not limited to money paid under a loan.  It can arise in other types of money transaction where the hallmarks of Quistclose trust exist.  In Typhoon 8 Research Ltd v Seapower Resources International Ltd [2002] 2 HKLRD 660, the court of appeal held that a Quistclose trust arises where a deposit was paid under a lease over a specific purpose and the landlord covenanted to hold the same throughout the currency of the lease, to deduct therefrom for specific purposes only and subject thereto, to refund the deposit to the tenant.

5.  Mere payment for a particular purpose will not give rise to a Quistclose trust. The parties shall have intended that the money is not at the free disposal of the recipient.  An arrangement that the money shall be used exclusively for the stated purpose is a restraint on the recipient’s freedom to dispose of the money.  (Twinsectra at 185 E-H; Typhoon 8 Research Ltd at §18)

6.  Where a Quistclose trust arises, the money remains the property of the lender (or payer) unless and until it is applied in accordance with his directions and insofar as it is not so applied, must be returned to him.  (Twinsectra at 187G; Typhoon 8 Research Ltd at §19)

THE FUND

7.  The Fund was paid pursuant to an agreement dated 4 August 2015 (“the Agreement”), under which the plaintiff together with 2 other investors, Madam Tam and Mr Lo, agreed to inject HK$1.5 million for the investment in the Project.  The Project was originally developed by the defendant with a PRC company.  The defendant told the plaintiff, Madam Tam and Mr Lo that he has injected a sum of HK$1 million into the Project.  The total investment required was said to be HK$3 million.

8.  The relevant terms of the Agreement are as follows:-

(1)   Clause 1 :  “in consideration of Lo, [P] and Tam jointly invest a total sum of $1.5 million into the [Project], [D] agrees to transfer and/or cause to be transfer (sic) [the Project] into a company to be formed by the parties (“the Company”) …”

(2)   Clause 3 :  “The said sum of $1.5 million referred to in Clause 1 above shall be injected by Lo, [P] and Tam into the [Project] as follows:-

(a) $1 million thereof – by [P] on or before 5.8.2015; and

(b) $0.5 million thereof – by Tam on or before 7.8.2015.”

(3)   Clause 5:     “Upon execution of this Agreement, [D] shall disclose all information (inclusive of documents) relating to the [Project] to Lo, [P] and Tam and as well as to the Company such information include, inter alia, the monetary investment of [D] into the same.”

9.  On 5 August 2015, the following day after the Agreement was signed, the plaintiff deposited HK$1 million and Madam Tam deposited HK$500,000, both into the defendant’s personal bank account for the specific purpose as set out in Clause 1 of the Agreement.

10.  The plaintiff said that he and the Company formed pursuant to Clause 1 of the Agreement have demanded the defendant to provide information and documents relating to the monetary investment into the Project.  Resolutions of the Company have been passed in November 2016 requiring the defendant to disclose the information and documents about the Fund.  However, the defendant has failed to do so.

11.  The defendant said that insofar as the monetary investment is concerned, he has already provided to the plaintiff in November 2016 (1) a statement dated 7 August 2015 made by the PRC Company, Shanghai Yu Hang stating that its company bank account can only accept payments from companies within the Mainland and such payments must be made in Renminbi instead of other currencies; (2) a receipt (“Receipt”) issued by Shanghai Yu Hang dated 10 August 2015 acknowledging receipt of RMB 2.4 million being service fee under a contract between Shanghai Yu Hang and the defendant’s company, Fototech.  The defendant has also written a number of emails to the plaintiff and the other investors updating them the status of the Project.

12.  The defendant said that because of the restriction in Shanghai Yu Hang’s bank account, he has transferred HK$2 million (including the Fund) to Shanghai Yu Hang in an unofficial way through a personal friend of him, whose company in the Mainland acted as a remittance agent.

13.  The plaintiff and Madam Tam were not satisfied with the answers of the defendant.  Madam Tam assigned her right in the sum of HK$500,000 to the plaintiff, whom commenced this action to require the defendant to give an account.

14.  At the hearing, counsel for the plaintiff confirmed that the scope of order to be sought is limited to an account, with documentary support, showing the movements of the Fund with identification of transferors and transferees for the period between the time when the Fund was deposited into the defendant’s personal bank account and the time when it was transferred to the defendant’s personal friend.

