MSR CAPITAL LTD v. KTH RECOVERY FUND II LTD AND OTHERS

cacv 404/2004

in the high court of the

hong kong special administrative region

court of appeal

civil appeal no. 404 of 2004

(on appeal from HCA NO. 2381 of 2004)

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REASONS FOR JUDGMENT

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Hon Rogers VP:

1.  I agree with the reasons for judgment of Le Pichon JA. 

Hon Le Pichon JA:

2.  This is an appeal from the order dated 23 December 2004 made by Deputy High Court Judge Carlson whereby the 5^th and/or 6^th defendant (“the custodians”) were ordered to make the payments set out in schedule 1 to the order from an account (the Sub-Fund Account) held by them as custodians for and on behalf of the 4^th defendant.  The Ironwood defendants appealed the order made.  The appeal was allowed with costs.  Written reasons were to be handed down later which we now do.

3.  Two groups of the defendants, namely, KTH Recovery Fund Ltd, KTH Capital Management Ltd and KTH Capital Ltd, being the 1^st, 3^rd and 4^th defendants (respectively “D1”, “D3” and “D4” and collectively “the KTH defendants”) and Ironwood Capital Ltd, KTH Investments Ltd and Chinese Enterprises Investments Development Ltd (respectively “Ironwood”, “D7” and “D8” and collectively “the Ironwood defendants”) made rival claims to the ownership of the Sub-Fund Account.  As a result, the custodians caused an interpleader summons to be issued. 

4.  The order appealed from was made on the application of the KTH defendants.  D4 was established as a collective investment vehicle with its share capital divided into (a) voting ordinary shares and (b) non-voting redeemable preference shares.  Whilst all the issued ordinary shares were held by D3, the redeemable preference shares were available for subscription by investors.  At all material times, Mr Wang Du (“Mr Wang”) and his wife Vivian Ding Li (“Ms Li”) were the directors of D3.  The KTH defendants claim that the monies in the account represent subscription monies paid by investors subscribing for an issue of redeemable preference shares in D4 pursuant to a Private Placement Memorandum.   The payments set out in schedule 1 to the summons were said to be fees and expenses including fees and expenses of directors and legal advisers authorised by the memorandum.  It was said that D8 was but one of the investors who had subscribed for shares pursuant to the memorandum and as shareholder had no legal equitable interest whatsoever in the property of the company.

5.  The Ironwood defendants claim to be beneficially entitled to the monies in the Sub-Fund Account.  These entities are owned and controlled by Mr Luo Xianping (“Mr Luo”).  Since 2000, D3 has acted as asset manager for Ironwood and, as such, had opened and maintained a bank account (“the Ironwood account”) with the custodians which D3 operated.  Since that date, Ironwood has entrusted D3 with over HK$192 million.  In 2001, Ironwood decided to invest in certain “non-performing loans” in the PRC held by a company called “China One”.  D3 was to implement the transaction.  Ironwood was to acquire what came to be known as Pool 1C assets and a consortium of which D7 was a member was to acquire the Non-Pool 1C assets. 

6.  It is the case of the Ironwood defendants that at the end of 2002, Mr Wang represented to Mr Luo that the entire balance was payable on closing on 12 March 2003 and as Ironwood and D7 did not have sufficient cash, Mr Wang recommended that other investors be invited to participate in D7’s investments in the Non-Pool 1C assets.  Mr Luo reluctantly agreed to the suggestion albeit upon certain conditions which it is necessary to go into for present purposes.  The effect of the agreement was the dilution of the shareholding of the Ironwood defendants in China One.  D3 therefore caused D4 to issue the memorandum for investors to subscribe to “Fund II” which is the Sub-Fund Account.  Mr Luo also accepted Mr Wang’s suggestion that Ironwood should hold its investment in Fund II through a separate company and did so through D8.  D8 is thus shown as one of the subscribers to Fund II.  Mr Luo was informed by Mr Wang that US$9.64 million had been raised including approximately US$4.8 million from Ironwood.  Although it is claimed that there are 6 other investors in Fund II, the Ironwood defendants contend that they are not genuine investors and that all the monies used for the subscription belonged to Ironwood.