15.  The plaintiff relied on two grounds initially, namely (1) the duty of the defendant to account under the Quistclose trust; and (2) the duty of the defendant to provide information under Clause 5 of the Agreement.  At the hearing, counsel for the plaintiff confirmed that he did not rely on Clause 5 of the Agreement and no serious oral submission has been made in this regard.  I therefore focus on the issue of Quistclose trust.

THE DEFENDANT’S OBJECTION

16.  Counsel for the defendant argued that it is a pre-requisite of a Quistclose trust that the identified purpose has failed. He argued that no Quistclose trust arose in the present situation because the Fund has been applied for the agreed purpose.  I have clarified with counsel for the defendant who confirmed that his argument was not that the duty was discharged as a result of the Fund having been applied to the agreed purpose, he maintained that a Quistclose trust has never arisen because of no failure of purpose.

17.  Counsel for the defendant relied on extracts in two textbooks.

18.  Firstly, The Law of Trust, by Thomas and Hudson, second edition at §26.69:-

“A Quistclose trust arises in a situation in which L lends money to B, a borrower, subject to a condition that B will use that money only for a specified purpose. In the event that the loan moneys are used for some other purpose in breach of that condition, equity deems a trust to have been created over the loan moneys in favour of L. L’s rights under the trust will defeat the rights of any third person to whom B may have transferred those moneys in breach of that condition. This trust is considered in most of the cases as being a form of automatic resulting trust such that the equitable title in the loan moneys passes back automatically on resulting trust to L as soon as those moneys are misapplied. ...” (emphasis added)

19.  Counsel for the defendant relied on the sentence highlighted in bold above.  It is of note that no authorities were cited by the learned authors in support of the highlighted sentence.

20.  Secondly, The Principles of Equity & Trusts, by Graham Virgo, second edition, pages 289 and 290 where the learned author identified “Failure of purpose” as one of the headings under “The Requirements of a Quistclose Trust”.  The paragraph under the heading “Failure of purpose” is as follows:-

“In many cases, it will be clear that the identified purpose has failed, but this may sometimes require more careful analysis. For example, in Re EVTR, the claimant deposited £60,000 for the sole purpose of enabling the company to buy equipment. The money was used to buy equipment, but, before that equipment was delivered, the company went into receivership and the purchase was terminated. A large part of the purchase price was repaid to the company. It was held that, although the equipment had been purchased, the purpose had ultimately failed because the equipment had not been delivered, and so the money that had been repaid was held on trust for the claimant.”

21.  The discussion under the above paragraph does not support the defendant’s contention that a Quistclose trust would only arise when there is a failure of the specified purpose.  The point referred to by the learned author is that the question of whether a trust exists usually arises in the context after the specified purpose has failed.  The example given in the above paragraph relates to the question whether after the failure of purpose, the money belonged to the recipient beneficiary or subject to the trust. 

22.  The contention that a Quistclose trust only arises after the failure of the specified purpose is in direct contravention with the clear and undisputed proposition enunciated by Lord Millet in Twinsectra that the money held under a Quistclose trust remains the property of the lender (or payer) unless and until it is applied in accordance with his directions and insofar as it is not so applied, must be returned to him.  It does not premise on any kind of new trust that came into being after the purpose has failed.

23.  Lord Millet[2]’s explanation in Twinsectra at 192H to 193C is clear and instructive:-

“100. … The lender pays the money to the borrower by way of loan, but he does not part with the entire beneficial interest in the money, and in so far as he does not it is held on a resulting trust for the lender from the outset. Contrary to the opinion of the Court of Appeal, it is the borrower who has a very limited use of the money, being obliged to apply it for the stated purpose or return it. He has no beneficial interest in the money, which remains throughout in the lender subject only to the borrower’s power or duty to apply the money in accordance with the lender’s instructions. When the purpose fails, the money is returnable to the lender, not under some new trust in his favour which only comes into being on the failure of the purpose, but because the resulting trust in his favour is no longer subject to any power on the part of the borrower to make use of the money. Whether the borrower is obliged to apply the money for the stated purpose or merely at liberty to do so, and whether the lender can countermand the borrower’s mandate while it is still capable of being carried out, must depend on the circumstances of the particular case.” (emphasis added)

“102. Like all resulting trusts, the trust in favour of the lender arises when the lender parts with the money on terms which do not exhaust the beneficial interest. It is not a contingent reversionary or future interest. It does not suddenly come into being like an 18^th century use only when the stated purpose fails. It is a default trust which fills the gap when some part of the beneficial interest is undisposed of and prevents it from being ‘in suspense’.” (emphasis added)

24.  Failure of purpose is, thus, not a pre-requisite for the creation of a Quistclose trust.

25.  The undisputed facts in the present case are that the Fund was injected for a specified purpose, the defendant was a mere conduit for payment and was not free to dispose of any part of the Fund other than for the specified purpose. I find that a Quistclose trust arose when the plaintiff and Madam Tam transferred the Fund to the defendant’s bank account pursuant to the Agreement for the specified purpose of investment in the Project.

AN ORDER FOR ACCOUNT

26.  The defendant submitted that the plaintiff should be satisfied with the Receipt which confirmed that the Fund was injected for the stated purpose.  The plaintiff is not entitled to ask how the Fund was transferred. This submission, in my view, has not given sufficient regard to the nature and basis of an order for account.

27.  Lord Millet has held in Libertarian Investments Ltd v Hall (2013) 16 HKCFAR 681 that:-

“167. It is often said that the primary remedy for breach of trust or fiduciary duty is an order for an account, but this is an abbreviated and potentially misleading statement of the true position. In the first place an account is not a remedy for wrong. Trustees and most fiduciaries are accounting parties, and their beneficiaries or principals do not have to prove that there has been a breach of trust or fiduciary duty in order to obtain an order for account. Once the trust or fiduciary relationship is established or conceded the beneficiary or principal is entitled to an account as of right. Although like all equitable remedies an order for an account is discretionary, in making the order the court is not granting a remedy for wrong but enforcing performance of an obligation.

168. In the second place an order for an account does not in itself provide the plaintiff with a remedy; it is merely the first step in a process which enables him to identify and quantify any deficit in the trust fund and seek the appropriate means by which it may be made good. Once the plaintiff has been provided with an account he can falsify and surcharge it. If the account discloses an unauthorised disbursement the plaintiff may falsify it, that is to say ask for the disbursement to be disallowed. This will produce a deficit which the defendant must make good, either in specie or in money. Where the defendant is ordered to make good the deficit by the payment of money, the award is sometimes described as the payment of equitable compensation; but it is not compensation for loss but restitutionary or restorative. The amount of the award is measured by the objective value of the property lost determined at the date when the account is taken and with the full benefit of hindsight.

169. But the plaintiff is not bound to ask for the disbursement to be disallowed. He is entitled to ask for an inquiry to discover what the defendant did with the trust money which he misappropriated and whether he dissipated it or invested it, and if he invested it whether he did so at a profit or a loss. If he dissipated it or invested it at a loss, the plaintiff will naturally have the disbursement disallowed and disclaim any interest in the property in which it was invested by treating it as bought with the defendant’s own money. If, however, the defendant invested the money at a profit, the plaintiff is not bound to ask for the disbursement to be disallowed. He can treat it as an authorised disbursement, treat the property in which it has been invested as acquired with trust money, and follow or trace the property and demand that it or its traceable proceeds be restored to the trust in specie.” (emphasis added)

28.  The order for an account is an equitable relief and is discretionary.  The plaintiff suggested that there is a reasonable suspicion on where the Fund has gone because the Receipt was dated after the prescribed period for payment to Shanghai Yu Hang.  I do not need to decide on this point.  On the evidence of the defendant, the Fund was in the defendant’s control for a short period of time. It is in respect of this short period of time that the plaintiff requires an account from the defendant.

29.  I am satisfied that the information sought (which is limited to movement from the time when the Fund was deposited into the defendant’s account to the time when the same was transferred to the defendant’s personal friend) is not oppressive, and should be within the power of the defendant.

DISPOSITION

30.  I have therefore made an order for account at the hearing with costs to the plaintiff and summarily assessed.