7.  The Ironwood defendants maintain that they are entitled to rescind the agreement to subscribe for the shares in Fund II because it was said that the representation was untrue and fraudulently made in that the balance of 75% was not in fact payable on closing but over a period of three years thereafter.  The “agreement” in question is described by Mr Luo in paragraph 51 of his affidavit dated 14 January 2005:

“51.  As Mr. Wang was involved throughout the negotiation as well as in the drafting of legal documentation in relation to the Huarong Transaction, he was and must have been fully aware of the fact that the Representation was completely untrue.  It was made fraudulently by Mr. Wang who had no reason to believe that it was true, and it was made in order to induce me to agree to convert [D7’s] 100% direct investment in the Non-Pool 1C assets and therefore the Shares into a diluted investment (i.e. 49.8%) through [D8] subscribing to Fund II (the ‘Agreement’).”

They rescinded by the commencement of proceedings in the Cayman Islands in April 2004, alternatively, by notice given in December 2004. 

8.  The judge allowed the payments set out in schedule 1 to the summons because, first, he considered that there was enough monies in the Sub-Fund Account to meet the claim of the Ironwood defendants (which he thought was limited to approximately US$4.8 million) as well as the payments sought.  Second, he accepted the submissions of the KTH defendants that considerations appropriate to a mareva injunction applied and it was accordingly legitimate allow the fees and expenses to be paid out of the Sub-Fund Account.

This appeal

9.  It would appear that in reckoning what was available, the judge took into account monies in the Ironwood account which indisputably belonged to Ironwood beneficially.  The Ironwood defendants’ claim to the Sub-Fund Account is not limited to US$4.8 million.  Properly understood, one of their complaints is that they have been denied access to movements in the Ironwood account operated by D3 as fiduciary.  They know that at least US$4.8 of the Sub-Fund Account has come from the Ironwood account because of what Mr Luo had been told by Mr Wang.  In fact after evidence had been filed in this case, it emerged that at least US$5.1 million of the Sub-Fund Account came from Ironwood.  They assert that the so-called other investors were not genuine investors and that all the monies in the Sub-Fund Account have come from the Ironwood account.

10.  The payments the judge authorised to be paid out of the Sub-Fund Account to the KTH defendants amounted to US$97,826.53 and HK$470,446.  When the individual items making up schedule 1 are examined, it is evident that the bulk of the payments were in respect of the following:

(1)	management fees from 24 September 2004 to 15 December 2004 to be paid to D3;
(2)	directors’ fees to be paid to Mr Wang and Ms Li;
(3)	legal fees incurred by D3 and D4 in respect of the proceedings in the Cayman Islands; and
(4)	solicitors’ fees incurred by D3 and D4 in respect of the present litigation.

The rest which total less than US$5,000 are various fees said to be payable to the Cayman government and the custodians although no demand for payment has been received from the custodians.

11.  Insofar as management fees are concerned, it is to be noted that the custodians resigned with effect from 15 October 2004.  They have been paid management fees due under the custodian agreement up to and including the month of September 2004.  It is not suggested that the management fees referred to in schedule 1 are due to the custodians; rather, it would appear that D3 is arrogating to itself the right to management fees as if it were the custodian.  In my view, there is no evidence before the court to show that D3 is entitled to any part of the management fees sought.

12.  Insofar as the judge drew an analogy with the situation pertaining in a mareva situation, such an analogy is false.  There is a real conceptual difference between a mareva injunction and a proprietary injunction.  The Ironwood defendants are advancing a proprietary claim to the Sub-Fund Account.  The legal fees incurred by the KTH defendants relate to the dispute as to its beneficial ownership.  If the Ironwood defendants succeed in their claim, to allow the payment of the legal fees would be little short of ordering the Ironwood defendants to finance the KTH defendants’ unsuccessful defence to the Ironwood defendants’ proprietary claim.  That is wrong in principle.  In a mareva situation, the monies the dissipation of which is sought to be restrained belong to the person sought to be restrained rather than the claimant.  There is no proprietary claim involved.

13.  As regards the minor items making up schedule 1 referred to above, Mr Sussex SC who appeared for the Ironwood defendants stated that his clients had no objection to payments to the custodian upon request but no such request had been made.  As to the other fees said to be payable, his clients’ stance was that they should not have to pay for corporate matters relating to D4.  It is clear that this court is not in a position to resolve these matters.  Accordingly, the appeal was dismissed without prejudice to the KTH defendants making such application as they see fit to the court below for payment of fees and expenses properly payable on the basis that they are not payments for financing the affairs of the KTH defendants.